This paper reviews the theory and evidence on the process by which corporations raise debt and equity capital and the associated effects on security prices. Findings from related transactions are used to test hypotheses about the stock price patterns accompanying announcements of security offerings. Various contractual alternatives employed in security issues are examined; for example, rights or underwritten offers, negotiated or competitive bid, best efforts or firm commitment contracts, and shelf or traditional registration. Finally, incentives for underpricing new issues are analyzed.

This paper provides an analysis of the choice of method for raising additional equity capital by listed firms. Examination of expenses reported to the SEC indicates that rights offerings involve significantly lower costs; yet underwriter are employed in over 90 percent of the offerings. The underwriting industry, finance textbooks, and corporate proxy statements offer several justifications for the use of underwriters. However, estimates of the magnitudes of these arguments indicate that they are insufficient to justify the additional costs of the use of underwriters. The use of underwriters thus appears to be inconsistent with rational, wealth-maximizing behavior by the owners of the firm. The paper concludes with an examination of alternate explanations of the observed choice of financing method.

Recent advances in the general equilibrium pricing of simple put and call options lay the foundation for the development of a general theory of the valuation of contingent claims assets. This paper provides a review of: (1) the development of the general equilibrium option pricing model by Black and Scholes, and the subsequent modifications of this model by Merton and others; (2) the empirical verification of these models; and (3) applications of these models to value other contingent claim assets such as the debt and equity of a levered firm and dual purpose mutual funds.

T HE index numbers of prices here presented in monthly form for the period I795 to I824 were constructed as a part of a study of the financial history of the United States during and immediately following the War of i8I2.1 To students of international trade, government finance, and money, banking, and prices, the developments of a hundred years ago are of interest because of the similarity between that period and the recent war and post-war period. It is hoped that the index numbers of commodity prices at wholesale may be of service to students of the history of these years. Such series provide a continuous record around which non-quantitative data may be organized, and, being sensitive barometers of economic life, they enable us to say something concerning the timing and the magnitude of the effect of the forces at work. A description of the construction of the indexes of prices in the United States from I795 to I824 is given in Part I below. Three indexes of prices in the Boston marketone of the prices of domestically produced goods, one of imported goods, and one of domes'tically produced and imported goods (the all commodities index) have been computed by months for the 30 years. In this section also indexes of prices of domestic goods quoted in the markets of New York, Philadelphia and Baltimore, from i8io to I8I9, are presented. In Part II the index numbers for the years i802-2o,have been examined to find out when business recessions and crises occurred, and some non-statistical material has been quoted which helps to explain the movements of prices in this period. Our conclusions concerning the causes of fluctuations in prices must necessarily be tentative, for the data upon which our judgment must be based are fragmentary.

We provide a positive analysis of a firm's decision to report the operations of a financial subsidiary on a consolidated versus an unconsolidated basis. Our evidence indicates that the firm is more likely to choose consolidated reporting the greater the operating, financial, and informational interdependencies between parent and subsidiary. Moreover, our evidence offers no support for the FASB hypothesis that firms use unconsolidated financial subsidíaries to understate the fixed claims on their balance sheets.

Some corporate decisions increase stockholder wealth while reducing the wealth of bondholders. When wealth transfers are large enough, stock prices can rise from decisions that reduce firm value. Yet, rational bondholders understand that actions taken after issuance will tend to increase stockholder wealth, and they forecast the value effects of future decision when bonds are sold. In an efficient market, the bond price at issuance reflects an unbiased forecast of the effects of such future actions. Thus, on average, bondholders will not suffer losses, although the firm (and hence its stockholders) must bear the costs of nonoptimal decisions motivated by wealth transfers from debtholders. Therefore, effective control of this bondholder-stockholder conflict can increase firm value. Bond covenants that constrain activities such as asset sales or dividend payments are examples of voluntary contracts that can reduce the costs generated when stockholders of a levered firm follow a policy that deviates from maximization of the firm's value. The cost-reducing benefits of covenants accrue to the firm's owners through the higher price the bonds command when issued. Furthermore, if covenants lower the costs that bondholders incur in monitoring managers, these cost reductions also are passed to stockholders through higher bond prices at issuance. Therefore, in structuring an optimal debt contract, the firm's managers face a trade-off between increased proceeds from the debt issue and reduced flexibility with respect to future policy choices. The constraints imposed through covenants are frequently specified in terms of accounting numbers. Debt covenants that employ accounting numbers are conventionally divided into (1) affirmative covenants, which require firms to maintain specified levels of accounting-based ratios, and (2) negative covenants, which limit certain investment and financing activities unless specified accounting-based conditions are met. For example, negative covenants restrict the payment of dividends, the disposition of assets, the issuance of additional debt, and merger activity; affirmative covenants specify minimum working capital and net worth requirements. Although standard covenants in debt issues require that accounting numbers be consistent with generally accepted accounting principles (GAAP), they normally do not prohibit managers from switching between accepted methods. In some bank-loan agreements, firms are required only to provide unaudited, internally generated financial statements, but the contract also requires the firm to maintain substantially the same set of GAAP. If a change becomes necessary, the bank must be notified in writing prior to the change with the reasons detailed (see Zimmerman 1975). Since different accounting techniques imply different accounting numbers, firms have incentives to relax onerous constraints through the choice of accounting techniques. Academic accountants have devoted substantial effort to obtain empirical evidence on the importance of debt agreements in determining accounting policy. (Watts and Zimmerman 119861 and Christie [19901 provide reviews.) Initial studies adopted indirect methods to account for the effect of debt covenants on accounting decision by using the firm's debt-equity ratio as an explanatory variable in cross-sectional regressions. This ratio is a proxy for closeness to covenant constraints, as well as for the expected costs should a breach occur. Duke and Hunt (1990) and Press and Weintrop (1990) offer evidence to support the use of the debt-equity ratio as a proxy for the closeness to debt covenant constraints. Christie (1990) documents significant support for this debt hypothesis by aggregating cross- sectional studies of accounting choice, generally concluding that the larger the firm's debt-equity ratio, the more likely the firm's managers are to select accounting procedures that shift reported earnings to the current period from future periods. Researchers have generally interpreted support for this debt hypothesis as evidence that managers act opportunistically. However, Watts and Zimmerman (1990) question whether the documented association is misinterpreted by researchers. Rather than reflecting managerial opportunism, the evidence may reflect the association among firms' investment opportunity sets, financial policies, and their efficient set of accounting methods. Even in theory, it is difficult to distinguish between opportunism and contracting efficiency as determinants of accounting policy choice. Given positive contracting costs, there will be a positive efficient amount of opportunism. Distinguishing between opportunism and efficiency is difficult in empirical work also. For example, a significant relation between accounting policy choice and leverage could indicate that managers of firms with high leverage act opportunistically in selecting accounting techniques to reduce costs imposed by constraints in debt covenants. Alternately, it could indicate that corporations for which a particular set of accounting techniques is efficient also tend to be those firms for which high leverage is efficient. Firms examined in these cross-sectional studies are not necessarily close to their debt covenant constraints at the date examined. When firms are not close to debt covenant constraints, managerial opportunism is a less plausible explanation for the documented association between leverage and accounting choice. Yet, since it is costly for firms to switch back and forth between accounting procedures, firms that switch accounting methods to delay default are likely to continue to employ incomes increasing accounting procedures, even if default is no longer likely (see Sweeney 1992). A firm's current accounting policies thus should depend on its historical choices and the time series of variables hypothesized to influence accounting policy. Therefore, cross-sectional studies do not provide the most direct or most powerful tests of the relation between accounting choice and debt contracts. Recent studies overcome a number of limitations inherent in cross sectional analyses by examining accounting-based defaults in debt covenants. Careful examination of the default process, its causes and cures, provides evidence on important aspects of the lending process. In this article, 1 review this developing literature to provide a richer under-standing of the costs of leverage. These costs have important implications. For accountants, they offer potential explanations of a firm's accounting policy choice; for financial economists, they enrich our understanding of the firm's optimal capital structure.

[Some corporate decisions increase stockholder wealth while reducing the wealth of bondholders. When wealth transfers are large enough, stock prices can rise from decisions that reduce firm value. Yet, rational bondholders understand that actions taken after issuance will tend to increase stockholder wealth, and they forecast the value effects of future decision when bonds are sold. In an efficient market, the bond price at issuance reflects an unbiased forecast of the effects of such future actions. Thus, on average, bondholders will not suffer losses, although the firm (and hence its stockholders) must bear the costs of nonoptimal decisions motivated by wealth transfers from debtholders. Therefore, effective control of this bondholder-stockholder conflict can increase firm value. Bond covenants that constrain activities such as asset sales or dividend payments are examples of voluntary contracts that can reduce the costs generated when stockholders of a levered firm follow a policy that deviates from maximization of the firm's value. The cost-reducing benefits of covenants accrue to the firm's owners through the higher price the bonds command when issued. Furthermore, if covenants lower the costs that bondholders incur in monitoring managers, these cost reductions also are passed to stockholders through higher bond prices at issuance. Therefore, in structuring an optimal debt contract, the firm's managers face a trade-off between increased proceeds from the debt issue and reduced flexibility with respect to future policy choices. The constraints imposed through covenants are frequently specified in terms of accounting numbers. Debt covenants that employ accounting numbers are conventionally divided into (1) affirmative covenants, which require firms to maintain specified levels of accounting-based ratios, and (2) negative covenants, which limit certain investment and financing activities unless specified accounting-based conditions are met. For example, negative covenants restrict the payment of dividends, the disposition of assets, the issuance of additional debt, and merger activity; affirmative covenants specify minimum working capital and net worth requirements. Although standard covenants in debt issues require that accounting numbers be consistent with generally accepted accounting principles (GAAP), they normally do not prohibit managers from switching between accepted methods. In some bank-loan agreements, firms are required only to provide unaudited, internally generated financial statements, but the contract also requires the firm to maintain substantially the same set of GAAP. If a change becomes necessary, the bank must be notified in writing prior to the change with the reasons detailed (see Zimmerman 1975). Since different accounting techniques imply different accounting numbers, firms have incentives to relax onerous constraints through the choice of accounting techniques. Academic accountants have devoted substantial effort to obtain empirical evidence on the importance of debt agreements in determining accounting policy. (Watts and Zimmerman [1986] and Christie [1990] provide reviews.) Initial studies adopted indirect methods to account for the effect of debt covenants on accounting decision by using the firm's debt-equity ratio as an explanatory variable in cross-sectional regressions. This ratio is a proxy for closeness to covenant constraints, as well as for the expected costs should a breach occur. Duke and Hunt (1990) and Press and Weintrop (1990) offer evidence to support the use of the debt-equity ratio as a proxy for the closeness to debt covenant constraints. Christie (1990) documents significant support for this debt hypothesis by aggregating cross-sectional studies of accounting choice, generally concluding that the larger the firm's debt-equity ratio, the more likely the firm's managers are to select accounting procedures that shift reported earnings to the current period from future periods. Researchers have generally interpreted support for this debt hypothesis as evidence that managers act opportunistically. However, Watts and Zimmerman (1990) question whether the documented association is misinterpreted by researchers. Rather than reflecting managerial opportunism, the evidence may reflect the association among firms' investment opportunity sets, financial policies, and their efficient set of accounting methods. Even in theory, it is difficult to distinguish between opportunism and contracting efficiency as determinants of accounting policy choice. Given positive contracting costs, there will be a positive efficient amount of opportunism. Distinguishing between opportunism and efficiency is difficult in empirical work also. For example, a significant relation between accounting policy choice and leverage could indicate that managers of firms with high leverage act opportunistically in selecting accounting techniques to reduce costs imposed by constraints in debt covenants. Alternately, it could indicate that corporations for which a particular set of accounting techniques is efficient also tend to be those firms for which high leverage is efficient. Firms examined in these cross-sectional studies are not necessarily close to their debt covenant constraints at the date examined. When firms are not close to debt covenant constraints, managerial opportunism is a less plausible explanation for the documented association between leverage and accounting choice. Yet, since it is costly for firms to switch back and forth between accounting procedures, firms that switch accounting methods to delay default are likely to continue to employ income-increasing accounting procedures, even if default is no longer likely (see Sweeney 1992). A firm's current accounting policies thus should depend on its historical choices and the time series of variables hypothesized to influence accounting policy. Therefore, cross-sectional studies do not provide the most direct or most powerful tests of the relation between accounting choice and debt contracts. Recent studies overcome a number of limitations inherent in cross-sectional analyses by examining accounting-based defaults in debt covenants. Careful examination of the default process, its causes and cures, provides evidence on important aspects of the lending process. In this article, I review this developing literature to provide a richer understanding of the costs of leverage. These costs have important implications. For accountants, they offer potential explanations of a firm's accounting policy choice; for financial economists, they enrich our understanding of the firm's optimal capital structure.]

Abstract This article focuses on the prudent investment theory in public utility rate making. It is author's opinion that successful regulation of public utility rates cannot be accomplished under the fair-value doctrine and that the investment method must be sanctioned if justice is to be done to the consumer, the utility, and the general public as well. Stated somewhat differently the author believes the fair-value basis of rate making altogether impracticable and unworkable, that it is basically wrong in its economic concept, that the circumstances which gave birth to the principle have long since ceased to exist, and that is a reasonably good job of public utility rate regulation is to be achieved it is through investment approach. No review of rate regulatory procedures in this country would be complete without a brief reference to leading decisions of the Supreme Court of the U.S. on the subject. Not only did the fair-value doctrine, which plagued regulation for many years, have its real genesis in a decision of that Court, but the decisions of that body have greatly influenced the thinking and pretty well dominated the practices in respect to public utility rate regulation.