Many studies use the book value of debt as a proxy for its market value because most corporate debt does not trade. I call this practice the book value of debt (BVD) approximation, and it appears to be justified by the observation that the average market value of debt is close to its book value. Many corporate bonds, however, trade at values significantly different from their book values, and consequently the BVD approximation can create important biases. I compare the accuracy of the BVD approximation to Merton's option pricing (OPT) model of corporate debt valuation, and find consistent evidence that the Merton model provides more accurate estimates. I also show that this model is an easily estimated alternative to the BVD approximation. In short, the BVD approximation not only creates significant biases, but it is also an unnecessary simplification.

Previous studies ignore the fact that employee stock options are warrants because these options have been an insignificant component of firms’ capital structures. I show that this assumption is no longer correct. For example, for more than 36% of my sample firms, employee stock options represent a more significant claim on firm value than the firm’s debt and preferred stock combined. Moreover, in contrast to the suggestions of previous research, I show that employee stock options are a significant claim on firms throughout the economy, including larger firms, older firms, and firms in “Old Economy” industries. Finally, I show that the presumption in prior studies that employee stock options are not warrants causes a potential misunderstanding of the risk-shifting interests of securityholders and biases the analysis of capital structure issues.

I investigate the relationship between the amount of information provided by a firm's comparables (i.e., firms in the same line of business as the firm being valued) and the precision of the firm's equity valuation. When investors have more information, previous studies argue that investors can make a more precise estimate of a firm's true equity value and this implies a lower (excess) stock return volatility around corporate events such as earnings announcements. I develop a simple model that shows a negative relationship between the amount of information provided by a firm's comparables and the firm's stock return volatility. Using alternative measures of information provided by comparables and different definitions of comparables, I consistently find a negative and significant relationship between these information measures and stock return volatility, ceteris paribus.

Previous studies document negative long-term abnormal stock returns following seasoned equity offering (SEO) issuances and conclude that markets are inefficient. Other studies, however, argue that these results are a manifestation of risk mismeasurement (i.e., the bad-model problem), not market inefficiency. We test the efficient market hypothesis (EMH) and avoid the bad-model problem by examining the long-term performance of our sample firms' bonds and stocks following their SEOs. Our results are inconsistent with the EMH. We also provide evidence that SEOs transfer wealth from shareholders to bondholders because SEOs reduce default risk.

Previous studies document negative long-term abnormal stock returns following seasoned equity offering (SEO) issuances and conclude that markets are inefficient. Other studies, however, argue that these results are a manifestation of risk mismeasurement (i.e., the bad-model problem), not market inefficiency. We test the efficient market hypothesis (EMH) and avoid the bad-model problem by examining the long-term performance of our sample firms' bonds and stocks following their SEOs. Our results are inconsistent with the EMH. We also provide evidence that SEOs transfer wealth from shareholders to bondholders because SEOs reduce default risk.

The well-documented phenomena of departures from the absolute priority rule (APR) have provoked an important public policy debate over their consequences. Some scholars argue that APR violations increase economic efficiency because they play an important role in the avoidance of inefficient liquidations and also mitigate inefficient risk incentives. Another group argues that APR violations should be abolished because they add greater uncertainty to the security valuation process; that is, they increase noise in security prices. To date, however, no evidence has been presented on the issue of how much noise APR violations add. We develop a theoretical model that allows an empirical test of the effect of APR violations on noise; our results suggest that APR violations importantly increase noise. Indeed, at least 30 percent, and as much as 85 percent of the noise in security prices may be attributable to APR violations. This does not suggest that the beneficial effects of APR violations are nonexistent or unimportant, but it does imply that failing to account for the effect of APR violations on noise in any modelling of optimal bankruptcy rules may lead to a suboptimal design. We also find that the amount of noise in this market appears to have declined over time as more institutional/informed investors have entered the market for bankrupt firms' securities and the effect of change in the bankruptcy law has become clearer, both consistent with the noisy rational expectations hypothesis.

This study shows the extent to which deviations from the absolute priority rule increase or decrease the bankruptcy emergence payoff to traded (i.e., usually junior claimants) bondholders. The data indicate that, on average, bondholders benefit, albeit slightly, from absolute priority rule (APR) violations. This paper also examines the degree to which the bond market, in the bankruptcy filing month, anticipates departures from the APR and other influences on the payoff to bondholders. In other words, we investigate the informational efficiency of the market for bankrupt bonds. Overall, despite the complex and lengthy nature of bankruptcy proceedings, the results support efficiency.

This study shows the extent to which deviations from the absolute priority rule increase or decrease the bankruptcy emergence payoff to traded (i.e., usually junior claimants) bondholders. The data indicate that, on average, bondholders benefit, albeit slightly, from absolute priority rule violations. This paper also examines the degree to which the bond market, in the bankruptcy filing month, anticipates departures from the absolute priority rule and other influences on the payoff to bondholders. In other words, the authors investigate the informational efficiency of the market for bankrupt bonds. Overall, despite the complex and lengthy nature of bankruptcy proceedings, the results support efficiency.

This study assesses the stock return performance of 131 firms emerging from Chapter 11. Using differing estimates of expected returns, we consistently find evidence of large, positive excess returns in 200 days of returns following emergence. We also examine the reaction of our sample firms' equity returns to their earnings announcements after emergence from Chapter 11. The positive and significant reactions suggest that our results are driven by the market's expectational errors, not mismeasurement of risk. The results provide an interesting contrast, but not a contradiction, to previous work that has documented poor operating performance for firms emerging from Chapter 11.