As is shown in the financial literature, the assumption of perfect and costless information often leads to the conclusion that corporate financial decisions are inconsequential to the value of the firm (e.g., Stiglitz [20] and Fama [6]). This conclusion seems to be in direct contradiction with the observed behavior of corporations that allocate real resources to implement financial policies. The gap between theory and observed behavior is bridged by introducing various frictions and market imperfections. A growing number of studies examine the optiraality of financial decisions when the assumption of perfect and costless information is replaced by allowing for informational asymmetry. The asymmetry is assumed to exist between corporate insiders who possess superior information about the firm's future earnings prospects and outside investors. The emphasis in this literature is on the ability of financial instruments to serve as signaling devices through which the true value of the firm can be revealed to the market without moral hazard or disclosure of confidential information. Although the signaling process is typically considered to be costly, it is advocated that firms may be better off if they employ this mechanism rather than reveal reliable, but confidential information, or not disclose at all.

This paper generalizes the past signaling literature from one variable to many. Multivariate models have been studied in the general rational expectations literature (e.g., Allen [1], Kraus and Sick [3]), but this appears to be the first multivariate signaling application. (Here, I distinguish signaling from rational expectations literature by the fact that agents may attempt to promulgate, suppress, or add noise to signals.) Talmor studies signaling models which are fully revealing (i.e., for which, in equilibrium, the values of the signaled parameters are correct).

The adequacy of the capital asset pricing models (CAPM) of Sharpe [27], Lintner [17], and Black [4] as empirical representations of capital market equilibrium is now seriously challenged (for example, see Ball [1], Banz [2], Basu [3], Cheng and Graver [8], Gibbons [15], Marsh [18], Reinganum [22], and Thompson [20]). Yet, the influence of earlier empirical studies (such as Black, Jensen, and Scholes [5] and Fama and MacBeth [11]) still remains; the current consensus seems to be that a security's beta is still an important economic determinant of equilibrium pricing even though it may not be the sole determinant. In light of the recent empirical evidence, however, the claim that a security's beta is an important determinant of equilibrium pricing should be reexamined.

In a world of heterogeneous investors, a competitive financial market has two major functions. First, it is the mechanism by which ownership of the existing supply of risky assets is distributed among investors. This is the role which is analyzed in detail by the standard Capital Asset Pricing Model (CAPM) and its many extensions. The second important market function is to aggregate the diverse information held by different investors into a single price. Most versions of the CAPM eliminate the information aggregation function by assuming that investors hold homogeneous beliefs with respect to the probability distribution of asset returns. Exceptions which deal with some aspects of the problem are Lintner [7], Grossman [4], Grossman and Stiglitz [5], and Figlewski [1, 3 ].

In a recent paper [3] we developed a theory of financial intermediariesas information producers. We argued that financial intermediaries are one class of market participants who specialize in the production of information and sell that informationtofirms with investments to finance which can profit from its distribution. In order to focus on financial intermediation, we sacrificed considerable generality in our model ofcompetitive information production in capital markets. In particular we assumed that there were only two types of assets available in the market known as type A and type B firms. Second, we assumed that information would be produced about all assets by only one information producer or that information was a declining cost industry. The approach we utilized is actually a special case of what has been called a screening or certification process (see Stiglitz [6] and Viscusi [7]), and what we prefer to callsorting. The sorting market is a market where high value and low value assets are distinguished by market participants who specialize in sorting. It is similar, but not identical, to the process of signaling developed by Spence [5] and applied to financial markets by Ross [4] and Bhattacharya [1]. Yet, the extant literature on sorting has, by and large, ignored the opportunity for thosewho stand to lose from sorting to offer side payments to thwart the sorting process. While the problem of side payments may be of minor significance for some applications of sorting and signaling models, the prospect of side payments appears to be an important if not crucial issue infinancial markets.

The use of third-party quality certification, or sorting, to overcome asymmetrically informed markets was examined recently by Viscusi (Bell Journal, Spring 1978, pp.277–279) in a labor market context. Campbell and Kracaw (CK) have extended the Viscusi equilibrium and applied it to the potentially more interesting financial markets context. CK examine the incentives for low-quality firms to offer side-payments (a financial economists' term for bribes) to information producers, or sorters, to prevent resolution of the information asymmetry. Introducing bribes formally into the analysis maylead to a better understanding of some financial institutions; an earlier CK paper is such an examination (Journal of Finance, September 1980, pp. 863–882). Perhaps, in other applications of the sorting model, other previously unjustifiable financial activities and their associated payments might be seen as side-payments for some sorting activity.

The purpose of this study is to examine the reaction of the Israeli stock market to a major economic reform that took place in Israel on October 28, 1977. On that Friday afternoon, after the closing of all businesses, TV and radio programs were interrupted fora major address by the Treasury Minister. The thrusts of the reform were the liberalization of foreign currency control, the unification of the exchange rates, and the floatingof the Israeli pound.

The paper by Lakonishok and Sadan represents an interesting attempt to link major economic reform to fundamental issues in financial valuation. Changes instituted by the Israeli government in the fall, 1977, are related to subsequent changes in security returns on the Tel Aviv Securities Exchange. The authors employ an event study methodology to investigate the market reaction to the announced reform, the market reaction to raw data and partially analyzed data, and the market reaction to easily acquired data and less easily acquired data.

Historically, preferred stock ranks well below common stock and bond issues as a source of financing in the private capital market. Relative to issuance of bonds, the issuance of preferred stock burdens the issuer with a fixed financing cost without benefitingthe issuer with the tax deductability associated with interest payments.

Professors Sorensen and Hawkins (hereafter SH) have utilized regression analysis to examine the pricing of preferred stocks both before and after a particular event. This event, the NAIC event, occurred in 1979 when the National Association of Insurance Commissioners (NAIC) adopted a rule permitting insurance companies to carry sinking fund preferred issues at book value rather than at the market value required before. SH results indicate nine to 12 variables have a significant effect on the pricing of preferred stock.

This paper is concerned with two decisions facing firms with defined benefit, trusteed pension plans: the amount of funds to contribute to the pension fund in any given period; and the selection of a particular mix of assets for that fund. The pension decision area is of importance for many firms today due to the recent rapid growth in pension costs in absolute terms and as a percent of firm profits. Unfunded liabilities (pension benefits payable net of pension assets) have become a sizable component of the capital structure of many firms. Pension funds (assets) also have grown rapidly due to liberalizationof pension benefits, inflation, the higher funding requirements of the pension reform law (ERISA), and the overall aging of the labor force.

The paper by Frankfurter and Hill is an interesting contribution to our understanding of the interrelationship between funding and portfolio investment decisions in pension fund management. This research summary is written with grea clarity, and the first three sections will be must reading for anyone doing serious work on the theory of corporate pension fund management. The reader would be well advised to go ahead and read the fourth section (“a numerical demonstration”) as well, for there theauthors clearly demonstrate both the power and serious weaknesses of a linear programming approach to this multiperiod, fixed horizon problem.

A great deal has been written about the existence of a multi-tiered stock market while little is known about the effects [8], Elia [16,17,18,19,20,21,22], Freund [25], Farrar [23], Klemkosky [29,30], Loomis [32], Robbins [47], Rosenberg [48], Seligman [5], Smidt [55], Soldofsky [56], West and Tinic [67], and Schultz [50]). More recent discussions have considered the current nature of the tiered market (Welles [65,66], Carson-Parker [11], Ang [1], Marcial [36,37,38], Lurie [34], Janeway [27], Buhl [10], and Loomis [33]). While changes may have occurred, we believe a tiered market exists and will continue to influence trading and relative pricing (Elia [17,18,19], Marcial [37,38], and Reilly [45]). Because a multi-tiered stock market will probably continue, it becomes important to determine the effects of the tiered market on the securities and firms involved. Specifically, this paper examines common stocks in one of three market tiers (based on various measures of size), in terms of trading activity, price volatility, and financing characteristics during the 15-year period 1964–1978. The total period is divided into three subperiods representing periods of increasing trading activity by institutional investors. Specifically, the first period is generally prior to the institutional impact, the second is a transitional period, and the recent period is when institutions havebecome the dominant trading group.

It is important to investigate the characteristics of firms in differing size categories (tiers) in order to document any size-related differences that may exist among these firms. Such investigations may lead to improvements in asset-pricing models as empiricists test the impacts of these differences on the actual pricing of securities. Reilly and Drzycimski (R & D) have provided evidence that a number of such differences exist: volatility, debt ratios, and trading volume appear not to be homogeneously distributed across firm size categories nor across time, but there are some difficulties with the paper that need airing.

This paper has developed a model of bank margins or spreads in which the bank is viewed as a risk-averse dealer. It was demonstrated that an interest spread or margin would always exist, and that this was the result of transactions uncertainty faced by the bank. Moreover, it was shown that this pure spread depended on four factors: the degree of managerial risk aversion; the size of transactions undertaken by the bank; bank market structure; and the variance of interest rates. The model implied that liability and asset structures had to be analyzed together since they were directly interrelated through transactions uncertainty. It was shown that because of this transactions uncertainty, hedging behavior was perfectly rational within an expected utility maximizing framework. Extending the model from a structure with one kind of loan and deposit to loans and deposits with many maturities should lead to further interesting insights into margin determination especially as “portfolio” effects may become apparent.

In this paper Ho and Saunders apply a model that has been used to analyze dealer spreads to banking.

A potential contribution to a field can arise whenever a well-developed framework of analysis in one problem area is applied to another field. The risk of a mechanical application, however, is that the institutional structure of the two problem areas is so different that no real insights are gained. What are the facts here?

Controversy over the implications of debt and the rationale belying capital structure has seemingly come to rest upon a plateau defined by Miller's equilibrium analysis of aggregate corporate debt [10]. In “Debt and Taxes,” Miller reasserts his contention that whether capital is obtained through debt or equity has no bearing on the market value of the firm and is, therefore, irrelevant--a notion which has long been accepted with some reluctance by the finance academe. When the Modigliani-Miller model was first offered some 20 years ago [11], it was accompanied by a set of assumptions which portrayed the world of corporate finance in such malleable terms as to make the irrelevancy propositions palatable. Adaptation of this theoretical model (by its originators) to its secular counterpart through the imposition of corporate taxes [12] brought about a reassuring reversal of the irrelevancy doctrine, but left in its stead the disconcerting prescription to maximize firm value by financing exclusively via debt. Consideration of tax effects at the personal level by Farrar and Selwyn [7] marked the next concession to reality by capital structure theorists. Instead of alienating the original model still further from observed corporate behavior, this step provided a means of reconciling the overwhelming advantage of debt financing at the corporate level with the ultimate after-tax “consumption possibilities” afforded to individual investors. Miller's analysis explains that corporations are forced to “gross up” nominal interest rates to attract bondholders who must be compensated for their personal tax liability [10]. Potential increases in market value due to the taxdeductibility of interest payments are exhausted in the competitive drive toward equilibrium—at which point there are no gains from leverage. The sanctity of the irrelevance theorem thus appears to have been restored at the aggregate level.