David C. Mauer

The Determinants of Corporate Liquidity: Theory and Evidence

We model the firms decision to invest in liquid assets when external financing is costly. The optimal amount of liquidity is determined by a tradeoff between the low return earned on liquid assets and the benefit of minimizing the need for costly external financing. The model predicts that the optimal investment in liquidity is increasing in the cost of external financing, the variance of future cash flows, and the return on future investment opportunities, while it is decreasing in the return differential between the firms physical assets and liquid assets. Empirical tests on a large panel of U.S. industrial firms support the models predictions.

The Impact of Information Technology Investment Announcements on the Market Value of the Firm

Determining whether investments in information technology IT have an impact on firm performance has been and continues to be a major problem for information systems researchers and practitioners. Financial theory suggests that managers should make investment decisions that maximize the value of the firm. Using event-study methodology, we provide empirical evidence on the effect of announcements of IT investments on the market value of the firm for a sample of 97 IT investments from the finance and manufacturing industries from 1981 to 1988. Over the announcement period, we find no excess returns for either the full sample or for any one of the industry subsamples. However, cross-sectional analysis reveals that the market reacts differently to announcements of innovative IT investments than to followup, or noninnovative investments in IT. Innovative IT investments increase firm value, while noninnovative investments do not. Furthermore, the markets reaction to announcements of innovative and noninnovative IT investments is independent of industry classification. These results indicate that, on average, IT investments are zero net present value NPV investments; they are worth as much as they cost. Innovative IT investments, however, increase the value of the firm.

Cross-Subsidies, External Financing Constraints, and the Contribution of the Internal Capital Market to Firm Value

This paper examines the link between the value of a diversified firm and the value of its internal capital. We construct measures of the value of internal capital market transactions based on the dollar flow of subsidies and transfers across segments, the relative investment opportunities of segments, and the likelihood that a segment receiving a subsidy would face external financing constraints if it were a stand-alone firm. We find that specific components of a diversified firms internal capital market are important determinants of its excess value. Subsidies to small financially constrained segments with good relative investment opportunities significantly increase excess value, while transfers of resources from segments with good relative investment opportunities significantly decrease excess value. Surprisingly, subsidies to small financially constrained segments with poor relative investment opportunities also significantly increase excess value, albeit to a lesser extent than the subsidies to constrained segments with good relative investment opportunities. We conclude that financing constraints drive the relationship between the internal capital market and firm value.

Investment under Uncertainty: The Case of Replacement Investment Decisions

We analyze the determinants of replacement investment decisions in a contingent claims model with maintenance and operation cost uncertainty. We find that the optimal time between replacements is increasing in the volatility of cost, the purchase price of a new asset, and the corporate tax rate; and is decreasing in the systematic risk of cost, the salvage value of the asset, and the investment tax credit. The optimal time between replacements can either increase or decrease with an increase in the depreciation rate. Extensions of the model to examine the effects of technological and tax policy uncertainty on replacement investment decisions give intuitive, but striking results. Uncertainty about the arrival of a technological innovation that would decrease maintenance and operation cost results in a significant decrease in replacement investment. Uncertainty in a tax law change that would encourage investment decreases current investment; and uncertainty in a tax law change that would discourage investment increases current investment.

Optimal Priority Structure, Capital Structure, and Investment

We examine the role of debt priority structure in resolving stockholder-bondholder conflicts over investment policy. In a dynamic model where the firm can issue multiple classes of debt, we show that the firm may underor overinvest in future growth options. We show that when debt priority is endogenized along with capital structure there is an interior optimal priority structure which virtually eliminates equityholders’ suboptimal investment incentives and fully exploits the debt capacity of future growth options. The optimal priority structure allocates priority to initial debt to mitigate suboptimal investment incentives and yet preserves priority for subsequent debt issues to maximize future debt capacity. A key implication of our analysis is that priority structure is a critical and heretofore unrecognized financial contracting device that helps to resolve stockholder-bondholder conflicts over investment policy. Several additional results have implications for empirical research in corporate finance.

The Effect of the Secondary Market on the Pricing of Initial Public Offerings: Theory and Evidence

This paper provides a theoretical and empirical investigation of the role of the secondary market in the pricing of initial public offerings. We argue that incomplete spanning of the primary issues in the secondary market and limited investor access play an important role in the pricing of initial public offerings. Utilizing a segmented market approach wherein IPO offering values are determined in the primary market and after-market bid prices are determined in the centrally accessed secondary market, we derive a price differential in the primary and secondary markets that is consistent with the received notion of IPO underpricing. Empirical tests on a large sample of IPOs provide results that are consistent with the predictions of our theoretical analysis.

Stockholder and Bondholder Wealth Effects of CEO Incentive Grants

We examine stock and bond price reactions to CEO equity compensation in a sample of firms where ExecuComp reports the first appearance of CEO stock option and/or restricted stock grants. For these grants, we find positive stock price reactions and negative bond price reactions. To examine the link between security holder wealth and managerial incentives, we compute the effect of these grants on the pay-performance (delta) and stock volatility (vega) sensitivities of the CEO’s wealth. We find that stock price reactions are decreasing in the change in delta and increasing in the change in vega, while bond price reactions are increasing in the change in delta and decreasing in the change in vega. These relations, however, depend on the CEO’s equity ownership prior to the grant. Consistent with the notion that equity-based compensation aggravates risk-shifting incentives, we find a strong negative relation between stockholder and bondholder wealth effects for grants that induce a large change in the vega of the CEO’s wealth. Stockholder and Bondholder Wealth Effects of CEO Incentive Grants

Corporate Call Policy for Nonconvertible Bonds

We examine corporate call policy for 1,642 nonconvertible bonds that were called during the period 1975-94. The vast majority of firms delay calls and call when the bond price exceeds the call price. We find that larger, less liquidity constrained firms with a larger opportunity cost of delaying a call have shorter call delays. There is no evidence that refunding transaction costs, wealth redistribution effects, call notice periods, or a desire to eliminate restrictive covenants influences the timing of calls. An examination of call motives suggests that there is no one underlying motive that fits the average call. Copyright 2000 by University of Chicago Press.

Corporate Debt Maturity Policy and Investor Tax-timing Options: Theory and Evidence

This paper argues that corporate debt maturity policy affects investor tax-timing options to tax-trade corporate securities. In a multiperiod model with interest rate uncertainty, we establish that a long-term debt maturity strategy maximizes investor tax-timing option value. The analysis predicts that the firm lengthens debt maturity as interest rate volatility increases and as the slope of the term structure increases. Empirical analysis supports the models interest rate volatility prediction.

Determinants of Corporate Call Policy for Convertible Bonds

For a sample of convertible bonds issued during the period 1980 through 2002, we empirically investigate the determinants of call policy. We find that the risk of a failed call over the call notice period helps explain why firms call only after conversion value exceeds call price by a substantial safety premium. We find strong evidence that cash flow considerations and a desire to mitigate agency conflicts influence call policy. We also find evidence that the decision to issue and subsequently call a convertible bond is influenced by a desire to obtain backdoor equity financing and to finance growth options. There is no evidence, however, that firms with favorable inside information are more likely to delay calls. Finally, we find that a significant portion of calls are associated with restructuring and merger activity, and with bond rating upgrades and downgrades. In these cases, there is little if any call delay.