Hayne E. Leland

Agency Costs, Risk Management, and Capital Structure

The joint determination of capital structure and investment risk is examined. Optimal capital structure reflects both the tax advantages of debt less default costs (Modigliani and Miller (1958, 1963)), and the agency costs resulting from asset substitution (Jensen and Meckling (1976)). Agency costs restrict leverage and debt maturity and increase yield spreads, but their importance is small for the range of environments considered. Risk management is also examined. Hedging permits greater leverage. Even when a firm cannot precommit to hedging, it will still do so. Surprisingly, hedging benefits often are greater when agency costs are low. Copyright The American Finance Association 1998.

Saving and Uncertainty: The Precautionary Demand for Saving

I. Introduction, 465. — II. A two period model of consumption, 466. — III. The effect of uncertainty on saving, 467. — IV. Decreasing risk aversion and precautionary saving, 468. — V. Speculations on the consumption function, 470. — VI. Conclusion, 472.

Insider Trading: Should It Be Prohibited?

Insider trading moves forward the resolution of uncertainty. Using a rational expectations model with endogenous investment level, I show that, when insider trading is permitted, (i) stock prices better reflect information and will be higher on average, (ii) expected real investment will rise, (iii) markets are less liquid, (iv) owners of investment projects and insiders will benefit, and (v) outside investors and liquidity traders will be hurt. Total welfare may increase or decrease depending on the economic environment. Factors that favor the prohibition of insider trading are identified.

Optimal Nonuniform Prices

We consider optimal nonuniform pricing schedules, where the price depends upon the amount purchased. Such schedules are regularly used by public utilities and other services. Welfare-optimal nonuniform prices are related to the theory of optimal uniform prices developed by Ramsey. We characterize situations in which upward or downward discontinuities in pricing schedules are optimal. Our results are applicable to a number of related problems, including optimal taxation, insurance, and incentives.

Prices and Qualities in Markets with Costly Information

This paper extends the seminal work of Akerlof, and Salop and Stiglitz in two directions: (i) the sellers can select both the selling prices and quality levels of their good, and (ii) the buyers can acquire price/quality information about individual sellers at a cost. We observe multiple price/quality combinations in equilibrium, which depend upon the distribution of information costs of consumers and upon whether quality, or price, or both are costly observable. Welfare comparisons of equilibrium are considered. We show that welfare will be greater when price advertising is permitted.

Optimal Risk Sharing and the Leasing of Natural Resources, with Application to Oil and Gas Leasing on the OCS

Future natural resource discoveries will most likely take place on public lands. Rights to potential oil and gas resources are transferred from the public to private firms through a lease; the lease specifies the nature of the rights granted. Federal offshore leases have specified that firms pay a royalty equivalent to one-sixth of the value of production. This royalty has remained unchanged since offshore leasing began, despite the significant changes in the value of tracts as reflected in winning bids. Leases of other countries specify quite-different payment schedules, with profit rather than production often determining the amount to be paid. Clearly, alternative forms of conditional payments have differing implications on risk sharing and on the exploration, development, and production decisions of firms. This paper develops a general theory of optimal lease payments, paying special attention to royalty and profit-share payments, since they are featured prominently in proposals for new Federal leasing policies.

Monopoly Pricing Structures with Imperfect Discrimination

While some firms, such as airlines, may have both the informational and legal capabilities for identifying and segmenting customers into different markets, most firms do not. When only the distribution characteristics of consumers is known, we characterize the situation as one of imperfect discrimination. Individuals in such markets cannot be identified; thus, all must face the same price structure. Some discrimination is nonetheless possible through the use of nonuniform pricing policies.

On dynamic investment strategies

Abstract This paper presents a new approach for analyzing dynamic investment strategies. Previous studies have obtained explicit results by restricting utility functions to a few specific forms; not surprisingly, the resultant dynamic strategies have exhibited a very limited range of behavior. In contrast, we examine what might be called the inverse problem: given any specific dynamic strategy, can we characterize the results of following it through time? More precisely, can we determine whether it is self-financing, yields path-independent returns, and is consistent with optimal behavior for some expected utility maximizing investor? We provide necessary and sufficient conditions for a dynamic strategy to satisfy each of these properties.

THE EFFECTIVENESS OF PRICE REGULATION

That it is easier to measure the costs of price regulation than the benefits is evident in the conflicting results of studies made to determine welfare gains. An econometric study based on a simple theory of demand by customer class concludes that: (1) the effectiveness of regulation across states is irregular, which suggests that state regulatory agencies confront firms with highly variable political climates and may serve customers with an uneven quality of benefits; (2) the pattern of cross-subsidization of prices that penalized residential customers in 1969 was gone or shifted to favor residential customers by 1974; (3) a more-detailed re-evaluation of the presumed benefits and costs of nonuniform pricing may be warranted; and (4) welfare improvements appear to be possible. The dominant question that emerges is how to explain what underlying forces contribute to the substantial state-to-state and between-customer variations in regulatory impact. 13 references, 6 tables.

Optimal Forward Exchange Positions

Properties of optimal forward exchange positions are examined in an expected utility framework. Models considered include multiple forward exchange markets and other alternatives for investment. The responses of optimal forward positions to changes in distributions of returns to speculation are examined, including changes in dispersion about a constant mean, held to be a more general notion of riskiness than variance. Policies to alter speculative behavior are suggested by the analysis. The results are distribution-free, and generalize and extend those of Feldstein (1968).