This paper investigates the distribution of equity ownership between entrenched corporate insiders and dispersed outsiders when management has the ability to divert or manipulate the cash flows and when it is costly for equity holders to verify or prove any managerial wrongdoing for a third party such as a court. Management chooses the distribution of equity ownership so as to maximize private benefits against the risk of potential control challenges. When shareholders are long term oriented, then outside shares trade at a premium over their value to management, and management is inclined to sell of its equity stake to dispersed outsiders. When shareholders are short-term oriented, then outside share trade at a discount below their value to management, and disciplinary pressure can be substantially reduced via strategic share purchases.

[This article investigates the distribution of equity ownership between entrenched management and dispersed outsiders when management has the ability to manipulate the cash flows and when it is costly for equity holders to prove managerial wrongdoing in court. Management chooses the distribution of equity ownership so as to maximize private benefits against the risk of potential control challenges. When shareholders are long-term oriented, then outside shares trade at a premium over their value to management, and management is inclined to sell off its equity stake to dispersed outsiders. When shareholders are short-term oriented, then outside shares trade at a discount below their value to management, and disciplinary pressure can be substantially reduced via strategic share purchases. Changes in the cost of capital drive a wedge between entrenched management's and dispersed outsider's valuation of shares. Management exercises its option to buy (sell) shares when the option is in the money: when management values shares more (less) than outsiders do.]

Journal Article Optimal Financial Contracting: Debt versus Outside Equity Get access Zsuzsanna Fluck Zsuzsanna Fluck New York University Address correspondence to Zsuzsanna Fluck, Department of Finance, Stern School of Business, New York University, 44 West 4th Street, Suite 9-190, New York, NY 10012, or e-mail: [email protected]. Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 11, Issue 2, April 1998, Pages 383–418, https://doi.org/10.1093/rfs/11.2.383 Published: 03 June 2015

[This article presents a theory of outside equity based on the control rights and the maturity design of equity. I show that outside equity is a tacit agreement between investors and management supported by the equity-holders' right to dismiss management regardless of performance and by the lack of a prespecified expiration date on equity. As a tacit agreement outside equity is sustainable despite management's potential for manipulating the cash flows and regardless of how costly it is for equityholders to establish a case against managerial wrongdoing. I establish that the only outside equity that investors are willing to hold in equilibrium is that with unlimited life, the very outside equity that corporations issue. Consistent with empirical evidence, this model predicts that debt-equity ratios are higher (lower) in industries with low (high) cash flow variability.]

Corporate bonds include restrictive covenants that may prevent firms from pursuing valuable growth opportunities ex post and are virtually impossible to renegotiate. We study a common but little-known contractual provision—the defeasance option—which allows issuers to immediately remove all covenants without retiring the bond. Our theoretical model predicts, and our empirical analysis confirms, that defeasance inclusion is more likely when covenants are numerous and issuers face financial constraints, uncertainty, and growth opportunities. We also show that investors require lower yields when defeasance is included in noncallable bonds, and higher yields in fixed-price callable bonds, where it raises call risk.

This paper investigates whether predictable patterns that previous empirical work in finance have isolated appear to be persistent and exploitable by portfolio managers. On a sample that is free from survivorship bias we construct a test wherein we simulate the purchases and sales an investor would undertake to exploit the predictable patterns, charging the appropriate transaction costs for buying and selling and using only publicly available information at the time of decision making. We restrict investment to large companies only to assure that the full cost of transactions is properly accounted for. We confirmed on our sample that contrarian strategies yield sizable excess returns after adjusting for risk, as measured by beta. Using analysts' estimates of long-term growth we construct a test of the Lakonishok, Shleifer, and Vishny (1994) hypothesis. We cannot reject the hypothesis that neither the low-expected-growth portfolio nor the high-expected-growth portfolio yielded any risk-adjusted excess return over the 1980s. Our finding suggests that the superior performance of contrarian strategies cannot adequately be explained by the superior performance of stocks with low expected growth.

This paper investigates the design of privatization mechanisms in emerging market economies characterized by political constraints that limit the set of viable privatization options. Our objective is to explain the striking diversity of mechanisms observed in practice and the frequent use of an apparently sub-optimal privatization mechanism: private negotiations. We develop a simple model in which privatization is to be carried out by a government agent, who plays favorites among bidders but is potentially disciplined by losing his private benefits of staying in office. If the political environment is such that the privatization agent himself aims at raising the fair value for the company, then privatization auctions and private negotiations are equally successful in raising public revenues. If, however, political considerations distort the agent’s incentives, it may be that a seemingly transparent auction will raise less revenue, than opaque private negotiations. We also show that information disclosure laws may have negative welfare implications: they may help the privatization agent to collude with some of the bidders to the disadvantage of non-colluding bidders.

The fastest growing segment of private equity (PE) deals is secondary buyouts (SBOs)—sales from one PE fund to another. Using a comprehensive sample of leveraged buyouts, we investigate whether SBOs are value-maximizing, or reflect opportunistic behavior. To proxy for adverse incentives, we develop buy and sell pressure indexes based on how close PE funds are to the end of their investment period or lifetime, their unused capital, reputation, deal activity, and fundraising frequency. We report that funds under pressure engage more in SBOs. Pressured buyers pay higher multiples, use less leverage, and syndicate less suggesting that their motive is to spend equity. Pressured sellers exit at lower multiples and have shorter holding periods. When pressured counterparties meet, deal multiples depend on differential bargaining power. Moreover, funds that invested under pressure underperform.