Contents

Managerial Ownership, Incentive Contracting, and the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders
J. Carr Bettis, John M. Bizjak, and Michael L. Lemmon

Takeover Defenses and Dilution: A Welfare Analysis
Atreya Chakraborty and Richard Arnott

Day Trading International Mutual Funds: Evidence and Policy Solutions
William N. Goetzmann, Zoran Ivkovich, and K. Geert Rouwenhorst

Performance Changes following Top Management Turnover: Evidence from Open-End Mutual Funds
Ajay Khorana

Firm Internationalization and the Cost of Debt Financing: Evidence from Non-Provisional Publicly Traded Debt
David M. Reeb, Sattar A. Mansi, and John M. Allee

Abstracts

Does Conditioning Information Matter in Estimating Continuous Time Interest Rate Diffusions?
Abhay Abhyankar and Devraj Basu

We examine an important aspect of empirical estimation of term structure models; the role of conditioning information in dynamic term structure models. The use of both real world or simulated data implicitly incorporates conditioning information. We examine the bias created in estimating the drift by a specific form of conditioning, namely truncation. Using the theory of enlargement of filtrations we provide estimates of the extent of this truncation bias for commonly used short rate models. We find that this truncation bias causes the drift of these models to have a nonlinear structure.

Managerial Ownership, Incentive Contracting, and the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders
J. Carr Bettis, John M. Bizjak, and Michael L. Lemmon

Zero-cost collars and equity swaps provide insiders with the opportunity to hedge the risk associated with their personal holdings in the company's equity. Consequently, their use has important implications for incentive-based contracting and for understanding insider trading behavior. Our analysis indicates that these transactions generally involve high-ranking insiders and effectively reduce their ownership by about 25%, on average. Given the potential of these financial instruments to substantially alter the incentive alignment between managers and shareholders, we suggest that increasing the transparency of these transactions may provide valuable information to investors.

Takeover Defenses and Dilution: A Welfare Analysis
Atreya Chakraborty and Richard Arnott

Existing theory suggests that, in an unregulated market for corporate control, the level of takeovers is suboptimal because shareholders do not receive the full benefit from them. However, existing theory neglects that the threat of takeover may divert managerial effort from productive to defensive activities. This paper shows that, when this is considered, takeovers may, in fact, be excessive.

Day Trading International Mutual Funds: Evidence and Policy Solutions
William N. Goetzmann, Zoran Ivkovich, and K. Geert Rouwenhorst

Daily pricing of mutual funds provides liquidity to investors but is subject to valuation errors due to the inability to observe synchronous, fair security prices at the end of the trading day. This may hurt fund investors if speculators strategically seek to exploit mispricing or if the net flow of money into funds is correlated with these pricing errors. We show that mutual funds are exposed to speculative traders by using a simple day trading rule that yields large profits in a sample of 391 U.S.-based open-end international mutual funds. We propose a simple "fair pricing" mechanism that alleviates these concerns by correcting net asset values for stale prices. We argue that fund companies and regulators should look at alternatives that allow funds to offer fair pricing to investors, which, in turn, decreases the need to resort to monitoring for day traders and redemption penalties.

Performance Changes following Top Management Turnover: Evidence from Open-End Mutual Funds
Ajay Khorana

I examine the impact of mutual fund manager replacement on subsequent fund performance. Using a sample of 393 domestic equity and bond fund managers that were replaced over the 1979--1991 period, for the underperformers, I document significant improvements in post-replacement performance relative to the past performance of the fund. On the other hand, the replacement of overperforming managers results in deterioration in post-replacement performance. I find evidence supporting the presence of strategic risk shifting in the fund portfolios prior to replacement. Furthermore, consistent with the notion of window dressing, I document that the level of portfolio turnover activity decreases significantly in the post-replacement period. Lastly, the replacement of poor performers is preceded by significant decreases in net new inflows in the fund.

Firm Internationalization and the Cost of Debt Financing: Evidence from Non-Provisional Publicly Traded Debt
David M. Reeb, Sattar A. Mansi, and John M. Allee

Recent research suggests that firm internationalization is associated with greater exchange rate risk and a higher cost of equity capital. However, there is no research on the relation between the level of firm international activity and the cost of debt financing. This study offers the first such empirical evidence using non-provisional public debt. Based on a sample of 2,194 U.S. firm year observations, we find that firms with greater levels of international activity have better credit ratings. We also find that the cost of debt financing is inversely related to the degree of firm internationalization beyond that incorporated in credit ratings. These results suggest that rating agencies do not fully incorporate firm international activity in their analysis resulting in a downward bias in credit ratings for international firms. In aggregate, the results imply that failing to incorporate firm international activity in debt pricing leads to potential omitted variable problems.