Knowledge that Transforms

We establish Markovian models in the Heath, Jarrow, and Morton (1992) paradigm that permit an exponential affine representation of riskless and risky bond prices while offering significant flexibility in the choice of volatility structures. Estimating models in our family is typically no more difficult than in the workhorse affine family. Besides diffusive and jump-induced default correlations, defaults can impact the credit spreads of surviving firms, allowing for a greater clustering of defaults. Numerical implementations highlight the importance of incorporating interest rate--credit spread correlations, credit spread impact factors, and the full credit spread curve when building a unified framework for pricing credit derivatives. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

The signing bonus is one of the most common elements of compensation packages for white-collar employees but has received little theoretical and empirical attention. This article investigates the use of a signing bonus as a tool for firms to signal to prospective employees: when they are uncertain regarding their fit with the firm, the signing bonus can serve as a credible signal of the firm's belief of said fit. The theory suggests that we should expect signing bonuses to be more common and larger when the economy is stronger, when employees are less certain of how well they will fit at the firm, when the quality of fit (known to the firm) is higher, and when performance pay is present. Employees receiving a signing bonus work harder, so the signing bonus also serves as an incentive device. This article also presents the first broad empirical look at the use of the signing bonus across industries and time. Evidence is consistent with the theory. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

This article examines the capital structure implications of defined benefit corporate pension plans. The magnitude of the liabilities arising from these pension plans is substantial. We show that leverage ratios for firms with pension plans are about 35% higher when pension assets and liabilities are incorporated into the capital structure. We estimate that the tax shields from pension contributions are about a third of those from interest payments. Pension contributions have a modest effect in lowering firms’ marginal corporate tax rates. Once pensions are considered, firms are less conservative in their choice of leverage than has been previously thought. We show that firms incorporate the magnitude of their pension assets and liabilities into their capital structure decisions.

This article examines the information content and consequences of third-party voting advice that arrives as news at an interim stage in corporate proxy contests. We first document significant stock returns around announcements of proxy vote recommendations. We then develop a multi-equation empirical procedure for disentangling the price impact of prediction effects (changes in contest outcome probabilities) from the price impact of certification effects (changes in outcome-contingent valuations). Both effects are present in the data: Voting advice is both predictive about contest outcomes and informative about the ability of dissidents to add value. Consequently, proxy advice plays a dual informational role.

We examine how residents of the United States allocate their stock portfolios internationally. We find that a large U.S. Foreign Direct Investment (FDI) position in a destination country in 1990 is associated with a relatively large stock portfolio position in that country in the 2001–2006 period. Moreover, a change in the U.S. FDI position from 1980 to 1990 helps predict the change in the U.S. Foreign Portfolio Investment position from 1994 to 2006. These results are rationalized by Van Nieuwerburgh and Veldkamp’s (2009) equilibrium model of learning and portfolio choice under an information processing constraint. FDI establishes marginal differences in the endowments of information about different countries, which later translate into differences in stock portfolio holdings. We control for cross-country differences in capital controls, proximity along different dimensions, corporate governance, and economic and capital market development. Our results also hold for the G6 countries collectively.

We develop a new solution method for a broad class of discrete-time dynamic portfolio choice problems. The method efficiently approximates conditional expectations of the value function by using (i) a decomposition of the state variables into a component observable by the investor and a stochastic deviation; and (ii) a Taylor expansion of the value function. We illustrate the accuracy of the method in handling several realistic features of portfolio choice problems such as intermediate consumption, multiple assets, multiple state variables, portfolio constraints, non-time-separable preferences, and nonredundant endogenous state variables. We finally use the method to solve a realistic large-scale life-cycle portfolio choice and consumption problem with predictable expected returns and recursive preferences.

Previous studies document that the stock returns of bond-issuing firms significantly underperform matched peers over the three to five years following issuance. We revisit this phenomenon and show that the underperformance is the result of an omitted return factor (a “bad model problem”). Debt issuers have significantly higher stock market liquidity than size and book-to-market matched counterparts, and differences in liquidity are largest for the worst-performing groups of issuers. When we additionally match on liquidity or when we include a liquidity factor in the model for expected returns, the evidence of underperformance disappears.

In this article, we use a large sample of transaction-level institutional trading data to analyze the role of institutional investors in initial public offerings (IPOs). The theoretical literature on IPOs has long argued that institutional investors possess private information about IPOs and that underpricing is a mechanism for compensating them to reveal this private information. We study whether institutions indeed have private information about IPOs, retain their information advantage in post-IPO trading, and are able to realize significant profits from their participation in IPOs. We also study institutional IPO allocations and allocation sales to analyze whether institutions play an important role in supporting IPOs in the aftermarket and are rewarded by underwriters for playing such a role. We find that institutions sell 70.2% of their IPO allocations in the first year, fully realize the “money left on the table,” and do not dissipate these profits in post-IPO trading. Further, institutions hold allocations in IPOs with weaker post-issue demand for a longer period, and they are rewarded for this by underwriters with more IPO allocations. Finally, institutional trading has predictive power for long-run IPO performance, especially in IPOs in which they received allocations; however, this predictive power decays over time. Overall, our results suggest that institutional investors possess significant private information about IPOs, play an important supportive role in the IPO aftermarket, and receive considerable compensation for their participation in IPOs.

We develop a structural model to investigate the effects of asymmetric beliefs and agency conflicts on dynamic principal--agent relationships. Optimism has a first-order effect on incentives, investments, and output, which could reconcile the private equity puzzle. Asymmetric beliefs cause optimal contracts to have features consistent with observed venture capital and research and development (R&D) contracts. We derive testable implications for the effects of project characteristics on contractual features. We calibrate our model to data on pharmaceutical R&D projects and show that optimism indeed significantly influences project values. Permanent and transitory components of risk have opposing effects on project values and durations. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected], Oxford University Press.

Using word content analysis, we decompose information in the initial public offering prospectus into its standard and informative components. Greater informative content, as a proxy for premarket due diligence, results in more accurate offer prices and less underpricing, because it decreases the issuing firm's reliance on bookbuilding to price the issue. The opposite is true for standard content. Greater content from high reputation underwriters and issuing firm managers, through Management's Discussion and Analysis, contribute to the informativeness of the prospectus. Our results suggest that premarket due diligence and disclosure by underwriters and issuers can serve as a substitute for costly bookbuilding. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.