Knowledge that Transforms

This study uses Treasury bond triplets, which consist of three different Treasury issues with a common maturity date, to investigate the theoretical and empirical influence of tax strategies on Treasury prices. The tax-option effect, which arises from the right to optimally realize gains and losses for tax purposes, is found to induce convexity in the relation among triplet bond prices, but the effect is too small to create an arbitrage opportunity. A previous study [Litzenberger and Rolfo (1984)] is shown to incorrectly isolate the tax-option effect and hence misstate some key result; a correction is provided.

Warrants are sometimes granted to underwriters in initial public offerings as part of the compensation for their services. We examine the effects of underwriter warrants in a sample of firm commitment offerings from 1983 through 1987. These warrants represent a significant component of the compensation to the underwriter and are associated with greater total costs of going public. Warrants appear to provide a mechanism for circumventing otherwise binding regulatory constraints, allowing issuers to offer extra compensation to underwriters marketing especially risky offerings.

To improve on the design of the production-sharing rule in a contract for exploration and development negotiated between a state-owned oil resources authority and a U.S. oil company, we use the Grossman and Hart (1983) principal-agent model. In the original contract, the company was granted a share of production as an incentive to maximize the net return to the authority. The optimal sharing rule we develop increases the expected return to the authority by 6% by improving the company's incentives to choose an optimal exploration program.

This paper studies managerial compensation, financial reporting, and dividend policies of the seven major domestic steel producers during requests for union concessions. Substantial layoffs, reported losses, and sacrifices by nonunion stakeholders buttressed managers' case for union concessions. From 1980 to 1988, sample firms reduced their work force by about 300,000 (almost two-thirds) and annual wage payments from 16.1 to 8.6 billion. Reported income is lower during union negotiations, controlling for cash flows, as is managerial pay, with average CEO salary plus bonus declining 18%. Dividend reductions and white-collar pay cuts are substantial, pervasive, and clustered during union negotiations.

Turner Broadcasting illustrates how organizational mechanisms can be adapted to prevent a majority owner from imposing costs on minority shareholders through inept management or opportunistic behavior. These mechanisms involve issuing preferred stock with unusual features, concentrating its ownership among a small group of investors, allowing the new preferred shareholders to elect several directors, and requiring supramajority approval of major management decisions by a reconstituted board of directors. The alienability of the preferred stock is restricted to help insure that its ownership stays concentrated and in the hands of those with the specific knowledge and incentives to be effective monitors.

This study examines why firms settle their overfunded defined benefit pension plans. Under the new accounting standard (FASB Statement No. 88), companies ‘settling’ their overfunded pension plan can immediately recognize a portion of deffered pension gain as current earnings. Focusing on settlement transactions unaccompanied by asset reversions, we examine financial characteristics of settlement firms, including earnings, debt covenants, management incentive compensation, and firms' risk and financial structures. Our results suggest that firms undertake settlement to offset a decline in earnings and mitigate restrictive debt covenant constraints. However, a settlement firm's systematic risk (beta) does not change after settlement.

This paper shows that the simulation-based rejection percentages for detecting abnormal log-transformed volume reported in Ajinkya and Jain [AJ] (1989) are sensitive to the method of inducing abnormal volume. We present an alternative inducement method that possesses desirable distributional properties. Under this method, for example, with fifty firm portfolios and one-day event periods a 20% volume increase is detected just over 40% of the time, while AJ suggest a detection rate of over 90%. Rejection percentages for abnormal volume at earnings announcement dates also are more consistent with our alternative method than with AJ's method.

This paper provides a model in which audited reports are valuable to entrepreneurs who have private information and seek to share risks with investors. A distinctive feature of the model is that the choice of auditor and the resulting audited report provide partial information about the entrepreneur's private information, and he resolves all remaining investor uncertainty by signalling with retained ownership. The value of an audit is increasing in audit quality and the firm-specific risk faced by the entrepreneur and is a nondecreasing function of the entrepreneur's expectations about the future value of the firm.

This paper provides evidence that repurchase tender offer announcements convey favorable information about the level and riskiness of future earnings. We show that analysts revise their forecasts of earnings per share upward following repurchase announcements. Repurchase announcement stock price reactions are positively correlated with revisions in short-term forecasts, but not correlated with revisions in long-term forecasts. Thus, the information is primarily about transitory changes in earnings. We also provide evidence that equity betas decline after repurchases. Our findings indicate that the equity beta decreases are due to decreases in the underlying riskiness of the firm's assets.

This research examines whether analysts' earnings forecasts incorporate information in price changes. Even if the forecasts do not explicitly depend upon price changes,there should nevertheless be a positive association between analysts' forecast revisions and prior price changes. Moreover, if analysts incorporate only their private information in formulating a forecast and ignore price changes, then the likelihood that their estimate is less than (greater than) the realization increases following price increases (decreases). Empirical results are consistent with these conjectures and indicate that analysts' forecasts do not fully reflect the information in prior price changes.