Knowledge that Transforms

This paper finds that discounts and premiums of closed-end funds reflect the market's assessment of anticipated managerial performance. Using single and multiple benchmarks, we present evidence that there is a significant and positive relation between stock fund premiums and future net asset value performance over the following year. The relation is not caused by the anticipation of future expenses. We also find that bond closed-end funds show no such relation between premium and asset value performance.

Commercial bank entry into securities underwriting can affect underwriter behavior because, unlike investment houses, banks also lend to firms. This raises several issues. Are banks better certifiers of firms’ securities than investment houses? If banks hold equity in firms rather than debt, does this make certification more credible? Would one type of underwriter drive out the other? This paper provides a model for analyzing such issues, and derives several interesting results. First, banks, as lenders to firms, can actually be better certifiers than investment houses. Second, equity holding can hinder banks’ certification ability. Finally, banks and investment houses can co-exist.

Deregulation provides a natural experiment for examining how governance adapts to structural changes in the business environment. We investigate the evolution of governance structure, characterized by ownership concentration, compensation policy, and board composition, in the U.S. airline industry during a 22-year period surrounding the Airline Deregulation Act of 1978. Consistent with theory, we find that after deregulation (i) equity ownership is more concentrated, (ii) CEO pay increases, (iii) stock option grants to CEOs increase, and (iv) board size decreases. Airlines’ governance structures gravitate toward the system of governance mechanisms used by unregulated firms. The adaptation process is gradual, however, suggesting that it is costly to alter organizational capital. We also present evidence on the relation between governance structure and firm survival.

To control risk-related incentive problems, equity holders are expected to manage both the convexity and slope of the relation between firm performance and managers’ wealth. I find stock options, but not common stockholdings, significantly increase the sensitivity of CEOs’ wealth to equity risk. Cross-sectionally, this sensitivity is positively related to firms’ investment opportunities. This result is consistent with managers receiving incentives to invest in risky projects when the potential loss from underinvestment in valuable risk-increasing projects is greatest. Firms’ stock-return volatility is positively related to the convexity provided to managers, suggesting convex incentive schemes influence investing and financing decisions.

This paper provides evidence on a previously unidentified source of managerial incentives: concerns about post-retirement board service. Both the likelihood that a retired CEO serves on his own board two years after departure, as well as the likelihood of serving as an outside director on other boards, are positively and strongly related to his performance while CEO. Retention on the CEO's own board depends primarily on stock returns, while service on outside boards is better explained by accounting returns. The evidence also suggests that firms consider ability in choosing board members.

We document substantial long-run post-issue underperformance by firms making straight and convertible debt offerings from 1975 to 1989. This long-run underperformance is more severe for smaller, younger, and NASDAQ-listed firms, and for firms issuing speculative grade debt. We also find strong evidence that the underperformance of issuers of both straight and convertible debt is limited to those issues that occur in periods with a high volume of issues. In contrast to earlier event studies that found insignificantly negative abnormal returns at the time of debt issue announcements and concluded that debt offerings had no impact on shareholder wealth, our results suggest that debt offerings, like equity offerings, are signals that the firm is overvalued. As with equity offerings and repurchases, the market appears to underreact at the time of the debt offering announcement so that the full impact of the offering is only realized over a longer time horizon.

This paper examines the time-series relations among expected return, risk, and book-to-market (B/M) at the portfolio level. I find that B/M predicts economically and statistically significant time-variation in expected stock returns. Further, B/M is strongly associated with changes in risk, as measured by the Fama and French (1993) (Journal of Financial Economics, 33, 3–56) three-factor model. After controlling for risk, B/M provides no incremental information about expected returns. The evidence suggests that the three-factor model explains time-varying expected returns better than a characteristics-based model.

Most derivative securities must be priced by numerical techniques. These models contain “distribution error” and “nonlinearity error”. The Adaptive Mesh Model (AMM) sharply reduces nonlinearity error by grafting one or more small sections of fine high-resolution lattice onto a tree with coarser time and price steps. Three different AMM structures are presented, one for pricing ordinary options, one for barrier options, and one for computing delta and gamma efficiently. The AMM approach can be adapted to a wide variety of contingent claims. For some common problems, accuracy increases by several orders of magnitude with no increase in execution time.

This paper analyzes the recommendations of common stocks made by the investment newsletters followed by the Hulbert Financial Digest. We conclude that, taken as a whole, the securities that newsletters recommend do not outperform appropriate benchmarks. Our data provide modest evidence that the future performance of a newsletter is related to its past performance, when performance is measure by raw returns. Evidence of persistence vanishes, however, when performance is measured by abnormal returns. We find little, if any, evidence of herding, i.e., cross-sectional dependence of recommendations, across newsletters. Newsletters tend to recommend securities that have performed well in the recent past. Finally, newsletters with poor past performance are more likely to go out of business.

This paper considers whether stock price elasticity affects corporate financial decisions. Basic economic principles and the existing theoretical literature predict that firms choosing the Dutch auction instead of the fixed price tender offer should be those firms expecting to face greater stock price elasticity. Econometric analysis suggests that firms choosing the Dutch auction instead of the fixed price tender offer between 1984 and 1989 are indeed those firms expecting to face greater stock elasticity, even though the average realized elasticities of the firms conducting the various tender offers fail to be significantly different. The expected elasticity remains an important determinant of the tender offer choice even when allowing for firm characteristics associated with the choice of repurchase method. Firms facing greater elasticity are also characterized. The findings suggest that expected stock price elasticity may be an important determinant of corporate financial decisions that affect the supply of, or demand for, stock.