Knowledge that Transforms

Execution costs, as measured by the quoted spread, the effective spread (which accounts for trades inside the quotes), the realized spread (which measures revenues of suppliers of immediacy), the Roll (1984) implied spread, and the post-trade variability, are twice as large for a sample of NASDAQ stocks as they are for a matched sample of NYSE stocks. The difference is not due to differences in adverse information, in market depth, or in the frequency of even-eighth quotes. Partial explanations are provided by differences in the treatment of limit orders and commissions in the two markets. We conclude that important explanations are the internalization and preferencing of order flow and the presence of alternative interdealer trading systems, factors that limit dealers' incentives to narrow spreads on NASDAQ.

This paper provides an explanation for the diversity in investment strategies and fees of open-end mutual funds. Mutual funds seek to dissuade redemptions through front- and back-end load fees. The empirical evidence is consistent with model predictions that such fees dissuade redemptions in open-end funds, and that funds hold more cash when there is uncertainty about redemptions. Furthermore, funds with load and redemption fees hold less cash that their no-load counterparts. The results suggest that aggressive funds are sensitive to cash flows and are likely to rely on fees to dissuade redemptions.

This paper examines the disciplining function of hostile takeovers in the U.K. in 1985 and 1986. We report evidence of high board turnover and significant levels of post-takeover restructuring. Large gains are anticipated in hostile bids as reflected in high bid premiums. However, there is little evidence of poor performance prior to bids, suggesting that the high board turnover does not derive from past managerial failure. Hostile takeovers do not therefore perform a disciplining function. Instead, rejection of bids appears to derive from opposition to post-takeover redeployment of assets and renegotiation over the terms of bids.

We study the signaling content of managers' dividend decisions for 145 NYSE firms whose annual earnings decline after nine or more consecutive years of growth. Using a variety of model specifications and definitions of favorable dividend signals, we find virtually no support for the notion that dividend decisions help identify firms with superior future earnings. Dividends tend not to be reliable signals because (i) a behavioral bias (overoptimism) leads managers to overestimate future earnings when growth prospects fade; and (ii) managers make only modest cash commitments when they increase dividends, undermining the reliability of such signals.

We report that 34% of targets of unsuccessful control contents between 1983 and 1989 experience a change in top manager within two years following the contest. Management turnover is concentrated among poorly performing firms in which outside blockholders acquire an ownership stake. These blockholders appear to facilitate post-contest asset restructurings that increase the value of the target and improve operating performance. In the absence of an outsider blockholder, managers typically retain their positions despite poor pre-contest performance and the use of value-reducing defensive tactics during the control contest. We conclude that monitoring by active outside investors facilitates valuable internal control efforts.

Stock splits should have no effect on firm value in perfect capital markets, yet stock prices increase on split announcements. The two traditional explanations are information signaling and improved liquidity for shares that trade at lower prices. We investigate these explanations by studying splits of American Depositary Receipts (ADRs) that are not associated with splits in their home-country stock, and which represent unique illustrations of the effect of liquidity. We interpret our findings as supportive of the liquidity explanation of stock split announcement effects.

We test the pecking order model of capital structure by examining the financing of firms that went public in 1983. We estimate a logit to predict external financing, and a multinomial logit to predict the type of financing using data on the IPO firms' security offerings during 1984–1992. Our results indicate that the probability of obtaining external funds is unrelated to the shortfall in internally generated funds, although firms with cash surpluses avoid external financing. Firms that access the capital markets do not follow the pecking order when choosing the type of security to offer.

This paper investigates the ability of the pecking-order model, the agency model, and the timing model to explain firms' decisions whether to issue debt or equity, the shock price reaction to their decisions and their actions afterward. We find strong support for the agency model. Firms often depart from the pecking order because of agency considerations. We fail to find support for the timing model.

Most sports teams play as either the favorite or the underdog and either at home or away. The failure to recognize the symmetric and interdependent relations between these characteristics has led previous researchers to use potentially biased methods to test for rationality and efficiency in football betting markets and thus to reach inappropriate conclusions. We develop a more general specification, which also incorporates ‘pick-em’ games and games played on neutral sites, and find little or no evidence against market efficiency in the NFL and college betting markets for regular season games. We do, however, uncover evidence of biased betting lines for Superbowls.

We develop an explanation for IPO underpricing in which the issuer's demand for ownership dispersion creates an incentive to underprice. Promoting oversubscription allows broad initial ownership, which in turn increases secondary-market liquidity. Increased liquidity reduces the required return to investors. Broad initial ownership, however, requires an increase in investor-borne information costs. These information costs are offset through initial underpricing. Empirical results are consistent with initial underpricing reflecting the level of ownership dispersion.