Knowledge that Transforms

[We propose that it is precisely because firms' repurchases of their own stock through tender offers are associated with large stock-price increases that repurchases are unattractive as a means of distributing cash. As a result, firms distribute some cash in the form of dividends--despite the tax disadvantage--and carry the rest to future periods. However, when their stock is sufficiently undervalued, firms distribute all accumulated cash through stock repurchases. We show that dividends are smoothed and are positively related both to earnings innovations and to previous period's dividends. Also, the stock-price reaction to a repurchase announcement, of a given size, is increasing in the previous period's dividends.]

[A firm must decide what security to sell to raise external capital to finance a profitable investment opportunity. There is ex ante asymmetry of information regarding the probability distribution of cash flow generated by the investment. In this setting, we derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to be an (the unique) equilibrium outcome. Using these conditions we show that the debt contract is (uniquely) optimal if and only if cash flows are ordered by (strict) conditional stochastic dominance. Finally, we derive an equivalence relationship between optimal security designs and designs that minimize mispricing.]

[I study the large premium (82 percent) attributed to voting shares on the Milan Stock Exchange. The premium varies according to the ownership structure and the concentration of the voting rights, and it can be rationalized in the presence of enormous private benefits of control. A case study seems to indicate that in Italy private benefits of control can easily be worth more than 60 percent of the value of nonvoting equity. A tentative explanation for these findings is provided.]

[This paper shows that S&P 500 stock betas are overstated and the non-S&P 500 stock betas are understated because of liquidity price effects caused by the S&P 500 trading strategies. The daily and weekly betas of stocks added to the S&P 500 index during 1985-1989 increase, on average, by 0.211 and 0.130. The difference between monthly betas of otherwise similar S&P 500 and non-S&P 500 stocks also equals 0.125 during this period. Some of these increases can be explained by the reduced nonsynchroneity of S&P 500 stock prices, but the remaining increases are explained by the price pressure or excess volatility caused by the S&P 500 trading strategies. I estimate that the price pressures account for 8.5 percent of the total variance of daily returns of a value-weighted portfolio of NYSE/AMEX stocks. The negative own autocorrelations in S&P 500 index returns and the negative cross autocorrelations between S&P 500 stock returns provide further evidence consistent with the price pressure hypothesis.]

[We show that entrepreneurs may prefer to allow insider trading even when it is not socially optimal. We examine a model in which an insider/manager allocates resources on the basis of his private information and outside information conveyed through the secondary-market price of the firm's shares. If the manager is allowed to trade, he will compete with informed outsiders, reducing the equilibrium quality of outside information. While the benefits to production of outside information are the same for society and entrepreneurs, we show that the social and private costs are different. Thus, entrepreneurs and society may disagree on the conditions under which insider trading restrictions should be imposed.]

[This article reexamines the autocorrelation patterns of short-horizon stock returns. We document empirical results which imply that these autocorrelations have been overstated in the existing literature. Based on several new insights, we provide support for a market efficiency-based explanation of the evidence. Our analysis suggests that institutional factors are the most likely source of the autocorrelation patterns.]

[We consider the multiperiod relationship between a client and a portfolio manager and the resulting problem of motivating a manager of unknown ability to acquire valuable information. We explore the contractual forms and the optimal retention policy of the client and find that the optimal initial set of contracts features a smaller performance-based fee component paid to the manager than in a first-best contract, and the contract choice elicits only partial information about the manager. As a result, ex post performance measurement is critical to future recontracting. In general, managers are retained only if the returns on their portfolio exceed the benchmark by an appropriate amount.]

[We model firms' choice between bank loans and publicly traded debt, allowing for debt renegotiation in the event of financial distress. Entrepreneurs, with private information about their probability of financial distress, borrow from banks (multiperiod players) or issue bonds to implement projects. If a firm is in financial distress, lenders devote a certain amount of resources (unobservable to entrepreneurs) to evaluate whether to liquidate the firm or to renegotiate its debt. We demonstrate that banks' desire to acquire a reputation for making the "right" renegotiation versus liquidation decision provides them an endogenous incentive to devote a larger amount of resources than bondholders toward such evaluations. In equilibrium, bank loans dominate bonds from the point of view of minimizing inefficient liquidation; however, firms with a lower probability of financial distress choose bonds over bank loans.]

[We propose alternative generalized method of moments (GMM) tests that are analytically solvable in many econometric models, yielding in particular analytical GMM tests for asset pricing models with time-varying risk premiums. We also provide simulation evidence showing that the proposed tests have good finite sample properties and that their asymptotic distribution is reliable for the sample size commonly used. We apply our tests to study the number of latent factors in the predictable variations of the returns on portfolios grouped by industries. Using data from October 1941 to September 1986 and two sets of instrumental variables, we find that the tests reject a one-factor model but not a two-factor one.]

[We test the empirical implications of several models of IPO underpricing. Consistent with the winner's-curse hypothesis, we show that in markets where investors know a priori that they do not have to compete with informed investors, IPOs are not underpriced. We also show that IPOs underwritten by reputable investment banks experience significantly less underpricing and perform significantly better in the long run. We do not find empirical support for the signaling models that try to explain why firms underprice. In fact, we find that (1) firms that underprice more return to the reissue market less frequently, and for lesser amounts, than firms that underprice less, and (2) firms that underprice less experience higher earnings and pay higher dividends, contrary to the models' predictions.]