Knowledge that Transforms

[I report a bound on the variance of price-dividend ratios and a decomposition of their variance into terms that reflect changes in dividend growth and discount rates. The specification is not restrictive. The test statistics do not require construction of ex post present values; instead, they are restrictions on means, variances, and covariances of price-dividend ratios, dividend growth, and discount rates. I consider implications for the mean price-dividend ratio, and I evaluate whether a low mean discount rate can rationalize the mean and variance of price-dividend ratios. The results do not indicate any striking rejections of present-value models. However, the bulk of the variance of price-dividend ratios must be accounted for by changing forecasts of discount rates, and discount rates must possess some unusual characteristics.]

[I investigate the empirical importance of information revelation in the pricing of block trades. In particular, I examine whether block prices are correlated with the unexpected part of firms' quarterly earnings. For my sample of block trades, information revelation does indeed appear to be a significant factor shortly before earnings announcements.]

[Evidence is provided on an implication of models by Myers and Majluf (1984) and Miller and Rock (1985), which predict that equity issues convey information about firms' future earnings. Consistent with the prediction, the results show that earnings forecast revisions by financial analysts subsequent to the announcement of equity issues are significantly related to announcement period abnormal returns.]

[When the market can observe the profitability of all projects with equal precision, then with stock compensation (i) the weight on any given project in managerial compensation is independent of the marginal productivity of effort in the project; (ii) the projects that are the noisiest indicators of managerial effort receive the most weight in compensation; and (iii) investors have the greatest incentive to collect information about projects that are the noisiest indicators of managerial effort.]

[I analyze optimal capital and ownership structures as resulting from anticipated future control contests. I focus on leverage as a device that enables the incumbent management to extract the maximum value from the rival. I show that firm value depends on both capital and ownership structures. The analysis leads to the following predictions: (i) more efficient managers use less debt, (ii) firms facing better rivals for control issue more debt, and (iii) firms with supermajority rules issue less debt. Several predictions are consistent with known empirical regularities.]

[A testable single-beta model of asset prices is presented. If state variables have a long-run stationary joint density function, then the rate return on a very long-term default-free discount bond will be perfectly correlated with the representative investor's marginal utility of consumption. Thus, the covariance of an asset's return with the return on such a bond will be an appropriate measure of the asset's riskiness. The model can be, therefore, applied or tested even though the market portfolio or aggregate consumption may not be observable. It also is shown that the expected rate of return on a very long-term bond is equal to its variance. This proposition can be tested to determine whether state variables follow stationary processes.]

[While the theoretical relation between taxes and capital structure has been extensively analyzed, the empirical evidence on this issue has thus far been inconclusive. One of the main difficulties confronting previous empirical studies of the cross-sectional relationship between taxes and leverage was the control of intervening variables. The Tax Reform Act of 1986 (TRA), which drastically changed the tax regime, provides a unique opportunity to assess the interaction between taxes and leverage decisions in a controlled environment. We test the relationship between leverage and certain tax-related variables for a large sample of companies in the years surrounding the enactment of the TRA. The results support the tax-based theories of capital structure. The findings indicate that there exists a substitution effect between debt and nondebt tax shields, and that both corporate and personal tax rates affect leverage decisions.]

[I provide a general equilibrium theory of the term structure of real interest rates in a discrete-time economy. I derive the prices for one-period and two-period real bonds and a simple recursive formula for general k-period bonds, and prove that the price formula with appropriately specified parameters converges to that of the Cox, Ingersoll, and Ross model (1985). In addition, I consider the behavior of nominal bond prices in a partial equilibrium setting in which an exogenous price level process is correlated with the real economy. Finally, I provide an illustrative empirical investigation of the model. The results indicate a significant correlation between the price level and the growth rate of consumption, which does not support the "money neutrality" assumption underlying Cox, Ingersoll, and Ross's nominal bond prices and related empirical studies, such as Gibbons and Ramaswamy (1992), Heston (1991), and Pearson and Sun (1991).]

[It is shown that the arbitrage pricing theory holds in each infinitesimal period of a continuous trading model under the assumption that dividend payoffs are functionals of factor and idiosyncratic uncertainty. This generalizes the one-period model's result that the arbitrage pricing theory holds under the assumption that price changes in a given period satisfy a factor structure. Since instantaneous returns in a multiperiod model are endogenously determined, the theory is derived under assumptions that may be viewed as restricting more primitive characteristics of the economy than the assumptions made for the one-period model.]

[We show that the incentive for managers to build their reputations distorts firms' investment policies in favor of relatively safe projects, thereby aligning managers' interests with those of bond-holders, even though managers are hired and fired by shareholders. This effect opposes the familiar agency problem of risky debt that is imperfectly covenant-protected, wherein shareholders are tempted to favor excessively risky projects in order to expropriate bondholders. Consequently, when managerial concern for reputation results in conservatism, it can actually make shareholders better off ex ante by allowing the firm to issue more debt. We examine how the optimal choice of leverage from the shareholders' standpoint is influenced by takeover activity, and how the adoption of anti-takeover measures affects a firm's investment policy and leverage choice.]