Corporate Finance

We present simple adverse selection model in which a firm finds it advantageous to insure against bad outcomes and thereby improve its credit quality and reduce its cost of capital.

This paper develops a model of growth and income inequalities in the presence of imperfect capital markets, and it analyses the tickle-down effect of capital accumulation. Moral hazard with limited wealth constraints on the part of the borrowers is the source of both capital market imperfections and the emergence of persistent income inequalities. Three main conclusions are obtained from this model. First, when the rate of capital accumulation is sufficiently high, the economy converges to a unique invariant wealth distribution.

We provide a framework in which we link the valuation and asset allocation policies of defined benefits plans with the lifetime marginal productivity schedule of the worker and the pension plan formula. In turn, we examine the retirement policies that are implied by the primitives of the model and the value of pension obligations. Our model provides an explicit valuation formula for a stylized defined benefits plan. The optimal asset allocation policies consist of the replicating portfolio of the pension liabilities and the growth optimum portfolio independent of the pension liabilities.

In this article I begin by discussing the rationale for mandatory convertibles from the point of view of issuers as well as investors. In general, convertibles securities reduce the costs of "information asymmetry" that can make equity offerings especially expensive for some smaller, high-growth companies (or any firm with little additional debt capacity where management is convinced its shares are undervalued).

The payoff of a barrier option depends on whether or not a specified asset price, index, or rate reaches a specified level during the life of the option. Most models for pricing barrier options assume continuous monitoring of the barrier; under this assumption, the option can often be priced in closed form. Many (if not most) real contracts with barrier provisions specify discrete monitoring instants; there are essentially no formulas for pricing these options, and even numerical pricing is difficult.

In this paper we provide valuation formulas for several types of American options on two or more assets. Our contribution is twofold. First, we characterize the optimal exercise regions and provide valuation formulas for a number of American option contracts on multiple underlying assets with convex payoff functions. Examples include options on the maximum of two assets, dual strike options, spread options, exchange options, options on the product and powers of the product, and options on the arithmetic average of two assets.

The paper demonstrates empirically that GAAP earnings have properties to serve as a substitute for dividends in equity valuation analysis. Dividends reduce subsequent GAAP earnings, and "intrinsic" equity prices calculated by forecasting earnings are thus reduced by current dividends. This is in accordance with the Miller and Modigliani principle—the displacement property—which states that the payment of dividends reduces prices, dollar for dollar.

We develop bounds and approximations for setting base-stock levels in production-inventory systems with limited production capacity. Our approximations become exact as inventories become critical, meaning either that the target service level is very high or the backorder penalty is very large. Our bounds apply even without this requirement. We consider both single-stage and multi-stage systems.