Knowledge that Transforms

Abstract We present a possible explanation for the lack of permanence of the very high levels of concentration of ownership that accompany leveraged buyouts. We first argue that some diffusion of ownership can be beneficial to the shareholders of a firm by encouraging the employees of the firm to enter into implicit contracts with the firm. The level of concentration of ownership that maximizes firm value is therefore that which trades off the well-known gains from monitoring with the gains from implicit contracting. We then argue that, in the process of concentrating the ownership of a firm that has excessively diffuse ownership to a level that maximizes firm value, investors in leveraged buyouts will choose an initial level of concentration of ownership that is very high. They will do so in order to put pressure on managers to breach existing implicit contracts. Following the breach of these contracts, investors will decrease the level of concentration of ownership to the level that maximizes firm value. There will be no further breach of implicit contracts, for such breach is incidental to the transformation of the firm from one that has excessively diffuse ownership to one that has the optimal level of diffusion of ownership. No change in the concentration of ownership therefore occurs once the level of diffusion of ownership that maximizes firm value has been attained. JEL Classification: G30.

Abstract This paper examines why firms choose to spend resources on acquiring ownership rights in other firms. Based on a unique data base of every individual intercorporate shareholding on the Oslo Stock Exchange during the period 1980–1994, we find that such investments serve at least three functions. First, they play a role incorporate governance, as managers in firms with low insider holdings, diffuse ownership structure and high free cash flow tend to mutually acquire equity stakes in each other, possibly in a collective attempt to protect their human capital in the market for corporate control. Second, interfirm equity holdings serve as financial slack for growing firms, reducing potential adverse selection costs by providing an internal funding source for new investments in long-term assets. Finally, our findings also suggest that intercorporate shareholdings are an integrated part of the investor’s cash flow management system by being a liquidity buffer when cash inflows and cash outflows are non-synchronous.

Abstract To create value and reduce agency costs, firms adopt available organizational structures that match their attributes. This paper studies the characteristics of firms that choose to become master limited partnerships (MLPs). The MLP sample is dominated by firms in low-growth industries that have highly focused operations and superior profitability compared to their industry peers. After becoming an MLP, sample firms reduce capital expenditures and increase cash distributions, taking advantage of their focus, profitability, and status as non-taxable entities. A subsample of MLPs subsequently change back to corporate form. After becoming corporations, these firms reverse course by cutting cash distributions and increasing capital spending. This cycle demonstrates how firms restructure to adopt organizational forms that best fit their needs.

As argued by Jensen (1993), the primary tasks of a firm’s board of directors are to advise, hire, fire and determine the level and form of managerial compensation. Managerial pay can be structured as part cash and in part be tied to a performance index, such as corporate earnings or the firm’s stock price. The latter effectively aligns the interest of managers with those of stockholders, which in turn reduces agency problems related to free cash flow, managerial time horizons and effort levels. At the same time, stock-based compensation increases managerial exposure to non-diversifiable risk, which may cause risk-averse managers to underinvest in risky projects. The trade-off between the benefits of managerial incentive alignment and the cost of underinvestment is largely an empirical issue, and the widespread observation that managerial compensation is primarily paid in cash 1 suggests that managerial risk aversion weighs heavily or that boards generally resort to substitute monitoring mechanisms. The paper by Angbazo and Narayanan (1997) is part of a rapidly growing empirical literature attempting to identify important cross-sectional determinants

Abstract In this paper we present and estimate a model of short-term interest rate volatility that encompasses both the level effect of Chan, Karolyi, Longstaff and Sanders (1992) and the conditional heteroskedasticity effect of the GARCH class of models. This flexible specification allows different effects to dominate as the level of the interest rate varies. We also investigate implications for the pricing of bond options. Our findings indicate that the inclusion of a volatility effect reduces the estimate of the level effect, and has option implications that differ significantly from the Chan, Karolyi, Longstaff and Sanders (1992) model.

As discussed in Merton (1993, Sections 5 and 6) and here in the section to follow, the effective delivery of many financial services depends critically on the credit-worthiness of the provider financial institution. Such service activities are said to be 'credit-sensitive'. The intermediary's credit standing can cause significant extemality-like effects on the various business activities of the intermediary, even when there are no interconnections among them. For example, the announcement by a U.S. investment bank that it is even thinking of entering into a new merchant-banking activity of extending bridge financing and other interim risk-taking positioning for restructuring firms can materially and negatively affect its over-the-counter derivatives-products business for corporate customers because those customers may perceive the risk of the merchant-banking involvement as jeopardizing the bank's ability to fulfill its obligations on its long-dated contractual agreements. Thus the potential merchant-banking business affects the derivative-products business although there is no overlap of personnel, customer base, location, or employee skill sets between them. The shared credit standing of the institution's individual businesses can therefore cause a significant failure ofthe principle of 'value-additivity', which complicates decentralization of the capital budgeting and financial decisions. The issue of monitoring credit quality are made more complex because those intermediaries such as banks and insurance companies that are principals to customer contractual agreements tend to be 'opaque' institutions, as defined in Ross (1989) and Merton