Showing papers in "Journal of Finance in 1991"
TL;DR: A review of the market efficiency literature can be found in this article, where the authors discuss the work that they find most interesting, and offer their views on what we have learned from the research on market efficiency.
Abstract: SEQUELS ARE RARELY AS good as the originals, so I approach this review of the market efficiency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency.
5,506 citations
TL;DR: In this article, a survey of capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations is presented, with a brief overview of the papers surveyed and their relation to each other.
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.
4,404 citations
TL;DR: In this article, the authors used a sample of 1,526 IPOs that went public in the U.S. in the 1975-84 period, and found that in the 3 years after going public these firms significantly underperformed a set of comparable firms matched by size and industry.
Abstract: The underpricing of initial public offerings (IPOs) that has been widely documented appears to be a short-run phenomenon. Issuing firms during 1975-84 substantially underperformed a sample of matching firms from the closing price on the first day of public trading to their three-year anniversaries. There is substantial variation in the underperformance year-to-year and across industries, with companies that went public in high-volume years faring the worst. The patterns are consistent with an IPO market in which (1) investors are periodically overoptimistic about the earnings potential of young growth companies, and (2) firms take advantage of these "windows of opportunity." NUMEROUS STUDIES HAVE DOCUMENTED two anomalies in the pricing of initial public offerings (IPOs) of common stock: (1) the (short-run) underpricing phenomenon, and (2) the "hot issue" market phenomenon. Measured from the offering price to the market price at the end of the first day of trading, IPOs produce an average initial return that has been estimated at 16.4%.1 Furthermore, the extent of this underpricing is highly cyclical, with some periods, lasting many months at a time, in which the average initial return is much higher.2 In this paper, I document a third anomaly: in the long-run, initial public offerings appear to be overpriced. Using a sample of 1,526 IPOs that went public in the U.S. in the 1975-84 period, I find that in the 3 years after going public these firms significantly underperformed a set of comparable firms matched by size and industry.
3,765 citations
TL;DR: In this article, the authors studied the causes and consequences of a security's liquidity, especially the effect of future liquidity on the security's current price-equivalently the effect on its required expected rate of return, its cost of capital.
Abstract: This paper shows that revealing public information to reduce information asymmetry can reduce a firm's cost of capital by attracting increased demand from large investors due to increased liquidity of its securities. Large firms will disclose more information since they benefit most. Disclosure also reduces the risk bearing capacity available through market makers. If initial information asymmetry is large, reducing it will increase the current price of the security. However, the maximum current price occurs with some asymmetry of information: further reduction of information asymmetry accentuates the undesirable effects of exit from market making. THIS PAPER STUDIES THE causes and consequences of a security's liquidity, especially the effect of future liquidity on the security's current price-equivalently the effect on its required expected rate of return, its cost of capital. Under conditions that we identify, reducing information asymmetry reduces the cost of capital. Under other (less typical) conditions, this reduced information asymmetry can have the opposite effect. We use public disclosure of information as the means of changing information asymmetry, but the points are more general. Our model is related to those of Kyle (1985), Glosten and Milgrom (1985), and Admati and Pfleiderer (1988). They assume that there is unlimited risk bearing capacity devoted to market making, which implies that changes in future liquidity never influence a security's cost of capital.1 In contrast, we develop a model of trade in an illiquid market with limited risk bearing capacity of risk-averse market makers and examine the effects of private information on the incentives of market makers to provide risk bearing
3,360 citations
TL;DR: In this paper, the authors evaluate alternative methods for classifying individual trades as market buy or market sell orders using intraday trade and quote data and identify two serious potential problems with this method, namely, that quotes are often recorded ahead of the trade that triggered them and that trades inside the spread are not readily classifiable.
Abstract: This paper evaluates alternative methods for classifying individual trades as market buy or market sell orders using intraday trade and quote data. We document two potential problems with quote-based methods of trade classification: quotes may be recorded ahead of trades that triggered them, and trades inside the spread are not readily classifiable. These problems are analyzed in the context of the interaction between exchange floor agents. We then propose and test relatively simple procedures for improving trade classifications. THE INCREASING AVAILABILITY OF intraday trade and quote data is opening new frontiers for financial market research. The improved ability to discern whether a trade was a buy order or a sell order is of particular importance. In Hasbrouck (1988), the classification of trades as buys or sells is used to test asymmetric-information and inventory-control theories of specialist behavior. In Blume, MacKinlay, and Terker (1989), a buy-sell classification is used to measure order imbalance in tests of breakdowns in the linkage between S&P stocks and non-S&P stocks during the crash of October, 1987. In Harris (1989), an increase in the ratio of buys to sells is used to explain the anomalous behavior of closing prices. In Lee (1990), the imbalance in buy-sell orders is used to measure the market response to an information event. In Holthausen, Leftwich, and Mayers (1987), a buy-sell classification is used to examine the differential effect of buyer-initiated and seller-initiated block trades. Most past studies have classified trades as buys or sells by comparing the trade price to the quote prices in effect at the time of the trade. In this paper, we identify two serious potential problems with this method, namely, that quotes are often recorded ahead of the trade that triggered them, and that
3,301 citations
TL;DR: In this article, the authors examined whether the presence of venture capitalists, as investors in a firm going public, can certify that the offering price of the issue reflects all available and relevant inside information.
Abstract: This paper provides support for the certification role of venture capitalists in initial public offerings. Consistent with the certification hypothesis, a comparison of venture capital backed IPOs with a control sample of nonventure capital backed IPOs from 1983 through 1987 matched as closely as possible by industry and offering size indicates that venture capital backing results in significantly lower initial returns and gross spreads. In effect, the presence of venture capitalists in the issuing firms serves to lower the total costs of going public and to maximize the net proceeds to the offering firm. In addition, we document that venture capitalists retain a significant portion of their holdings in the firm after the IPO. THE ABILITY OF THIRD-PARTY specialists to certify the value of securities issued by relatively unknown firms in capital markets that are characterized by asymmetric information between corporate insiders and public investors has attracted much academic interest in recent years. Several authors, including James (1990), Blackwell, Marr, and Spivey (1990), and Barry, Muscarella, Peavy, and Vetsuypens (1991) have developed and tested models based at least in part on the formal certification hypothesis presented in Booth and Smith (1986). A related body of work, represented by DeAngelo (1981), Beatty and Ritter (1986), Titman and Trueman (1986), Johnson and Miller (1988), Carter (1990), Simon (1990), and Carter and Manaster (1990) has examined how investment bankers and auditors help resolve the asymmetric information inherent in the initial public offering (IPO) process. In this paper we examine whether the presence of venture capitalists, as investors in a firm going public, can certify that the offering price of the issue reflects all available and relevant inside information. We hypothesize that venture capitalists can perform this function; that it will be an economically
2,490 citations
TL;DR: In this article, the interactions of security trades and quote revisions are modeled as a vector autoregressive system and the extent of the information asymmetry is measured as the ultimate price impact of the trade innovation.
Abstract: This paper suggests that the interactions of security trades and quote revisions be modeled as a vector autoregressive system. Within this framework, a trade's information effect may be meaningfully measured as the ultimate price impact of the trade innovation. Estimates for a sample of NYSE issues suggest: a trade's full price impact arrives only with a protracted lag; the impact is a positive and concave function of the trade size; large trades cause the spread to widen; trades occurring in the face of wide spreads have larger price impacts; and, information asymmetries are more significant for smaller firms. CENTRAL TO THE ANALYSIS of market microstructure is the notion that in a market with asymmetrically informed agents, trades convey information and therefore cause a persistent impact on the security price. The magnitude of the price effect for a given trade size is generally held to be a positive function of the proportion of potentially informed traders in the population, the probability that such a trader is in fact informed (i.e., the probability that a private information signal has in fact been observed), and the precision of the private information. The close dependence of the price impact on these factors, which may be referred to as the extent of the information asymmetry, provides a strong motivation for the empirical determination of this impact. This paper strives to achieve such a determination in a framework that is robust to deviations from the assumptions of the formal models. In the process, the framework establishes a rich characterization of the dynamics by which trades and quotes interact. The market considered here is a specialist market in which a designated market-maker exposes bid and ask quotes to the trading public. An extensive theory has evolved that analyzes the market-maker's exposure to traders with superior information.' Concerning the extent of the information asymmetry, this body of theory yields two important empirical predictions: first,
1,800 citations
TL;DR: In this paper, the authors compared cross-sectional differences in returns on Japanese stocks to the underlying behavior of four variables: earnings yield, size, book to market ratio, and cash flow yield.
Abstract: This paper relates cross-sectional differences in returns on Japanese stocks to the underlying behavior of four variables: earnings yield, size, book to market ratio, and cash flow yield. Alternative statistical specifications and various estimation methods are applied to a comprehensive, high-quality data set that extends from 1971 to 1988. The sample includes both manufacturing and nonmanufacturing firms, companies from both sections of the Tokyo Stock Exchange, and also delisted securities. Our findings reveal a significant relationship between these variables and expected returns in the Japanese market. Of the four variables considered, the book to market ratio and cash flow yield have the most significant positive impact on expected returns.
1,597 citations
TL;DR: A positive slope of the yield curve is associated with a future increase in real economic activity: consumption (nondurables plus services), consumer durables, and investment It has extra predictive power over the index of leading indicators, real short-term interest rates, lagged growth in economic activity, and lagged rates of inflation as discussed by the authors.
Abstract: A positive slope of the yield curve is associated with a future increase in real economic activity: consumption (nondurables plus services), consumer durables, and investment It has extra predictive power over the index of leading indicators, real short-term interest rates, lagged growth in economic activity, and lagged rates of inflation It outperforms survey forecasts, both in-sample and out-of-sample Historically, the information in the slope reflected, inter alia, factors that were independent of monetary policy, and thus the slope could have provided useful information both to private investors and to policy makers THE FLATTENING OF THE yield curve in 1988 and its inversion in early 1989 have been interpreted by many business economists and financial analysts as evidence that a recession is imminent Implicit in this interpretation is the presumption that a flattening of the yield curve predicts a drop in future spot interest rates and that these lower rates are associated with a lower level of real GNP Recent empirical work on the term structure of interest rates confirms that changes in the slope of the yield curve predict the correct direction of future changes in spot rates, yet there is little empirical work on the predictability of changes in real economic activity1 Indeed, given the near-random-walk empirical behavior of real GNP, a finding that the yield curve can predict future changes in real output would be very impressive2 Predictability of changes in real output is associated with other equally important questions: How much extra information is there in the term
1,444 citations
TL;DR: In this article, the authors examine the theory that fluctuations in discounts of closed-end funds are driven by changes in individual investor sentiment and find that both closed end funds and small stocks tend to be held by individual investors.
Abstract: This paper examines the proposition that fluctuations in discounts of closed-end funds are driven by changes in individual investor sentiment. The theory implies that discounts on various funds move together, that new funds get started when seasoned funds sell at a premium or a small discount, and that discounts are correlated with prices of other securities affected by the same investor sentiment. The evidence supports these predictions. In particular, we find that both closed-end funds and small stocks tend to be held by individual investors, and that the discounts on closed-end funds narrow when small stocks do well.
1,431 citations
TL;DR: In this article, the authors measured the conditional risk of 17 countries and found that countries' risk exposures help explain differences in performance and that these risk exposures change through time and that the world price of covariance risk is not constant.
Abstract: In a financially integrated global market, the conditionally expected return on a portfolio of securities from a particular country is determined by the country's world risk exposure. This paper measures the conditional risk of 17 countries. The reward per unit of risk is the world price of covariance risk. Although the tests provide evidence on the conditional mean variance efficiency of the benchmark portfolio, the results show that countries' risk exposures help explain differences in performance. Evidence is also presented which indicates that these risk exposures change through time and that the world price of covariance risk is not constant. IN A WORLD WITH increasingly integrated financial services, why do industrialized countries have much different average stock returns? Why have Japanese stocks done so well compared to all other countries through 1989 and so poorly recently? If we view countries as stock portfolios in a global market, asset pricing theory suggests that cross-sectional differences in countries' risk exposures should explain the cross-sectional variation in expected returns. This paper tests whether conditional versions of the Sharpe (1964) and Lintner (1965) asset pricing model are consistent with behavior of returns in 17 countries. Country risk is defined as the conditional sensitivity (or covariance) of the country return to a world stock return. This risk is allowed to vary through time. The reward per unit of sensitivity is the world price of covariance risk. Conditional covariances are calculated for each country. The differences in the countries' conditional covariances should explain the differences in national performance if there is only one source of risk. The empirical results indicate that the time-varying covariances are able to capture some, but not all, of the dynamic behavior of the country returns. This could be due to incomplete market integration, the existence of more than one source of risk, or some other misspecification. The world price of covariance risk is also calculated. This measure exhibits significant time
TL;DR: In this article, a production-based asset pricing model is proposed, which is analogous to the standard consumption-based model, but it uses producers and production functions in the place of consumers and utility functions.
Abstract: This paper describes a production-based asset pricing model. It is analogous to the standard consumption-based model, but it uses producers and production functions in the place of consumers and utility functions. The model ties stock returns to investment returns (marginal rates of transformation) which are inferred from investment data via a production function. The production-based model is used to examine forecasts of stock returns by business-cycle related variables and the association of stock returns with subsequent economic activity. THIS PAPER DESCRIBES A production-based asset pricing model. It is analogous to the standard consumption-based model, but it uses producers and production functions in the place of consumers and utility functions. The production-based model is used to explain two links between stock returns and economic fluctuations that have been the focus of much recent empirical research in finance. These are: 1) a number of variables forecast stock returns, including the term premium, the default premium, lagged returns, dividend-price ratios, and investment; and 2) many of the same variables, and stock returns in particular, forecast measures of economic activity such as investment and GNP growth.1 Since the production-based model is explicitly analogous to the consumption-based model, I start with a review of that model's logic. The consumption-based model ties asset returns to marginal rates of substitution which are inferred from consumption data (or state variables presumed to drive consumption) through a utility function. It is derived from the consumer's first order conditions for optimal intertemporal consumption demand. Its
TL;DR: The role of financial markets in economic development is explored in this article, where a stock market emerges to allocate risk and explores how the stock market alters investment incentives in ways that change steady state growth rates.
Abstract: An extensive literature documents the role of financial markets in economic development. To help explain this relationship, this paper constructs an endogenous growth model in which a stock market emerges to allocate risk and explores how the stock market alters investment incentives in ways that change steady state growth rates. The paper demonstrates that stock markets accelerate growth by (1) facilitating the ability to trade ownership of firms without disrupting the productive processes occurring within firms and (2) allowing agents to diversify portfolios. Tax policy affects growth directly by altering investment incentives and indirectly by changing the incentives underlying financial contracts. AN EXTENSIVE LITERATURE DOCUMENTS and discusses the role of financial markets in economic development.1 In an exhaustive study of three dozen developed and developing countries over the period 1860-1963, Goldsmith (1969) provides evidence of a positive relationship between the ratio of financial institutions' assets to GNP and output per person. Goldsmith also presents data showing "that periods of more rapid economic growth have been accompanied, though not without exception, by an above-average rate of financial development" (p. 48). In addition, Romer (1989) and others have shown, using cross-country data sets that range from 20 to over 100 years, that there exist startling differences in per capita output growth rates with no tendency for these growth rates to converge unconditionally.2 This paper helps explain these observations which have not been previously reconciled within the context of a general equilibrium optimizing model. Along with recent work by Bencivenga and Smith (1991), Greenwald and Stigliz (1989), and Greenwood and Jovanovic (1990), this paper constructs a model that links the financial system with the steady state growth rate of per capita output.3 Specifically, the model extends and links two literatures. The
TL;DR: In this article, the authors discuss some of the methodological issues in detecting chaotic and nonlinear behavior in macroeconomic and financial time series and discuss the key features of deterministic chaotic systems via a number of examples.
Abstract: After the stock market crash of October 19, 1987, interest in nonlinear dynamics, especially deterministic chaotic dynamics, has increased in both the financial press and the academic literature. This has come about because the frequency of large moves in stock markets is greater than would be expected under a normal distribution. There are a number of possible explanations. A popular one is that the stock market is governed by chaotic dynamics. What exactly is chaos and how is it related to nonlinear dynamics? How does one detect chaos? Is there chaos in financial markets? Are there other explanations of the movements of financial prices other than chaos? The purpose of this paper is to explore these issues. CHAOS HAS CAPTURED THE fancy of many macroeconomists and financial economists. The attractiveness of chaotic dynamics is its ability to generate large movements which appear to be random, with greater frequency than linear models. As a result, there has been an explosion of papers searching for chaotic behavior in macroeconomic and financial time series. The purpose of this paper is to discuss some of the methodological issues in detecting chaotic and nonlinear behavior. Section I provides a description of the key features of deterministic chaotic systems via a number of examples. Section II shows how deterministic chaos can, in principle, be detected using the method of correlation dimension proposed by Grassberger and Procaccia (1983). Section III deals with some limitations of this method. The Grassberger/Procaccia method requires a substantial number of data points, which is difficult to obtain in standard economic and financial time series. It also lacks a statistical theory for hypothesis testing. A different but related method has been proposed by Brock, Dechert, and Scheinkman (1987). Under the null hypothesis of independence and identical distribution (IID), the Brock, Dechert, and Scheinkman statistic has been shown to have good finite sample properties and good power against departures from IID. Some Monte Carlo evidence is
TL;DR: For a sample of 704 mergers and tender offers over the period 1972-1987, Huang and Walkling as mentioned in this paper analyzed the relation between takeover gains and the Tobin's q ratios of targets and bidders and showed that the relation is strengthened after controlling for the characteristics of the offer and the contest.
Abstract: This paper analyzes the relation between takeover gains and the q ratios of targets and bidders for a sample of 704 mergers and tender offers over the period 1972-1987 Target, bidder, and total returns are larger when targets have low q ratios and bidders have high q ratios The relation is strengthened after controlling for the characteristics of the offer and the contest This evidence confirms the results of the work by Lang, Stulz, and Walkling and shows that their findings also hold for mergers and after controlling for other determinants of takeover gains IN A RECENT PAPER, Lang, Stulz, and Walkling (LSW) (1989) document that the abnormal returns in tender offers are related to the Tobin's q ratios of the targets and the bidders In particular, they find that target, bidder, and total returns are higher when takeover targets have high q ratios and bidders have low q ratios where one is used as a cutoff point to separate high q firms from low q firms In fact, bidders with high q ratios have significant positive abnormal returns when they engage in a takeover, while bidders with low q ratios have significant negative abnormal returns The best takeovers, in terms of value creation, are those where a high q firm takes over a low q firm The opposite scenario holds for the worst case takeovers—low q firms taking over high q firms If q is interpreted as a measure of managerial performance, these findings imply that better performing firms also make better acquisitions and that more value can be created from taking over poorly performing companies While the results of LSW are insightful, they leave a number of questions unanswered Their sample consists only of tender offers Several studies have documented that the returns to targets in mergers are smaller than those in tender offers (see Jensen and Ruback (1983) and Huang and Walkling (1987)] It would therefore be useful to see whether the LSW (1989) results hold for a larger sample which includes both mergers and tender offers Previous research has also shown that the characteristics of the takeover (hostile versus friendly and single versus multiple bidder), the form of payment (cash versus securities), the time period (before 1968, 1968-1980, 1981, and later), and the relative size of target and bidder are important determinants of the magnitude of takeover gains and their distribution
TL;DR: In this article, a model for pricing American options on jump-diffusion processes with systematic jump risk was derived for the S&P 500 futures options over 1985-1987, showing that out-of-the-money puts became unusually expensive during the year preceding the crash and that implicit distributions were negatively skewed during October 1986 to August 1987.
Abstract: Transactions prices of S&P 500 futures options over 1985-1987 are examined for evidence of expectations prior to October 1987 of an impending stock market crash. First, it is shown that out-of-the-money puts became unusually expensive during the year preceding the crash. Second, a model is derived for pricing American options on jump-diffusion processes with systematic jump risk. The jump-diffusion parameters implicit in options prices indicate that a crash was expected and that implicit distributions were negatively skewed during October 1986 to August 1987. Both approaches indicate no strong crash fears during the 2 months immediately preceding the crash. ATTEMPTS TO EXPLAIN WHAT caused the stock market crashes around the world in October 1987 have suffered from the paucity of major economic developments occurring around that time that could have triggered the crashes. Shifting expectations regarding monetary policy, foreign investors' fears of a dollar decline, increasing riskiness of assets-none of these appeared major enough, if present at all, to explain the magnitude of the crashes. And although portfolio insurance strategies could conceivably magnify the effects of a jump in fundamentals, the initiating jump in fundamentals appears to be lacking.
TL;DR: In this paper, the relation between changes in financial investment opportunities and changes in the macroeconomy was studied and it was shown that the market excess return is negatively correlated with recent economic growth and positively correlated with expected future economic growth.
Abstract: This paper studies the relation between changes in financial investment opportunities and changes in the macroeconomy. States variables such as the lagged production growth rate, the default premium, the term premium, the short-term interest rate and the market dividend-price ratio are shown to be indicators of recent and future economic growth. Further, the market excess return is negatively correlated with recent economic growth and positively correlated with expected future economic growth. These results offer straightforward interpretations of recent evidence on the forecasts of the market excess return by state variable via their forecasts on the macroeconomy.
TL;DR: In this article, the authors examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news and find that a small firm portfolio contains a large proportion of marginal firms-firms with low production efficiency and high financial leverage.
Abstract: We examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news We find that a small firm portfolio contains a large proportion of marginal firms-firms with low production efficiency and high financial leverage We construct two size-matched return indices designed to mimic the return behavior of marginal firms and find that these return indices are important in explaining the time-series return difference between small and large firms Furthermore, risk exposures to these indices are as powerful as log(size) in explaining average returns of size-ranked portfolios WHY DO SMALL CAPITALIZATION stocks earn higher mean returns than large capitalization stocks? One view is that small and large stocks have different sensitivities to the risk factors important for pricing assets (see Chan, Chen, and Hsieh (1985) and Huberman, Kandel, and Karolyi (1987))1 This view emphasizes that the risk differences between small and large stocks arise from the differences in their time series responses to changes in the underlying risk factors Chan, Chen, and Hsieh (1985) find that small firms are more exposed to production risk and changes in the risk premium Huberman, Kandel, and Karolyi (1987) find that returns of firms within the same size range tend to respond to risk factors in similar ways, and their returns tend to move together Although these studies have shown that there are risk differences between small and large firms, they do not suggest why Smallness by itself does not necessarily imply higher risk, and differences in market capitalizations do not explain why small and large firms have different responses to economic news This study suggests that the small firms examined in the empirical litera
TL;DR: Prize Lecture to the memory of Alfred Nobel, December 7, 1990 as discussed by the authors, and this abstract was borrowed from another version of this item, which was published in 1990.
Abstract: Prize Lecture to the memory of Alfred Nobel, December 7, 1990.(This abstract was borrowed from another version of this item.)
TL;DR: In this article, the authors examine the hypothesis that an important role of corporate takeovers is to discipline the top managers of poorly performing target firms and find that turnover rate for the top manager of target firms in tender offer-takeovers significantly increases following completion of the takeover and that prior to the takeover these firms were significantly underperforming other firms in their industry as well as other target firms which had no post-takeover change in the top executive.
Abstract: This paper examines the hypothesis that an important role of corporate takeovers is to discipline the top managers of poorly performing target firms. We document that the turnover rate for the top manager of target firms in tender offer-takeovers significantly increases following completion of the takeover and that prior to the takeover these firms were significantly under-performing other firms in their industry as well as other target firms which had no post-takeover change in the top executive. We interpret the results to indicate that the takeover market plays an important role in controlling the nonvalue maximizing hehavior of top corporate managers.
TL;DR: The authors compare three forms of common stock repurchases: Dutch-auction self-tender offers, open-market share repurchase programs, and fixed-price self-to-buyback offers and show that buyback announcement returns are higher when insider wealth is at risk, following negative net-of-market stock returns, and unrelated to prior market returns.
Abstract: We compare three forms of common stock repurchases. Dutch-auction self-tender offers and open-market share repurchase programs are weaker signals of stock undervaluation than fixed-price self-tender offers. The price increase from buyback announcements is greater when insider wealth is at risk, greater following negative net-of-market stock returns, and unrelated to prior market returns. Buyback announcement returns are also increasing in the fraction of shares sought, which is consistent with both signalling and an upward-sloping supply curve for stock.
TL;DR: In this paper, the authors developed a model in which the dependence of the brokerage commission rate on share price provides an incentive for brokers to produce research reports on firms with low share prices.
Abstract: We develop a model in which the dependence of the brokerage commission rate on share price provides an incentive for brokers to produce research reports on firms with low share prices. Stock splits therefore affect the attention paid to a firm by investment analysts. Managers with favorable private information about their firms have an incentive to split their firm's shares in order to reveal the information to investors. We find empirical evidence that is consistent with the major new prediction of the model, that the number of analysts following a firm is inversely related to its share price.
TL;DR: In this article, the effects of the liquidity of capital assets on their prices were investigated and it was shown that the return on assets should be an increasing function of their illiquidity (other things equal).
Abstract: The efrect8 of aaaet liquidity on expected retuma for __ ts with infinite maturities (&toc:ka) are eumined for bonda(Treuury notes and bills with matched maturities of lellll than 6 months). The yield to maturity ill higher on notes. which have lower liquidity. The yield di1ferential between notes and billa is a decreuing and convex function of the time to maturity. The results provide a robUlt confirmation of the liquidity effect in auet pricing. THIs PAPER STUDIES EMPIRICALLY the effects of the liquidity of capital assets on their prices. Amihud and Mendelson (1986. 1989) proposed that liquidity affects asset prices because investors require a compensation for bearing transaction costs. Transaction costs-paid whenever the asset is traded-form a sequence of cash outflows. The discounted value of this cost stream proxies for the value 1088 due to illiquidity. which lowers the asset's value for any given cash flow that the asset generates. 1 As a result. the return on assets should be an increasing function of their illiquidity (other things equal). For stocks. the illiquidity effect is expected to be strong because their transaction cost sequence is infinite. Amihud and Mendelson (1986, 1989) demonstrated that common stocks with lower liquidity yielded significantly higher average returns, after controlling for risk and for other factors. These results on the importance of liquidity in the pricing of stocks raise additional questions: (i) does the liquidity effect depend on the specific controls used by Amihud and Mendelson (1986, 1989)1 (ii) does illiquidity have a similarly strong effect on the pricing of bonds. whose maturities are finite? and (iii) if liquidity affects bond yields, how is this effect related to the bond's time to maturity?
TL;DR: In this paper, the authors present a model of a financially distressed firm with outstanding bank debt and public debt, and show that Chapter 11 reorganization law increases investment, and characterize the types of corporate financial structures for which this increased investment enhances efficiency.
Abstract: We present a model of a financially distressed firm with outstanding bank debt and public debt. Coordination problems among public debtholders introduce investment inefficiencies in the workout process. In most cases, these inefficiencies are not mitigated by the ability of firms to buy back their public debt with cash and other securities—the only feasible way that firms can restructure their public debt. We show that Chapter 11 reorganization law increases investment, and we characterize the types of corporate financial structures for which this increased investment enhances efficiency. DURING THE LATE 1980S there was a dramatic increase in the leverage of U.S. corporations, raising concerns about the corporate sector's financial stability.^ Indeed, by June 1990, 156 (24%) of the 662 companies that issued high-yield bonds between 1977 and 1988 had either defaulted, gone bankrupt, or restructured their public debt. The face value of these distressed bonds amounts to nearly 21 billion dollars.^ The central question raised by these distressed firms is easy to put but hard to answer: What is the effect of financial distress on a firm's operating performance? There are two competing views. The first, an application of the
TL;DR: In this paper, the authors identify negotiated trades of large-percentage blocks of stock as corporate control transactions and investigate the importance of active block investor's specific managerial expertise and incentives for firm value.
Abstract: We identify negotiated trades of large-percentage blocks of stock as corporate control transactions. When a block trades and the firm is not fully acquired, cumulative abnormal returns average 5.6%, and 33% of the chief executives are replaced within a year. Stock-price increases are larger when control passes to the new blockholder, when management does not resist the blockholder's effort to influence corporate policy, and when the block purchaser eventually fully acquires the firm. These findings suggest that the specific skills and expertise of blockholders, and not just the concentration of ownership, are important determinants of firm value. WE EXAMINE 106 NEGOTIATED trades of at least 5% of the common stock of New York Stock Exchange (NYSE)- and American Stock Exchange (AMEX)listed corporations. Our primary objective is to assess the impact of these transactions on the firms whose shares are traded. We also investigate the importance of active block investor's specific managerial expertise and incentives for firm value. The emerging literature on concentrated ownership focuses on how the level of ownership affects a blockholder's incentives to undertake a variety of corporate decisions. Although it has been recognized that a blockholder's identity also can be important, less attention has been paid to this issue. Several recent, studies, however, provide evidence that blockholders' incentives and expertise are not homogeneous. For example, Holderness and Sheehan (1985) find that the stock market reacts more favorably to initial block accumulations by six controversial investors, who are often portrayed in the press as "raiders," than to initial accumulations by a random sample of investors. Morck, Shleifer, and Vishny (1988) find that firm value tends to be lower when the firm is run by a member of the founder's family than when it is run by an officer unrelated to the founder. Brickley, Lease, and Smith (1988) document that institutional blockholders are less willing to vote against management on antitakeover amendments when they are likely to have business dealings with the firm. When a block trades, the concentration of ownership typically does not change, but the blockholder's identity does
TL;DR: In this article, a stationary portfolio policy is proposed, in which portfolio proportions are allowed to fluctuate with portfolio consumption, in the form of two control barriers between portfolio proportions, and the expected utility is maximized.
Abstract: The presence of any friction in financial markets qualitatively changes the nature of the optimization problem faced by an investor. It requires one to either act or do nothing, an issue which, of course, does not arise in frictionless situations. The investor considered here accumulates wealth without consuming until some terminal point in time when he consumes all. His objective is to maximize the expected utility derived from that terminal consumption. We postpone the terminal point far into the future to obtain a stationary portfolio rule. The portfolio policy is in the form of two control barriers between which portfolio proportions are allowed to fluctuate. We show how to calculate them.
TL;DR: In this paper, the authors examined the losses realized in bank failures during the period 1985 through mid-year 1988, using data from the Federal Deposit Insurance Corporation (FDIC) as the difference between the book value of assets and the recovery value net of the direct expenses associated with the failure.
Abstract: This paper examines the losses realized in bank failures Losses are measured as the difference between the book value of assets and the recovery value net of the direct expenses associated with the failure I find the loss on assets is substantial, averaging 30 percent of the failed bank's assets Direct expenses associated with bank closures average 10 percent of assets An empirical analysis of the determinants of these losses reveals a significant difference in the value of assets retained by the FDIC and similar assets assumed by acquiring banks THE 1980S HAVE WITNESSED an unprecedented number of commercial bank and savings and loan failures For example, between 1982 and year-end 1988, 791 commercial banks failed, more than twice the number of failures that occurred in the previous 40 years1 The magnitude and sources of the losses realized in these and future bank failures have important implications for the adequacy of the deposit insurance fund and the resources of the Resolution Trust Corporation, as well as the efficacy of the policies these agencies use to dispose of a filed institution's assets2 In this paper I examine the losses realized in bank failures during the period 1985 through mid-year 1988 Losses are measured using data from the Federal Deposit Insurance Corporation (FDIC) as the difference between the book value of a bank's assets at the time of its closure and the value of the assets in an FDIC receivership or the value of the assets to an acquirer This measure of loss I refer to as "loss on assets" Losses include expenses incurred in the liquidation and sale of assets, losses associated with forced liquidation including lost charter value (ie, the value of the right to continue to operate) and past unrealized losses (ie, losses on assets that occur prior to the bank's failure but are not reported on the bank's balance sheet at the time of the failure)3
TL;DR: In this article, the authors examined foreign direct investment by studying shareholder wealth gains for 1273 U.S. firms acquired during the period 1970-1987 and found that cross-border takeovers are more frequent in research and development intensive industries than are domestic acquisitions.
Abstract: This paper examines foreign direct investment by studying shareholder wealth gains for 1273 U.S. firms acquired during the period 1970-1987. Three findings stand out. First, cross-border takeovers are more frequent in research and development intensive industries than are domestic acquisitions; furthermore, in three-fourths of cross-border transactions the buyer and seller are in related industries. These industry patterns suggest that costs and imperfections in product markets play an important role in foreign direct investment. Second, targets of foreign buyers have significantly higher wealth gains than do targets of U.S. firms. This cross-border effect is comparable in size to the wealth effects of all-cash and multiple bids, two effects receiving substantial attention in the finance literature, and is robust to inclusion of these two variables. Third, while the cross-border effect on wealth gains is not well explained by industry and tax variables, it is positively related to the weakness of the U.S. dollar, indicating a significant role for exchange rate movements in foreign direct investment.
TL;DR: In this article, the authors studied the informational role of strategic insider trading around corporate dividend announcements based on the efficient equilibrium in a signalling model with endogenous insider trading and found that insider trading immediately prior to the announcement of dividend initiations has significant explanatory power.
Abstract: The informational role of strategic insider trading around corporate dividend announcements is studied based on the efficient equilibrium in a signalling model with endogenous insider trading. Insider trading immediately prior to the announcement of dividend initiations has significant explanatory power. For firms with insider selling prior to the dividend initiation announcement, the excess returns are negative and significantly lower than for the remaining firms (with no insider trading or just insider buying) as implied by our model. Another implication is that dividend increases may elicit a positive or negative stock price response depending on the firm's investment opportunities. THERE IS CONSIDERABLE EMPIRICAL evidence on stock price reaction to the announcement of dividend changes.1 Since the documented evidence suggests that these announcements convey to the market some private information possessed by corporate insiders, signalling models have been used to explain the price reaction. Although recent signalling models have shed some light on important aspects of the announcement effect of dividends, many questions remain. Why should dividend increases be treated always as good news by the market? How do the investment opportunities available to the firm affect the market response to dividend changes?2 Since insiders often have material private information prior to announcements of major dividend changes (e.g., initiation of dividends), how would their own trading activity
TL;DR: In this paper, the authors developed tests of unconditional mean-variance efflciency under weak distributional assumptions using a Generalized Method of Moments framework, which is potentially more robust than commonly employed tests which rely on the assumption that asset returns are normally distributed and temporarily i.i.d.
Abstract: This paper develops tests of unconditional mean-variance efflciency under weak distributional assumptions using a Generalized Method of Moments framework. These tests are potentially more robust than commonly employed tests which rely on the assumption that asset returns are normally distributed and temporarily i.i.d. Using returns for size-based portfolios from 1926 to 1988 we show that the conclusion concerning the mean-variance effilciency of market indexes can be sensitive to the test considered. THE APPLICATION OF MULTIVARIATE statistical techniques in financial economics has become common practice in recent years. Much of the development has been in the area of testing asset pricing models. The assumption that asset returns follow a time invariant multivariate normal distribution permits tests of restrictions on model parameters in a pooled time series-cross-section framework. These tests can be interpreted as tests of the mean-variance efficiency of a portfolio or combination of portfolios. Gibbons (1982), Jobson and Korkie (1982), Stambaugh (1982), Shanken (1985, 1987), Kandel and Stambaugh (1987), MacKinlay (1987), and Gibbons, Ross, and Shanken (1989) are examples of work presenting multivariate tests of the capital asset pricing model.' Connor and Korajczyk (1988) and Lehmann and Modest (1988) present multivariate tests of the arbitrage pricing model; Breeden, Gibbons, and Litzenberger (1989) present multivariate tests of the consumption based CAPM. Although these papers assume the normality of asset returns, little analysis has been conducted to understand the sensitivity of the inferences to violations of this assumption.2'3