A firm which produces a single product, whose production cost is a linear function of the production level and where net price per unit is constant, has a Pre-Tax Earnings function which is a linear function of the production level (see Figure I).

State-preference theory has developed as a choice-theoretic framework through which many problems of finance and economics dealing with time and uncertainty can be analyzed. Hirshleifer [3], [4], [5], [6] has used the approach to provide significant insights to areas such as production and exchange, investment decisions, and speculative behavior. However, the theory has not made progress in attempting to incorporate state-labeled utility functions into the body of the theory. This paper will develop a method of graphically and analytically allowing for differing utility functions across states. As a further step, the impact of belief-deviation upon the tangency optimum will be discussed. Finally, the significance of these findings upon the consideration of risk will be discussed.

The comment by Linke and Kim correctly observes that the assumption regarding the maintenance of constant proportional use of capital sources is not appropriate for our argument and should be deleted. As our analysis did not make use of this assumption, the two conclusions hold.

1. The weighted average cost of capital calculated with the usual weights (original capital structure proportions) is not in general equal to the discount rate which equates the current value of the firm to the present value of future cash flows.

2. The above conclusion holds for any weights which can be constructed from the cash flows.

There are two well-known distinct aspects to the behavior of a risk-averse individual towards a risky proposition: the position he takes, long or short, with regard to the gamble, and the scale of the position taken–the amount by which he goes long or short. On one hand, the first aspect depends only on the individual's assessment of the expected return from the gamble relative to a safe return. The second aspect, on the other hand, will be influenced by the individual's degree of risk aversion and the level of risk of the gamble.

J. M. Keynes' theory of portfolio management (modified and refined by Tobin)occupied an important role in his analysis of the demand for money. According to this theory, financial investors were thought to vary the composition of their portfolios between money and securities on the basis of expected yields on securities. When yields were expected to rise, investors would shift out of securities and into money. Conversely, when yields were expected to fall, investors would shift out of money and into securities. Hence, the asset, or portfolio, demand for money was argued to be negatively related to the expected yields on securities.

The speed of stock price reaction to news exhibits substantial time variation. Higher risk-bearing capacity of financial intermediaries, lower passive ownership of stocks, and more informative news increase price responses to contemporaneous news; surprisingly, these interaction variables also increase price responses to lagged news (underreaction). A simple model with limited attention and three investor types (institutional, noninstitutional, and passive) predicts the observed variation in news responses. A long–short trading strategy based on news sentiment earns high returns, which increase when conditioning on the interaction variables. The interactions we document are robust to the choice of news source.

Nonbank lenders have been playing an increasing role in supplying debt, especially after the Great Recession. How important are the distortions in the greater regulation of banks that differentially limit risk-taking across alternative providers of credit? How might the growing role of nonbanks in credit markets affect financial stability? This selective review addresses these questions and discusses how banks and nonbanks helped provide liquidity to the nonfinancial sector during the COVID-19 pandemic shock. We argue that tighter bank regulation has created incentives for nonbanks to increase their participation in credit markets, a trend that creates concerns about financial stability.

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.

This article examines whether and how stock mispricing can affect the probability of CEO turnover. In a sample of 1,573 US public firms, I find that, after controlling for fundamental performance, a 1-standard-deviation negative uninformative stock price shock increases the likelihood of CEO turnover by 10%. The mispricing-turnover sensitivity is stronger at firms with an independent board, and a difference-in-difference analysis further supports that finding. Ancillary results suggest that independent directors’ career concerns may play a role in the response of independent boards to mispricing.

This article studies how industry peers’ stock prices respond when another firm in the industry is acquired by a foreign firm. The average stock price reactions of industry peers in horizontal foreign acquisitions around deal announcements are significantly negative. Peers’ returns are more negative in growing, less specialized, and competitive industries. Moreover, the negative stock price reactions of industry peers are related to future decreases in their operating performance. Overall, these results suggest that foreign acquisitions have strong competitive effects for the industry peers of U.S. target companies.

We study how the U.S. government’s anti-counterfeiting enforcement actions through Special 301 Reports influence U.S. businesses. We show that anti-counterfeiting enforcement in foreign countries improves U.S. firms’ sales, profitability, and valuations. Firms significantly reduce capital and research and development investments when their brands and products are protected from counterfeiting activities. Anti-counterfeiting enforcement measures also improve brand asset value, brand profitability, brand inventiveness, market penetration, and customer loyalty.

We study when CEOs with legal expertise are valuable for firms. In general, lawyer CEOs are negatively associated with frequency and severity in employment civil rights, contract, labor, personal injury, and securities litigation. This effect is partly induced by the CEO’s management of litigation risk and reduction in other risky policies. Lawyer CEOs are further associated with an increase in gatekeepers providing additional legal oversight and a decrease in innovative activities with high litigation risk. Lawyer CEOs are more valuable during periods of enhanced compliance requirements and regulatory pressure and in industries with high litigation risk or better growth opportunities.

We exploit the arrival of industry-wide synergistic merger waves to identify whether classified boards deter takeover bids. In a stylized model, we show that when target classified boards are costly to bidders, their negative effect on takeover likelihood should be more pronounced during merger waves. Using a sample of takeover bids in the United States between 1990 and 2016, we find strong evidence supporting this prediction. The results are robust to accounting for the benefits of classified boards and controlling for other antitakeover provisions. Our findings suggest that classified boards effectively reduce a firm’s exposure to the takeover market.

We exploit the information content of option prices to construct a novel measure of bank tail risk. We document a persistent increase in tail risk for the U.S. banking industry following the global financial crisis, except for banks designated as systemically important by the Dodd–Frank Act. We show that this post-crisis difference in tail risk for large and small banks is consistent with the too-big-to-fail (TBTF) status of large banks being reinforced by the Dodd–Frank designation: Naming the banks whose failure could threaten the financial stability of the U.S. gave investors a list of banks the government deemed as TBTF.

We document a strong positive initial market reaction to merger announcements from bidders with either large earnings growth or significant earnings decline, relative to those with neutral earnings change, reflecting a U-shaped pattern between bidders’ earnings growth and announcement returns. However, the higher initial returns for bidders with earnings decline subsequently reverse, whereas the higher returns for bidders with high growth do not. We further show that the return patterns are driven by a tendency for retail investors to gamble that merger and acquisition deals initiated by poorly performing bidders will generate high synergies.

Using a large sample of leveraged loans, we provide evidence that, despite having fewer creditor control rights, covenant-lite (Cov-Lite) loans have similar recovery rates and significantly lower spreads than loans with maintenance covenants. We find that the propensity to borrow Cov-Lite is related to various proxies for the reputational capital of a borrowing firm’s private equity sponsor. We construct a simple model to illustrate the relationship between reputational capital, covenants, and loan spreads in the leveraged loan market. Our model illustrates how reputational capital can substitute for covenants in mitigating agency costs of debt, leading to lower loan spreads for Cov-Lite loans.

This article investigates the impact of exchange-traded fund (ETF) ownership on seasoned equity offerings (SEOs). We find that increases to firms’ ETF ownership is positively related to their propensity to conduct an SEO. ETF ownership is also associated with less negative SEO announcement returns, smaller discounts, and better long-run stock returns. Our evidence is consistent with equity issuance following investor demand for stocks driven by greater participation in ETFs, suggesting a possible alternative source of market timing opportunity.

This article investigates spillovers from foreign economies to the U.S. through changes in long-term Treasury yields. We document a decline in the contribution of U.S. domestic news to the variance of long-term Treasury yields and an increased importance of overnight yield changes, a proxy for foreign shocks’ contribution to U.S. yields. A model that identifies U.S., Euro area, and U.K. shocks that move global yields suggests that foreign shocks account for at least 20% of the daily variation in long-term U.S. yields in recent years. We also document the predictability of long-term U.S. yields by the U.S.–foreign yield spread.

We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.