The role of lockups in takeover contests

We examine breakup fees and stock lockups as devices for prospective target firms to encourage bidder participation in takeover contests. Unless bidding costs for the first bidder are too high, breakup fees provide for the socially desirable degree of competition and ensure the efficient allocation of the target to the highest‐valued buyer in a takeover auction. In contrast, stock lockups permit the target firm to subsidize entry of a new bidder at the expense of an incumbent bidder. Stock lockups induce too much competition when offered to a second bidder and too little competition when offered to a first bidder. Despite their socially wasteful properties, target management would favor stock lockups, as they induce takeover competition at least cost to the target.     

Hedging and competition

We consider firms that, all else equal, wish to minimize variability in their internal capital (due to convex costs of raising external funds). The firms can hedge the cash flow risk of the project, but not that of winning or losing the auction. We characterize optimal hedging and bidding strategies in this competition framework. We show that access to financial markets makes firms bid more aggressively, possibly even above their valuation for the project. In addition, hedging increases the variance of bids and makes firm values more dispersed. Further, with hedging, the covariance of internal capital changes with the risk factor is negative, and is more negative, the higher the correlation of the hedging instrument with the risk factor.     

Dynamic auction environment with subcontracting

This article provides evidence on the role of subcontracting in the auction‐based procurement setting with private cost variability and capacity constraints. We demonstrate that subcontracting allows bidders to modify their costs realizations in a given auction as well as to control their future costs by reducing backlog accumulation. Restricting access to subcontracting raises procurement costs for an individual project by 12% and reduces the number of projects completed in equilibrium by 20%. The article explains methodological and market design implications of subcontracting availability.     

Endogenous asymmetry in a dynamic procurement auction

We show how to numerically solve for a Markov‐perfect equilibrium of a dynamic auction game where a procurer repeatedly purchases construction services from capacity‐constrained firms. We find that the procurer is best off scheduling frequent auctions for small project sizes. Otherwise, firm capacity utilization rates become larger and more asymmetric, which softens competition and increases procurement costs. We also find that forward‐looking bidding dampens the competition‐softening effects of asymmetry: farsighted firms compete more intensely than myopic ones. This can undermine the goal of a bid‐preference‐style affirmative action program: more farsighted firms respond less to the asymmetry induced via bid preferences.     

The Effect of Bankruptcy Protection on Investment: Chapter 11 as a Screening Device

Asymmetric information and conflicts of interest between equity and debt holders can force a distressed but efficient firm to liquidate and may enable a distressed inefficient firm to continue. In the extreme, if it is costless for an inefficient firm to mimic an efficient firm in a debt restructuring, efficient and inefficient firms are equally likely to continue or liquidate. This article shows that Chapter 11 procedures impose costs on inefficient firms that would otherwise mimic efficient firms. This separation induces voluntary filing for bankruptcy by inefficient firms and consequently enables efficient firms to continue when they would otherwise be liquidated.     

Regulating bidder participation in auctions

Regulating bidder participation in auctions can potentially increase efficiency compared to standard auction formats with free entry. We show that the relative performance of two such mechanisms, a standard first‐price auction with free entry and an entry rights auction, depends nonmonotonically on the precision of information that bidders have about their costs prior to deciding whether to participate in a mechanism. As an empirical application, we estimate parameters from first‐price auctions with free entry for bridge‐building contracts in Oklahoma and Texas and predict that an entry rights auction increases efficiency and reduces procurement costs significantly.     

Resource Allocation Auctions within Firms

There is growing interest in the use of markets within firms. Proponents have noted that markets are a simple and efficient mechanism for allocating resources in economies in which information is dispersed. In contrast to the use of markets in the broader economy, the efficiency of an internal market is determined in large part by the endogenous contractual incentives provided to the participating, privately informed agents. In this paper, we study the optimal design of managerial incentives when resources are allocated by an internal auction market, as well as the efficiency of the resulting resource allocations. We show that the internal auction market can achieve first‐best resource allocations and decisions, but only at an excessive cost in compensation payments. We then identify conditions under which the internal auction market and associated optimal incentive contracts achieve the benchmark second‐best outcome as determined using a direct revelation mechanism. The advantage of the auction is that it is easier to implement than the direct revelation mechanism. When the internal auction mechanism is unable to achieve second‐best, we characterize the factors that determine the magnitude of the shortfall. Overall, our results speak to the robust performance of relatively simple market mechanisms and associated incentive systems in resolving resource allocation problems within firms.     

Auctions in bankruptcy

This paper examines whether mandatory auctions promote the efficient restructuring of distressed firms relative to a reorganization-based bankruptcy system such as Chapter 11. Under a mandatory auction system, aggressive bidding by a coalition of incumbent management and pre-bankruptcy creditors may deter outside bidders, may result in the coalition paying more than its valuation to acquire the firm, and may result in assets remaining in a lower value use. In a reorganization-based bankruptcy system, management's voluntary choice to seek an auction conveys information about the coalition's valuation, which facilitates competition. Our model shows that a reorganization-based bankruptcy system that encourages, but does not mandate auctions, can actually increase the likelihood that an outside bidder enters and the assets of the bankrupt firm are redeployed.     

Dutch Auction Repurchases: An Analysis of Shareholder Heterogeneity

This paper documents that firms face upward-sloping supply curves when they repurchase shares in a Dutch auction, and it analyzes the market reaction to these offers. The announcement price increase is highly correlated with the ultimate repurchase premium. Prices decline at expiration only for pro-rated offers. The cumulative return is positive and highly correlated with the repurchase premium, excepting pro-rated offers. Much of this price increase is consistent with movement along an upward-sloping supply curve. Trading volume around the Dutch auction parallels fixed-price repurchases. Supply elasticity is larger for firms with large trading volume, firms included in the S&P 500 Index, and takeover targets.     

Why Does Book Building Drive Out Auction Methods of IPO Issuance? Evidence from Japan

We examine Japan's 1997 introduction of book building as analternative to a previously required hybrid auction method.Despite higher cost for some issuers, all issuers in Japan nowselect book building. Book building enables more accurate valuationof firms, but gains from accurate valuation are partly redistributive.Thus book building can drive auction-method offerings from themarket even if it yields no aggregate benefit. Compared to theauction regime, book building reduces issue costs for largeissuers. Auctioning is less costly for small issuers, but appearsto foreclose some small firms from issuing. The aggregate costsof book building and auctioning are similar.     

Agency costs of free cash flow and conditional conservatism

This study investigates whether agency costs of free cash flow (FCF) are associated with conditional conservatism. Prior research documents that conditional conservatism improves ex ante efficient investment decisions and facilitates ex post monitoring of managers’ investment decisions. As conditional conservatism can provide protection from possible managerial expropriation, the demand for conditional conservatism should increase with the agency costs of FCF. Using excess cash as a proxy for the agency costs of FCF, I provide evidence that firms with higher agency costs of FCF incorporate losses in a timelier manner relative to gains compared to their counterparts. Additionally, the association between excess cash and conditional conservatism predictably varies with the presence of alternative monitoring mechanisms that mitigate FCF problems, such as debt or dividend payouts or repurchases. Further investigation suggests that greater conservatism is associated with a lower likelihood of overinvestment among firms bearing high agency costs of FCF, demonstrating the ability of conservatism to reduce agency costs of FCF.     

Market structure, informational efficiency and liquidity: An experimental comparison of auction and dealer markets

We report the results of 18 market experiments that were conducted in order to compare the call market, the continuous auction and the dealer market. Transaction prices in the call and continuous auction markets are much more efficient than prices in the dealer markets. The call market shows a tendency towards underreaction to new information. Execution costs are lowest in the call market and highest in the dealer market. The trading volume and Roll's (Journal of Finance (1984) 1127–1139) serial covariance estimator are inappropriate measures of execution costs in the present context. The relation between private signals, trading decisions and trading profits is analyzed.     

Costs of broad-based stock option plans

We generate estimates of the costs of broad-based stock option programs under varying assumptions about why firms use these pay schemes. We show that, if accounting considerations alone drive option grants, a typical firm in our sample incurs between 50 cents and one dollar of real costs in order to increase reported pre-tax net income by one dollar. This cost is reduced, but is still quite substantial, if accounting leads firms to grant options rather than restricted stock. We also show that, if option grants are efficient, the patterns in our data are consistent with firms using these grants to attract and retain employees.     

Tacit collusion and capacity withholding in repeated uniform price auctions

This article analyzes tacit collusion in infinitely repeated multiunit uniform price auctions in a symmetric oligopoly with capacity‐constrained firms. Under two popular definitions of the uniform price, when each firm sets a price‐quantity pair, perfect collusion with equal sharing of profit is easier to sustain in the uniform price auction than in the corresponding discriminatory auction. Moreover, capacity withholding may be necessary to sustain this outcome. Even when firms may set bids that are arbitrary finite step functions of price‐quantity pairs, in repeated uniform price auctions maximal collusion is attained with simple price‐quantity strategies exhibiting capacity withholding.     

Rookie directors and firm performance: Evidence from China

This paper examines the benefits and costs associated with rookie independent directors (RIDs) in Chinese public companies from 2008 to 2014. We find that RIDs attend more board meetings. Boards with more RIDs tunnel less to controlling shareholders, suggesting that RIDs are efficient monitors. However, in state-owned firms, the presence of RIDs is negatively associated with investment efficiency, suggesting a potential cost of appointing RIDs. Overall, firms with more RIDs have higher operating performance, especially when tunneling is a more common issue, when board experience is less important and when monitoring costs are relatively low.     

Competitive procurement with ex post moral hazard

Unlike standard auctions, we show that competitive procurement may optimally limit competition or use inefficient allocation rules that award the project to a less efficient firm with positive probability. Procurement projects often involve ex post moral hazard after the competitive process is over. A procurement mechanism must combine an incentive scheme with the auction to guard against firms bidding low to win the contract and then cutting back on effort. While competition helps reduce the rent of efficient firms, it exacerbates the problem due to moral hazard. If allocative efficiency is a requirement, limiting the number of participants may be optimal. Alternatively, the same incentives can be optimally provided using inefficient allocation rules.     

Restructuring of the Dutch Nonlife Insurance Industry: Consolidation,Organizational Form,and Focus

Since the deregulation of the European insurance market in 1994, Dutch nonlife insurance firms have sized up and increased their focus. Concurrently, the stock organizational form has become increasingly dominant. This article investigates these 1995–2005 trends from a cost‐efficiency perspective. We observe substantial economies of scale that are even larger for smaller firms. In line with the efficient structure hypothesis, both stocks and mutuals are found to have comparative cost advantages. Supporting the strategic focus hypothesis, we find that more specialized insurers have lower costs. Thick frontier efficiency estimates point to large cost X‐inefficiencies that have moderately decreased over time.     

Life-cycle effects in small business finance

This paper studies the life-cycle profiles of small firms’ cost and use of credit using a panel of Finnish firms. The choice of method matters for the conclusions drawn about the relationship between firm age and financing costs; the cross-sectional age profiles of financing costs are hump-shaped and consistent with hold-up theories, whereas methods that control for cohort fixed effects demonstrate that the financing costs decrease monotonically as the firms mature. The life-cycle profiles of the use of credit also indicate that firms are more dependent on financial intermediaries in the early periods of their lives. Furthermore, the cohorts born during recessions pay higher financing costs and use smaller amounts of bank loans, even after their creditworthiness is controlled for. The recession cohort effect appears to be more related to the experience of starting-up the firm in the recession than to the CEOs growing up in a recession during their early adulthood.     

Liquidity and firm investment: Evidence for Latin America

This paper explores the relationship between firms' investment and stock market liquidity. Using a panel of Latin American firms, I find evidence that a higher trading volume and a higher industry-adjusted trading volume are associated with higher firm investment (PPE, Total Assets, and Inventory). This relationship is higher in episodes where the firm decides to issue shares, and it is also greater for firms with tighter financial constraints and better investment opportunities. This evidence is consistent with a mispricing channel, where firms issue and invest the proceeds to take advantage of low cost of capital, or with a cost channel, where liquidity is associated with lower issuance costs. Also, it is less related with an informational channel, where a liquid market helps a manager to take more efficient decisions, since this channel does not necessarily predict an increase in investment, but only more efficient investment.     

The Effect of Leverage on Bidding Behavior: Theory and Evidence from the FCC Auctions

This is an exploration of how bidding behavior of firms in variousauctions is affected by their capital structure. The theoreticalmodel considers a first-price sealed bid and an English auction.We find that as debt levels increase, firms tend to reduce theirbids. The lower bids give the competition incentives to reducetheir bids as well. These results are investigated empiricallyusing data from the 1994–1995 FCC spectrum auctions. Consistentwith the theoretical model, higher debt levels of the biddingfirm and of the competition tend to lead to lower bids. Additionaldeterminants of bidding behavior in these auctions are alsoanalyzed.