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Abstract:
Shareholder agreements govern the relations among shareholders in privately-held companies, such as joint ventures or venture capital-backed firms. We provide an economic explanation for the use of put and call options, pre-emption rights, catch-up clauses, drag-along rights, demand rights, and tag-along rights in shareholder agreements. We view these clauses as a response to a problem of dynamic, double moral hazard, whereby the value of the venture depends on ex ante investments and ex post transfers. Contract clauses i) preserve the incentives to make ex ante investments and ii) minimize ex post transfers. We extend our framework to discuss the use of other clauses, such as the option to extend the life of a business alliance. (JEL: G34).

Shareholder Agreements, Put Options, Call Options, Pre-emption Rights, Catch-up Clauses, Drag-along Rights, Demand Rights, Tag-along Rights

Abstract:
Shareholder agreements govern the relations among shareholders in privately-held companies, such as joint ventures or venture capital-backed firms. We provide an explanation for the use of put and call options, pre-emption rights, drag-along rights, demand rights, tag-along rights, and catch-up clauses in shareholder agreements. We view these clauses as serving to preserve the parties' incentives to make ex ante investments when ex post renegotiation may alter the parties' shares of the payoff. We extend our framework to discuss the use of other clauses, such as the option to extend the life of a business alliance.

Shareholder agreements, put options, call options, pre-emption rights, drag-along rights, demand rights, tag-along rights, catch-up clauses

Abstract:
Shareholder agreements govern the relations among shareholders in privately-held firms, such as joint ventures or venture capital-backed firms. We provide an explanation for the use of put and call options, tag-along rights, drag-along rights, demand rights, piggy-back rights, and catch-up clauses in shareholder agreements. We view these clauses as serving (1) to induce the parties to make ex ante investments, (2) to preclude ex post transfers by the party that has the ability to engage in such transfers, and (3) to achieve the efficient ex post allocation of stakes in the firm.

Shareholder Agreements, Put Options, Call Options, Pre-emption Rights, Catch-up Clauses, Drag-along Rights, Demand Rights, Tag-along Rights

Abstract:
We provide a direct estimate of the magnitude of agency costs in publicly-held corporations. We compute an explicit performance benchmark that compares a firm's actual Tobin's Q to the Q* of a hypothetical value-maximizing firm having the same inputs and characteristics as the original firm. The Q of the average sample firm is around 16% below its Q*, equivalent to a $1,432 million reduction in its potential market value. We relate the shortfall in value to the incentives provided to CEOs. Boards appear to grant CEOs too few shares and too many options which are insufficiently sensitive to firm risk.

Abstract:
We model owners as solving a multidimensional problem when taking their firms public. Owners can affect the level of underpricing through the choices they make in promoting an issue, such as which underwriter to hire or what exchange to list on. The benefits of reducing underpricing in this way depend on the owners' participation in the offering and the magnitude of the dilution they suffer on retained shares. We argue that the extent to which owners trade-off underpricing and promotion is determined by the minimization of their wealth losses. Evidence from a sample of U.S. IPOs confirms our empirical predictions.

Abstract:
We distinguish between discovery information and private foreknowledge in the valuation of initial public offerings of corporate securities. An underwriter gathers discovery information to value and price the issue. The issuing firm relies on this information to make the optimal investment decision. In the absence of syndicate restrictions, the inevitable errors in pricing give outsiders the opportunity to acquire private foreknowledge to effect wealth transfers from the underwriter. Because this activity is costly but has no influence on the issuer's investment, it reduces the parties' joint wealth. They therefore have an incentive to organize their arrangements to avoid the associated losses. We show how various features of the syndicate system perform this function, increasing the returns to investment banking and decreasing the cost of capital to issuing firms.

Abstract:
We analyze the role of knowhow acquisition in the formation and duration of joint ventures. Two parties become partners in a joint venture to benefit from each other's knowhow. Joint operations provide each party with the opportunity to acquire part of its partner's knowhow. A party's increased knowhow provides the impetus for the dissolution of the joint venture. We characterize the conditions under which dissolution takes place, identify the party that buys out its partner, determine the time to dissolution, establish its comparative statics, and examine the implications of knowledge acquisition for the desirability of joint venture formation. (JEL code: G34)

Abstract:
We analyze the role of knowhow acquisition in the formation and duration of joint ventures. Two parties become partners in a joint venture in order to benefit from each other's knowhow. Joint operations in the joint venture provide each party with the opportunity to acquire part of its partner's knowhow. A party's increased knowhow provides the impetus for the dissolution of the joint venture, as it decreases the need for the partner's knowhow. Dissolution takes the form of the buy out of one partner by the other. We characterize the conditions under which such dissolution takes place, identify the party that buys out its partner, determine the time to dissolution, establish its comparative statics, and examine the implications of knowledge acquisition for the desirability of joint venture formation.

Joint Ventures, Knowhow Acquisition, Optimal Dissolution Time, Continuous-Time Corporate Finance.

Abstract:
We analyze the role of knowhow acquisition in the formation and duration of joint ventures. Two parties become partners in a joint venture in order to benefit from each other's knowhow. Joint operations in the joint venture provide each party with the opportunity to acquire part of its partner's knowhow. A party's increased knowhow provides the impetus for the dissolution of the joint venture, as it decreases the need for the partner's knowhow. Dissolution takes the form of the buy out of one partner by the other. We characterize the conditions under which such dissolution takes place, identify the party that buys out its partner, determine the time to dissolution, establish its comparative statics, and examine the implications of knowledge acquisition for the desirability of joint venture formation.

Joint Ventures, Knowhow Acquisition, Optimal Dissolution Time, Continuous-Time Corporate Finance.

Abstract:
In spite of the fact that they can draw on a larger, more liquid and more diversified pool of capital than the equity of reinsurance companies, financial markets have failed to displace reinsurance as the primary risk-sharing vehicle for natural catastrophe risk. We show that this failure can be explained by differences in information gathering incentives between financial markets and reinsurance companies. Using a simple model of an insurance company that seeks to transfer a fraction of its risk exposure either through financial markets or through traditional reinsurance, we find that the supply of information by informed traders in financial markets may be excessive relative to its value for the insurance company, causing reinsurance to be preferred. We show that whether traditional reinsurance or financial markets are ultimately selected depends crucially on the information acquisition cost structure and on the degree of redundancy in the information produced. Limits on the ability of informed traders to profitably take advantage of their information make the use of financial markets more likely.

Catastrophe risk, insurance, reinsurance, financial markets, private and public financing

Abstract:
Over the period 2002 to 2003, Switzerland and the European Union (EU) were engaged in negotiations regarding banking secrecy. The EU's stated goal was for Switzerland to abolish banking secrecy. Switzerland refused and offered to impose a withholding tax on interest income instead. The two parties eventually agreed on the latter solution. We examine the effect of these negotiations on the share prices of four Swiss banks: UBS, Credit Suisse Group (CSG), Julius Baer (Baer), and Vontobel. Overall, investors believe that bank profitability will not be impacted by the imposition of the withholding tax. The event-by-event response of the share prices differs across banks. Whereas the two universal banks (UBS and CSG) primarily react to the threat of sanctions on their EU-based operations, the private banks (Baer and Vontobel) react strongly to events suggesting that banking secrecy might be abolished.

Banking Secrecy, Switzerland, Event Study

Abstract:
When information is costly, a seller may wish to prevent prospective buyers from acquiring information, for the cost of information acquisition is ultimately borne by the seller. A seller can achieve the desired prevention of information acquisition through posted-price selling, by offering prospective buyers a discount that is such as to deter them from gathering information. No such prevention is possible in the case of an auction. Clearly, a discount is costly to the seller. We establish the result that the seller prefers posted-price selling when the cost of information acquisition is high, and auctions when it is low. We view corporate bonds as an instance of the former case, and government bonds as an instance of the latter.

Government Bonds, Corporate Bonds, Auctions, Posted-price Selling, Costly Information

Abstract:
We characterize the conditions under which two firms choose to (i) merge, (ii) form an alliance, or (iii) trade assets. For that purpose, we distinguish between the firms' assets, their knowhow, and their core competencies. We show that a merger is chosen when the two firms have similar core competencies. When one firm has markedly higher core competencies than the other, that firm operates the assets separately if it also has markedly higher knowhow. Finally, an alliance is chosen when the firm with markedly higher core competencies has markedly lower knowhow.

Mergers, Alliances, Asset Sales, Knowhow, Core Competencies, Dissolution, Superseding, Dynamic Corporate Finance.

Abstract:
We examine the relation between firm value and managerial incentives in a sample of 1,307 publicly-held U.S. firms in 1992-1997. As predicted by Berle and Means (1932), we find that CEOs do not maximize firm value when they are not the residual claimant: our firms have higher Tobin s Q, the higher are CEO stockholdings. We also investigate the incentive properties of options and find that CEOs appear to hold too many options and that these options are insufficiently sensitive to firm risk. Our results do not appear to be driven by endogeneity biases. To assess the economic significance of the suboptimal provision of incentives, we compute an explicit performance benchmark which compares a firm s actual Tobin s Q to the Q* of a hypothetica fully-efficient firm having the same inputs and characteristics as the original firm. The Q of the average sample firm is around 12% lower than its Q*, equivalent to a $751 million reduction in its potential market value.

Abstract:
Every equilibrium model of IPO underpricing predicts a positive relationship between ex ante uncertainty about firm value and the extent to which entrepreneurs will issue shares at a discount to their subsequent market value. Since ex ante uncertainty is unobservable, the empirical literature has used a number of proxies for such uncertainty. The purpose of this note is to show that a popular proxy, the inverse of gross flotation proceeds, may be inappropriate for the purpose of testing the positive relation predicted by theory. We prove that an inverse relation between underpricing and IPO proceeds holds true because of dilution, even as uncertainty remains unchanged.

Underpricing, IPO proceeds, Uncertainty

Abstract:
We model owners as solving a multidimensional problem when taking their firms public. Owners can affect the level of underpricing through the choices they make in promoting an issue, such as which underwriter to hire or what exchange to list on. The benefits of reducing underpricing in this way depend on the owners' participation in the offering and the magnitude of the dilution they suffer on retained shares. We argue that the extent to which owners trade-off underpricing and promotion is determined by the minimization of their wealth losses. Evidence from a sample of U.S. IPOs confirms our empirical predictions.

Abstract:
We view debt and outside equity as serving to elicit credible information from different specialists about the value of an enterprise in its various uses. The equity valuation specialist provides a price forecast for equity that reveals information about the value for the enterprise in its primary use. The debt valuation specialist provides a price forecast for debt that reveals information about the value of the enterprise in its alternative use. The prices forecast by the valuation specialists credibly reveal their private information because they are required to buy the associated claims at the forecast prices, thereby bonding their valuations.

Abstract:
We model the role various forms of nonrecourse secured debt play in efficiently allocating control rights over assets whose value is state-specific. Ex ante, the entrepreneur makes a noncontractable investment that is specific to the best use of the asset in the status quo, or good, states. The lender makes a noncontractable investment in redeployment that is specific to the next best use of the asset in the bad states. The face amount of the loan is chosen to equal the value of the asset in the critical state that separates the good and bad states, with the loan being secured by the asset. If a good state prevails, the entrepreneur maintains control and captures the entire surplus from his use of the asset. If a bad state prevails, he defaults and relinquishes the asset because it is worth less to him than his obligation under the loan. The lender then redeploys the asset to its next best alternative use and captures the entire surplus from doing so. This state-contingent transfer of control avoids the ex post bargaining that wold otherwise split the redeployment surplus between the parties and distort their ex ante specific investments. Unlike other prominent models of financial contracting, ours imposes no wealth constraint on the entrepreneur and requires no intermediate signal to identify the ex post state of the world. Moreover, it is consistent with a wide range of financial practices including financial leasing, real options, vendor financing, secured and unsecured debt, project finance, and the general pattern of debt priorities and their disposition in bankruptcy.

Abstract:
This paper presents a unified theory of debt and outside equity based on specialized valuation of the corporate enterprise. We model the decision of an entrepreneur to use debt and equity finance to get credible information from different specialists about the value of the enterprise in various uses across alternative states of the world. The equity valuation specialist -- who could be a venture capitalist or another type of equity partner -- provides a price forecast for equity that reveals demand-side information about the value of the enterprise in the good sates. His equity share represents a claim on the cash flow generated by the enterprise in its primary use. The debt valuation specialist provides a price forecast for debt that reveals information about the value of the enterprise in the bad states. His loan represents a claim on the cash flow generated by the enterprise if redeployed to its next best use. The prices forecast for debt and equity by the valuation specialists credibly reveal their private information because the entrepreneur requires them to buy the associated claim at the forecast price, thereby bonding their valuations. In contrast to recent work on the role of debt and outside equity in communicating supply-side information to outside investors, we focus on the communication of demand-side information to the entrepreneur. We provide testable implications that conflict with those provided by accepted informational explanations for debt and outside inquiry.

Abstract:
This paper provides an explanation for the increase in firm value observed upon spin-off that is based upon the transmission of information about the various assets (or divisions) of a firm from informed to uninformed investors. Spin-offs serve to transmit information from informed to uninformed investors by increasing the number of traded securities, from whose prices uninformed investors can infer part of the private information of informed investors. The additional information made available to uninformed investors improves their estimates of, and decreases their uncertainty about value of the assets of the firm. It thus increases their demand for the securities issued by the firm in the presence of positive information about the value of the assets of the firm, in turn increasing the price of these securities and the value of the firm. The increase in firm value made possible by a spin-off is shown to be related to the amount of trading that follows the spin-off, as uninformed investors increase their total holdings of the various securities. The private information made available to uninformed investors is also made available to managers, who are thereby enabled to make better investment decisions.

Abstract:
We develop the implications of the observation that entrepreneurs can affect, to some extent at least, the level of underpricing in their firms? Initial Public Offerings (IPOs) by, for example, choosing highly reputable investment bankers as underwriters. We argue that entrepreneurs can, and will, minimize underpricing, but that they will do so only to an extent that is commensurate with the minimization of their wealth losses. Our empirical results suggest this is indeed the case in the United States: entrepreneurs will minimize underpricing until their marginal wealth losses equal the marginal cost of reducing headline underpricing. This suggests that private benefits may not be of primary importance when going public.

Abstract:
This paper presents a possible explanation for the lack of permanence of the very high level of concentration of ownership that accompanies leveraged buyouts. It argues that some diffusion of ownership can be beneficial to shareholders by encouraging employees to enter into implicit contracts with the firm. It then argues that investors in leveraged buyouts choose an initial level of concentration of ownership that is very high in order to breach existing implicit contracts. They then decrease the level of concentration of ownership in order to encourage employees to enter into new implicit contracts.

Abstract:
This paper provides a common explanation for a variety of asset financing arrangements that are observed in practice, specifically leasing, secured debt, project finance without recourse, and vendor financing. Such arrangements are viewed as serving to allocate ownership of one or many assets to those users best able to make use of these assets, in a manner that precludes ex-post bargaining and therefore avoids the distortion of ex-ante investment. The paper also provides a partial explanation for the various levels of seniority of debt.

Abstract:
We present an information-based explanation for spinoffs. When the various divisions of a firm are spun off into several firms that have separate stock market listings, the number of traded securities increases. This makes the price system more informative. It improves the quality of the investment decisions made by managers, and reduces uninformed investors' uncertainty about the value of the divisions. Both effects serve to increase the sum-total of the market values of the spun-off divisions above the market value of the original firm.