We support and generalize our original results (1978) in light of potential impediments to a pure market solution to agency problems and potential causal links between liquidation and bankruptcy. In the case of bankruptcy costs, market impediments are easily eliminated through the inclusion of simple provisions in corporate charters and bond indentures. Further, we demonstrate that recent attempts to link liquidation costs to capital structure are without merit. If the firm is to be liquidated on the basis of a rule other than one that maximizes the total value of all the claimants, arbitrage profits arise, and informal reorganization will discipline management to follow the liquidation rule that is optimal for existing securityholders. Also, we find that the pure market solution is not readily generalizable to other classes of agency problems, particularly the risk incentive problem. However, the alternative solution of the risk incentive problem through complex financing contracting may be useful in explaining complexities in contemporary financial contracts.

In a world characterized by perfect and complete capital markets, the success (or failure) of a merger is judged by the merger's impact on stockholder wealth. With completeness, the merger's impact on the probability distribution generating stockholder returns is unimportant. The perfect market assumption guarantees that the stockholder not satisfied with the consolidated firm's return distribution can frictionlessly sell his shares and reorder his portfolio; hence his only concern is the merger's impact on wealth. However, if we acknowledge the existence of commissions, taxes, and other frictions, or if markets are not complete, the merger's impact on the stockholder return distribution becomes relevant. In this study we will analyze 149 mergers involving large N.Y.S.E. firms. We will examine four different hypotheses related to the impact of merger on attributes of the stockholder return distribution. We focus our analysis on risk-related attributes including beta, total variance, residual variance, and several other risk-related attributes. In a companion paper, merger's impact on wealth is calculated for the same sample but will not be reported here.

In the late 1930s, Macaulay [7] and Hicks [6] independently introduced the concept of duration as a measure of the length of a stream of cash flows and a measure of the elasticity of the present value of the stream with respect to a change in the rate of discount, respectively. Approximately 15 years later, Reddington [8] and Heynes and Kirton [5] used the concept to develop interest rate immunization rules for the portfolio management of insurance companies. More recently, Fisher and Weil [1] have developed duration based rules to help investors find investments that will insure them of having some fixed amount of money available at a specific future point in time. In [2], Grove uses duration to link the investor's decision to speculate or immunize with his subjective forecast of future interest rate movements. Finally, Haugen and Wichern [3, 4] show the relationship between duration and the characteristics of bonds and stocks. Also, in analyzing the effect of financial leverage on interest rate risk, they demonstrate how the financial manager can manipulate the capital structure of his firm, so as to render the present value of the common stock insensitive to changes in the rate of interest.

The two related problems of agency and informational asymmetry have received increasing attention in finance. In particular, prominent authors in this area (e.g., Jensen and Meckling [7], Ross [15, 16], Leland and Pyle [10], etc.) have demonstrably argued that the financial structure of the firm can be determined in the process of eliminating, or at least reducing, the costs associated with these problems.

Strides have been made recently in the discovery and refinement of theoretical models which purport to describe the relationship between asset prices and their risk attributes. (See especially Lintner [13,14,15], Sharpe [19], Mosin [17,18] and Fama [7,8.9].) The models have gained widespread acceptance because of their intuitive appeal and because most reported empirical evidence [1,4,5,11,20,21] allegedly supports their predictive value. It is our purpose to analyze critically one aspect of the nature of this evidence, reveal its inherent weakness, and to design an alternative test to examine the risk-return function. After observing the performance of an extremely large number of issues over long periods of time, we find little support for the notion that risk premiums have, in fact, manifested themselves in realized rates of return.

The traditional valuation framework is unsuited to the task of valuing a growth stock when the capitalization rate is specified in terms of market leverage, simply because it is impossible to maintain a constant ratio of book to market leverage over the growth horizon. This severely limits the usefulness of the traditional model in analyzing the valuation problem. We have proposed a more general form of the model which allows us to show the consistency between M-M's Propositions I and II under growth.

Although Imai and Rubenstein are correct that our proof — that the Miller- Modiglianl (M-M) and Sharpe-Lintner-Mossin (S-L-M) capital asset pricing models are mutually consistent — is incomplete, their comments indicate some confusion about the relationships involved in the equilibrium pricing of assets in these models. Further, they seem to imply that Stiglitz's proof in terms of dollar returns is in some sense superior to a proof in terms of rates of return. This is erroneous. Accordingly, we shall further clarify the relationships inherent in the models and correct our presentation of the proof of the invariance of capital costs in the context of the S-L-M model.

This study has addressed itself to that group most immediately affected in corporate acquisition, the stockholders of acquired companies. We find that in the years observed, acquired company stockholders seem to have benefited from the acquisitions. This study differs from other studies of post-merger performance of the common stock of acquirors and not the performance of securities received by acquirees in exchange for their common stock. It should also be noted that most of the financial gain resulting from the acquisitions accrued at the time of merger because of substantial premiums paid by acquirors. While the stockholders of the acquired companies have, on average, benefited, these results tell us little of the effect of mergers on the welfare of society or, for that matter, of their effect on the stockholders of the acquiring firm. If the merger cannot be justified on the basis of some economy of scale or synergistic advantage, the newcomers reap their lucrative returns only at the expense of the old guard. If the acquiring firm pays a premium in acquisition on the basis of justifiably sound expectations of increased profits, social welfare is not necessarily enhanced. Increased profitability may not reflect increased efficiency; it may, for example, be a manifestation of decay in the competitive environment.

We have discussed some of the effects of rate regulation in the property and casualty insurance industry. One consequence of the regulatory environment is that an optimal capital structure may clearly exist in this industry. If the rate of return to the insureds is generally deficient, we would expect that property and casualty stock companies would have an incentive to lever themselves to the maximum extent permissible by selling insurance. The classic monopoly of the economic literature finances its lucrative investment opportunities in a competitive capital market. The stock insurance company invests in that market, but the relative distribution of the return earned there may be less than equitable due to the process and standards of rate regulation.

After integrating risky debt instruments into the generalized asset pricing model developed by Sharpe and Lintner, we have demonstrated that the required return-to-equity capital in this model is a linear function of the debt-to-equity ratio with a slope equal to the difference between the unlevered cost of equity and the direct cost of debt. Consequently, we take the average cost of capital to be invariant with respect to leverage. The particular nature of the debt instrument issued by the firm does not affect this result.

Our analysis supporting the net operating income valuation construct is of interest in that it takes into account not only the variance of the probability distribution of equity returns but also the covariance relationships between these returns and all other returns in the system. Further, we need not rely on assumptions of “equivalent return” classes or arbitrage possibilities to arrive at our solution. More important, our conclusion is quite general in that we demonstrate indifference toward finance with any instrument regardless of its inherent risk characteristics.

Stocks differ in the variability of their prices; thus, as the level of stock market prices swings periodically, one observes a change in structure as the prices of more volatile issues change relative to those of a more stable character. Here we attempt to empirically establish some of the differentiating characteristics of these volatile issues. In doing so we add to the empirical and analytical work of Fritzemeier [4], Clendenin [2], Latané [7], Malkiel [8], and Heins and Allison [6]. Only the last of these efforts used regression techniques.