The recent world-wide increase in consumer prices has created an intense interest in inflation on the part of both the academic and the financial communities. For example, in his American Financial Association presidential address, Professor Lintner [4, p. 259] states “few matters are of more serious concern to students of finance and to members of the financial community than the impacts of inflation on our financial institutions and markets and its implication for investment policy.”

This paper develops an equilibrium factor pricing theory when investors have heterogeneous beliefs about asset payoffs generated by the Ross linear factor model. Investors receive private information about the unknown parameters of the payoff process. They use this private information and equilibrium prices to predict asset payoffs. The paper develops a closed form price function for a noisy rational expectations equilibrium and relates it to the general solution. Even though we allow for a large number of investors, diversity of beliefs and parameter uncertainty both persist in equilibrium. We show that investors' beliefs about expected payoffs are approximately linear in the asset's betas, thus establishing the APT. As investors prefer to hold high information assets in equilibrium, the relative weight of these assets in the APT pricing bound is higher. The reverse is true for low information assets.

The increase in corporate liquidity over the past ten years, together with higher levels of interest rates and growing sophistication among corporate treasurers and bank portfolio managers, have contributed to the increasing importance of various money-market instruments. The relative position of the Treasury bill has declined, and bank time certificates of deposits, short-term issues of municipalities, and commercial paper have assumed greater importance. The fundamental reason for the attractiveness of alternatives to Treasury bills is, of course, the additional yield that the investor can obtain in the substitute instruments. The differential yield spread over Treasury bills can be explained substantially by two factors—the difference in marketability and the existence of some default risk on the alternative securities.

Bradford Cornell's paper develops a small, but important result for the literature on currency of denomination of international trade contracts. The selection of a contract currency determines which party will bear exchange risk in addition to inflation risk. The contract currency problem in international trade is therefore closely related to other contracting issues, such as the pricing of nominal bonds under inflation uncertainty. More graphically, exchange risk can be illustrated by a difference in the units ofaccount of income and consumption streams. For example, if an agent produces only corn and consumes only wheat, he faces an exchange risk if the price of wheat relative to cornis uncertain.

Two general methods of computing the rate of return on common stock are being discussed widely. These methods are the internal rate of return and the geometric mean of the annual rates of return. The Gordon-Shapiro formulation, , is the best known model of the former type.

We show that political contributions are associated with reduced civil and criminal sanctions for fraudulent executives. These managers benefit more from contributions if their firm also gained from the fraud, if they occupy top positions in firms with weak boards, or if they contribute to powerful politicians. Political contributions reduce budgetary resources for government enforcers and lengthen the Securities and Exchange Commission’s case time-to-resolution. They also facilitate penalty transfer from fraudulent managers to the firm, resulting in their entrenchment and long-term destruction of shareholder value. Our findings highlight an agency cost of political contributions and a mechanism undermining the disciplining effect of regulations.

An assimilation bias occurs when people’s evaluative judgment is positively influenced by a previously observed signal. We study this effect by examining investors’ appraisal of M&A deals announced 1 day after other firms in the same 1-digit SIC as the merging parties release earnings surprises. Consistent with assimilation effects, acquirers’ M&A announcement stock return initially correlates with the previous day’s earnings surprises. This effect reverses after 1 week. Assimilation generates other distortions as more positive surprises are related to increases in bid competition, takeover premiums, and withdrawn M&As. Evidence from IPOs corroborates the presence of assimilation effects in financial markets.

Firms become more efficient at innovation activities when they face pressure to meet earnings per share (EPS) targets using stock repurchases. Using a regression-discontinuity framework, we find that incentives to engage in “EPS-motivated buybacks” are followed by more citations and higher values for firms’ new patents. We trace these effects to improved allocation of R&D resources and a greater focus on novel innovation. The positive effects are concentrated among ex ante “innovation-efficient” firms that achieve better patenting outcomes after reorganizing (but not cutting) their R&D investments. Our findings illustrate that short-term earnings pressure can act through a free cash flow channel that motivates more efficient spending.

An unintended consequence of recent governance reforms in the United States is firms’ greater reliance on older director candidates, resulting in noticeable board aging. We investigate this phenomenon’s implications for corporate governance. We document that older independent directors exhibit poorer board meeting attendance, are less likely to serve on or chair key board committees, and receive less shareholder support in annual elections. These directors are associated with weaker board oversight in acquisitions, CEO turnovers, executive compensation, and financial reporting. However, they can also provide particularly valuable advice when they have specialized experience or when firms have greater advisory needs.

This article analyzes the optimal allocation of losses via a Central Clearing Counterparty (CCP) in the presence of counterparty risk. A CCP can hedge this risk by mutualizing losses among its members. This protection, however, weakens members’ incentives to manage counterparty risk. Delegating members’ risk monitoring to the CCP alleviates this tension in large markets. To discipline the CCP at minimum cost, members offer the CCP a junior tranche and demand capital contribution. Our results endogenize key layers of the default waterfall and deliver novel predictions on its composition, collateral requirements, and CCP ownership structure.

We study the valuation of collateral by comparing spreads on loans by the same bank, to the same borrower, at the same origination date, but backed by different types of collateral. Pledging collateral reduces borrowing costs by 23 BPS on average. The effect varies across different types of collateral, with marketable securities being most valuable, and real estate and accounts receivables and inventory being more valuable than fixed assets and a blanket lien. Further, the rate reduction from pledging collateral is sensitive to the value of the underlying collateral, and collateral tends to be more valuable for smaller and private firms and for loans with longer maturity.

We investigate whether firms’ number of credit relationships with financial institutions affects labor market outcomes. Using 5 million observations on matched credit and labor panel data from Brazil, we estimate IV regressions, employing exogenous variation in firm-lender relationships due to nationwide bank M&A activity. Firms with more relationships employ more workers and pay higher wage bills. Credit availability, cost of credit, and financial institution heterogeneity are economic channels. The firm-level results translate into positive macroeconomic effects in municipalities and states. The evidence is novel and indicates the positive effects of multiple relationships on labor market outcomes in an emerging economy.

This study examines the historic security market performance of REIT shares during the six-year period 1968–1973. Performance measures suggested by Sharpe, Treynor, and Jensen were calculated for a sample of 30 larger and older REITs on both a pre- and post-tax basis. Principal conclusions are: 1) The average mortgage trust sampled had “outperformed” the S&P 500 while equity and hybrid trusts have fared poorer than the S&P 500. 2) The differences in performance levels are due principally to return levels and not risk differentials. 3) A substantial portion of the risk inherent in an REIT is diversifiable risk. This together with other evidence suggests that most REITs have not diversified risk exposure to the extent they indicated they would and were able to. 4) Performance rankings using before- and after-tax returns were identical, suggesting that certain espoused tax advantages unique to REITs have been virtually meaningless on a practical level.

Miller has analyzed capital structure in the presence of both corporate and personal taxes. The present work investigates the effect of inflation on both interest rates and equity returns when the Miller equilibrium condition is employed in a loanable funds model. Both an interest rate effect and a redistribution effect are derived. The interest rate effect forces the responsiveness of the interest rate to the inflation rate to be below that hypothesized by Darby. However, the redistribution effect may change this responsiveness in either direction.

The Capital Asset Pricing Model predicts that investors will hold diversified portfolios, but many households actually hold very few assets. The paper examines the asset pricing implications of one possible explanation for this phenomenon, fixed costs of holding assets. While earlier authors found the exact asset pricing effects of such costs in single-period models under restrictive assumptions, I derive a general upper bound on these effects that is also valid in continuous time. Illustrative calculations reveal that large holding costs must be postulated to generate significant asset pricing effects.

Since the seminal article by Black and Scholes on the pricing of corporate liabilities, the importance in finance of contingent claims has become widely recognized. The key to the valuation of such claims has been found to lie in the solution to certain partial differential equations, the best known of which is that derived by Black and Scholes in their original article from the assumption that the value of the asset underlying the contingent claim follows a geometric Brownian motion.

In [2], I gave a solution of an extended cash balance problem which disallows overdrafts and shortselling. This solution is incorrect. To show this, we produce a counterexample constructed by Carl Norstrøm. In the notation of the note [2], let x0 = 0, y0 = 3, d(t) = 0, α = 0, T = 10, M1 = M2 = ∞

and r2 (t) = .1. Applying the procedure in [2] to this problem, we obtain the policy of impulse-selling all the securities at t = 0. On the other hand, it is obvious by inspection that the optimal policy is to keep the securities until t = 5, at which time, turn them into cash by an impulse-sale. We note, in passing, that the solution by inspection in this case is possible because there is no bounds on the control variable.

Considerable attention has been focused recently on models of firms under uncertainty in which there is an incomplete set of securities markets. In these models, each firm can issue only one security and consumers can generate consumption plans only through the purchase of firms' securities. Consequently, if the economy is competitive, each stockholder of a firm will impute the same value to the firm in equilibrium, where this value is given by the market price of the firm's security. However, stockholders will not, in general, have the same implicit prices for state-contingent consumption. Since the financial market is said to be incomplete if the number of independent securities is less than the number of states of nature, consumers cannot hedge perfectly, whichimplies that unconstrained Pareto-optimal allocations are not generally attainable (see [2] and [3]). Finally, it is unclear what firms' objectives should be in these models because profit maximization is not well defined; firms' profits in different states cannot be aggregated into a single index. It is still generally accepted, however, that firms should operate in their own stockholders'interests, a necessary condition for allocative efficiency.

The rising cost of funds internationally is forcing multinational corporations to pay more attention to effective cash management on a global basis. However, the available literature is preoccupied with cash management in only one currency. This is a serious oversight given the heavy involvement of U.S. firms overseas. In 1970, for example, the ratio of foreign source earnings plus income from abroad (royalties, fees, service charges) to total U.S. corporate after-tax profits was over 25 percent [14]. If export and import activities were included, this statistic would be more impressive yet.

During the “credit crunch” of 1966, starts of single-family residences fell 19.2 per cent, from 964,000 to 779,000. At that time, 10 states had usury laws limiting the maximum nominal interest rate that could be charged to individuals on residential mortgages to 6 per cent. When interest rates rose to high levels in 1966, there were widespread complaints that this artificial restriction caused residential construction to decline by even larger amounts in those states having 6 per cent usury laws as lenders shifted funds to other states not having this restriction. However, when nominal interest rates rise to the legal maximum, mortgages trade at a discount and the effective yield rises above the legal rate. Presumably, it is the effective yield, not the nominal rate, that is relevant for directing the flow of funds into alternative investments. Thus, there is good reason to doubt that the usury laws did restrict residential construction in spite of the contention by those in the mortgage and construction industries. The purpose of this study is to determine if—and if so, to what extent—state usury laws caused a decline in residential construction in 1966.