Firms initiating broad‐based employee share ownership plans often claim employee stock ownership plans (ESOPs) increase productivity by improving employee incentives. Do they? Small ESOPs comprising less than 5% of shares, granted by firms with moderate employee size, increase the economic pie, benefiting both employees and shareholders. The effects are weaker when there are too many employees to mitigate free‐riding. Although some large ESOPs increase productivity and employee compensation, the average impacts are small because they are often implemented for nonincentive purposes such as conserving cash by substituting wages with employee shares or forming a worker‐management alliance to thwart takeover bids.

Our results highlight the importance of interaction among management, labor, and investors in shaping corporate governance. We find that strong union laws protect not only workers but also underperforming managers. Weak investor protection combined with strong union laws are conducive to worker–management alliances, wherein poorly performing firms sell assets to prevent large‐scale layoffs, garnering worker support to retain management. Asset sales in weak investor protection countries lead to further deteriorating performance, whereas in strong investor protection countries they improve performance and lead to more layoffs. Strong union laws are less effective in preventing layoffs when financial leverage is high.

This paper investigates the effects of seniority rules and restrictive dividend convenants on the over‐ and under‐investment incentives associated with risky debt. We show that increasing seniority of new debt decreases the incidence of under‐investment but increases over‐investment, and vice versa. Under symmetric information, the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets (i.e., project financing). Under asymmetric information, the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project's cash flow in the same rate. If this is not possible, the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large. With regard to dividend convenants, we show that their effect depends on whether or not dividend payments are conditioned on future investments. When they are unconditioned, allowing more dividends increases the under‐investment incentive. In contrast, conditional dividends decrease the underinvestment incentive and increase the over‐investment incentive.

This paper investigates the effects of seniority rules and restrictive dividend convenants on the over- and under-investment incentives associated with risky debt. We show that increasing seniority of new debt decreases the incidence of under-investment but increases over-investment, and vice versa. Under symmetric information, the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets (i.e., project financing). Under asymmetric information, the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project's cash flow in the same rate. If this is not possible, the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large. With regard to dividend convenants, we show that their effect depends on whether or not dividend payments are conditioned on future investments. When they are unconditioned, allowing more dividends increases the under-investment incentive. In contrast, conditional dividends decrease the underinvestment incentive and increase the over-investment incentive.

This paper investigates whether merger bids have an impact on the wealth of the participating firms' bondholders and stockholders. Monthly and daily bond and stock returns are calculated relative to the announcement date of a merger bid for a sample of conglomerate mergers. The results show that while the stockholders of target firms gain from a merger bid, no other securityholders either gain or lose. To provide direct evidence on the existence of “diversification effects” and “incentive effects,” we test whether the bondholders' returns are dependent upon the correlation between the returns of the merging firms and whether the size of the bondholders' and stockholders' returns in individual mergers are correlated. The results are consistent with a capital market that efficiently resolves conflicts of interest between stockholders and bondholders.

In this paper we examine the ex-dividend day returns of several taxable and non-taxable distributions. The ex-dividend day returns for the taxable common stocks are consistent with the hypothesis that dividends are taxed more heavily than capital gains. However, the ex-dividend day returns of preferred stocks suggest that preferred dividends are taxed at a lower rate than capital gains; non-taxable stock dividends and splits are priced on ex-dividend days as if they are fully taxable; and non-taxable cash distributions are priced as if investors receive a tax rebate with them. We also find that each of these distributions exhibits abnormal return behavior for several days surrounding the ex-dividend day. We investigate several possible explanations for this anomaly, but none is capable of explaining the phenomenon.