Showing papers on "Equity (finance) published in 1989"

Data-snooping biases in tests of financial asset pricing models

Abstract: Tests of financial asset pricing models may yield misleading inferences when properties of the data are used to construct the test statistics. In particular, such tests are often based on returns to portfolios of common stock, where portfolios are constructed by sorting on some empirically motivated characteristic of the securities such as market value of equity. Analytical calculations, Monte Carlo simulations, and two empirical examples show that the effects of this type of data snooping can be substantial. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.(This abstract was borrowed from another version of this item.)

Equity and Disconfirmation Perceptions as Influences on Merchant and Product Satisfaction

Abstract: Prior work on the equity and disconfirmation determinants of transaction satisfaction was extended to product satisfaction. Based on perceptions of inputs and outcomes of buyer, dealer, and salesperson, two subtractive versions of the equity formula—absolute equity difference and equity advantage—were tested with fairness and preference as mediating variables. Both variables were related only to the equity advantage formula, and disconfirmation and fairness were shown to be distinct components of post-transaction dispositions. Moreover, product satisfaction was shown to be a function of product disconfirmation, complaining, and satisfaction with the dealer. The latter apparently mediates both fairness and salesperson satisfaction.

Using Equity Participation to Support Exchange: Evidence from the Biotechnology Industry

Abstract: In many industries, interfirm arrangements play an important role in the development, commercialization, and diffusion of technical know-how. These arrangements can involve various activities, including R&D, technology transfer, manufacturing, materials supply, and marketing, and can be governed by various types of organizational and contractual arrangements. Interfirm arrangements are often viewed as intermediate or hybrid forms along an institutional continuum of markets to hierarchies. Because most arrangements involve multiple dimensions of governance, however, it is extremely difficult to locate actual arrangements along this continuum. As a result, most empirical analyses have examined variance along particular structural dimensions such as the ownership of capital equipment (Monteverde and Teece, 1982b) or the contract duration (Joskow). This article examines the motives for using partial equity investments in collaborative relationships. These equity linkages include both classic joint ventures (where two or more parties create a separate, jointly owned entity) and direct minority equity investments (where one party takes an equity position in its partner).

Equity Issues and Stock Price Dynamics

Abstract: This paper presents an information-theoretic, infinite horizon model of the equity issue decision. The model's predictions about stock price behavior and issue timing explain most of the stylized facts in the empirical literature: (a) equity issues on average are preceded by an abnormal positive return on the stock, although there is considerable variation across firms, (b) equity issues on average are preceded by an abnormal rise in the market, and (c) the stock price drops significantly at the announcement of an issue. In this model, the price drop at issue announcement is uncorrelated with the social cost of suboptimal investment due to asymmetric information; the welfare loss may be small even if the price drop is large.

The Corporate Bankruptcy Decision

Abstract: A central tenet in economics is that competition drives markets toward a state of long-run equilibrium in which those firms remaining in existence produce at minimum average costs. In the transition to long-run equilibrium, inefficient firms, firms using obsolete technologies and those producing products that are in excess supply are eliminated. Consumers benefit because in the long run, goods and services are produced and sold at the lowest possible prices. The legal mechanism through which inefficient firms most often are eliminated is that of bankruptcy. In 1984, around 62,000 business firms filed for bankruptcy. Two-thirds of them filed to liquidate in bankruptcy and the rest filed to reorganize in bankruptcy (Administrative Office of the U.S. Courts, 1985). The total liabilities of firms that filed for bankruptcy in 1985 came to approximately $33 billion (Dun & Bradstreet, 1986).1 Economic theory suggests that bankruptcy should serve as a screening process designed to eliminate only those firms that are economically inefficient and whose resources could be better used in some other activity. However, firms typically file for bankruptcy voluntarily. When they do, creditors are not all repaid in full and large redistributional effects occur. Managers of firms do not take creditors' losses fully into account in deciding either how to run the firm or whether and when to file for bankruptcy. This suggests that firms in bankruptcy might not always be economically inefficient and that inefficient firms might not always end up in bankruptcy. Rather, firms may shut down and file for bankruptcy versus continuing to operate because managers respond to the potential for redistribution from creditors to equity, rather

Financial Reporting, Supplemental Disclosures, and Bank Share Prices

Abstract: A prominent feature of financial reporting regulation over the past 15 years has been the explosion in the volume of required financial disclosures. A plausible explanation for this development is the shift in regulatory emphasis from viewing the role of the primary financial statements as being to provide complete measures of net income and market value of common equity to viewing financial disclosures (both primary financial statements as well as supplemental disclosures) as providing a rich set

Cash Distributions to Shareholders

Abstract: Economists have long been puzzled by why firms pay dividends when alternative methods of rewarding shareholders and financiers exist which involve less taxes. This paper will highlight the fact that firms can distribute cash to equity holders in ways more lightly taxed than dividends. The two methods we examine are share repurchase programs and cash-financed mergers and acquisitions. So why should cash distributions from firms to shareholders ever take the form of dividends? This paper first provides evidence on the explosive growth in dividend cash payments, and then discusses how this evidence should affect theories about corporate finance.

Security Analyst Monitoring Activity: Agency Costs and Information Demands

Abstract: This paper explores the determinants of monitoring activity provided by security analysts. Jensen and Meckling have argued that analysts play the role of monitors of managerial performance as a means of reducing agency costs of debt and equity. The other major role analysts play is that of making security markets more informationally efficient. The empirical results reported in this paper support the role of analyst monitoring as an efficient device for controlling agency-related costs of debt and equity and as a response to the information demands of investors.

“Active Investors, LBOs, and the Privatization of Bankruptcy*”

Abstract: In this testimony to the House Ways and Means Committee on February 1, 1989 (when LBOs and other highly leveraged transactions were under fierce attack by politicians and the media), the author identified “LBO associations” such as KKR and Forstmann Little as a valuable innovation in organizational form—a new model of management and governance that was competing directly with the headquarters of large public corporations, especially conglomerates. In the author's words, LBOs “substitute incentives provided by compensation and ownership plans for the direct monitoring and often centralized decision-making in the typical corporate bureaucracy.” In illustrating his point, the author noted that whereas the CEOs of U.S. companies during the '70s and '80s saw their personal wealth go up by only about $3 for every $1,000 increase in firm value, the average CEO in an LBO experienced a change of $64 per $1,000—and for the partners of the LBO firm, the closest equivalent to a conglomerate CEO, the change was about $200 per $1,000. Based on the performance of the first wave of LBOs to return to public ownership, such dramatic concentrations of equity ownership appear to have produced large gains in operating efficiency. (And since the author's testimony, these findings have been confirmed by subsequent studies of later periods and in other countries.) The heavy debt loads in these transactions, besides making possible the concentration of equity ownership, also perform an important control function, intensifying the search for efficiencies and discouraging reinvestment in low-return projects. For those LBOs that have trouble servicing their debt loads, the author argues that the costs of insolvency should turn out to be significantly lower than for traditional public companies because LBOs provide strong incentives to keep the process of reorganizing troubled companies out of the bankruptcy court (a prediction that, although proving wrong in the early‘90s, has turned out to be true of the most recent wave of private equity deals).

Why Don't the Prices of Stocks and Bonds Move Together?

Abstract: The 1970s were associated with very low real interest rates and a large drop in equity values relative to dividends and earnings. This paper explores the possible roles of increased risk and reduced productivity growth in accounting for the behavior of bond and stock prices in a simple general equilibrium model. Both disturbances unambiguously lower the riskless interest rate, but may cause the stock market to respond perversely depending on the degree of aversion to intertemporal substitution and the share of the corporate sector in total wealth. Copyright 1989 by American Economic Association.

Investment, Financing Decisions, and Tax Policy

Abstract: mists have analyzed the effects of taxes on capital spending. Most studies assume that firms respond to prices set in centralized securities markets, such as market interest rates of Tobin's q, and firms undertake all profitable investment projects. Firms choose the mix or finance among internal funds, debt, and new equity independently; the availability of finance does not limit investment. The implications for tax policy are clear: the marginal tax rate on returns from a new project matters for investment, not the firm's average tax burden on returns from its investments in place. For firms that face imperfect markets for

Universal Hedging: Optimizing Currency Risk and Reward in International Equity Portfolios

Abstract: Investors can increase their returns by holding foreign stocks in addition to domestic ones. They can also gain by taking the appropriate amount of exchange risk. But what amount is appropriate? Assume that investors see the world in light of their own consumption goods and count both risk and expected return when figuring their optimum hedges. Assume that they share common views on stocks and currencies and that markets are liquid and there are no barriers to international investing. In this perfect world, it is possible to derive a formula for the optimal hedge ratio. This formula requires three basic inputs—the average across countries of the expected returns on the world market portfolio; the average across countries of the volatility of the world market portfolio; and the average across all pairs of countries of exchange rate volatility. These values can be estimated from historical data. The formula, in turn, gives the circumstances for three rules. (1) Hedge foreign equity. (2) Hedge less than 100 ...

Do Firms Care Who Provides Their Financing

Abstract: Several types of evidence are presented to demonstrate that firms are concerned with who provides their financing, not just with the debt/equity distinction. Aggregate and industry trends and patterns in the incremental sources of financial capital are documented, and a large sample of incremental corporate financial decisions is econometrically analyzed. There are large and persistent differences in the patterns of internal and external financing, both in the aggregate and across industries. Individual firms are shown to have distinct preferences for different providers of funds. Several indicators of potentially costly hidden information problems are important and significant determinants of choices between private and publicly-marketed sources, even after controlling for the type of security (debt or equity).

Information Effects Associated with Debt-for-Equity and Equity-for-Debt Exchange Offers

Abstract: This study investigates the information effect caused by a firm's change in capital structure via debt-for-equity and equity-for-debt exchange offers. The evidence suggests that the former transactions lead to abnormal stock price increases, while the latter lead to abnormal stock price decreases. In addition, findings based on analysis of bond returns and cross-sectional regressions do not lend support to the wealth-transfer- and tax-effect hypotheses, but they are consistent with the information-effect hypothesis. RECENT STUDIES PROVIDE EVIDENCE that firms' capital structure changes are associated with changes in common stock prices.1 For instance, Masulis (1980, 1983) reports that exchange offers that result in increases (decreases) in leverage are associated with positive (negative) abnormal common stock returns. He interprets his findings as being consistent with tax-based theories of optimal capital structure, a positive debt level information effect, and leverage-induced wealth transfers across securities.2 Mikkelson (1981, 1985) reports significant negative abnormal common stock returns at the announcement of convertible debt calls that force conversion of debt to common stock. He interprets this finding as being consistent with tax and information effects. Neither of these

The Informational Content of Initial Public Offerings

Abstract: The ability of capital markets to distinguish firms of different value by the size of their initial equity offerings is attenuated when insiders can sell equity more than once. A model is developed in which there is price risk from holding equity between periods. When the uncertainty is small, there must be pooling in the first period. When uncertainty is large, the pooling equilibria dominate the separating equilibrium. THE SIZE OF AN entrepreneur's initial public offering of equity can be informative. This point was made in Leland and Pyle (1977) and Stiglitz (1982). An entrepreneur with a good project can signal the value of the project by his or her willingness to retain equity. An implicit assumption of this analysis is that the entrepreneur has only one opportunity to sell equity. The assumption of a single sale is important since, once the entrepreneur has signalled his or her project value by retaining equity, investors should be willing to purchase the remaining equity. However, if entrepreneurs with bad projects foresee this, they too may wish to retain equity initially and render themselves indistinguishable from entrepreneurs with good projects. The current paper develops a model with two trading periods to capture the impact of having repeat sales of equity. There is a public offering in the first period. Then the entrepreneur can make an open-market sale in the second period. However, there is exogenous price risk, which makes it costly for the entrepreneur to wait to sell. In this context the value of the entrepreneur's project may not be revealed in the first period. Retaining equity is not very costly when uncertainty is small, and there will only be pooling equilibria in this case. In such a situation, no information is revealed in the first period. When the level of uncertainty is great, there does exist a separating equilibrium. However, the pooling equilibria Pareto-dominate the separating equilibrium. Throughout the analysis the focus will be on Paretooptimal equilibria. The idea that an informed agent can profitably trade over time has been examined in related contexts. Kyle (1985) looked at the optimal trading strategy for an insider whose sequence of purchases is hidden in the aggregate order flow. In equilibrium, the insider's information is not completely incorporated into the market price until the close of trading.

A Total Differential Approach to Equity Duration

Abstract: (1989). A Total Differential Approach to Equity Duration. Financial Analysts Journal: Vol. 45, No. 5, pp. 30-37.

The Effects of Financial Disclosure Levels on Firms' Choices among Alternative Foreign Stock Exchange Listings*

Abstract: Firms are increasingly adopting a global perspective. Nowhere is this more evident than in the accelerating internationalization of the world’s financial capital markets. In just five years the dollar volume of debt and equity securities placed annually by firms outside of their national borders has increased by 900%. ’ In the US, primary offerings of foreign debt and equity have averaged over $5 billion per year since 1975.2 Between 1974 and 1984, the dollar volume of foreign stocks traded in secondary markets in the US rose 839% (from $3.6 billion to $30.2 billion) while secondary market transactions by foreign investors in US stocks increased by more than 843% (from $14.7 billion to nearly $124 billi~n).~ A recent survey lists 472 companies as having active international trading in their equity securities. Once a firm decides to list its equity securities on a foreign exchange, available evidence suggests that the choice of listing location(s) is not random. In fact, major stock exchanges have had varying degrees of success in attracting foreign listings. The contrast between the Zurich and New York stock exchanges is particularly striking. While the Zurich Stock Exchange (ZUR) had 194 foreign firms on its roster at the end of 1986, the New York Stock Exchange (NYSE), which is considerably larger in both market value and volume of shares traded, listed a mere 63 foreign firms.’ During 1986 there were 21 new listings of foreign stocks on the Zurich exchange compared to only 9 on the NYSE. Zurich is becoming a center for the sale, listing, and trading of international equities. The NYSE, in contrast, continues to be dominated by domestic issues. Expert and anecdotal evidence suggest that when firms list their securities on foreign exchanges, financial disclosure levels are an important determinant of exchange choices. Responding to competitive pressures, the Securities and Exchange Commission (SEC) in the US and regulatory authorities in several other countries are currently engaged in public policy debates regarding appropriate accounting disclosures and listing requirements for foreign securities trading within their jurisdictions.6 These ongoing reappraisals of financial disclosure policies and the observed differences in the numbers of foreign securities listed on various exchanges raise a key question: Are choices among alternative foreign stock exchange listings significantly influenced by $financial disclosure levels ? This study addresses this question by presenting empirical evidence on the cross-sectional association between the financial disclosure levels of nine major stock exchanges (in eight countries) and the observed exchange choices of a sample of 207 US and non-US firms whose equity securities are listed on at least one foreign exchange. We interpret “financial disclosure’’ broadly to include both mandated accounting, listing and regulatory requirements and voluntary disclosures dictated by the expectations of market participants. Examining large firms with at least one foreign listing allows us to more effectively control for factors motivating firms’ decisions to list abroad and to concentrate on factors influencing choices among alternative foreign exchange listings. Results from univariate and multivariate tests are consistent with financial disclosure levels influencing foreign exchange listing decisions. The next section examines previous research and presents expert and anecdotal evidence suggesting a possible association between disclosure levels and choices among alternative foreign stock exchange listings. Section 3 develops testable propositions and describes sample selection procedures. Section 4 presents the empirical results. Section 5 provides a discussion and summary.

Financing the small firm

Abstract: This study presents a framework to delineate financing the small firm. Special consideration is given to small firms' unique financing sources such as trade and bank credit, entrepreneur's own resources, informal investment, and venture capital. The small firm has limited or no access to many traditional debt and equity markets that supply long term financing to the corporate world, and therefore operates in segmented and imperfect financial markets. The links between small firms' financing opportunities and managerial goals are traced from the start-up stage through establishing a mature firm. As the small firm matures, it operates in a broader financial market. This study establishes the foundation for future empirical research.

Equity Issues and Stock Price Dynamics

Abstract: This paper presents an information-theoretic, infinite horizon model of the equity issue decision. The model's predictions about stock price behavior and issue timing explain most of the stylized facts in the empirical literature: (a) equity issues on average are preceded by an abnormal positive return on the stock, although there is considerable variation across firms, (b) equity issues on average are preceded by an abnormal rise in the market, and (c) the stock price drops significantly at the announcement of an issue. In this model, the price drop at issue announcement is uncorrelated with the social cost of suboptimal investment due to asymmetric information; the welfare loss may be small even if the price drop is large.

Market valuation of bank assets and deposit insurance in Canada

Abstract: We examine a sample of Canadian banks and use option pricing theory to infer the market value of a bank's assets from the observed market value and volatility of its equity. We find that market value estimates are significantly different from corresponding book values. These differences vary significantly across banks, suggesting that market values provide bank-specific information not found in book values. We also derive that risk-adjusted deposit insurance premia for these banks. Our results suggest that the current fixed rate deposit insurance premium system has resulted in significant

Performance of Cooperatives and Investor-Owned Firms in the Dairy Industry

Abstract: A comparison of regional dairy cooperatives with investor-owned dairy firms from the period 1976-87 produced empirical findings that are at variance with the hypotheses suggested by the theory of cooperatives The cooperatives in the sample performed significantly better than the IOFs when compared by leverage, liquidity, asset turnover, and coverage ratios, while the rate of return to equity was not found to be significantly different Techniques are also proposed for valuing the nonmarket aspects of cooperatives that are not captured by financial ratio analysis

The impact of deposit insurance on S&L shareholders' risk/return trade- offs

Abstract: This article empirically examines how savings and loan associations' (S&Ls') stock returns respond to asset mix changes. When deposit insurance is underpriced, increases in financial leverage and the riskiness of the asset portfolio should lead to increases in expected return on common stock. In particular, changes in asset components which increase the volatility of an institution's portfolio should lead the stock market to upwardly revalue S&L equity. This hypothesis is examined using data for the July 1984–December 1989 period. Increases in commercial mortgage loans, acquisition and development loans, and investments in service corporations appear to cause higher return for shareholders of poorly capitalized, failing S&Ls. Similar increases appear to have little impact on the common stock returns of well-capitalized S&Ls.

Why Do Multinational Firms Seek Out Joint Ventures

Abstract: This paper uses a model of dichotomous choice to distinguish the characteristics of Swedish multinational firms that seek out joint ventures from those that do not. The findings suggest that firms with little experience of foreign production and highly diversified product lines are the most likely to share equity. In general, it is found that multinational firms that have the most to offer the developing countries are reluctant to enter into joint venture agreements. Therefore, imposing joint-venture status on multinationals may prevent the inflow of advanced technologies.

An Intertemporal Equilibrium Beta Pricing Model

Abstract: implications of this model under various restrictions on investor preferences and on the dynamic behavior ofdividends. We describe conditions under which the econometric techniques typically usedfor estimating and testing the APT can be shown to be consistent with our economic model. We relate our intertemporal version of the APT to the static APT and to Merton's intertemporal capital asset pricing model. We develop an intertemporal, discrete-time, competitive equilibrium version of Ross's arbitrage pricing theory (APT) and discuss the econometric content of this model under various restrictions on investor preferences and on the multivariate stochastic process determining dividends. We also discuss the distinctions between this model, the static APT, and the intertemporal capital asset pricing model (ICAPM) of Merton (1973). The key distinction from the static APT is that corporate dividends, rather than equity returns, are assumed to obey an approximate factor model. The factor model on equity returns as well as the APT restriction on asset expected returns is derived endogenously.

Equity Capital and Restructuring of Cooperatives as Investor-Oriented Firms

Abstract: The inability of financially successful cooperatives to recognize appreciation of patron’s equity creates a dilemma for cooperative members. The value of an enterprise as an investor-oriented firm may exceed the value of patron’s participation in a limited patronage horizon. This difference has been a factor in the decision of several cooperatives to restructure wholly or partially as investor-oriented firms. Reasons for valuation differences are discussed and related to six cases of cooperative restructuring.

User fees and equity issues in public hunting expenditures: the case of ring-necked pheasant in Oregon.

Abstract: Declining real budgets for wildlife agencies are focusing attention on the potential for user fees to supply specific services. While Hemingway's statement may suggest the intensity of interest by some participants, few would believe that such sentiments reflect average willingness to pay. Valuation studies are therefore useful to assess both the likelihood of success of a fee system as well as equity consequences of fee structures. With such information, policy makers can compare likely revenues from user fees with the cost of supplying specific wildlife enhancement programs (Matulich, Workman and Jubenville 1987). Valuation information also enables policy makers to more fully understand attendant welfare effects. While use of nonmarket valuation procedures in this context is limited, some studies have assessed the impact of user fees for specific public goods (e.g., Huszar and Seckler 1974). The overall purpose of this study is to investigate economic aspects of implementing user fees for a public, game enhancement program for ring-necked pheasants in Oregon. The analysis is based on a closedform contingent valuation survey of hunters during the 1986 western Oregon pheasant season. Econometric estimates of a logit model are then used to estimate (1) willingness to pay for the existing program; (2) participation rates, revenue, and willingness to pay for programs with varying user fees, including a simple Ramsey price system; and (3) the distribution of these variables among income classes.