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Volume 48: Issue 3 (July 1993)

The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

Pages: 831-880  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04022.x  |  Cited by: 4655


Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increasing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.

Option Valuation with Systematic Stochastic Volatility

Pages: 881-910  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04023.x  |  Cited by: 111


We use an extension of the equilibrium framework of Rubinstein (1976) and Brennan (1979) to derive an option valuation formula when the stock return volatility is both stochastic and systematic. Our formula incorporates a stochastic volatility process as well as a stochastic interest rate process in the valuation of options. If the “mean,” volatility, and “covariance” processes for the stock return and the consumption growth are predictable, our option valuation formula can be written in “preference‐free” form. Further, many popular option valuation formulae in the literature can be written as special cases of our general formula.

Measuring Asset Values for Cash Settlement in Derivative Markets: Hedonic Repeated Measures Indices and Perpetual Futures

Pages: 911-931  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04024.x  |  Cited by: 57


Two proposals are made that may facilitate the creation of derivative market instruments, such as futures contracts, cash settled based on economic indices. The first proposal concerns index number construction: indices based on infrequent measurements of nonstandardized items may control for quality change by using a hedonic repeated measures method, an index number construction method that follows individual assets or subjects through time and also takes account of measured quality variables. The second proposal is to establish markets for perpetual claims on cash flows matching indices of dividends or rents. Such markets may help us to measure the prices of the assets generating these dividends or rents even when the underlying asset prices are difficult or impossible to observe directly. A perpetual futures contract is proposed that would cash settle every day in terms of both the change in the futures price and the dividend or rent index for that day.

Invisible Parameters in Option Prices

Pages: 933-947  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04025.x  |  Cited by: 58


This paper characterizes contingent claim formulas that are independent of parameters governing the probability distribution of asset returns. While these parameters may affect stock, bond, and option values, they are “invisible” because they do not appear in the option formulas. For example, the Black‐Scholes (1973) formula is independent of the mean of the stock return. This paper presents a new formula based on the log‐negative‐binomial distribution. In analogy with Cox, Ross, and Rubinstein's (1979) log‐binomial formula, the log‐negative‐binomial option price does not depend on the jump probability. This paper also presents a new formula based on the log‐gamma distribution. In this formula, the option price does not depend on the scale of the stock return, but does depend on the mean of the stock return. This paper extends the log‐gamma formula to continuous time by defining a gamma process. The gamma process is a jump process with independent increments that generalizes the Wiener process. Unlike the Poisson process, the gamma process can instantaneously jump to a continuum of values. Hence, it is fundamentally “unhedgeable.” If the gamma process jumps upward, then stock returns are positively skewed, and if the gamma process jumps downward, then stock returns are negatively skewed. The gamma process has one more parameter than a Wiener process; this parameter controls the jump intensity and skewness of the process. The skewness of the log‐gamma process generates strike biases in options. In contrast to the results of diffusion models, these biases increase for short maturity options. Thus, the log‐gamma model produces a parsimonious option‐pricing formula that is consistent with empirical biases in the Black‐Scholes formula.

Top‐Management Compensation and Capital Structure

Pages: 949-974  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04026.x  |  Cited by: 454


The interrelationship between top‐management compensation and the design and mix of external claims issued by a firm is studied. The optimal managerial compensation structures depend on not only the agency relationship between shareholders and management, but also the conflicts of interests which arise in the other contracting relationships for which the firm serves as a nexus. We analyze in detail the optimal management compensation for the cases when the external claims are (1) equity and risky debt, and (2) equity and convertible debt. In addition to the role of aligning managerial incentives with shareholder interests, managerial compensation in a levered firm also serves as a precommitment device to minimize the agency costs of debt. The optimal management compensation derived has low pay‐performance sensitivity. With convertible debt, instead of straight debt, the corresponding optimal managerial compensation has high pay‐to‐performance sensitivity. A negative relationship between pay‐performance sensitivity and leverage is derived. Our results provide a reconciliation of the puzzling evidence of Jensen and Murphy (1990) with agency theory. Other testable implications include (1) a relationship between the risk premium in corporate bond yields and top‐management compensation structures, and (2) the announcement effect of adoption of executive stock option plans on bond prices. The model yields implications for management compensation in banks and Federal Deposit Insurance reform. Our results explain the dynamics of top‐management compensation in firms going through financial distress and reorganization.

Influence Costs and Capital Structure

Pages: 975-1008  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04027.x  |  Cited by: 20


This paper analyzes the role of capital structure in the presence of intrafirm influence activities. The hierarchical structure of large organizations inevitably generates attempts by members to influence the distributive consequences of organizational decisions. In corporations, for example, top management can reallocate or eliminate quasi rents earned by their employees, while at the same time, they must rely on these employees to provide them with information vital to their decision making. This creates the opportunity for lower level managers to influence top management's discretionary decisions. As a result, divisional managers may attempt to inflate the corporate perception of their relative contributions to the firm, or to take actions that make the elimination of their rents more costly for the firm. This incentive to influence is especially acute when managers fear losing their jobs, for example in the event of a divestiture.

Market Integration and Price Execution for NYSE‐Listed Securities

Pages: 1009-1038  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04028.x  |  Cited by: 81


For New York Stock Exchange (NYSE) listed securities, the price execution of seemingly comparable orders differs systematically by location. In general, executions at the Cincinnati, Midwest, and New York stock exchanges are most favorable to trade initiators, while executions at the National Association of Security Dealers (NASD) are least favorable. These intermarket price differences depend on trade size, with the smallest trades exhibiting the biggest per share price difference. Collectively, these results raise questions about the adequacy of the existing intermarket quote system (ITS), the broker's fiduciary responsibility for “best execution,” and the propriety of order flow inducements.

The Investment Performance of U.S. Equity Pension Fund Managers: An Empirical Investigation

Pages: 1039-1055  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04029.x  |  Cited by: 127


This paper presents an empirical examination of the selectivity and market timing performance of a sample of U.S. equity pension fund managers. Regardless of the choice of benchmark portfolio or estimation model, the average selectivity measure is positive and the average timing measure is negative. However both selectivity and timing appear to be somewhat sensitive to the choice of a benchmark when managers are classified by investment style. Meta‐analysis revealed some real variation around the mean values for each measure. The 80 percent probability intervals for selectivity revealed that the best managers produced substantial risk‐adjusted excess returns. We also found a negative correlation between selectivity and timing, but we argue that the observed negative correlation in our data is largely an artifact of negatively correlated sampling errors for the two estimates.

Author Index of the Abstracts

Pages: 1057-1058  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb00392.x  |  Cited by: 0

Abstracts of Papers Presented at the 1993 AFA Meetings

Pages: 1059-1123  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04030.x  |  Cited by: 0

Minutes of the Annual Membership Meeting

Pages: 1125-1126  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04031.x  |  Cited by: 0

Michael Keenan

Report of the Executive Secretary and Treasurer

Pages: 1127-1128  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04032.x  |  Cited by: 0

Michael Keenan

Consolidated Revenues and Expenses Reports

Pages: 1129-1130  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04033.x  |  Cited by: 0

Report of the Managing Editor of the Journal of Finance for the Year 1992

Pages: 1131-1142  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04034.x  |  Cited by: 0

René M. Stulz

Report of the AFA Representative to the National Bureau of Economic Research*

Pages: 1143-1145  |  Published: 7/1993  |  DOI: 10.1111/j.1540-6261.1993.tb04035.x  |  Cited by: 0

Robert S. Hamada