Job Market Paper
Stock Performance and Merger Choices [pdf]
Firms that have experienced recent gains in the stock market are more likely to engage in deals that redraw their boundaries - whether by acquiring other firms, being acquired themselves, or by doing spinoffs. Merging firms also appear to match assortatively by stock performance: successful firms merge with other successful firms. I show how both these patterns arise naturally in a model where reorganization imposes nontrivial costs.
Assortative matching by stock performance is difficult to test directly. Showing that industry and time adjusted stock returns of merger partners are positively correlated is not sufficient. This is because the correlation could be driven by unmeasured operational similarities between merger partners rather than by similarity of financial performance per se. I propose another test for assortative matching based on market reactions to merger announcements. If firms sort by performance, and performance is not perfectly observed, then merger announcements will convey information to the market about the performance of firms. The market response to a firm announcing a merger would be increasing in its proposed partner's performance (since that is an indication that the firm itself is of high quality). And, holding constant the performance of the merger partner, the market response would be declining in the firm's own past performance (since that is an indication that the firm was previously overvalued). I find empirical support for this effect in the market response to merger announcements.
Other Papers
Volatility, Human Capital and CEO Pay [pdf]
One of the benefits of human capital, whether in the form of innate skill or acquired through education and experience, might be an improved ability to respond to changing circumstances. If a type of volatility observed in the economy is caused primarily by structural shifts rather than by routine fluctuations, then the volatile sectors are experiencing genuinely new environments and should therefore have an increased demand for human capital. Consistent with this view, I find that manufacturing industries that experience more volatile productivity growth are more skill intensive. A similar result holds in a comparison of all nonfinancial industries using asset return volatility. I then explore the link between asset volatility and the wages of chief executive officers (CEOs). Since an important part of what executives do is to allocate a firm's resources in the face of economic uncertainty, one might expect that volatility is a factor in determining their wages. I find that while the relationship between a CEO's wage and the volatility of his or her own firm is small and ambiguous, CEO wages rise sharply with industry volatility. CEOs in industries with more volatile assets are paid substantially more than those running similar sized firms in more stable industries. Compensating differentials for riskier pay cannot explain a large part of this wage premium, suggesting that being in a more volatile industry increases the responsibilities of a CEO in much the same way that running a larger firm does.
Why Don't More Leveraged Firms Have More Volatile Stock? [pdf]
Contrary to what one might expect, the stock prices of more leveraged firms tend to be slightly less volatile than that of less leveraged firms. This can be explained by the fact that more volatile firms leverage less, so that a firm's leverage compensates to some extent for its underlying volatility. I study the effect of leverage on the stock volatility of a firm, and how compensatory leverage distorts this causal effect when we look at a cross section of firms. The elasticity of a firm's stock volatility with respect to its leverage is theoretically derived as strictly positive and less than unity. The degree of compensation through leverage is non monotonic in how it distorts this causal effect in a cross sectional regression of stock volatility on leverage. Very low and very high levels of compensation preserve the causal relationship, while intermediate levels tilt the regression line downwards.
The Coordinating Role of Firms. [pdf]
I provide a contractual foundation to a coordination based theory of the firm. An economy faces the problem of linking together knowledge that is dispersed across different individuals in the economy. Arriving at the right allocation requires some kind of aggregation of this dispersed knowledge, and this involves costly communication between people. Both the firm and the price mechanism emerge as alternate ways to economize on the amount of communication involved in aggregating the knowledge in the economy.
Why do Public Enterprises and Protected Private Monopolies Have Inflated Costs?
Industries run by monopolies shielded by regulation, whether they are public enterprises or protected private monopolies, end up producing at higher cost than they would have under competition. Standard economic theory does not predict this. Indeed, the Schumpeterian view predicts quite the opposite. To explain the higher costs of shielded industries, I present a model in which the presence of transaction costs provide a role for entrepreneurial ideas in the lowering of costs. Entrepreneurial ideas are best expressed through running firms. Choking off competition from firms is a way of choking off new entrepreneurial ideas in the industry, which leads to inflated costs in the protected industry.
