The Journal of Finance

The Dark Side of Internal Capital Markets: Divisional Rent‐Seeking and Inefficient Investment

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00299

David S. Scharfstein, Jeremy C. Stein

We develop a two‐tiered agency model that shows how rent‐seeking behavior on the part of division managers can subvert the workings of an internal capital market. By rent‐seeking, division managers can raise their bargaining power and extract greater overall compensation from the CEO. And because the CEO is herself an agent of outside investors, this extra compensation may take the form not of cash wages, but rather of preferential capital budgeting allocations. One interesting feature of our model is that it implies a kind of “socialism” in internal capital allocation, whereby weaker divisions get subsidized by stronger ones.

How Investors Interpret Past Fund Returns

Published: 09/11/2003   |   DOI: 10.1111/1540-6261.00596

Anthony W. Lynch, David K. Musto

The literature documents a convex relation between past returns and fund flows of mutual funds. We show this to be consistent with fund incentives, because funds discard exactly those strategies which underperform. Past returns tell less about the future performance of funds which discard, so flows are less sensitive to them when they are poor. Our model predicts that strategy changes only occur after bad performance, and that bad performers who change strategy have dollar flow and future performance that are less sensitive to current performance than those that do not. Empirical tests support both predictions.

SYSTEMATIC RISK, FINANCIAL DATA, AND BOND RATING RELATIONSHIPS IN A REGULATED INDUSTRY ENVIRONMENT

Published: 05/01/1974   |   DOI: 10.1111/j.1540-6261.1974.tb03067.x

Ronald W. Melicher, David F. Rush

The Behavior of the Interest Rate Differential Between Tax‐exempt Revenue and General Obligation Bonds: A Test of Risk Preferences and Market Segmentation

Published: 03/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb01096.x

DAVID S. KIDWELL, TIMOTHY W. KOCH*

This paper presents evidence that the yield differential between revenue bonds and similar general obligation bonds varies contracyclically with the level of economic activity. The evidence also indicates that significant investor‐borrower induced market segmentation exists in the municipal bond market. An increase in the relative demand by commercial banks for tax‐exempt securities and/or an increase in the supply of revenue bonds relative to the supply of general obligation bonds increase the yield spread between the two classes of debt. These findings were the result of a series of empirical tests with both macroeconomic and microeconomic data.

Marginal Tax Rates: Evidence from Nontaxable Corporate Bonds: A Note

Published: 03/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb04953.x

JAMES ANG, DAVID PETERSON, PAMELA PETERSON

This study offers an alternative method of calculating marginal personal tax rates through the pairing of nontaxable (industrial development and pollution control) and taxable corporate bonds. This procedure is shown to produce matched bond pairs that are comparable. Two hundred pairs of bonds are examined from the second quarter of 1973 through the second quarter of 1983. Testing of the marginal tax rate relationships indicates that the marginal personal tax rate is less than the corporate statutory tax rate.

Market Statistics and Technical Analysis: The Role of Volume

Published: 03/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb04424.x

LAWRENCE BLUME, DAVID EASLEY, MAUREEN O'HARA

We investigate the informational role of volume and its applicability for technical analysis. We develop a new equilibrium model in which aggregate supply is fixed and traders receive signals with differing quality. We show that volume provides information on information quality that cannot be deduced from the price statistic. We show how volume, information precision, and price movements relate, and demonstrate how sequences of volume and prices can be informative. We also show that traders who use information contained in market statistics do better than traders who do not. Technical analysis thus arises as a natural component of the agents' learning process.

Visibility Bias in the Transmission of Consumption Beliefs and Undersaving

Published: 03/21/2023   |   DOI: 10.1111/jofi.13223

BING HAN, DAVID HIRSHLEIFER, JOHAN WALDEN

We model visibility bias in the social transmission of consumption behavior. When consumption is more salient than nonconsumption, people perceive that others are consuming heavily, and infer that future prospects are favorable. This increases aggregate consumption in a positive feedback loop. A distinctive implication is that disclosure policy interventions can ameliorate undersaving. In contrast with wealth‐signaling models, information asymmetry about wealth reduces overconsumption. The model predicts that saving is influenced by social connectedness, observation biases, and demographic structure, and provides new insight into savings rates. These predictions are distinct from other common models of consumption distortions.

Agency Problems, Equity Ownership, and Corporate Diversification

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb03811.x

DAVID J. DENIS, DIANE K. DENIS, ATULYA SARIN

We provide evidence on the agency cost explanation for corporate diversification. We find that the level of diversification is negatively related to managerial equity ownership and to the equity ownership of outside blockholders. In addition, we report that decreases in diversification are associated with external corporate control threats, financial distress, and management turnover. These findings suggest that agency problems are responsible for firms maintaining value‐reducing diversification strategies and that the recent trend toward increased corporate focus is attributable to market disciplinary forces.

International Stock Return Predictability: What Is the Role of the United States?

Published: 03/19/2013   |   DOI: 10.1111/jofi.12041

DAVID E. RAPACH, JACK K. STRAUSS, GUOFU ZHOU

We investigate lead‐lag relationships among monthly country stock returns and identify a leading role for the United States: lagged U.S. returns significantly predict returns in numerous non‐U.S. industrialized countries, while lagged non‐U.S. returns display limited predictive ability with respect to U.S. returns. We estimate a news‐diffusion model, and the results indicate that return shocks arising in the United States are only fully reflected in equity prices outside of the United States with a lag, consistent with a gradual information diffusion explanation of the predictive power of lagged U.S. returns.

A New Approach to International Arbitrage Pricing

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05126.x

RAVI BANSAL, DAVID A. HSIEH, S. VISWANATHAN

This paper uses a nonlinear arbitrage‐pricing model, a conditional linear model, and an unconditional linear model to price international equities, bonds, and forward currency contracts. Unlike linear models, the nonlinear arbitrage‐pricing model requires no restrictions on the payoff space, allowing it to price payoffs of options, forward contracts, and other derivative securities. Only the nonlinear arbitrage‐pricing model does an adequate job of explaining the time series behavior of a cross section of international returns.

Debt Contracting on Management

Published: 02/19/2020   |   DOI: 10.1111/jofi.12893

BRIAN AKINS, DAVID DE ANGELIS, MACLEAN GAULIN

Change of management restrictions (CMRs) in loan contracts give lenders explicit ex ante control rights over managerial retention and selection. This paper shows that lenders use CMRs to mitigate risks arising from CEO turnover, especially those related to the loss of human capital and replacement uncertainty, thereby providing evidence that human capital risk affects debt contracting. With a CMR in place, the likelihood of CEO turnover decreases by more than half, and future firm performance improves when retention frictions are important, suggesting that lenders can influence managerial turnover, even outside of default states, and help the borrower retain talent.

TAX‐INDUCED BIAS IN REPORTED TREASURY YIELDS*

Published: 12/01/1970   |   DOI: 10.1111/j.1540-6261.1970.tb00869.x

Alexander A. Robichek, W. David Niebuhr

Interactions of Corporate Financing and Investment Decisions: A Dynamic Framework

Published: 09/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb02453.x

DAVID C. MAUER, ALEXANDER J. TRIANTIS

This article analyzes the interaction between a firm's dynamic investment, operating, and financing decisions in a model with operating adjustment and recapitalization costs. Using numerical analysis, we solve the model for cases that highlight interaction effects. We find that higher production flexibility (due to lower costs of shutting down and reopening a production facility) enhances the firm's debt capacity, thereby increasing the net tax shield value of debt financing. While higher financial flexibility (resulting from lower recapitalization costs) has a similar effect, production flexibility and financial flexibility are, to some extent, substitutes. We find that the impact of debt financing on the firm's investment and operating decisions is economically insignificant.

Stock Returns following Large One‐Day Declines: Evidence on Short‐Term Reversals and Longer‐Term Performance

Published: 03/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb04428.x

DON R. COX, DAVID R. PETERSON

We examine stock returns following large one‐day price declines and find that the bid‐ask bounce and the degree of market liquidity explain short‐term price reversals. Further, we do not find evidence consistent with the overreaction hypothesis. We observe that securities with large one‐day price declines perform poorly over an extended time horizon.

Sources of Entropy in Representative Agent Models

Published: 08/12/2013   |   DOI: 10.1111/jofi.12090

DAVID BACKUS, MIKHAIL CHERNOV, STANLEY ZIN

We propose two data‐based performance measures for asset pricing models and apply them to models with recursive utility and habits. Excess returns on risky securities are reflected in the pricing kernel's dispersion and riskless bond yields are reflected in its dynamics. We measure dispersion with entropy and dynamics with horizon dependence, the difference between entropy over several periods and one. We compare their magnitudes to estimates derived from asset returns. This exercise reveals tension between a model's ability to generate one‐period entropy, which should be large, and horizon dependence, which should be small.

Founding‐Family Ownership and Firm Performance: Evidence from the S&P 500

Published: 05/06/2003   |   DOI: 10.1111/1540-6261.00567

Ronald C. Anderson, David M. Reeb

We investigate the relation between founding‐family ownership and firm performance. We find that family ownership is both prevalent and substantial; families are present in one‐third of the S&P 500 and account for 18 percent of outstanding equity. Contrary to our conjecture, we find family firms perform better than nonfamily firms. Additional analysis reveals that the relation between family holdings and firm performance is nonlinear and that when family members serve as CEO, performance is better than with outside CEOs. Overall, our results are inconsistent with the hypothesis that minority shareholders are adversely affected by family ownership, suggesting that family ownership is an effective organizational structure.

BUDGET BALANCE AND EQUILIBRIUM INCOME*

Published: 03/01/1965   |   DOI: 10.1111/j.1540-6261.1965.tb00185.x

David J. Ott, Attiat F. Ott

Death and Taxes: The Market for Flower Bonds

Published: 07/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb04578.x

DAVID MAYERS, CLIFFORD W. SMITH

Certain U.S. Government securities, known as flower bonds, can be redeemed at par plus accrued interest for the purpose of paying estate taxes, if held at the time of death. Thus, a flower bond, selling at a discount, is like a straight bond plus a life insurance policy. An equilibrium derived from a rational flower bond pricing model implies the existence of clienteles: individuals with the highest death probabilities hold the deepest discount flower bonds. The empirical implication, that bonds with the deepest discount should be redeemed at the fastest rate, is tested and the results support the proposition.

The WACC Fallacy: The Real Effects of Using a Unique Discount Rate

Published: 02/06/2015   |   DOI: 10.1111/jofi.12250

PHILIPP KRÜGER, AUGUSTIN LANDIER, DAVID THESMAR

In this paper, we test whether firms properly adjust for risk in their capital budgeting decisions. If managers use a single discount rate within firms, we expect that conglomerates underinvest (overinvest) in relatively safe (risky) divisions. We measure division relative risk as the difference between the division's asset beta and a firm‐wide beta. We establish a robust and significant positive relationship between division‐level investment and division relative risk. Next, we measure the value loss due to this behavior in the context of acquisitions. When the bidder's beta is lower than that of the target, announcement returns are significantly lower.

Wholesale Funding Dry‐Ups

Published: 10/10/2017   |   DOI: 10.1111/jofi.12592

CHRISTOPHE PÉRIGNON, DAVID THESMAR, GUILLAUME VUILLEMEY

We empirically explore the fragility of wholesale funding of banks, using transaction‐level data on short‐term, unsecured certificates of deposit in the European market. We do not observe a market‐wide freeze during the 2008 to 2014 period. Yet, many banks suddenly experience funding dry‐ups. Dry‐ups predict, but do not cause, future deterioration in bank performance. Furthermore, during periods of market stress, banks with high future performance tend to increase reliance on wholesale funding. We therefore fail to find evidence consistent with adverse selection models of funding market freezes. Our evidence is in line with theories highlighting heterogeneity between informed and uninformed lenders.