The Journal of Finance

Efficient Funds in a Financial Market with Options: a New Irrelevance Proposition

Published: 06/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb00653.x

KOSE JOHN

Under the same assumptions that Ross used to assert the existence of an efficient fund (on which a spanning set of options can be written) we prove that almost any portfolio is an efficient fund. From a constructive point of view, a randomly chosen vector of portfolio weights yields an efficient fund. When the Ross assumptions are relaxed, a limited notion of efficiency‐maximal efficiency‐is the best attainable. The maximally efficient funds are also everywhere dense in the portfolio space. Some implications are discussed and illustrative examples given.

Risk‐Shifting Incentives and Signalling Through Corporate Capital Structure

Published: 07/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb04573.x

KOSE JOHN

This paper examines optimal corporate financing arrangements under asymmetric information for different patterns of temporal resolution of uncertainty in the underlying technology. An agency problem, a signalling problem and an agency‐signalling problem arise as special cases. The associated informational equilibria and the optimal financing arrangements are characterized and compared. In the agency‐signalling equilibrium the private information of corporate insiders at the time of financing is signalled through capital structure choices which deviate optimally from agency‐cost minimizing financing arrangements, which in turn induce risk‐shifting incentives in the investment policy. In the pure signalling case the equilibrium is characterized by direct contractual precommitments to implement investment policies which are riskier than pareto‐optimal levels. Empirical implications for debt covenants and the announcement effect of investment policies and leverage increasing transactions on existing stock and bond prices are explicitly derived.

Dividends, Dilution, and Taxes: A Signalling Equilibrium

Published: 09/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb02363.x

KOSE JOHN, JOSEPH WILLIAMS

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.

Information Content of Insider Trading Around Corporate Announcements: The Case of Capital Expenditures

Published: 07/01/1990   |   DOI: 10.1111/j.1540-6261.1990.tb05108.x

KOSE JOHN, BANIKANTA MISHRA

There is gathering evidence of insider trading around corporate announcements of dividends, capital expenditures, equity issues and repurchases, and other capital structure changes. Although signaling models have been used to explain the price reaction of these announcements, a usual assumption made in these models is that insiders cannot trade to gain from such announcements. An innovative feature of this paper is to model trading by corporate insiders (subject to disclosure regulation) as one of the signals. Detailed testable predictions are described for the interaction of corporate announcements and concurrent insider trading. In particular, such interaction is shown to depend crucially on whether the firm is a growth firm, a mature firm, or a declining firm. Empirical proxies for firm technology are developed based on measures of growth and Tobin's q ratio. In the underlying “efficient” signaling equilibrium, investment announcements and net insider trading convey private information of insiders to the market at least cost. The paper also addresses issues of deriving intertemporal announcement effects from the equilibrium (cross‐sectional) pricing functional. Other announcement effects relate the intensity of the market response to insider trading, variance of firm cash flows, risk aversion of the insiders, and characteristics of firm technology (growth, mature, or declining).

Costly Contracting and Optimal Payout Constraints

Published: 05/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb03567.x

KOSE JOHN, AVNER KALAY

Risky Debt, Investment Incentives, and Reputation in a Sequential Equilibrium

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb05012.x

KOSE JOHN, DAVID C. NACHMAN

The agency relationship of corporate insiders and bondholders is modeled as a dynamic game with asymmetric information. The incentive effect of risky debt on the investment policy of a levered firm is studied in this context. In a sequential equilibrium of the model, a concept of reputation arises endogenously resulting in a partial resolution of the classic agency problem of underinvestment. The incentive of the firm to underinvest is curtailed by anticipation of favorable rating of its bonds by the market. This anticipated pricing of debt is consistent with rational expectations pricing by a competitive bond market and is realized in equilibrium. Some empirical implications of the model for bond rating, debt covenants, and bond price response to investment announcements are explored.

Top‐Management Compensation and Capital Structure

Published: 07/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04026.x

TERESA A. JOHN, KOSE JOHN

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.

Efficient Signalling with Dividends and Investments

Published: 06/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb02570.x

RAMASASTRY AMBARISH, KOSE JOHN, JOSEPH WILLIAMS

An efficient signalling equilibrium with dividends and investments or, equivalently, dividends and net new issues of stock is constructed, and its properties are identified. Because corporate insiders can exploit multiple signals, the efficient mix must minimize dissipative costs. In equilibrium, many firms both distribute dividends and deviate from first‐best investment. Also, the impact of dividends on stock prices is positive. By contrast, the announcement effect of new stock is negative for firms with private information primarily about assets in place and positive for firms with inside information mainly about opportunities to invest.

Corporate Governance and Risk‐Taking

Published: 07/19/2008   |   DOI: 10.1111/j.1540-6261.2008.01372.x

KOSE JOHN, LUBOMIR LITOV, BERNARD YEUNG

Better investor protection could lead corporations to undertake riskier but value‐enhancing investments. For example, better investor protection mitigates the taking of private benefits leading to excess risk‐avoidance. Further, in better investor protection environments, stakeholders like creditors, labor groups, and the government are less effective in reducing corporate risk‐taking for their self‐interest. However, arguments can also be made for a negative relationship between investor protection and risk‐taking. Using a cross‐country panel and a U.S.‐only sample, we find that corporate risk‐taking and firm growth rates are positively related to the quality of investor protection.

Insider Trading around Dividend Announcements: Theory and Evidence

Published: 09/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb04621.x

KOSE JOHN, LARRY H. P. LANG

The informational role of strategic insider trading around corporate dividend announcements is studied based on the efficient equilibrium in a signalling model with endogenous insider trading. Insider trading immediately prior to the announcement of dividend initiations has significant explanatory power. For firms with insider selling prior to the dividend initiation announcement, the excess returns are negative and significantly lower than for the remaining firms (with no insider trading or just insider buying) as implied by our model. Another implication is that dividend increases may elicit a positive or negative stock price response depending on the firm's investment opportunities.

Asymmetry of Information, Regulatory Lags and Optimal Incentive Contracts: Theory and Evidence

Published: 05/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb02245.x

RICHARD S. BOWER, KOSE JOHN, ANTHONY SAUNDERS

The Voluntary Restructuring of Large Firms In Response to Performance Decline

Published: 07/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb03999.x

KOSE JOHN, LARRY H. P. LANG, JEFFRY NETTER

Much of the research on corporate restructuring has examined the causes and aftermath of extreme changes in corporate governance such as takeovers and bankruptcy. In contrast, we study restructurings initiated in response to product market pressures by “normal” corporate governance mechanisms. Such “voluntary” restructurings, motivated by the discipline of the product market and internal corporate controls, will play a relatively more important role in the 1990s due to a weakening in the discipline of the takeover market. Our data suggest that the firms retrenched quickly and, on average, increased their focus. There is no evidence of abnormally high levels of forced turnover in top managers. There is, however, a significant and rapid cut of 5% in the labor force. Further, the cost of goods sold to sales and labor costs to sales ratios both decline rapidly, more than 5% in the first two years after the negative earnings. The firms cut research and development, increased investment, and also reduced their debt/asset level by over 8% in the first year after the negative earnings. We also document the reasons management and analysis reported for the negative earnings. Overwhelmingly the firms blame bad economic conditions and, to a lesser extent, foreign competition.