We examine differences in financial leverage between parent and spun-off firms that emerge from corporate spin-offs. Our tests control for past financing choices and the costs of adjusting capital structure, factors that can obscure cross-sectional patterns among firms' target leverage ratios. We find that firms that emerge from spin-offs with more financial leverage have a higher cash flow return on assets, lower variability of industry operating income, and a greater proportion of fixed assets. The positive relation between profitability and the use of financial leverage, in a setting that is free of pecking order effects, is particularly important because it contrasts with existing evidence. Our results indicate that the ability to cover debt payments and default-related costs are important determinants of the use of financial leverage, as implied by the trade-off theory of capital structure. We find no evidence that managerial incentives or governance characteristics affect the difference in leverage ratios in firms that emerge from spin-offs.

Although institutional investors have a preference for large capitalization stocks, over time they have shifted their preferences toward smaller, riskier securities. These changes in aggregate preferences have arisen primarily from changes in the preferences of each class of institution, rather than changes in the importance of different classes. Evidence also suggests that recent growth in institutional investment combined with this shift in preferences helps explain why markets in general, and smaller stocks in particular, have exhibited greater firm-specific risk and liquidity in recent years. Additional analyses suggest that institutional investors moved toward smaller securities because such securities offer “greener pastures.”

We develop a theory of market crashes based on differences of opinion among investors. Because of short-sales constraints, bearish investors do not initially participate in the market and their information is not revealed in prices. However, if other previously bullish investors bail out of the market, the originally bearish group may become the marginal “support buyers,” and more will be learned about their signals. Thus accumulated hidden information comes out during market declines. The model explains a variety of stylized facts about crashes and also makes a distinctive new prediction—that returns will be more negatively skewed conditional on high trading volume.

This article reviews tax research related to domestic and multinational capital structure, payout policy, compensation policy, risk management, and organizational form. For each topic, the theoretical arguments explaining how taxes can affect corporate decision making and firm value are reviewed, followed by a summary of the related empirical evidence and a discussion of unresolved issues. Tax research generally supports the hypothesis that high tax rate firms pursue policies that provide tax benefits. Many issues remain unresolved, however, including understanding whether tax effects are of first-order importance, why firms do not pursue tax benefits more aggressively, and whether corporate actions are affected by investor-level taxes.

This article provides several new insights into the economic sources of skewness. First, we document the differential pricing of individual equity options versus the market index and relate it to variations in return skewness. Second, we show how risk aversion introduces skewness in the risk-neutral density. Third, we derive laws that decompose individual return skewness into a systematic component and an idiosyncratic component. Empirical analysis of OEX options and 30 stocks demonstrates that individual risk-neutral distributions differ from that of the market index by being far less negatively skewed. This article explains the presence and evolution of risk-neutral skewness over time and in the cross section of individual stocks.

Market returns before the offer price is set affect the amount and variability of initial public offering (IPO) underpricing. Thus an important question is “What IPO procedure is best adapted for controlling underpricing in “hot” versus “cold” market conditions?” The French stock market offers a unique arena for empirical research on this topic, since three substantially different issuing mechanisms (auctions, bookbuilding, and fixed price) are used there. Using 1992–1998 data, we find that the auction mechanism is associated with less underpricing and lower variance of underpricing. We show that the auction procedure's ability to incorporate more information from recent market conditions into the IPO price is an important reason.

We analyze how two dimensions of technological progress affect competition in financial services. While better technology may result in improved information processing, it might also lead to low-cost or even free access to information through, for example, informational spillovers. In the context of credit screening, we show that better access to information decreases interest rates and the returns from screening. However, an improved ability to process information increases interest rates and bank profits. Hence predictions regarding financial claims' pricing hinge on the overall effect ascribed to technological progress. Our results generalize to other financial markets where informational asymmetries drive profitability, such as insurance and securities markets.

Reload options, call options granting new options on exercise, are popularly used in compensation. Although the compound option feature may seem complicated, there is a distribution-free dominant policy of exercising reload options whenever they are in the money. The optimal policy implies general formulas for numerical valuation. Simpler formulas for valuation and hedging follow from Black–Scholes assumptions with or without continuous dividends. Time vesting affects the optimal policy, but numerical results indicate that it is nearly optimal to exercise in the money whenever feasible. The results suggest that reload options produce similar incentives as employee stock options and share grants.

This article studies an intertemporal economy with liquidity constrained and unconstrained individuals. We use a stopping time approach to solve the finite horizonconstrained consumption portfolio problem with constant relative risk aversion and to examine the structure of equilibrium. The impact of the constraint on the optimal consumption and the financing portfolio is assessed. The equilibrium state price density is related to the exercise boundary of an American-style contingent claim with nonlinear payoff. This stopping time characterization enables us to prove the existence of an equilibrium and can be implemented numerically. Properties of equilibrium bond and stock returns are examined.