Knowledge that Transforms

Initial public offerings that receive secondary market price support from their underwriters are characterized by severely attenuated selling by small-quantity, presumably retail, traders and more aggressive selling by large-quantity, presumably institutional, traders. The increase in institutional trading is concentrated in the first day of trading while the attenuation of retail trading persists. This pattern exists in spite of the likelihood that retail investors receive relatively large initial allocations of (fully-priced) stabilized offers. Thus the evidence is consistent with institutional investors being the primary beneficiaries of price stabilization efforts and with the use of penalty bids to constrain retail selling activity.

A unique data set from the Tel-Aviv Stock Exchange (TASE) is used to study the effect of trading mechanisms on stock return volatility. The TASE represents a natural experiment which allows separation of the overnight information effect from the trading mechanism effect. The data span a time period in which the order of the trading mechanisms (a sequential continuous mechanism and a call auction) was switched. Since overnight information should impact opening prices equally across periods, this affords an unparalleled opportunity to examine the trading mechanism effect without the confounding effect of the non-trading period. This paper finds that the null, that opening variances equal closing variances, cannot be rejected for either period. Further, the tests cannot reject null that the ratio of opening to closing return variances is equal across periods. This suggests that the trading mechanisms on the TASE do not differ in their effect upon return volatility.

This study extends the existing literature of international banking by constructing a model of foreign intermediaries in Australia. An unresolved question is establishing those factors that result in banking across borders. While a variety of theories attempt to explain international banking, empirical tests are sparse (Mahajan, A., Rangan, N., Zardkoohi, A., 1996. Journal of Banking and Finance 20, 283–306). This study considers if the results to date apply in non US settings. Foreign bank size was found to be a positive function of bank licence, parent size and time in Australia, and a negative function of Australian net interest margins and fees. The negative sign on net interest margins and fees is consistent with De Young, R., Nolle, D., 1996. Journal of Money, Credit and Banking 28, 622–636. Foreign bank profits were a positive function of Australian net interest margins and fees. There was limited evidence of defensive expansion. This paper concludes that foreign bank size is explained well by the existing theories of international banking, but a wider model is appropriate for foreign bank profits.

A considerable volume of research shows that asset prices respond to changes in the Federal Reserve's discount rate. While several competing hypotheses have been advanced to explain the market's response to discount rate announcements, comparatively little effort has been made to differentiate among alternative hypotheses. The result is an abundance of evidence establishing that asset prices respond to discount rate announcements, but little if any agreement about why markets respond. This article attempts to fill a void in the literature by pointing out how competing hypotheses differ and by constructing tests explicitly designed to differentiate among competing explanations. The evidence suggests that the market's reaction to discount rate changes is purely an announcement effect, i.e., a reaction to new information contained in the announcement, that the direct effect of discount rate changes on market rates is nil, that the announcement effect is invariant to the Federal Reserve's operating procedure and that, generally speaking, changes in the discount rate do not signal a change in monetary policy. The announcement effect appears to vary with both the nature and extent of the information that the announcement of a discount rate change is believed to contain.

We consider the provision of venture capital in a dynamic agency model. The value of the venture project is initially uncertain and more information arrives by developing the project. The allocation of the funds and the learning process are subject to moral hazard. The optimal contract is a time-varying share contract which provides intertemporal risk-sharing between venture capitalist and entrepreneur. The share of the entrepreneur reflects the value of a real option. The option itself is based on the control of the funds. The dynamic agency costs may be high and lead to an inefficient early stopping of the project. A positive liquidation value explains the adoption of strip financing or convertible securities. Finally, relationship financing, including monitoring and the occasional replacement of the management improves the efficiency of the financial contracting.

This paper develops a signalling model of call of convertible securities (bonds or preferred stock) in the presence of corporate taxes and asymmetric information about future earnings. In equilibrium, managers with relatively unfavorable information call to force convertible holders to convert to common stock (in spite of the loss of corporate tax benefits if the convertibles are bonds), while those with relatively favorable information do not call. The model predicts that the announcement period common stock returns are more negative at the call of convertible bond than at the call of convertible preferred stock. Furthermore, we predict that when the importance of the tax deductibility of interest differs among firms, so does the stock price reaction to the announcement of convertible debt call. Specifically, the loss of equity value at the announcement decreases with the amount of non-debt tax shield that the calling firm owns, decreases with the book value of convertible debt called, and increases with corporate taxes.

For the banking system, forecasting the risk of company failure supposes that tools for detecting company difficulties which make use of widely available computer databses are available. Such tools can be used as a decision-making aid in credit arrangements on a case-by-case basis and also to manage risk arising on all the bank’s committments. This article presents: (a) the constructin of the Banque de France industry score: i.e. the choice of data and statistical method, the validation of the tool, and the estimated probability of failure according to the score function; (b) the method of diagnosing a company’s individual risk; (c) the use of the score as a probabilistic tool for evaluating the risk arising on a portfolio of commitments.

In this article, I examine the effect of pre-existing relationships between a firm and its potential lender on the potential lender's decision whether or not to extend credit to the firm. I find that a potential lender is more likely to extend credit to a firm with which it has a pre-existing relationship as a source of financial services, but that the length of this relationship is unimportant. These findings provide empirical support for theories of financial intermediation positing that banking relationships generate valuable private information about the financial prospects of the financial institution's customer. The results also provide evidence that potential lenders are less likely to extend credit to firms with multiple sources of financial services, in support of the theory that the private information a financial institution generates about a firm is less valuable when the firm deals with multiple sources of financial services.