The current literature or business finance states that debt is a cheaper source of capital than stock (tending to reduce the firm's cost of capital), because interest is deductible for income tax purposes while the return to common stockholders is subject to tax. It is even possible to issue debt without increasing the risk to the owners (the debt is issued to stockholders in proportion to the ownership of stock, or equivalently investors buy a mixture of stocks and bonds on the market). However, it is argued in this paper that if we assume that the present stockholders have no further resources available for investment in the firm, but the enterprise needs additional resources, then the present stockholders have to make a basic decision about whether to issue stock or debt to raise the additional needed capital. The issuance of debt in this situation increases risk, and the issuance of stock dilutes ownership. Even when bondholders require a much lower contractual return than the expected annual return of stockholders, the issuance of more stock may be preferred to the issuance of debt.

When a company goes public, it is standard practice that the underwriting syndicate allocates more shares than are issued. The underwriter thus holds a short position that it commonly fills by aftermarket trading when market prices fall or, when prices rise, by executing the so-called overallotment option. This option is a standard feature of initial public offering (IPO) arrangements that allows the underwriter to purchase more shares from the issuer at the original offer price. We propose a theoretical model to study the implications of this combination of short position and overallotment option on the pricing of the IPO. Maximizing the sum of both the profits from their share of the offer revenue and the potential profits from aftermarket trading, we show that underwriters strategically distort the offer price. This results either in exacerbated underpricing when favorably informed underwriters lower prices to secure a signaling benefit, or in informationally inefficient offer prices when underwriters pool in offer prices irrespective of their information.

It is well known that different combinations of investments involve different risks. In recent years the analysis of risk has tended to focus on two moments of the probability distribution of returns, the mean and variance. This paper considers the effect on the variance of an investment fund of adding dependent investments.

The growing sensitivity of savings deposits to flow in response to changes in interest rate differentials has become so commonplace in the past decade that the term “disintermediation” has become a part of the economists' vocabulary. It is a major conclusion of this paper that the volatility of savings deposits began to increase as early as 1950 for savings and loan associations and credit unions and as early as 1945 for mutual savings banks. As an indication of this, we proxy changes in the competitive environment for savings deposits by making yearly estimates of the elasticity of savings deposits with respect to deposit rates at savings and loan associations, mutual savings banks, and credit unions.

Previous studies have found that positive abnormal stock returns are associated with corporate spin-offs and divestitures. Using a simplified model of the process of investor tax trading, we show that an improvement in the value of the tax-timing option component of securities prices is a likely contributing factor to those abnormal returns. The analysis indicates that the same phenomenon also may be part of the explanation for the generally higher returns observed for spin-offs than for divestitures, both when leverage is and is not present in the restructuring transactions.

Between 2009 and 2013, the Fly on the Wall (FLY) leaked 58% of recommendation revisions with a median delay of 27 minutes relative to the IBES announcement time. We show that FLY improves price discovery, but leaked recommendations hamper brokers’ ability to offer price improvement on trades routed through them. Three major brokers sued FLY; using key court dates, we show significant wealth and real effects to the brokerage industry. Overall, the speed with which analyst recommendations are disseminated has led to more rapid price discovery at the expense of a decline in the scope of the sell-side research industry.

The rise of stock indexing has raised concerns that index investing impedes arbitrage and degrades price discovery. This article uses Russell’s reconstitution to identify the causal effect of index investing on information arbitrage and price discovery. Although index investing has no discernible effect on the ability of arbitrageurs to trade and impound news into the prices of large- and mid-cap stocks, we find that index investing increases the speed of price adjustment to news for micro-cap stocks. Our causal evidence identifies the relaxation of arbitrage constraints as a mechanism through which indexing facilitates informed trading for more arbitrage-constrained micro-cap stocks.

The elimination in 1975 of fixed minimum brokerage commission rates for agency transactions in equity securities was one of the more highly publicized events in the still-ongoing process of the deregulation of American financial markets. While, prior to that time, commission rates on large stock transactions—that were executed primarily for institutions—had become increasingly subject to negotiation, individual investors effectively faced an industry-wide fixed price schedule for the vast majority of their transactions. At the insistence of the Securities and Exchange Commission, the privilege of negotiation on commission rates was extended to securities trades of all sizes as of May 1, 1975, a date the brokerage industry only half-humorously dubbed “Mayday”.

Previous investigators have shown that the Sharpe measure of the performance of a managed portfolio may be flawed when the portfolio manager has market timing ability. Herein we develop the exact conditions under which the Sharpe measure will completely and correctly order market timers according to ability. The derived conditions are necessary, sufficient, and observable. We compare these derived conditions to empirical estimates of actual market conditions and find that, under typical market conditions, the practice of using quarterly portfolio return data will frequently result in a failure of the Sharpe measure to order timers according to ability. We show, however, that such failures can be greatly reduced by more frequent sampling of managed portfolio returns.

The usual formulation of the portfolio selection problem through meanvariance analysis assumes that the variance-covariance matrix of the rate of returns on risky assets is non-singular. In view of the literature discussing the creation of riskless portfolio from carefully balanced quantities of risky securities (e.g., shares and warrants as in Black-Scholes [1]), the assumption of non-singularity may be challenged. Consequently, the proofs of the classical theorems of portfolio management may no longer be developed as originally presented. Buser [2] presents a means of using a singular variance-covariance matrix in the derivation of portfolio weights, which, although slightly flawed by a mathematical error, still provides some interesting insights about the efficient frontier. We present a corrected version of Buser's method in Section II; in Section III, we comment on some of the implications of his presentation and indicate some more precise results.

We examine the price behavior of the firm's common stock associated with cancelled straight debt offerings. Excluding utilities, we find negative excess returns associated with offering and cancellation announcements. Further, the stronger withdrawal reactions we find, when the funds were to be used for capital expenditures, may signal a decline in profitable investment opportunities. These results are consistent with Miller and Rock's (1985) hypothesis.

Theory says an American call should never be exercised early, except possibly just before an ex-dividend date. But the best market bid is regularly lower than the intrinsic value for in-the-money short-maturity options. An American option can always be exercised to recover the intrinsic value, whereas selling a European call in the market may return considerably less. The article derives the liquidity value of American exercise in closed form as a function of the bid–ask spread and shows empirically that it is of comparable magnitude to, and often greater than, the theoretical value of American exercise to collect a dividend.

This article studies how changes in investor protection regulations affect local entrepreneurial activity, relying on the heterogeneous impact of a 2011 SEC regulation change on the definition of accredited investors across U.S. cities. Using a difference-in-differences approach, I show that cities more affected by the regulation change experienced a significantly larger decrease in local angel financing, entrepreneurial activity, innovation output, employment, and sales. I find that small business loans and second-lien mortgages became entrepreneurs’ partial substitutes for angel investment. My cost-benefit analysis suggests that the costs of protecting angel investors through the 2011 regulation change outweigh its benefits.

We exploit the expiring nature of hedge fund lockups to create a new measure of funding liquidity risk that varies within funds. We find that hedge funds with lower funding risk generate higher returns, and this effect is driven by their increased exposure to equity-mispricing anomalies. Our results are robust to a variety of sampling criteria, variable definitions, and control variables. Further, we address endogeneity concerns in various ways, including a placebo approach and regression discontinuity design. Collectively, our results support a causal link between funding risk and the ability of managers to engage in risky arbitrage.

Managers’ incentives to round up reported earnings per share (EPS) cause an underrepresentation of the number 4 in the first post-decimal digit of EPS, or “quadrophobia.” We develop a novel measure of aggressive financial reporting practices based on a firm’s history of quadrophobia. Quadrophobia is pervasive, persistent, and successfully predicts future restatements, Securities and Exchange Commission enforcement actions, and class action litigation. It is more pronounced when executive compensation is more closely tied to the stock price and when the firm anticipates violating debt covenants. Quadrophobia is especially strong when rounding-up EPS allows firms to meet analyst expectations, and investors seem not to see through this behavior.

Prior research finds that Dodd–Frank Act’s regulations on credit rating agencies (CRAs) increase rated firms’ risk of rating downgrades, regardless of their credit quality. Our difference-in-difference estimates suggest that after Dodd–Frank, low-rated firms, which face steep costs from a further downgrade, significantly reduce their debt issuance and investments compared to similar unrated firms. Our results are not driven by credit supply or the financial crisis. They reveal an unintended consequence of Dodd–Frank: Greater regulatory pressure on CRAs leads to negative spillover effects on firms concerned about credit ratings, regardless of their credit quality.

This article introduces a new holding horizon measure of active management and examines its relation to future risk-adjusted fund performance (alpha). Our measure reveals a wide cross-sectional dispersion in mutual fund investment horizons, and shows that long-horizon funds exhibit positive future long-term alphas by holding stocks with superior long-term fundamentals. Further, stocks largely held by long-horizon funds outperform stocks largely held by short-horizon funds by more than $ 3\% $ annually, adjusted for risk, over the following 5-year period. We also find a clientele effect: to reduce liquidity costs, long-horizon funds attract more long-term investors through share classes that carry load fees.

The thoughts presented in this paper were developed during the first stage of an ongoing research project. This project is designed to shed light on the management of the size and exchange composition of financial assets and liabilities in the U.S. multinational companies (MNCs). The study also intends to analyze the impact of these policies on the international and national financial markets.

This paper corrects the bond option formula presented by R. Rabinovitch ((1989), Equation (10)). With just one state variable driving the economy, the formula should be the same as the ones presented by Jamshidian (1989) and Chaplin (1987).

For decision makers, we emphasize that it is feasible to consider multiple subjective criteria in a capital budgeting problem. The applicability of the procedures outlined is enhanced by the limited data base necessary to obtain subjective rankings, remembering that here we are only concerned with side criteria.

In this paper, we have formulated the capital investment problem in a graph theoretic framework. We characterized the problem as being composed of a set of finite alternatives, a set of subjective criteria, and a set of resource constraints. This formulation leads to an integer programming problem in which the rankings of sets of alternatives on the multiple subjective criteria are aggregated into a single index. It is stressed that we used a single budgetary constraint in the example but that the procedure can accommodate additional constraints. We also assumed that management has specific side criteria and that it is possible for the decision makers to rank all alternatives for each of those criteria.

The application of the above procedure to any problem involves three steps:

1) From the decision maker, or groups of decision makers,

the agreement matrix π is developed. This involves:

a) defining the alternatives,

b) defining the side criteria,

c) asking management to rank each alternative under each criterion, and

d) if appropriate, asking management to weigh the relative importance of each of the side criteria.

2) From the technical considerations of the problem, determine the resource constraints. In our example, this included the investment requirements of each alternative and the total resources available.

3) Solve the problem as posed above as a group of m integer programming problems.