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Volume 40: Issue 4 (September 1985)

Dividend Policy under Asymmetric Information

Pages: 1031-1051  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02362.x  |  Cited by: 1532


We extend the standard finance model of the firm's dividend/investment/financing decisions by allowing the firm's managers to know more than outside investors about the true state of the firm's current earnings. The extension endogenizes the dividend (and financing) announcement effects amply documented in recent research. But once trading of shares is admitted to the model along with asymmetric information, the familiar Fisherian criterion for optimal investment becomes time inconsistent: the market's belief that the firm is following the Fisher rule creates incentives to violate the rule.

Dividends, Dilution, and Taxes: A Signalling Equilibrium

Pages: 1053-1070  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02363.x  |  Cited by: 679


A signalling equilibrium with taxable dividends is identified. In this equilibrium, corporate insiders with more valuable private information optimally distribute larger dividends and receive higher prices for their stock whenever the demand for cash by both their firm and its current stockholders exceeds its internal supply of cash. In equilibrium, many firms distribute dividends and simultaneously issue new stock, while other firms pay no dividends. Because dividends reveal all private information not conveyed by corporate audits, current stockholders capture in equilibrium all economic rents net of dissipative signalling costs. Both the announcement effect and the relationship between dividends and cum‐dividend market values are derived explicitly.

Optimal Release of Information By Firms

Pages: 1071-1094  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02364.x  |  Cited by: 635


This paper provides a positive theory of voluntary disclosure by firms. Previous theoretical work on disclosure of new information by firms has demonstrated that releasing public information will often make all shareholders worse off, due to an adverse risk‐sharing effect. This paper uses a general equilibrium model with endogenous information collection to demonstrate that there exists a policy of disclosure of information which makes all shareholders better off than a policy of no disclosure. The welfare improvement occurs because of explicit information cost savings and improved risk sharing. This provides a positive theory of precommitment to disclosure, because it will be unanimously voted for by stockholders and will also represent the policy that will maximize value ex ante. In addition, it provides a “missing link” in financial signalling models. Apart from the effects on information production analyzed in this paper, most existing financial signalling models are inconsistent with a firm taking actions which facilitate future signalling because release of the signal makes all investors worse off.

The Structure and Incentive Effects of Corporate Tax Liabilities

Pages: 1095-1114  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02365.x  |  Cited by: 35


This paper describes situations in which tax liabilities assume the form of a negative position in a call option. This structure motivates an examination of the investment decisions of taxed corporations in the presence of risk. It is shown that the structure of the tax liability creates an incentive to underinvest in more risky projects and an incentive for conglomerate merger. These effects are then evaluated in the presence of conflicts of interest between stockholders and bondholders, and under alternative assumptions about the tax code, and about the timing of investment and financing decisions.

The Impact of Inflation on the Aggregate Debt‐Asset Ratio

Pages: 1115-1125  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02366.x  |  Cited by: 12


This paper demonstrates that, contrary to the results of previous studies, the impact of inflation on the aggregate debt‐asset ratio cannot be determined theoretically. However, it is shown that inflation is likely to increase this ratio when personal income tax schedules are indexed to the price level and/or when leverage‐related costs are relatively high and the personal tax rate on income from holding common stocks is relatively low.

Taxes, Default Risk, and Yield Spreads

Pages: 1127-1140  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02367.x  |  Cited by: 33


This paper develops a model of bond prices and yield spreads that incorporates the effect of both taxes and differences in default probabilities. The tax loss consequences of default are recognized. Traditionally, tax‐free (municipal) bond yields have been viewed as linearly related to taxable yields with a slope coefficient equal to one minus the tax rate and the intercept representing differences in default risk. While our model supports the linearity assumption, it implies that the slope and intercept are both functions of both the break‐even tax rate and the default probability(ies). Clientele effects among both municipal and taxable bonds are demonstrated. Finally, the implied marginal tax rates and the implied default probabilities are estimated for different categories of municipal bonds.

Asset Returns, Discount Rate Changes, and Market Efficiency

Pages: 1141-1158  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02368.x  |  Cited by: 66


The primary purpose of this paper is to reconcile the previous findings of discount rate endogeneity with the presence of discount rate announcement effects in securities markets. The crux of this reconciliation is the distinction between “technical” discount rate changes that are endogenous and “nontechnical” changes which contain some informative policy implications. In essence, we attempt to separate expected discount rate changes from unexpected changes, or equivalently, the expected component of discount rate changes from the unexpected component. If markets are efficient, the former should have no announcement effects while the latter may be associated with an announcement effect. Accordingly, the focus of the empirical analysis is on the interaction between discount rate exogeneity, the specific monetary policy regime, and accouncement effects. In addition, we examine whether the behavior of these markets in the postannouncement period is consistent with the rapid price adjustment implied by market efficiency.

Optimal Bank Behavior under Uncertain Inflation

Pages: 1159-1171  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02369.x  |  Cited by: 4


In this paper, we derive a model of the individual banking firm facing stochastic inflation. The bank is considered as a depository financial intermediary operating in the primary market as a multiproduct price discriminating firm. A secondary market is also considered where liquidity surpluses and deficits are traded. Two types of assets and liabilities are assumed: deposits and loans linked to a general price level and nonlinked instruments. Effects of changes in the parameters such as inflation rate and variability, reserve requirements are analyzed.

Yes, The APT Is Testable

Pages: 1173-1188  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02370.x  |  Cited by: 67


The Arbitrage Pricing Theory (APT) has been proposed as an alternative to the mean‐variance Capital Asset Pricing Model (CAPM). This paper considers the testability of the APT and points out the irrelevance for testing of the approximation error. We refute Shanken's objections, including his assertion that Roll's critique of the CAPM is applicable to the APT. We also explain the testability of the APT on subsets, and we explore the relationship between the APT and the CAPM.

Multi‐Beta CAPM or Equilibrium‐APT?: A Reply

Pages: 1189-1196  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02371.x  |  Cited by: 44


Upper and Lower Bounds of Put and Call Option Value: Stochastic Dominance Approach

Pages: 1197-1217  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02372.x  |  Cited by: 98


Applying stochastic dominance rules with borrowing and lending at the risk‐free interest rate, we derive upper and lower values for an option price for all unconstrained utility functions and alternatively for concave utility functions. The derivation of these bounds is quite general and fits any kind of stock price distribution as long as it is characterized by a “nonnegative beta.”

On Option Pricing Bounds

Pages: 1219-1233  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02373.x  |  Cited by: 98


The purpose of this article is to compare the Perrakis and Ryan bounds of option prices in a single‐period model with option bounds derived using linear programming. It is shown that the upper bounds are identical but that the lower bounds are different. A comparison of these bounds, together with Merton's bounds and the Black‐Scholes prices in a lognormal securities market, is presented.

A Complete Analysis of Full Pareto Efficiency in Financial Markets for Arbitrary Preferences

Pages: 1235-1243  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02374.x  |  Cited by: 10


This paper provides a complete analysis of the necessary and sufficient conditions for financial markets to achieve fully Pareto‐efficient allocation of aggregate wealth through trade in economies with arbitrary preferences. We show that full Pareto efficiency obtains only if the market structure of contingent claims spans the information partition of a minimal aggregate wealth statistic and a Halmos‐Savage sufficient statistic for the beliefs of the traders. All the known allocation efficiency results in the literature due to Arrow, Hakansson, John, Ross, and others are unified by this result.

Easy Proofs of Unanimity and Optimality without Spanning: A Pedagogical Note

Pages: 1245-1250  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02375.x  |  Cited by: 5


Asset Pricing, Higher Moments, and the Market Risk Premium: A Note

Pages: 1251-1253  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02376.x  |  Cited by: 55


Book Reviews

Pages: 1255-1261  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02377.x  |  Cited by: 0

Book reviewed in this article:


Pages: 1262-1262  |  Published: 9/1985  |  DOI: 10.1111/j.1540-6261.1985.tb02378.x  |  Cited by: 0