The Quarterly Journal of Finance

We provide arguments and present evidence that corporate governance structures are composed of interrelated mechanisms, which are in turn endogenous responses to the costs and benefits firms face when they choose those mechanisms. Examining board structures and the use of corporate charter provisions in a sample of more than 2,300 firms over a four-year period, we find that firms cluster in their use of governance mechanisms. In particular, the set of charter provisions that firms use, as measured by the Gompers et al. (2003) G Index, is associated with board structure, with the laws of the state in which the firm is incorporated, and with firm and industry characteristics. We also find that some governance structures appear to serve as substitutes. Specifically, firms that have powerful boards (as measured by board independence) also have the greatest number of charter provisions, suggesting that the market for corporate control is less effective as a monitoring mechanism for these firms. In contrast, firms that have less powerful boards tend to have few charter provisions, suggesting that the market for corporate control plays a greater monitoring role at such firms. To address potential endogeneity issues, we employ three-stage least squares analysis to estimate these relationships within a system of equations. Our results from this analysis are consistent with the hypothesis that powerful boards serve as a substitute for the market for corporate control. Finally, our findings suggest that causality runs from the board to the choice of charter provisions, but not vice versa.

The connections between stock market volatility and returns are studied within the context of a general equilibrium framework. The framework rules out a priori any purely statistical relationship between volatility and returns by imposing uncorrelated innovations. The main model generates a two-factor structure for stock market volatility along with time-varying risk premiums on consumption and volatility risk. It also generates endogenously a dynamic leverage effect (volatility asymmetry), the sign of which depends upon the magnitudes of the risk aversion and the intertemporal elasticity of substitution parameters.

Because stock options have a dual role as both compensation and incentives, a portion of option value represents compensation and a portion represents incentives. We develop a model that measures the tradeoff between the compensation and incentive values of options. Empirical estimates over a 14-year period show that the median option contains $1.08 of incentives for every $1.00 of compensation and that option compensation is around 30% of total compensation. We also find that firms that use options more as a compensation device use fewer options and reduce other cash payments suggesting a resourceful and not abusive use of options.

This paper argues that firms may not issue debt in order to avoid the adverse selection cost of debt. Theory suggests that since debt is a concave claim, it may be mispriced when outside investors are uninformed about firms' risk. The empirical literature has however paid little attention to the caveat that the "lemons" problem of external financing first identified by Myers (1984) only leads to debt issuance, i.e., a pecking order, if debt is risk free or, if it is risky, that it is not mispriced. This paper examines whether and for what firms the adverse selection cost of debt is more than a theoretical possibility and how this cost relates to other costs of debt such as bankruptcy. In the absence of any direct measure of something that is unknown to investors and thus cannot be in the econometrician's information set, we present extensive strong and robust evidence in a large unbalanced panel of publicly traded US firms from 1971 to 2001 that firms avoid issuing debt when the outside market is likely to know little about their risk.

In 2007 and 2008, the mortgage market failed. It failed in a number of dimensions: Default rates rose to their highest levels since the great depression, and mortgage liquidity ground to a halt. This failure has produced recriminations: Blame has been laid at the feet of borrowers, brokers, lenders, investment banks, investors and government and quasi-government entities that guaranteed mortgages. These recent events have produced an important debate: Whether the U.S. mortgage market requires a federal guarantee in order to best serve consumers, investors and markets. My view is that such a guarantee is necessary. I will divide my argument into four areas:

(1) I will argue that the United States has had a history of providing guarantees, either implicit or explicit, regardless of its professed position on the matter. This phenomenon goes back to the origins of the republic. It is in the best interest of the country to acknowledge the existence of such guarantees, and to price them appropriately before, rather than after, they become necessary.

(2) I will argue that in times of economic stress, such as now, the absence of government guarantees would lead to an absence of mortgages.

(3) I will argue that a purely "private" market would likely not provide a 30 year fixed rate pre-payable mortgage. I think that this is no longer a particularly controversial statement; what is more controversial is whether such a mortgage is necessary — I will argue that it is.

(4) I will argue that in the absence of a federal guarantee, the price and quantity of mortgages will vary across geography. In particular, rural areas will have less access to mortgage credit that urban areas, central cities will have less access than suburbs. Condominiums already are treated less favorably than detached houses, and this difference is likely to get larger in the absence of a guarantee.

This paper evaluates the major alternative proposals for reforming the U.S. home mortgage market assuming that the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mae, will be closed. The paper compares proposals that advocate primary reliance on private markets to take on the GSE functions with proposals that advocate government mortgage guarantees, including a discussion of how these plans differ in terms of duration, scope, and risk-sharing. The paper concludes with a discussion of current government attempts to expedite the modification or refinancing of existing mortgages, including a plan for the transition from the current situation to the long-term reforms.