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Abstract:
This paper models the real investment and financial portfolio decisions of a regulated utility, selling power at fixed prices to consumers and buying power in an unregulated spot market. Consumer demand is stochastic and subject to large shocks. Utilities can either meet consumers' demand by buying power on the spot market or by adding capacity. The risk associated with a surge in consumer demand can be hedged by trading in a financial derivatives market. Solving for the optimal policy for an individual utility, we show that, as power shortfalls increase, the optimal hedge position is a nonlinear mixture of price risk and quantity risk hedging. We then examine the aggregate impact of these hedging positions and show that the spot price process shifts from a marginal-cost-based regime to a regime based on aggregate financial capacity of the power industry. Although individual utilities, acting as price takers, can lower their expected power shortfalls by hedging with derivatives, derivative demand in the aggregate increases spot price volatility when power default occurs, and may thus increase the number of power defaults. At the same time, punitive regulatory penalties for power defaults may actually increase aggregate defaults by encouraging utilities to hedge outage risks through derivative markets rather than through increased capacity.

Utilities, Risk Management, Capacity choice, Contagion effect

Abstract:
In this paper, we develop an economic rationale for a the following stylized facts: Web-based firms command high (and highly volatile) valuations relative to earnings, spend profligately on advertising and marketing, and usually lose money. Our rationale is based on the winner-take-all structure of high-fixed-cost, low-marginal-cost, markets for information goods. This market structure ensures that market participation and the investment strategy are highly stochastic. Moreover, if a firm chooses to participate in a web market, it is optimal to act very aggressively through saturation advertising. While increases in advertising costs reduce the probability of entry, once the decision to enter is made, firm strategies are insensitive to advertising price. These competitive strategies generate returns that are highly positively skewed, following a Pareto-like distribution. Thus, firms have a small chance of huge gains combined with a large probability of ruin. In dynamic competition, firms weakened by early rounds are is less likely to challenge in subsequent rounds. However, when a challenge is attempted, it is always aggressive. In addition, since large expenditures in the first period produce valuable strategic real options in later periods, which are treated as expenses using traditional accounting methodology, the financial valuation of internet firms may actually be negatively related to performance using standard accounting measures of profitability that fail to capitalize these strategic real options.

Abstract:
We consider default by firms that are part of a single clearing mechanism. The obligations of all firms within the system are determined simultaneously in a fashion consistent with the priority of debt claims and the limited liability of equity. We first show, via a fixed-point argument, that there always exists a clearing payment vector that clears the obligations of the members of the clearing system; under mild regularity conditions, this clearing vector is unique. Next, we develop an algorithm that both clears the financial network in a computationally efficient fashion and provides information on the systemic risk faced by individual system firms. Finally, we produce qualitative comparative statics for financial networks. These comparative statics imply that, in contrast to single-firm results, unsystematic, nondissipative shocks to the system will lower the total value of the network and may lower the value of the equity of some of the individual network firms.

Credit risk, Default, Clearing Systems

Abstract:
We consider default by firms that are part of a single clearing mechanism. The obligations of all firms within the system are determined simultaneously in a fashion consistent with the priority of debt claims and the limited liability of equity. We first show, via a fixed-point argument, that there always exists a "clearing payment vector" that clears the obligations of the members of the clearing system; under mild regularity conditions, this clearing vector is unique. Next, we develop an algorithm that both clears the financial network in a computationally efficient fashion and provides information on the systemic risk faced by individual system firms. Finally, we produce qualitative comparative statics for financial networks. These comparative statics imply that, in contrast to single-firm results, unsystematic, nondissipative shocks to the system will lower the total value of the network and may lower the value of the equity of some of the individual network firms.

Abstract:
In this paper, we develop a dynamic model of institutional share dumping surrounding control events. Institutional investors sometimes dump shares, despite trading losses, in order to manipulate share prices and trigger activism by "relationship" investors. These institutional investors are motivated to trade not only by trading profits but also by a desire to protect the value of their inventory and to disguise the quality of their own information. Relationship investor profit from targeting firms both by improving firm performance and by generating private information.

Strategic trading, Ownership structure, Corporate governance

Abstract:
In this paper, we develop a dynamic model of institutional share dumping surrounding control events. Uninformed institutional investors dump shares, despite trading losses, in order to manipulate share prices and trigger activism by activist "relationship" investors. Nonactivist institutional investors, who have private information regarding both firm value and the quality of their own information, are motivated to trade not only by trading profits but also by a desire to protect the value of their inventory and to disguise the quality of the information underlying their trades. Relationship investors, who use price and volume information to identify target firms, profit both from improving firm performance and from their private information about their own targeting activity. In addition to explicating recent empirical results on the relationship between institutional investor trading and corporate control events, the paper provides a number of new insights into the interaction between market microstructure and corporate governance, including predictions regarding the effect of share volume on subsequent governance activity, the relationship between the trading patterns of activist and nonactivist strategic investors, the effect of order flow on subsequent shareholder activism, and the effect of institutions' portfolio positions on the informativeness of their trading activity.

Capital and Ownership Structure and Corporate Governance

Abstract:
This article investigates investor activism when a number of investors are capable of expending resources to exercise a role in corporate governance rather than the single large monitoring shareholder featured in most of the extant literature. Managers choose a level of perk consumption based on their conjectures regarding investor monitoring strategies. Institutional investors make monitoring decisions and engage in strategic trade in anonymous financial markets with other agents whose trades are motivated either by liquidity or by portfolio- balancing considerations. In this setting, it is shown that a core group of monitoring institutions emerges endogenously to curtail managerial opportunism. These core institutions pursue activist policies and engage in heavy trading on both the buy and sell side of the market. In addition a fringe group of monitoring institutions, which are somewhat active and trade only on the buy side, may emerge. Although the smallest institutions are passive, there is no monotonic relationship between shareholdings and activism. In fact, among those institutions that choose to monitor with positive probability, those with smaller holdings are the most active. In addition to characterizing the emergence of monitoring activity in the presence of numerous potential activist investors, comparative statics are also developed. Some these comparative statics are counterintuitive from the perspective of models that fail to endogenize both security market structure and shareholder activism: For example, it is shown that, despite the attendant exacerbation of the free-rider problem, some dispersion of institutional holdings can actually increase monitoring efficiency, and that increasing the size of the shareholdings controlled by informed institutional investors may lower bid-ask spreads.

Abstract:
This study finds a significant and pervasive decline but not an elimination of CEO optionbased compensation after the corporate governance scandals around 2000-2001 centered on executive option compensation. Some, but not all, of the drop is predicted by changes in the characteristics of firms, CEOs, boards of directors, and markets. In the cross-section, the change in CEO options is positively related to firm size, growth opportunities, ownership by large pension funds, and CEO experience and negatively related to firm age, board size, and "fair" value expensing of options. The findings provide significant support for the hypothesis that CEO options are affected by optimal contracting considerations, the hypothesis that CEO power is a significant determinant of CEO options, and, to some extent, the hypothesis that differences in perceived and actual costs of CEO options are important. Overall, however, the optimal contracting hypothesis is most able to explain the cross-sectional variation in the decline in options after the scandals.

Executive stock options, Executive compensation, Corporate governance

Abstract:
We model and experimentally examine the board structure-performance relationship. We examine single-tiered boards, two-tiered boards, insider-controlled boards and outsider-controlled boards. We find that even insider-controlled boards frequently adopt institutionally preferred rather than self-interested policies. Two-tiered boards adopt institutionally preferred policies more frequently, but tend to destroy value by being too conservative, frequently rejecting good projects. Outsidercontrolled single-tiered boards, both when they have multiple insiders and only a single insider, adopt institutionally preferred policies most frequently. In those board designs where the efficient Nash equilibrium produces strictly higher payoffs to all agents than the coalition-proof equilibria, agents tend to select the efficient Nash equilibria.

outside directors, corporate governance

Abstract:
We study the relation between liquidity costs and the kurtosis of daily stock returns for size-based portfolios of NYSE/AMEX stocks from 1964 to 2003. We document a robust, positive, and significant relation between the liquidity costs of trade and the kurtosis of daily stock return distributions. This relation holds for most standard measures of liquidity costs, as well as with simple proxies for liquidity costs such as stock price and firm size. The relation is also confirmed by the shift in kurtosis accompanying stock splits and by the relation between kurtosis and stock splits observed in non-U.S. stock markets.

Asset pricing anomalies, daily return, kurtosis, liquidity costs, transaction

Abstract:
This paper models the capital structure of a multinational firm. The analysis shows that differences between legal systems in the enforcement of creditor rights, (recently documented by empirical research) can explain the complex mix of parent and subsidiary financing observed in most multinational firms, even in the absence of both tax differentials and private information. Optimal capital structures minimize the default premia associated with the multinational's overall financing package by equating the marginal enforcability of debt contracts in the host and home countries. The implications of this model are consistent with the extant empirical research and suggest a number of new testable implications for the financing of multinational firms.

Abstract:
We examine voting by a board designed to mitigate conflicts of interest between privately informed insiders and owners. Our model demonstrates that, as argued by researchers and the business press, boards with a majority of trustworthy but uninformed "watchdogs" can implement institutionally preferred policies. Our laboratory experiments strongly support this conclusion. Our model also highlights the necessity of penalties on insiders when there is dissension among board members. However, penalties for dissent appeared to have little impact on the experimental outcomes.

Abstract:
We examine voting by a board designed to mitigate conflicts of interest between privately informed insiders and owners. Our model demonstrates that, as argued by researchers and the business press, boards with a majority of trustworthy but uninformed "watchdog" agents can implement institutionally preferred policies. Our laboratory experiments strongly support this conclusion. Our model also highlights the necessity of penalties on insiders when there is dissension among board members. However, penalties for dissent appeared to have little impact on the experimental outcomes.

corporate governance, implementation, experimental economics, mechanism design

Abstract:
This paper develops a new theory of CEO compensation based on the opacity of the internal workings of corporations to outsiders and the CEO's ability to divert or tunnel corporate resources to self-enriching uses. In this setting, neither high powered option compensation nor fixed salary compensation is optimal. Firm-value-maximizing compensation designs are low powered, featuring compensation that increases linearly in the book value of assets but is highly concave in performance. This optimal design can be implemented with a menu of capped bonus payments similar to the 80/120 bonus plans observed in practice. Given optimal compensation design, tunneling is concentrated in high market/book firms that are overvalued by outsiders. Eliminating the gap between inside and outside valuations eliminates the optimality of low powered compensation and renders high powered option compensation the best deterrent to tunneling.

management compensation, corporate governance, corporate fraud

Abstract:
We examine corporate security choice by simulating an economy populated by adaptive agents who learn about the structure of security returns and prices through experience. Through a process of evolutionary selection, each agent gravitates toward strategies that generate the highest payoffs. Despite the fact that markets are perfect and agents maximize value, a financing hierarchy emerges in which straight debt dominates other financing choices. Equity and convertible debt display significant underpricing. In general, the smaller the probability of loss to outside investors, the more likely the firm is to issue the security and the smaller the security's underpricing.

Abstract:
We examine corporate security choice by simulating an economy populated by adaptive agents who learn about the structure of security returns and prices through experience. Each agent experiments with different strategies and, through a process of evolutionary selection, gravitates toward strategies that generate the highest payoffs. Despite the fact that markets are perfect and agents maximize value, financing decisions are relevant because of pricing errors generated by imperfect learning. A financing hierarchy emerges in which straight debt dominates other financing choices. Equity and convertible debt securities display significant underpricing. Complex securities with theoretical appeal are not issued frequently. In general, the safety-first criterion defines the hierarchy of security issuance, that is, the smaller the probability of loss to outside investors produced by a security, the more likely the firm is to issue the security and the smaller the security's underpricing.

corporate financing, adaptive learning, genetic algorithm, security choice

Abstract:
We model long-run firm performance, management compensation, and corporate governance in a dynamic, nonstationary world. We show that the relations between firm performance, managerial compensation, and governance policies, which in a single-period context can best be rationalized by managerial influence, arise naturally in this dynamic setting where managers have no power over governance policy. For example, passive ``do-nothing'' boards are associated with rising firm valuations; substantial variation in management pay is generated by luck; managerial diversion of firm resources for private consumption is likely to accompany stock price declines which immediately follow sustained increases. Further, the threat of corporate control changes can adversely affect firm value, and incentive compensation schemes such as stock grants may not produce as much shareholder value as simple salary compensation. Finally, we demonstrate that optimal governance and compensation structures are highly dependent on the firm's asset base, its legal environment, and the effectiveness of the corporate control market.

governance, institutional design, management compensation

Abstract:
We model long-run firm performance, management compensation, and corporate governance in a dynamic, nonstationary world. We show that the relations between firm performance, managerial compensation, and governance policies, which in a single-period context can best be rationalized by managerial influence, arise naturally in this dynamic setting where managers have no power over governance policy. For example, passive "do-nothing" boards are associated with rising firm valuations; substantial variation in management pay is generated by luck; managerial diversion of firm resources for private consumption is likely to accompany stock price declines which immediately follow sustained increases. Further, the threat of corporate control changes can adversely affect firm value, and incentive compensation schemes such as stock grants may not produce as much shareholder value as simple salary compensation. Finally, we demonstrate that optimal governance and compensation structures are highly dependent on the firm's asset base, its legal environment, and the effectiveness of the corporate control market.

governance, institutional design

Abstract:
We analyze a financially-distressed firm,indebted to a number of creditors who hold claims of (perhaps) different priority. The firm's owners have the option of choosing the sequencing of restructuring negotiations with creditors. Both the cases of public and confidential negotiations are considered. We show that sequencing flexibility is highly beneficial to debtors, and that the optimal sequencing of restructuring negotiations involves exploiting the liabilities toward one creditor to moderate the demands of others. When the total number of creditors is small, the entrepreneur may also find confidential negotiations optimal. When the number of creditors is large, too much uncertainty on the part of creditors regarding entrepreneurial negotiating strategy, can become counterproductive. In this case, entrepreneurial payoffs can be increased by dividing creditors into groups and negotiating sequentially with each group.

Abstract:
We model corporate governance in a world with competitive securities markets as well as markets for corporate assets. We show that varying the liquidity and opacity of corporate assets, the vitality of the market for corporate control, and the costs of enforcing shareholder rights to cash flows leads to a plethora of institutional designs. When asset liquidity is high, shareholder rights are enforced through the option to liquidate as in a mutual fund. When the opacity of corporate assets is relatively high and asset liquidity is relatively low, firms will eschew reliance on board monitoring and instead rely on shareholder activism. An increase in the cost of ownership concentration, by increasing the inefficiency of shareholder activism, will increase the reliance on board activism and decrease the reliance on CEO compensation. Decreases in the cost of enforcement of shareholder rights and the opacity of corporate assets, and increased raider activity further strengthen the preference for activist boards.

governance, asset liquidity, institutional design

Abstract:
We model corporate governance in a world with competitive securities markets as well as markets for corporate assets. We show that varying the liquidity and opacity of corporate assets, the vitality of the market for corporate control, and the costs of enforcing shareholder rights to cash flows leads to a plethora of institutional designs. When asset liquidity is high, shareholder rights are enforced through the option to liquidate as in a mutual fund. When the opacity of corporate assets is relatively high and asset liquidity is relatively low, firms will eschew reliance on board monitoring and instead rely on shareholder activism. An increase in the cost of ownership concentration, by increasing the inefficiency of shareholder activism, will increase the reliance on board activism and decrease the reliance on CEO compensation. Decreases in the cost of enforcement of shareholder rights and the opacity of corporate assets, and increased raider activity further strengthen the preference for activist boards.

governance, asset liquidity, institutional design

Abstract:
In this paper, we consider the effect of labor market constraints on the Initial Public Offering (IPO) activity of investment banks. We posit that identifying IPO quality requires specialized screening labor that takes time to train. Positive shocks to economy's production frontier stimulate IPO demand. At this higher level of demand, screening labor costs must rise to clear the labor market. This results in underwriters optimally reducing screening quality, in the process encouraging firms with sub-marginal projects to also apply, further straining the screening labor market. In equilibrium, underpricing can be quite significant both because of lower quality screening and because of its role in lowering the quality of the applicant pool. Our model's predictions are consistent with empirical results such as positive correlation between IPO volume and underpricing, reduced information search per project during hot markets, and the persistence of high IPO volume in the face of increased underpricing.

IPO, hot markets, underpricing, capacity constraints

Abstract:
This paper embeds security design in a model of evolutionary learning. We consider a competitive and perfect financial market where agents, as in Allen and Gale (1988), have heterogeneous valuations for cash flows. Our point of departure is that, instead of assuming that agents are endowed with rational expectations, we model their behavior as the product of adaptive learning. Our results demonstrate that adaptive learning profoundly affects security design. Securities are mispriced even in the long run and optimal designs trade off under pricing against intrinsic value maximization. The evolutionary dominant security design calls for issuing securities that engender large losses with a small but positive probability, and otherwise produce stable payoffs. These designs are almost the exact opposite of the pure state claims which are optimal in the rational expectations framework.

corporate financing, adaptive learning, genetic algorithm, security choice

Abstract:
We analyse a bargaining game in which one party, called the buyer, has the option of choosing the sequence of negotiations with other participants, called sellers. When the sequencing of negotiations is confidential and the sellers' goods are highly complementary, efficient, non-dissipative equilibria exist in which the buyer randomizes over negotiation sequences. In these equilibria, the buyer can obtain higher pay-offs than in pure strategy equilibria or in public negotiations. The degree of sequencing uncertainty that maximizes buyer pay-offs is inversely related to the aggregate bargaining power of the sellers.

Abstract:
We analyze a bargaining game in which one party, called the buyer, is the active player and has the option of choosing the sequence of negotiations with other participants, called sellers. If the negotiations are public, the sellers who are negotiated with late in the sequence are in stronger bargaining positions and are able to extract larger payoffs from the buyer.
However, the total payouts to the sellers are invariant to the buyer's sequencing strategy. When the sequencing of negotiations is confidential, the situation is more complex and interesting. Equilibria exist in which the deal collapses and thus the Coase conjecture fails to hold. Also, there exist equilibria that feature deterministic negotiation sequencing and replicate the payoffs from public negotiations. More interestingly, new classes of efficient, non-dissipative equilibria emerge in which the buyer endogenously injects strategic uncertainty by randomizing over negotiation sequences. In fact, when the aggregate bargaining power of the sellers is small, equilibria featuring uniform randomization across negotiation sequences maximize the buyer's payoff. When the aggregate bargaining power of the sellers is large, uniform randomization is not optimal for the buyer, and may not even be supported by an equilibrium. In these cases, equilibria featuring fairly intricate strategies, e.g., dividing sellers into groups, uniformly randomizing within each group and randomizing asymmetrically across sequences of groups, generate higher payoff to the buyer than equilibria featuring deterministic or uniformly randomized negotiating sequences.

Abstract:
This paper develops a new theory of multinational capital structure based on legal-system arbitrage: The optimal capital structure for the multinational minimizes the value of the ex post opportunism options created by the diverse legal systems under which the multinational operates. This theory explains the complex mix between parent and subsidiary financing observed in most multinationals, even in the absence of both tax differentials and private information. Optimal capital structures minimize the default premia associated with the multinational's overall financing package by equating the marginal enforceability of debt contracts in the host and headquarters countries. Consistent with extant empirical research, the analysis shows that multinational utilization of local financing will be positively related to the creditor-friendliness of the local legal system. Further, the model provides an explanation for the fact that multinationals do not simply obtain all their financing in the location featuring the most creditor-friendly legal regime. In addition, the model produces many new empirical predictions regarding issues such as the venue selected by the multinational for restructuring, the optimal allocation of capital within the multinational, and the impact of currency risk on credit spreads and financing policy.

Abstract:
Short-term financial claims held by uninformed outside investors impose a tax on insider opportunism by diluting the ownership stake of opportunistic owner-managers. By thus limiting managerial opportunism, short-term financing increases firm value and social welfare. When given a choice, owner-managers will prefer socially beneficial short-term external financing over internal financing. We show that these results are equilibrium outcomes of a model where firms can act opportunistically in product markets. Moreover, we document the same beneficial eect of short-term external finance in a laboratory experiment implementing this game.

Adverse selection, financing, reputation

Abstract:
This paper documents the short and long term balance sheet effect of cash flow shocks. We show that cash savings in the short run and debt reduction in both the short and the long run account for a substantial fraction of cash flow use. Although, in the long run, investment exhibits substantial sensitivity to cash flows, investment does not absorb the entire cash flow shock. In fact, the tighter the financial constraints, the smaller the fraction of cash flow absorbed by investment and the more by leverage reduction. Firms stage their response to positive cash flow shocks, delaying investment while building up cash flow stocks and reducing leverage. These results suggest that much of the short-run economic effect of cash flow shocks to the corporate sector may be channeled into corporate debt market rather than capital goods market especially when financing constraints tighten.

Cash Inflow, Cash Flow Sensitivity, Cash Flow Identity, Measurement Error

Abstract:
This paper considers the team management of mutual funds, fund manager ability, fund performance, and holdings. We find evidence suggesting a positive relation between fund performance and team management concurrent with a negative relation between managerial ability and the use of team management. Consistent with the notion that team management suppresses portfolio eccentricity and leads to more generic trading strategies, thereby both increasing returns and making returns less informative of fund manager ability, we also find that team management is associated with less idiosyncratic portfolio holdings and a greater loading on large capitalization, low book-to-market, and momentum stocks.

Team Management, Fund Performance, Self Selection

Abstract:
We examine auction design in a context where symmetrically informed buyers and sellers of a good with a common but uncertain value learn through experience. Buyer strategies, even in the very long run, do not converge to the Bertrand-Nash strategy of bidding the expected value of the good. Moreover, first- and second-price auctions are not revenue equivalent. The outcomes of the auctions are sensitive to both the number of participating bidders and the reservation price. When only a small number of bidders participate, the sellers tend to employ a first-price auction even though it generates a lower average revenue than a second-price auction.

Auction design, adaptive learning, genetic algorithm

Abstract:
This paper models the real investment and financial portfolio decisions of a regulated utility, selling power at fixed prices to consumers and buying power in an unregulated spot market. Consumer demand is stochastic and subject to large shocks. Utilities can either meet consumers' demand by buying power on the spot market or by adding capacity. The risk associated with a surge in consumer demand can be hedged by trading in a financial derivatives market. Solving for the optimal policy for an individual utility, we show that, as power shortfalls increase, the optimal hedge position is a nonlinear mixture of price risk and quantity risk hedging. We then examine the aggregate impact of these hedging positions and show that the spot price process shifts from a marginal-cost-based regime to a regime based on aggregate financial capacity of the power industry. Although individual utilities, acting as price takers, can lower their expected power shortfalls by hedging with derivatives, derivative demand in the aggregate increases spot price volatility when power default occurs, and may thus increase the number of power defaults. At the same time, punitive regulatory penalties for power defaults may actually increase aggregate defaults by encouraging utilities to hedge outage risks through derivative markets rather than through increased capacity.

Utilities, Risk Management, Capacity choice, Contagion effect

Abstract:
This paper models, and experimentally simulates, the free-rider problem in a takeover when the raider has the option to "resolicit," that is, to make a new offer after an offer has been rejected. In theory, the option to resolicit, by lowering offer credibility, increases the dissipative losses associated with free riding. In practice, the outcomes of our experiment support the overall predictions of theory. Although in resolicitation treatments, raider offers generally exceeded equilibrium predictions, shareholder tendering probabilities were less than predicted by either actual or equilibrium offers. The net effect of higher-than-predicted raider offers and lower-than-predicted shareholder tendering was negative. Thus, as predicted by theory, the option to resolicit increased the total dissipative costs associated with free riding, and reduced raider gains to less than three percent of synergy value.

Key words: corporate takeovers, experimental economics, resolicit

Abstract:
This paper considers the team management of mutual funds, fund manager ability, performance, and holdings. We find evidence suggesting there is a positive relation between performance and team management concurrent with a negative relation between managerial ability and the use of team management. Consistent with the notion that the team management suppresses portfolio eccentricity and leads to more generic trading strategies, thereby both increasing returns and making returns less informative of fund manager ability, we also find that team management is associated with less idiosyncratic portfolio holdings and a greater loading on large capitalization, low book-to-market, and momentum stocks.

Abstract:
We study the relation between liquidity costs and the kurtosis of daily stock returns for NYSE/Amex stocks from 1983 to 2007. We develop a analytical model connecting market microstructure effects to the kurtosis in return distribution and we provide empirical evidence linking the liquidity costs of trade to the kurtosis in daily stock return distribution. This association holds regardless of controls for size, price, volume, time series volatility and risk; and we find robust results regardless using Fama-MacBeth regression specifications and test controlling for endogeneity bias.

Asset pricing anomalies, daily return, kurtosis, liquidity costs, transaction costs

Abstract:
This paper investigates the relation between stock liquidity and firm performance. We find that firms with liquid stocks have better firm performance as measured by the firm market-to-book ratio. This result holds when we include industry or firm fixed effects, control for idiosyncratic risk, control for endogenous liquidity with instrumental variables, or use alternative measures of liquidity. To identify the causal effect of liquidity on firm performance, we study an exogenous shock to liquidity --- the decimalization of stock trading --- and document that the increase in liquidity around decimalization improved firm performance. We next investigate the causes of liquidity’s beneficial effect. We show that liquidity increases the information content of market prices and enhances the value of performance sensitive managerial compensation. Finally, momentum trading, analyst coverage, investor overreaction and liquidity’s valuation effects do not appear to drive our results.

Stock Market Liqui, Firm Performance, Feedback Mechanism, Managerial Compensation, Blockholder Intervention

Abstract:
This paper develops and experimentally implements a simple multi-negotiation bargaining game, in which one agent, called the "developer," must reach agreements with a series of other agents, called "landowners," in order to implement a value-increasing project. The game has a unique subgame perfect Nash equilibrium under which the surplus from the project is split between the landowner and developer without any dissipation of value. In the actual experiments, however, on average almost half of the value of the project was dissipated. The costs of dissipation fell disproportionately on the developer, who was able to capture less than 5% of the value generated by the project. The results of this experiment call into question the ability of private negotiations between a large number of parties, even in a world without explicit contracting costs, to induce Pareto-optimal allocations of property rights.

Sequential bargaining, Coase Theorem, experiment

Abstract:
This article models, and experimentally simulates, the free-rider problem in a takeover when the raider has the option to "resolicit," that is, to make a new offer after an offer has been rejected. In theory, the option to resolicit, by lowering offer credibility, increases the dissipative losses associated with free riding. The outcomes of our experiment support this prediction and produce losses from free riding even higher than theoretically predicted. These dissipation losses reduce raider gains to less than 3% of synergy value of the acquisition

Abstract:
In this paper, we examine acquisitions of two financially distressed retailers - Federated's takeover of Macy's, and Zell Chilmark's takeover of Carter Hawley Hale. In both cases the raider purchased some of the target's outstanding debt to launch its takeover attempt. These debt purchases appear to have been facilitated by two salient factors - the raider's expertise in dealing with distressed firm restructuring and the ability of the raider to acquire a large blockholding of debt. Our analysis indicates that, when these factors are present, it is optimal for a raider to initiate a takeover of a distressed firm through purchasing a block of the firm's debt. Target bondholder reaction will be favorable whereas shareholder reaction may be either favorable or unfavorable.

Abstract:
In this paper, we examine two acquisitions of financially distressed retailers: Federated's takeover of Macy's, and Zell Chilmark's takeover of Carter Hawley Hale. In both cases the raider purchased some of the target's outstanding debt to launch its takeover attempt. These debt purchases appear to have been facilitated by two salient factors: the raider's comparative advantage over existing debtholders and the presence of large blockholdings of debt. Our analysis of indicates that, when these factors are present, it is optimal for a raider to initiate a takeover of a distressed firm through purchasing a block of debt. Target bondholder reaction will be favorable while shareholder reaction may be either favorable or unfavorable.

Abstract:
This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very “low powered,” i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation that Jensen () argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks.

G3, J3

Abstract:
We posit that screening IPOs requires specialized labor which is in fixed supply. A sudden increase in demand for IPO financing increases the compensation of IPO screening labor. This results in reduced screening, encouraging sub-marginal firms to enter the IPO market, further fueling the demand for screening labor. The model's conclusions are consistent with empirical findings of increased underpricing during hot markets, positive correlation between issue volume and underpricing, and with tipping points between hot and cold markets. Finally, the model makes sharp predictions relating the IPO market to fundamental values of firms and to investment banking returns.

G20, G24

Abstract:
We model and experimentally examine the board structure performance relationship. We examine single-tiered boards, two-tiered boards, insider-controlled boards, and outsider-controlled boards. We find that even insider-controlled boards frequently adopt institutionally preferred rather than self-interested policies. Two-tiered boards adopt institutionally preferred policies more frequently but tend to destroy value by being too conservative, frequently rejecting good projects. Outsider-controlled single-tiered boards, both when they have multiple insiders and only a single insider, adopt institutionally preferred policies most frequently. In those board designs where the efficient Nash equilibrium produces strictly higher payoffs to all agents than the coalition-proof equilibria, agents tend to select the efficient Nash equilibria.

G34, C72

Abstract:
This study reviews papers from the Eastern Finance Association's Symposium on Corporate Finance, Incentives, and Strategy. I identify the common themes underlying these papers and place the studies in the broader context of contemporary academic finance research. Further, I discuss new directions for future research in corporate finance that are suggested in these studies.

Abstract:
We analyze a distressed firm indebted to many creditors. The firm's owners have the option of choosing the sequence of restructuring negotiations with the creditors. We show that sequencing flexibility is beneficial to firm owners, and that the optimal sequencing of restructuring negotiations involves exploiting the firm's liabilities to some creditors so as to moderate the demands of others. Moderately distressed firms will eschew renegotiations with creditors in strong bargaining positions. Severely distressed firms will extract concessions from all creditors. In this case, owners can gain if they can credibly commit to conditional restructuring agreements that link the concessions of one creditor to concessions by others.

Abstract:
We present an economic mechanism, and supportive empirical evidence, for the transmission of information between equity securities first documented by Lo and MacKinlay (1990). It is argued that the past returns on stocks held by informed institutional traders will be positively correlated with the contemporaneous returns on stocks held by noninstitutional uninformed traders. Evidence consistent with this hypothesis is then presented. We document that the returns on the portfolio of stocks with the highest level of institutional ownership lead the returns on portfolios of stocks with lower levels of institutional ownership. This effect persists after firm size is controlled for and is apparent at longer lags than the size-related lag effects documented in Lo and MacKinlay (1990).

Abstract:
In this paper we analyze the optimal design of debt- maturity, coupon payments, and dividend payout restrictions under asymmetric information. In our model, if the asymmetry of information is concentrated around long-term cash flows, firms finance with coupon-bearing long-term debt that partially restricts dividend payments. If the asymmetry of information is concentrated around near-term cash flows and there exists a significant possibility that they will be unable to refinance short-term debt, firms finance with coupon-bearing long-term debt that does not restrict dividend payments. Finally, if the asymmetry of information is uniformly distributed across dates, firms finance with short-term debt. Thus, it is the distribution of informational asymmetry across dates rather than the degree of information asymmetry per se that determines firms' debt-financing policies.

Abstract:
A common theme in the literature on corporate control is that, when share ownership is diffuse, the free-rider problem prevents raiders from making acquisitions at tender prices below the post-acquisition share price. In this paper, we address this question by formulating a nonstandard model of takeovers of diffusely held firms. It is demonstrated that, even when individual shareholdings are infinitesimal relative to firm size, takeovers succeed with positive probability and equilibria exist in which the raider earns substantial per share profits. Further, the Nash equilibria of the game are characterized with regard to raider profit, the aggregate fraction of shares tendered, and the relation between raider profit and the degree of randomization exhibited by shareholder tendering strategies.

Abstract:
It is generally acknowledged that myopic investment policies are one of the pressing problems facing U.S. industry. This paper provides a rationale for such myopic investment policies based on managerial opportunism and the allocation of control rights between shareholders and managers. In the analysis, shareholder myopia is a rational response to the hold-up problem engendered by the ability of managers to opportunistically exploit their capacity to generate firm- specific rents. Active shareholder control of the firm's policies exacerbates this myopic tendency. In contrast, when shareholder control is weak, the hold-up problem can mitigate investment distortions.

Abstract:
We examine corporate issuance and payout policies in the presence of both adverse selection (in capital markets) and managerial opportunism. We show that, when shareholders determine policies, debt financing is always optimal in the presence of either pure adverse selection or pure managerial opportunism. However, when both of these problems are simultaneously present, equity issuance may become an optimal signaling mechanism. Shareholders utilize the three signals at their disposal, dividend policy, capital structure, and security pricing, hierarchically. The most preferred signaling mechanism being restricting dividends, followed by equity financing, and finally underpricing securities. When managers determine policies, these results may reverse.

Abstract:
This paper investigates, from both a theoretical and clinical perspective, bond tender offers accompanied by a threat to call nontendered bonds, or so-called STACs. The theoretical analysis explains the use of STACs and derives conditions under which the call threats embedded in STACs are credible. These conditions relate to the degree of bondholder coordination, and the relative costs of adverse selection and suboptimal call policies. Next, three cases of actual STACs-James River, May Department Stores, and Houston Power and Light-are investigated. A rough correspondence between the evolution of these STACs and the different strategic equilibria of the model is established.

Abstract:
It is generally agreed that stockholder/bondholder agency conflicts are an important factor in the determination of corporate debt maturity policies. It has also frequently been argued that agency considerations favor shorter debt maturities. In this paper, we show that if the locus of the agency problem is the firm's ability to manipulate the timing of firm cash flows, short-term debt induces an agency problem by encouraging investment myopia. Despite this, short-term debt may be an optimal financing vehicle when the agency conflict is accompanied by asymmetry of information between the firm and outside investors. Further, long-term covenanted debt, which eliminates myopic bias in investment policies, may induce negative informational effects sufficiently powerful to preclude its use.

Abstract:
This paper simulates, via a genetic-learning algorithm, the problems of free-riding and coordination failure when shareholders are confronted with a tender offer bid between pre-and post-takeover firm value. The outcomes produced in the simulations offer qualified support for the hypothesis that coordination to tendering strategies permitting offer success will only be partial. Further, coordination is impaired by increasing the number of shareholders. Generally increasing the divisibility of share holdings improves coordination and increases shareholder profits. Interestingly, for those parameters of the share tendering distribution which are predicted by the Nash hypothesis (e.g., the proportion of shares tendered) the results of the simulations usually approximate the results predicted by the Nash hypothesis. Moreover, those deviations from Nash outcomes which are observed are usually consistent with the biases observed in experiments on human subjects.

Abstract:
This paper models an economy in which managers, whose efforts affect firm performance, are able to make "inside" trades on claims whose value is also dependent on firm performance. Managers are able to trade only on "good news," that is, on returns above market expectations. Further, managers cannot trade at all unless permission for such trading is granted by shareholders. Insider trading is in derivative securities and thus does not adversely affect the firm's cost of raising funds. In this setting, it is shown that a prohibition on insider trading may still generate welfare improvement over a regime that allows shareholders to determine insider trading policy. This result obtains because insider trading, although improving managerial effort incentives for any fixed compensation level, also improves the bargaining position of shareholders relative to managers. This reduces the willingness of shareholders to provide expensive effort-assuring managerial compensation packages.

Abstract:
We examine the role of bargaining power, informational asymmetry, and equity participation restrictions on the division of the gains from cooperation between multinational and domestic firms. When the bargaining advantage rests with the multinational, equity participation restrictions can increase the profits to domestic firms and encourage sub-optimal investment policies. Overinvestment occurs when the multinational's bargaining advantage is reinforced by an informational advantage, while underinvestment occurs when the domestic firm possesses the informational advantage. Equity participation restrictions, however, do not affect investment policies or the division of gains from joint ventures when the bargaining advantage rests with the domestic firm.

Abstract:
In this paper we show, in an incomplete contracts framework which combines asymmetric information and moral hazard, that by permitting insiders to trade on personal account the equilibrium level of output can be increased and shareholder welfare can be improved. This result follows for two reasons. First, insider trading impounds information regarding managerial taste for perk consumption into asset prices and this allows shareholders to choose more efficient portfolio allocations. Secondly, allowing insider trading can induce managers to increase their stake in the firm beyond the that obtained through bargaining with shareholders. This effect leads in a reduction in managerial perk consumption and/or increased managerial effort.

Abstract:
In this paper we develop a framework for examining the effectiveness of boards in controlling self-interested managerial behavior. We show that, even if outside directors are uninformed and are unable to monitor management, they are crucial to implementing efficient corporate policies. Outside directors are effective when they possess sufficient votes to block management proposals and are able to coordinate their actions. In some cases, outside directors can be effective even if they receive no performance-contingent compensation from the firm. Finally, even when insiders have identical interests, efficiency can be increased by including multiple insiders on the board.

Abstract:
We examine corporate issuance and payout policies in the presence of both adverse selection (in capital markets) and managerial opportunism. Our results establish the importance of the locus of decision control in the firm. When shareholders determine policies, debt financing is always optimal in the presence of either adverse selection or managerial opportunism. However, when both of these problems are simultaneously present, equity issuance can become an optimal signaling mechanism. Shareholders' most preferred signaling mechanism is restricting dividends, followed by equity financing, and finally underpricing securities. When managers determine policies, a reversed hierarchy may by obtained.

Abstract:
This paper investigates the use of debtor-in possession (DIP) financing by firms reorganizing under the protection of Chapter 11. A model is developed in which there is asymmetric information between the creditors of a bankrupt firm and its management. In this context, it is demonstrated that reliance on DIP financing resolves informational asymmetries regarding the true economic value of bankrupt firms. Empirical results support the model's conclusions. The signaling role of DIP finance is evidenced both by positive stock and bond price reactions to DIP announcements and the fact that firms employing DIP financing have more successful reorganizations.

Abstract:
This paper compares the predictions of finite-shareholder models of conditional and unconditional takeover offers with the outcomes of laboratory experiments. In addition to differentiating between types of offers, the experimental designs span small and large firms as well as different levels of offer premiums. It is found that in unconditional offers to large groups of subjects (28 - 40), the symmetric Nash equilibrium predicts observed tendering frequencies quite accurately. For other experimental designs, the results are mixed. The analysis of shareholder tendering strategies from the experiment yields insights into (i) the effects of takeover offer designs, (ii) the appropriateness of finite-shareholder models for research, and (iii) the costs of free-riding when shareholders are non-atomistic.

Abstract:
Our analysis explains how vulture investors (vultures) can build reputations for toughness, and these reputations can be exploited to profit from the purchase of distressed-firm claims. Vultures are able to successfully exploit their reputations both in anonymous and non-anonymous markets. If markets are not anonymous, vultures purchase the claims that are most likely to render them marginal in debt restructurings. Their profits are proportional to the degree of uncertainty regarding firm's true financial true condition. In anonymous markets, vulture's disguise their security acquisitions. By disguising their acquisitions, vulture's create uncertainty regarding the identity of the marginal creditor in corporate restructurings. This facilitates successful bluffing and enables other creditors to profit from the vulture activity.

Abstract:
The relationship between asset demand and information quality in rational expectations economies is analyzed. First we derive a number of new summary descriptive statistics that measure four basic characteristics of investment style: asset selection, market timing, aggressiveness, and specialization. Then we relate these statistics to the divergence between a given investor's information structure and the market average information structure. Finally, we demonstrate that informational differentials can be identified, and consistently estimated, using OLS from the time series of observed asset demand.

Abstract:
We provide experimental evidence that non-binding pre-play communication between bidders in auctions of shares facilitates the adoption of equilibrium strategies: collusive strategies in uniform-price auctions, and the unique equilibrium in undominated strategies in discriminatory auctions. When communication between bidders is introduced, clearing prices and auctioneer profits in uniform-price auctions fall below those observed in discriminatory auctions. This evidence suggests that uniform-price auctions of Treasury securities may result in lower revenues than the currently-employed discriminatory procedure.

Abstract:
We provide experimental evidence that non-binding pre-play communication between bidders in auctions of shares facilitates the adoption of equilibrium strategies: collusive strategies in uniform-price auctions, and the unique equilibrium in undominated strategies in discriminatory auctions. When communication between bidders is introduced, clearing prices and auctioneer profits in uniform-price auctions fall below those observed in discriminatory auctions. This evidence suggests that uniform-price auctions of Treasury securities may result in lower revenues than the currently-employed discriminatory procedure.

Abstract:
The purpose of the this paper is to study the design of securities when a firm must raise external capital from an asymmetrically informed capital market and when the firm has operating discretion in the management of the capital raised that embodies the essence of the asset substitution problem. It is shown that in this setting, if the operating discretion is sufficiently broad, there is no dissipation of value from asset substitution and hence no agency costs of this incentive problem, but the security design problem is severely constrained. Optimal operating policy decisions result in limiting security designs essentially to convex claims on firm cash flow. In this context, both equity and levered equity (the residual claim being inside debt) are natural candidates for optimal security designs. We characterize the private productivity information of the firm that yields equity as an optimal security design. This characterization involves an intuitive comparison of indices of mispricing gains of equity vis-a-vis those of levered equity. The relevant conditions are satisfied in a varietyof contexts, but they are not universal. We then pursue further the security designs that minimize mispricing and we show that in this context the optimal security designs are scaled versions of levered equity, which includes the conditions under which equity is optimal as a limiting case. This gives theoretical foundation for the use of inside debt in managing the asset substitution problem even when there are no agency costs of asset substitution.