Two essays in corporate finance

In the first chapter of my dissertation I study the costs and benefits of resource allocation by firms and by markets. When a firm forms a market closes. Resources that were previously allocated via the price system are now allocated by managerial authority. We explore the choice of organizational form using a model in which agents negotiate prices on behalf of their principals when there is trade in a market. Admitting agency issues into price formation introduces a need for a principal to have the authority to coordinate economic activity. This can be achieved by closing a market and forming a firm. Closing a market, however, results in a loss of information from market prices, information that can be used to reduce the cost of contracting. Hence, when the market is internalized within the firm, information from market prices is lost. Choice of organizational form, a market or a firm, is then determined by the relative value of central authority over agents versus information from market prices. In the second chapter I study the strategic decision of a manager between paying out dividends and repurchasing shares. The predominance of dividends over share repurchases, as a means to distribute cash to shareholders, has been a long-standing puzzle. In this chapter we demonstrate how the co-existence of two monitoring entities, a large shareholder and an outside raider, can explain some of the observed patterns in the usage of dividends and repurchases. While the cost of a dividend is a higher tax rate a share repurchase is costly to the manager because it results in a higher equity concentration and hence more monitoring by the large shareholder. Thus, the manager finds it optimal to pay dividends either during times in which the takeover market is relatively inactive or if the firms equity structure is one which consists of a small group of insiders and a large group of monitoring shareholders. In all other cases the manager optimally switches to a share repurchase