"Does the Market Matter for More Than Investment?"
ABSTRACT: Many papers document the effect of stock prices on corporate
investment. We know high stock prices imply high investment, but we
know little about what low stock prices imply, other than the
implied flip side (low investment). This paper studies the behavior
of low stock price firms and adds to this literature in several
ways. First, a theoretical model is developed reconciling this
finding with the existing investment-stock price dependence
empirical results. If investment is likely to increase the interim
stock price, the manager will invest and monitor costs less
pertinaciously. Second, a new dimension of corporate behavior
that is stock price dependent is documented. Low stock prices
precede a lower cost structure. Third, empirical tests provide
strong support for the model. In particular, low stock prices
predate lower costs, investments, and higher cash flows. Robustness
checks reveal that the results are not driven by firms' financial
constraints or issuance of debt and equity securities.
"Private Equity as Financial Intermediation" with Anjan Thakor and Arnoud W. A. Boot
ABSTRACT: We present a model in which private equity emerges endogenously as a
form of financial intermediation. The key to the model is twofold.
First, investors have different levels of alignment with the
manager. Second, trading in public markets results in little surplus
for those with high alignment. Private equity investors solve a
coordination problem created in the public market by competition.
For each potential private equity investor with a high level of
alignment with the manager, any trading creates a frenzy in which
the marginal surplus is zero. Thus, forming a coalition of private
equity investors and extracting benefit from the higher alignment
provides more surplus than the cost of forming the coalition. The
benefit is greatest when the public market has a low level of
alignment and a large amount of volatility. The firm's benefit for
issuing private equity is the gain from having investors with a
higher level of alignment. If equity scrutiny is likely to result in
an unfavorable opinion of the project, debt will be selected.
Further, if the asset-substitution problem is large, then public
debt is not an option and private debt will be selected in order to
monitor project choice.
