This paper is an attempt to improve on the ability of financial management to arrive at a desirable or close to “optimal” cash balance for a firm at a point in time. There have been several comments on this subject in literature over the years including the contributions of Keynes, Hicks and Samuelson. In recent years Baumol and Beranek have presented us with more specific models. This paper tends to be more operational than the Baumol or Beranek presentations and hence tends perhaps to lose some of the sophistication of the more theoretical models; it attempts to present a reasonably operational method for providing for cash balances for transactions and precautionary purposes. But let us first examine these two models briefly.

The purpose of this paper is to show that the internal rate of return (IRR) even when unique and real may nevertheless be an incorrect measure of the return on investment, and to prove that all projects characterized by negative flows occurring only at the beginning and end will be mixed investments for which the IRR, whether unique and real or not, is not a correct measure of investment return.

This paper presents a test of the theory of rational option exercise. Exercise data from the market for options on Treasury bond futures are used to test the model of rational early exercise developed by Barone-Adesi and Whaley (1987) (BAW). The results show that the BAW model underestimates the futures price that will trigger exercise for calls and overestimates this price for puts. The exercise bias is observed to change across option maturities and the direction of the bias is consistent with the direction of the model-pricing bias observed by Whaley (1986).

Small sample t-test results are reported in the literature that indicate the difference between futures and forward exchange rates are statistically insignificant. Much research draws on this finding, which is in contrast with theory. The evidence presented here suggests this difference does not follow a normal distribution, so the small sample inferences based on the t-tests may be suspect. As appropriate alternatives, nonparametric distribution-free tests are used to reexamine the difference for two sample periods, one covering the 1970s and the other the 1970s and 1980s. A significant divergence is observed for several currencies as well as for a sample of pooled currencies. The results are stronger for samples covering the 1980s. The economic significance of the forward-futures differentials is examined and theoretical justifications are discussed.

This paper provides empirical evidence that the quality option in T-bond futures is much less valuable than previously indicated. In addition, a dynamic trading strategy involving multiple switches of the cash bonds held in a long cash versus short futures position is shown to produce substantially greater profits than the single exercise of the quality option. These findings suggest that the optimal management of long cash/short futures positions is likely to involve dynamic trading strategies while passive strategies appear more appropriate for short cash/long futures positions. It is also shown that required variation margin payments are frequently large and may impact the profitability and risk of such positions to a greater extent than either of these options. Further, evidence is given indicating that observed T-bond futures prices reflect an imputed value for the options and risks inherent in such positions.

In this paper, we explore the nature of equilibria in an asymmetrically informed bank credit market in which credit applicants know their own (intrinsic) default risks, but potential lenders can discover these default risks only by expending resources to produce information. The resolution of informational asymmetries in the capital market is, in the contemporary view, considered a very important function served by financial intermediaries like commercial banks and, in the opinion of some, even the primary justification for their existence [17]. We, therefore, focus on how the presence of asymmetric information—in particular, the response of (expected) profit-maximizing banks to it—affects the equilibrium prices and quantities of credit offered in the banking system.

This paper examines a firm's debt level, investment timing, and investment scale choices in a continuous-time model where the output price of a good that the firm produces depends on a stochastic demand-shift variable and the total industry supply of the good. Using the simple symmetric Cournot-Nash equilibrium assumption that all firms are identical and therefore follow the same financing and investment strategies, we show that competition decreases the output price and hence encourages a firm to wait for a higher demand level before it is profitable to invest. We also demonstrate how uncertainty, bankruptcy costs, and corporate taxation affect the firm's financing and investment decisions.

Discount rates affect stock prices directly via the discount-rate channel or indirectly via the cash-flow channel because expected future cash-flow growth varies with the discount rate. The traditional Macaulay duration captures the effect from the discount-rate channel. I propose a novel duration measure, the effective equity duration, to capture the effects from both channels. I estimate it around unexpected policies in the federal funds rates. I find that the equity yield curve is hump-shaped because expected future cash-flow growth increases with the discount rate. The effective equity duration captures information other than monetary policy risk.

Policy risk, rather than information asymmetry, explains the cross-sectional underpricing of privatized initial public offerings. The issuer governments of high policy risk issues tend to retain a large equity stake and underprice more with underpricing increasing in retained equity. While the issuer government's retained equity is an observable signal for policy risk, we find that the quality of a country's bureaucratic machinery is a more intuitive and practical measure of policy risk. Policy risk also explains the absence of a systematic relation between the initial returns on privatized and private initial public offerings.

I document wage convergence in conglomerates using detailed plant-level data: Workers in low-wage industries collect higher-than-industry wages when the diversified firm also operates in high-wage industries. I confirm this effect by exploiting the implementation of the North American Free Trade Agreement (NAFTA) and changes in minimum wages at the state level as sources of exogenous increases in wages in some plants. I then track the evolution of wages of the remaining workers of the firm, relative to workers of unaffiliated plants. Plants where workers collect higher-than-industry wages operate with higher capital intensity, suggesting that internal labor markets may affect investment decisions in internal capital markets.

This paper reassesses two conflicting hypotheses on the valuation impacts of private placements of equity (PPEs), the monitoring/certification hypothesis and the managerial entrenchment hypothesis, by focusing on the shareholder approval, active buyer, and premium pricing features of PPEs. We find that PPEs with these features have significant positive announcement returns and insignificant mean long-run returns, while the corresponding announcement and long-run returns for PPEs without such features are significantly negative. Firms with value-enhancing PPE features are better governed and use proceeds more efficiently. Thus, the heterogeneous nature of PPEs helps reconcile the puzzling return patterns and conflicting hypotheses regarding PPEs.

Ceteris paribus, investors prefer to purchase municipal bonds selling close to their par value. That is, investors are willing to purchase at the lowest yield a municipal bond alike in all respects to other municipal bonds, but with a coupon that permits it to be sold at or near its par value. Conversely, investors are willing to purchase municipal bonds with coupons that cause them to be sold at prices either greatly above or greatly below par only at penalty or premium yields relative to similar par bonds.

This study develops an econometric model that incorporates features of price dynamics across assets as well as through time. With the dynamic factors extracted via the Kalman filter, we formulate an asset pricing model, termed the dynamic factor pricing model (DFPM). We then conduct asset pricing tests in the in-sample and out-of-sample contexts. Our analyses show that the ex ante factors are a key component in asset pricing and forecasting. By using the ex ante factors, the DFPM improves upon the explanatory and predictive power of other competing models, including unconditional and conditional versions of the Fama and French (1993) 3-factor model. In particular, the DFPM can explain and better forecast the momentum portfolio returns, which are mostly missed by alternative models.

We examine investors’ preference for directors serving on fewer versus more boards (“busy directors”) by measuring market reaction to busy directors’ resignations at the companies that still keep these directors on the board. We find a positive reaction implying a preference for fewer directorships. The reaction is more positive when the need for the director’s services is greater, when the resignation frees up more of the director’s time, and when the director is of higher quality. Furthermore, we find that following their resignation, directors increase their board responsibilities/leadership at firms that still retain them and seek no board appointments elsewhere.

In this article, we shall discuss several of the alternative definitions of risk that have been proposed from time to time. We shall show that one definition — risk is the probability of loss — leads to a formulation of the investment decision problem as a chance constrained problem. Three different strategies are then proposed by which an investor can reduce risk. It is our belief that professional investors utilize all three strategies and that risk, in many such cases, is not a substantial constraint on investor behavior.

The need for a corporate marginal cost of capital to be used for internal accept-reject decisions (either as a rate of discount for net-present-value (NPV) computations or as a “cut-off” rate with the internal rate of return (IRR) criterion) has led numerous textbook writers to advocate some variant of a weighted average cost of capital. These authors agree substantially on how costs of individual sources of capital are to be assessed but are uncertain of how the weights should be determined, whether they should reflect the firm's existing capital structure, a target structure, or the mix, however determined, in the firm's forthcoming capital budget, and whether they should be based on book or market values. Moreover, it is not obvious how book or even market values should be measured. These writers have not proven that their intuitively held definitions do in general, for capital budgeting, imply maximizing shareholder wealth.

The default of a major corporation or municipality generates debate over the impact these failures have on the borrowing cost of other issuers. Theory suggests that in efficient markets individual failures by themselves should not increase the level of interest rates in a market unless the default provides unanticipated information about other issuers. The default of New York City in the summer of 1975 was believed by many to have provided information that increased the perceived risk of investors and consequently increased new issue borrowing costs in the municipal bond market. Empirical research by Forbes and Peterson [2] and Gramlich [3] supports this contention, reporting that borrowers paid as much as 119 basis points more because of the New York City crisis. A study by Hoffland [6] suggests that the impact of the default was not just temporary, but was felt long after 1975. Though less scientific, others note that during 1975 municipal borrowing costs rose to record high levels with most issues carrying their interest cost during the summer of 1975.

The absence of observable innovation data for a firm often leads us to exclude or classify these firms as non-innovators. We assess the reliability of six methods for dealing with unreported innovation using several different counterfactuals for firms without reported R&D or patents. These tests reveal that excluding firms without observable innovation or imputing them as zero innovators and including a dummy variable can lead to biased parameter estimates for observed innovation and other explanatory variables. Excluding firms without patents is especially problematic, leading to false-positive results in empirical tests. Our tests suggest using multiple imputation to handle unreported innovation.

Union and public pension funds, the most prolific institutional activists employing low-cost targeting methods, are often accused of pursuing private benefits. Extant literature finds that unions representing workers, as stakeholders, are not aligned with shareholders. Limiting shareholder power may mitigate “special interest” activism but can also exacerbate managerial agency problems. In two different settings, majority approved and withdrawn shareholder proposals, we examine and find supportive evidence that the director labor market as a corporate governance mechanism can selectively mitigate the negative influence that conflicted stakeholder-shareholder union funds have over firms without stifling all influence of low-cost activists.

Liquidity trading following mutual fund outflows creates a potentially powerful empirical setting in which stock price variation is unrelated to changes in firm fundamentals. Instrumental variables (IVs) drawn from this setting impose an additional assumption that managers sell firms in proportion to portfolio weights. I show that this assumption causes selection bias in these IVs. It misallocates large price impacts to poorly performing, illiquid firms with lower growth – firms that managers systematically avoid selling. Simulations show that selection bias doubles the magnitude of regression coefficients and precludes potential fixes. Numerous recent studies exploiting these IVs should be reevaluated.