Knowledge that Transforms

We develop a measure of free cash flow using Tobin's q to distinguish between firms that have good investment opportunities and those that do not. In a sample of successful tender offers, bidder returns are significantly negatively related to cash flow for low q bidders but not for high q bidders; further, the relation between cash flow and bidder returns differs significantly for low q and high q bidders. This result holds for several cash flow measures suggested in the literature and also in multivariate regressions controlling for bidder and contest-specific characteristics.

This paper analyzes the SEC's proxy regulations and assesses their effects on corporate governance. The proxy rules began in 1935 as a minimal series of disclosure requirements and a prohibition against fraud. By 1956, they imposed extensive and wide-ranging disclosure requirements on anyone wishing to communicate about voting issues and required that all such communications be cleared in advance — in essence, censored — by the SEC. I present evidence that since that time, the rules have significantly increased the costs of communication and coordinated action among shareholders. They have thus deterred shareholder initiatives and inhibited the development of a private market for information about voting issues.

Many authors have identified the hazards of ignoring event-induced variance in event studies. To determine the practical extent of the problem, we simulate an event with stochastic effects. We find that when an event causes even minor increases in variance, the most commonly-used methods reject the null hypothesis of zero average abnormal return too frequently when it is true, although they are reasonably powerful when it is false. We demonstrate that a simple adjustment to the cross-sectional techniques produces appropriate rejection rates when the null is true and equally powerful tests when it is false.

This paper models debt renegotiation as a bargaining game between debtholders and shareholder-oriented management, in which management credibly threatens to run down firm assets to force concessions from the creditors. Creditors anticipate this opportunistic behavior by management, creating an upper bound on debt capacity that is less than the value of the firm. If an advantage to debt is introduced, such as favorable tax treatment, an interior optimal capital structure obtains even in the absence of realized bankruptcy costs. Our model also explains variations in debt-equity ratios and the use of certain puzzling debt covenants.

Common-stock prices fall a statistically significant 2 percent in response to underwritten convertible debt call announcements. We find that the significant negative price reaction is confined to underwritten calls — stock-price responses to non-underwritten calls average an insignificant −0.84 percent. The results support the idea that managers are more likely to use underwriters the more unfavorable the information they possess about future firm cash flows. An agency cost interpretation of underwritten calls is also consistent with the results, but is not supported by management ownership and corporate liquidity evidence.

This paper asks whether market fundamentals can explain the recent run-up and decline of Japanese equity values and price-earnings ratios. Accounting differences explain about half of the long-run disparity between U.S. and Japanese P/Es. For example, if Japanese firms used U.S. accounting rules, the Japanese P/E ratio would have been 32.6, not 53.7, in 1989. Accounting differences cannot, however, explain the doubling of this ratio in 1986, nor its decline in 1990. Similarly, we are unable to isolate changes in required stock returns or growth expectations that are large enough to explain recent Japanese stock price movements.

We argue that hedging and risk management activities of modern corporations arise as a direct consequence of attempts to create shareholder wealth through financial innovation. We formalize this argument by examining in detail corporate issues of foreign currency exchange warrants. We then focus on one multiple issuer to demonstrate how the foreign exchange risk created by the sale of the warrants can be eliminated. The use of off-balance-sheet risk management techniques to lock in the benefits of selling overpriced securities raises questions about the information content of innovative corporate financing decisions.

This paper investigates share-price performance following corporate takeovers. We use multifactor benchmarks from the portfolio evaluation literature that overcome some of the known mean-variance inefficiencies of more traditional single-factor benchmarks. Studying 399 U.S. takeovers consummated in the 1975–1984 period, we conclude that previous findings of poor performance afer takeover are likely due to benchmark errors rather than mispricing at the time of the takeover.

In this paper we analyze how anticipating a forthcoming public announcement affects the market reaction to the announcement by altering investors' incentives to acquire private information. Specifically, we study price change, volume, and information asymmetry at the time of the announcement. We also investigate how information acquisition, information asymmetry, price, and volume are influenced by the quality of prior knowledge, the marginal cost of gathering information, the degree of risk tolerance, and noise. Finally, we compare market reactions to anticipated announcements of known precision with the response to announcements that are either unanticipated or of uncertain quality.

This paper develops and tests a model of intraday security price movements which incorporates the effects of both trading volume and unanticipated information. We estimate our model using transaction data from a NYSE specialist and find strong evidence of information asymmetry, although the inventory effect appears weak. The parameter estimates are used to compute the costs of trading, and we find that implicit bid-ask spreads were significantly higher in October 1987 than in the rest of that year. We also examine large-block versus smaller trades and buyer-initiated versus seller-initiated trades.