Abstract: The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes explain a substantial portion of the difference, the remaining portion of the spread is closely related to the factors that we commonly accept as explaining risk premiums for common stocks. Both our time series and cross-sectional tests support the existence of a risk premium on corporate bonds. THE PURPOSE OF THIS ARTICLE is to examine and explain the differences in the rates offered on corporate bonds and those offered on government bonds ~spreads!, and, in particular, to examine whether there is a risk premium in corporate bond spreads and, if so, why it exists. Spreads in rates between corporate and government bonds differ across rating classes and should be positive for each rating class for the following reasons: 1. Expected default loss—some corporate bonds will default and investors require a higher promised payment to compensate for the expected loss from defaults. 2. Tax premium—interest payments on corporate bonds are taxed at the state level whereas interest payments on government bonds are not. 3. Risk premium—The return on corporate bonds is riskier than the return on government bonds, and investors should require a premium for the higher risk. As we will show, this occurs because a large part of the risk on corporate bonds is systematic rather than diversifiable. The only controversial part of the above analyses is the third point. Some authors in their analyses assume that the risk premium is zero in the corporate bond market.1

Abstract: Executive stock ownership and stock option pay are often assumed to have congruent incentive effects; however, these incentives have asymmetrical risk properties, and executives may respond to them...

Abstract: An important challenge for all economies, at which only a few have succeeded, is creating the preconditions for a strong market for common stocks and other securities. A strong securities market rests on a complex network of legal and market institutions that ensure that minority shareholders (1) receive good information about the value of a company's business and (2) have confidence that a company's managers and controlling shareholders won't cheat them out of most or all of the value of their investment. A country whose laws and related institutions fail on either count cannot develop a strong securities market, forcing firms to rely on internal financing or bank financing - both of which have important shortcomings. In this Article, Professor Bernard Black explains why these two investor protection issues are critical, related, and hard to solve. He discusses which laws and institutions are most important for each, which of these laws and institutions can be borrowed from countries with strong securities markets, and which must be homegrown. A shorter and earlier version of this article was published as "The Core Institutions that Support Strong Securities Markets," Business Lawyer, Vol. 55, pp. 1565-1607, 2000. This earlier article is available at http://ssrn.com/abstract_id=231120

Abstract: An important challenge for all economies, at which only a few have succeeded, is creating the preconditions for a strong market for common stocks and other securities. A strong securities market rests on a complex network of legal and market institutions that ensure that minority shareholders (1) receive good information about the value of a company's business and (2) have confidence that a company's managers and controlling shareholders won't cheat them out of most or all of the value of their investment. A country whose laws and related institutions fail on either count cannot develop a strong securities market, forcing firms to rely on internal financing or bank financing - both of which have important shortcomings. In this Article, Professor Bernard Black explains why these two investor protection issues are critical, related, and hard to solve. He discusses which laws and institutions are most important for each, which of these laws and institutions can be borrowed from countries with strong securities markets, and which must be homegrown. A shorter and earlier version of this article was published as "The Core Institutions that Support Strong Securities Markets," Business Lawyer, Vol. 55, pp. 1565-1607, 2000. This earlier article is available at http://ssrn.com/abstract_id=231120

Abstract: This paper investigates the effect of company brand perceptions on investor incentives to hold stocks. We find that, after controlling for other postulated determinants of stockholdings, there is a negative and significant cross-sectional relation between percentage institutional holdings and brand visibility. This finding indicates a propensity for individual investors to hold stocks with strong brand recognition, which is consistent with the hypothesis that individuals prefer to invest in companies whose products are readily recognized. Furthermore, we find that institutional holdings are positively related to firm size and beta, while being negatively related to total return volatility. Our analysis supports the notion that institutional portfolios eschew the relatively neglected sector characterized by small firms with high total volatility, whereas individual investors prefer holding stocks with low systematic risk and high recognition. The results contribute to our understanding of how financial market investors form their equity portfolios.

Abstract: Death spiral convertibles are privately held convertible securities (preferred stock or debentures) with a conversion price that is set at a discount from the average (or sometimes the minimum) of past stock prices in a look-back period. Although, in theory, these securities have the potential to reduce agency costs of debt and problems related to adverse selection, they have been called "death spirals" because of their potential to create dilution and stock price declines. On the basis of all 487 issues announced before August 1998, we find that this bad reputation is indeed justified: an investor who buys the common stock of the issuer loses, on average, 34% of his wealth one year after the issue date. Although our sample period coincides with one of the strongest bull markets in U.S. history, in 85% of the cases one-year post-announcement returns are negative. However, we also find that issuers also experience a significant decline in operating profitability relative to benchmark firms.

Abstract: We derive a measure of diluted EPS that incorporates economic implications of the dilutive effects of employee stock options. We show that the existing FASB treasury-stock method of accounting for the dilutive effects of outstanding options systematically understates the dilutive effect of stock options, and thereby overstates reported EPS. Using firm-wide data on 731 employee stock option plans, we find that economic dilution from options in our proposed measure of options-diluted EPS is, on average, 100% greater than dilution in reported diluted EPS using the FASB treasury-stock method. We examine the implications of our analysis for stock price valuation, the price-earnings relation, and the return-earnings relation. We demonstrate analytically that when firms have options outstanding, empirical applications of equity valuation models that use reported per share earnings as an input (e.g., Ohlson, 1995), yield upwardly biased estimates of the market value of common stock. We predict that observed return-earnings and price-earnings coefficients are expected to be smaller the greater the difference between our measure of economic dilution from options and FASB treasury-stock method dilution from options, and provide weak empirical support for this prediction.

Abstract: With fixed costs of participating in the stock market, consumers with high income will participate in the stock market, but consumers with lower income will not participate. If a fully funded defined-contribution Social Security system tries to exploit the equity premium by selling a dollar of bonds per capita and buying a dollar of equity per capita, consumers who save but do not participate in the stock market will increase their consumption, thereby reducing saving and capital accumulation. Calibration of a general-equilibrium model indicates that this policy could reduce the aggregate capital stock substantially, by about 50 cents per capita.

Abstract: Methods are disclosed for creating new types of securities, including equity dividend strips, equity dividend strip futures, equity dividend strip options, new index fund stocks, new mutual fund investments, and related securities are created in consideration of the cash dividends paid by companies issuing the original stock. Similar financial products are created for nondividend paying stock. Additionally, the principles of the present invention can be employed to provide new corporate financing methods which make use of the aforementioned securities. An example of such a new method is the issuance of original common stock with a detachable dividend strip. Purchase both and put the dividend strip into your retirement account. Purchase both and donate the dividend strip to charity. Give the dividend strip to a minor child, or a child in college. The stock does not need to be paying dividends at the time the dividend strip is created. The dividend strip covers all future dividends, even if there are none now. Investors can set dividend policy themselves, as long at the constraint is met: total dividends paid by company=total dividend received by security holders. Many security holders will have only stripped stock, or only stripped dividend.

Abstract: This paper studies the extent to which real estate prices impact common stock prices in Hong Kong. Real estate-related firms account for over 30 percent of Hong Kong's stock market capitalization. The real estate markets are therefore major determinants of changes in common stock prices. This study, using data during the 1974-1998 period, not only supports empirically that both unexpected changes in residential and office property prices are important determinants of the change in stock prices for Hong Kong, it also finds that the property and stock price series are cointegrated. Impulse response function based on an error-correction VAR model is used to examine the dynamic relationships between real estate and common stock prices.

Abstract: Margin loans have long been associated in the popular mind with instability in security markets, and the potential for margin lending to exacerbate the amplitude of cycles in stock prices has received considerable attention in the years since the Crash of 1929. Despite the many empirical studies of the association between margin loans or margin requirements and the volatility of stock returns, there has been no definitive answer, and the consensus among financial economists is that margin lending plays little, if any, role in shaping the probability distribution of returns on common stocks. Perhaps as a result of this, the Federal Reserve System's margin requirements have not been changed since 1974. ; This study addresses the role of margin requirements from the vantage points of economic theory and the historical record. The author reviews many of the key empirical studies of the link between margin requirements and stock prices. Economic theory suggests many reasons that the link might be weak, and this is supported by many of the empirical studies. ; The author estimates a model of the returns on common stocks in the period 1975-2001. The model includes information on the amount of margin debt outstanding. He concludes that margin loans are a statistically significant factor in the determination of stock returns, and that the effect is stronger and more reliable for the NASDAQ Composite index than for the S&P 500 index. However, the economic significance of margin debt is so low that this study is not able to support a return to the active margin policy that existed prior to 1974.

Abstract: Because of transactions costs andinvestor/manager information asymmetries, internallygenerated funds should be less costly than fundsraised by issuing common shares. This suggests thatas firms use more internal funds relative toexternal equity, their costs of equity capital willfall and the rate the market uses to discountunexpected earnings of such firms will be lower. Wehypothesize that (1) firms having a higherproportion of internal to external equitywill have larger earnings response coefficients, and(2) this effect will be magnified for high growthfirms since the disparity between inside informationand publicly available information about high growthfirms' investment opportunities is greatest. Wefind support for both hypotheses using pooled andannual cross-sectional regressions after controllingfor other determinants of ERCs. The results arealso generally robust to alternative measures of themix of equity funding sources and of unexpectedearnings and to consideration of other factorsaffecting the mix of equity capital.

Abstract: This paper develops a theory of the joint allocation of formal control and cash-flow rights in venture capital deals. We argue that when the need for investor support calls for very high-powered outside claims, entrepreneurs should optimally retain formal control in order to avoid excessive interference. Hence, we predict that risky claims should be be negatively correlated to control rights, both along the life of a start-up and across deals. This challenges the idea that risky claims should a ways be associated to more formal control, and is in line with contractual terms increasingly used in venture capital, in corporate venturing and in partnership deals between biotech start-ups and large drug companies. The paper provides a theoretical explanation to some puzzling evidence documented in Gompers (1997) and Kaplan and Stromberg (2000), namely the inclusion in venture capital contracts of contingencies that trigger both a reduction in VC control and the conversion! of her preferred stocks into common stocks.

Abstract: Options market microstructure research relies primarily on transactions and quote data available from the CBOE In most implementations, the data do not include information on whether a given trade is buyer-or seller-initiated As a result, some researchers have used trade classification rules developed for common stocks These rules include the quote, the tick, the Lee-Ready (1991) and the Ellis-Michaely-O'Hara (2000) methods Using a proprietary CBOE data set that reports trade direction, we find that the correct classification rate for the quote rule is 83%, and that for the Lee-Ready, Ellis-Michaely-O'Hara, and tick rules is 80%, 77%, and 59%, respectively The main forms of option trade misclassification include outside-quote trades and reversed-quote trades (ie, buying at the bid and selling at the ask) Other factors, such as trading frequency, volume, moneyness, and maturity have indirect effects by influencing the probability of outside-quote and reversed-quote trades Underlying asset price changes around the time of the trade are found to enhance classification precision On further analysis, we are able to isolate trades that are misclassified almost 50% of the time by any method These are the components of index spreads and index combinations other than those executed on RAES These trades comprise approximately 15% of the sample and their elimination results in higher than 87% correct classification rate for the quote rule

Abstract: In 1973, Fischer Black, Myron Scholes, and Robert Merton pointed out that securities issued by a corporation can be priced as claims whose values are contingent on the value of the enterprise as a whole. The notion of treating corporate securities as contingent claims is intrinsically important, but it is also important because it integrates a variety of otherwise loosely related topics, including equity risk, credit risk, seniority and subordination, early redemption of callable debt, and conversion of convertible debt. Bringing together developments from the past thirty years in contingent valuation, this book examines the relative value of securities in a corporation's capital structure, including debt of different priorities, convertible debt, common stock, and warrants. The book emphasizes the importance of accounting for the institutional characteristics of default, bankruptcy, and voluntary recapitalization of a financially distressed firm, as well as the exercise of managerial discretion in calling debt for early redemption, servicing debt, paying dividends to common shareholders, and undertaking strategic actions such as leveraged recapitalizations and spin-offs.

Abstract: For more than 20 years pension and endowment funds have used multiple active investment managers with complementary styles to manage their U.S. common stocks. Theory tells us that the approach—diversifying with active managers—is suboptimal. Evidence presented by the author supports the theory, indicating that the strategy has underperformed by the margin of its cost, which is approximately 1.2% per year. Passive management is one solution, and passive allocations have risen steadily for 20 years. Many funds, however, demonstrate reluctance to pursue a purely passive approach. The author recommends that those funds consider employing one or more whole portfolios in managing their active U.S. equity assets. Successfully employed in managing fixed income and international equities, whole portfolios embrace the totality of the opportunity set represented by the asset class. Whole portfolios allow investment managers to make a broader range of relative–value judgments than occurs under the multiple–specialist model. At the same time their use frees the client from having to manage the collective style of several active managers, eliminating in the process fairly arbitrary and rigid boundaries within the active equity portfolio. Using whole portfolios is also conducive to hiring fewer managers, an important step in avoiding “closet indexing.”

Abstract: Recent research regarding debt covenant violation hasemphasized the economic consequences of technical defaultand the information conveyed to the capital markets byannouncements of technical default. Studies have shown, forexample, that firms manipulate accruals in an effort to postponetechnical violations (e.g., Defond and Jiambalvo, 1994; andSweeney, 1994), that the costs of technical violation can besubstantial (Beneish and Press, 1993), and that common shareprices respond negatively when violations are disclosed (Beneishand Press, 1995a). These studies reveal that technical debtcovenant violations are significant, often recurring, economicevents that are considered important by managers and value-relevant by common stock investors. We add to this research byinvestigating the changes in firm risk that are associated withinitial technical debt covenant violations.

Abstract: Units are bundles of common stock and warrants. By issuing units, firms precommit to a future and uncertain seasoned offering at the exercise price of the warrants. This study shows that the issuance of units seasoned offerings in France is accompanied by significant abnormal returns of on average 9-12%, depending on the computing methods. Underpricing increases with the risk of the issuer and the relative size of the future seasoned equity issue linked to warrant exercises. Our results are consistent with our signaling hypothesis. [ABSTRACT FROM AUTHOR]

Abstract: Most studies of corporate stock repurchase focus on the effect of stock buyback announcements on the stock price performance of companies announcing the programs, and on the corporate motives for undertaking stock buyback programs. The study described in this article examines the effects of actual stock buyback activities on corporate performance, addressing the question whether buybacks are associated with increases in economic value or EVA. In general, the study reports that the operating performance of buyback companies is better than that of non-buyback companies, and that performance improves in the year following the initiation of repurchasing activities. Although it is not the central focus of this study, the findings are consistent with both the free cash flow and the information signaling hypotheses as motives for engaging in stock buybacks.

Abstract: This paper provides additional evidence on the relationship between corporate taxes and debt using panel data on Italian companies. The panel covers 1054 companies for the years 1982?1994. The paper follows the Graham-Shevlin methodology for calculating company specific marginal tax rates (MTR) relying on the non-linearity of corporate tax schedules resulting from company losses and the ensuing tax provisions (carry-forward and backward rules). In the period covered by the panel there were in Italy two taxes on corporate income (IRPEG and ILOR), with different loss carry-forward rules, whose statutory tax rates and tax bases changed several times. For these reasons the simulated MTRs display both cross-sectional and time-series variation. The paper tests whether taxes encourage the use of debt by analysing incremental financing decisions. In order to cope with the endogeneity of the MTR the paper considers two different specifications. The first uses the lagged value of the simulated MTR. The second employs the estimate of before-financing MTR proposed by Graham et al. (1998). Significant cross-sectional tax effects are identified under both specifications whereas time-series variation cannot be identified if due account is taken of firm-fixed tax effects.The paper also investigates whether personal taxes affect corporate financing decisions. The MTR may either overstate or understate the fiscal benefit of debt financing according to whether, at the personal level, interest income is taxed at a rate that is higher or lower than the tax rate on returns from common stocks. Differences in the dividend-payout ratio across companies and several reforms in interest, dividend and capital gains taxation provide sufficient cross-section and time-series variations to identify the effect of personal taxes on debt usage.

Abstract: In a short sale, an investor sells a share of stock he does not own and profits when the price of the stock declines. A peculiar feature of short sales is the apparent increase in the number of shares of stock beneficially held by investors over and above the actual number of shares issued by the corporation. It has previously been noted that this may create problems in the execution of proxy votes. In this paper, we illustrate a related problem in the prosecution of claims of securities fraud. We examine this problem using the recent case of Computer Learning Centers, Inc. (CLC), in which the number of short sales was extremely large. Plaintiffs in the Computer Learning Centers case proposed a class including all those who purchased CLC common stock from April 30, 1997, to April 6, 1998. Defendants opposed certification of the class, focusing on the large number of short sales and the resulting difficulty in establishing which members of the class actually had standing to sue. The court denied the motion for class certification. Although the court gave plaintiffs leave to amend the class, the case was settled before a new class was identified.

Abstract: We examine companies that issue tracking stock or undertake a minority carve-out. These restructurings create equity claims on a business unit yet the parent retains control. Although the average announcement stock price effect is approximately 3%, our evidence implies that these equity restructurings do not lead to an improvement in operating performance. We conclude that corporate restructuring without a change in control of assets does not enhance operating performance. Like other research, our tests are unable to identify the reasons for the positive stock price effects of tracking stock and minority carve-out arrangements.

Abstract: In a short sale, an investor sells a share of stock he does not own and profits when the price of the stock declines. A peculiar feature of short sales is the apparent increase in the number of shares of stock beneficially held by investors over and above the actual number of shares issued by the corporation. It has previously been noted that this may create problems in the execution of proxy votes. In this paper we illustrate a related problem in the prosecution of claims of securites fraud. We examine this problem using the recent case of Computer Learning Centers, Inc., (CLC) in which the number of short sales was extremely large. Plaintiffs in the Computer Learning Centers case proposed a class including all those who purchased CLC common stock from April 30, 1997 to April 6, 1998. Defendants opposed certification of the class, focusing on the large number of short sales and the resulting difficulty in establishing which members of the class actually had standing to sue. The court denied the motion for class certification. Although the court gave plaintiffs leave to amend the class, the case was settled before a new class was identified.

Abstract: This study reviews Tag el-Din's (1996) paper and raises the possibilities that his organizational models may create other kinds of inefficiency. Furthermore, using Canadian stock data we extended his study and found that excess speculative activities (bubbles) do not add any information to the stock markets. Consequently, according to our empirical evidence, in light of Tag el-Din's view, to achieve an efficient and stable stock market, a highly regulatory normative stock exchange is needed. In this regard this study proposes that the central bank and the government ensure that the investors in the stock markets have comprehensive knowledge of the stock market mechanism. Furthermore, the study proposes that government levies a tax on short-term horizon investment returns.

Abstract: This paper analyzes corporate governance decisions at firms making initial public offerings (IPOs) of common stock between 1996 and 1999. Our objective is to examine relationships between firms' corporate governance practices and the quality and availability of accounting- and market-based measures of firm performance. We collect a sample of 464 companies from the manufacturing, internet, and technology (non-internet) industries, and examine how CEO incentives vary with industry and with the extent of venture capital influence. We first study determinants of executives' compensation-related incentives and share ownership at the time of the IPO, and then examine factors affecting firms' decisions over executive compensation grants and CEO turnover subsequent to the IPO. Consistent with prior research that finds earnings are of limited usefulness in firm valuation for internet firms, we find internet and non-internet firms place differing importance on earnings and information in stock returns in determining post-IPO compensation grants. We also find that firms with little or no venture capital influence display significantly stronger association with accounting and stock performance measures than firms with more intense monitoring by venture capitalists.

Abstract: Author(s): Frieder, Laura; Subrahmanyam, Avanidhar | Abstract: This paper investigates the effect of company brand perceptions on investor incentives to hold stocks. We find that, after controlling for other postulated determinants of stockholdings, there is a negative and significant cross-sectional relation between percentage institutional holdings and brand visibility. This finding indicates a propensity for individual investors to hold stocks with strong brand recognition, which is consistent with the hypothesis that individuals prefer to invest in companies whose products are readily recognized. Furthermore, we find that institutional holdings are positively related to firm size and beta, while being negatively related to total return volatility. Our analysis supports the notion that institutional portfolios eschew the relatively neglected sector characterized by small firms with high total volatility, whereas individual investors prefer holding stocks with low systematic risk and high recognition. The results contribute to our understanding of how financial market investors form their equity portfolios.

Abstract: This study examines how a Securities and Exchange Commission rule change affected the design of executive compensation contracts. It shows that a change in insider holding requirements for employee stock options led to a widespread decrease in the use of stock appreciation rights. Further, we find firms that decrease their use of stock appreciation rights compensate employees by increasing their use of employee stock options.The Securities and Exchange Commission rule change provides a unique opportunity to examine the use of compensation methods as it caused firms to examine their policies and make an active decision to modify their practices. Cross-sectionally, we find the likelihood a firm decreases its use of stock appreciation rights positively associated with the magnitude of expense associated with stock appreciation rights, the firm's use of income-increasing accounting methods, leverage, and the ratio of market to book value of assets. We also find a significant interaction effect for the magnitu...