Knowledge that Transforms

This study investigates senior management turnover in financially distressed firms. In any given year, 52% of sampled firms experience turnover if they are either in default on their debt, bankrupt, or privately restructuring their debt to avoid bankruptcy. A significant number of changes are initiated by firms' bank lenders. Following their resignation from these firms, managers are not subsequently employed by another exchange-listed firm for at least three years. Results are consistent with managers experiencing large personal costs when their firms default.

This paper investigates the determinants of security design. We consider the assignment of both cash flows and voting rights, focusing on corporate control. We postulate that a conflict of interest exists between contestants for control and outside investors. The conflict arises because private benefits of control give contestants an incentive to acquire control even when this reduces firm value. Security design is a tool for resolving these conflicts and maximizing firm value. Our main result is that a single voting security is optimal.

This study documents the organizational changes that took place at the O.M. Scott & Sons Company in response to its leveraged buyout. Our findings confirm that both the pressure of servicing a heavy debt load and management equity ownership lead to improved performance. Equally important at Scott, however, and undocumented in large-sample studies, are debt covenants restricting how the cash required for debt payments can be generated, the adoption of a strong incentive compensation plan, a reorganization and decentralization of decision making, and the relationship between managers, the leveraged buyout sponsors, and the board of directors.

This paper investigates the effect of share repurchase through transferable put rights (TPRs) on shareholder wealth and corporate control. Transferable put rights make the put option, which is implicit in a tender offer, marketable. Shareholders who do not tender their shares increase their proportional ownership of the firm and extract some of the gains of the tender offer from exiting shareholders. Finally, TPRs improve tax efficiency by ensuring that only shareholders who have the highest tax bases will tender.

Equity valuation effects of decisions by corporations to shift assets to master limited partnerships (MLPs) are examined for the period 1982–1987. Positive average abnormal returns are found for (1) total conversions of corporations to MLPs (5.89%), (2) rollouts of subsets of assets by distribution of MLP equity claims to parent-firm shareholders (6.41%), and (3) rollouts of subsets of assets by public sale of MLP equity claims (2.41%). The positive effects are consistent with tax advantages, reduction in free cash flow, and information signaling. The positive effects for rollouts of subsets of assets are also consistent with reductions in information asymmetry and improvements in asset management.

This paper investigates the hypothesis that bank loans convey information to the capital market regarding the value of the borrowing firm. Unlike previous researchers, we distinguished between new bank loans and loan renewals. For new loans, the excess stock return for borrowers around the loan announcement is not significantly different from zero. For favorable loan revisions, the excess return is significantly positive: for unfavorable revisions, it is significantly negative. We interpret these results to imply that banks play an important role as transmitters of information in capital markets, but new bank loans per se do not communicate information.

Expected returns on common stocks and long-term bonds contain a term or maturity premium that has a clear business-cycle pattern (low near peaks, high near troughs). Expected returns also contain a risk premium that is related to longer-term aspects of business conditions. The variation through time in this premium is stronger for low-grade bonds than for high-grade bonds and stronger for stocks than for bonds. The general message is that expected returns are lower when economic conditions are strong and higher when conditions are weak.

We analyze the pricing of 63 block trades between 1978 and 1982 involving at least 5% of the common stock of NYSE or Amex corporations. These blocks are typically priced at substantial premiums to the post-announcement exchange price. We argue that the premiums, which average 20%, reflect private benefits that accrue exclusively to the blockholder because of his voting power. The premiums paid by both individual and corporate block purchasers increase with firm size, fractional ownership, and firm performance. Individuals pay larger premiums for firms with greater leverage, lower stock-return variance, and large cash holdings.

For a sample of successful tender offers, we find that the shareholders of high q bidders gain significantly more than the shareholders of low q bidders. In general, the shareholders of low q targets benefit more from takeovers than the shareholders of high q targets. Typical bidders have persistently low q ratios prior to the acquisition announcement while target q ratios decline significantly over the five years before the tender offer. Our results are consistent with the view that takeovers of poorly managed targets by well-managed bidders have higher bidder, target, and total gains.