Knowledge that Transforms

[I examine a series of stock splits in Japan in which firms restrict the ability of their investors to sell their shares for a period of approximately 2 months. By removing potential sellers from the market, the restrictions have the effect of increasing the impact of trading on prices. The greater the desire of investors to trade, and the greater the restrictions, the larger the impact of the restrictions. In the data, particularly severe restrictions are associated with returns of over 30% around the ex-date, most of which are reversed when investors are allowed to sell again. Firms are more likely to issue equity or redeem convertible debt during the restricted period, suggesting strong incentives for manipulation.]

[Do bond investors demand credit quality or liquidity? The answer is both, but at different times and for different reasons. Using data on the Euro-area government bond market, which features a unique negative correlation between credit quality and liquidity across countries, we show that the bulk of sovereign yield spreads is explained by differences in credit quality, though liquidity plays a nontrivial role, especially for low credit risk countries and during times of heightened market uncertainty. In contrast, the destination of large flows into the bond market is determined almost exclusively by liquidity. We conclude that credit quality matters for bond valuation but that, in times of market stress, investors chase liquidity, not credit quality.]

[The investment boundaries defined by Grenadier (2002) for an oligopoly investment game determine equilibria in open-loop strategies. As closed-loop strategies, they are not equilibria, because any firm by investing sooner can preempt the investments of other firms and expropriate the growth options. The perfectly competitive outcome is produced by closed-loop strategies that are mutually best responses. In this equilibrium, the option to delay investment has zero value, and the simple NPV rule is followed by all firms.]

[We present evidence on the benefits of changes in control from mergers and acquisitions. We find that the stronger the acquirer's shareholder rights relative to the target's, the higher the synergy created by an acquisition. This result supports the hypothesis that acquisitions of firms with poor corporate governance by firms with good corporate governance generate higher total gains. We also find that the synergy effect of corporate governance is shared by target shareholders and acquiring shareholders, in that both target returns and acquirer returns increase with the shareholder-rights difference between the acquirer and the target.]

[We model demand-pressure effects on option prices. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of the unhedgeable parts of the two options. Empirically, we identify aggregate positions of dealers and end-users using a unique dataset, and show that demand-pressure effects make a contribution to wellknown option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of index options, and cross-sectional tests show that demand impacts the expensiveness of single-stock options as well.]

[This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very "low powered," i. e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation that Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high marketto-book firms that have received negative productivity shocks.]

[The asset allocation of defined benefit pension plans is a setting where both risk-shifting and risk-management incentives are likely be present. Empirically, firms with poorly funded pension plans and weak credit ratings allocate a greater share of pension fund assets to safer securities such as government debt and cash, whereas firms with well-funded pension plans and strong credit ratings invest more heavily in equity. These relations hold both in pooled regressions and within firms and plans over time. The incentive to limit costly financial distress plays a considerably larger role than risk shifting in explaining variation in pension fund investment policy among firms in the United States.]

[We show that investor recognition and bonding associated with a U.S. cross-listing are distinct effects using a sample of Canadian firms. In contrast to the post-listing decline documented in the literature, we find that cross-listed firms with a single class of shares enjoy a permanent increase in valuation if they attract and maintain investor recognition over time. Valuations of firms that fail to widen their U.S. shareholder base return to prelisting levels within two years. Cross-listed firms with dual-class shares exhibit a permanent increase in valuation regardless of the level of U.S. investor holdings, consistent with firmlevel bonding]

[We take a simple q-theory model and ask how well it can explain external financing anomalies, both qualitatively and quantitatively. Our central insight is that optimal investment is an important driving force of these anomalies. The model simultaneously reproduces procyclical equity issuance waves, the negative relation between investment and average returns, long-term underperformance following equity issues, positive long-term drift following cash distributions, the mean-reverting operating performance of issuing and cashdistributing firms, and the failure of the in explaining the long-term stock-price drifts. However, the model cannot fully capture the magnitude of the positive drift following cash distributions observed in the data.]

[A new methodology is proposed to estimate theoretical prices of financial contingent claims whose values are dependent on some other underlying financial assets. In the literature, the preferred choice of estimator is usually maximum likelihood (ML). ML has strong asymptotic justification but is not necessarily the best method in finite samples. This paper proposes a simulation-based method. When it is used in connection with ML, it can improve the finite-sample performance of the ML estimator while maintaining its good asymptotic properties. The method is implemented and evaluated here in the Black-Scholes option pricing model and in the Vasicek bond and bond option pricing model. It is especially favored when the bias in ML is large due to strong persistence in the data or strong nonlinearity in pricing functions. Monte Carlo studies show that the proposed procedures achieve bias reductions over ML estimation in pricing contingent claims when ML is biased. The bias reductions are sometimes accompanied by reductions in variance. Empirical applications to U. S. Treasury bills highlight the differences between the bond prices implied by the simulation-based approach and those delivered by ML. Some consequences for the statistical testing of contingent-claim pricing models are discussed.]