Knowledge that Transforms

Previous research examining the relation between dividend yield and equity returns documents a U-shaped pattern arising from the positive CAPM-adjusted average excess return of zero-dividend firms. In contrast, this paper reports that zero-dividend firms earn negative average excess returns relative to firms of similar size. Despite the apparent conformity of these results to the predictions of after-tax asset pricing models, the negative size-adjusted excess returns cannot be drive solely by tax effects. These excess returns, which are concentrated in the initial zero-dividend years and approach - 1% per month, are attributed to possible dividend-expectation effects rather than taxes.

To economists, agency problems present challenges that can be resolved through optimal contracting or incentive mechanisms. To politicians, agency problems represent entitlements to be allocated among favored constituencies. Corporate management constitutes a powerful constituency independent of the interests of workers, local communities, and other corporate stakeholders. The political process has, for politically rational but economically dabatable reasons, systematically subordinated investors' desire to resolve agency problems to managers' desire to be protected from capital-market discipline. Politically explicit modes of analysis thus complement traditional tools of finance theory and improve our ability to explain capital-market structure and behavior.

The paper investigates how quickly prices attain new equilibrium levels after large-block transactions, and measures the associated temporary and permanent price effects. We find that prices adjust within at most three trades, with most of the adjustment occurring in the first trade. The temporary price effect for seller-initiated transactions is related to block size, but the temporary price effect observed for buyer-initiated transactions is no larger than that observed in 100 share trades. Most of the price effect associated with block trades is permanent and is related to block size, regardless of the initiating party.

This paper investigates the effect of California's Proposition 103 on the market value of publicly traded property- and liability-insurance companies. The passage of this referendum on November 8, 1988 moved California from a market-oriented to a heavily regulated insurance-pricing system. During the period surrounding the election, the average stock price of insurance companies doing business in California declined by 6.91%. The decline is positively related to the proportion of a firm's premiums affected by the referendum and the proportion generated in other states where insurance regulation is likely to change, and negatively related to the firm's profitability.

Law and politics affect the financial structure of the public corporation, perhaps as much as economics. Law restricts financial institutions from holding large equity blocks and from networking the small blocks they do own. Impetus for these restrictions came from several sources: a public-spirited belief that financial stability would be fostered by financial fragmentation, American federalism (each state created its own insular set of financial institutions), rivalries between groups of financial institutions, and popular mistrust of powerful private financial institutions. The stability of many of these rules also derives from the political resistance that one would expect corporate managers and benefited financial institutions to offer to any change.

Venture-capital organizations raise money from individuals and institutions for investment in early-stage businesses that offer high potential but high risk. This paper describes and analyzes the structure of venture-capital organizations, focusing on the relationship between investors and venture capitalists and between venture-capital firms and the ventures in which they invest. The agency problems in these organizations and to the contracts and operating procedures that have evolved in response are emphasized. Venture-capital organizations are contrasted with large, publicly traded corporations and with leveraged buyout organizations.

We investigate the market's reaction to original-issue deep discount (OID) bonds, which are issued at prices well below par and with coupons set below the market rate. Until July 1982 OID debt offered large tax advantages. Before that date stock-price responses to announcements of OID debt are significantly positive, in contrast to the negative, albeit insignificant, responses associated with par debt announcements. No stock-price gains are observed for OID debt issued after the tax advantages are removed. We conclude that in 1981–82 opportunities provided by financial innovation offset the negative information effects typically associated with debt-financing announcements.

We show that bid-ask errors in transaction prices are the predominant source of apparent price reversals in the short run for NASDAQ firms. Once we extract measurement errors in prices caused by the bid-ask spread, we find little evidence of market overreaction. On the contrary, we find that security returns are positively, and not negatively, autocorrelated. We also show that bid-ask errors lead to substantial spurious volatility in transaction returns; about half of measured daily return variances can be induced by the bid-ask effect.

This paper examines the agency problem between shareholders and debtholders of Japanese and U.S. firms. Whereas U.S. institutional investors are restricted from doing so, Japanese financial institutions take large equity positions in firms to which they lend, particularly in firms more susceptible to the agency problem. Debt ratios of U.S. firms are negatively related to the firm's potential to engage in risky, suboptimal investments, whereas Japanese debt ratios show no such relation. The evidence is consistent with the notion that the agency problem is mitigated to a greater degree in Japan than in the U.S.

Auctions allocate resources to their highest-valued uses. Yet bankruptcy does not use auctions. Instead judges determine a value and parcel out interests on the assumption that this valuation is correct. Errors inevitable in this process lead many persons to conclude that bankruptcy is inefficient. This essay argues that the conclusion does not follow. The costs of error in valuation may be less than the cost of conducting an auction. Legal rules endure because they are efficient or because they transfer wealth. Transfers are an implausible explanation of the current bankruptcy regime, leaving efficiency as the prevailing explanation.