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Abstract:
In this paper I claim that public-going owner-managers do not know the true value of their firms. The price that the stock-market sets for the firm's shares after the IPO is a better estimate for the true firm-value than the prior that management had before the offering. Because a higher firm-value implies more positive NPV projects, the post- IPO price gives management valuable information about the optimal investment policy. In particular, a post-IPO price higher than expected is an encouragement for expansion while overpricing or less than expected underpricing should lead managers to adjust their investment plans downward. Information-production by the market increases the precision of the post-IPO stock-price as an estimate of true firm value. By selling higher stakes at lower prices, managers can entice market-participants to produce more valuable information. If information-production is costlier, the entrepreneur's profits will be less and she will have to sell a larger stake of her company at a lower price. It is therefore in the entrepreneur's interest to help investors evaluate her firm, or to wait with the IPO until investors have become more familiar with it. The presented theory is congruent with the existence of Green Shoe options, Unit-IPOs and hot-issue markets. The paper contains a preliminary empirical test of the 'market-feedback hypothesis'. I find that underpricing significantly helps explaining the variance in capital expenditures in the year after the offering.

Abstract:
This paper investigates how long it takes until dispersed information on the valuation of IPO-firms is incorporated in secondary market prices, and how the speed of information aggregation relates to market microstructure and IPO characteristics. We find that it takes one week for all IPO-related information to be reflected in the market price for 2,511 IPOs in the U.S. Using a novel methodology to gauge event-time volatility, we attribute the quick aggregation of information to bookbuilding and liquidity in the secondary market. Our results contrast with Ellul and Pagano (2005) who report slower information aggregation in U.K. fixed price IPOs.

IPOs, market microstructure, information aggregation

Abstract:
An Endless Leverage Certificate is a novel structured product that has become very popular among European retail investors. ELC-holders have the right to claim the difference between the value of underlying and a contractual financing level at any time during the unlimited life of the contract. Because the financing level increases at a predetermined rate, the contract can be interpreted as a plain vanilla levered position. ELCs have a contractual stoploss barrier, so that issuers can semi-statically hedge their positions by buying (or selling) the underlying. If they do, they are exposed to gap risk, the risk that the underlying precipitates through the barrier and the financing level. This may happen overnight, or due to large jumps. For a large sample of stock ELCs, we find that ELCs are overpriced by less than 1%, and that many ELC-investors exercise too late. We also find that average bid ask spreads are much smaller than on other derivatives. An intraday event study on stoploss terminations shows a pronounced increase in trading activity following stoploss events but a negligible price impact.

Financial Innovation, Financial Derivatives, Structured Products

Abstract:
An Endless Leverage Certificate is a novel structured product that has become very popular among European retail investors. ELC-holders have the right to claim the difference between the value of underlying and a contractual financing level at any time during the unlimited life of the contract. Because the financing level increases at a predetermined rate, the contract can be interpreted as a plain vanilla levered position. ELCs have a contractual stoploss barrier, so that issuers can semi-statically hedge their positions by buying (or selling) the underlying. If they do, they are exposed to gap risk, the risk that the underlying precipitates through the barrier and the financing level. This may happen overnight, or due to large jumps. For a large sample of stock ELCs, we find that ELCs are overpriced by less than 1%, and that many ELC-investors exercise too late. We also find that average bid ask spreads are much smaller than on other derivatives. An intraday event study on stoploss terminations shows a pronounced increase in trading activity following stoploss events but a negligible price impact.

Financial Innovation, Financial Derivatives, Structured Products.

Abstract:
We examine performance in publicly listed U.K. companies over a period that encompasses the issuance of the Cadbury Committee's Code of Best Practice, which calls for the abolition of the combined CEO/COB position. We find that companies splitting the combined CEO/COB position to conform to the Code's requirement did not exhibit any absolute or relative improvement in performance when compared to various peer-group benchmarks. We do not necessarily scoff at mandated board structures, but the evidence suggests that this particular legislature coerced the abandonment of the combined CEO/COB position and appears to be wide of the mark.

Cadbury, CEO, Directors, Governance, UK

Abstract:
We compare the auction mechanisms that are used to open and close the trading day on two major European stock exchanges, Euronext (Paris) and Xetra (Frankfurt). The French exchange offers a transparent auction mechanism which discloses five levels of limit orders and has a fixed closing time. The Xetra system is more opaque and randomizes the ending time. For size and trading turnover matched samples, we find that the Euronext auctions attracts more trading volume, while the price impact during the auctions is lower. This suggests that the transparent Euronext auctions are better geared to sunshine trading and quantity discovery. On the other hand, the Xetra auction returns see less subsequent reversals, indicating an improved price discovery.

Market Microstructure, Pre-trade Transparency, Liquidity, Call Auctions

Abstract:
We present an overlapping generations model with spatial separation and agents who face liquidity risk to investigate the widely held belief that financial intermediaries exist because they save on transaction costs. We find that if agents only use a pure exchange mechanism, they engage in active portfolio duration rebalancing even when they do not need to consume. An intergenerational financial intermediary reduces the number of rebalancing transactions by catering to a diversified its client base. Our model also shows transaction costs can dampen cyclicality in exchange economies, and that intermediated economies are less cyclical still.

Financial Intermediation, Overlapping Generations, Liquidity

Abstract:
In this paper we investigate under what conditions financial intermediaries can improve welfare through intergenerational risk sharing. We review the constraints suggested by the extant literature and propose a new limitation on intergenerational risk sharing: We argue that an intermediary's asset pool is constrained by its members' temptation to liquidate the scheme when it accumulates too much assets. We call such a scenario a bank raid. We characterize the bank raid constraint, and find it to be so restrictive that it rules out most allocations suggested in the literature. Nevertheless, we find that bank raid proof coalitions can improve welfare vis-à-vis the market allocation, but only if early withdrawals can be prohibited.

Financial Intermediation, Overlapping Generations

Abstract:
In this paper we analyze the statistical properties of three popular measures of price discovery used in empirical market micro structure research. We find that the variance ratio is a consistent estimator for the informativeness of trades or time periods if the price process follows a martingale. The R2 of unbiasedness regressions is consistent for all price processes, also if they exhibit autocorrelation or have a drift. However, the R2 is, like the variance ratio, biased for small samples. We find that weighted price contribution (WPC) is an unbiased estimator for driftless martingales. We characterize the bias of the WPC if the underlying process is autocorrelated and/or has a drift, and propose three WPC variants to adjust for these biases.

market microstructure, price discovery, weighted price contribution

Abstract:
We examine performance in publicly listed U.K. companies over a period that encompasses the issuance of the Cadbury Committee's Code of Best Practice, which calls for the abolition of the combined CEO/COB position. We find that companies splitting the combined CEO/COB position to conform to the Code's requirement did not exhibit any absolute or relative improvement in performance when compared to various peer-group benchmarks. We do not necessarily scoff at mandated board structures, but the evidence suggests that this particular legislature coerced the abandonment of the combined CEO/COB position and appears to be wide of the mark.