Program Meeting: Corporate Finance

NBER Reporter: Summer 2000

Corporate Finance

The NBER's Program on Corporate Finance met in Cambridge on April 14. Program Director Raghuram Rajan of the University of Chicago chose the following papers for discussion:

Eugene F. Fama, University of Chicago, and Kenneth R. French, NBER and MIT, "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?"

Discussant: John R. Graham, Duke University

Oliver D. Hart, NBER and Harvard University, and John H. Moore, London School of Economics, "On the Design of Hierarchies: Coordination versus Specialization" (NBER Working Paper No. 7388)

Discussant: Bengt Holmstrom, NBER and MIT

Artyom A. Durnev, University of Michigan; Randall Morck, University of Alberta; and Bernard Yeung, New York University, "Do Stock Prices Guide the Allocation of Capital?"

Discussant: Gregor M. Andrade, Harvard University

Jeremy C. Stein, NBER and MIT, "Information Production and Capital Allocation: Decentralized versus Hierarchical Firms" (NBER Working Paper No. 7705)

Discussant: Ulf Axelson, University of Chicago

Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer, NBER and Harvard University, "Government Ownership of Banks" (NBER Working Paper No. 7620)

Discussant: Mihir A. Desai, NBER and Harvard University

Philippe Aghion, University College London; Patrick Bolton, NBER and Princeton University; and Jean Tirole, MIT, "Exit Options in Corporate Finance: Liquidity versus Incentives"

Discussant: Stewart C. Myers, NBER and MIT

The percent of firms paying cash dividends fell from 66.5 in 1978 to 20.7 in 1998. Fama and French suggest that this decline is attributable in part to the changing characteristics of publicly traded firms. The population of publicly traded firms is composed increasingly of small firms with low profitability and strong growth opportunities; these characteristics are typical of firms that have never paid dividends. Even after controlling for these characteristics, Fama and French show that firms are becoming less likely to pay dividends. This lower propensity to pay is at least as important as changing characteristics in the declining incidence of dividend payers.

Hart and Moore develop a model of hierarchies based on the allocation of authority. A firm's owners have ultimate authority over a firm's decisions, but they have limited capacity or desire to exercise this authority. Hence, owners may defer to subordinates. However, these subordinates also have limited capacity or desire to exercise authority, so they may defer to their subordinates. Hart and Moore analyze the optimal chain of command given that different agents have different tasks: some agents are engaged in coordination and others in specialization. The authors' theory throws light on the nature of hierarchy, the optimal degree of decentralization, and firm boundaries.

Durnev, Morck, and Yeung show that industries with larger firm-specific variation in stock prices grow faster, adjust faster, allocate capital with greater precision, add more value, and use more external financing. These findings support the view that greater firm-specific variation in stock prices reflects the capitalization in stock prices of higher intensity firm-specific information and is associated with better firm-specific capital allocation. The authors propose that higher firm-specific price variation may be one indicator of greater functional-form market efficiency, in the sense of Tobin (1982).

Stein assesses different organizational forms in terms of their ability to generate information about investment projects and efficiently allocate capital to these projects. A decentralized approach -- with small, single-manager firms -- is most attractive when information about individual projects is "soft" and cannot be transmitted credibly. Holding firm size fixed, soft information also favors flatter organizations with fewer layers of management. In contrast, large hierarchical firms with multiple layers of management are at a comparative advantage when information can be "hardened" costlessly and passed along within the hierarchy. As a concrete application of the theory, Stein discusses the consequences of consolidation in the banking industry. When large banks acquire small banks, there is a pronounced decline in lending to small businesses. To the extent that small-business lending relies heavily on soft information, this result is consistent with the theory.

La Porta, Lopez-de-Silanes, and Shleifer investigate a neglected aspect of financial systems of many countries around the world: government ownership of banks. They assemble data that establish four findings. First, government ownership of banks is large and pervasive around the world. Second, such ownership is particularly significant in countries with low levels of per capita income, underdeveloped financial systems, interventionist and inefficient governments, and poor protection of property rights. Third, government ownership of banks is associated with slower subsequent financial development. Finally, government ownership of banks is associated with lower subsequent growth of per capita income and, in particular, with lower growth of productivity rather than slower factor accumulation. This evidence is inconsistent with the optimistic "development" theories of government ownership of banks common in the 1960s, but supports the more recent "political" theories of the effects of government ownership of firms.

Aghion, Bolton, and Tirole characterize optimal security design in the context of a corporate financing problem with monitoring and demand for liquidity. Optimal incentives to efficiently monitor the firm dictate that investments and compensation contracts be illiquid. But the liquidity premium on illiquid investments may be so high that it might be efficient to trade optimal incentives for greater liquidity. Building on the fundamental complementarity between speculative monitoring (which increases the informativeness of prices) and active monitoring (which is enhanced when investments are more liquid), Aghion, Bolton, and Tirole then spell out the conditions on the underlying parameters under which more or less liquidity is warranted. Finally, the authors apply the model to the analysis of common exit provisions in venture capital financing.

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