Showing papers in "The Journal of Business in 2005"
TL;DR: In this article, a two-factor model with time-varying betas that accommodates various degrees of market integration is used to examine contagion during crisis periods and measure the proportion of volatility driven by global, regional, and local factors.
Abstract: Contagion is usually defined as correlation between markets in excess of that implied by economic fundamentals; however, there is considerable disagreement regarding the definition of the fundamentals, how they might differ across countries, and the mechanisms that link them to asset returns. Our research starts with a two-factor model with time-varying betas that accommodates various degrees of market integration. We apply this model to stock returns in three different regions: Europe, Southeast Asia, and Latin America. In addition to examining contagion during crisis periods, we document time variation in world and regional market integration and measure the proportion of volatility driven by global, regional, and local factors.
896 citations
TL;DR: In this article, the link between asset valuation and investor sentiment is investigated and it is shown that market pricing errors implied by an independent valuation model are positively related to sentiment, while future returns over multi-year horizons are negatively related with sentiment, and the results are robust to the inclusion of other variables that have been shown to forecast stock returns.
Abstract: The link between asset valuation and investor sentiment is the subject of considerable debate in the profession. If excessive optimism drives prices above intrinsic values, periods of high sentiment should be followed by low returns, as market prices revert to fundamental values. Using survey data on investor sentiment, we provide evidence that sentiment affects asset valuation. Market pricing errors implied by an independent valuation model are positively related to sentiment. Future returns over multiyear horizons are negatively related to sentiment. These results are robust to the inclusion of other variables that have been shown to forecast stock returns.
772 citations
TL;DR: In this paper, the authors examined the relationship between default and recovery rates on credit assets and empirically explained this critical relationship, finding that recovery rates are a function of supply and demand for the securities, with default rates playing a pivotal role.
Abstract: This paper analyzes the association between default and recovery rates on credit assets and seeks to empirically explain this critical relationship. We examine recovery rates on corporate bond defaults over the period 1982–2002. Our econometric univariate and multivariate models explain a significant portion of the variance in bond recovery rates aggregated across seniority and collateral levels. We find that recovery rates are a function of supply and demand for the securities, with default rates playing a pivotal role. Our results have important implications for credit risk models and for the procyclicality effects of the New Basel Capital Accord.
564 citations
TL;DR: In this article, the authors analyze mutual fund flows over the last 30 years and find negative relations between flows and front-end load fees and find no relation between operating expenses and flows.
Abstract: We argue that the purchase decisions of mutual fund investors are influenced by salient, attention‐grabbing information. Investors are more sensitive to salient, in‐your‐face fees, like front‐end loads and commissions, than operating expenses; they buy funds that attract their attention through exceptional performance, marketing, or advertising. We analyze mutual fund flows over the last 30 years and find negative relations between flows and front‐end‐load fees. In contrast, we find no relation between operating expenses and flows. Additional analyses indicate that marketing and advertising, the costs of which are often embedded in funds' operating expenses, account for this surprising result.
522 citations
TL;DR: The authors decompose diversification benefits into two parts: one component due to variation in the average correlation across markets, and another part due to the variation in investment opportunity set, and infer that periods of globalization have both benefits and drawbacks for international investors.
Abstract: The correlation structure of the world equity markets varied considerably over the past 150 years and was high during periods of economic integration. We decompose diversification benefits into two parts: one component due to variation in the average correlation across markets, and a another component due to the variation in the investment opportunity set. From this, we infer that periods of globalization have both benefits and drawbacks for international investors. Globalization expands the opportunity set, but as a result, the benefits from diversification rely increasingly on investment in emerging markets.
503 citations
TL;DR: This paper examined the hypothesis that business groups facilitate mutual insurance among affiliated firms and found substantial evidence of risk sharing by Japanese, Korean, and Thai groups but little evidence of it elsewhere, and no correlation between measures of capital market development and the nature of the legal system.
Abstract: We examine the hypothesis that business groups facilitate mutual insurance among affiliated firms and find substantial evidence of risk sharing by Japanese, Korean, and Thai groups but little evidence of it elsewhere. We also find no correlation between measures of capital market development and the nature of the legal system, on the one hand, and the extent of risk sharing provided by business groups, on the other. The popular view that risk sharing in business groups is important is not validated by our analysis; other reasons are more likely to explain the ubiquity of business groups around the world.
431 citations
TL;DR: In this article, the authors examine the information embedded in the stock and option markets prior to takeover announcements and find that call-volume imbalances are strongly related to next-day stock returns.
Abstract: Which market attracts informed investors prior to extreme informational events? We examine the information embedded in the stock and option markets prior to takeover announcements. Normally, buyer‐seller initiated stock volume imbalances are predictors of next‐day stock returns and option volume is uninformative. However, prior to takeover announcements, call‐volume imbalances are strongly related to next‐day stock returns. Cross‐sectional analysis shows that takeover targets with the largest preannouncement call‐imbalance increases experience the highest announcement‐day returns. These findings suggest that, with pending extreme informational events, the options market plays an important role in price discovery.
301 citations
TL;DR: In this paper, the authors analyzed 1,493 first-time director appointments to Fortune 1000 boards, during 1997-99, to investigate whether certain outside directors are better than others, concluding that CEOs are sought as outside directors to enhance firm value.
Abstract: I analyze 1,493 first‐time director appointments to Fortune 1000 boards, during 1997–99, to investigate whether certain outside directors are better than others. Reactions to director appointments are higher when appointees are CEOs of other companies than when they are not. CEOs are more likely to obtain outside directorships when the companies they head perform well. Well‐performing CEOs are also more likely to gain directorships in organizations with growth opportunities. Because, for these firms, a large portion of their value hinges upon realizing their growth potential, I conclude that CEOs are sought as outside directors to enhance firm value.
290 citations
TL;DR: In this article, the authors show that, after controlling for the well-known nonlinear patterns in the behavior of earnings, dividend changes contain no information about future earnings changes and also show that dividend changes are negatively correlated with future changes in profitability (return on assets).
Abstract: One of the most important predictions of the dividend‐signaling hypothesis is that dividend changes are positively correlated with future changes in profitability and earnings. Contrary to this prediction, we show that, after controlling for the well‐known nonlinear patterns in the behavior of earnings, dividend changes contain no information about future earnings changes. We also show that dividend changes are negatively correlated with future changes in profitability (return on assets). Finally, we investigate whether including dividend changes improves out‐of‐sample earnings forecasts. We find that models that include dividend changes do not outperform those that do not include dividend changes.
251 citations
TL;DR: In this article, the authors employed the portfolio holdings of 268 U.K. equity mutual funds to test the accuracy of the Lakonishok, Shleifer, and Vishny (1992) measure of herding.
Abstract: The portfolio holdings of 268 U.K. equity mutual funds are employed to test the accuracy of the Lakonishok, Shleifer, and Vishny (1992) measure of herding and test for herding among U.K. mutual fund managers. After adjusting for the biases in the LSV herding measure, the results reveal the existence of a modest amount of fund manager herding in the largest and smallest individual U.K. stocks but little herding in other stocks or stocks aggregated by industry. Contrary to previous U.S. results, we find that U.K. mutual fund managers tend to herd out of large stocks after high excess returns.
228 citations
TL;DR: In this article, the effect of board composition on the restructuring activities of a sample of 94 firms that experienced a material decline in performance was examined and it was shown that firms with a majority of outside directors on the board are more likely to initiate asset restructuring and employee layoffs.
Abstract: We examine the effect of board composition on the restructuring activities of a sample of 94 firms that experienced a material decline in performance. We document that firms with a majority of outside directors on the board are more likely to initiate asset restructuring and employee layoffs and that the reduction in the scale of operations is larger for these firms than firms without a majority of outside directors. We also find subsequent improvements in operating performance for firms with a majority of outside directors that restructure and conclude that board composition has a material impact on corporate performance.
TL;DR: The authors examined the impact of personal wealth on small business loan turndowns across demographic groups and found that greater personal wealth is associated with a lower probability of loan denial, even after controlling for personal wealth.
Abstract: We examine the impact of personal wealth on small business loan turndowns across demographic groups. Information on home ownership, home equity, and personal net worth, in combination with a rich set of explanatory variables, furthers our understanding of the credit market experiences of small businesses across demographic groups. We find substantial unexplained differences in denial rates between African‐American‐, Hispanic‐, Asian‐, and white‐owned firms. We find that greater personal wealth is associated with a lower probability of loan denial. However, even after controlling for personal wealth, large differences in denial rates across demographic groups remain.
TL;DR: In this article, the authors argue that the existence of a credit derivatives market may cause entrepreneurs to issue sub-investment grade bonds instead and engage in second-best behavior, which can therefore cause disintermediation and thus reduce welfare.
Abstract: The credit derivatives market provides a liquid but opaque forum for secondary market trading of banking assets I show that, when entrepreneurs rely on the certification value of bank debt to obtain cheap bond market finance, the existence of a credit derivatives market may cause them to issue sub-investment grade bonds instead and engage in second-best behavior Credit derivatives can therefore cause disintermediation and thus reduce welfare I argue that this effect can be most effectively countered by the introduction of reporting requirements for credit derivatives
TL;DR: In this paper, the determinants of the patterns of banks' foreign investment using a unique database of 260 large banks from OECD countries were investigated, and they found that high integration between the home and destination countries affects the location choice.
Abstract: This paper investigates the determinants of the patterns of banks' foreign investment using a unique database of 260 large banks from OECD countries. Consistent with previous research, we find that high integration between the home and destination countries affects the location choice. However, institutional characteristics and measures of potential profit opportunities in the destination countries are more important than economic integration; they affect differently the decision between opening a branch or acquiring a subsidiary. Profit opportunities are a key factor especially affecting subsidiaries, so are lower regulatory restrictions. On the other hand, financial centers attract branches but not subsidiaries.
TL;DR: In this paper, a model of portfolio choice and stock trading volume with loss-averse investors is presented, and the model generates a positive correlation between trading volume and stock return volatility but suggests that this relationship is nonlinear.
Abstract: We present a model of portfolio choice and stock trading volume with loss‐averse investors. The demand function for risky assets is discontinuous and nonmonotonic: As wealth rises beyond a threshold, investors follow a generalized portfolio insurance strategy, which is consistent with the disposition effect. In addition, loss‐averse investors hold no stocks unless the equity premium is quite high. The elasticity of the aggregate demand curve changes substantially, depending on the distribution of wealth across investors. In an equilibrium setting, the model generates positive correlation between trading volume and stock return volatility but suggests that this relationship is nonlinear.
TL;DR: The authors examined the diffusion of credit scoring models for small business lending using data for large banking organizations, and found that organizations with fewer separately chartered banks but more branches innovate earlier than those located in the New York Federal Reserve district.
Abstract: Financial innovation has been described as the “life blood of efficient and responsive capital markets.” Yet, few quantitative investigations have studied financial innovations and the diffusion of these new technologies. In this paper, we examine the diffusion of one such technology: credit scoring models for small business lending. Using data for large banking organizations, our hazard model indicates that banking firms with more branches innovate earlier, as do those located in the New York Federal Reserve district. Our Tobit model confirms these results and finds that organizations with fewer separately chartered banks but more branches innovate earlier.
TL;DR: In this article, the authors investigate the effect of a change in a company's CEO on stock price volatility and find significant, long-lived increases in volatility following CEO turnover after controlling for firm characteristics and marketwide volatility.
Abstract: This study investigates the effect on stock‐price volatility of a significant event in the life of the firm, a change in its CEO. We find significant, long‐lived increases in volatility following CEO turnover after controlling for firm characteristics and marketwide volatility. These increases are larger after forced departures and outside successions following voluntary departures. Stock prices also respond more strongly to earnings announcements following turnovers. These results are consistent with more informative signals of value driving the increased volatility, helping resolve two sources of uncertainty: possible changes in the firm's strategy and doubt about the successor CEO's ability.
TL;DR: In this article, the authors provide a direct estimate of the magnitude of agency costs in publicly held corporations and compute an explicit performance benchmark that compares a firm's actual Tobin's Q to the Q* of a hypothetical value-maximizing firm having the same inputs and characteristics as the original firm.
Abstract: We provide a direct estimate of the magnitude of agency costs in publicly held corporations. We compute an explicit performance benchmark that compares a firm's actual Tobin's Q to the Q* of a hypothetical value‐maximizing firm having the same inputs and characteristics as the original firm. The Q of the average sample firm is around 16% below its Q*, equivalent to a $1,432 million reduction in its potential market value. We relate the shortfall to the incentives provided CEOs. Boards appear to grant CEOs too few shares and too many options that are insufficiently sensitive to firm risk.
TL;DR: The authors study firms adopting stock-option plans for outside directors in a sample of Fortune 1000 firms from 1997 to 1999, and conclude that such stockoption plans help align the incentives of outside directors and shareholders, thereby improving firm value.
Abstract: We study firms adopting stock‐option plans for outside directors in a sample of Fortune 1000 firms from 1997 to 1999. Fixed‐effects models accounting for self‐selectivity bias indicate that companies with such plans have higher market‐to‐book ratios and profitability metrics. Option plan adoptions generate positive cumulative abnormal returns (CARs) and favorable revisions in analysts' earnings forecasts. Outside director appointments produce CARs close to zero for firms with option plans but significantly negative CARs for firms without them. We conclude that such stock‐option plans help align the incentives of outside directors and shareholders, thereby improving firm value.
TL;DR: This article found that the initial Internet bank startups tended to underperform branching bank startups and suggested that Internet-only business models were not economically viable for banks, however, firms that pioneer new business models may benefit substantially from experience as they grow older, and firms that use automated production technologies may benefit from scale effects as they grows larger.
Abstract: The initial Internet bank startups tended to underperform branching bank startups This suggested that Internet‐only business models were not economically viable for banks However, firms that pioneer new business models may benefit substantially from experience as they grow older, and firms that use automated production technologies may benefit from scale effects as they grow larger Econometric analysis of Internet‐only bank startups finds strong evidence of the latter, but not the former, effect The results suggest that Internet‐only banking success depends on attaining sufficient scale and strong management practices
TL;DR: In this paper, the authors consider a market similar to the auction that the NYSE uses to open the trading day and compare equilibria and find that traders who demand liquidity are better off when the limit order book is open while liquidity suppliers are better than when the book is closed.
Abstract: The NYSE opened the limit‐order book to off‐exchange traders during trading hours. We address the welfare implications of this change in market structure. We model a market similar to the auction that the exchange uses to open the trading day. We consider two different environments. In the first, only the specialist sees the limit‐order book, while in the second the information in the book is available to all traders. We compare equilibria and find that traders who demand liquidity are better off when the book is open while liquidity suppliers are better off when the book is closed.
TL;DR: In this article, the authors study institutional herding in Japan and find that herding occurs on a lower level than in the United States but with a large impact on price movements.
Abstract: We study institutional herding in Japan. Japanese firms are primarily owned by financial institutions and other corporations, they may belong to a business group (the keiretsu), and they have experienced several distinct economic regimes in its recent past. Overall, we find herding in Japan occurs on a lower level than in the United States but with a large impact on price movements. The price impact is even greater for keiretsu-affiliated firms. We also find the effects and behavior of institutional herding depends on the economic condition and the regulatory environment.
TL;DR: In this article, the authors examine the determinants of biotech-pharmaceutical alliance prices to determine whether the market for alliances is characterized by asymmetric information, and they find that inexperienced companies receive substantially discounted payments when forming their first alliance.
Abstract: We examine the determinants of biotech‐pharmaceutical alliance prices to determine whether the market for alliances is characterized by asymmetric information. We find that inexperienced biotech companies receive substantially discounted payments when forming their first alliance. A jointly developed drug is more likely to advance in clinical trials than a drug developed by a single company, so the first‐deal discount is not consistent with the drug's subsequent performance. Biotech companies receive substantially higher valuations from venture capitalists and the public equity market after forming their first alliance, which implies that alliances send a positive signal to prospective investors.
TL;DR: The authors examined the link between equity risk premiums and demographic changes using a long sample for the United States, Japan, United Kingdom, Germany, and France and a shorter sample for 15 countries.
Abstract: We examine the link between equity risk premiums and demographic changes using a long sample for the United States, Japan, United Kingdom, Germany, and France and a shorter sample for 15 countries. We find demographic variables significantly predict excess returns internationally. However, the demographic predictability previously found in the United States for the average population age does not extend to other countries. Pooling international data, we find, on average, faster growth in the fraction of retired persons significantly decreases risk premiums. This demographic predictability of premiums is strongest in countries with well‐developed social security systems and lesser‐developed financial markets.
TL;DR: This article examined the effect of financial flexibility and the level and certainty of operating performance on the choice to change dividends, pay special dividends, and repurchase shares, finding that firms that increase payouts exhibit positive concurrent income shocks and decreases in income volatility, but there is limited evidence of subsequent performance improvements.
Abstract: This study examines the effect of financial flexibility and the level and certainty of operating performance on the choice to change dividends, pay special dividends, and repurchase shares Firms that increase payouts have excess financial flexibility and exhibit positive concurrent income shocks and decreases in income volatility, but there is limited evidence of subsequent performance improvements The results are opposite for firms that cut dividends Thus, the decision to alter payout levels appears to convey information about contemporaneous income and changes in operating risk
TL;DR: In this paper, a simulation experiment was conducted to evaluate a maximum likelihood method applicable to the problem of estimating the value and risk of a firm's assets, neither of which is directly observable.
Abstract: A difficulty that arises when implementing structural bond pricing models is the estimation of the value and risk of the firm's assets, neither of which is directly observable. We perform a simulation experiment to evaluate a maximum likelihood method applicable to this problem. Contrasting the performance of the maximum likelihood estimators to that of estimators traditionally used in academia and industry, we find strong support for the maximum likelihood approach. In fact, the inefficiency of the traditional estimator may help explain the failure of past attempts to implement structural bond pricing models.
TL;DR: The authors found that while bank directors received significantly less equity-based compensation throughout most of the 1990s, by 1999, their use of such compensation was indistinguishable from a matched sample of industrial firms.
Abstract: Although deregulation leads to changes in the duties of boards of directors, little is known about changes in their incentives. U.S. banking deregulation and associated changes during the 1990s lends itself to a natural experiment. These industry shocks forced bank directors to face expanded opportunities, increased competition, and an expanding market for corporate control. While bank directors received significantly less equity‐based compensation throughout most of the 1990s, by 1999, their use of such compensation is indistinguishable from a matched sample of industrial firms. Our results suggest firms respond to deregulation by improving internal monitoring through aligning directors' and shareholders' incentives.
TL;DR: The authors found strong evidence of persistence in abnormal returns generated by fund managers over 1-year time horizons but weaker evidence over longer horizons, even when an allowance is made for momentum in stock returns.
Abstract: Previous work on U.K. pension funds found only slight evidence of fund manager persistence but survivorship bias in the construction of these data samples may have disguised true persistence. Using a large sample of pension funds over the period 1983–97 in which there is less survivorship bias, we find strong evidence of persistence in abnormal returns generated by fund managers over 1‐year time horizons but weaker evidence over longer horizons. Even when an allowance is made for momentum in stock returns, we find pension‐fund managers exhibit performance persistence.
TL;DR: In this paper, the authors proposed a two-stage approach to model and forecast the S&P 500 index options IVS, where the first stage models the surface along the cross-sectional moneyness and time-to-maturity dimensions, and the second stage model the dynamics of the first-stage implied volatility surface coefficients by means of vector autoregression models.
Abstract: One key stylized fact in the empirical option pricing literature is the existence of an implied volatility surface (IVS). The usual approach consists of Þtting a linear model linking the implied volatility to the time to maturity and the moneyness, for each cross section of options data. However, recent empirical evidence suggests that the parameters characterizing the IVS change over time. In this paper we study whether the resulting predictability patterns in the IVS coefficients may be exploited in practice. We propose a two-stage approach to modeling and forecasting the S&P 500 index options IVS. In the Þrst stage we model the surface along the cross-sectional moneyness and time-to-maturity dimensions, similarly to Dumas et al. (1998). In the second-stage we model the dynamics of the cross-sectional Þrst-stage implied volatility surface coefficients by means of vector autoregression models. We Þnd that not only the S&P 500 implied volatility surface can be successfully modeled, but also that its movements over time are highly predictable in a statistical sense. We then examine the economic signiÞcance of this statistical predictability with mixed Þndings. Whereas proÞtable delta-hedged positions can be set up that exploit the dynamics captured by the model under moderate transaction costs and when trading rules are selective in terms of expected gains from the trades, most of this proÞtability disappears when we increase the level of transaction costs and trade multiple contracts off wide segments of the IVS. This suggests that predictability of the time-varying S&P 500 implied volatility surface may be not inconsistent with market efficiency.
TL;DR: In this paper, the authors employ stochastic frontier cost and profit models to estimate the efficiency of multibillion dollar European and U.S. banks and conclude potential efficiency gains are possible via geographic expansion of large European and United States banks.
Abstract: This paper employs stochastic frontier cost and profit models to estimate the efficiency of multibillion dollar European and U.S. banks. Empirical results suggest that both large European and U.S. banks have decreasing (increasing) cost (profit) returns to scale. Also, large banks in Europe and the United States similarly exhibit increasing returns to scale and decreasing (increasing) scope economies for the cost (profit) model. However, large U.S. banks have higher average profit efficiency than European banks on average. We conclude potential efficiency gains are possible via geographic expansion of large European and U.S. banks.