Artur Raviv
Alan E. Peterson Professor of Finance
Kellogg School of Management
Northwestern University
2001 Sheridan Road, Evanston, IL 60208
Phone: (847) 491-8342 (office) / Fax: (847) 491-5719
e-mail address:

Working papers:

Control of Corporate Decisions: Shareholders vs. Management
(with Milton Harris)
January 2008

Abstract: Activist shareholders have lately been attempting to assert themselves in a struggle with management and regulators over control of corporate decisions. These efforts have met with mixed success. Meanwhile, shareholders have been pressing for changes in the rules governing access to the corporate proxy process, especially in regard to nominating directors. The key issue which these events have brought to light is whether, in fact, shareholders will be better off with enhanced control over corporate decisions. Proponents of increased shareholder participation argue that such participation is needed to counter the agency problems associated with management decisions. Opponents counter that shareholders lack the requisite knowledge and expertise to make effective decisions or that shareholders may have incentives to make value-reducing decisions. In this paper, we investigate what determines the optimality of shareholder control, taking account of some of the above arguments, both pro and con. Our main contribution is to use formal modeling to uncover some factors overlooked in these arguments. For example, we show that the claims that shareholders should not have control over important decisions because they lack sufficient information to make an informed decision or because they have a non-valuemaximizing agenda are flawed. On the other hand, it has been argued that, since shareholders have the "correct" objective (value maximization) and can always delegate the decision to insiders when they believe insiders will make a better decision, shareholders should control all major decisions. We show that this argument is also flawed.
Publications, published discussions and reviews:

Note: The links point to resources that require subscription to access the full text of the published papers.

A Theory of Board Control and Size
(with Milton Harris)
Review of Financial Studies, forthcoming

Abstract: This paper presents a model of optimal control of corporate boards of directors. We determine when one would expect inside versus outside directors to control the board, when the controlling party will delegate decision-making to the other party, the extent of communication between the parties, and the number of outside directors. We show that shareholders can sometimes be better off with an insider-controlled board. We derive endogenous relationships among profits, board control, and the number of outside directors that call into question the usual interpretation of some documented empirical regularities.

Allocation of Decision-Making Authority
(with Milton Harris)
Review of Finance, 2005, 9(3): 353-383

Abstract: This paper addresses the question of what determines where in a firm's hierarchy investment decisions are made. We present a simple model of a CEO and a division manager to analyze when the CEO will choose to allocate decision-making authority over an investment decision to a division manager. Both the CEO and thedivision manager have private information regarding the profit maximizing investment level. Because the division manager is assumed to have a preference for "empire", neither manager will communicate her information fully to the other. We show that the probability of delegation increases with the importance of the division manager's information and decreases with the importance of the CEO's information. A somewhat counterintuitive result is that, in some circumstances, increases in agency problems result in increased willingness of the CEO to delegate the decision. We also characterize situations in which the CEO prefers to commit to an allocation of authority ex ante, instead of deciding based on her private information.Finally, even though the division manager is biased toward larger investments, we show that under certainconditions, the average investment will be smaller when the decision is delegated. These results help explain some findings in the empirical literature. A number of other empirical implications are developed.

Organization Design
(with Milton Harris)
Management Science, July 2002, 48(7): 852-865

Abstract: This paper attempts to explain organization structure based on optimal coordination of interactions among activities. The main idea is that each manager is capable of detecting and coordinating interactions only within his limited area of expertise. Only the CEO can coordinate company wide interactions. The optimal design of the organization trades off the costs and benefits of various configurations of managers. Our results consist of classifying the characteristics of activities and managerial costs that lead to the matrix organization, the functional hierarchy, the divisional hierarchy, or a fiat hierarchy. We also investigate the effect of changing the costs of various managers on the nature of the optimal organization, including the extent of centralization.

Capital Budgeting and Delegation
(with Milton Harris)
Journal of Financial Economics, December 1998, 50(3): 259-289

Abstract: As part of our ongoing research into capital budgeting processes as responses to decentralized information and incentive problems, we focus in this paper on when a level of a managerial hierarchy will delegate the allocation of capital across projects and time to the level below it. In our model, delegation is a way to save on costly investigation of proposed projects. Therefore, it is more extensive the larger are the costs of such investigations. This delegation takes advantage of the fact that the lower-level manager's preferences are assumed to be similar (though not identical) to those of the higher level.

The Capital Budgeting Process: Incentives and Information
(with Milton Harris)
Journal of Finance, September 1996, 51(4): 1139-1174

Abstract: We study the capital allocation process within firms. Observed budgeting processes are explained as a response to decentralized information and incentive problems. It is shown that these imperfections can result in underinvestment when capital productivity is high and overinvestment when it is low. We also investigate how the budgeting process may be expected to vary with firm or division characteristics such as investment opportunities and the technology for information transfer.

The Role of Games in Security Design
(with Milton Harris)
Review of Financial Studies, Summer 1995, 8(2): 327-367

Abstract: We contend that security design should be approached as a problem of game design. That is, contracts should specify that procedures that govern the behavior of contract participants in determining outcomes as well as the allocations resulting from those outcomes. We characterize optimal contracts in two nested classes: all contracts (including those that depend on the state) and state-independent contracts. We demonstrate that, in situations in which the dependence of contracts on the state is limited, contracts designed as games can improve the allocation of resources relative to nonstrategic allocation rules.

Differences of Opinion Make a Horse Race
(with Milton Harris)
Review of Financial Studies, Fall 1993, 6(3): 473-506

Abstract: A model of trading in speculative markets is based on differences of opinion among traders. Our purpose is to explain some of the empirical regularities that have been documented concerning the relationship between volume and price and the time-series properties of price and volume. We assume that traders share common prior beliefs and receive common information but differ in the way in which they interpret this information. Some results are that absolute price changes and volume are positively correlated, consecutive price changes exhibit negative serial correlation, and volume is positively autocorrelated.

Financial Contracting Theory
(with Milton Harris)
Laffont, Jean-Jacques, editor (1992). Advances in Economic Theory, Sixth World Congress, Vol. II, Cambridge: Cambridge University Press, pp. 64-150.

The Theory of Capital Structure
(with Milton Harris)
Journal of Finance (Golden Anniversary Review Article), March 1991, 46(1): 297-355
Errata: The Theory of Capital Structure, Journal of Finance, September 1992, 47(4): 1659.
Reprinted in Keasey, Kevin, Steve Thompson and Mike Wright, editors (1999). Corporate Governance International Library of Critical Writings in Economics, vol. 106, Cheltenham, U.K. and Northampton, Mass.: Edward Elgar, pp. 268-326.

Abstract: This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax-based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided.

Capital Structure and the Informational Role of Debt
(with Milton Harris)
Journal of Finance, March 1990, 45(2): 321-349

Abstract: This paper provides a theory of capital structure based on the effect of debt on investors' information about the firm and on their ability to oversee management. We postulate that managers are reluctant to relinquish control and unwilling to provide information that could result in such an outcome. Debt is a disciplining device because default allows creditors the option to force the firm into liquidation and generates information useful to investors. We characterize the time path of the debt level and obtain comparative statics results on the debt level, bond yield, probability of default, probability of reorganization, etc.

The Design of Securities
(with Milton Harris)
Journal of Financial Economics, November 1989, 24(2): 255-287
Reprinted in Brennan, Michael J. (1996), The Theory of Corporate Finance, International Library of Critical Writings in Financial Economics, vol. 1, Cheltenham, U.K.: Edward Elgar, pp. 387-419.

Abstract: This paper investigates the determinants of security design. We consider the assignment of both cash flows and voting rights, focusing on corporate control. We postulate that a conflict of interest exists between contestants for control and outside investors. The conflict arises because private benefits of control give contestants an incentive to acquire control even when this reduces firm value. Security design is a tool for resolving these conflicts and maximizing firm value. Our main result is that a single voting security is optimal.

Alternative Models of Investment Banking
Bhattacharya, Sudipto and George M. Constantinides, editors (1989). Financial Markets and Incomplete Information: Frontiers of Financial Theory, vol. 2, Totowa, New Jersey: Rowman and Littlefield, pp. 225-232.

Corporate Control Contests and Capital Structure
(with Milton Harris)
Journal of Financial Economics, 1988, 20(1): 55-86

Abstract: This paper explores the determinants of corporate takeover methods (proxy fights versus tender offers) and their outcomes and price effects. We focus on the effect of leverage on the takeover method and outcome. The model predicts, for example, that the target's stock price appreciates less following a successful proxy contest than in a successful tender offer. In addition, we obtain several other results on price effects and on the capital structure changes that accompany contests for corporate control. Some of our results are compared with the existing empirical evidence.

Corporate Governance. Voting Rights and Majority Rules
(with Milton Harris)
Journal of Financial Economics, 1988, 20(1): 203-235

Abstract: In this paper, we derive conditions under which the simple majority voting rule for electing controlling management and one share-one vote constitute a socially optimal corporate governance rule. We also show that other majority rules and/or multiple classes of shares are not socially optimal. Finally we show that an entrepreneur would choose to issue two securities, one with only cash flow claims and no votes and one with only votes and no cash flow claims, if this were allowed. This scheme, regardless of the majority rule adopted, is not socially optimal.

A Sequential Signalling Model of Convertible Debt Call Policy
(with Milton Harris)
Journal of Finance, December 1985, 40(5): 1263-1281

Abstract: In this paper we attempt to resolve two puzzles concerning convertible debt calls. The first is that although it has been shown that conversion of these bonds should optimally be forced as soon as this is feasible, actual calls are significantly delayed relative to this prescription. The second is that common stock returns are significantly negative around the announcement of the call of a convertible debt issue. Our purpose is to simultaneously rationalize managers' observed call decisions and the market's reaction to them in a framework in which managers behave optimally given their private information, compensation schemes, and investors' reactions to their call decisions. Moreover, investors' reactions are rational in the sense of Bayes' rule given managers' call policy. In equilibrium, a decision to call is (correctly) perceived by the market as a signal of unfavorable private information. In addition to rationalizing observed call delays and negative stock returns at call announcement, several other testable implications are derived.

Underpricing of Seasoned Issues
(with John E. Parsons)
Journal of Financial Economics, September 1985, 14(3): 377-397

Abstract: In this paper we provide a model of the underwritten offerings of new shares of seasoned securities. Our purpose is to explain why the offering price chosen by the underwriter is lower than the market price of the firm's shares. Our model recognizes the interdependence between the markets surrounding the announcement and sale of the new issue and recognizes as well the effect which asymmetric information regarding investor demands has upon the prices in these markets.

Management Compensation and the Managerial Labor Market. An Overview
Journal of Accounting and Economics, April 1985, 7(1-3): 239-245

Comments on "Economic Foundations for Pricing"
Journal of Business, January 1984, 57(1), Part 2: S35-S38

Asymmetric Information, Incentives and Intrafirm Resource Allocation
(with Milton Harris and Charles H. Kriebel)
Management Science, June 1982, 28(6): 604-620

Abstract: This paper considers the question: How should a firm allocate a resource among divisions when the productivity of the resource in each division is known only to the division manager? Obviously if the divisions (as represented by their managers) are indifferent among various allocations of the resource, the headquarters can simply request the division managers to reveal their private information on productivity knowing that the managers have no incentive to lie. The resource allocation problem can then be solved under complete (or at least symmetric) information. This aspect is a flaw in much of the recent literature on this topic, i.e., there is nothing in the models considered which makes divisions prefer one allocation over another. Thus, although in some cases elaborate allocation schemes are proposed and analyzed, they are really unnecessary. In the model we develop, a division can produce the same output with less managerial effort if it is allocated more resources, and effort is costly to the manager. We further assume that this effort is unobservable by the headquarters, so that it cannot infer divisional productivity from data on divisional output and managerial effort. Given these assumptions, we seek an optimal resource allocation process. Our results show that certain types of transfer pricing schemes are optimal. In particular, if there are no potentially binding capacity constraints on production of the resource, then an optimal process is for each division to choose a transfer price from a schedule announced by the headquarters. Division managers receive a fixed compensation minus the cost of the resource allocated to them at the chosen transfer price. Resources are allocated on the basis of the chosen transfer prices. If there is a potentially binding constraint on resource production, a somewhat more complicated, but similar, scheme is require.

Applications of a Productivity Model for Computer Systems
(with Charles H. Kriebel)
Decision Science, April 1982, 13(2): 266-284

Abstract: The performance evaluation of computer systems as they impact on final user requirements for services is a complex task. A management-oriented approach to the issue based on conventional economic theory was described in a previous report as an outgrowth of a joint university-industry research project. In this sequel we report our experience in estimating, testing, and applying this conceptual model.

A Theory of Monopoly Pricing Schemes with Demand Uncertainty
(with Milton Harris)
American Economic Review, June 1981, 71(3): 347-365

Allocation Mechanisms and the Design of Auctions
(with Milton Harris)
Econometrica, November 1981, 49(6): 1477-1499

Abstract: Recent advances in optimal mechanism design are used to show that a certain type of auction, similar to the "open English auction," is an optimal mechanism in a certain class of environments.

An Economics Approach to Modeling the Productivity of Computer Systems
(with Charles H. Krehbiel)
Management Science, March 1980, 26(3): 297-311.

Abstract: The problem of linking computing and information services to end user needs for performance evaluation has been a long standing issue in the systems literature. A joint university-industry research project was begun in 1975 to better understand the problem. The specific goals of the project have been: (1) to develop a theory or conceptual framework for productivity measurement of the computing and information services function, (2) to pilot test the theory through empirical analysis at field sites, and (3) to evaluate the results and report the conclusions (success and failure). This paper is addressed to the first of these goals; the empirical tests and experience based on the framework are reported in a sequel paper. Our approach to modeling the productivity of computer systems is based on conventional economic theory and empirical analysis. The economics paradigm is to view the organization as a marketplace for computing and information services which contains elements of supply and demand. In this paper our concern centers on the supply of services. A model of the production process for computing services available within an organization is developed which quantitatively relates input resources and output products or services; the model also incorporates output quality as an integral function of the relevant variables in the process. Various measures of production efficiency are defined based on this model. The productivity of a computer system is defined in terms of these measures and we discuss their application for administrative decisions in performance evaluation.

The Demand for Automated Bibliographic Systems: A Diffusion Model
(with L, Lave and S. Leinhardt)
Dordick, Herbert S., editor (1979), Sixth Annual Telecommunications Policy Research Conference, Lexington Books, pp. 329-344

Product Reliability and Market Structure
(with Dennis Epple)
Southern Economic Journal, July 1979, 46(1): 280-287

Optimal Incentive Contracts with Imperfect Information
(with Milton Harris)
Journal of Economic Theory, April 1979, 20(2): 231-259

The Design of an Optimal Insurance Policy
American Economic Review, March 1979, 69(1): 84-96
Reprinted in Dionne, Georges and Scott E. harrington, editors (1991). Foundations of Insurance Economics: Readings in Economics and Finance, Huebner International Series on Risk, Insurance and Economic Security. Berlin: Springer, pp. 251-263

Product Safety: Liability Rules, Market Structure, and Imperfect Information
(with Dennis Epple)
American Economic Review, March 1978, 68(1): 84-95

Some Results on Incentive Contracts with Applications to Education and Employment, Health Insurance, and Law Enforcement
(with Milton Harris)
American Economic Review, March 1978, 68(1): 20-30

Investment Banking: An Economic Analysis of Optimal Underwriting Contracts
(with Gershon Mandelker)
Journal of Finance, June 1977, 32(3): 683-694

Durability of Capital Goods: Taxes and Market Structure
(with Eitan Zemel)
Econometrica, April 1977, 45(3): 703-718.

Abstract: This paper examines the durability of capital goods produced under different market structures when tax considerations are included. Since investment tax credit and depreciation allowances are realized by the owner of the durable good, the durability of products produced by an industry which sells its output differs from that of an industry which rents. For each of these two commercial forms we consider both monopolistic and competitive market structure. Potential gains from different forms of regulation are discussed.

Maintenance policies when failure distribution of equipment is only partially known
(with Z. Kander)
Naval Research Logistics Quarterly, September 1974, 21(3): 419-429.

Abstract: An optimal schedule for checking an equipment subject to failure which can be detected by inspection only, is derived. Increasing failure rate and one percentile specify the otherwise unknown life distribution. Dynamic programming methodology yields the solution which minimizes the maximum expected cost. Numerical examples are presented and compared with models employing differing amounts of knowledge.

Discussion of "Transmission Planning Using Discrete Dynamic Optimizing"
IEEE Transactions on Power Apparatus and Systems, July 1973, PAS-92(4): 1369-1370.

Raviv's home page
Finance Department
Kellogg School of Management
Northwestern University