This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very “low powered,” i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation that Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks.

This article investigates investor activism when there are a number of strategic investors that are capable of intervening in corporate governance. These strategic investors can monitor and/or trade in anonymous financial markets. In equilibrium, a core group of monitoring investors emerges endogenously to curtail managerial opportunism. These core activists both intervene and trade aggressively. Although the smallest investors are passive, there is no monotonic relationship between the size of preexisting shareholdings and activism. In fact, among those investors who choose activism, those with the smallest holdings are the most aggressive.

In this article we model the financing decisions of a firm as a sequential signaling game. We prove that, when insiders have perfect information regarding the firm's future cash flows, the application of “refinements” to the set of admissible equilibria leads to the dominance of debt over equity financing. However, we show that when insiders observe the firm's cash flows imperfectly, there may exist sequential equilibria in which this “pecking order” breaks down and some firms strictly prefer equity to debt financing. We also prove that, despite the breakdown of the pecking order, the announcement effect of equity financing will be negative relative to debt financing.

This article models, and experimentally simulates, the free-rider problem in a takeover when the raider has the option to “resolicit,” that is, to make a new offer after an offer has been rejected. In theory, the option to resolicit, by lowering offer credibility, increases the dissipative losses associated with free riding. The outcomes of our experiment support this prediction and produce losses from free riding even higher than theoretically predicted. These dissipation losses reduce raider gains to less than 3% of synergy value of the acquisition

This article compares the predictions of finite-shareholder models of conditional and unconditional takeover offers with the outcomes of laboratory experiments. In addition to differentiating between types of offers, the experimental designs span small and large firms as well as different levels of offer premiums. It is found that in unconditional offers to large groups of subjects (28–40), the symmetric Nash equilibrium predicts observed tendering frequencies quite accurately. For other experimental designs, the results are mixed. The analysis of shareholder tendering strategies from the experiment yields insights into (I) the effects of takeover offer designs, (ii) the appropriateness of finite-shareholder models for research, and (iii) the costs of free riding when shareholders are nonatomistic.

A firm must decide what security to sell to raise external capital to finance a profitable investment opportunity. There is ex ante asymmetry of information regarding the probability distribution of cash flow generated by the investment. In this setting, we derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to be an (the unique) equilibrium outcome. Using these conditions we show that the debt contract is (uniquely) optimal if and only if cash flows are ordered by (strict) conditional stochastic dominance. Finally, we derive an equivalence relationship between optimal security designs and designs that minimize mispricing.

We examine the design of compensation contracts and determination of investment policies when a manager has private information regarding the effect of investment on both the firm's cash flows and the private benefits she is able to extract from employment. We show that, in general, the optimal mechanism is characterized by a menu of salary and option contracts. When the manager's private information relates only to the firm's cash flows, the firm overinvests relative to the Pareto optimal level. On the other hand, if the private information relates only to private benefits, the firm will underinvest.

The relationship between asset demand and information quality in rational expectations economies is analyzed. First we derive a number of new summary descriptive statistics that measure four basic characteristics of investment style: asset selection, market timing, aggressiveness, and specialization. Then we relate these statistics to the divergence between a given investor's information structure and the market average information structure. Finally, we demonstrate that informational differentials can be identified, and consistently estimated, using ordinary least squares, from the time-series of observed asset demand.

We analyse a bargaining game in which one party, called the buyer, has the option of choosing the sequence of negotiations with other participants, called sellers. When the sequencing of negotiations is confidential and the sellers' goods are highly complementary, efficient, non-dissipative equilibria exist in which the buyer randomizes over negotiation sequences. In these equilibria, the buyer can obtain higher pay-offs than in pure strategy equilibria or in public negotiations. The degree of sequencing uncertainty that maximizes buyer pay-offs is inversely related to the aggregate bargaining power of the sellers.

We analyze a distressed firm indebted to many creditors. The firm's owners have the option of choosing the sequence of restructuring negotiations with the creditors. We show that sequencing flexibility is beneficial to firm owners, and that the optimal sequencing of restructuring negotiations involves exploiting the firm's liabilities to some creditors so as to moderate the demands of others. Moderately distressed firms will eschew renegotiations with creditors in strong bargaining positions. Severely distressed firms will extract concessions from all creditors. In this case, owners can gain if they can credibly commit to conditional restructuring agreements that link the concessions of one creditor to concessions by others.