Knowledge that Transforms

Share-price responses to 95 announcements of increased research and development (R & D) spending are significantly positive on average, even when the announcement occurs in the face of an earnings decline. High-technology firms that announce increases in R & D spending experience positive abnormal returns on average, whereas announcements by low-technology firms are associated with negative abnormal returns. Further, in our cross-sectional analyses we find that higher R & D intensity than the industry average leads to larger stock-price increases only for firms in high-technology industries.

We investigate the underlying causes and the announcement effects of plant closings. The closing in our sample do not appear related to takeover activity. Instead, they appear motivated by declining firm profitability. Firms announcing closings have lower earnings than market or industry medians; earnings typically improve slightly after the announcement. We find a negative stock-market reaction to plant-closing announcements.

Prebuyout bondholders, on average, suffer statistically significant wealth losses in leveraged buyouts. Bonds with strong covenant protection, however, gain value, while those with no protection lose value. The disposition of bonds after buyouts, e.g., remained outstanding, called, tendered, defeased, is also strongly linked to type of covenant protection. We also document that covenant use declines for bonds issued after 1980. Finally, the losses to bondholders are small compared with the gains accruing to shareholders.

I investigate changes in operating performance after 58 management buyouts of public companies completed during 1977–1986. Operating returns increase significantly from the year before to the year after buyouts as measured by operating cash flows (before interest and taxes) per employee and per dollar of operating assets. Subsequent changes in operating returns suggest that this increase is sustained. Adjustments in the management of working capital contribute to the increase in operating returns. The increase is not, however, the result of layoffs or reductions in expenditures for advertising, maintenance and repairs, research and development, or property, plant, and equipment.

We test the mean-variance efficiency of a given portfolio using a Bayesian framework. Our test is more direct than Shanken's (1987b), because we impose a prior on all the parameters of the multivariate regression model. The approach is also easily adapted to other problems. We use Monte Carlo numerical integration to accurately evaluate 90-dimensional integrals. Posterior-odds ratios are calculated for 12 industry portfolios from 1926–1987. The sensitivity of the inferences to the prior is investigated by using three different distributions. The probability that the given portfolio is mean-variance efficient is small for a range of plausible priors.

I present new evidence on the direct costs of bankruptcy and violation of priority of claims. In a sample of 37 New York and American Stock Exchange firms that filed for bankruptcy between November 1979 and December 1986, direct costs average 3.1% of the book value of debt plus the market value of equity, and priority of claims is violated in 29 cases. The breakdown in priority of claims occur primarily among the unsecured creditors and between the unsecured creditors and equity holders. Secured creditors' contracts are generally upheld.

This paper examines financial distress and its effect on organizational efficiency. Imperfect information and conflicts of interest among the firm's claimholders influence the outcome of financial distress. Methods for resolving distress and controlling conflicts of interest are discussed. New evidence on financial restructuring and distress costs is presented along with evidence on the organizational restructuring that accompanies financial distress. The evidence demonstrates that financial distress has benefits as well as costs, and that financial and ownership structure affect the net costs.

Management plays a dominant role in selecting outside directors, inviting skepticism about outsiders' ability to make independent judgments on firm performance. Our examination of wealth effects surrounding outside director appointments finds significantly positive share-price reactions. We find no clear evidence that outside directors of any particular occupation are more or less valuable than others. The results are consistent with the hypothesis that outside directors are chosen in the interest of shareholders.

Many contingent claims incorporate options on yield levels. I derive closed-form expressions for European yield-option prices using a general equilibrium model in which the underlying yield is the relevant state variable. The properties of these options differ markedly from those of conventional options on traded assets. For example, yield-call values can be less than their intrinsic value and can be decreasing functions of the underlying yield. These features have important hedging implications. I examine the empirical implications of the model using price data for the 13-week T-bill options traded on the Chicago Board Options Exchange.

This paper estimates the systematic risk of the debt in public leveraged recapitalizations. We calculate this risk as a function of the difference in systematic equity risk before and after the recapitalization. The increase in equity risk is surprisingly small after a recapitalization, ranging from 37% to 57%, depending on the estimation method. If total company risk is unchanged, the implied systematic risk of the post-recapitalization debt in twelve transactions averages 0.65. Alternatively, if the entire market-adjusted premium in the leveraged recapitalization represents a reduction in fixed costs, the implied systematic risk of this debt averages 0.40.