Knowledge that Transforms

This paper demonstrates that differences in managerial ownership data cannot explain contradictory empirical evidence on the relation between equity ownership and the entrenchment of managers. Three commonly used sources of managerial equity ownership data are described and contrasted. The Value Line Investment Survey is shown to be a relatively low-cost substitute for the data on beneficial ownership by officers and directors found in corporate proxy statements.

Proponents of state antitakeover legislation argue that previous empirical tests by financial economists of the wealth effects of Pennsylvania's 1990 antitakeover law are biased. We show that the proponents are correct. In particular, firm size, event-time clustering, and non-synchronous trading effects account for the wealth decreases reported in earlier studies. We also show, however, that both proponents and critics of the Pennsylvania legislation have ignored the earliest press release about it. The wealth effect associated with this announcement is negative, large, and statistically significant. These results therefore are consistent with the hypothesis that the Pennsylvania law decreased company values and with the hypothesis that the initial market reaction is an unbiased estimate of the law's effect on firm values.

This paper seeks to provide an explanation for why corporate officers manage the disclosure of accounting information. We show that earnings management affects firm value when value-maximizing managers and investors are asymmetrically informed. In equilibrium, the strategic management of reported earnings influences investors' assessments of the market values of companies' shares.

Previous work suggests that, when the debtor has private information on the future profitability of the firm, financial distress is costly even if debt can be renegotiated. This paper shows that adverse selection problems can be completely avoided by offering creditors a mix of cash and equity in the renegotiation. Empirical evidence indicates that this is common practice in corporate debt workouts. However, asymmetric information leads to inefficiencies if equity is not treated as the residual claim in bankruptcy. In this case, equilibria exist in which distressed firms go to court too often.

We estimate continuous-time event-history models of the acquisition of conglomerate vs. non-conglomerate and predatory vs. friendly acquisitions among the 1962 Fortune 500 between January, 1963, and December, 1968. Our analysis of predatory acquisitions reveals that there were strong disciplinary motivations for these acquisitions in the 1960s. Q ratios were, by a large margin, the most important determinant of predatory acquisition likelihood. Surprisingly, however, corporate boards appear to have provided little alternative to predatory acquisition as a monitoring mechanism during this period. Friendly acquisitions, on the other hand, were concentrated among firms with low price-earnings ratios and high return on equity, suggestive of the earnings manipulation story often associated with conglomerate acquisitions. Our analysis of conglomerate acquisitions reveals that there were strong disciplinary motivations for conglomerate acquisitions during this period. Conglomerate targets had low Q ratios and were as likely as non-conglomerate targets to be acquired in a predatory fashion. We find no evidence that conglomerate acquisitions were motivated by a desire to improve earnings-per-share numbers, as some have maintained. In addition, regardless of type or tenor, we find managerial ownership, firm size, and industrial organization motivations for acquisition are consistently important determinants of acquisition likelihood.

This article hypothesizes that the level of managerial ownership affects both the informativeness of earnings and the magnitude of discretionary accounting accrual adjustments. The hypothesis draws on the theory of the firm, and exploits: (1) separation of ownership from control of economic decisions, (2) the extent and consequences of accounting-based contractual constraints, and (3) managers' incentives in selecting and applying accounting techniques. Results show managerial ownership is positively associated with earnings' explanatory power for returns and inversely related to the magnitude of accounting accrual adjustments. Moreover, ownership is less important for regulated corporations, suggesting regulation monitors managers' accounting choices.

This paper evaluates the effects of allowing auditors to limit their liability by incorporating. Using a model that integrates the audit market with the market for the firms being audited, it predicts that, once incorporation becomes an option, the least wealthy employed auditors under unlimited liability either exit the audit market or earn lower profits from auditing than before. The most wealthy employed auditors earn higher profits; they incorporate and remove wealth from their corporations. The model also explains the recent shift in auditors' attitudes toward incorporation, and why insurance and other wealth-sheltering devices imperfectly substitute for incorporation.

Prior studies document an insignificant effect of unrealized gains/losses (URGL) and a negative effect of realized gains/losses (SGL) on bank stock returns. We argue that these results may reflect the omission of changes in value of other net assets resulting from interest rate changes. We find that after controlling for effects of other (on-balance sheet) net assets, both URGL and SGL have significant positive effects on bank returns in normal periods. But the SGL effect is significantly lower in periods of low capital and earnings. These findings are relevant to the market value accounting debate.

A theoretical and empirical analysis of within-job and promotion-based incentives for middle managers is presented, using personnel data from a firm. Within-job incentives are stronger than implied by previous studies. Evidence is provided that promotions sort employees by ability, and also generate incentives. Promotions are associated with large increases in lifetime earnings, as long as performance is sustained in the future. There is little evidence that the firm trades off within-job and promotion-based incentives as predicted. Instead, it appears to use a simple incentive scheme, resulting in declining incentives for those passed over for promotion.