John K. Wald

Are Two Heads Better than One? The Impact of Changes in Management Structure on Performance by Firm Size

Abstract We investigate how switching between two alternative management structures affects firms, and how this impact varies with firm size. Under one structure a single executive serves as both chief executive officer (CEO) and chairman of the board (COB). Under the alternative structure two separate executives fill these positions. In order to evaluate which management structure is optimal, we examine the impact of a change in management structure on firm performance. A change from one to two executives induces negative abnormal returns for small firms, but positive abnormal returns for large firms. These impacts are also evident with accounting profitability measures of returns. Our results are consistent with the hypothesis that small firms benefit more from the clarity and decisiveness of decision-making under a single executive, while large firms benefit more from the checks and balances of having two executives in the CEO and COB positions.

State Laws and Debt Covenants

We examine whether state laws impact the use of debt covenants by using a sample of U.S. public bond issues from 1987 to 2004. We consider variation in state laws with respect to the minimum asset‐to‐debt ratio necessary for a payout and with respect to antitakeover statutes. We find that firms incorporated in states with stricter restrictions on distributions are less likely to include debt covenants that constrain payouts, limit additional debt, or restrict the sale of assets. Thus, state payout restrictions appear to be a substitute for the use of these debt covenants. On the other hand, firms incorporated in states with stronger antitakeover statutes are somewhat more likely to use debt covenants. This finding is consistent with the notion that firms with antitakeover protection are more likely to suffer from agency problems and, thus, are more likely to use debt covenants to minimize agency costs.

Explaining Exchange Rate Risk in World Stock Markets: A Panel Approach

Using a GARCH approach, we estimate a time-varying two-factor international asset pricing model for weekly equity index returns of 16 OECD countries. A trade-weighted basket of exchange rates and the MSCI world market index are used as risk factors. We find significant currency risk exposures in country equity index returns. We then explain these currency betas using several country-specific macroeconomic variables with a panel approach. We find that imports, exports, credit ratings, and tax revenues significantly affect currency risks in a way that is consistent with some economic hypotheses. Similar conclusions are obtained by using lagged explanatory variables, and thus these macroeconomic variables may be useful as predictors of currency risk exposures. Our results are robust to a number of alternative specifications.

Optimal limit order choice

We describe a method for optimally choosing whether to place a market or limit order (and at what price) using a risk-averse investors expected utility maximization. We allow for a continuum of investor information, risk aversion, and security characteristics. We show that the choice of optimal market or limit order can be analyzed in a mean-variance framework and combined with the entire portfolio-rebalancing problem. Using NYSE trade order and quote (TORQ) data, we estimate the parameters in our theoretical model and demostrate how they could be used to find optimal limit order discounts under a variety of scenarios.

Capital structure with dividend restrictions

This paper develops a symmetric information model of a new firm which incorporates a constraint on dividend payments known as a balance sheet test. This test solves moral hazard problems that arise in credit markets where complete contracting over future actions is not possible. This constraint breaks down the traditional symmetric information result of separability between financial and real variables, and thus maximizing shareholder returns in this setting is not equivalent to maximizing total firm value. As a consequence, equity values are always positive, and the average product of capital is an important determinant of capital structure.

Do Stock Markets Catch the Flu

We examine the impact of influenza on stock markets. For the United States, a higher incidence of flu is associated with decreased trading, decreased volatility, decreased returns, and higher bid-ask spreads. Consistent with the flu affecting institutional investors and market makers, the decrease in trading activity and volatility is primarily driven by the incidence of influenza in the greater New York City area. However, the effect of the flu on bid-ask spreads and returns is related to the incidence of flu nationally. International data confirm our findings of a decrease in trading activity and returns when flu incidence is high.

Debt Covenants, Bankruptcy Risk, and Issuance Costs

Riskier firms use more covenants, yet effective covenants should reduce the probability of bankruptcy by restricting management’s actions. We disentangle these two relations between covenant use and bankruptcy risk by considering predicted and actual covenant use. We find that predicted covenant use is associated with a higher probability of bankruptcy and shorter firm survival, whereas actual covenant use is associated with a lower probability of bankruptcy and longer firm survival. This evidence is consistent with the notion that the use of covenants reduces bankruptcy risk. However, theory suggests that two covenants -- stock issuance restrictions and rating decline puts -- do not reduce the probability of bankruptcy. Empirically, we find that the use of either of these covenants implies a higher probability of bankruptcy and a shorter survival time. On the cost side, we find evidence that corporate bonds with more restrictive covenants have higher issuance costs. While we find some evidence that bonds with more covenants are more difficult to sell, we argue that this covenant-issue cost relation is mainly driven by the risk to underwriters. Overall, these results both confirm some essential aspects of, and expand upon, Smith and Warner’s (1979) costly contracting hypothesis.

Adding Bankruptcy to Models of Investment

Tests for liquidity constraints typically rely on investment models which do not fully incorporate bankruptcy risk. By explicitly adding bankruptcy risk to a model of investment I show that prior findings of liquidity constraints may instead be finding bankruptcy risk. Empirically, bankruptcy risk appears to be both a statistically and economically significant determinant of investment.

Lender Laws and International Lending

Little attention has been paid to the role of lender country laws in the

Are Tails Fat Enough to Explain Smile

7 trillion multinational syndicated loan market. We find that strong lender country creditor rights substitute for weak borrower creditor rights, and that stronger lender creditor rights are associated with a lower cost of borrowing after controlling for borrower creditor rights. These findings are robust to accounting for the borrower’s endogenous choice of lender, for borrower country laws, for the borrower’s foreign assets, and for loan guarantees provided by the borrower’s parent company or major shareholders. We also find that stronger lender property rights imply larger loans.