Researchers are increasingly using data from the Nasdaq market to examine pricing behavior, market design, and other microstructure phenomena. The validity of any study that classifies trades as buys or sells depends on the accuracy of the classification method. Using a Nasdaq proprietary data set that identifies trade direction, we examine the validity of several trade classification algorithms. We find that the quote rule, the tick rule, and the Lee and Ready (1991) rule correctly classify 76.4%, 77.66%, and 81.05% of the trades, respectively. However, all classification rules have only a very limited success in classifying trades executed inside the quotes, introducing a bias in the accuracy of classifying large trades, trades during high volume periods, and ECN trades. We also find that extant algorithms do a mediocre job when used for calculating effective spreads. For Nasdaq trades, we propose a new and simple classification algorithm that improves over extant algorithms.

This study shows that international firms listing their shares on the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE) experience a significant increase in visibility, as proxied by analyst coverage and print media attention (The Wall Street Journal or Financial Times). The increase in analyst following is also associated with a decrease in the cost of equity capital after the listing event in a way consistent with Merton's (1987) investor recognition hypothesis. Our results are stronger for NYSE listing firms than for LSE listing firms. This may partially compensate firms for the higher costs associated with NYSE listing (compared to LSE listing).

This paper examines the role of large shareholders in monitoring managers when they propose antitakeover charter amendments. We attempt to distinguish between two competing hypotheses: the “active monitoring hypothesis” and the “passive voting hypothesis.” We find a statistically significant positive relation between institutional ownership and the stockholder wealth effects of various types of amendments, after controlling for ownership concentration among institutions, managerial ownership, and firm size. Our empirical evidence lends support to the “active monitoring hypothesis” proposed by Demsetz (1983) and Shleifer and Vishny (1986) that the existence of large shareholders leads to better monitoring of managers.

During 1980–2000, an average of 310 companies per year went public in the United States. Since 2000, the average has been only 99 initial public offerings (IPOs) per year, with the drop especially precipitous among small firms. Many have blamed the Sarbanes-Oxley Act of 2002 and the 2003 Global Settlement’s effects on analyst coverage for the decline in IPO activity. We find very little support for the conventional wisdom, and we offer an alternative explanation. Our economies of scope hypothesis posits that the advantages of selling out to a larger organization, which can speed a product to market and realize economies of scope, have increased relative to the benefits of operating as an independent firm.

In considering trade credit, we need to ask three questions:

1. Why do nonfinancial firms commonly participate in the process of financial intermediation by extending credit to their customers?

2. What explains differences in credit periods between firms and industries as well as over time for specific firms and industries?

3. How do changing monetary conditions affect the credit that firms extend to their customers?

To answer these questions, we first identify two reasons for credit sales: the first we might call a financing motive, and the second a transactions motive. The transactions motive can readily be understood—it costs something to match the time pattern of payment for goods with the time pattern of receipt of goods. Buyers benefit if bills are allowed to accumulate for periodic payment. Furthermore, trade credit gives buyers time to plan for the payment of unexpected purchases, enables them to forecast future cash outlays with greater certainty, and simplifies their cash management. To the extent that buyers benefit, sellers have an opportunity to sell credit. It is likely that, to a large extent, the aggregate stock of trade credit is explained by the transactions motive.

For financial management to make wealth maximizing capital budgeting decisions, a model that will determine correctly the market value of a project's levered cash flows is required. A capital budgeting model should account not only for the effects of the investment decision, but also for the effects of the financing decision and the interactions between the two decisions. In perfect capital markets all the effects of the financing decision pertain to the tax shield created by debt financing. Thus, as originally shown by Modigliani and Miller [8], the value of a project's levered cash flow stream equals the market value the stream would have if it were unlevered plus the market value of the stream of tax savings on interest payments associated with the debt employed to finance the project. While this result is completely general with respect to the specific processes utilized by the market to value the two components, MM specified the value of the unlevered component as the present value of the unlevered cash flows discounted at the appropriate risk adjusted unlevered cost of capital and they specified the value of the tax savings component as the present value of the tax shield on interest discounted at the cost of debt. Accordingly, the value of a project's levered cash flows is specified as the sum of these two present values, one representing the effects of the investment decision and the other capturing the effects of the financing decision. The MM valuation model has been extended to normative capital budgeting analysis by Myers [9] in terms of the adjusted present value (APV) model.

This study analyzes the relation between chief executive officer (CEO) personal risk-taking, corporate risk-taking, and total firm risk. We find evidence that CEOs who possess private pilot licenses (our proxy for personal risk-taking) are associated with riskier firms. Firms led by pilot CEOs have higher equity return volatility, beyond the amount explained by compensation components that financially reward risk-taking. We trace the source of the elevated firm risk to specific corporate policies, including leverage and acquisition activity. Our results suggest that nonpecuniary risk preferences revealed outside the scope of the firm have implications for project selection and various corporate policies.

We study whether the constraints on firms’ operations imposed by laborunions affect firms’ costs of equity. The cost of equity issignificantly higher for firms in more unionized industries. This effect holdsafter controlling for several industry and firm characteristics, is robust toendogeneity concerns, and is not driven by omitted variables. Moreover, theunionization premium is stronger when unions face a more favorable bargainingenvironment and is highly countercyclical. Unionization is also positivelyrelated to various measures of operating leverage. Our findings suggest thatlabor unions increase firms’ costs of equity by decreasingfirms’ operating flexibility.

We examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt capacity largely explain the use of new external equity financing by publicly traded firms. Finally, we present evidence that reconciles the frequent equity issues by small, high-growth firms with the pecking order. After accounting for debt capacity, the pecking order theory appears to give a good description of financing behavior for a large sample of firms examined over an extended time period.

This paper shows that there is a close relation between corporate governance and the portfolios held by investors. Most firms in countries with poor investor protection are controlled by large shareholders, so that only a fraction of the shares issued by firms in these countries can be freely traded and held by portfolio investors. We show that the prevalence of closely-held firms in most countries helps explain why these countries exhibit a home bias in share holdings and why U.S. investors underweight foreign countries in their portfolios. We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders (the world float portfolio). The world float portfolio differs sharply from the world market portfolio. In regressions explaining the portfolio weights of U.S. investors, the world float portfolio has a positive significant coefficient but the world market portfolio has no additional explanatory power. This result holds when we control for country characteristics. An analysis of foreign investor holdings at the firm level for Sweden confirms the importance of the float portfolio as a determinant of these holdings.

Under the assumption that individuals are single-period maximizers of the expected utility of their future wealth, this essay extends the mean-variance security valuation model developed by Sharpe [10], Lintner [4, 5, and 6], and Mossin [7 and 8] to a general parameter-preference model, with and without the simplifications of homogeneous subjective probabilities and the existence of a risk-free security. Results with quadratic and cubic utility are developed as special cases.

A link between the firm's operating decisions and the riskiness of its stocks was established. Differences in the production process affecting the relative shares of fixed and variable costs (i.e., the operating leverage) were found, both analytically and empirically, to be associated with risk differentials. Specifically, other things equal, the higher the operating leverage (i.e., the lower the unit variable costs) the larger the overall and systematic risk of the stocks.

Various practical implications are suggested by these findings. On the firm level, it can be expected that large capital expenditures associated with an operating leverage increase will increase stock riskiness. In these cases, the cut-off rate used for the capital budgeting decision (i.e., the cost of capital) should allow for the increased risk. The use of the current cost of capital as the cut-off rate would probably result in a decrease in stock prices, adversely affecting stockholders' wealth. On the investor level, these findings might assist in the estimation of common stocks' risk given expected changes in the firm's operating leverage. Specifically, they suggest that, if a firm will experience a significant operating leverage change, the estimation of risk measures based exclusively on historical returns would be inappropriate.

We examine the association of a venture capital (VC) firm’s reputation with the post-initial public offering (IPO) long-run performance of its portfolio firms. We find that VC reputation, measured by the past market share of VC-backed IPOs, has significant positive associations with long-run firm performance measures. While more reputable VCs initially select better-quality firms, more reputable VCs continue to be associated with superior long-run performance, even after controlling for VC selectivity. We find that more reputable VCs exhibit more active post-IPO involvement in the corporate governance of their portfolio firms, and this continued VC involvement positively influences post-IPO firm performance.

In this study, we examine the impact of security analysts' monitoring and marketing functions on firms' market value. We postulate that security analysts' monitoring of corporate performance helps motivate managers, thus reducing the agency costs associated with the separation of ownership and control. We also argue that the information intermediary function provided by security analysts helps expand the breadth of investor cognizance. Consistent with these conjectures, this study finds that analyst following exerts a significant and positive impact on firms' market value. We also find evidence that security analysts have a stronger incentive to follow stocks of high quality companies, since such stocks arc easier to market. Hence, the security analysis activities appear to be determined, in part, by the marketing considerations of brokerage companies.

It has long been market folklore that the best time to buy stocks is when individual investors are bearish, and the best time to sell is when individual investors are bullish. We examine the forecast power of three popular measures of individual investor sentiment: the level of discounts on closed-end funds, the ratio of odd-lot sales to purchases, and net mutual fund redemptions. Using data from 1933 to 1993, we find that fund discounts and net redemptions predict the size premium, the difference between small and large firm returns, but little evidence that the odd-lot ratio predicts returns.

This article incorporates well-documented managerial traits into a tradeoff model of capital structure to study their impact on corporate financial policy and firm value. Optimistic and/or overconfident managers choose higher debt levels and issue new debt more often but need not follow a pecking order. The model also surprisingly uncovers that these managerial traits can play a positive role. Biased managers' higher debt levels restrain them from diverting funds, which increases firm value by reducing this manager-shareholder conflict. Although higher debt levels delay investment, mildly biased managers' investment decisions can increase firm value by reducing this bondholder-shareholder conflict.

We find that stock liquidity increases stock price crash risk. To identify the causal effect, we use the decimalization of stock trading as an exogenous shock to liquidity. This effect is increasing in a firm’s ownership by transient investors and nonblockholders. Liquid firms have a higher likelihood of future bad earnings news releases, which are accompanied by greater selling by transient investors, but not blockholders. Our results suggest that liquidity induces managers to withhold bad news, fearing that its disclosure will lead to selling by transient investors. Eventually, accumulated bad news is released all at once, causing a crash.

The vector of equilibrium aggregate market values (or per share prices) of a given set of risk assets trading in purely competitive markets of individually risk-averse investors has been derived in earlier work under certain simplifying assumptions, including the absence of taxes and transactions costs and a single (uniform) holding period for the assessment of uncertain outcomes (See [8], [9], [10], [15], and [12]). The other critical assumptions in these studies were (a) the existence of a riskless asset available for holding or borrowing at a fixed, exogenously determined interest rate, (b) an assumption that all investors act in terms of identical joint probability distributions over end-of-period outcomes, and (c) the acceptance of a mean-variance criterion for portfolio decisions.

Stock market average returns and Sharpe ratios are significantly higher on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. The average announcement-day excess return from 1958 to 2009 is 11.4 basis points (bp) versus 1.1 bp for all the other days, suggesting that over 60% of the cumulative annual equity risk premium is earned on announcement days. The Sharpe ratio is 10 times higher. In contrast, the risk-free rate is detectably lower on announcement days, consistent with a precautionary saving motive. Our results demonstrate a trade-off between macroeconomic risk and asset returns, and provide an estimate of the premium investors demand to bear this risk.

We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.