Agency-Based Asset Pricing

We analyze the interaction between managerial decisions and firm value/asset prices by embedding the standard agency model of the firm into an otherwise standard asset pricing model. When the manager-agent's compensation depends on the firm's stock price performance, stock prices are set to induce the creation of future cash flows, instead of representing the discounted value of exogenous cash flows, as in the standard model. In our case, stock prices are formed via trading in the market to induce the managers to hold the number of shares consistent with the optimal effort level desired by the outside investors. We compare two price formation mechanisms, corresponding to two firm ownership structures. In the first, stock prices are formed competitively among a continuum of dispersed investors. In the second, stock prices are set by a single block shareholder, as a bargaining solution. Under both mechanisms there are persistent, dynamic, patterns of asst prices, The level of the equity premium and the return volatility depend on the risk aversion of the agents in the economy and the ownership structure of firms.

The Greenspan Era: Discretion, Rather Than Rules

What stands out in retrospect about U.S. monetary policy during the Greenspan Era is the ongoing movement away from mechanistic restrictions on the conduct of policy, together with a willingness on occasion to depart even from what more flexible guidelines dictated by contemporary conventional wisdom would imply, in the interest of carrying out the Federal Reserve System%u2019s dual mandate to pursue both stable prices and maximum employment. Part of this change was procedural %u2013 for example, the elimination of money growth targets. The most substantive demonstration of policy flexibility came in the latter half of the 1990s, as unemployment fell below 6% (in 1994), then below 5% (in 1997), and then remained below 5% for more than four years, yet the Federal Reserve did not tighten monetary policy. This policy stance was consistent with a view of the economy, including faster productivity growth and increased exposure to international competition, that Chairman Greenspan had articulated nearly a decade before.

Do Financial Institutions Matter?

In standard asset pricing theory, investors are assumed to invest directly in financial markets. The role of financial institutions is ignored. The focus in corporate finance is on agency problems. How do you ensure that managers act in shareholders' interests? There is an inconsistency in assuming that when you give your money to a financial institution there is no agency problem but when you give it to a firm there is. It is argued both areas need to take proper account of the role of financial institutions and markets. Appropriate concepts for analyzing particular situations should be used.

Dynamic Scoring: Alternative Financing Schemes

Neoclassical growth models predict that reductions in capital or labor tax rates are expansionary when lump-sum transfers are used to balance the government budget. This paper explores the consequences of bond-financed tax reductions that bring forth a range of possible offsetting policies, including future government consumption, capital tax rates, or labor tax rates. Through the resulting intertemporal distortions, current tax cuts can be contractionary. The paper also finds that more aggressive responses of offsetting policies to debt engender less debt accumulation and less costly tax cuts.

Why Managers Hold Shares of Their Firms: An Empirical Analysis

We examine the relationship between CEO ownership and stock market performance. Firms in which the CEO voluntarily holds a considerable share of outstanding stocks outperform the market by more than 10% p.a. after controlling for traditional risk factors. The effect is most pronounced in firms that are characterized by large managerial discretion of the CEO. The abnormal returns we document are one potential explanation why so many CEOs hold a large fraction of their own company’s stocks. We also examine several potential explanations why the existence of an owner CEO is not fully reflected in prices but leads to abnormal returns.CEO-Ownership, Asset Pricing with large shareholders.

Equity Issuance and Divident Policy under Commitment

This paper studies a model of corporate finance in which firms use stock issuance to finance investment. Since the firm recognizes the relationship between future dividends and stock prices, future variables enter in the constraints and optimal policy is in general time inconsistent. We discuss the nature of time inconsistency and show that it arises because managers promise to incorporate value maximization gradually into their objective function. This shows how one could change managers’ incentives in order to enforce the optimal contract under full commitment. We then characterize several cases where time consistency arises and we study different examples where policy is time inconsistent. This allows us to address some outstanding issues in the literature about dividend policy and equity issuance. In particular, our results suggest that growing firms that can credibly commit will pay lower dividends at the beginning and promise higher dividends in the future, consistent with empirical evidence. Our results also suggests that compensation that is tied to stock options creates incentives to inflate prices and pay lower dividends. This is consistent with the empirical evidence of increased stock option compensation and payout through repurchases instead to dividends during the last decades.Stock Issuance; time inconsistency; dividend policy

Agency Conflicts, Investment, and Asset Pricing

Corporations in most countries are run by controlling shareholders whose cash flow rights are substantially smaller than their control rights in the firm. This separation of ownership and control allows the controlling shareholders to pursue private benefits at the cost of outside minority investors by diverting resources away from the firm and distorting corporate investment and payout policies. We develop a dynamic stochastic general equilibrium asset pricing model that acknowledges the implications of agency conflicts through imperfect investor protection on security prices. We show that countries with weaker investor protection have more overinvestment, lower market-to-book equity values, larger expected equity returns and return volatility, higher dividend yields, and higher interest rates. These predictions are consistent with empirical findings. We develop new predictions: countries with high investment-capital ratios have both higher variance of GDP growth and higher variance of stock returns. We provide evidence consistent with these hypotheses. Finally, we show that weak investor protection causes significant wealth redistribution from outside shareholders to controlling shareholdersinvestment, asset pricing, investor protection

Asset Dividend Yield Skew Implied in Corporate Credit Spreads

Given that asset volatility skew expresses several levels of business risk according to the leverage used, the goal of this paper is to prove the relevance of dividend policy (skew effect) in the credit spreads of a company. In a simple analysis framework, this work highlights significant implications for the analysis of some recent market phenomena: Dividend Aristocrats (DA), the Low Volatility Anomaly (LVA) and the Credit Spread Puzzle (CSP). Whilst the DA classifies high dividend yield (and also, oddly, high asset volatility) companies in the S&P500, the LVA highlight the fact that low-risk firms generate a better performance with respect to high-risk firms, contrary to the CAPM (Capital Asset Pricing Model). The CSP refers to the structural model’s inability (and not only) to explain empirical credit spreads fully, in particular for investment grade issuers. The evidence that these latter companies are highly profitable (‘Dividend Aristocrats’) seems to confirm the Pecking Order Theory. In addition, for investment grade companies a slight increase in leverage implies higher received benefits in terms of the risk-return combination, thus also supporting the Trade-off Theory

The Social Cost of Near-Rational Investment

We show that the stock market may fail to aggregate information even if it appears to be efficient; the resulting collapse in the dissemination of information may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors around their optimal investment policies. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When stock prices reflect less information, the perceived and the actual volatility of stock returns rise. This increase in financial risk makes holding stocks unattractive, distorts the long-run level of capital accumulation, and causes costly ( first-order) distortions in the long-run level of consumption