Knowledge that Transforms

This paper evaluates the influence of financial contracting costs on public corporations' incentives to lease fixed capital. We argue that firms facing high costs of external funds can economize on the cost of funding by leasing. We construct several measures of leasing propensity, plus some a priori indicators of the severity of financial constraints facing firms. We find that the share of total annual fixed capital costs attributable to either capital or operating leases is substantially higher at lower-rated, non-dividend-paying, cash-poor firms — those likely to face relatively high premiums for external funds.

We examine whether sample selection bias explains the difference in returns between ‘value’ stocks (high book-to-market ratios) and ‘glamour’ stocks (low book-to-market ratios). Selection bias on Compustat is not a severe problem: for CRSP primary domestic firms, the proportion missing from Compustat is not large and the average return is not very different from the Compustat sample. Mechanical problems with matching Cusip identifiers account for much of the discrepancy between CRSP and Compustat. The superior performance of value stocks is confirmed for the top quintile of NYSE-Amex stocks, using a sample free from selection bias.

We investigate the relation between liquidation costs of assets and composition of capital structure for firms that reorganized under Chapter 11 of the Bankruptcy Code. Firms with high liquidation costs emerge from Chapter 11 with relatively low debt ratios. The debt of these firms is more likely to be public and unsecured, and to have less restrictive covenant terms; these firms are also more likely to raise new equity capital. Assets with high liquidation costs thus lead firms to choose capital structures that make financial distress less likely.

We examine valuation effects on firms in the same industry as entities that are the subject of carve-outs (initial public offerings of subsidiary equity), spin-offs, and asset sell-offs. Share price reactions for rivals are negative in response to equity carve-outs. In comparison, rival stock returns are positive for spin-offs and normal for asset sell-offs, restructuring actions that do not entail a public offering of equity. Our results suggest managers conduct equity carve-outs when outside investors are likely to price the new shares higher than managers' perceived value.

The evidence reported in this paper suggests that institutional investors capture a large fraction of the short-run profits associated with IPOs. The favored status enjoyed by institutional investors in underpriced offerings appears, however, to carry a quid pro quo expectation that they will participate in less-attractive issues as well. This finding conforms with the Benveniste and Spindt (1989) and Benveniste and Wilhelm (1990) prediction that U.S. underwriters behave strategically in the allocation of IPOs.

An examination of the executive compensation structure of 153 randomly-selected manufacturing firms in 1979–1980 provides evidence supporting advocates of incentive compensation, and also suggests that the form rather than the level of compensation is what motivates managers to increase firm value. Firm performance is positively related to the percentage of equity held by managers and to the percentage of their compensation that is equity-based. Moreover, equity-based compensation is used more extensively in firms with more outside directors. Finally, firms in which a higher percentage of the shares are held by insiders or outside blockholders use less equity-based compensation.

On November 17, 1988, the board of directors of Nestlé AG decided to allow foreign investors to hold Nestlé registered stock, reversing a longstanding practice. This decision had a tremendous impact on the prices of the firm's three classes of common stock, as well as on the prices of several other corporations traded on the Zürich stock exchange. These price changes can be explained by the hypothesis that demand curves slope down.

We study the managerial labor market's ability to discriminate between good and bad managerial performance. Using a sample of failed and nonfailed Texas banks, we find that the context of job loss affects the manager's ability to regain comparable employment. Managers associated with banks that failed for reasons arguably beyond the managers' control were twice as likely to regain comparable banking posts as managers at other failed banks. We also detect a relation between the probability of post-failure reemployment and a manager's rank within the firm and to proxies for managerial self-dealing and competence.

We empirically investigate the relation between corporate value, leverage, and equity ownership. For ‘high-growth’ firms corporate value is negatively correlated with leverage, whereas for ‘low-growth’ firms corporate value is positively correlated with leverage. The results also hint that the allocation of equity ownership among insiders, institutions, blockholders, and atomistic outside shareholders is of marginally greater significance in low-growth than in high-growth firms. The overall interpretation of the results is that debt policy and equity ownership structure ‘matter’ and that the way in which they matter differs between firms with many and firms with few positive net present value projects.

In this paper I find that aggregate security returns are highly correlated with concurrent unexpected cash flows into mutual funds, but unrelated to concurrent expected flows. An unexpected inflow equal to 1% of total stock fund assets ($4.75 billion) corresponds to a 5.7% increase in the stock price index. Further, fund flows are correlated with the returns of the securities held by the funds, but not with the returns of other types of securities. I find evidence of a positive relation between flows and subsequent returns and evidence of a negative relation between returns and subsequent flows.