Corporate finance.

The NBER's Program on Corporate Finance met in Cambridge on April 9. Program Director Raghuram Rajan, NBER and University of Chicago, organized the meeting. The program was:

Patrick Bolton and Howard Rosenthal, Princeton University, "Political Intervention in Debt Contracts: Moratoria and Bailouts"

Discussant: Jesus Santos, University of Chicago

Jeremy Berkowitz, Federal Reserve System, and Michelle J. White, University of Michigan, "Bankruptcy and Small Firms' Access to Credit"

Discussant: Mitchell Petersen, Northwestern University 

Katrina Ellis, Roni Michaely, and Maureen O'Hara, Cornell University, "When the Underwriter Is the Market Maker: An Examination of Trading in the IPO Aftermarket"

Discussant: Manju Puff, Stanford University 

George P. Baker and Brian J. Hall, NBER and Harvard University, "CEO Incentives and Firm Size" (NBER Working Paper No. 6868)

Discussant: Robert Gertner, NBER and University of Chicago

Gustavo Grullon, Rice University, Roni Michealy, and Bhaskaran Swaminathan, Cornell University, "Dividend Changes as a Sign of Firm Maturity"

Discussant: Robert McDonald, Northwestern University

Bolton and Rosenthal develop a simple, dynamic general equilibrium model of an agricultural economy in which poor farmers borrow from rich farmers. The authors allow for both idiosyncratic and aggregate shocks - so there may be default ex post. They consider equilibrium in the economy with and without political intervention, either in the form of a bailout or a moratorium. They then compare their results to historical evidence from the Panic of 1819 in the United States. With no aggregate uncertainty, political intervention always improves ex post efficiency and may also improve ex ante efficiency. Anticipated bailouts, but not moratoriums, will always occur in equilibrium. The threat of moratoriums also enhances efficiency. With aggregate uncertainty, the differences between moratoriums and bailouts may collapse, with both occurring only in bad times and improving ex ante efficiency.

Do personal bankruptcy laws affect small firms' access to credit? When a firm is unincorporated, its debts are personal liabilities of the firm's owner, so lending to that firm is equivalent to lending to its owner. If the firm fails, the owner has an incentive to file for personal bankruptcy. States are allowed to set their own bankruptcy exemption levels, and they vary widely. The higher the exemption level, the more attractive it is for debtors who live in that state to file for bankruptcy. Berkowitz and White present a model of credit markets which shows that the supply of credit falls and demand for credit rises when noncorporate firms are located in states with higher bankruptcy exemption levels. The authors also find that high homestead and personal property exemptions are associated with an increased probability of noncorporate firms being denied credit. These exemptions do not affect the probability of corporate firms being denied credit, though. There is weak evidence that both types of firms receive smaller loans when located in states that have high bankruptcy exemptions, but no evidence that interest rates are affected by bankruptcy exemptions. A prior filing for bankruptcy nearly triples the probability that noncorporate firms are denied credit, the authors find.

Part of the contract between underwriters and issuers in an initial public offering (IPO) is that the underwriter will provide liquidity in the subsequent trading of the newly traded security. Ellis, Michaely, and O'Hara examine the aftermarket trading activities in the first three months after the stock has gone public of underwriters, syndicate members, and other unaffiliated marketmakers. They focus in particular on whether the provision of liquidity is a cost subsidized by the fees generated from the underwriting process, or a profit center unrelated to the underwriting activities. They find that the lead underwriter is by far the most dominant marketmaker in every IPO in their sample, taking a substantial inventory position in the aftermarket trading. The lead underwriter also engages in stabilization activity for less successful IPOs and uses the overallotment option to reduce his inventory risk. After including the overallotment option, the lead underwriter has a much smaller inventory exposure. Other syndicate members play a negligible role in aftermarket trading, the authors find. While the compensation to the underwriter arises primarily from fees, aftermarket trading does generate positive profits which are positively related to the degree of underpricing.

How can we reconcile the enormous differences in pay sensitivities between executives in large and small firms? Baker and Hall show that between firms in the smallest and largest deciles in their sample, one measure of CEO incentives - the dollar change in CEO wealth per dollar change in firm value - falls by a factor of ten, while another measure of CEO incentives - the value of CEO equity stakes - increases by roughly the same magnitude. The crucial parameter, they find, is the elasticity of CEO productivity with respect to firm size. Their results suggest that CEO marginal product rises significantly, and that CEO incentives overall are roughly constant or decline slightly, with firm size. They also show that the appropriate measure of incentives depends on the type of CEO activity being considered. For activities whose dollar impact is the same for large and small firms, such as the purchase of a corporate jet, the dollars-on-dollars measure is appropriate, and large firms suffer significant agency problems because of their weak incentives. For activities whose percentage impact is similar across firms of different sizes, such as a corporate reorganization, the equity stake measure is better, and the incentive problem faced by large firms is not as severe.

Grullon, Michealy, and Swaminathan ask whether dividends increase as firms mature. Clearly, firms become less risky as they mature and have fewer growth opportunities available. The authors show that firms whose dividends increase experience a subsequent decline in their systematic risk, the return on their assets, and capital expenditures. The decline in a firm's risk manifests itself not only through the reduction in the systematic risk of equity but also through improvement in the firm's debt ratings. In addition, the positive market reaction to an increase in dividends, despite the subsequent decline in earnings and investments, is related to information about the decline in systematic risk (and the cost of capital). However, investors seem to underestimate the extent of the decline in risk and to overestimate the extent to which earnings will continue to grow following dividend increases. Finally, the authors show that the magnitude of the price drift in the three years after a change in dividends is larger when the change in the firm's systematic risk is greater.