Knowledge that Transforms

We develop a dynamic model of learning about worker ability in a competitive labor market. The model produces three testable implications regarding wage dynamics: (1) although the role of schooling in the labor market's inference process declines as performance observations accumulate, the estimated effect of schooling on the level of wages is independent of labor-market experience; (2) timeinvariant variables correlated with ability but unobserved by employers ( such as certain test scores) are increasingly correlated with wages as experience increases; and (3) wage residuals are a martingale. We present evidence from the NLSY that is broadly consistent with the model's predictions.

Exploiting the analogy with the private provision of a public good, this paper studies debt restructuring with an arbitrary number of creditors using mechanism design. Creditors differ in the value they expect to receive in bankruptcy, and this value is private information. As with public goods, too little debt forgiveness is granted in equilibrium relative to the first best. Creditors are more willing to make concessions under common values than under pure private values, an opposite phenomenon to the “winners' curse” in auctions. Exchange offers are an optimal restructuring scheme for the debtor, because they allow creditors to contribute to debt forgiveness at different levels.Journal of Economic LiteratureClassification Numbers: G34, G33.

This paper empirically examines contagion effects of bank failures by analyzing the behavior of deposit flows in a sample of failed and healthy banks over the 1929–1933 period. We find evidence of contagion for 1930–1932, while none seems to have existed in 1929 or 1933. In addition, the pace of contagion accelerated over 1930–1932. We find that even during 1930–1932, failing-bank deposit outflows exceeded those at a matched control sample of nonfailing banks. This finding is consistent with the presence of a significant number of informed depositors who distinguished among ex ante failing and nonfailing banks.Journal of Economic LiteratureClassification Number: G21.

We analyze the interrelationships among the corporate organization structure, the capital structure, and the ownership structure of a firm with multiple projects, when incumbent management derives control benefits. The choices made by firm management are: (1) Whether to set up projects as a joint firm or as separate firms (spin-off), (2) the amount of debt financing to use, (3) the structure of the debt contract (e.g., straight debt on the joint firm, limited-recourse project financing, or spin-off with straight debt), and (4) the fraction of equity to hold in each firm (ownership structure). Differences in managerial ability across projects, benefits of control, and the probability of loss of control through a takeover or through bankruptcy are driving factors in this model. We relate the project characteristics to the optimality of spin-offs and limited-recourse project financing arrangements, and derive implications for the allocation of debt and the ownership structure across projects.Journal of Economic LiteratureClassification Numbers: G32, G34, D21.

We develop a model of trading volume when agents have different valuation and face transaction costs. In particular, the differential valuation is induced by differential tax status which generates trading around the distribution of cash dividends. Our model predicts that trading volume is negatively affected by idiosyncratic risk of dividend-paying stocks. Volume is negatively affected by the systematic risk of these stocks only in the presence of transaction costs.Journal of Economic LiteratureClassification Numbers: G11, G12, H20.

This paper studies the relation between the premiums in takeover bids involving exchange-listed target firms from 1975-91 and the pre-announcement stock price runups. The evidence shows that the pre-bid runup and the post-announcement increase in the target's stock price (the ‘markup’) are generally uncorrelated. With little substitution between the runup and the markup, the runup is an added cost to the bidder. This finding has important implications for assessing the costs of insider trading. It also raises interesting questions about the role of information from public capital markets in private takeover negotiations.

Underwriters have an incentive to overstate investor interest in order to persuade some investors to purchase shares at a price in excess of their initial estimate of the fair value. We show that this incentive is eliminated when the underwriter commits to secondary market price stabilization. Destroying the underwriter's incentive to overstate interest reduces the total surplus captured by initial investors in initial public offerings. Further efficiency gains are associated with penalty bid systems that permit the underwriter to make the stabilization commitment selectively. Price stabilization can thus be viewed as a bonding mechanism that improves the efficiency of the primary equity market.

This paper is an econometric analysis of the information content of automated orders arriving at the NYSE. The model captures the joint behavior of automated orders and also the return on the stock index future and the futures-spot basis. The results indicate that orders contain information useful in predicting stock returns beyond the information contained in the reported trades. Furthermore, program and index-arbitrage orders contain information beyond that available from the futures return and basis, suggesting that these orders are not merely passive conveyors of common-factor information. Nonprogram, program, and index-arbitrage orders have roughly similar price impacts.

We use when-issued transactions data to assess the Treasury's current experiment with uniform auctions. When-issued volume is higher under uniform as compared to discriminatory auctions, suggesting a higher information release, which should reduce pre-auction uncertainty and the winner's curse. Under uniform auctions, when-issued volatility falls after the auction and again after the outcome announcement. The pattern is the opposite for discriminatory auctions. This is further evidence that uniform auctions increase pre-auction information and lower the short squeeze. A direct comparison of markups in uniform and discriminatory auctions yields mixed results.

We examine the relation between exchange rate variability and stock return volatility for U.S. multinational firms and decompose this relation into components of systematic and diversifiable risk. Focusing on two five-year periods around the 1973 switch from fixed to floating exchange rates, we find a significant increase in volatility of monthly stock returns corresponding to the period of increased exchange rate variability, even relative to the increase in stock return volatility for three control samples. In conjunction with this increase in total volatility there is also an increase in market risk (beta) for multinational firms.