Previous research finds that fundamental macroeconomic news has little effect on stock prices. We show that after allowing for different stages of the business cycle, a stronger relationship between stock prices and news is evident. In addition to stock prices, we examine the effect of real activity news on proxies for expected cash flows and equity discount rates. We find that when the economy is strong the stock market responds negatively to news about higher real economic activity. This negative relation is caused by the larger increase in discount rates relative to expected cash flows.

[We argue that when bankruptcy code is creditor friendly, excessive liquidations cause levered firms to shun innovation, whereas by promoting continuation upon failure, a debtorfriendly code induces greater innovation. We provide empirical support for this claim by employing patents as a proxy for innovation. Using time-series changes within a country and cross-country variation in creditor rights, we confirm that a creditor-friendly code leads to a lower absolute level of innovation by firms, as well as relatively lower innovation by firms in technologically innovative industries. When creditor rights are stronger, technologically innovative industries employ relatively less leverage and grow disproportionately slower.]

We examine the extent to which a fund's cash flows are affected by the stellar performance of other funds in its family -- and consequences of such spillovers. We show that star performance results in greater cash inflow to the fund and to other funds in its family. Moreover, families with higher variation in investment strategies across funds are shown to be more likely to generate star performance. We argue that spillovers may induce lower ability families to pursue star-creating strategies. Consistent with our conjecture, families with high variation in investment strategies across funds significantly underperform low-variation families.

[This article studies an asymmetric information game with "type convergence," in which, under some realizations of a common uncertainty, inducing informed agents to reveal their types through self-selection by contract choice is either costly or impossible. Under other realizations, self-selection permits costless distinctions between informed agents. I obtain sufficient conditions under which contracting with options prior to the realization of the common uncertainty leads to the existence of a perfectly separating, costless Nash equilibrium. Applications to variable rate loan commitments and life insurance contracting are discussed.]

We show that wrongful discharge laws—laws that protect employees against unjust dismissal—spur innovation and new firm creation. Wrongful discharge laws, particularly those that prohibit employers from acting in bad faith ex post, limit employers' ability to hold up innovating employees after the innovation is successful. By reducing the possibility of holdup, these laws enhance employees' innovative efforts and encourage firms to invest in risky but potentially mould-breaking projects. We develop a model and provide supporting empirical evidence of this effect using the staggered adoption of wrongful discharge laws across U.S. states.

This article illustrates an incentive-aligning role of debt in the presence of optimal compensation contracts. Owing to information asymmetry, value-maximizing compensation contracts allow managerial rents following high investment outcomes. The manager has an incentive to increase these rents by choosing investments that generate greater information asymmetry. An aptly chosen debt level mitigates this incentive, because investments that generate greater information asymmetry have more volatile outcomes. The greater volatility would make the debt risky, causing the shareholders to focus on high outcomes and therefore compensation contracts that reduce managerial rents. At the optimum, the manager avoids opportunistic investments, and the shareholders offer value-maximizing compensation contracts. Empirically, the analysis predicts a negative relationship between leverage and market-to-book that is reversed at extreme market-to-book ratios, a negative relationship between leverage and profitability, a negative relationship between leverage and pay-for-performance, and a positive relationship between pay-for-performance and investment opportunities.

This article illustrates an incentive-aligning role of debt in the presence of optimal compensation contracts. Owing to information asymmetry, value-maximizing compensation contracts allow managerial rents following high investment outcomes. The manager has an incentive to increase these rents by choosing investments that generate greater information asymmetry. An aptly chosen debt level mitigates this incentive, because investments that generate greater information asymmetry have more volatile outcomes. The greater volatility would make the debt risky, causing the shareholders to focus on high outcomes and therefore compensation contracts that reduce managerial rents. At the optimum, the manager avoids opportunistic investments, and the shareholders offer value-maximizing compensation contracts. Empirically, the analysis predicts a negative relationship between leverage and market-to-book that is reversed at extreme market-to-book ratios, a negative relationship between leverage and profitability, a negative relationship between leverage and pay-for-performance, and a positive relationship between pay-for-performance and investment opportunities.

[We examine whether options granted to non-executive employees affect firm performance. Using new data on option programs, we explore the link between broad-based option programs, option portfolio implied incentives, and firm operating performance, utilizing an instrumental variables approach to identify causal effects. Firms whose employee option portfolios have higher implied incentives exhibit higher subsequent operating performance. Intuitively, the implied incentive-performance relation is concentrated in firms with fewer employees and in firms with higher growth opportunities. Additionally, the effect is concentrated in firms that grant options broadly to non-executive employees, consistent with theories of cooperation and mutual monitoring among co-workers.]

We examine whether options granted to non-executive employees affect firm performance. Using new data on option programs, we explore the link between broad-based option programs, option portfolio implied incentives, and firm operating performance, utilizing an instrumental variables approach to identify causal effects. Firms whose employee option portfolios have higher implied incentives exhibit higher subsequent operating performance. Intuitively, the implied incentive-performance relation is concentrated in firms with fewer employees and in firms with higher growth opportunities. Additionally, the effect is concentrated in firms that grant options broadly to non-executive employees, consistent with theories of cooperation and mutual monitoring among co-workers. 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.

[As the number of bank failures increases, the set of assets available for acquisition by surviving banks enlarges but the total liquidity available with surviving banks falls. This results in "cash-in-the-market" pricing for liquidation of banking assets. At a sufficiently large number of bank failures, and in turn, at a sufficiently low level of asset prices, there are too many banks to liquidate and inefficient users of assets who are liquidity-endowed may end up owning the liquidated assets. In order to avoid this allocation inefficiency, it may be ex-post optimal for the regulator to bail out some failed banks. We show, however, that there exists a policy that involves granting liquidity to surviving banks in the purchase of failed banks, which is equivalent to the bailout policy from an ex-post standpoint. Crucially, this liquidity provision policy gives banks incentives to differentiate, rather than to herd, makes aggregate banking crises less likely, and thereby dominates the bailout policy from an ex-ante standpoint.]