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The European Financial Management was founded in 1994 by Dr. John Doukas to serve as a high quality refereed publication outlet that publishes significant new research as it relates to European corporations, financial institutions and capital markets. The EFM journal is published in five issues per year [January, March, June, September and November ] and its acceptance rate is about 9%. The June issue is based on the Keynote Address and a small set of articles selected from the papers presented at the Annual Meetings of the European Financial Management Association. The articles published in the EFM journal are indexed and abstracted in the Social Science Citation Index.
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European Financial Management, VOL 7:1, March 2001
European Financial Management, VOL 7:2, June 2001
European Financial Management, VOL 7:3, September 2001
European Financial Management, VOL 7:4, December 2001
European Financial Management, VOL 8:1, March 2002
European Financial Management, VOL 8:2, June 2002
European Financial Management, VOL 8:3, September 2002
European Financial Management, VOL 8:4, December 2002
European Financial Management, VOL 9:1, March 2003
European Financial Management, VOL 9:2, June 2003
European Financial Management, VOL 9:3, September 2003
European Financial Management, VOL 9:4, December 2003
European Financial Management, VOL 10:1, March 2004
European Financial Management, VOL 10:2, June 2004
European Financial Management, VOL 10:3, September 2004
European Financial Management, VOL 10:4, December 2004
European Financial Management, VOL 11:1, January 2005
European Financial Management, VOL 11:2, March 2005
European Financial Management, VOL 11:3, June 2005
European Financial Management, VOL 11:4, September 2005
European Financial Management, VOL 11:5, November 2005
European Financial Management, VOL 12:1, January 2006
European Financial Management, VOL 12:2, March 2006
European Financial Management, VOL 12:3, June 2006
European Financial Management, VOL 12:4, September 2006
European Financial Management, VOL 12:5, November 2006
European Financial Management, VOL 13:1, January 2007
European Financial Management, VOL 13:2, March 2007
European Financial Management, VOL 13:3, June 2007
European Financial Management, VOL 13:4, September 2007
European Financial Management, VOL 13:5, November 2007
European Financial Management, VOL 14:1, January 2008
European Financial Management, VOL 14:2, March 2008
European Financial Management, VOL 14:3, June 2008
European Financial Management, VOL 14:4,
September 2008
European Financial Management, VOL 14:5,
November 2008
European Financial Management, VOL 15:1,
January 2009
European Financial Management, VOL 15:2,
March 2009
European Financial Management, VOL 15:3,
June 2009
European Financial Management, VOL 15:4,
September 2009
European Financial Management, VOL 16:1,
January 2009
European Financial Management, VOL 16:2,
January 2009
European Financial Management, Newly Accepted Papers
European Financial Management, VOL 7:1 March 2001
Efficiency in the pricing of the FTSE 100 futures contract
Joelle Miffre
ISMA Centre, The University of Reading, Reading,
Berks. UK
Abstract
This paper studies the pricing efficiency in the FTSE
100 futures contract by linking the predictable movements in futures returns to
the time-varying risk and risk premia associated with prespecified factors. The
results indicate that the predictability of the FTSE 100 futures returns is
consistent with a conditional multifactor model with time-varying moments. The
dynamics of the factor risk premia, combined with the variation in the betas,
capture most of the predictable variance of returns, leaving little variation to
be explained in terms of market inefficiency. Hence the predictive power of the
instruments does not justify a rejection of market efficiency.
Keywords:FTSE 100 Futures Contract, Efficiency, Time-varying Risk, Risk Premia.
JEL: G12, G13, G14
European Financial Management, VOL 7:1 March 2001
The Pricing of French Unit Seasoned Equity Offerings
Pierre
Chollet and Edith Ginglinger
IAE, Université de Tours, Tours cedex 3,
France
ESA, IRG, Université Paris XII, Créteil, France
Abstract.
Units are bundles of common stock and warrants. By
issuing units, firms precommit to a future and uncertain seasoned offering at
the exercise price of the warrants. This study shows that the issuance of units
seasoned offerings in France is accompanied by significant abnormal returns of
on average 9 to 12%, depending on the computing methods. Underpricing increases
with the risk of the issuer and the relative size of the future seasoned equity
issue linked to warrant exercises. Our results are consistent with our signaling
hypothesis.
Keywords:Units, Warrants, Seasoned Equity Offerings, Underpricing, Signaling
JEL: G14, G32
European Financial Management, VOL 7:1 March 2001
Competition and Integration Among Stock Exchanges in Europe: Network
Effects, Implicit Mergers and Regulatory Considerations
Carmine Di
Noia
Divisione Mercati, Commissione Nazionale per le Societa e la Borsa
(CONSOB) Roma, Italy
Abstract
The economic theory of network externalities and a
simple-game theoretical framework are used to explore the issue of competition
among stock exchanges and the possibility of consolidation in the European
stock-exchange industry, among the different exchanges. The main features of
this paper are the following: the treatment of exchanges as firms; the
application of network externalities to study competition among exchanges; the
extension of network externalities, through implementing ``cross-network''
effects; and the existence of equilibria where exchanges may decide, even
unilaterally, to achieve full compatibility through implicit mergers and remote
access, specializing only in trading or listing services. One implication is
that consolidation of European exchanges into one may occur with a
welfare-efficient outcome or with a lock-in to a Pareto-inferior equilibrium.
This is due to the network externalities and the different starting points of
the various exchanges. ``Implicit mergers'' among exchanges together with remote
access are always weakly (in half of the cases, strictly) more efficient than
the actual competition. This finding also sheds light on the existence and
efficacy, especially in the U.S., of automated trading systems, which are
exchanges specializing in trading services.
Keywords:Securities Exchanges, Competition, Implicit Merger, Network Effect, Remote Access
JEL: C71, D43, F36, G15
European Financial Management, VOL 7:1 March 2001
Improving Portfolio Performance with Option Strategies: Evidence from
Switzerland
Dusan Isakov and Bernard Morard
HEC, University
of Geneva, Switzerland
HEC, University of Geneva, Switzerland
Abstract
This paper investigates the performance of a global
investment strategy that combines diversification and option strategies, in
particular the covered call strategy, on the Swiss Exchange over the epriod
1989-1996. As the return distributions of portfolios including options are
possibly non-normal, the mean-variance framework may not be appropriate to
assess the relative performance of such portfolios. Stochastic dominance and
modified betas are the alternative approaches, robust to departure from
normality, used in this paper to compare the performance of portfolios. The
results show that the use of option strategies consistently improves the
performance of stock portfolios, even in the presence of transaction costs.
Keywords:Covered Call Options, Portfolio Management, Stochastic Dominance
JEL: G11, G13
European Financial Management, VOL 7:1 March 2001
Stock Exchange Reforms and Market Efficiency: The Italian Evidence
Giovanni Majnoni and Massimo Massa
Banca d'Italia, Research
Department, Italy
INSEAD, France
Abstract
This paper examines whether the reforms introduced by
the Italian Stock Exchange from 1991 to 1994 (creation of specialised
intermediaries, obligation to trade on the official markets, screen-based
trading and cash settlement) did increase market efficiency. The issue is
addressed using both the traditional information efficiency model, which tests
market efficiency by verifying the predictability of prices conditional on some
information subset and a microstructure approach that measures efficiency as the
distance of the price movements from their efficient components, represented by
a random walk process. The joint analysis of daily and intraday data on prices
and volumes validates the hypothesis that most of the reforms have increased
market efficiency over the sample period, except for cash settlement, which
appears to have substantially reduced it.
Keywords:Stock Market, Informational Efficiency, Trading Systems
JEL: G14
European Financial Management, VOL 7:1 March 2001
PROFESSIONAL FORUM
Efficiency Barriers to the Consolidation of the European Financial
Services Industry
Allen N. Berger, Robert DeYoung, Gregory F.
Udell
Board of Governors of the Federal Reserve System and Wharton
Financial Institutions Center
Federal Reserve Bank of Chicago
Kelley
School of Business, Indiana University
Abstract
Cross-border consolidation of financial
institutions within Europe has been relatively limited, possibly reflecting
efficiency barriers to operating across borders, including distance; differences
in language, culture, currency and regulatory/supervisory structures; and
explicit or implicit rules against foreign competitors. EU policies such as the
Single Market Programme and European Monetary Union attenuate some but not all
of these barriers. The evidence is consistent with the hypothesis that these
barriers offset most of any potential efficiency gains from cross-border
consolidation. Banks headquartered in other EU nations have slightly lower
average measured efficiency than domestic banks and non-EU-based foreign banks.
Keywords: Banks, Mergers, Efficiency, Europe, Financial institutions.
JEL: G21, G22, G24, G28, G34, F23
European Financial Management, VOL 7:2 June 2001
Identifying The Risk Structure of Mutual Fund Returns
Martin J.
Gruber
Stern School of Business, NYU
Keynote Address at the European Financial Management Association 2000 Annual Meetings, Athens, Greece, June 2000.
Keywords: Mutual Fund Returns; Risk; Benchmarks and Indexes; Asset Management; Performance Measures
JELClassification : G11, G12
European Financial Management,VOL 7:2 June 2001
The Structure of Banking Systems in Developed and Transition Economies
DwightJaffee and Mark Levonian
Haas School of Business,
University of California, Berkeley, USA
Visiting Scholar, Federal Reserve
Bank of San Francisco, USA
Abstract
The paper empirically analyzes the determinants of
banking system structure (as measured by bank assets, number, branches and
employees) for 26 developed OECD countries. The estimated regressions are
then applied to 23 transition economies, to obtain benchmarks for the efficient
structure of their banking systems. The actual and benchmark measures of
banking structure are compared to evaluate the state of banking system
development, including the computation of a measure of "banking system
convergence". The results are objective and replicable multidimensional measures
of banking system development for the transition economies.
Keywords: Banks, Banking systems, Banking structure, Transition economies, Developing Economies
JEL Classification: G21, O16, P34
European Financial Management,VOL 7:2 June 2001
Paying for Minimum Interest Rate Guarantees: Who Should Compensate
Who?
Bjarne A. Jensen and Carsten Sorensen
Abstract
Defined contribution pension schemes and life insurance
contracts often have a mandatory minimum interest rate guarantee as an
integrated part of the contract. This guarantee is an embedded put option issued
by the institution to the individual, who is forced to hold the option in the
portfolio. However, taking the inability to short this saving and other
institutional restrictions into account the individual may actually face a
restriction on the feasible set of portfolio choices, hence be better off
without such guarantees. We measure the effect of the minimum interest guarantee
constraint through the wealth equivalent and show that guarantees may induce a
significant utility loss for relatively risk tolerant investors. We also
consider the case with heterogenous investors sharing a common portfolio.
Investors with different risk attitudes will experience a loss of utility by
being forced to share a common portfolio. However, the relatively risk averse
investors are partly compensated by the minimum interest rate guarantee, whereas
the relatively risk tolerant investors are suffering a further utility loss.
Keywords:Minimum interest rate guarantee, asset allocation restrictions, utility loss, wealth equivalent, heterogenous investors.
JEL Classification: G11,G13
European Financial Management,VOL 7:2 June 2001
European Managerial Perceptions of the Net Benefits of Foreign Stock
Listings
Franck Bancel and Usha R. Mittoo
ESCP-EAP, France
University of Manitoba, Canada
Abstract
This study surveys the European managers on the costs,
benefits and net benefits of foreign listing. Increase in prestige and
visibility and growth in shareholders are perceived as the major benefits and
the costs of public relations and legal fees are cited as the major costs by the
managers. While a majority of managers (60 percent) perceive that benefits
outweigh the costs of foreign listing, about 30 percent also view the net
benefits to be negative. Perceived net benefits are positively related to the
increase in the total trading volume after foreign listing, the financial
disclosure levels of the firm and the dual listing on both the U.S. and European
foreign exchanges. Without the influence of these factors, the perceived net
benefits are negative.
Keywords: Foreign listing, European Managers, survey, costs and benefits
JEL Classification: G15, G30, G39
European Financial Management,VOL 7:2 June 2001
Shareholder Wealth Effects of Corporate Selloffs: Impact of Growth
Opportunities,Economic Cycle and Bargaining Power
George Alexandrou
and Sudi Sudarsanam
University of Essex, UK
Cranfield University
School of Management, UK
Abstract
Most of the existing empirical evidence on corporate
selloffs documents significant wealth gains for the seller’s shareholders. We
investigate the sources of these wealth gains by examining the impact of
business and financial strategy, the economic environment during selloff, the
bargaining advantages of the seller including information asymmetry. We find
evidence that sellers with growth opportunities and financially strong sellers
enjoy higher returns. Selloffs during recessions generate larger wealth gains
than those during economic boom. Information asymmetry due to the buyer’s
location being different from the purchased division’s gives the seller a
bargaining advantage leading to larger wealth gains. Relatively large
divestments are more beneficial to seller shareholders than small ones. The
study highlights the importance of both firm specific and environmental factors
in explaining the wealth gains associated with corporate selloffs.
Keywords: Selloffs, business strategy, financial distress, economic environment and information asymmetry
JEL Classification:
European Financial Management,VOL 7:2 June 2001
The Effects of Liberalization on Market and Currency Risk In The European
Union
Francesca Carrieri
Faculty of Management, McGill
University, Canada
Abstract
This paper investigates the effects of liberalization on
the pricing of market and currency risk for a number of financial markets in the
European Union(EU). An International Asset Pricing Model with a multivariate
GARCH-in-Mean specification and time-varying prices of risk is used for the four
markets with the largest capitalization in the EU. Only one price of market risk
exists and international investors are rewarded for their exposure to currency
risk. The evidence shows that all prices of risk are time-varying and have been
decreasing during the process of liberalization. There is also evidence that
markets react to period of uncertainty in the process toward the completion of
liberalization. In addition, the operation of the European Monetary System has
generated lower covariances. As a consequence, total risk premia have declined
in the last decade.
Keywords: International Asset Pricing, Currency Risk, Liberalization, European Union
JEL Classification: G12, G15
European Financial Management, VOL 7:3 September 2001
Value Maximization, Stakeholder Theory and the Corporate Objective
Function
Michael Jensen (Mjensen@hbs.edu)
Harvard Business
School,
Abstract.
This paper examines the role of the corporate objective
function productivity and efficiency,social welfare ,and the
accountability of managers and directors.I argue that since it is logically
impossible to maximize in more than one dimension,purposeful behavior requires a
single valued objective function.Two hundred years of work in economics and
finance implies that in the abscence of externalities and monopoly(and when all
goods are priced),social welfare is maximized when each firm in an economy
maximizes its total market value.Total value is not just the value of the equity
but also includes the market values of all other financial claims including
debt,preferred stock and warrants.
Stakeholders
theory argues that managers should make decisions so as to take account of all
the stakeholders in a firm(including not only financial claimants but also
employees,customers,communities,government officials and under some
interpratations the environment,terrorists,blackmailers and thieves).Because the
advocates of stakeholder theory refuse to specify how to make the necessary
tradeoffs among these competing intereststhay leave managers with a theory that
makes it impossible for them to make purposeful decisions.With no way to keep
score,stakeholder theory makes managers unaccountable for their actions.It seems
clear that such a theory can be attractive to the selfinterest of managers and
directors.
It takes more
than the acceptance of value maximization as the organizational objective to
create value.As a statement of corporate purpose or vision,value maximization is
not likely to tap into the energy and enthusiasm of employees and managers to
create value.Seen in this light,changes in longterm market value becomes the
scoreborad that managers,directors and others use to assess the success or
failure of the organization.It must be complemented by the corporate
vision,strategy and tactics that unite participants in the organization in
its struggle for survival and dominance in its competitive arena.
Since a firm cannot maximize value if it ignores
the interests of its stakeholders,enlightened value maximization can utilize
much of the structure of stakeholder theory by accepting longterm maximization
of the value of the firm as the criterion for making the requisite tradeoffs
among its stakeholders,managers, directors,strategists and management
scientisits can benefit from enlightened stakeholder theory as well.enlightened
stakeholder specifies value maximization or value seeking as the firm's
objective and therefore resolves the logical problems that cause traditional
stakeholder theory to fail as a guide to corporate action.
Keywords: Value Maximization; Stakeholder Theory; Balanced Scorecard; Multiple Objectives; Social Welfare; Social Responsibility; Corporate Objective Function; Corporate Purpose; Tradeoffs; Corporate Governance; Strategy; Special Interest Groups
JEL Classification: G3, G30, G32
European Financial Management,VOL 7:3 September 2001
Agency Costs and Strategic Considerations behind Sell-offs: The UK
Evidence
Kevin M.J. Kaiser and Aris Stouraitis
McKinsey &
Co, Paris, France
Department of Economics and Finance, City University of
Hong Kong,Hong Kong
Abstract.
We analyse the impact of the motivation behind the
sell-off and the use of the proceeds from the sale on the value of UK firms
divesting assets during 1984-1994. Our findings suggest that managers do not
create value when they divest assets in order to raise cash, in order to
reshuffle assets without increasing corporate focus and when they do not
announce the motivation behind the transaction. In contrast, we find value
increases for firms refocusing during the 1990s and for firms divesting
loss-making assets for operational reasons. Returning the proceeds from the sale
yo shareholders or reducing leverage were also associated with value increases,
whereas reinvesting the proceeds for growth had a negative impact during the
1980s, which disappeared after 1990, as a result of disciplinary role of the
economic turndown on the investment behaviour of firms.
Keywords:Corporate Structuring, Sell-offs, Agency Costs, Refocusing
JEL Classification: G34, G14
European Financial Management,VOL 7:3 September 2001
Smiles, Bid-Ask Spread and Option Pricing
Ignacio Pena, Gonzalo
Rubio and Gregorio Serna
Universidad Carlos III de Madrid, Spain
Universidad del Pais Vasco, Spain
Universidad Carlos III de Madrid,
Spain
Abstract.
Given the evidence provided by Longstaff (1995) and
Pena, Rubio and Serna (1999) a serious candidate to explain the pronounced
pattern of volatility estimates across exercise prices might be related to
liquidity costs. Using all calls and puts transacted between 16:00 and 16:45 on
the Spanish IBEX-35 index futures from January 1994 to October 1998 we extend
previous papers to study the influence of liquidity costs, as proxied by the
relative bid-ask spread, on the pricing of options. Surprisingly, alternative
parametric option pricing models incorporating the bid-ask spread seem to
perform poorly relative to Black-Scholes.
Keywords:Smiles, Bid-Ask Spread, Implied Volatility Function, Option Pricing
JEL Classification: G12, G13
European Financial Management,VOL 7:3 September 2001
Belgian Intragroup Relations and the Determinants of Corporate Liquid
Reserves
Marc Deloof
Faculty of Applied Economics, University
of Antwerp - UFSIA, Belgium
Abstract.
The determinants of liquid reserves are investigated for
a sample of 1038 large Belgian non-financial firms in the 1992-1994 period. The
results confirm the hypothesis that the terms of payment of intragroup claims
can be adjusted to the firm’s liquidity needs, thereby reducing the need for
liquid reserves. Furthermore, the results confirm the transaction motive for
holding liquid reserves, but only partially confirm the precautionary motive
Finally, the results indicate that liquid reserves play a significant role in
the financing of new investments, as predicted by the pecking order model of
Myers and Majluf (1984).
Keywords:Liquid Reserves, Corporate Groups, Pecking Order
JEL Classification: G31, G32
European Financial Management,VOL 7:3 September 2001
Decomposing and Testing Long-Run Returns With An Application to Initial
Public Offerings in Denmark
Jan Jakobsen and Ole Sorensen
Department of Finance, Copenhagen Business School, Denmark
Department of
Accounting and Auditing, Copenhagen Business School, Denmark
Abstract.
An improved method for measuring and testing long-run
returns is proposed. The method adjusts for the right-skewed distribution of
long-run buy-and-hold returns by decomposing average cross-sectional
buy-and-hold returns into mean components and volatility components. The method
is applied to initial public offerings in Denmark. The mean component under
performance of initial public offering stocks compared to the market is 30
percent and significant after five years. Comparing to matching firms, the
underperformance of IPO stocks is 13 percent after five years but insignificant.
Keywords: Initial Public Offerings; Long-Run Returns; Right Skewed Distributions
JEL Classification: G14, G32
European Financial Management,VOL 7:3 September 2001
PROFESSIONAL FORUM
The Impact of the Introduction of the Euro on Foreign Exchange Risk Management in UK Multinational Companies
Eilidh Christie and Andrew Marshall
Arthur Anderson, Glasgow and
the Department of Accounting and Finance, University of Strathclyde,UK
Department of Accounting and Finance, Curran Building, Glasgow ,Scotland,UK
Abstract
One of the arguments in favour of the euro is that it
will eliminate foreign exchange risk for companies in the euro-zone. There could
also be benefits for companies outside this zone, although their currency risk
with the euro remains. This paper considers this, by examining the effect of the
euro on the currency risk management of UK multinational companies (MNCs). Using
the responses from a questionnaire and interviews we found that the euro, which
is being widely used in UK MNCs, is generally favoured due to reductions in
exchange uncertainty and costs of managing currency risk. Nonetheless, contrary
to what would theoretically be expected, there was no exact relationship in the
reduction in hedging activity accompanied by this reduction in risk. The
majority of MNCs stated that their hedging activities would remain unchanged.
The capacity of MNCs to benefit from reductions in risk and hedging depend on
the proportion of non-UK European trade, the industry sector and the ability to
transfer risk down the supply chain. Finally, despite the reductions in currency
exposure experienced by the majority of companies the euro will not encourage UK
MNCs to expand international trade.
Keywords: Euro, foreign exchange risk management.
JEL Classification : F23; F31
European Financial Management, VOL 7:4 December 2001
The Emerging Role of the European Commission
in Merger and
Acquisition Monitoring:The Boeing / Mc Donnell Douglas Case
Nihat Aktas,Eric de Bodt,Michel Levasseur and André Schmitt
Institut d’Administration et de Gestion, Université Catholique de
Louvain,Belgium
Institut d’Administration et de Gestion, Université
Catholique de Louvain,Belgium and Ecole Supérieure des Affaires,
Université de Lille , France
Institut d’Administration et de Gestion,
Université Catholique de Louvain,Belgium and Ecole Supérieure des
Affaires, Université de Lille , France
Ecole Supérieure des Affaires,
Université de Lille , France
Abstract.
The object of this study is to evaluate the consequences
of the application of the EEC regulation n°4064/89 to non-European
companies. We focus on the Boeing – Mc Donnell Douglas merger case, one of the
first non-European mergers considered by the Commission. The analysis of
abnormal returns on the two securities shows that the threat of a ban of the
merger by the Commission were not perceived as credible at first. But when
Boeing decided to ask the support of the American government, just after the
decision of the European Commission to extend its investigations to the long
term exclusivity contracts, the role of the Commission emerged.
Key words: mergers and acquisitions, regulation costs, concentration control, event studies
JEL Classification : G14; G18; G34
European Financial Management, VOL 7:4 December 2001
Why do firms raise foreign currency denominated debt?Evidence from Finland
Matti Keloharju and Mervi Niskanen
Helsinki School of Economics
and Business Administration, Helsinki,Finland
Häme Polytechnic University,
Finland
Abstract
This study examines the determinants of the decision to
raise currency debt. The results suggest that
hedging figures importantly in the currency-of-
denomination decision: firms in which exports
constitute a significant fraction of net sales are more likely to
raise currency debt.However, firms also tend to borrow
in periods when the nominal interest rate for the loan
currency, relative to other currencies, is lower than usual.
This is consistent with the currency debt issue decision
being affected by speculative motives. Large firms, with a
wider access to the international capital markets, are
more likely to borrow in
foreign currencies than
small firms.
Keywords: Currency of denomination, hedging, speculation
JEL classification: F23, G32
European Financial Management, VOL 7:4 December 2001
Simulating the Evolution of the Implied Distribution
George Skiadopoulos and Stewart Hodges
Associate Research Fellow
at the Financial Options Research Centre,University of Warwick,UK
Director
of the Financial Options Research Centre, Warwick Business School,University of
Warwick.UK.
Abstract:
Motivated by the implied stochastic volatility
literature (Britten-Jones and Neuberger (1998), Derman and Kani (1997), Ledoit
and Santa-Clara (1998)),this paper proposes a new and general method for
constructing smile-consistent stochastic volatility models. The method is
developed by recognizing that option pricing and hedging can be accomplished via
the simulation of the implied risk neutral distribution. We devise an algorithm
for the simulation of the implied distribution, when the first two moments
change over time. The algorithm can be implemented easily and it is based on an
economic interpretation of the concept of mixture of distributions. It
can
also be generalized to cases where more complicated forms for the mixture are
assumed.
Keywords: Smile-Consistent stochastic volatility models, Implied Distribution, Mixture of Distributions, Simulation.
JEL Classification: G 13
European Financial Management, VOL 7:4 December 2001
What Determines IPO Gross Spreads in Europe?
Sami Torstila
Helsinki School of Economics and Business
Administration, Finland
Abstract
This paper examines the behavior of underwriting gross
spreads in European IPO markets using a data set of 565 IPOs by European issuers
in the period 1986 - 1999. Privatizations have lower gross spreads than other
IPOs, other things remaining equal. Gross spreads on European listings by
European issuers are significantly lower than on U.S. listings by European
issuers, except on the technology stock - oriented EASDAQ and Frankfurt Neuer
Markt exchanges. IPOs involving a U.S. bulge bracket underwriter (for joint
U.S./Europe listings) or bookbuilding are characterized by relatively higher
spreads.
Keywords: initial public offerings, gross spreads, European equity markets
JEL classification: G24, G32
European Financial Management, VOL 7:4 December 2001
Binomial Option Pricing Biases and Inconsistent Implied Volatilities
Brent J. Lekvin and Ashish Tiwari
School of Business and
Economics, Michigan Technological University, Houghton, MI,USA
Department of
Finance, Henry B. Tippie College of Business Administration, University of Iowa,
Iowa City, IA ,USA
Abstract
We evaluate the binomial option pricing methodology (OPM)
by examining simulated portfolio strategies. A key aspect of our study involves
sampling from the empirical distribution of observed equity returns. Using
a Monte Carlo simulation, we generate equity prices under known volatility and
return parameters. We price American-style put options on the equity and
evaluate the risk-adjusted performance of various strategies that require
writing put options with different maturities and moneyness
characteristics. The performance of these strategies is compared to an
alternative strategy of investing in the underlying equity. The relative
performance of the strategies allows us to identify biases in the binomial OPM
leading to the well-known volatility smile. By adjusting option prices so
as to rule out dominated option strategies in a mean-variance context, we are
able to reduce the pricing errors of the OPM with respect to option prices
obtained from the LIFFE. Our results suggest that a simple recalibration
of inputs may improve binomial OPM performance.
Keywords: option pricing; binomial model; implied volatility; volatility smile
JEL classification: G13
European Financial Management, VOL 8:1 March 2002
Short-Run Returns Arond the Trades of Corporate Insiders on the London Stock Exchange
Sylvain Friederich, Alan Gregory, John Matatko and Ian
Tonks
Financial Markets Group, London School of Economics and Universite
de Paris - I.
School of Business and Management, University Of
Exeter.
Department of Economics, University of Bristol.
Abstract
Previous work examined the long-run profitability of
strategies mimicking the trades of company directors in the shares of their own
company, as a way of testing for market efficiency. The current paper examines
patterns in abnormal returns in the days around these on the London Stock
exchange.
We find movements in returns that are consistent with the directors
engaging in short-term market timing. We also report that some types of trades
have superior predictive content over future returns. In particular,
medium-sized trades are more informative for short-term returns than large ones,
consistently with Barclay and Warner's(1993) "stealth trading" hypothesis
whereby informed traders avoid trading in blocks.
Another contribution of
this study is to properly adjust the abnormal return estimates for
microstructure (spread) transactions costs using daily bid-ask spread data. On a
net basis, we find that abnormal returns all but disappear.
Keywords: market efficiency, corporate insiders, insider trading, informed trading, London Stock Exchange
JEL Classification: G14
European Financial Management, VOL 8:1 March 2002
Backtesting Derivative Portfolios with Filtered Historial Simulation(FHS)
Giovanni Barone-Adesi, Kostas Giannopoulos and Les Vosper
Usi, via
Buffi 13, Lugano 6900 Switzerland.
University of Westminster, London,
UK
The London Clearing House, Aldgate High Street, London, UK
Abstract
Filtered historical simulation provides the general
framework to our backtests of portfolios of derivative securities held by a
large sample of financial institutions. We allow for stochastic volatility and
exchange rates. Correlations are preserved implicitly by our simulation
procedure. Options are repriced at each node. Overall results support the
adequacy of our framework, but our VaR numbers are too high for swap portfolios
at long horizons and too low for options and futures portfolios at short
horizons.
Keywords: Value-at-risk; historical simulation; GARCH.
JEL Classification: G19
European Financial Management, VOL 8:1 March 2002
Estimating Systematic Risk Using Time Varying Distributions
Gregory Koutmos and Johan Knif
Charles F. Dolan School of Business,
Fairfield University, Fairfield, CT,06430, USA
Hansen, Swedish School of
Business and Economic Administration, P.O.Box#287, FIN-65101, Vasa Finland
Abstract
This article proposes a dynamic vector GARCH model for the
estimation of time-varying betas. The model allows the conditional variances and
the conditional covariance between individual portfolio returns and market
portfolio returns to respond asymmetrically to past innovations depending on
their sign. Co variances tend to be higher during market declines. There is
substantial time variation in betas but the evidence on beta Asymmetry is mixed.
Specifically, in fifty percent of the cases betas are Higher during market
declines and for the remaining fifty percent the opposite is true. A time series
analysis of estimated time varying betas reveals that they follow stationary
mean-reverting processes. The average degree of persistence is approximately
four days. It is also found that the static market model overstates non-market
or, unsystematic risk by more than ten percent. On the basis of an array of
diagnostics it is confirmed that the vector GARCH model provides a richer
framework for the analysis of the dynamics of systematic risk.
Keywords: dynamic betas; mean-reversion in betas; asymmetric covariance; time-varying distributions; vector GARCH;
JEL classification: G12, G15
European Financial Management, VOL 8:1 March 2002
European Mutual Fund Performance
Roger Otten and Dennis Bams
Maastricht University and
FundPartners, PO BOX 616 6200 MD Maastricht, The Netherlands
Maastricht
University and ING Group, PO BOX 616 6200 MD Maastricht, The Netherlands
Abstract
This paper presents an overview of the European mutual
fund industry and investigates mutual fund performance using a survivorship bias
controlled sample of 506 funds from the 5 most important mutual fund countries.
The latter is done using the Carhart (1997) 4-factor asset-pricing model. In
addition we investigate whether European fund managers exhibit hot hands,
persistence in performance. Finally the influence of fund characteristics on
risk-adjusted performance is considered. Our overall results suggest that
European mutual funds and especially small cap funds are able to add value, as
indicated by their positive after cost alphas. If we add back management fees, 4
out of 5 countries exhibit significant out-performance at an aggregate level.
Finally, we detect strong persistence in mean returns for funds investing in the
United Kingdom. Our results deviate from most US studies that argue mutual funds
under-perform the market by the amount of expenses they charge.
Key words: Mutual Funds, Performance Evaluation, Portfolio Management, Style Analysis
JEL Classification: G12, G20, G23
European Financial Management, VOL 8:1 March 2002
PROFESSIONAL FORUM
The New Basel Capital Accord: Making it Effective with Stronger Market Discipline
Harald Benink and Clas Wihlborg
Rotterdam School of Management,
Erasmus University Rotterdam,P.O. Box 1738, 3000 DR Rotterdam, The
Netherlands
Department of Finance, Copenhagen Business School, Solbjerg Plads
3, DK-2000 Frederiksberg, Denmark & School of Economics and Commercial Law,
Gothenburg University, Sweden
Abstract
In January 2001 the Basel Committee on Banking Supervision
proposed a new capital adequacy framework to respond to deficiencies in the 1988
Capital Accord on credit risk. The main elements or “pillars” of the proposal
are capital requirements based on the internal risk-ratings of individual banks,
expanded and active supervision and information disclosure requirements to
enhance market discipline. We discuss the incentive effects of the proposed
regulation. In particular, we argue that it provides incentives for banks to
develop new ways to evade the intended consequences of the proposed regulation.
Supervision alone cannot prevent banks from “gaming and manipulation” of
risk-weights based on internal ratings. Furthermore, the proposed third pillar
to enhance market discipline of banks’ risk-taking is too weak to achieve its
objective. Market discipline can be strengthened by a requirement that banks
issue subordinated debt. We propose a first phase for introducing a requirement
for large banks to issue subordinated debt as part of the capital requirement.
Key words: asset pricing, general equilibrium, value-at-risk, risk management.
JEL classification: G11, G12
European Financial Management, VOL 8:2, June 2002
Neoclassical Finance, Alternative Financeand the Closed End Fund Puzlle
Stephen A. Ross
Keynote Address at the European Financial Management Association 2001 Annual Meetings, Lugano Switzerland, June 2001.
European Financial Management, VOL 8:2 June 2002
The Effect of VaR Based Risk Management on asset and the Volatility Smile
Arjan Berkelaar, Phornchanok Cumperayot and Roy Kouwenberg
Abstract
Value-at-Risk (VaR) has become the standard criterion for accessing risk in the financial industry. Given the widespread usage of VaR, it becomes increasingly important to study the effects of VaR based risk management on the prices of stocks and options. We solve a continuous-time asset pricing model, based on Lucas (1978) and Basak and shapiro ( 2001), to investigate these effects. We find that the presence of risk manegements tends to reduce market
volatility, as intended. Howeverl, in some cases VaR risk management undesirably raises the probablity of extreme losses. Finally, we demonstrate that option prices in an economy with VaR risk managers display a volatility smile.
Key words: Mutual Funds, Performance Evaluation, Portfolio Management, Style Analysis
JEL classification: G11, G12
European Financial Management, VOL 8:2 June 2002
Board Overlap, Seat Accumulation and Share Prices
Claudio Loderer and Urs Peyer
Abstract
We examine the board overlap among firms listed in Switzerland. Collusion, managerial entrenchment and financial participation cannot explain it. The overlap appears to be induced by banks and by the accumulation of seats by the most popular directors. We also document that seat accumulation is negatively related to firm value, possibly because of the conflicts of interest that multiple directorships induce and the time constraints directors face. Contrary to popular beliefs, however, the directors of traded firms do not generally hold more than one mandate in other traded firms. They do hold multiple seats in nontraded firms.
Key words: Board of Director, Board Overlap, Board Composition, Firm Value
JEL classification: G34
European Financial Management, VOL 8:2 June 2002
Planning Your Own Debt
Soren Nielson and Rolf Poulsen
Abstract
We model the Danish market for mortgage backed securities with a two-factor interest re=ate model and use a stochastic programming approach to analyse now an individual home-owner should initially compose and subsequently readjust his mortgage in an optimal way. Results show that the "rules of thumb" used by financial institutions are reasonable, although best suited formore aggressive mortgagors, for whom the delivery option of some value. More risl-averse investors should also re-adjust frequently, but use more diversified portfilios. Results are insensitive to whether one or two factor model is used, provided the former is suitably calibrated.
Key words: Term structure of interest, mortgage-backed securities, portfolio choice, stochastic programming.
JEL classification: C61, D81, E43, G11, G21
European Financial Management, VOL 8:2 June 2002
Dispersion in Analyst Forecasts and the Profitability of Earnings Momentum Strategies
Andreas Dische
Abstract
This paper shows that the dispersion in analysts' consensus forecasts contains incremental information to predict future stock returns. Consistent with prior research, stock prices in the German market underreact to news about future earnings and drift in the direction suggested by analysts' forecasts revisions. Even higher abnormal returns can be achieved by applying such an earnings momentum strategy to stocks with a low dispersion in analyst forecasts. These results support one of the recent behavioral models in which investors underweight new evidence and conservatively update their beliefs in the right direction, but by too little in magnitude with respect to more objective information.
Keywords: analyst forecasts, dispersion, momentum, underreaction, investor behavior.
JEL classification: G12, G14
European Financial Management, VOL 8:3 September 2002
Performance and Policy of Foundation-Owned Firms in Germany
Markus Herrmann and Gunter Franke
Abstract
This paper compares performance and policy of foundation owned firms and of listed corporations in Germany. Foundations have no owners so that there exist no natural persons with financial ownership claims on firms which are wholly owned by foundations. This suggests weaker outside control of foundation owned firms implying lower profitability. The empirical findings show a slightly better performance of foundation owned firms compared to
corporations. Foundation owned firms display higher labor intensity, lower labor productivity and lower salary levels. This policy promotes job security without endangering the viability of foundation owned firms.
Keywords: corporate governance, foundation owned firms, performance, business policy, ownership structure.
JEL Classification: G30 - G33
European Financial Management, VOL 8:3 September 2002
Diversification, Ownership and Control of Swedish Corporations
John A. Doukas, Martin Holmen and Nickolaos G. Travlos*
Abstract
We study the short- and long-term valuation effects of
Swedish takeovers. Using a sample of 93 bidding firms that acquired 101 targets
between 1980 and 1995, we find that diversifying acquisitions lead to a negative
market reaction and deterioration of the operating performance of the bidder.
Announcement and performance gains in each of the three years following the
acquisition occur only when bidders expand their core than their peripheral
lines of business. Our findings suggest that focused acquisitions lead to
greater synergies and operating efficiencies than diversifying acquisitions.
Intra-group acquisitions, however, show that bidders do not realize significant
gains whether they adopt diversifying or focusing investment strategies by
purchasing firms controlled by the Wallenberg and SHB conglomerate groups.
Intra-group targets realize significant gains regardless bidder’s investment
strategy. Finally, the evidence does not support the view that
intra-conglomerate acquisitions are associated with expropriation of minority
shareholders. However, they appear to enhance the control rights of large
shareholders of the bidding firm.
Keywords: Conglomerate and Non-conglomerate Acquisitions; Corporate Focus; Diversification
JEL classification: G34
European Financial Management, VOL 8:3 September 2002
External Financing Costs and Economies of Scale in Investment Banking: The Case of Seasoned Equity Offerings in Germany
Thomas Buhner and Christoph Kaserer
Abstract
This paper is focused on the cost of raising equity
capital in Germany. In the spirit of Altinkiliç and Hansen (2000) it challenges
the conventional wisdom that flotation costs are characterized by economies of
scale.
For a sample of 120 SEOs on the German capital market over the years
1993-1998 it is found that average total flotation costs amount to 1.61 percent
of gross proceeds, while average underwriting fees are about 1.32 percent.
Moreover, it turns out that flotation costs rise the larger the free float of
the company is and the larger the share of stocks offered within a firm
commitment cash offering is. As far as the economies of scale view is concerned,
we do not find clear evidence in favour of decreasing marginal flotation costs.
Moreover, fixed costs seem not to be very high in that they account on average
for not more than 14 to 24 percent of total flotation costs or total
underwriting fees, respectively.
Keywords: raising capital, seasoned equity offerings, underwriting fees, economies of scale, German stock market
JEL Classification: G24
European Financial Management, VOL 8:3 September 2002
Stock Index-Linked Debt and Shareholder Value: Evidence from the Paris Bourse
Gordon S. Roberts, Vasumathi Vijayraghavan and Sebouh Aintablian
Abstract
French banks and nonfinancial companies issue index-linked
debt whose value at maturity is indexed to the CAC 40 or to a basket of European
indices. This paper examines stock announcement effects associated with these
bonds on three dates: the date the issuer’s General Assembly decides future
capital needs, the publication in the journal of the COB (the stock market
board) and the issue date. We find the issuance of index-linked debt has
significant positive announcement effects on the issue date, which we attribute
to its market-completion property. In order to examine further whether market
completion is at play, we decompose the value of the bond at issue into its
straight bond and option values. We determine that the bonds are overvalued
again supporting market completion.
Keywords: announcement effect, index-linked debt, market completion
JEL Classification: G14, G32
European Financial Management, VOL 8:3 September 2002
The Distribution of Information Among Institutional and Retail Investors in IPOs
Matti Keloharju and Sami Torstila
Abstract
This study examines investor performance in IPOs using a unique database comprising 85,384 investors and 29 offerings from Finland. The evidence indicates that on average institutional investors do not obtain larger initial returns than retail investors, as the incentive to acquire information is limited by allocation rules which favour small orders. This result is in contrast to findings by Aggarwal et al. (2001), who show that institutional
investors perform better in a bookbuilding environment. Within each investor category, however, large orders are associated with the best performance, suggesting that information differences figure more importantly within rather than between categories.
Key words: IPOs, investment performance, institutional investors, retail investors
JEL classification: G32, G14
European Financial Management, VOL 8:3 September 2002
PROFESSIONAL FORUM
Anatomy of the Eurobond Market 1980-2000
Anouk Claes, Marc J.K. De Ceuster, Ruud Polfliet
University of
Antwerp UFSIA, Prinsstraat 13, 2000 Antwerp, Belgium
Abstract
In this paper, we provide descriptive evidence of primary
market activity in the Eurobond market for the period 1980-2000. This study
explores the Bondware Database that contains 33 024 publicly issued Eurobonds.
We analyse some characteristics of the issuers (nationality, industry and credit
quality), the intermediary parties (bookrunners, lead managers) and the
structures used for the bonds (currencies, size, years to maturity, interest and
repayment structure, embedded options).
Keywords: Eurobond market, primary market, Bondware
JEL Classification: G15, G100
European Financial Management, VOL 8:4 December 2002
Competition on the London Stock Exchange
Nicholas Taylor
Abstract
This paper investigates the determinants of the level of
competition on the order-driven market organised by the London Stock Exchange.
In contrast to previous empirical market microstructure studies, we treat the
level of competition as an endogenous variable. The statistical nature of the
measures of competitive activity used in this paper necessitate use of a count
regression model. Using a sample of 50 stocks, we find that users of the system
tend to follow the lead of other users (termed the 'herding effect') and that
competition is greater during the period when the US exchanges are open (termed
as 'US effect'). In addition, the level of competition is positively related to
the bid-ask spread pertaining to a particular stock (termed the 'spread
effect'). The latter result is most likely due to traders following a strategy
where trade immediacy is traded off against price advantage. Finally, we find
that the magnitude of the herding effect, the spread effect and the fit of the
count regression models (termed the 'fit effect') vary in a predictable manner
across the liquidity of stocks.
Keywords: Count models, competition, limit-orders, liquidity.
JEL Classification: G14; C32
European Financial Management, VOL 8:4 December 2002
The Impact of Macroeconomic and Financial Variables on Market Risk: Evidence from International Equity Returns
Dilip K. Patro, John K. Wald and Yangru Wu*
Abstract
Using a GARCH approach, we estimate a time-varying two-factor
international asset pricing model for the weekly equity index returns of 16 OECD
countries. We find significant time-variation in the exposure (beta) of country
equity index returns to the world market index and in the risk-adjusted excess
returns (alpha). We then explain these world market betas and alphas using a
number of country-specific macroeconomic and financial variables with a panel
approach. We find that several variables including imports, exports, inflation,
market capitalization, dividend yields and price-to-book ratios significantly
affect a country’s exposure to world market risk. Similar conclusions are
obtained by using lagged explanatory variables and thus these variables may be
useful as predictors of world market risks. Several variables also significantly
impact the risk-adjusted excess returns over this time period. Our results are
robust to a number of alternative specifications. We further discuss some
economic hypotheses that may explain these relationships.
Keywords: World market risk; Determinants of country risk exposure; Panel estimation
JEL classification: F30, G12
European Financial Management, VOL 8:4 December 2002
Yield Spread and Term to Maturity: Default vs. Liquidity
Antonio Diaz and Eliseo Navarro
Abstract
The aim of this paper is the analysis of the yield spreads
between Treasury and non-Treasury Spanish fixed income assets and its
relationship with the term to maturity. We find a downward sloping term
structure of yield spreads for investment-grade bonds that seems to be contrary
to the crisis at maturity theory. However, we claim that this outcome is caused
mainly by the effect of liquidity on yield spreads. Once the effect of liquidity
and other factors are removed we find that there is a positive relationship
between default premiums and term to maturity. That result is now consistent
with the existing literature.
Keywords: Corporate bonds; Yield spread; Default risk; Liquidity; Term to maturity market
JEL Classification: G10, E43
European Financial Management, VOL 8:4 December 2002
Valuation Effects of Listing on a More Prominent Segment of the Stock Market
J. F. Bacmann, M. Dubois and C. Ertur
Abstract
We examine the behaviour of stock prices during the period
around the transfer to the Marché à Règlement Mensuel. First, we discuss the
financial reasons, which can justify abnormal returns around the transfer.
Second, an event study based on a sample of 71 firms is set up to test the
existence of the exchange listing effect on the French market. Third, we explore
three hypotheses in order to explain the impact on stock returns: the
informative content of the transfer, the increase in the relative size of the
firm’s investor base and the reduction of trading costs (immediacy and adverse
selection). Cross-sectional regressions show that the increase in the relative
size of the firm’s investor base is the only variable, which helps to explain
the valuation effect.
Keywords: Exchange listing, event study, analyst following, liquidity, trading activity, systematic risk, firm’s investor base.
JEL Classification: G12, G14
European Financial Management, VOL 8:4 December 2002
Extracting Information from Options Markets: Smiles, State-Price Densities and Risk-Aversion
Christophe Perignon and Christophe Villa
Abstract
In this paper, recent techniques of estimating implied
information from derivatives markets are presented and applied empirically to
the French derivatives market. We determine nonparametric implied volatility
functions, state-price densities and historical densities from a high-frequency
CAC 40 stock index option dataset. Moreover, we construct an estimator of the
risk-aversion function implied by the joint observation of the cross-section of
option prices and time-series of underlying asset value. We report a decreasing
implied volatility curve with the moneyness of the option. The estimated
relative risk-aversion functions are positive and globally consistent with the
decreasing relative risk-aversion assumption.
Key words: Risk-aversion; state-price density; non-parametric methods
JEL classification: G12, G13, C13
European Financial Management, VOL 8:4 December 2002
PROFESSIONAL FORUM
A Note on the Three-Portfolio Matching Problem
Fabio Trojani, Paolo Vanini and Luigi Vignola
Abstract
A typical problem arising in the financial planning for
private investors consists in the fact that the initial investor’s portfolio,
the one determined by the consulting process of the financial institution and
the universe of instruments made available to the investor have to be
matched/optimized when determining the relevant portfolio choice. We call this
problem the three-portfolios matching problem. Clearly, the resulting portfolio
selection should be as close as possible to the optimal asset allocation
determined by the consulting process of the financial institution. However, the
transition from the investor’s initial portfolio to the final one is complicated
by the presence of transaction costs and some further more specific constraints.
Indeed, usually the portfolios under consideration are structured at different
aggregation levels, making portfolios comparison and matching more difficult.
Further, several investment restrictions have to be satisfied by the final
portfolio choice. Finally, the arising portfolio selection process should be
sufficiently transparent in order to incorporate the subjective investor’s
trade-off between the objectives ’optimal portfolio matching’ and ’minimal
portfolio transitbute to its market-completion property. In order to examine
further whether market completion is at play, we decompose the value of the bond
at issue into its straight bond and option values. We determine that the bonds
are overvalued again supporting market completion.
Keywords: announcement effect, index-linked debt, market completion
JEL Classification: G14, G32
European Financial Management, VOL 9:1 March 2003
Passive Investment Strategies and Efficient Markets
Burton Malkiel
Abstract
This paper presents the case for and the evidence in favor of
passive investment strategies and examines the major criticisms of the
technique. I conclude that the evidence strongly supports passive investment
management in all markets? Small-capitalization stocks as well as
large-capitalization equities, U.S. markets as well as international markets and
bonds as well as stocks. Recent attacks on the efficient market hypothesis do
not weaken the case for indexing.
Key words: passive investment strategies; efficient markets
JEL classification: G11, G14
European Financial Management, VOL 9:1 March 2003
What is an Asset Price Bubble? An Operational Definition
Jeremy J. Siegel
Abstract
This paper reviews and analyzes the current definitions of bubbles in
asset prices. It makes the case that one cannot identify a bubble immediately, but one has to wait a sufficient amount of time to determine whether the previous prices can be justified by subsequent cash flows. The paper proposes an operational definition of a bubble as any time the realized asset return over given future period is more than two standard deviations from its expected return. Using this framework, the paper shows how the great crash of 1929 and 1987-both periods generally characterized as bubbles-prove not to be bubbles but the low point in stock prices in 1932 is a "negative bubble." The paper then extends this analysis to the internet stocks and concludes that it is virtually certain that it is a bubble.
Key words: asset prices; asset returns; bubbles; internet bubble; irrational exuberance
JEL classification: G12, G14
European Financial Management, VOL 9:1 March 2003
Herd Behavior and Cascading in Capital Markets: A Review and Synthesis
David Hirshleifer and Siew Hong Teoh
Abstract
We review theory and evidence relating to herd behavior,
payoff and reputational interactions, social learning and informational cascades
in capital markets. We offer a simple taxonomy of effects and evaluate how
alternative theories may help explain evidence on the behavior of investors,
firms and analysts. We consider both incentives for parties to engage in herding
or cascading and the incentives for parties to protect against or take advantage
of herding or cascading by others.
Key Words: herd behavior, informational cascades, social learning,
analyst herding, capital markets, financial reporting, behavioral finance,
investor psychology, market efficiency
European Financial Management, VOL 9:1 March 2003
Contrarian and Momemtum Strategies in the Spanish Stock Market
Carlos Forner and Joaquin Marhuenda
Abstract
There is extensive international evidence that the momentum
strategy yields positive abnormal returns when short-term periods are
considered, while for long-term periods the contrarian strategy is the effective
one. However, this topic has received scarce attention in the Spanish Stock
Market. In this paper we show that these two phenomena seem to be present in
this marketand concretely, that the 12-month momentum strategy and the 60-month
contrarian strategy yield positive abnormal returns, although the effectiveness
of the contrarian strategy is under suspicion when non-overlapping test-periods
are used. So, this work adds additional evidence that the results obtained for
the literature on this topic are not from data snooping.
Keywords: Efficiency, Contrarian Strategy, Momentum Strategy, Risk
JEL classification: G14, G11, G12
European Financial Management, VOL 9:1 March 2003
Post-earnings-announcement Drift in the UK
Weimin Liu, Norman Strong and Xinzhong Xu
Abstract
This paper fills a void in the market efficiency literature
by testing for the presence of post-earnings announcement drift in a non-US
market. We test for drift using alternative earnings surprise measures based on:
(i) the time-series of earnings; (ii) market prices; and (iii) analyst
forecasts. Using each of the measures we find evidence of significant
post-earnings-announcement drift, robust to alternative controls for risk and
market microstructure effects. Using a one-dimensional analysis, the price-based
measure of earnings surprise gives the strongest drift and using a
two-dimensional analysis the drift associated with the price-based measure
almost subsumes drift associated with the other two measures. Our conclusion is
that the UK stock market is inefficient with respect to publicly available
corporate earnings information. This evidence provides out-of-sample
confirmation of the post-earnings-announcement drift documented in the US.
Keywords: Post-earnings-announcement drift; market efficiency, earnings surprises
JEL classification: G14; M41
European Financial Management, VOL 9:1 March 2003
Spanish Stock Returns: Where is the Weather Effect?
Angel Pardo and Enric Valor
Abstract
Psychological studies support the existence of an influence of weather on mood. It could affect the behaviour of market traders, as suggested by some authors, and this should be reflected by the stock returns. This paper investigates the possible relation between weather and market index returns in the context of the Spanish market, in order to test the above hypothesis. In 1989, this market changed its open outcry trading system into a computerised and decentralised trading system. Therefore, it is possible to check the influence of weather variables (sunshine hours and humidity levels) on index returns in an open outcry trading system, and to compare it with a screen traded environment. The empirical evidence indicates that, independently of the trading system, there is no influence of weather on stock prices. Thus, these findings do not contest the notion of efficient market.
European Financial Management, VOL 9:2 June 2003
Keynote Address
Michael Jenson
European Financial Management, VOL 9:2 June 2003
Secured Creditor Recovery rates from Management Buy-outs in Distress
David Citron, Mike Wright, Rod Ball and Fred Rippington
Abstract
Buy-out literature suggests that secured creditors will recoup substantial proportions of the funds they extend to finance the initial buy-out. This paper uses a unique dataset of 42 failed MBOs to examine the extent of credit recovery by secured lenders under UK insolvency proceduresand the factors that influence the extent of this recovery. On average, secured creditors recover 62 per cent of the amount owed. The percentage of secured credit recovered is increased where the distressed buy-outs is sold as a going concern and where the principal reason for failure concerns managerial factors. The presence of a going concern qualification in the audit report and the size of the buy-out reduce the recovery rate by secured creditors.
Keywords: bankruptcy; secured debt; financial distress resolution
JEL Classification: G33; G32
European Financial Management, VOL 9:2 June 2003
The Underinvestment and Overinvestment Hypothesis: An Analysis using Panel Data
Arthur Morgado and Julio Pindado
Abstract
We study the relationship between firm value and investment to test the underinvestment and overinvestment hypotheses. The results obtained, using panel data methodology as the estimation method, indicate that the abovementioned relation is quadratic, whichimplies that thereexists an optimal level of investment. As a consequence, firms that invest less than the optimal level suffer from an underinvestment problem, while those investing more than the optimum suffer from overinvestment. The quadratic relation is maintained when firms are classified depending on their investment opportunities, the optimum being in accordance with the quality of investment opportunities.
Keywords: Firm investment, firm value, underinvestment, overinvestment, investment opportunities.
JEL Classification: G31
European Financial Management, VOL 9:2 June 2003
Dynamic Portfolio Selection: The Relevance of Switching Regimes and Investment Horizon
Andreas Graflund and Birger Nilsson
Abstract
This paper investigates the questions of dynamic portfolio selection and intertemporal hedging within a Markovian regime-switching framework. The investment opportunity set is spanned by a well-diversified home-market portfolio and the risk-free asset. Our results highlight the economic importance of regimes, as optimal portfolio weights are clearly
dependent on the prevailing regime. We present evidence that the question of intertemporal hedging is a more complex issue than is hinted in the previous literature, since demand for intertemporal hedging is present in some regimes, but not in others. Finally, our main findings are qualitatively unchanged across the four largest stock markets in the world.
Keywords: intertemporal hedging, dynamic portfolio selection, regime switching
JEL Classification: G11, G15, C15, C32
European Financial Management, VOL 9:2 June 2003
Conditioning Information and European Bond Fund Performance
Maria Ceu Cortez, Florida Silva and Manuel Rocha Armada
Abstract
In this paper we evaluate the performance of European bond funds using unconditional and conditional models. As conditioning information we use variables that we find to be useful in predicting bond returns in the European Market.
The results show that, in general, bond funds are not able to outperform passive strategies. These findings are robust to whatever model (unconditional versus conditional and single versus multi-index) we use. The multi-index model seems to add some explanatory power in relation to the single-index model. Furthermore, when we incorporate the predetermined information variables, we can observe a slight tendency towards better performance. This evidence is consistent with previous studies on stock funds and comes in support of the argument that conditional models might allow for a better assessment of performance. However, our results suggest that the impact of additional risk factors seems to be greater than the impact of incorporating predetermined information variables.
Keywords: Performance Evaluation, Conditional Models, Bond Funds
JEL Classification: G11, G12, G14
European Financial Management, VOL 9:2 June 2003
Managerial Equity Ownership and the Demand for Outside Directors
Kenneth V. Peasnell, Peter F. Pope and Steve Young
Abstract
This paper examines the linkage between the use of outside directors and managerial ownership. We conjecture there are two linkages: the standard incentive-alignment demand for monitoring when managers own little stock and an entrenchment-amelioration demand when managerial stock ownership is high. As a consequence, we predict the association between managerial ownership and board composition will be nonlinear (U-shaped if the entrenchment effect is sufficiently pronounced). Using U.K. data, we find that both quadratic and logarithmic models outperform the simple linear relationship assumed in prior research and that the substitution between managerial ownership and board composition is stronger than hitherto supposed.
Keywords: managerial ownership; board of directors; Cadbury Report
JEL Classification: G32; G3
European Financial Management, VOL 9:2 June 2003
PROFESSIONAL FORUM
Simple Construction of the Efficient Frontier
David Feldman and Haim Reisman
Abstract
We provide simple methods of constructing known results. At the core of our
methods is the identification of a simple concise basis that spans the Capital Market Line
(CML). We show that a portfolio whose risky assets weights are the product of the inverse
variance-covariance matrix of (nonredundant) security rates of return times the vector of the
excess expected rates of return over the risk-free rate is a CML portfolio. This portfolio and the risk-free security span the CML. In addition, with this basis, there is immediate construction of the efficient frontier of risky assets (the "hyperbola"), "tangency" portfolios, "reflection" portfolios, and a CAPM relationship. Our method is quick and simple. It is easy to derive, teach, implement, interpret, and remember.
Keywords: portfolio frontier, efficient frontier, capital market line, asset pricing
JEL Classification: G10, G11, G12
European Financial Management, VOL 9:3 September 2003
The Impact of Institutional Differences on Derivatives Usage: A Comparative Study of US and Dutch Firms
Gordon M Bobnar, Abe de Jong and Victor Marcae
Abstract
This paper examines the influence of institutional differences on corporate risk management practices in the US and the Netherlands. We compare results to surveys in each country using a strategy that corrects for differences over industry and size classes across the Dutch and US samples. We document several differences in the firms’ uses and attitudes towards derivatives and attempt to attribute them to the differences in the institutional environments between the US and the Netherlands. We find that institutional differences appear to have an important impact on risk management practices and derivatives use across US and Dutch firms.
Keywords: risk management; derivatives; hedging; international finance
JEL classification: F30; G15; G32
European Financial Management, VOL 9:3 September 2003
Incorporating Collateral Value Uncertainty in Loss-Given-Default Estimates and Loan-to-Value Ratios
Esa Jokivuolle and Samu Peura
Abstract
We present a model of risky debt in which collateral value is correlated
with the possibility of default. The model is then used to study the expected loss given default, primarily as a function of collateral. The results obtained could prove useful for estimating losses given default in many popular models of credit risk which assume them constant. We also examine the problem of determining sufficient collateral to secure a loan to a desired extent. In addition to bank practitioners, regulators might find our analysis useful in reviewing banks' lending standards relative to current collateral values. In particular, the current proposals for The New (Basel) Capital Accord involve options for the use of banks' own loss given default estimates which might benefit from the analysis in this paper.
Keywords: credit risk, collateral, loss given default, loan-to-value, Basel II
JEL Classification: G13, G21
European Financial Management, VOL 9:3 September 2003
Price Differentials Between Classes of Dual-Class Stocks: Voting Premium or Liquidity Discount?
Robert Neumann
Abstract
A series of papers suggest that private benefits can explain the price differentials between stock classes carrying different voting rights. However, in Denmark the premium is negative for several firms over long periods. This indicates that in the absence of takeover contests, where the voting right becomes crucial in a transfer of corporate control, the price differential in stock classes with identical dividend rights is more likely to reflect investors' liquidity risks. Whereas the existing literature tends to focus primarily on corporate control-related explanations, this paper documents the impact of liquidity on price spreads between dual-class shares.
Keywords: Dual-class shares; voting rights; Liquidity risk; Ownership structure
JEL Classification: G32, G34
European Financial Management, VOL 9:3 September 2003
Strategic Management of Cost efficiencies in Networks: Cross-country Evidence on European Branch Banking
Nayantara D. Hensel
Abstract
This paper examines the role of cost efficiencies on efficient management
of branch networks in the contemporary European commercial banking industry. The analysis, which could be generalized to other industries, indicates that larger banks are more likely to have heavily utilized branch networks than smaller banks and to exhibit fewer cost efficiencies from
building more branches. The finding of this result within each country suggests the role of internal firm size regardless of competitive conditions. The similar cross-country finding suggests the impact of factors such as market structure/ concentration levels and type of
non-price competition. Larger banks often generate less income per unit asset deployed. Cross-border efficiency might be improved by greater use of banks with under-used networks by banks with over-used networks.
Keywords: European banking; cost efficiencies; market structure
JEL Classification: L10, L89, L21, G21, F23, F36
European Financial Management, VOL 9:3 September 2003
Firm Defaults and the Correlation Effect
Hans Gersbach and Alexander Lipponer
Abstract
We examine how the correlations of bank loan defaults depend on the correlations of asset returns and how correlations and diversification are affected by macroeconomic risks. We highlight the main properties of the relationship between asset re-turns
and default correlations, illustrating how adverse macroeconomic shocks raise not only the likelihood of defaults, but also the correlation of defaults. The latter effect, called correlation effect, may account for more than 50% of the increase in the credit risk.
Keywords: Credit Portfolio Management, Default Correlations, Macroeconomic Shocks, Correlation Effect, Monte-Carlo Simulation
JEL Classification: F47, G11, G33
European Financial Management, VOL 9:3 September 2003
PROFESSIONAL FORUM
Paying People to Lie: The Truth About the Budgeting Process
Michael C. Jensen
Abstract
This paper analyzes the counterproductive effects associated with using budgets or targets in an organization's performance measurement and compensation systems. Paying people on the basis of how their performance relates to a budget or target causes people to game the system and in doing so to destroy value in two main ways: 1. both superiors and subordinates lie in the formulation of budgets and therefore gut the budgeting process of the critical unbiased information that is required to coordinate the activities of disparate parts of an organization, and 2. they game the realization of the budgets or targets and in doing so destroy value for their organizations. Although most managers and analysts understand that budget gaming is widespread, few understand the huge costs it imposes on organizations and how to lower them.
My purpose in this paper is to explain exactly how this happens and how managers and firms can stop this counterproductive cycle. The key lies not in destroying the budgeting systems, but in changing the way organizations pay people. In particular to stop this highly counterproductive behavior we must stop using budgets or targets in the compensation formulas and promotion systems for employees and managers. This means taking all kinks, discontinuities and non-linearities out of the pay-for-performance profile of each employee and manager. Such purely linear compensation formulas provide no incentives to lie, or to withhold and distort information, or to game the system.
While the evidence on the costs of these systems is not extensive, I believe that solving the problems could easily result in large productivity and value increases?sometimes as much as 50 to 100% improvements in productivity. I believe the less intensive reliance on such budget/target systems is an important cause of the increased productivity of entrepreneurial and LBO firms. Moreover, eliminating budget/target-induced gaming from the management system will eliminate one of the major forces leading to the general loss of integrity in organizations. People are taught to lie in these pervasive budgeting systems because if they tell the truth they often get punished and if they lie they get rewarded. Once taught to lie in this system people generally cannot help but extend that behavior to all sorts of other relationships in the organization.
Keywords: Budgeting, Budgets, Compensation, Performance Measurement, Gaming, Lying, Loss of Integrity, Truthfulness, Sandbagging, Motivation, Productivity, Incentives, Control Systems, Accounting Irregularities, Fraud, Goldbricking, Channel Stuffing, Cooking the Books, Managing Earnings, Managing the Numbers
European Financial Management, VOL 9:4 December 2003
Differences between European and American IPO Markets
Jay R. Ritter
Abstract
This brief survey discusses recent developments in the European initial public offering (IPO) market. The spectacular rise and fall of the Euro NM markets and the growth of bookbuilding as a procedure for pricing and allocating IPOs are two important patterns. Gross spreads are lower and less clustered than in the U.S. Unlike the U.S., some European IPOs, especially those in Germany, have when-issued trading prior to the final setting of the offer price. Current research includes empirical studies on the valuation of IPOs and both theoretical and empirical work on the determinants of short-run underpricing.
European Financial Management, VOL 9:4 December 2003
Choice of Selling Mechanism at the IPO: The Case of the French Second Market
Sigrid Vandemaele
Abstract
This study examines the choice of flotation mechanism within the framework of the French Second Market. Between 1983 and 1996, a firm that opted for a quotation on the Second Market, had the choice between (i) an auction-like procedure (there were two variants) and (ii) a fixed-price introduction procedure. Several interesting results are presented. First, the choice for an auction-like procedure appears to be positively related to firm valuation uncertainty at the IPO. Second, the likelihood of opting for an auction-like procedure decreases as the reputation of the investment bank guiding the flotation increases. Third, the likelihood of opting for an auction is increasing in the number of secondary shares sold by venture capitalists and investment banks.
Keywords: IPO; Contract Choice
JEL Classification: G32
European Financial Management, VOL 9:4 December 2003
Privatization Initial Public Offerings: The Polish Experience
Ranko Jelic and Richard Briston
University of Birmingham,
Birmingham Business School, Birmingham, UK
Abstract
The Polish government has preferred gradual direct sales to privatisation initial public offerings (PIPOs) by a 2.8 to 1 margin. Evidence suggests that the government has attempted to manage the timing of PIPOs. We, however, find no evidence of underpricing of PIPOs to a greater degree than that found for issues in the private sector. Both domestic and international investors in PIPOs earned predominantly positive returns up to 36 months after listing. The difference between PIPOs and private sector IPOs average returns is
statistically significant only for international investors.
Keywords: Privatisation, IPOs, Economies in Transition
JEL Classification: G18, G32, P31
European Financial Management, VOL 9:4 December 2003
Takeover Defenses and IPO Firm Value In the Netherlands
Peter Roosenboom and Tjalling van der Goot
Tilburg University and Center, University of Amsterdam
Abstract
The central question of this study involves the relation between the use of takeover defenses and IPO firm value. We report that management frequently uses takeover defenses before taking the firm public. The use of takeover defenses is primarily motivated by managerial entrenchment. IPO investors anticipate potential conflict of interests with mangement and reduce the price they pay for the IPO shares if takeover defenses are adopted. Although managers internalize this cost of takeover defenses to the degree they own pre-IPO stock, they are likely to gain through private control benefits.
Non-management pre-IPO owners lose. Their shares are worth less, but different from managers, they do not get offsetting private control benefits. We infer that managers use takeover defenses to protect private control benefits at non-management pre-IPO owners’ expense.
Keywords: initial public offering, takeover defense, firm valuation
JEL Classification: G32, G34
European Financial Management, VOL 9:4 December 2003
Should Firms Going Public Enjoy Tax Benefits? An Analysis of the Italian Experience in the '90s
Arioso Giudici and Stefano Paleari
Abstract
In Italy tax benefits are granted to firms going public. However, dDoes such tax relief really reduce the corporate tax burden ? In this workburden? In this study we tackle the issue, by considering 21 industrial firms that were listed on the Italian Exchange from 1995 to 1997, enjoying1997 and enjoyed a temporary tax rate cut-off. We find that the increase in the taxable income reported by these firms largely counterbalances the effect of the tax relief. We conclude that a tax rate cut-off may not necessarily provoke a reduction in the tax burden for newly listed firms, since in the short runterm they report larger earnings compared towith privately-owned companies. We claim that this ‘induced’ effect is mainly due to: the significant improvement ofthe operating performance in the year of the listing, tolisting; the reduction of the debt tax shield, to the increase in investments as well as to more transparency in accounting.shield; an increase in investment and more accounting transparency. Our findings suggest that tax relievesrelief for IPO firms does not necessarily provoke a loss of revenues for the Government.mean a loss of revenue for the government.
Keywords: Initial public offerings; Italian stock exchange; Tax relief; Corporate income tax
JEL Classification: G10, H20
European Financial Management, VOL 10:1 March 2004
Shareholder Wealth Effects of European Domestic and Cross-border Takeover Bids
Marc Goergen and Luc Renneboog
Abstract
This paper analyses the short-term wealth effects of large intra-European takeover bids. We find announcement effects of 9% for the target firms compared to a statistically significant announcement effect of only 0.7% for the bidders. The type of takeover bid has a large impact on the short-term wealth effects with hostile takeovers triggering substantially larger price reactions than friendly operations. When a UK firm is involved, the abnormal returns are higher than those of bids involving both a Continental European target and bidder. There is strong evidence that the means of payment in an offer has an impact on the share price. A high market-to-book ratio of the target leads to a higher bid premium, but triggers a negative price reaction for the bidding firm. We also investigate whether the predominant reason for takeovers is synergies, agency problems or managerial hubris. Our results suggest that synergies are the prime motivation for bids and that targets and bidders share the wealth gains.
Keywords: Mergers and acquisitions, domestic and cross-border takeover bids, hostile takeovers, the market for corporate control, short-term wealth effects.
JEL Classification: G32, G34
European Financial Management, VOL 10:1 March 2004
Shareholder value Creation in European M&As
José Manuel Campa and Ignacio Hernando
Abstract
This paper looks at the value generated to shareholders by the announcement of mergers and acquisitions involving firms in the European Union over the period 1998-2000. Cumulative abnormal shareholder returns due to the announcement of a merger reflect a revision of the expected value resulting from future synergies or wealth redistribution among stakeholders. Target firm shareholders receive on average a statistically significant cumulative abnormal return of 9% in a one-month window centred on the announcement date. Acquirers’ cumulative abnormal returns are null on average. When distinguishing in terms of the geographical and sectoral dimensions of the merger deals, our main finding is that mergers in industries that had previously been under government control or that are still heavily regulated generate lower value than M&A announcements in unregulated industries. This low value creation in regulated industries becomes significantly negative when the merger involves two firms from different countries and is primarily due to the lower positive return that shareholders of the target firm enjoy upon the announcement of the merger. This evidence is consistent with the existence of obstacles (such as cultural, legal, or transaction barriers) to the successful conclusion of this type of transaction, which lessen the probability of the merger actually being completed as announced and, therefore, reduce its expected value.
Keywords: mergers and acquisitions, Europe, event study.
JEL Classification: G34, G38, L44
European Financial Management, VOL 10:1 March 2004
Target Company Cross-Border Effects in Acquisitions into the UK
Jo Danbolt
Abstract
We analyze the abnormal returns to target shareholders in cross-border and domestic acquisitions of UK companies. The cross-border effect during the bid month is small (0.84 percentage points), although cross-border targets gain significantly more than domestic targets during the months surrounding the bid. We find no evidence for the level of abnormal returns in cross-border acquisitions to be associated with market access or exchange rate effects, and only limited support for an international diversification effect. However, the cross-border effect appears to be associated with significant payment effects, and there is no significant residual cross-border effect once various bid characteristics are controlled for.
Keywords: Mergers and acquisitions; shareholder returns; cross-border; differential wealth effects
JEL Classification: G34, G14, G15
European Financial Management, VOL 10:1 March 2004
Explaining the M&A-success in European Bank mergers and acquisitions
Patrick Beitel, Dirk Schiereck and Mark Wahrenburg
Abstract
We study 98 large M&As of European bidding banks from 1985 to 2000 in order to investigate drivers of excess returns to the shareholders of the targets, the bidders, and to the combined entity of the bidder and the target. Our findings show that many of 13 drivers identified mostly from prior, US-focused research have significant explanatory power, indicating that the stock market reaction to M&A-announcements of European bidding banks can be at least partly forecasted. Our results are largely consistent with the US-experience and confirm the preference of stock markets for focused transactions and against diversification. Moreover, we find that less active bidders create more value than more active/experienced bidders. This stands in contrast to some US research and may indicate that managers of frequent European bidding banks may be motivated by other objectives than creating shareholder value.
JEL Classification: G14, G21, G34
Keywords: European banks; bank mergers; mergers and acquisitions; shareholder value
European Financial Management, VOL 10:1 March 2004
An examination of takeovers, job loss and the wage decline within UK industry
Til Beckmann and William Forbes
Abstract
This paper investigates the effects of takeovers on workers’ employment prospects and wages in the United Kingdom for the years 1987-1995. We address directly the idea that takeovers involve a "breach of trust" with employees. Our results provide no support for the breach of trust hypothesis and rather suggest shareholders and workers in the post-acquisition joint entity are locked in a form of ``equal misery`` following the execution of the takeover.
There already an exist a wide range of event studies documenting the effect of takeovers on shareholders and a smaller number of studies discussing the impact of takeovers on employees. The contribution of the present study is to relate the separate effects of acquisition on these two groups to each other. By doing so we seek to test directly the proposition that takeovers reallocate rents from workers to target shareholders, via the bid-premia paid on acquisition.
Keywords: Restructuring, job loss, trust, wealth transfers
JEL Classification: G3, G18, L14
European Financial Management, VOL 10:1 March 2004
Dynamics in ownership and firm survival: Evidence from corporate Germany
Florian Heiss and Jens Koke
Abstract
This study investigates the determinants of changes in corporate ownership and firm failure for German firms. We find that many of the determinants of failure also affect ownership changes in this bank-based economy. They include poor performance, weak corporate governance, high leverage, and small firm size. The ownership structure also plays a role for both events. Separate analyses of one of these events are therefore likely to miss important effects. The implications for the German corporate governance system are that the differences to countries with more market-based systems are not as pronounced as previously speculated.
Keywords: Bankruptcy, corporate governance, ownership structure
JEL Classification: G32, G33, G34
European Financial Management, VOL 10:2 June 2004
Why Study Large Projects? An Introduction to Research on Project Finance
Benjamin Esty
Abstract
Despite the fact that more than $200 billion of capital investment was financed through
project companies in 2001, an amount that grew at a compound annual rate of almost 20% during
the 1990s, there has been very little academic research on project finance. The purpose of this
article is to explain why project finance in general and why large projects in particular merit
separate academic research and instruction. In short, there are significant opportunities to
study the relationship among structural attributes (i.e., high leverage, contractual details,
and concentrated equity ownership), managerial incentives, and asset values, as well as improve
current practice in this rapidly growing field of finance.
European Financial Management, VOL 10:2 June 2004
Keeping Up with the Joneses and the Home Bias
Beni Lauterbach and Haim Reisman
Abstract
We argue that when individuals care about their consumption relative to that of their neighbors, a home bias emerges, that is investors overweight domestic stocks in their portfolios. Domestic stocks are preferred because they also serve the objective of mimicking the economic fortunes and welfare of the investor’s neighbors, countrymen, and social reference group. We also demonstrate that globalization mitigates the home bias, and derive a modified International CAPM.
Keywords: International diversification; Home bias; Relative preferences; International CAPM.
JEL Classification: F30, G11, G12, G15
European Financial Management, VOL 10:2 June 2004
Investor Sentiment and the Closed-end Fund Puzzle: Out-of-Sample Evidence
John A. Doukas and Nikolaos T. Milonas
Abstract
In this paper we examine the proposition that small investor sentiment, measured by the change in the discount/premium on closed-end funds, is an important factor in stock returns. We conduct an out-of-sample test of the investor sentiment hypothesis in a market environment that is more likely to be prone to investor sentiment than the U.S.. We fail to provide supporting evidence of the claim of Lee, Shleifer, and Thaler (1991) that investor sentiment affects the risk of common stocks. Consistent with Elton, Gruber, and Busse (1998), who show that investor sentiment does not enter the return generating process, our tests do not detect investor sentiment in a capital market that is more susceptible to small investor sentiment. Our results provide additional support against the claim that investor sentiment represents an independent and systematic asset pricing risk.
Keywords: Closed-end-funds; discounts/premiums; investor sentiment; stock returns.
JEL Classification: G12, G14
European Financial Management, VOL 10:2 June 2004
Corporate Governance and Expected Stock Returns: Evidence from Germany
W. Drobetz, A. Schillhofer, and H. Zimmermann
Abstract
Recent empirical work shows evidence of higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm-level corporate governance also help to explain firm performance in a cross-section of companies within a single jurisdiction. Constructing a broad cor-porate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evi-dence that expected stock returns are negatively correlated with firm-level corpo-rate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high-CGR firms and shorted low-CGR firms earned abnormal returns of around 12 percent on an annual basis during the sample period.
JEL Classification: G12, G34, G38
European Financial Management, VOL 10:2 June 2004
Why Do Firms Hold Cash? Evidence from EMU Countries
Miguel A. Ferreira and Antonio S. Vilela
Abstract
This paper investigates the determinants of corporate cash holdings in EMU countries. Our results suggest that cash holdings are positively affected by the investment opportunity set and cash flows and negatively affected by asset’s liquidity, leverage and size. Bank debt and cash holdings are negatively related, which supports that a close relationship with banks allows the firm to hold less cash for precautionary reasons. Firms in countries with superior investor protection and concentrated ownership hold less cash, supporting the role of managerial discretion agency costs in explaining cash levels. Capital markets development has a negative impact on cash levels, contrary to the agency view.
Keywords: Cash holdings; Liquidity; Agency costs; Corporate Governance.
JEL Classification: G3, G32, G39
European Financial Management, VOL 10:2 June 2004
Implied Foreign Exchange Risk Premia
Nikolaos Panigirtzoglou
Abstract
This paper uses implied volatilities from foreign exchange option prices and the results of no-arbitrage theory to estimate foreign exchange risk premia. In particular, under the assumption of no-arbitrage, the foreign exchange risk premium is driven by the difference between investors’ market prices of risk in the two currencies. In an international economy with three currencies, sterling, US dollar and Deutschemark, we can use the information on implied volatilities of the three cross rates to derive estimates of implied or ex ante market prices of risk and of foreign exchange risk premia. The foreign exchange risk premia estimates are then compared to survey-based risk premia.
Keywords: foreign exchange; risk premia; pricing kernel.
JEL Classification: G12, G15, F31
European Financial Management, VOL 10:2 June 2004
Why European Firms issue Convertible Debt?
Franck Bancel and Usha R. Mittoo
Abstract
We survey European managers to gain some insights into motivations of convertible issuance. Our analysis shows that a majority of firms issue convertibles as “delayed equity” and as “debt sweetener”. Managers also use convertibles to avoid short-term equity dilution and to signal firm’s future growth opportunities. We document a large cross-sectional variation across firms in rationales for issuing convertibles and find mixed support for most theoretical models. Our evidence suggests that the popularity of convertibles is driven primarily by their versatility in adjusting their design to fit the financing needs of individual firms, and by their increased demand among institutional investors.
Keywords: Convertible Debt, European Managers, Survey, Delayed Equity, Debt Sweetener
JEL Classification: G32, G15, F23
European Financial Management, VOL 10:3 September 2004
Divergence of US and Local Returns in the After-Market for Equity Issuing ADRs
Padma Kadiyala and Avanidhar Subrahmanyam
Abstract
We study one-year post-listing prices and returns to equity issuing ADRs that listed in the US between January 1991 and
October 2000. ADRs from countries that impose restrictions on capital flows are priced at a premium to their home market
ordinaries. While the mean premium for the full sample is statistically indistinguishable from zero, after an adjustment
for asynchronous trading, the magnitude of the premium to ADRs from restricted markets is 11.33% at the 300-day post listing
interval, which is statistically significant. In the short run (30 days) following listing, the magnitude of the premium is
larger for ADRs with larger excess demand from US investors. At the longer 300-day horizon, Nasdaq listed ADRs earn a larger
premium than their NYSE/AMEX listed counterparts. Time-series regressions and two-stage cross-sectional regressions
establish that the premium to foreign equity issuers is greater if the US listing attracts liquidity and if US returns have
a lower correlation with the local country index.
Keywords: ADRs, Market Efficiency, International Finance
JEL Classification: F30, G12, G14
European Financial Management, VOL 10:3 September 2004
An empirical analysis of Finnish mutual fund expenses and returns
Timo Korkeamaki and Thomas Smythe, Jr.
Abstract
A tremendous amount of research examines U.S. mutual funds, but fund markets also thrive in other countries. However, research about these fast growing markets is lacking. This study addresses Finnish funds. Fast growth of the Finnish fund industry, strong bank dominance in the industry, and recent EU membership make it an interesting market to examine. The Finnish fund market is also of particular interest since it had the fastest growth among the EU countries during 1996-2000. We find evidence that bank-managed and older funds charge higher expenses but investors are not compensated for paying higher expenses with higher risk-adjusted returns, suggesting a potential agency problem. Overall, Finnish fund expenses have decreased over time, consistent with EU membership reducing market
segmentation and generating competition.
Keywords: Mutual funds, fees, returns, international.
JEL Classification: G15, G18, G20
European Financial Management, VOL 10:3 September 2004
Multinational Diversification and Corporate Performance: Evidence From European Firms
Ike Mathur, Manohar Singh and Kimberly C. Gleason
Abstract
We investigate the empirical relationship between accounting based measures of performance and the degree of multinational diversification for a set of European chemical industry firms. We find that for these firms, the degree of multinational diversification is strongly related to superior financial performance. The results hold for each of the three sample years. The findings suggest that multinational firms outperform purely domestic and exporting firms. The results provide strong support for gains from multinational diversification. The results indicate that while greater European unification may have eroded potential benefits of exploiting international capital and product market imperfections, the benefits of firm specific economies of scope and scale as well as managerial and financial synergies are still realized through exports.
Keywords: Multinational diversification; corporate performance; European unification
JEL Classification: F23, F21, F31
European Financial Management, VOL 10:3 September 2004
The Cost of Capital of Cross-listed Firms
Koedijk Kees and Van Dijk
Abstract
This paper analyzes the cost of capital of firms with foreign equity listings. Our purpose is to shed light on the question whether international and domestic asset pricing models yield a different estimate of the cost of capital for cross-listed stocks. We distinguish between (i) the multifactor ICAPM of Solnik (1983) and Sercu (1980) including both the global market portfolio and exchange rate risk premia, and (ii) the single factor domestic CAPM. We test for the significance of the cost of capital differential in a sample of 336 cross-listed stocks from nine countries in the period 1980-1999. Our hypothesis is that the cost of capital differential is substantial for firms with international listings, as these are often large multinationals with a strong international orientation. We find that the asset pricing models yield a significantly different estimate of the cost of capital for only 12 percent of the cross-listed companies. The size of the cost of capital differential is around 50 basis points for the U.S., 80 basis points for the U.K., and 100 basis points for France.
Keywords: Cross-listings, cost of equity capital, foreign exchange exposure
JEL Classification: G15, G31, F31
European Financial Management, VOL 10:3 September 2004
The Effects of Monetary Unification on German Bond Markets
Hans Dewachter, Marco Lyrio and Konstantijn Maes
Abstract
We develop a benchmark against which the effects of ECB monetary policy on the German bond market can be evaluated. We first estimate an affine term structure model for the pre-EMU period linking the German yield curve with the Bundesbank monetary policy. The German monetary policy and its implied yield curve are then reprojected onto the EMU period. The reprojected yield curve differs significantly from the observed one. Short-term interest rates during the EMU period are significantly lower than they would have been in case the Bundesbank were still in charge of monetary policy. Furthermore, yield spreads increased substantially during the EMU period.
Keywords: EMU, ECB, Bundesbank, central bank monetary policy rule, essentially affine term structure model
JEL Classification: E43, E44, E52, E58
European Financial Management, VOL 10:3 September 2004
Exchange Rates and Capital Flows
Robin Brooks, Hali Edison, Manmohan S. Kumar, Torsten Sloka
Abstract
This paper explores the ability of portfolio and foreign direct investment flows to track movements in the euro and the yen against the dollar. Net portfolio flows from the euro area into U.S. stocks possibly reflecting differences in expected productivity growth track movements in the euro against the dollar closely. Net FDI flows, which capture the recent burst in cross-border M&A activity, appear less important in tracking movements in the euro-dollar rate, possibly because many M&A transactions consist of share swaps. Movements in the yen versus the dollar remain more closely tied to conventional variables such as the current account and interest differential.
Keywords: Exchange rate models, euro/dollar and yen/dollar exchange rates, capital flows
JEL Classification: F31, F32
European Financial Management, VOL 10:4 December 2004
The Agency Costs of Overvalued Equity and the Current State of Corporate Finance
Michael C. Jensen
Keywords: Overpriced Equity; market mistakes; misvaluation; failure of corporate governance; control; incentives; Investment banks; security analysts; naïve investors.
European Financial Management, VOL 10:4 December 2004
Analyzing Perceived Downside Risk: the Component Value-at-Risk Framework
Winfried G. Hallerbach and Albert J. Menkveld
Abstract
Multinational companies face increasing risks arising from external risk factors, e.g. exchange rates, interest rates and
commodity prices, which they have learned to hedge using derivatives. However, despite increasing disclosure requirements,
a firm’s net risk profile may not be transparent to shareholders. We develop the ‘Component Value-at-Risk (VaR)’
framework for companies to identify the multi-dimensional downside risk profile as perceived by shareholders. This framework
allows for decomposing downside risk into components that are attributable to each of the underlying risk factors. The firm
can compare this perceived VaR, including its composition and dynamics, to an internal VaR based on net exposures as it known
to the company. Any differences may lead to surprises at times of earnings announcements and thus constitute a litigation threat
to the firm. It may reduce this information asymmetry through targeted communication efforts.
Keywords: Value-at-Risk, factor models, risk decomposition
JEL Classification: G3, G32, G1, G14
European Financial Management, VOL 10:4 December 2004
The Comovement of US and UK Stock Markets
Tom Engsted and Carsten Tanggaard
Abstract
US and UK stock returns are highly positively correlated over the period 1918-1999. Using VAR-based variance
decompositions, we investigate the nature of this comovement. Excess return innovations are decomposed into news about future
dividends, real interest rates, and excess returns. We find that the latter news component is the most important in explaining
stock return volatility in both the US and the UK and that stock return news is highly correlated across countries. This is evidence
against Beltratti and Shiller's (1993) finding that the comovement of US and UK stock markets can be explained in terms of a simple
present value model. We interpret the comovement as indicating that equity premia in the two countries are hit by common real shocks.
Keywords: Comovement of stock returns; Variance decomposition; VAR model; Bias-correction; Bootstrap simulation.
JEL Classification: C32, G12
European Financial Management, VOL 10:4 December 2004
How Fundamental are Fundamental Values? Valuation Methods and Their Impact on the Performance of German Venture Capitalists
Ingolf Dittmann, Ernst Maug and Johannes Kemper
Abstract
This paper studies how the use of alternative valuation methodologies affects investment performance for a sample of 53 German venture capitalists.
We measure investment performance by the amount of investments they need to write off and by the number of companies they take public. We find that a significant number
of investment managers use discounted cash flow (DCF) techniques, but only a minority appears to use a discount rate related to the cost of capital. The majority applies
DCF using subjective discount rates. We present evidence that the use of DCF is correlated with superior investment performance only if applied in conjunction with an
objectifiable discount rate. Also, funds that invest with a longer horizon perform better. The use of multiples is not significantly correlated with investment performance.
We conclude that a focus on fundamental values confers an advantage.
Keywords: DCF, Performance, Valuation, Venture Capital, IPO
JEL Classification: G15, G24, G31
European Financial Management, VOL 10:4 December 2004
PROFESSIONAL FORUM
Political Uncertainty, Financial Crisis, and Market Volatility
Jianping Mei and Limin Guo
Abstract
This paper examines the impact of political uncertainty on financial crises using a panel of twenty-two emerging markets. By examining political election cycles, we find that eight out of nine of the financial crises happened during the periods of political election and transition. Using a combination of probit and switching regression analysis, we find that there is a significant relationship between political election and financial crisis after controlling for differences in economic and financial conditions. We observe increased market volatility during political election and transition periods. Our results suggest that political uncertainty could be a major contributing factor to financial crisis. Thus, politics does matter in emerging markets. Since the odds of financial crisis tend to be much larger during the political election periods, institutonal investors should take that into account when making emerging market investment during those time periods.
Keywords: Political Elections, Currency Devaluation, and Market Contagion
European Financial Management, VOL 11:1 January 2005
Financial Integration and EMU
Franklin Allen and Wei-Ling Song
Abstract
This paper investigates the effect of European Monetary Union on the integration of the financial services industry within Europe using data on the
announcements of M&A’s within the industry. We find some evidence that EMU has helped financial integration within the Euro area. In addition, financial institutions in
EMU countries became more active in initiating integration between EMU and non-EMU partners, which also contributed to overall regional integration within Europe.
The more active role of EMU institutions suggests that institutions residing in the Eurozone became stronger players in the corporate control market. However, EMU does
not facilitate the entry of non-European institutions into Europe.
Keywords: Financial integration, financial institutions, mergers, euro
JEL Classification: G21, G34, F23
European Financial Management, VOL 11:1 January 2005
A Parimutuel Market Microstructure for Contingent Claims Trading
Jeffrey Lange and Nicholas Economides
Abstract
Parimutuel principles are widely used as an alternative to fixed odds gambling in which a bookmaker acts as a dealer by quoting fixed rates of return on specified wagers. A parimutuel game is conducted as a call auction in which odds are allowed to fluctuate during the betting period until the betting period is closed or the auction “called”. The prices or odds of wagers are set based upon the relative amounts wagered on each risky outcome. In financial microstructure terms, trading under parimutuel principles is characterized by (1) call auction, non-continuous trading; (2) riskless funding of claim payouts using the amounts paid for all of the claims during the auction; (3) special equilibrium pricing conditions requiring the relative prices of contingent claims equal the relative aggregate amounts wagered on such claims; (4) endogenous determination of unique state prices; and (5) higher efficiency. Recently, a number of large investment banks have adopted a parimutuel mechanism for offering contingent claims on various economic indices, such as the U.S. Nonfarm payroll report and Eurozone Harmonized inflation.
Our paper shows how the market microstructure incorporating parimutuel principles for contingent claims which allows for notional transactions, limit orders, and bundling of claims across states is constructed. We prove the existence of a unique price equilibrium for such a market and suggest an algorithm for computing the equilibrium.
We also suggest that for a broad class of contingent claims, that the parimutuel microstructure recently deployed offers many advantages over the dominant dealer and exchange continuous time mechanisms.
Keywords: market microstructure, contingent claims, exchange, Parimutuel, Financial options, risk
JEL Classification: G10, G13, G14
European Financial Management, VOL 11:1 January 2005
The Capital Structure of Swiss Companies: An Empirical Analysis Using Dynamic Panel Data
Philippe Gaud, Elion Jani, Martin Hoesli and André Bender
Abstract
In this paper, we analyze the determinants of the capital structure for a panel of 104 Swiss companies listed in the Swiss stock exchange. Dynamic tests are performed for the period 1991-2000. It is found that the size of companies and the importance of tangible assets are positively related to leverage, while growth and profitability are negatively associated with leverage. The sign of these relations suggest that both the pecking order and trade-off theories are at work in explaining the capital structure of Swiss companies, although more evidence exists to validate the latter theory. Our analysis also shows that Swiss firms adjust toward a target debt ratio, but the adjustment process is much slower than in most other countries. It is argued that reasons for this can be found in the institutional context.
Keywords: Capital structure, Dynamic panel data, Trade-off theory, Pecking order theory
JEL Classification: G32
European Financial Management, VOL 11:1 January 2005
Contrarian Profits and the Overreaction Hypothesis: The Case of the Athens Stock Exchange
Antonios Antoniou, Emilios C. Galariotis and Spyros I. Spyrou
Abstract
This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.
Keywords: Overreaction, Delayed reaction, Contrarian Profits, Multifactor Models, and Emerging Stock Markets
JEL Classification: G1
European Financial Management, VOL 11:1 January 2005
Use of the Proceeds and Long-Term Performance of French SEO Firms
Pierre Jeanneret
Abstract
This paper examines the long-term stock performance of French SEO with rights by looking at the intended use of the proceeds. Firms that raise equity for pure capital structure motives are separated from the ones that use the SEO proceeds to finance specific investment projects. Issuers in the fist category are concerned about preserving their financial flexibility and they are expected to evolve in a capital structure irrelevancy framework. On the other hand, issuers in the second category are more inclined to be sensitive to adverse selection problems or agency conflicts and thus, they should be more exposed to under-reaction on the long-run. According to a matching firm methodology, “Financing New Investment” issuers underperform their benchmark at a rate of 4 % to 8 % per year over a 36-month horizon while “Capital Structure” issuers do not show any abnormal performance. These results are robust according to alternative Beta pricing models. In addition, managers of both issuer’s types time the SEO after a period of positive abnormal performance in order to sell overpriced securities. However, only the “Financing New Investment” sample experiences a performance reversal; the abnormal returns decreasing gradually from the issue on, to become significantly negative 24 months after the event.
Keywords: Seasoned equity offerings, long-term event study, abnormal performance, under-reaction, use of the proceeds, window of opportunity
JEL Classification: G14, G32
European Financial Management, VOL 11:2 March 2005
Are Euro Area Small Cap Stocks an Asset Class? Evidence from Mean-Variance Spanning Testsº
Giovanni Petrella
Abstract
In this paper we perform regression-based tests for mean-variance spanning in order to detect the effect of investing in euro area small capitalization stocks on the minimum variance frontier, and apply different measures to assess the extent of diversification gains. Empirical analysis shows that euro area small and mid cap stocks, as classified by size quartile and quintile rankings, arise as truly autonomous asset classes. This result is robust to different methodologies used to form size-based portfolios, and holds relative to both euro area large cap stocks and other international asset classes, US small capitalization stocks included.
Keywords: asset allocation; portfolio diversification; small cap stocks
JEL Classification: G11, G15
European Financial Management, VOL 11:2 March 2005
Socialism and Intrafirm Asset Allocation
Petra Joerg, Claudio Loderer and Lukas Roth
Abstract
We rely on a survey of Swiss firms to document deviation from first-best for reasons of internal “fairness” when allocating resources. This “socialist” practice is more widespread in smaller than in larger firms. It ignores the reputation and past performance of the managers who apply for funding, but takes into account their hierarchical position and their past use of resources. Socialism is only partially explained by concerns about empire building and managerial optimism, and it is not meant to benefit shareholders.
Keywords: Capital budgeting, Internal socialism, Empire building, Managerial optimism, Performance
JEL Classification: G31, L22, M14
European Financial Management, VOL 11:2 March 2005
An Intertemporal International Asset Pricing Model: Theory and Empirical Evidence
Jow-ran Chang, Vihang Errunza, Ked Hogan and Mao-wei Hung
Abstract
We extend Campbell's (1993) model to develop an intertemporal international asset pricing model (IAPM). We show that the expected
international asset return is determined by a weighted average of market risk, market hedging risk, exchange rate risk and exchange rate hedging
risk. These weights sum up to one. Our model explicitly separates hedging against changes in the investment opportunity set from hedging against
exchange rate changes as well as exchange rate risk from intertemporal hedging risk. A test of the conditional version of our intertemporal IAPM
using a multivariate GARCH process supports the asset pricing model. We find that the exchange rate risk is important for pricing international
equity returns and it is much more important than intertemporal hedging risk.
Keywords: International Finance, Asset Pricing, Currency Risk, Intertemporal
JEL Classification: G11, G12, G15
European Financial Management, VOL 11:2 March 2005
Liability Risk for Outside Directors: A Cross-Border Analysis
Bernard Black, Brian Cheffins and Michael Klausner
Abstract
Much has been said recently about the risky legal environment in which outside directors of public companies operate, especially in the United States,
but increasingly elsewhere as well. Our research on outside director liability suggests, however, that directors' fears are largely unjustified. We examine the law and
lawsuit outcomes in four common law countries (Australia, Canada, Britain, and the United States) and three civil law countries (France, Germany, and Japan). The legal
terrain and the risk of "nominal liability" (a court finds liability or the defendants agree to a settlement) differ greatly depending on the jurisdiction. But nominal
liability rarely turns into "out-of-pocket liability," in which the directors pay personally damages or legal fees. Instead, damages and legal fees are paid by the
company, directors' and officers' (D&O) insurance, or both. The bottom line: outside directors of public companies face only a tiny risk of out-of-pocket liability.
We sketch the political and market forces that produce functional convergence in outcomes across countries, despite large differences in law, and suggest reasons to think
that this outcome might reflect sensible policy.
European Financial Management, VOL 11:2 March 2005
Credit Rationing, Customer Relationship and the Number of Banks: an Empirical Analysis
Eric de Bodt, Frédéric Lobez and Jean-Christophe Statnik
Abstract
The recent important transformations of the banking sector, especially through numerous mergers and acquisitions, both in Europe and in the USA,
have raised serious concerns for the financing of small businesses (SBS). Indeed, SBS are known to be heavily dependent of this financing channel but to be rather opaque.
It has long been thought that banks classically solved this problem by developing long term customer relationships. But will the new large banks, born from the current
restructuring process, be able to continue to play this role? If not, what strategy should SBS develop to compose their bank pool in order to avoid, as much as possible,
credit rationing? These questions are at the heart of our analysis. We show that there is no unique rule: all depends on the degree of SBS opacity and the kind of bank the
SBS are working with.
Keywords: Credit Rationing, Customer Relationship, Bank Pool
JEL Classification: G10, G18, G28, G38
European Financial Management, VOL 11:3 June 2005
Do Insider Trading Laws Work?
Arturo Bris
Abstract
This paper presents the first comprehensive global study of insider trading laws and their first enforcement.
In a sample of 4,541 acquisitions from 52 countries, I find that insider trading enforcement increases both
the incidence, and the profitability of insider trading. The expected total insider trading gains increase.
Consequently, laws that proscribe insider trading fail to eliminate insider profits. However, harsher laws
work better at reducing the incidence of illegal insider trading.
Keywords: Insider trading, Takeovers, Market regulation
JEL Classification: G38, G34, G15
European Financial Management, VOL 11:3 June 2005
European Momentum Strategies, Information Diffusion, and Investor Conservatism
John A. Doukas and Phillip J. McKnight
Abstract
In this paper we conduct an out-of-sample test of two behavioral theories that have been proposed to explain
momentum in stock returns. We test the gradual-information-diffusion model of Hong and Stein (1999) and the
investor conservatism bias model of Barberis, Shleifer and Vishny (1998) in a sample of 13 European stock markets
during the period 1988 to 2001. These two models predict that momentum comes from the (i) gradual dissemination
of firm-specific information and (ii) investors’ failure to update their beliefs sufficiently when they observe new public
information. The findings of this study are consistent with the predictions of the behavioral models of Hong and
Stein’s (1999) and Barberis et al. (1998). The evidence shows that momentum is the result of the gradual diffusion of
private information and investors’ psychological conservatism reflected on the systematic errors they make in forming
earnings expectations by not updating them adequately relative to their prior beliefs and by undervaluing the
statistical weight of new information.
Keywords: Short-term momentum returns, Gradual dissemination of information, Investor psychological conservatism
JEL Classification: G1, G11, G14
European Financial Management, VOL 11:3 June 2005
Who Controls US?
Yoser Gadhoum, Larry H.P. Lang and Leslie Young
Abstract
Berle and Means asserted that US corporations typically have dispersed shareholders; their evidence did not support this conclusion. Today, 59.74
percent of US corporations have “controlling shareholders” who hold at least 10 percent of the shares; 24.57 percent are controlled and managed by
a family; 16.33 percent are controlled by a widely-held financial institution; 13.55 percent are controlled through family trusts. In all size ranges, the US has more
corporations controlled by families than by financial institutions. In almost all size ranges, it has a higher percentage of family-controlled corporations than any of
next four largest economies.
Keywords: Corporate Governance, Ownership Structure
JEL Classification: G32
European Financial Management, VOL 11:3 June 2005
The Performance of U.K. International Unit Trusts
Jonathan Fletcher and Andrew Marshall
Abstract
We evaluate the performance of U.K. unit trusts with international equity
objectives between January 1985 and December 2000 relative to domestic benchmark strategies.
We use performance measures based on Jensen (1968), Ferson and Schadt (1996), and the Chen and
Knez (1996) law of one price (LOP). We find more favorable trust performance using the Jensen
and Ferson and Schadt measures relative to the LOP measure. There is evidence of inferior
performance by some international trusts using the unconditional LOP measure. The charges
and investment sector of the trust also has an impact on the performance of the trusts using the LOP measure.
Keywords: International investment, Fund performance
JEL Classification: G10, G12
European Financial Management, VOL 11:3 June 2005
Noise and the Trading Mechanism: The Case of SETS
Patricia Chelley-Steeley
Abstract
On October 20, 1997, the London Stock Exchange introduced a new trading systemcalled SETS. This system was to replace the dealer system SEAQ,
which had been inoperation since 1986. Using the iterative sum of squares test introduced by Inclan andTiao(1994), we investigate whether there was a
change in the unconditional variance ofopening and closing returns, at the time SETS was introduced. We show that for theFTSE-100 stocks traded on
SETS, on the days following its introduction, there was awidespread increase in the volatility of both opening and closing returns. However,
nosynchronous volatility changes were found to be associated with the FTSE-100 index orFTSE-250 stocks. We conclude therefore that the
introduction of the SETS tradingmechanism caused an increase in noise at the time the system was introduced.
Keywords: Trading Mechanism, Noise, SETS, Opening and Closing Returns
JEL Classification: G16
European Financial Management, VOL 11:4 September 2005
Understanding Regulation
Andrei Shleifer*
Keywords: Government Regulation; Regulation of Securities Markets
JEL Classification: G21
* Keynote Address at the 2004 European Financial Management Association Meetings, Basel, Switzerland, June 2004
A Reconsideration of Tax Shield Valuation
Enrique R. Arzac and Lawrence R. Glosten
Abstract
A quarter-century ago, Miles and Ezzell (1980) solved the valuation problem of a firm that follows a constant leverage ratio L = D/S. However, to this
day, the proper discounting of free cash flows and the computation of WACC are often misunderstood by scholars and practitioners alike. For example, it is common for
textbooks and fairness opinions to discount free cash flows at WACC with beta input S = [1+(1–)L]u, although the latter is not consistent with the assumption of constant
leverage. This confusion extends to the valuation of tax shields and the proper implementation of adjusted present value procedures. In this paper, we derive a general
result on the value of tax shields, obtain the correct value of tax shields for perpetuities, and state the correct valuation formulas for arbitrary cash flows under
a constant leverage financial policy.
Keywords: Tax Shield Valuation, WACC, APV, Cost of Capital, Leveraged Beta
JEL Classification: G13, G30, G31, G32, G33
A Conditional Assessment of the Relationships Between the Major World Bond Markets
Delroy M. Hunter and David P. Simon
Abstract
This paper uses a bivariate GARCH framework to examine the lead-lag relations and the conditional correlations between 10-year US government
bond returns and their counterparts from the UK, Germany, and Japan. We find that while mean and volatility spillovers exist between the major
international bond markets, they are much weaker than those between equity markets. The results also indicate that the correlations between the US and
other major bond market returns are time varying and are driven by changing macroeconomic and market conditions. However, in contrast to the finding
that the benefits of international diversification in equity markets evaporate during high-stress periods, we find that the benefits of
diversification across major government bond markets do not decrease during periods of extremely high bond market volatility or following extremely
negative US and foreign bond returns.
Keywords: International bonds, conditional correlation, bond correlation, diversification benefits
JEL Classification: G15
Is Investment-Cash Flow Sensitivity Caused by Agency Costs or Asymmetric Information? Evidence from the UK
Grzegorz Pawlina and Luc Renneboog
Abstract
We investigate the investment-cash flow sensitivity of a large sample of the UK listed firms and confirm that investment is
strongly cash flow-sensitive. Is this sensitivity a result of agency problems when managers with high discretion overinvest, or of
asymmetric information when managers owning equity are underinvesting if the market (erroneously) demands too high a risk premium?
We find that investment-cash flow sensitivity results mainly from the agency costs of free cash flow. The magnitude of the
relationship depends on insider ownership in a non-monotonic way. Furthermore, we obtain that outside blockholders, such as financial
institutions, the government, and industrial firms (only at high control levels), reduce the cash flow sensitivity of investment via
effective monitoring. Finally, financial institutions appear to play a role in mitigating informational asymmetries between firms
and capital markets. We corroborate our findings by performing additional tests based on the stochastic efficient frontier approach
and power indices.
Keywords: Investment-cash flow sensitivity; Ownership and control; Asymmetric information; Liquidity constraints; Agency costs of free cash flow; Large shareholder monitoring; Shapley values.
JEL Classification: D92, G31, G32
Equity Issuance, CEO Turnover and Corporate Governance
David Hiller, Linn Scott, Patrick McColgan
Abstract
There is substantial evidence on the effect of external market discipline on chief executive turnover decisions in poorly performing companies.
In this study we present evidence on the role of institutional monitoring in these decisions through the equity issuance process.
We find that firms which undertake equity offerings are associated with an increased rate of forced CEO turnover that is focused on the managers of poorly performing companies.
At the same time, equity offerings increase the likelihood of a new CEO being appointed from outside the current management team.
We also provide evidence that independent boards are more likely to forcibly remove CEOs from their position, although this is not conditional on poor performance.
Keywords: : CEO Turnover, Equity Issuance, Board Structure.
JEL Classification: G32
European Financial Management, VOL 11:5 November 2005
Rain or Shine: Where is the Weather Effect?
William N. Goetzmann and Ning Zhu
Abstract
There is considerable empirical evidence that emotion influences decision-making. In this paper, we use a database of individual investor accounts to examine the weather effects on traders. Our analysis of the trading activity in five major U.S. cities over a six-year period finds virtually no difference in individuals’ propensity to buy or sell equities on cloudy days as opposed to sunny days. If the association between cloud cover and stock returns documented for New York and other world cities is indeed caused by investor mood swings, our findings suggest that researchers should focus on the attitudes of market-makers, news providers or other agents physically located in the city hosting the exchange. NYSE spreads widen on cloudy days. When we control for this, the weather effect becomes smaller and insignificant. We interpret this as evidence that the behavior of market-makers, rather than individual investors, may be responsible for the relation between returns and weather. .
Keywords: : Weather Effect, Market Efficiency, Order Flow, Volatility, Individual Behavior .
JEL Classification: G12, G14
Divergence of Opinion Surrounding Extreme Events
Tim Loughran and Jennifer Marietta-Westberg
Abstract
This paper examines the stock market performance of a large sample of new issues (IPOs and SEOs) following an extreme price movement during the first three years after the offering. Strong underperformance follows either a positive or negative (at least +/ 15%) one day return event. This poor performance cannot be explained by the Fama-French four-factor methodology, or by the generally low stock returns of growth firms. Unlike recent issuers, non-issuers report no poor performance following a similar extreme event using the four-factor methodology. The extreme event date shows very high levels of turnover, a measure of divergence of opinion. Finally, there is a strong negative linkage between higher levels of divergence of opinion and subsequent stock performance. .
Keywords: :
JEL Classification:
Does the Precision of News Affect Market Underreaction? Evidence from Returns Following Two Classes of Profit Warnings.
George Bulkley and Renata Herrerias
Abstract
We evaluate whether the market reacts rationally to profit warnings by testing for subsequent abnormal returns.
Warnings fall into two classes: those that include a new earnings forecast, and those that offer only the guidance that earnings will be below current expectations.
We find significant negative abnormal returns in the first three months following both types of warning. There is also evidence that underreaction is more pronounced when the disclosure is less precise.
Abnormal returns are significantly more negative following disclosures that offer only qualitative guidance than when a new earnings forecast is included.
Keywords: : Profit warnings; Market efficiency; Anomalies.
JEL Classification: G12; G14
Can Companies Influence Investor Behavior through Advertising? Super Bowl Commercials and Stock Returns
Frank Fehle, Sergey Tsyplakov and Vladimir Zdorovtsov
Abstract
Recent research shows that mood and attention may affect investors’ choices.
In this paper we examine whether companies can create such mood and attention effects through advertising.
We choose a natural experiment by investigating price reactions and trading activity for firms employing TV commercials in nineteen Super Bowl broadcasts over the 1969 – 2001 period. We find significant positive abnormal returns for firms which are readily identifiable from the ad contents, which is consistent with the presence of mood and attention effects. For recognizable companies with the number of ads greater than the sample mean, the event is followed by an average abnormal one day return of 45 basis points. The effect appears to persist in the short term with the 20-day post-event cumulative abnormal returns for such firms averaging two percent. We find significant abnormal net buying activity for small trades in shares of recognized Super Bowl advertisers indicating that small investors tend to be the ones most attracted by the increased publicity.
Keywords: : Investor Behavior, Advertising.
JEL Classification: G12, G14.
Does Overconfidence Affect Corporate Investment? CEO Overconfidence Measures Revisited
Ulrike Malmeddier and Geoffrey Tate
Abstract
This article presents the growing research area of Behavioral Corporate
Finance in the context of one specific example: distortions in corporate
investment due to CEO overconfidence. We first review the relevant
psychology and experimental evidence on overconfidence. We then summarize
the results of Malmendier and Tate (2005a) on the impact of overconfidence
on corporate investment. We present supplementary evidence on the
relationship between CEOs’ press portrayals and overconfident investment
decisions. This alternative approach to measuring overconfidence, developed
in Malmendier and Tate (2005b), relies on the perception of outsiders
rather than the CEO’s own actions. The robustness of the results across
such diverse proxies jointly corroborates previous findings and suggests
new avenues to measuring executive overconfidence.
Keywords: Behavioral Corporate Finance, CEO overconfidence, corporate investment
JEL Classification: G14, G31, G32, D80
On the Stability of the Cross-Section of Expected Stock Returns in the Cross-Section: Understanding the Curious Role of Share Turnover
Avanidhar Subrahmanyam
Abstract
In this paper, we shed further light on cross-sectional predictors of stock return performance.
Specifically, we explore whether the cross-section of expected stock returns is robust within stock groups sorted by past monthly return.
We find that the book/market and momentum effects are remarkably robust to sorting on past returns.
However, share turnover is negatively related to future returns for stocks with abnormally low stock price performance in the recent past, but positively related to returns for well-performing stocks. This casts doubt on the use of turnover as a liquidity proxy, but is consistent with turnover being a proxy for momentum trading which pushes prices in the direction of past price movements.
Our results are robust to both NYSE/AMEX and Nasdaq stocks, and also robust to stratifying the sample by time period.
Keywords: Market efficiency, trading activity
JEL Classification: G12, G14
European Financial Management, VOL 12:1 January 2006
Share Repurchases, Dividends, and Executive Options: the Effect of Dividend Protection
Eva Liljeblom and Daniel Pasternack
Abstract
We study the determinants of share repurchases and dividends in Finland. We find that higher foreign ownership serves as a determinant of share
repurchases and suggest that this is explained by the different tax treatment of foreign and domestic investors. Further, we also find support for the signalling and a
gency cost hypotheses for cash distributions. The fact that 41% of the option programmes in our sample are dividend protected allows us to test more directly the
"substitution/managerial wealth" hypothesis for the choice of distribution method. When options are dividend protected, the relationship between dividend distributions
and the scope of the options programme turns to a significantly positive one instead of the negative one documented in US data.
Keywords: Share repurchases, Executive options, Foreign owners
JEL Classification: G12, G32, G35
Optimal Portfolio Allocation Under Higher Moments
Eric Jondeau and Michael Rockinger
Abstract
We evaluate how departure from normality may affect the allocation of assets. A Taylor series expansion of the expected utility allows to focus on
certain moments and to compute the optimal portfolio allocation numerically. A decisive advantage of this approach is that it remains operational even for a large number
of assets. While the mean-variance criterion provides a good approximation of the expected utility maximization under moderate non-normality, it may be ineffective under
large departure from normality. In such cases, the three-moment or four-moment optimization strategies may provide a good approximation of the expected utility.
Keywords: Asset allocation, Stock returns, Non-normality, Utility function
JEL Classification: C22, C51, G12
Acquisitions: Private versus Public
Paul Draper and Krishna Paudyal
Abstract
Takeovers of privately held companies represent more than 80% of all takeovers. Despite their significance, studies of such takeovers and their
impact on the wealth of shareholders are rare. Using a very large, near exhaustive, sample of listed and privately held UK targets we examine the
impact of such takeovers on the risk adjusted return of listed UK acquirers over the period 1981 to 2001. Acquirers of private firms earn significant
positive returns during the period surrounding the bid announcement although the gains are dependent on target status, mode of payment, and the
relative size of those involved. The much quoted conclusion, derived from the experiences of listed firm bidders, that the shareholders of acquiring
firms fail to gain from takeovers, cannot be generalized. Acquiring a privately held company is an attractive option for maximizing shareholder
wealth.
Keywords: Acquisitions, Target status, Managerial motives, Excess returns, Mode of payment
JEL Classification: G34
The Determinants Of Corporate Trade Credit Policies In A Bank-Dominated Financial Environment: The Case Of Finnish Small Firms
Jyrki Niskanen and Mervi Niskanen
Abstract
This paper examines trade credit policies of small firms operating in a bank-dominated environment (Finland). We find that
creditworthiness and access to capital markets are important determinants of trade credit extended by sellers. The level of
purchases is positively correlated with the level of accounts payable. Larger and older firms and firms with strong internal
financing are less likely to use trade credit, whereas firms with a high ratio of current assets to total assets, and firms subject
to loan restructurings use it more. Negative loan decisions by financial interme-diaries increase and a close bank-borrower
relationship decreases the probability that a firm does not take advantage of trade credit discounts.
Keywords: Trade Credit, Bank-dominated Financial Market, Small firms’ financial policies
JEL Classification: G30, G32
Stock Price and Volume Effects Associated with Compositional Changes in European Stock Indices
Cristina Vespro
Abstract
This paper provides further evidence of price and volume effects associated with index compositional changes by analysing the
inclusions (exclusions) from the French CAC40 and SBF120 indices, as well as the FTSE100. I find evidence supporting the price
pressure hypothesis associated with index fund rebalancing, but weak or no evidence for the imperfect substitution, liquidity
and information hypotheses. The results improve on recent evidence from the S&P500 index. The evidence for the FTSE100 additions
shows, in particular, that markets learn about an imminent inclusion and incorporate this information into prices, even before
the announcement date.
Keywords: Stock index revisions, Index composition, Price and Volume effects, Price Pressure
JEL Classification: G12, G14
European Financial Management, VOL 12:2 March 2006
The Effect of Crossing-Network Trading on Dealer Market's Bid-Ask Spreads
Carole Gresse
Abstract
This article provides new insights into market competition between traditional
exchanges and alternative trading systems in Europe. It investigates the relationship between the
trading activity of a crossing network (CN) and the liquidity of a traditional dealer market (DM)
by comparing data from the SEAQ quote-driven segment of the London Stock Exchange (LSE) and internal
data from the POSIT crossing network. A cross-sectional analysis of bid-ask spreads shows that DM
spreads are negatively related to CN executions. Risk-sharing benefits from CN trading dominate
fragmentation and cream-skimming costs. Further, risk-sharing gains are found to be related to
dealer trading in the CN.
Keywords: Crossing networks, Alternative trading systems, Dealer markets, Liquidity, Transaction costs, Risk sharing
JEL Classification: G19
The Determinants of Corporate Debt Maturity Structure: Evidence from France, Germany and UK
Antonios Antoniou, Yilmaz Guney, and Krishna Paudyal
Abstract
We examine the determinants of the debt maturity structure of French, German
and British firms. These countries represent different financial and legal traditions that may
have implications on corporate debt maturity structure. Our model incorporates the factors representing three major theories (tax considerations, liquidity and signalling, and contracting costs)
of debt maturity. It also controls for capital market conditions. The results confirm the applicability
of most theories of debt maturity structure for the UK firms. However, the evidence from France and
Germany are mixed. Therefore, the findings suggest that the debt maturity structure of a firm is
determined by firm-specific factors and the country's financial systems and institutional traditions
in which it operates.
Keywords: Dynamic Debt Maturity Structure, Panel Data, System-GMM
JEL Classification: G20, G32
European Foreign Exchange Risk Exposure
Aline Muller and Willem F. C. Verschoor
Abstract
We find that about 13 percent of our sample of 817 European multinational
firms experienced economically significant exposure effects to the Japanese
yen, 14 percent to the U.S. dollar and 22 percent to the U.K. pound. Our
evidence differs substantially from the U.S. experience and is robust
across sub-sample periods, suggesting that a depreciating (appreciating)
Euro against foreign currencies has a net negative (positive) impact on
European stock returns. Short-term exposure seems to be relatively well
hedged, where considerable evidence of long-term exposure is found. Firms
with weak liquidity positions tend to have smaller exposures. Foreign
exposure is found to increase with firm size.
Keywords: Exchange Risk, European multinational firms, Hedging policies, Intervaling, Long-term exposure
JEL Classification: F3, G12
Corporate Performance, Corporate Governance, and Top Executive Turnover in Finland
Benjamin Maury
Abstract
This paper empirically investigates how corporate governance forces and firm performance
affect top executive turnover in Finnish listed companies. I document an increase in CEO, top management,
and board turnover in response to poor stock price performance and operating income losses. The sensitivity
of the relation between stock price performance and CEO turnover is significantly higher in firms with a
two-tier board structure (when the CEO is not the Chairman), but significantly lower when the CEO or a board
member is the controlling shareholder. These results suggest that both the ownership structure and the board
design have implications for the disciplining of managers.
Keywords: Corporate governance, Ownership structure, Board design, Two-tier board, Management turnover, Board turnover
JEL Classification: G3, G32, G38
An Integrated Framework of Corporate Governance and Firm Valuation
Stefan Beiner, Wolfgang Drobetz, Markus M. Schmid, and Heinz Zimmermann
Abstract
Recent empirical research shows evidence of a positive relationship between the quality
of firm-specific corporate governance and firm valuation. Instead of looking at one single
corporate governance mechanism in isolation, we construct a broad corporate governance
index and apply five additional variables related to ownership structure, board
characteristics, and leverage to provide a comprehensive description of firm-level corporate
governance for a representative sample of Swiss firms. To control for potential
endogeneity of these six governance mechanisms, we develop a system of simultaneous
equations and apply three-stage least squares (3SLS). Our results support the widespread
hypothesis of a positive relationship between corporate governance and firm
valuation.
Keywords: Corporate governance, Principal-agent problems, Ownership structure, Firm valuation, Endogeneity
JEL Classification: G12, G32, G34, G38
European Financial Management, VOL 12:3 June 2006
Improved Estimates of Correlation Coefficients And Their Impact on the Optimum Portfolios
Edwin J. Elton, Martin J. Gruber and Jonathan Spitzer
Abstract
To implement mean variance analysis one needs a technique for forecasting correlation coefficients. In this article we investigate the ability of several techniques to forecast correlation coefficients between securities. We find that separately forecasting the average level of pair-wise correlations and individual pair-wise differences from the average improves forecasting accuracy. Furthermore, forming homogenous groups of firms on the basis of industry membership or firm attributes (eg. Size) improves forecast accuracy.
Accuracy is evaluated in two ways: First, in terms of the error in estimating future correlation coefficients. Second, in the characteristics of portfolios formed on the basis of each forecasting technique. The ranking of forecasting techniques is robust across both methods of evaluation and the better techniques outperform prior suggestions in the literature of financial economics.
Keywords: Portfolio management correlation , forecasting
JEL Classification: G11
Is Country Diversification Better than Industry Diversification?
Kent Hargis and Jianping Mei
Abstract
In this paper, we develop a framework in which one can examine the source of industry and country diversification by examining
their underlying return components. We find that the global cash flow factor explains on average 39% of the variation of country
cash flows and global discount rates explain 55% of the variation of country discount rates. These are much less than the explanatory
power of the two factors over industry cash flow and discount rate variations, which are 72% and 78% respectively. This suggests that
global factors are much less important for return components at country level than at the industry level. As a result, both better
diversification of expected returns and cash flows across countries determine the larger benefits of country diversification versus
industry diversification. Moreover, emerging markets tend to have much smaller co-movements of both dividends and expected returns
with those of the world, suggesting a lower degree of integration with the world goods and financial markets. Our results cast
doubt on the prevailing wisdom that country diversification should be replaced by industry diversification.
Keywords: Return Decomposition, Time-varying Risk Premiums, and Market Integration
JEL Classification: G15
The Importance of Industry and Country Effects in the EMU Equity Markets
Miguel Almeida Ferreira and Miguel Ângelo Ferreira
Abstract
Most empirical studies find that country effects are larger than industry effects in
stock returns, although industry effects have gained in importance recently. Our results
support the dominance of country effects relative to industry and common effects in
the EMU equity markets in the 1975-2001 period. However, there is an increasing
importance of industry effect relative to country effect in the 1990s. In fact, industry
effects is similar in magnitude to country effect in the post-euro period. The evolution of
the ratio of country to industry effect is explained by the decrease in the cross-sectional
variance of interest rate movements across EMU countries. Thus, there is evidence that
nominal convergence has reduced the differences between national equity markets.
Keywords: International equity markets, Diversification, Volatility, EMU
JEL Classification: G11, G15
Herding in the German Mutual Fund Industry
Andreas Walter and Friedrich Moritz Weber
Abstract
This paper analyses the trading activity of German mutual funds in the 1998–2002 period to investigate whether German mutual
fund managers are engaged in herding behaviour. An-other objective of the study is to determine the impact of this herd-like trading
on stock prices. Our results provide evidence of herding and positive feedback trading by German mutual fund managers. We show that
a significant portion of herding detected in the German market is associated with spurious herding as a consequence of changes in
benchmark index compo-sition. Investigating the impact of mutual fund herding on stock prices, we find that herding seems to neither
destabilise nor stabilise stock prices.
Keywords: Mutual funds; Herding; Positive feedback trading; German stock market
JEL Classification: D7, G14, G23
Why and How UK Firms Hedge
Amrit Judge
Abstract
This paper attempts to differentiate among the theories of hedging by using disclosures in the annual reports of 400 UK companies
and data collected via a survey. I find, unlike many previous US studies, strong evidence linking the decision to hedge and the
expected costs of financial distress. The tests show that this is mainly because my definition of hedging includes all hedgers and
not just derivative users. However, when the tests employ the same hedging definition as previous US studies, financial distress cost
factors still appear to be more important for this sample than samples of US firms. Therefore, a secondary explanation for the
strong financial distress results might be due to differences in the bankruptcy codes in the two countries, which result in higher
expected costs of financial distress for UK firms. The paper also examines the determinants of the choice of hedging method
distinguishing between non-derivative and derivatives hedging. My evidence shows that larger firms, firms with more cash, firms
with a greater probability of financial distress, firms with exports or imports and firms with more short-term debt are more likely
to hedge with derivatives. Thus, differences in opportunities, in incentives for reducing risk and in the types of financial price
exposure play an important role in how firms hedge their risks.
Keywords: Corporate hedging; Risk management; Derivatives; Financial distress costs
JEL Classification: G32, G33
Competition and Concentration in the New European Banking Landscape
Christos Staikouras and Anastasia Koutsomanoli-Filippaki
Abstract
This paper measures the degree of concentration and competition in the enlarged European Union (EU) banking environment over the
period 1998-2002. In the empirical part we opt for a methodology as proposed by Panzar and Rosse based on a non-structural estimation
of market competition. Our results suggest that European banks were operating under conditions of monopolistic competition and that
bank interest income in the 10 new EU member states were earned under conditions of higher competition than those that existed in the
old EU banking countries. The opposite result was observed for total operating revenues. Smaller banks earn interest income in a less
competitive environment than larger banks, while the opposite is observed for total revenues.
Keywords: European banks; banking structure; competition; concentration; Panzar-Rosse methodology
JEL Classification: G21, L10, P20
European Financial Management, VOL 12:4 September 2006
Has Finance Made the World Riskier?
Raghuram G. Rajan
Abstract
Developments in the financial sector have led to an expansion in its ability to spread risks.
The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households.
On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle.
Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behavior makes more likely.
As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past.
The paper discusses the implications for monetary policy and prudential supervision.
In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.
Keywords: financial development, financial-sector-induced turmoil, risk and derivatives
JEL Classification:G20, G21, G22
Is it the Law or the Lawyers? Investment Covenants Around the World
Douglas Cumming and Sofia Johan
Abstract
This paper introduces a new dataset from 50 private investment funds from 17 countries around the world.
We analyse the frequency of use of investment covenants imposed by institutional investors governing the activities of private investment fund managers in areas pertaining to investment decisions, investment powers, types of investments, fund operations, and limitations on liability.
While the data indicate a role for country legality in affecting the frequency of use of fund covenants, the data further indicate that the presence of legally trained managers has a more pronounced role in affecting the use of covenants.
As private equity and venture capital investment increases across Europe and elsewhere, our results indicate that legal practice factors will matter more than the legal setting for the establishment of covenants governing new funds.
Keywords: Empirical Contracts; Private Equity; Law and Finance
JEL Classification: G24, G28, G31, G32, G35
An Analysis of Changes in Board Structure During Corporate Governance Reforms
David HIllier and Patric McColgan
Abstract
This study examines the evolution of company board structure during a period of corporate governance reform.
Using data over a time period following the publication of the Cadbury Report (1992) we present evidence of an increase
in the independence of UK boards, as measured by an increased willingness to employ independent non-executive directors, and
to separate the positions of the CEO and the Chairman of the Board.
In examining the determinants of these changes, we find that boards change more readily in response to changes in managerial control,
equity issuance and corporate performance than changes in the firm-specific operating environment of companies.
Keywords: Board size; board composition; firm-specific characteristics; owner-specific characteristics.
JEL Classification:G32, G34, G38
Bidder CEO and Other Executive Compensation in UK M and As
Jerry Coakley and Stavroula Iliopoulou
Abstract
This paper investigates the impact of M&As on bidder (CEO and other) executive
compensation employing a unique sample of 100 completed bids in the UK over the
1998-2001 period. Our findings indicate that less independent and larger boards
award CEOs significantly higher bonuses and salary following M&A completion both
for the full sample and for the UK and US sub-samples. UK CEOs and executives are
rewarded more for the effort exerted in accomplishing intra-industry or large mergers
than for diversifying or small mergers and their cash pay is unaffected by other
measures of their managerial skill or performance. US bidders are rewarded at
higher levels than their UK counterparts and their remuneration is related only to
measures of CEO dominance over the board of directors. Overall our findings offer
support for the managerial power rather than the agency theory perspective on
managerial compensation.
Keywords: Executive compensation; managerial power; agency theory.
JEL Classification: G34; J33
The Importance of Corporate Foreign Debt in Managing Exchange Rate Exposures in Non-Financial Companies
Tom Aabo
Abstract
This empirical study of the exchange rate exposure management of Danish non-financial firms listed on the Copenhagen Stock Exchange shows that debt denominated in foreign currency (“foreign debt”) is a very important alternative to the use of currency derivatives. The results show that the relative importance of foreign debt is positively related to (1) the extent of foreign subsidiaries, (2) the relative value of assets in place, and (3) the debt ratio. The pivotal role of time horizon is emphasized. These findings are important to firms in other countries with open economies.
Keywords: exchange rate exposure management; financial hedging; foreign debt
JEL Classification: F23, F31, G15
European Financial Management, VOL 12:5 November 2006
The Role of Investment, Financing and Dividend Decisions in Explaining Corporate Ownership Structure: Empirical Evidence from Spain
Julio Pindado and Chabela De La Torre
Abstract
This paper analyses the determinants of ownership structure by focusing on the role played by investment,
financing and dividend decisions. The use of the Generalized Method of Moments allows us to provide new evidence
on this important corporate governance topic, since it controls for the endogeneity problem. Our most relevant findings
show that: i) increases in debt lead insiders to limit the risk they bear by reducing their holdings; ii) monitoring by
large outside owners substitutes for the disciplinary role of debt; and iii) both inside and outside owners are
encouraged to increase their stakes in the firm in view of higher dividends. Our results hold after controlling for
equity issues and share repurchases.
Keywords: Ownership structure, investment, financing and dividend decisions, agency costs, panel data.
JEL Classification:G31, G32, G35.
The Impact of Corporate Governance on Closed-End Funds
Gordon Gemmill and Dylan C. Thomas
Abstract
This study uses a large sample of UK-listed closed-end funds to examine whether governance has an impact on two indicators of fund performance: the level of fund-management fees and the discount at which a fund trades. Fees are under the control of the directors, and we find that they are inversely related to fund returns, even after allowing for differences across investment sectors. Fees are, on average, higher if a fund has a large board, few directors from outside the fund-family, many directors from within the fund-family, and low ownership by the management company. Discounts for funds are wider if the management company or any blockholder has a significant long-term stake, suggesting that investors are wary of entrenched management. The results suggest that boards are frequently compromised in their duty to shareholders by their dependence on fund-management companies.
Keywords: closed-end funds, corporate governance, fund management expenses, discounts
JEL Classification:G30, G34.
Corporate Governance and Information Efficiency in Security Markets
Charlie X. Cai, Kevin Keasey and Helen Short
Abstract
Abstract
This paper investigates a neglected topic in corporate governance research; namely, do governance characteristics affect the market reaction to news?
The topic is important given the emphasis by governance regulations and codes of best practice on the need for greater transparency of corporate activities.
For the first time in the corporate governance literature, we show that corporate governance characteristics (particularly the presence of founding family directors and gender diverse boards) affect the market reaction to company specific news. The results of the paper point to the analysis of the impact of governance characteristics on the market reaction to news being a new and complementary research agenda within corporate governance.
Keywords: Corporate Governance, Market Reaction to News
JEL Classification:G34, G14
Management Going-concern Disclosures: Impact of Corporate Governance and Auditor Reputation
Jinnn-Yang Uang, David B. Citron, Sudi sudarsanam and Richard J Taffler
Abstract
Abstract
The U.K. regulatory requirements relating to going-concern disclosures require directors to report on the going-concern status of their firms. Such directors have incentives not to report fairly in the case of financially-distressed firms. We expect effective corporate governance mechanisms will encourage directors to report more truthfully in such situations. This paper tests this proposition explicitly using a large sample of going-concern cases over the period 1994-2000. We find that whereas auditors’ going-concern opinions predict the subsequent resolution of going-concern uncertainties directors’ going-concern statements convey arbitrary and unhelpful messages to users. However, robust corporate governance structures and high auditor reputation constrain directors to be more truthful in their going-concern disclosures, bringing these more into line with the more credible auditor opinions.
Keywords: corporate governance; going concern; financial distress; Cadbury disclosure
JEL Classification:G33, G34, G38, M42
Valuation Effects of Short Sale Constraints: The Case of Corporate Takeovers
George Alexandridis, Antonios Antoniou and Huainan Zhao
Abstract
We examine the relation between the degree of short sale constraints for acquiring firms’ equity and post takeover stock performance. We find that negative long-run abnormal returns appear to decline (in economic and statistical terms) as the extent and persistence of institutional block-holder ownership increase, after accounting for the size, book-to-market and method of payment effects. In the spirit of Miller (1977), such evidence implies that the degree of short sale constraints serves as an important determinant of acquiring firms’ short-run overpricing. It appears that the presence of concentrated institutional presence mitigates and in most cases eliminates, through effective arbitrage, any short-run overpricing that may be responsible for the long-run underperformance of acquirers, preserving in this way efficiency in the takeover markets.
Keywords: short sale constraints; institutional ownership; mergers and acquisitions; long-term wealth effects.
JEL Classification:G14, G23, G34
European Financial Management, VOL 13:1 January 2007
Payout Policy Pedagogy: What Matters and Why
Harry DeAngelo, Linda DeAngelo
Abstract
This paper argues that we should abandon MM (1961) irrelevance as the foundation for teaching payout
policy, and instead emphasize the need to distribute the full value generated by investment policy (“full
payout”). Because MM’s assumptions restrict payouts to an optimum, their irrelevance theorem does not
provide the appropriate prescription for managerial behavior. A simple example clarifies why the correct
prescription is “full payout,” and why both payout and investment policy matter even absent agency costs
(DeAngelo and DeAngelo (2006)). A simple life-cycle generalization explains the main stylized facts
about the payout policies of U.S. and European firms.
Keywords:Dividends, Payout policy, Dividend puzzle
JEL Classification:G35, G32, H25.
Capital Cash Flows, APV and Valuation
Laurence Booth
Abstract
This paper examines three different methods of valuing companies and projects: the adjusted Present Value (APV), capital cash flows (CCF) and weighted average cost of capital (WACC) methods. It develops the appropriate WACC and beta leveraging formulae appropriate for each valuation model, so that given a particular valuation model the correct APV and CCF values can be determined from the WACC value and vice versa. Further it goes on to show when the perpetuity formulae give poor estimates of the value of individual cash flows, even though the overall values are correct. The paper cautions that the APV and CCF models require more information than is currently known, such as the value of the corporate use of debt, and consequently can give misleading results, particularly in sensitivity analyses.
Keywords:Capital cash flows, APV, Valuation,
JEL Classification:G31, G32.
Examining the Relationships between Capital, Risk and Efficiency in European Banking
Yener Altunbas, Santiago Carbo, Edward P.M. Gardener, and Philip Molyneux
Abstract
This paper analyses the relationship between capital, risk and efficiency for a large sample of European banks between 1992
and 2000. In contrast to the established US evidence we do not find a positive relationship between inefficiency and bank risk-taking.
Inefficient European banks appear to hold more capital and take on less risk. Empirical evidence is found showing the positive
relationship between risk on the level of capital (and liquidity), possibly indicating regulators’ preference for capital as a
mean of restricting risk-taking activities. We also find evidence that the financial strength of the corporate sector has a positive
influence in reducing bank risk-taking and capital levels. There are no major differences in the relationships between capital, risk
and efficiency for commercial and savings banks although there are for co-operative banks. In the case of co-operative banks we do
find that capital levels are inversely related to risks and we find that inefficient banks hold lower levels of capital. Some of
these relationships also vary depending on whether banks are among the most or least efficient operators.
Keywords: Bank capital, risk, efficiency, credit, European banks
JEL Classification: E5, E52, G21
The Validity of the Economic Value Added Approach: an Empirical Application
Dimitris Kyriazis and Christos Anastassis
Abstract
This study investigates the relative explanatory power of the Economic Value Added model with respect to stock returns and firms’ market value, compared to established accounting variables (e.g. net income, operating income), in the context of a small European developing market, namely the Athens Stock Exchange, in its first market-wide application of the EVA measure.
Relative information content tests reveal that net and operating income appear to be more value relevant than EVA.
Additionally, incremental information tests suggest that EVA unique components add only marginally to the information content of accounting profit.
Moreover, EVA does not appear to have a stronger correlation with firms’ Market Value Added than the other variables, suggesting that-for our Greek dataset- EVA, even though useful as a performance evaluation tool, need not necessarily be more correlated with shareholder’s value than established accounting variables.
Keywords: economic value added, residual income, market value added, relative information content, incremental information content
JEL Classification: G3, G31,M41
The Determinants of Financial Structure: New Insights from Business Start-ups
Nancy Huyghebaert and Linda Van De Gucht
Abstract
Business start-ups lack prior history and reputation, face high failure risk, and have highly concentrated ownership.
The resulting information and incentive problems, combined with entrepreneurial private benefits of control, affect
initial financing decisions. This paper examines simultaneously the impact of these issues on leverage, debt mix
and maturity. We find that start-ups with high adverse selection and risk shifting problems contract less bank debt
but compensate with other debt sources. Start-ups in growing industries have lower leverage, but raise more bank debt.
Entrepreneurs with large private control benefits contract less but longer term bank loans to lower the default probability.
Keywords:capital structure; information and incentive problems; private benefits of control; start-ups.
JEL Classification:C31, G21, G32
Measuring Value-at-Risk in Project Finance Transactions
Stefano Gatti, Alvaro Rigamotti, Francesco Saita and Mauro Senati
Abstract
Despite the remarkable importance of project finance in international financial markets, no quantitative models to measure and quantify the risk associated with a deal for the project’s lenders have been developed yet. The topic has recently become crucial, since the New Basle Capital Accord gives banks a choice of whether to adopt simpler (but possibly higher) standard capital requirements or to develop internal rating models for project finance transactions. The paper proposes how Monte Carlo simulations may be used to derive a Value at Risk estimate for project finance deals and discusses the critical issues that must be considered when developing such a model.
Keywords: Project finance, Value at Risk, credit risk management
JEL Classification: C15, C65, G31, G33
A New Econometric Model of Index Arbitrage
Nick Taylor
Abstract
This paper introduces a new econometric model of the mispricing associated with (contemporaneous)
differences between spot and futures prices. Like existing models, this model assumes
that the level of arbitrage activity is positively related to the magnitude of absolute mispricing.
However, unlike existing models, the new model assumes that a parameter governing a key
feature of this relationship varies over time. Specifically, several versions of a smooth transition
model of mispricing are introduced that each allow the shape of the transition function to be
determined by a set of explanatory variables. Using high frequency data from the S&P 500 spot
and futures market, the results show that the nature of the non-linearity in mispricing corresponds
to arbitrageur behavior that varies (in a periodic fashion) over the trading day. This is
evinced by the superior fit of the new model of mispricing, in comparison to the results based
on existing econometric models of mispricing. Finally, the observed periodicity in arbitrageur
behavior indicates that arbitrageurs prefer to trade during certain periods within the trading
day – a result that contradicts the findings obtained when using existing econometric models of
mispricing.
Keywords:Index arbitrage, smooth transition, intraday periodicity.
JEL Classification:C22; C41; G14.
European Financial Management, VOL 13:2 March 2007
Conditional Performance of Hedge Funds : Evidence from Daily Returns
Hossein Kazami, and Ying Li
Abstract
Using daily returns on a set of hedge fund indices, we study (i) the properties of the indices' conditional density functions and (ii) the presence of asymmetries in conditional correlations between hedge fund indices and other investments and between hedge fund indices themselves. We use the SNP approach to obtain estimates of conditional densities of hedge fund returns and then proceed to examine their properties. In general, a nonparametric GARCH(1,1) model appears to provide the best fit for all strategies. We find that the conditional third and fourth moments are significantly affected by changes in the current volatility of returns on hedge fund indices. We examine changes in the conditional probability of tail events and report significant changes in the probability of extreme events when the conditioning information changes. These results have important implications for models of hedge fund risk that rely on probability of tail events. We formally test for the presence of asymmetries in conditional correlations to determine if there is contagion between hedge funds and other investments and between various hedge fund indices in extreme down markets versus extreme up markets. We generally do not find strong evidence in support of asymmetric correlations.
Keywords: Hedge funds; contagion; conditional volatility; skewness.
JEL Classification: G11, G12, G23
Capacity Constraints and Hedge Fund Strategy Returns
Naranyan Naik, Tarun Ramodorai and Maria Stromqvist
Abstract
Hedge funds have generated significant absolute returns (alpha) in the decade between 1995 and 2004. However, the level of alpha has declined substantially over this period. We investigate whether capacity constraints at the level of hedge fund strategies have been responsible for this decline. For four out of eight hedge fund strategies, capital inflows have statistically preceded negative movements in alpha, consistent with this hypothesis. We also find evidence that hedge fund fees have increased over the same period. Our results provide support for the Berk and Green (2004) rational model of active portfolio management.
Keywords:Hedge funds; capacity constraints; alpha; factor models; performance fees; flows
JEL Classification:G11, G12, G23
Hedge Fund Indices: Reconciling Investability and Representativity
Felix Goltz, Lionel Martellini, and Mathieu Vaissié
Abstract
Following a growing concern among investors about the quality of hedge fund index return data, this paper addresses the question whether designing hedge fund indices that fulfil the usual requirements (in particular representative and investable) is or not a feasible task, given a variety of features that are specific to that industry. To test whether or not investability should necessarily come at the cost of representatitivity, we use a well-known methodology in asset pricing literature based on the concept of factor replicating portfolios. Our results suggest that it is actually possible to construct representative indices based on a limited number of funds that are open to new investments, except perhaps in the case of equity market neutral strategies, provided that i) these funds are suitably selected and ii) a portfolio is constructed with the objective of replicating the common trend in hedge fund returns for a given strategy. A range of robustness tests are performed that show that high correlation of the factor replicating portfolios with the common factor of returns for each strategy is remarkably stable with respect to modifying the number of funds in the replicating portfolio or changing the frequency of rebalancing.
Keywords: hedge funds, factor replicating portfolios, hedge fund indices.
JEL Classification: G11, G12, G23
The Style Consistence of Hedge Funds
R. Gibson and S.Gyger
Abstract
This study examines the style classification and the style consistency of
hedge funds using a new proprietary database over the period May 1989 to
April 1999. First, a hard clustering procedure is applied to classify hedge funds
into homogeneous groups. It is shown that the methodology is robust and can
be used to build stable hedge funds indexes. The method performs equally
well as the principal component analysis in explaining in- and out-of-sample
cross-sectional hedge funds’ returns. Second, we extend hard to fuzzy cluster
memberships, relaxing the full assignment of the funds to individual clusters.
We apply the fuzzy clustering methodology to estimate hedge funds’ probabilistic
exposure to various styles. We introduce three consistency indicators
to quantify the hedge fund managers’ style opportunism levels. We finally
document that there is no evidence that style consistency leads to superior
hedge funds’ performance.
Keywords: Hedge funds; style classification; style consistency; cluster analysis.
JEL Classification: G11
The Performance of Hedge Fund Strategies and the Asymmetry of Return Distributions
Bill Ding and Hany A. Shawky
Abstract
We present hedge fund performance estimates that adjust for stale prices, Fama-French risk factors and Skewness. We contrast these new performance estimates with traditional performance measures. Using three-factor models to adjust for staleness in prices and to incorporate Fama-French factors along with the Harvey-Siddique (2000) two-factor model that incorporates Skewness, we find that for the period 1990-2003, all hedge fund categories achieve above average performance when measured against an aggregate market index. More significantly, however, when we estimate performance at the individual hedge fund level, we discover that only 40 to 47% of the funds are shown to achieve an above average performance over that time period depending on the model used. These results have important implications for investors, endowments and pensions when they choose hedge fund managers.
Keywords: Hedge funds, Skewness, Coskewness, Performance
JEL Classification: G29.
Hedge Fund Risk Measures: A Cross-Sectional Approach
Bing Liang and Hyuna Park
Abstract
This paper analyzes the risk-return trade-off in the hedge fund industry. We compare semi-deviation, value-at-risk (VaR), Expected Shortfall (ES) and Tail Risk (TR) with standard deviation at the individual fund level as well as the portfolio level. Using the Fama and French (1992) methodology and the combined live and defunct hedge fund data from TASS, we find that the left-tail risk captured by Expected Shortfall (ES) and Tail Risk (TR) explains the cross-sectional variation in hedge fund returns very well, while the other risk measures provide statistically insignificant or marginally significant results. During the period between January 1995 and December 2004, hedge funds with high ES outperform those with low ES by an annual return difference of 7%. We provide empirical evidence on the theoretical argument by Artzner et al. (1999) that ES is superior to VaR as a downside risk measure. We also find the Cornish-Fisher (1937) expansion is superior to the nonparametric method in estimating ES and TR.
Keywords: hedge funds, expected shortfall, tail risk, conditional VaR, Cornish-Fisher expansion
JEL Classification: G11, G12, C31
European Financial Management, VOL 13:3 June 2007
Investor Attention and Time-Varying Comovements
Lin Peng, Wei Xiong and Tim Bollerslev
Abstract
This paper analyzes the effect of an increase in market-wide uncertainty on
information flow and asset price comovements. We use the daily realized volatility
of the 30-year treasury bond futures to assess macroeconomic shocks that
affect market-wide uncertainty. We use the ratio of a stock’s idiosyncratic realized
volatility with respect to the S&P 500 futures relative to its total realized
volatility to capture the asset price comovement with the market. We find
that market volatility and the comovement of individual stocks with the market
increase contemporaneously with the arrival of market-wide macroeconomic
shocks, but decrease significantly in the following five trading days. This pattern
supports the hypothesis that investors shift their (limited) attention to processing
market-level information following an increase in market-wide uncertainty and
then subsequently divert their attention back to asset-specific information.
Keywords: Time-Varying Comovement, Information Flow, Volatility Dynamics, Attention Constraints
JEL Classification: G12, G14
Is the Aggregate Investor Reluctant to Realize Losses?
Evidence from Taiwan
Brad M. Barber, Yi-Tsung Lee, Yu-Jane Liu, Terrance Odean
Abstract
We ask whether the typical investor and the aggregate investor exhibit a bias known as the disposition effect, the tendency to sell investments are held for a profit at a faster rate than investments held for a loss. We analyze all trading activity on the Taiwan Stock Exchange (TSE) for the five years ending in 1999. Using a dataset that contains all trades (over one billion) and the identity of every trader (nearly four million), we find that in aggregate, investors in Taiwan are about twice as likely to sell a stock if they are holding that stock for a gain rather than as loss. Eighty-four percent of all Taiwanese investors sell winners at a faster rate than losers. Individuals, corporations, and dealers are reluctant to realize losses, while mutual funds and foreigners, who together account for less than five percent of all trades (by value), are not.
Keywords:
JEL Classification:
All Guts, No Glory: Trading and Diversification among Online Investors
Anders Anderson
Abstract
I explore cross-sectional portfolio performance in a sample containing 324,736 transactions
conducted by 16,831 Swedish investors at an Internet discount brokerage firm
during the period May 1999 to March 2002. On average, investors hold undiversified
portfolios, show a strong preference for risk, and trade aggressively. I measure
performance using a panel data model, and explain the cross-sectional variation using
investors’ turnover, portfolio size and degree of diversification. I find that turnover
is harmful to performance due to fees, and is therefore more predominant among investors
with small portfolios. I argue that the degree of diversification is a proxy for
investor skill, and it has a separate and distinct positive effect on performance. Investors
underperform the market by about 8.5% per year on average, of which half can
be attributed to trading costs.
Keywords: Investor behavior; performance evaluation; panel data models.
JEL Classification: G11, D14, C33
Valuation in the US Commercial Real Estate
Eric Ghysels, Alberto Plazzi and Rossen Valkanov
Abstract
We consider a log-linearized version of a discounted rents model to price
commercial real estate as an alternative to traditional hedonic models. First, we
verify a key implication of the model, namely, that cap rates forecast commercial
real estate returns. We do this using two different methodologies: time series
regressions of 21 US metropolitan areas and mixed data sampling (MIDAS)
regressions with aggregate REITs returns. Both approaches confirm that the
cap rate is related to fluctuations in future returns. We also investigate the
provenance of the predictability. Based on the model, we decompose fluctuations
in the cap rate into three parts: (i) local state variables (demographic and
local economic variables); (ii) growth in rents; and (iii) an orthogonal part.
About 30% of the fluctuation in the cap rate is explained by the local state
variables and the growth in rents. We use the cap rate decomposition into our
predictive regression and find a positive relation between fluctuations in economic
conditions and future returns. However, a larger and significant part of the cap
rate predictability is due the orthogonal part, which is unrelated to fundamentals.
This implies that economic conditions, which are also used in hedonic pricing of
real estate, cannot fully account for future movements in returns. We conclude
that commercial real estate prices are better modeled as financial assets and
that the discounted rent model might be more suitable than traditional hedonic
models, at least at an aggregate level.
Keywords:
JEL Classification:
A Breakdown of the Valuation Effects of International Cross-Listing
Arturo Bris, Salvatore Cantale and George Nishiotis
Abstract
It is well known that cross-listing domestic stocks in foreign exchanges has
significant valuation effects on the listed company's shares. Using a sample
of firms with dual shares, we explore the differential effects of
cross-listing on prices and we are able to separate the different sources of
the benefits of cross-listing. These sources include market segmentation,
liquidity, and the bonding of controlling shareholders to lower
expropriation of firm resources. \ Our results show that even though the
market segmentation and bonding effects are both statistically significant,
the economic significance of segmentation is more than double that of
bonding. Furthermore, we document an economically and statistically
significant increase in the liquidity of both share classes after the
listing. Overall, our results explain why less and less firms are willing to
list in the U.S.: Sarbanes Oxley has increased the cost of adopting better
governance while its benefits are not substantial; and market segmentation
has decreased significantly in the last years.
Keywords:
JEL Classification:
Acquisitions, Overconfident Managers and Self-Attribution Bias
John A. Doukas and Dimitris Petmezas
Abstract
We examine whether acquisitions by overconfident managers generate superior abnormal returns and whether managerial overconfidence stems from self-attribution. Self-attribution bias suggests that overconfidence plays a greater role in higher order acquisition deals predicting lower wealth effects for higher order acquisition deals. Using two alternative measures of overconfidence (1) high order acquisition deals and (2) insider dealings we find evidence supporting the view that average stock returns are related to managerial overconfidence. Overconfident bidders realize lower announcement returns than rational bidders and exhibit poor long-term performance. Second, we find that managerial overconfidence stems from self-attribution bias. Specifically, we find that high-order acquisitions (five or more deals within a three-year period) are associated with lower wealth effects than low-order acquisitions (first deals). That is, managers tend to credit the initial success to their own ability and therefore become overconfident and engage in more deals. In our analysis we control for endogeneity of the decision to engage in high-order acquisitions and find evidence that does not support the self-selection of excessive acquisitive firms. Our analysis is robust to the influence of merger waves, industry shocks, and macroeconomic conditions.
Keywords: Managerial Overconfidence, Self-Attribution Bias, Mergers and Acquisitions, Corporate Governance, Short-term and Long-term Performance.
JEL Classification: G14, G30, G34
Bank Mergers and Diversification: Implications for Competition PolicyALBERT
Banal-Estanol and Marco Ottaviani
Abstract
This paper analyses competition and mergers among risk averse banks. We show
that the correlation between the shocks to the demand for loans and the shocks to
the supply of deposits induces a strategic interdependence between the two sides of
the market. We characterize the role of diversification as a motive for bank mergers
and analyse the consequences of mergers on loan and deposit rates. When the value
of diversification is sufficiently strong, bank mergers generate an increase in the
welfare of borrowers and depositors. If depositors have more correlated shocks than
borrowers, bank mergers are relatively worse for depositors than for borrowers.
Keywords: risk aversion; imperfect competition; bank mergers; welfare of depositors and borrowers.
JEL Classification: D43, G21, G32, G34
European Financial Management, VOL 13:4 September 2007
The Economics of IPO Stabilization, Syndicates and Naked Shorts
Tim Jenkinson and Howard Jones
Abstract
Stabilization is the bidding for and purchase of securities by an underwriter immediately after an offering for the purpose of preventing or retarding a fall in price. Stabilization is price manipulation, but regulators allow it within strict limits - notably that stabilization may not occur above the offer price. For legislators and market authorities, a false market is a price worth paying for an orderly market. This paper compares the rationale for regulators’ allowing IPO stabilization with its effects. It finds that stabilization does have the intended effects, but that underwriters also seem to have other motives to stabilize, including favouring certain aftermarket sellers and enhancing their own reputation and profits. A puzzling aspect of stabilization is why underwriters create ‘naked short’ positions which are loss-making to cover when, as is usual, the aftermarket price rises to a premium. We set up a model to show that the lead underwriter may profit from a naked short at the expense of the rest of the syndicate given the way commissions are apportioned between them. We argue that a naked short mitigates the misalignment of interests which stabilization causes between issuer and lead underwriter, although it does so at the expense of the non-lead underwriters.
Keywords: IPO, stabilization, syndicates
JEL Classification:
Do European Primarily Internet Banks Show Scale and Experience Efficiencies?
Javier Delgado, Iganacio Hernando and Maria J. Nieto
Abstract
Empirical evidence shows that Internet banks worldwide have underperformed newly chartered
traditional banks mainly because of their higher overhead costs. European banks have not been an
exception in this regard. This paper analyses, for the first time in Europe, whether this is a temporary
phenomenon and whether Internet banks may generate scale economies in excess of those available to traditional banks.
Also do they (and their customers) accumulate experience with this new business model, allowing them to perform as well or
even better than their peers, the traditional banks?. To this end, we have generally followed the same analytical framework and
methodology used by DeYoung (2001, 2002, forthcoming) for Internet banks in the USA although the limitations in the availability
of data, as well as the existence of different regulatory frameworks and market conditions, particularly in the retail segment, in the 15
European Union countries have required some modifications to the methodology. The empirical analysis confirms that, as is the case for
US banks, European Internet banks show technologically based scale economies, while no conclusive evidence exists of technology based
learning economies. As Internet banks get larger, the profitability gap with traditional banks shrinks. To the extent that Internet banks are
profitable, European authorities may encourage a larger number of consumers to use this delivery channel, by tackling consumers´ security
concerns. This would allow Internet banks to capture more of the potential scale efficiencies implied in our estimations.
Keywords:
JEL Classification:
Exchange Rates and the Conversion of Currency-Specific Risk Premia
Astrid Eisenberg and Markus Rudolf
Abstract
How do the risk factors that drive asset prices influence exchange rates?
Are the parameters of asset price processes relevant for specifying exchange rate process?
Most international asset pricing model focus on the analysis of asset returns given exchange rate processes.
Little work has been done on the analysis of exchange rate dependent on the asset returns.
This paper uses an international stochastic discount factor (SDF) framework to analyze the
interplay between asset prices and exchange rates. So far, this approach has only been implemented
in international term structure model. We find that exchange rates serve to convert currency-specific
discount factors and currency-specific theory (IAPT). Our empirical investigation of exchange rates and
stock markets of four countries presents evidence for the conversation of currency-specific is premia by exchange rates.
Keywords:stochastic discount factor,international asset pricing, international arbitrage pricing theroy, factor risk premium, price of risk conversion
JEL Classification: F21, F31, G12, G15
The Performance of Local versus Foreign Mutual Fund Managers
Roger Otten and Dennis Bams
Abstract
Previous literature on the home bias indicates that informational disadvantages contribute
to an over-investing in domestic assets. The general idea is that local investors outperform
foreign investors because they have superior access to information on local
firms. In this paper we re-examine the latter argument by looking at mutual funds. More
specifically we examine the performance of US equity funds (locals) versus UK equity
funds (foreigners) both investing in the US equity market. For that purpose we construct
a survivorship bias controlled database of 2,531 mutual funds during 1990-2000. After
controlling for tax treatment, fund objectives, management expenses, investment style
and time-variation in betas, we find no significant difference in risk-adjusted performance
between US and UK mutual funds. We do however find a home bias for the UK funds.
Keywords: Mutual Funds, Home Bias, Performance evaluation
JEL Classification: G12, G20, G23
Managerial Stock Options and the Hedging Premium
Niclas Hagelin, Martin Holmen, John Knopf and Bengt Pramborg
Abstract
Previous studies have found mixed evidence on whether hedging increases firm value.
Some studies have shown that managerial incentives may influence firm hedging. In this paper
we provide evidence that when hedging is based upon incentives from managers’ options, firm value decreases.
Keywords: hedging; managerial incentives; firm value.
JEL Classification: G32, F31
UK evidence on the characteristics versus covariance debate
Edward Lee, Weimin Liu and Norman Strong
Abstract
We evaluate the Fama-French three-factor model in the UK using the approach of Daniel and Titman (1997) to
determine whether characteristics or covariance risk better explains the size and value premiums. Across all three factors,
we find that return premiums bear little relationship to the corresponding loadings. We show that small and value stocks earn higher
returns irrespective of their return covariance. Our study contributes to the existing literature by reporting original findings on the
Fama-French three factor model in the UK and by reporting results that complement existing evidence from similar studies in the US and Japan.
Keywords: value, size, factor loadings, return predictability
JEL Classification: G10, G12, G15, G30
Irrevocable Commitments and Going Private
Mike Wright, Charlie Weir and Andrew Burrows
Abstract
This paper adds to growing interest in public to private buy-outs and mechanisms to ensure bid success. Using a unique, hand-collected dataset of 155 public to private buy-outs we provide one of the first examinations of the determinants of irrevocable commitments. Irrevocable commitments involve undertakings given by existing shareholders to agree to sell their shares to the bidder before the bid to take the company private is announced. We find that, for management buy-outs, the level of irrevocable commitments is increased by the bid premium, the reputation of the private equity backer and board shareholdings. The level of irrevocable commitments is reduced by rumours of a takeover bid and bid value. We therefore find evidence that management and private equity firms’ activity prior to the bid’s announcement can have an important impact on the process of going private.
Keywords: Public to private transactions, irrevocable commitments
JEL Classification: G34
Stock Concentration, Trading Cost and the Profitability of Momentum Trading Strategies: Further Evidence from the UK
Sam Ageyei-Ampomah
Abstract
This paper examines the post-cost profitability of momentum trading strategies in the UK over the period 1988 – 2003 and provides direct evidence on stock concentration, turnover and trading cost associated with the strategy. We find that after factoring out transaction costs the profitability of the momentum strategy disappears for shorter horizons but remains for longer horizons. Indeed, for ranking and holding periods up to 6-months, profitable momentum returns would not be available to most average investors as the cost of implementation outweighs the possible returns. However, we find post-cost profitability for ranking and /or holding periods beyond 6 months as portfolio turnover and its associated cost reduces. We find similar results for a sub-sample of relatively large and liquid stocks.
Keywords: : Momentum strategy, Transaction costs, Portfolio Turnover, Market Efficiency
JEL Classification: G10, G11, G14
European Financial Management, VOL 13:5 November 2007
Optimal Microstructures
Maureen O’Hara
Abstract
Keynote Address at the European Financial Management Association meetings (EFMA), Madrid, Spain July 2006
Keywords: Microstructure, liquidity, bond markets, ambiguity, algorithmic trading
JEL Classification: G10, G14, D02
On the Magnet Effect of Price Limits
David Abad and Roberto Pascual
Abstract
The “magnet” or “gravitational” effect hypothesis asserts that, when trading halts are rule-based, investors concerned with a likely impediment to trade advance trades in time. This behavior actually pushes prices further towards the limit. Empirical studies about the magnet effect are scarce, most likely because of the unavailability of data on rule-based halts. In this paper, we use a large database from the Spanish Stock Exchange (SSE), which combines intraday stock specific price limits and short-lived rule-based call actions to stabilize prices, to test this hypothesis. The SSE is particularly well suited to test the magnet effect hypothesis since trading halts are price-triggered and, therefore, predictable to some extent. Still, the SSE microstructure presents two particularities: (i) a limit-hit triggers an automatic switch to an alternative trading mechanism, a call auction, rather than a pure halt; (ii) the trading halt only lasts 5 minutes. We find that, even when prices are within a very short distance to the price limits, the probability of observing a limit-hit is unexpectedly low. Additionally, prices either initiate reversion (non limit-hit days) or slow down gradually (limit-hit days) as they come near the intraday limits. Finally, the most aggressive traders progressively become more patient as prices approach the limits. Therefore, both the price patterns and the trading behavior reported near the limits do not agree with the price limits acting as magnetic fields. Consequently, we conclude that the switching mechanism implemented in the SSE does not induce traders to advance their trading programs in time.
Keywords: Price limits, non-discretionary trading halts, magnet effect, rule-based auctions, electronic order driven markets
JEL Classification: G1, G14, D44
Operating Performance of Newly Privatized Firms in Central European Transition Economies
Wolfgang Aussenegg and Ranko Jelic
Abstract
This study examines the operating performance of privatized firms in three Central European Transition Economies between 1990 and 1998. Overall, we find no evidence of a significant improvement in operating performance for the first six years after privatization. Contrary to the increasing empirical evidence for non-transition economies, our privatized firms experi-ence no improvement in profitability, capital investments, efficiency, and output, a significant drop in employment, as well as a significant increase in leverage. The most important deter-minants of the performance changes following privatization were country effects, timing of the privatization sales, industry classification, and state ownership after privatization. Our findings are consistent with the empirical evidence that the transition process proved to be more difficult than expected and that, although necessary, privatizations do not necessarily produce equal efficiency gains in transition economies (Megginson, 2005; Havrylyshyn and McGettigan, 1999).
Keywords: Privatization, Operating Performance, Transition Economies, Self-selection
JEL Classification: G32, P34, P52
Cross-sectional Tests of Conditional Asset Pricing Models: Evidence from the German Stock Market
Andreas Schrimpf, Michael Schröder and Richard Stehle
Abstract
We study the performance of conditional asset pricing models and multifactor models in explaining the German cross-section of stock returns. We focus on several variables, which (according to previous research) are associated with market expectations on future market excess returns or business cycle conditions. Our results suggest that the empirical performance of the Capital Asset Pricing Model (CAPM) can be improved when allowing for time-varying parameters of the stochastic discount factor. A? conditional CAPM using the term spread explains the returns on our size and book-to-market sorted portfolios about as well as the Fama-French three-factor model and performs best in terms of the Hansen-Jagannathan distance. Structural break tests do not necessarily indicate parameter instability of conditional model specifications. Another major finding of the paper is that the Fama-French model – despite its generally good cross-sectional performance – is subject to model instability. Unconditional models, however, do a better job than conditional ones at capturing time-series predictability of the test portfolio returns.
Keywords: Cross-Section of Stock Returns, Conditional Asset Pricing Models, Multifactor Models, Hansen-Jagannathan Distance, Value Premium
JEL Classification: G12
The Effect of Socially Responsible Investing on Portfolio Performance
Peer Osthoff and Alexander Kempf
Abstract
More and more investors apply socially responsible screens when building their stock portfolios. This raises the question whether these investors can increase their performance by incorporating such screens into their investment process. To answer this question we implement a simple trading strategy based on socially responsible ratings from the KLD Research & Analytics: Buy stocks with high socially responsible ratings and sell stocks with low socially responsible ratings. We find that this strategy leads to high abnormal returns of up to 8.7% per year. The maximum abnormal returns are reached when investors employ the best-in-class screening approach, use a combination of several socially responsible screens at the same time, and restrict themselves to stocks with extreme socially responsible ratings. The abnormal returns remain significant even after taking into account reasonable transaction costs.
Keywords: Socially responsible investing, portfolio management, trading strategy
JEL Classification: G11, G12, G20, G23, M14
Volatility-Spillover Effects in European Bond Markets
Charlotte Christiansen
Abstract
Volatility spillover from the US and aggregate European bond markets into
individual European bond markets using a GARCH volatility-spillover model is analysed.
Strong statistical evidence of volatility spillover from the US and aggregate European bond
markets is found. For EMU countries, the US volatility-spillover effects are rather weak
(in economic terms) whereas the European volatility-spillover effects are strong. The bond
markets of EMU countries have become much more integrated after the introduction of
the euro, and in recent years they have become close to being perfectly integrated. The
main driver of the integration appears to be convergence in interest rates.
Keywords: Euro Introduction; Government Bonds; Integration of Bond Markets; International Bond Markets; Volatility Spillover
JEL Classification: C32; E43; F36; G12; G15
Corporate Raiders, Performance and Governance in Europe
Ettore Croci
Abstract
I analyze 136 block purchases made by corporate raiders in Europe between 1990 and 2001. Contrary to the hypothesis that these investors expropriate the target companies, there is a positive market reaction to the first public announcement of these purchases. In the long-run, raiders earn an abnormal profit when they sell their stakes. When they still held their positions at the end of the sample period, abnormal returns were insignificant. Raiders’ activities do not improve operating performance. The findings are consistent with superior stock picking ability among these investors, but do not support the hypothesis that raiders are governance champions.
Keywords: corporate control; corporate raiders; Europe; event study; corporate governance.
JEL Classification: G34.
Capital Structure Swaps and the Intrinsic Wealth of Long-term Shareholder
Thomas J. O'Brien , Linda Schimd Klein and Jamfes I. Hilliard
Abstract
We show how capital structure swaps can increase the wealth of a firm’s long-term shareholders when a firm’s debt or equity is misvalued. We review the conventional rule that a firm should issue equity and use the proceeds to retire outstanding debt (an equity-for-debt swap) when equity is overvalued, or repurchase equity with proceeds of new debt (a debt-for-equity swap) when equity is undervalued. We also analyze the more complex case where a firm’s debt and equity are both undervalued, showing the optimal swap may be to issue undervalued equity, contrary to the conventional rule.
Keywords: capital structure, swaps, debt, equity, asymmetric information
JEL Classification: G30/G32
European Financial Management, VOL 14:1 January 2008
Behavioral Finance: A Review and Synthesis
Avanidhar Subrahmanyam
Abstract
I provide a synthesis of the behavioral finance literature over the past
two decades. I review the literature in three parts, namely, (i) empirical
and theoretical analyses of patterns in the cross-section of average stock
returns, (ii) studies on trading activity, and (iii) research in corporate
finance. Behavioral finance is an exciting new field because it presents
a number of normative implications for both individual investors and
CEOs. The papers reviewed here allow us to learn more about these
specific implications.
Keywords: Behavioral Finance, Market Efficiency, Cross-Section of Stock Returns
JEL Classification: G00, G10, G11, G14, G31, G32, G34
Clustering in U.S. Stock Prices After Decimalization
David Ikenberry and James Weston
Abstract
Early in 2001, U.S. equity markets transitioned from trading in discrete price fractions to a smoother decimal format with a tick size of one penny. Theory suggests in an unconstrained world, stock prices should be distributed uniformly, particularly if the cost of defeating time priority is low. This regime change provides a natural experiment to test whether investors instead prefer to trade at particular price points even when their choices are essentially unconstrained by regulation. Instead of uniformity, we find widespread evidence of price clustering at increments of five and ten cents (nickels and dimes); the overall magnitude of clustering is double in scale of what is otherwise expected. Previous studies which documented clustering around even-eighths argued that these patterns were a rational market response to trading impediments. We report consistent findings, but also find that the overall level of post-decimalization clustering is far more extensive than is reasonably explained by prior hypotheses. The evidence instead suggests a more fundamental human bias for prominent numbers as discussed in the psychology literature. Contrary to previous studies, we find no difference in price clustering, ceteris paribus, between the Nasdaq and NYSE after decimalization. Should regulators choose to revisit the notion of tick size, our evidence suggests that for many stocks there would be only minor impact between the transaction prices that prevail now and those that would occur if the tick size were increased to five cents.
Keywords: decimalization; investor behavior; price clustering.
JEL Classification: G12, G14
Wolf in Sheep’s Clothing: The Active Investment Strategies Behind Index Performance
Angelo Ranaldo and Rainer Haberle
Abstract
This paper argues that the commonly used market indices imply forms of active investment management in disguise. The selection and rebalancing rules make these indices highly exclusive and dynamic regarding their underlying components and significantly bias their performance. Any passive investment tracking these indices turns into an active strategy characterised by market timing and state-dependent performance. Evidence is provided that exclusive indices outperform (underperform) more inclusive peer indices in upward (downward) markets. The constitution and maintenance rules of exclusive indices correspond to a set of active trading and investment rules similar to momentum strategies.
Keywords: index performance, active / passive investment management, momentum strategies, index constituents; selection and rebalancing rules; performance measurement; “buy-and-hold” strategy.
JEL Classification: G11
Overconfidence and Investor Size
Anders Ekholm and Daniel Pasternak
Abstract
Recent research documents that institutional or large investors act as antagonists to other investors by showing opposite trading behavior following the disclosure of new information. Using an extremely comprehensive official transactions data set from Finland, we set out to explore the interrelation between investor size and behavior. More specifically, we test whether investor size is positively (negatively) correlated with investor reaction following positive (negative) news. We document robust evidence of that investor size affects investor behavior under new information, as larger investors on average react more positively (negatively) to good (bad) news than smaller investors. We furthermore find that the performance of smaller, or more overconfident, investors is in general hurt by their behavior.
Keywords: investor size; trading behavior; overconfidence
JEL Classification: G10 G12, G14
Adaptive Learning in an Expectational Difference Equation with Several Lags: Selecting among Learnable REE
Mikael Bask
Abstract
It is demonstrated that adaptive learning in least squares sense may be incapable to satisfactorily reduce the number of attainable equilibria in a rational expectations model when focusing on the forward-solutions to the model. The model examined, as an illustration, is a basic asset pricing model for exchange rate determination that is augmented with technical trading in the currency market in the form of moving averages since it is the most commonly used technique according to questionnaire surveys. The forward-solutions to such a model are preferable to the backward-solutions that normally are utilized since announcement effects is an important feature in currency trade. Because of technical trading in foreign exchange, the current exchange rate depends on jmax lags of the exchange rate, meaning that the model has jmax+1 rational expectations equilibria, where several of them are adaptively learnable in least squares sense. However, since past exchange rates should not affect the current exchange rate when technical trading is absent in currency trade, it is possible to single out a unique equilibrium among the adaptively learnable equilibria that is economically meaningful.It is worth noting that the model examined can also be viewed as a model for stock price determination in which the forward-solutions to the model are preferable to the back-ward-solutions since the importance of announcement effects is a common characteristic for currency and stock markets.
Keywords: asset pricing, exchange rates, heterogeneous agents, least squares learnability, rational expectations equilibria and technical trading.
JEL Classification: C62, F31 and G12
* * * * * * * * * * *New Paradigms in Stock Market Indexing
Derek Jun, Burton G. Malkiel
Abstract
Considerable recent interest has been shown in a new set of stock-market indices that are weighted by fundamental factors such as sales, earnings, dividends or book values, rather than by capitalization. In this paper, we analyze the performance of Fundamental Indexing™ (“FI”). First, we show that the source of FI’s recent excellent performance is not from its ability to systematically arbitrage mispricing in a noisy market but from increasing the portfolio’s exposure to stocks with low price-to-book values and with small capitalizations. We find that FI does not produce a positive alpha when its excess returns are explained by the Fama-French three-factor model of CAPM beta, the value premium and the size premium. Second, we show that it is possible to construct a portfolio of exchange-traded funds with similar factor loadings that can replicate, and sometimes, even outperform FI. However, we caution investors not to expect consistent outperformance from portfolios tilted towards value and small-cap stocks. Historical data shows evidence of mean reversion in the performance of such strategies.
Keywords:Indexing, Fundamental Indexing, Fama-French Model, Small Cap Stocks, and Value Premium
JEL Classification:G11, G14
Why Have Debt Ratios Increased for Firms in Emerging Markets?
Todd Mitton
Abstract
I study trends in capital structure between 1980 and 2004 in a sample of over 11,000 firms from 34 emerging markets. The average firm's market-value debt ratio rose by 15 percentage points over this quarter century. I study how this rise in leverage was influenced by firm-level factors and by the availability of debt financing at the country level. The central finding is that the increase in debt ratios can largely be attributed to changes in the characteristics of emerging market firms over this period. For the average firm, the most prominent determinants of capital structure – size, profitability, asset tangibility, and growth opportunities – all shifted in the direction implying a higher optimal level of debt. At the country level, increased financial development within the country is associated with lower debt ratios, but increased financial openness to foreign markets is associated with higher debt ratios.
Keywords: emerging markets; capital structure; financial development
JEL Classification: G32; G15
On the Equivalence Between the APV and the WACC Approach in a Growing Leveraged Firm
Mario Massari, Francesco Roncaglio and Laura Zanetti
Abstract
While in a steady state framework the choice between the wacc approach (Modigliani-Miller, 1963) and the adjusted present value (APV) approach (Myers, 1974) is irrelevant since the two approaches provide the same result, however, in a growing firm context the wacc equation seems to be inconsistent with the APV result.
In this paper we propose a simple model to evaluate the tax savings in a growing firm in order to show under which assumptions the two approaches lead to the same results. We demonstrate that the use of the wacc model in a steady-growth scenario gives rise to some unusual assumptions with regard to the discount rates to be used in calculating tax shields. We show that the widely used wacc formula, if used, as it is in most cases, in a growth context, implies that a) debt tax shield related to already existing debt are discounted using kd; b) debt tax shield related to new debt, due to company’s growth, are discounted, according to a mixed procedure, using both ku and kd. We discuss the inconsistency of such a discounting procedure and the preferred features of the APV approach.
Keywords: valuation techniques, growth, APV, WACC, tax-shields
JEL Classification: G31
Timing and Wealth Effects of German Dual Class Stock Unifications
Ingolf Dittmann and Niels Ulbricht
Abstract
This paper studies the reasons and the costs of separating ownership from control by analyzing the decision of German dual class firms to consolidate their share structure from dual to single class equity between 1990 and 2001. We find that the firm value increases significantly by an average 4% on the announcement day. A significant part of the variation in abnormal returns can be explained by the ownership structure and by changes in liquidity. A logit analysis of the unification decision yields that firms are more likely to unify if their controlling shareholder loses only little voting power in a stock unification. Also, firms that are financially constrained are more likely to abolish dual class shares; these firms often issue additional shares after the stock unification..
Keywords: Capital structure; entrenchment; financial constraints; liquidity; ownership structure.
JEL Classification: G32, G34
European Financial Management, VOL 14:2 March 2008
Economic Sentiment and Yield Spreads in Europe
Eva Ferreria , Maria-Isabel Martinez, Eliseo Navaroo and Gonzalo Rubio
Abstract
According to Harvey (1988), the forecasting ability of the term spread on economic growth is due to the fact that interest rates reflect investors’ expectations about the future economic situation when deciding their plans for consumption and investment. Past literature has used ex-post data on output or consumption growth as proxies for their expected value. In this paper, we employ a direct measure of economic agents’ expectations, the Economic Sentiment Indicator elaborated by the European Commission, to test this hypothesis. Our results indicate that a linear combination of European yield spreads explains a surprising 93.7% of the variability of the Economic Sentiment Indicator. This ability of yield spreads to capture economic agent expectations may be the actual reason of the predictive power of yield spreads about future business cycle.
Keywords: Economic Sentiment Indicator; term structure of interest rates; yield spreads; principal components; expected economic growth?
JEL Classification: G12, E43
Corporate Sell-offs in the UK: Use of Proceeds, Financial Distress, and Long-Run Impact on Shareholder Wealth
Edward Lee and Stephen Lin
Abstract
This study examines the long-run return performance following UK corporate sell-off announcements. We observe significant negative abnormal returns up to five years subsequent to sell-off announcements. Our finding is robust to various specifications, irrespective of the intended use of proceeds. We also find a significantly positive association between long-run abnormal returns and the magnitude of cash proceeds for sellers reducing corporate debt as well as for sellers with deeper financial distress or higher growth prospects. Overall, we find that UK corporate sell-offs are associated with declines in subsequent shareholder wealth.
Keywords: Sell-offs, financial distress, long-run performance
JEL Classification: G34
Dispersed Trading and the Prevention of Market Failure: The Case of the Copenhagen Stock Exchange
David C. Porter, Carsten Tanggaard, Daniel G. Weaver and Wei Yu
Abstract
With augmented demands on power grids resulting in longer and larger blackouts combined with heightened concerns of terrorist attacks, trading institutions and policy makers have widened their search for systems that avoid market failure during these disturbing events. We provide insight into this issue by examining trading behavior at the Copenhagen Stock Exchange during a major blackout. We find that although market quality declined, markets remained functional and some price discovery occurred during the blackout period suggesting that the NOREX structure of interlinked trading systems combined with widely dispersed trading locations may be a viable means of protection against market failure during massive power disruptions or terrorist attacks.
Keywords: Power failure; fragmented markets; market failure
JEL Classification: G1; G14; G18
How Much Is Too Much: Are Merger Premiums Too High?
Antonios Antoniou, Philippe Arbour and Huainan Zhao
Abstract
Is it too much to pay target firm shareholders a 50% premium on top of market price? Or is it too much to pay a 100% premium when pursuing mergers and acquisitions? How much is too much? In this paper, we examine how the extent of merger premiums paid impacts both the long-run and announcement period stock returns of acquiring firms. We find no evidence that acquirers paying high premiums underperform those paying relatively low premiums in three years following mergers, and the result is robust after controlling for a variety of firm and deal characteristics. Short term cumulative abnormal returns are moreover positively correlated to the level of the premium paid by acquirers. Our evidence therefore suggests that high merger premiums paid are unlikely to be responsible for acquirers’ long-run post merger underperformance.
Keywords: Mergers and Acquisitions; Corporate Takeovers; Merger Premiums; Abnormal Returns; Event Study
JEL Classification: G14; G34
An Empirical Analysis of the Pricing of Bank Issued Options versus Options Exchange Options
Jenke Ter Horst and Chris Veld
Abstract
Since 1998, large investment banks have become active as issuers of options,
generally referred to as call warrants or bank-issued options. This has led to
an interesting situation in the Netherlands, where simultaneously call warrants
are traded on the stock exchange, and long-term call options are traded on the
options exchange. Both entitle their holders to buy shares of common stock. We
start with a direct comparison between call warrants and call options, written
on the same stock and with the same exercise price, but where the call option
has a longer time to maturity. In 13 out of 16 cases we find that the call warrants
are priced higher, which is a clear violation of basic option pricing rules. In the
second part of the analysis we use option pricing models to compare the pricing
of call warrants and call options. If implied standard deviations from options
are used to price the call warrants, we find that the call warrants are strongly
overpriced during the first five trading days. The average overpricing is between
25 and 30 percent. Only a small part of the overpricing can be explained by
rational arguments such as transaction costs. We suggest that the overvaluation
can be explained by a combination of an active financial marketing by the banks
and the framing effect.
Keywords: financial marketing, framing, bank-issued options, long-term call options, call warrants
JEL Classification: G13 and G14
Regime Change and the Role of the International Markets on the Stock Return of small open Economies
Don Bredin and Stuart Hyde
Abstract
We examine the in°uence of US, UK and German macroeconomic
and ¯nancial variables on the stock returns of two relatively small, open
European economies, Ireland and Denmark. Within a nonlinear frame-
work, we allow for time variation via regime switching using a smooth
transition regression (STR) model. We ¯nd that US (global) and UK
and German (regional) stock returns are signi¯cant determinants of re-
turns in both markets. Further, global information represented by oil and
US asset price movements drive changes between states in each market.
Signi¯cantly, the role of country-speci¯c domestic variables is typically
con¯ned to a single state while global and regional variables pervade all
states.
Keywords: Smooth transition, Regime switching
JEL Classification: G15, F30, F37, C32
Capital Structure and Assets: Effects of an Implicit Collateral
Christian Riis Flor
Abstract
This paper analyzes a firm’s capital structure choice when assets have outside
value. Valuable assets implicitly provide a collateral and increase tax shield ex-
ploitation. The key feature in this paper is asset value uncertainty, implying that
it is unknown ex ante whether the equity holders ex post optimally sell the as-
sets or re-optimize the capital structure. Ex ante, more uncertain asset value
decreases leverage, but not firm value, and selling the assets becomes less likely.
Firms should tend to invest in assets whose value is less correlated to changes in
earnings and, in addition, asset sales are less likely when this correlation is low.
Keywords: Optimal capital structure; uncertain asset value; debt restructuring.
JEL Classification: G32, G33, G34
European Financial Management, VOL 14:3 June 2008
Non-Monotonicity of the Tversky-Kahneman Probability-Weighting Function A Cautionary Note
Jonathan Ingersoll
Abstract
Cumulative Prospect Theory has gained a great deal of support as an alternative to Expected Utility Theory as it accounts for a number of anomalies in the observed behavior of economic agents. Expected Utility Theory uses a utility function and subjective or objective probabilities to compare risky prospects. Cumulative Prospect Theory alters both of these aspects. The concave utility function is replaces by a loss-averse utility function and probabilities are replaced by decision weights. The latter are determined with a weighting function applied to the cumulative probability of the outcomes. Several different probability weighting functions have been suggested. The two most popular are the original proposal of Tversky and Kahneman and the compound-invariant form proposed by Prelec. This note shows that the Tversky-Kahneman probability weighting function is not increasing for all parameter values and therefore can assign negative decision weights to some outcomes. This in turn implies that Cumulative Prospect Theory could make choices not consistent with first-order stochastic dominance.
Keywords: prospect theory; decision weights; probability-weighting function.
JEL Classification: C91; D10; D81; G19
Testing Conditional Asset Pricing Models Using a Markov Chain Monte Carlo Approach
Manuel Ammann and Michael Verhofen
Abstract
We use Markov Chain Monte Carlo (MCMC) methods for the parameter estimation and the testing of conditional asset pricing models. In contrast to traditional approaches, it is truly conditional because the assumption that time variation in betas is driven by a set of conditioning variables is not necessary. Moreover, the approach has exact finite sample properties and accounts for errors-in-variables. Using S&P 500 panel data, we analyze the empirical performance of the CAPM and the Fama and French (1993) three-factor model. We find that time-variation of betas in the CAPM and the time variation of the coefficients for the size factor (SMB) and the distress factor (HML) in the three-factor model improve the empirical performance. Therefore, our findings are consistent with time variation of firm-specific exposure to market risk, systematic credit risk and systematic size effects. However, a Bayesian model comparison trading off goodness of fit and model complexity indicates that the conditional CAPM performs best, followed by the conditional three-factor model, the unconditional CAPM, and the unconditional three-factor model.
Keywords: Markov Chain Monte Carlo, Conditional Asset Pricing, Bayesian Analysis
JEL Classification: G12
Have European Stocks Become More Volatile?
Colm Kearny and Valerio Poti
Abstract
We examine the dynamics of idiosyncratic risk, market risk and return correlations in European equity markets using weekly observations from 3515 stocks listed in the 12 Euro area stock markets over the period 1974-2004. Similarly to Campbell, Lettau, Malkiel and Xu (2001), we find a rise in idiosyncratic volatility, implying that it now takes more stocks to diversify away idiosyncratic risk. Contrary to the United States, however, market risk is trended upwards in Europe and correlations are not trended downwards. Both the volatility and correlation measures are pro-cyclical, and they rise during times of low market returns. Market and average idiosyncratic volatility jointly predict market wide returns, and the latter impact upon both market and idiosyncratic volatility. This has asset pricing and risk management implications.
Keywords: Idiosyncratic risk, correlation, portfolio management, asset pricing.
JEL Classification: C32, G11, G12, G12, G15.
The Determinants of Foreign Currency Hedging: Does Foreign Currency Debt Induce a Bias?
Ephraim Clark and Amrit Judge
Abstract
In this paper we use UK data to present strong empirical evidence that explains the mixed results in previous studies with respect to the effect of financial distress on the demand for corporate hedging. We build on recent studies that have identified a strong link between foreign currency (FC) debt use and leverage. Given this relationship, we show that using leverage variables as proxies for financial distress and the failure to distinguish between FC debt users and non-users causes misleading inference. More specifically, when we partition our sample of FC hedgers into firms that use and do not use foreign debt, we show that leverage variables are significantly related to the FC hedging decision for firms that use FC debt either in isolation or in combination with FC derivatives but not for firms that only use FC derivatives. This suggests that FC debt users are influencing these results. However, we also find that other financial distress cost proxies with no obvious link to FC debt use are significant determinants in the corporate demand for FC hedging, including derivatives use.
Keywords: Corporate hedging; foreign currency hedging; derivatives; financial distress; foreign currency debt.
JEL Classification: F30, G32, G33
Minority Protection and Dividend Policy in Finland
Seppo Kinkki
Abstract
This paper highlights some theoretical arguments and empirical results on whether legal-based minority protection affects corporate cash dividends in Finland. The Company Act in Finland states that shareholders having one tenth of all shares can demand a so-called minority dividend, which is half of the profit of the fiscal year, yet not more than 8% of the equity. Minority dividend, as in Finland, is rarely used in EU countries. I find, that minority protection is a better influence over managerial control than controlling shareholders having absolute voting power. When there is no controlling shareholder and coalition costs are lowest, minority protection in Finland is better than minority protection in mandatory dividend countries. Combining strong shareholder rights (as in the USA) and minority dividend (as in Finland) could decrease agency costs both vertically and horizontally.
Keywords: dividends, minority protection, agency problems
JEL Classification: G32, G35
Predicting Agency Rating Migrations with Spread Implied Rating
Jiaming Koo and Simone Varotto
Abstract
Rating agencies are known to be prudent in their approach to rating revisions, which results in delayed rating adjustments. For a large set of eurobonds we derive credit spread implied ratings and compare them with agency ratings. Our results indicate that spread implied ratings often anticipate the future movement of agency ratings and hence can help track credit risk in a more timely manner. This finding has important implications for risk managers in banks who, under the new Basel 2 regulations, have to rely more on credit ratings for capital allocation purposes, and for portfolio managers who face rating-related investment restrictions.
Keywords: Credit rating, Spread implied rating, Credit risk
JEL Classification: C20, G11, G23, G33
Asymmetric Volume-Return Relation and Concentrated Trading in LIFFE Futures
Tribhuvan N. Puri and George C. Philippatos
Abstract
This study demonstrates that intraday volume and return on LIFFE interest rate and currency futures exhibit an asymmetric volume-return relationship characterized by significantly larger volume associated with negative returns than with non-negative returns. This finding is unlike the stylized asymmetric relation often observed in equity markets, where the volume on price rise is larger than the volume on price decline. The asymmetric relationship in LIFFE futures is also found to be dynamic as the direction of asymmetry can reverse during the day. It has been argued in the past that a costly short sale restriction that requires a higher transaction cost on a short position than on a long position is responsible for the asymmetric effect in equity markets. Since such a restriction is absent in futures markets, they should not exhibit any asymmetric volume behavior. Based on the results of this research, the costly short sale hypothesis is rejected. An alternative explanation of the asymmetric relation observed in futures is presented based on recent information models that take into consideration asymmetrically-informed traders, their dispersion of beliefs, quality and quantity of the information signal, and how the traders process it. The paper also confirms a strong U-shape trading pattern in 15-minute volume, but no such pattern is identified in intraday returns.
Keywords: LIFFE futures, volume-return asymmetric relationship, costly short-sale constarint, dispersion of beliefs,information quality, trading pattern, market microstructure.
JEL Classification: G10,G13, G15
Keywords: Hedge funds; style classification; style consistency; cluster analysis.
JEL Classification: G11
European Financial Management, VOL 14:4 , September 2008
Trust in Financial Markets
Colin Mayer
Abstract
This paper examines contemporaneous and historical evidence on the structure of ownership and control of corporate sectors in developed countries to draw lessons for development of financial markets. It records the critical role that equity markets played in the ownership and financing of corporations at the beginning of the 20th century. It notes that this occurred in the absence of formal systems of regulation and that equity markets functioned on the basis of informal relationships of trust. These were sustained through local stock markets in the UK, banks in Germany, and business coordinators and family firms in Japan. The paper explores the concept of trust that is required to promote the development of financial markets.
Keywords: Corporate ownership, control, investor protection, trust
JEL Classification: O16
Social Networks and Corporate Governance
Avanidhar Subrahmanyam
Abstract
We analyze frameworks that link corporate governance and firm values to governing
boards’ social networks and innovations in technology. Because agents create social
networks with individuals with whom they share commonalities along the dimensions
of social status and income, among other attributes, CEOs may participate in board
members’ social networks, which interferes with the quality of governance. At the
same time, social connections with members of a board can allow for better evaluation
of the members’ abilities. Thus, in choosing whether to have board members with
social ties to management, one must trade off the benefit of members successfully
identifying high ability CEOs against the cost of inadequate monitoring due to social
connections. Further, technologies like the Internet and electronic mail that reduce the
extent of face-to-face networking cause agents to seek satisfaction of their social needs
at the workplace, which exacerbates the impact of social networks on governance. The
predictions of our model are consistent with recent episodes that appear to signify
inadequate monitoring of corporate disclosures as well as with high levels of executive
compensation. Additionally, empirical tests support the model’s key implication that
there is better governance and lower executive compensation in firms where networks
are less likely to form.
Keywords:
JEL Classification:
Debt, Equity, and Hybrid Decoupling: Governance and Systemic Risk Implications
Abstract
We extend here our prior work, which focused on equity decoupling (Hu and Black, 2006, 2007, 2008), by providing a systematic treatment of debt decoupling and an initial exploration of hybrid decoupling. Equity decoupling involves unbundling of economic, voting, and sometimes other rights customarily associated with shares, often in ways that permit avoidance of disclosure and other obligations. Debt decoupling involving the unbundling of the economic, contractual control rights, and legal and other rights normally associated with debt, through credit derivatives and securitization. Corporations can have empty and hidden creditors, just as they can have empty and hidden shareholders. “Hybrid decoupling” across standard equity and debt categories is also possible. Debt decoupling can pose risks at the firm level for what can be termed “debt governance” -- the overall relationship between creditor and debtor, including creditors' exercise of contractual and legal rights with respect to firms and other borrowers. Widespread debt decoupling can also involve externalities and therefore creates systemic financial risks; we explore those risks.
Keywords: equity decoupling; debt decoupling; hybrid decoupling; vote buying; equity swaps; credit default swaps; CDOs; securitization; systemic risk
JEL Classification: : G18; G32; G34; K22
Cited in FT (Jan 27, 2007)The Impact of Corporate Governance on Executive Compensation
Stephen G. Sapp
Abstract
This paper examines the relationship between the compensation of the top five executives at a set of over 400 publicly listed Canadian firms and various internal and external corporate governance-related factors. The media is full of stories suggesting a relationship between large executive compensation packages and failures in governance at various levels within organizations, but there exists little formal analysis of many of these relationships. Our analysis provides empirical evidence supporting some of these assertions, refuting others and documenting new relationships. We find that variances in internal governance related to differences across firms in the characteristics of the CEO, compensation committee and board of directors do influence both the level and composition of executive compensation, especially for the CEO. Considering external measures of corporate governance, we find that different types of shareholders and competitive environments impact executive compensation. We do not find that either the internal or external governance characteristics dominate.
Keywords: Executive compensation; corporate governance
JEL Classification: G32; M52
The Evolution of Corporate Governance and Firm Performance in Emerging Markets:The Case of Sellier and Bellot
Tomas Jandik and Craig G. Rennie
Abstract
This paper investigates the evolution of corporate governance and firm performance in transition economies. It focuses on barriers that impeded adoption of optimal corporate governance at Czech ammunition manufacturer Sellier and Bellot (S&B) following voucher privatization in 1993. Exogenously imposed diffuse ownership, combined with legal, capital market, and accounting deficiencies, contributed to poor corporate governance and weak firm performance.This study shows how legal, capital market, and accounting deficiencies hinder corporate governance evolution; it demonstrates monitoring and incentive mechanisms can create value in transition economies; it suggests effective privatization not only involves rapid ownership transfer but careful accounting and securities regulation and legal protection.
Keywords: Corporate governance; Ownership structure; Capital markets; Corporation and securities law; Transition economies; Czech Republic
JEL Classification: : G32; G34; K22
Corporate Restructuring and Bondholder Wealth
Luc Renneboog and Peter G. Szilagyi
Abstract
This paper provides an overview of existing research on how corporate restructuring affects the wealth of bondholders. Restructuring is defined as any transaction that affects the firm’s underlying capital structure. Thus, it reaches well beyond asset restructuring and includes transactions such as leveraged buyouts, security issues and exchanges, and the issuance of stock options. We identify significant gaps in the literature, emphasize the potential differences between bondholder wealth changes in market- and stakeholder-oriented governance systems, and provide valuable insights into methodological advances. Many issues obviously remain, as empirical evidence is still incomplete and focuses almost exclusively on the US. In stakeholder-oriented regimes, the potential for research remains constrained by the lesser development of bond markets that disclose information on creditor wealth shocks. Still, on-going debt securitization should now allow for the investigation of at least some critical issues. This is imperative, as the position of creditors in the firm differs substantially across governance systems despite the gradual convergence of these regimes across the world.
Keywords: bondholder wealth; corporate restructuring; mergers and acquisitions; event studies; bond returns.
JEL Classification: G12, G14, G34, G35
Corporate Real Estate Sale and Leaseback Effect: Empirical Evidence from Europe
Tomi Gronlund, Antti Louko, and Mika Vaihekoski
Abstract
Corporate real estate disposals have increased in Europe during the past few years. In this research paper, we study market reactions of publicly traded European companies’ real estate sale and leaseback announcements during 1998–2004. This study is one of the first ones to study the sale and leaseback impact on corporate value with a pan-European data. We find that the sale and leaseback announcements have on average positive impact to firm’s value which is in line with the previous studies. However, we also find that the positive effect is mainly caused by the deals with high transaction value to company market value ratio. Smaller transactions do not create on average any abnormal returns. Our results support the hypothesis that the positive sale and leaseback announcement effect is a consequence of revealed hidden value of the company’s assets. Thus, sale and leaseback can also be seen as a mechanism for revealing the hidden value of company’s assets to the market.
Keywords: real estate; sale and leaseback; hidden value; tax savings; event study
JEL Classification: G14
European Financial Management, VOL 14:5 November 2008
Psychological Bias as a Driver of Financial Regulation
David Hirshleifer
Abstract
I propose here the psychological attraction theory of financial regulation—that regulation is the result of psychological biases on the part of political participants—voters, politicians, bureaucrats, and media commentators; and of regulatory ideologies that exploit these biases. Some key elements of the psychological attraction approach are: salience and vividness, omission bias, scapegoating and xenophobia, fairness and reciprocity norms, overconfidence, and mood effects. This approach further emphasizes emergent effects that arise from the interactions of individuals with psychological biases. For example, availability cascades and ideological replicators have powerful effects on regulatory outcomes
Keywords: Investor psychology; regulation; salience; omission bias; scapegoating; xenophobia; fairness; reciprocity; norms; mood; availability cascades; overconfidence; evolutionary psychology; memes; ideology; replicators
JEL Classification: G0; G28; H0; H1; H10
The Long-Term Effect of the Sarbanes-Oxley Act on Cross-Listing Premia
Kate Litvak
Abstract
This paper uses a triple difference approach to assess whether the adoption of the Sarbanes-Oxley Act predicts long-term changes in cross-listing premia of affected foreign firms. I measure cross-listing premia as the difference between the Tobin’s q of a cross-listed company and a non-cross-listed company from the same country matched on propensity to cross-list (first difference). I find that average premia for firms cross-listed on levels 2 or 3 (subject to SOX) declined in the year of SOX adoption (2002) and remained significantly below their pre-SOX level through year-end 2005 (second difference). Firms listed on levels 2 or 3, which are subject to SOX, experienced larger declines in premia than firms listed on levels 1 or 4, which are not subject to SOX (third difference). The estimated decline is 0.15-0.20 depending on specification. Riskier firms and firms from high-disclosing and high-GDP countries suffered larger post-SOX declines. Firm size predicts smaller declines in premia in well-governed countries. Faster-growing firms in poorly-governed countries experienced smaller declines in premia. The results are robust to the use of different before-and-after periods; the use of annual, quarterly, or monthly data; the use of individual companies’ Tobin’s q’s instead of matched pairs, and different regression specifications. The overall evidence is consistent with the view that SOX negatively affected cross-listed premia, and particularly hurt riskier firms and firms from well-governed countries, while perhaps helping high-growth firms from poorly-governed countries. At the same time, after-SOX, level-23 firms continue to enjoy a substantial premium, estimated at about 0.32.
Keywords: Sarbanes-Oxley Act; International Listings; Securities Regulation; Corporate Governance
JEL Classification: G3; G14; G18; G38; K22
Corporate Governance When Managers Set Their Own Pay
Pablo Ruiz-Verdu
Abstract
This paper presents a model of the firm in which the manager has discretion over his own
compensation, constrained only by the threat of shareholder intervention. The model addresses
two main questions. How does shareholder power affect managers' compensation and their incen-
tives to maximize firm value? And what is the optimal level of shareholder power? Expectedly,
the model shows that increasing shareholder power leads to lower managerial pay. Greater
shareholder power, however, also weakens the manager's incentives to maximize value and may
even lead to lower profits for shareholders. There might, thus, be too much, as well as too little,
shareholder power. The model characterizes the optimal level of shareholder power and yields
predictions about the relation between shareholder power, managerial pay, performance, and
firm characteristics.
Keywords: Executive compensation, corporate governance, shareholder power, managerial power.
JEL Classification: G30, G34, D86, L20, M52.
Which Factors Affect Bond Underwriting Fees? The Role of Banking Relationships
Marco Navone, Giuliano Iannotta
Abstract
The question of which factors are relevant in determining bond underwriting fees is empirically investigated by analyzing 2,202 bond issues completed by European firms during the 1993 – 2003 period. Four major results emerge from the analysis. First, the introduction of the single currency in 1999 has generated an increase in competition among banks, and, as a result, a reduction in underwriting fees. Second, a strong relationship with the issuer’s main bank reduces the level of underwriting fees. Third, new issuers are charged with lower underwriter fees relative to firms that have completed issues without building any strong relationship with a bank. Fourth, higher reputation banks charge lower underwriting fees. The implications of these findings are also discussed.
Keywords: Undewriting, Relationship, European bonds.
JEL Classification: G20, G24, L14
Required Rates of Return for Corporate Investment Appraisal in the Presence of Growth Opportunities
Jo Danbolt, Ian R. C. Hirst, Eddie Jones
Abstract
Traditional methods of estimating required rates of return overstate hurdle rates in the presence of growth opportunities. We attempt to quantify this effect by developing a simple model which: (i) identifies those companies that have valuable growth opportunities; (ii) splits the value of shares into ‘assets-in-place’ and ‘growth opportunities’; and (iii) splits the equity B into B for ‘assets-in-place’ and ‘growth opportunities’. We find growth opportunities for UK companies over the 1990-2004 period to average 33% of equity value. Incorporating the effect of growth opportunities, the average cost of capital for investment purposes falls by 1.1 percentage points.
Keywords: Cost of capital, Beta, Growth opportunities, Assets-in-place
JEL Classification: G31
The Lead-Lag Relationship Between Cash And Stock Index Futures In A New Market
Manolis G. Kavussanos, Ilias D. Visvikis and Panayotis Alexakis
Abstract
This paper investigates the lead-lag relationship in daily returns and volatilities between price movements of the FTSE/ATHEX-20 and FTSE/ATHEX Mid-40 stock index futures and the underlying cash indices in the relatively new futures market of Greece. Empirical results show that there is a bi-directional relationship between cash and futures prices. However, futures lead the cash index returns, by responding more rapidly to economic events than stock prices. This speed is much higher in the more liquid FTSE/ATHEX-20 market. Moreover, results indicate that futures volatilities spill information over to the corresponding cash market volatilities in both investigated futures markets, but volatilities in the cash markets have no effect on the volatilities of futures markets. Overall, it seems that new market information is disseminated faster in the futures market compared to the stock market. This implies that the futures markets can be used as price discovery vehicles, providing further evidence that derivatives markets contribute to completing and stabilising capital markets in Greece. A further finding of this study is that futures volume and disequilibrium effects between cash and futures prices are important variables in the explanation of volatilities in cash and futures markets.
Keywords: stock index futures markets, price discovery, Granger causality, VECM-GARCH, GIR analysis, volatility spillovers.
JEL Classification: G13, G14, C32
European Financial Management, VOL 15:1 January 2009
The Subprime Panic
GARRY GORTON
Abstract
Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.
Keywords: Banking panic, credit crisis, securitization, subprime mortgages, ABX index, credit derivatives
JEL Classification: G1,G2
Cash Flow Sensitivity of Investment
Armen Hovakimian and Gayane Hovakimian
Abstract
Investment cash flow sensitivity is associated with both underinvestment when cash flows are low and overinvestment when cash flows are high. The accessibility of external capital is positively correlated with cash flows, intensifying investment cash flow sensitivity. Managers actively counteract the variations in internal and external liquidity by accumulating working capital when liquidity is high and draining it when liquidity is low. These results imply that cash flow sensitive firms face financial constraints, which are binding in low cash flow years. Traditional indicators of financial constraints, such as size and dividend payout, successfully distinguish firms that may potentially face constraints, but are less successful in distinguishing between periods of tight and relaxed constraints. These periods are much more clearly separated by the KZ index, which, on the other hand, is less successful in identifying firms that are likely to face liquidity constraints.
Keywords: Investment cash flow sensitivity, financial constraints, investment, managerial overconfidence
JEL Classification: G30, G31, G32
The Dark Side of International Cross-Listing: Effects on Rival Firms at Home
Michael Melvin and Magali Valero
Abstract
We analyze the stock price impact of firms’ U.S. cross-listing on home-market rival firms. Using an empirical event study approach we find negative cumulative average abnormal returns for the rival firms around both the listing and announcement of listing dates. The evidence suggests both positive and negative spillover effects on rival firms, where the dominant effect is that investors see rivals at a relative disadvantage to the cross-listing firm. As firms cross-list in the US and commit to the increased disclosure and investor protection associated with the US listing, they are better able to take advantage of growth opportunities relative to their non cross-listing counterparts, and this results in negative spillover effects on rival firms. Our results are consistent with the idea that firms cross-list as a means to reduce agency costs of controlling shareholders and thus are able to exploit growth opportunities as they have better access to external finance.
Keywords: Cross-listings; Rival firms; Growth opportunities
JEL Classification: G15
Are Venture Capitalists a Catalyst For Innovation?
Stefano Caselli, Stefano Gatti and Francesco Perrini
Abstract
In this paper we test two hypotheses concerning the presence of innovation
in venture capital investments and the growth of innovative venture backed
firms. To examine these hypotheses we considereda sample of 37 Italian
venture backed firms that went public on the Italian stock exchange between
1995 and 2004 and by a statistical matching procedure we picked 37 twin
firms among the non-venture backed IPOs for the same period. Our evidence
shows that innovation is an important factor during the selection phase but
once the investment is made, the company does not promote continued
innovation and concentrates all efforts to improve other economic and
managerial aspects.
Keywords: growth, innovation projects, venture capital, propensity score
JEL Classification: L21, D21, D92, C14, C33
The Components of the Bid-Ask Spread: Evidence from the Athens Stock Exchange
Timotheos Angelidis and Alexandros Benos
Abstract
We analyze the components of the bid-ask spread in the Athens Stock Exchange (ASE), which was recently characterized as a developed market. For large and medium capitalization stocks, we estimate the adverse selection and the order handling component of the spreads as well as the probability of a trade continuation on the same side of either the bid or the ask price, using the Madhavan et al. (1997) model. We extend it by incorporating the traded volume and we find that the adverse selection component exhibits U-shape patterns, while the cost component pattern depends on the stock price. For high priced stocks, the usual U-shape applies, while for low-priced ones, it is an increasing function of time, mainly due to the order handling spread component. Furthermore, the expected price change and the liquidity adjustment to Value-at-Risk that is needed are higher in the low capitalization stocks, while the most liquid stocks are the high priced ones. Moreover, by estimating the Madhavan et al. (1997) model for two distinct periods we explain why there are differences in the components of the bid-ask spread.
Keywords: Bid-Ask Spread, Asymmetry Information, Transaction Costs, Price Impact.
JEL Classification: D4, C1
The Size and Structure of the World Mutual Fund Industry
Sofia Ramos
Abstract
This paper analyses the mutual fund industry for 20 countries using a new database of more than 50,000 mutual funds. The results suggest that more developed industries provide more benefits to investors as they diversify more internationally, charge lower annual charges and present more product sophistication. The results also have important policy implications by emphasizing the role of competition and contestability in industry development. Fewer barriers to entry are positively associated with a larger industry, and concomitantly with more efficiency in terms of returns and fees.
Keywords: Mutual Funds, Competition, Mutual Fund Industry, Entry Barriers.
JEL Classification: G15, G23
Competition between Exchanges: Euronext versus Xetra
Maria Kasch-Haroutounian and Erik Theissen
Abstract
Exchanges in Europe are in a process of consolidation. After the failure of the proposed merger between Deutsche Börse and Euronext, these two groups are likely to become the nu-clei for further mergers and co-operation with currently independent exchanges. A decision for one of the groups entails a decision for the respective trading platform. Against that back-ground we evaluate the attractiveness of the two dominant continental European trading sys-tems. Though both are anonymous electronic limit order books, there are important differ-ences in the trading protocols. We use a matched-sample approach to compare execution costs in Euronext Paris and Xetra. We find that both quoted and effective spreads are lower in Xetra. The differences are more pronounced for less liquid stocks. When decomposing the spread we find no systematic differences in the adverse selection component. Realized spreads, on the other hand, are significantly higher in Euronext. Neither differences in the number of liquidity provision agreements nor differences in the minimum tick size or in the degree of domestic competition for order flow explain the different spread levels. We thus conclude that Xetra is the more efficient trading system.
Keywords: Competition between exchanges, bid-ask spread
JEL Classification: G10, G15
The Value of Adjusting the Bias in Recommendations: International Evidence
German Lopez-Espinosa, Marina Balboa-Ramon and Juan Carlos Gomez-Sala
Abstract
The financial literature has shown that both earnings forecasts and investment recommendations are optimistically biased. However, while the bias in earnings forecasts has decreased over time and even some recent studies show that they are no longer optimistic, in the case of investment recommendations this bias still remains relatively constant over time. Therefore, it seems that recommendations are less credible to investors than earnings forecasts. The vast majority of recommendation studies have been carried out at the country level. In this paper, we use an international context to study whether profitable investment strategies exist when adjusting the recommendation bias of each analyzed country. The adjustment we propose to correct this bias takes into account the differences across countries, and also varies in time to correct for the changes in bias over time within countries. Our empirical results show that there are in fact significant differences in the level of bias among countries, with the United States and the United Kingdom being the countries with the highest bias. Second, the adjusted consensus portfolios are more orthogonal to typical investment styles (Size, Book-to-Market and Attention) and we find that investors could implement a higher number of profitable investment strategies using this adjusted measure. In this line, the results show that the countries with the lowest bias obtain the highest risk adjusted abnormal returns. Third, our work entails a practical implication, as it shows the value embedded in a simple necessary adjustment in the global asset management context. This is an important result showing that profitable investment strategies exist when considering a global portfolio based on adjusted recommendations.
Keywords: Country-bias, adjusted consensus, international portfolio management, investment strategy
JEL Classification: G10, G14, G20, G24
European Financial Management, VOL 15:2 March 2009
Risk and Asset Management: Introduction
Lionel Martellini
The Performance of Characteristics-based Indices
Noel Amenc, Felix Goltz, Veronique Le Sourd
Abstract
This paper analyses a set of characteristics-based indices that, it has been argued, outperform market cap-weighted indices. We analyse the performance of an exhaustive list of these indices and show that i) the outperformance over value-weighted indices may be negative over long time periods, and ii) there is no significant outperformance over equal-weighted indices. An analysis of the style and sector exposures of characteristics-based indices reveals a significant value tilt. When this tilt is properly adjusted for, the abnormal returns of these indices decrease considerably. Moreover, it is straightforward to construct portfolios with higher Sharpe ratios than characteristics-based indices through factor or sector tilts.
Keywords: market portfolio, value premium, performance measurement, characteristics-based indices
JEL Classification: G11, G12
Do Inflation-Linked Bonds Still Diversify?
Marie Briere, Ombretta Signori
Abstract
The diversifying power of inflation-linked (IL) bonds relative to traditional asset classes has changed significantly. In this paper, we study the dynamics of conditional volatilities and correlations for three asset classes, IL bonds, nominal bonds and equities, in the United States and Europe. Using a DCC-MVGARCH for the period 1997-2007, we highlight the change that took place in 2003. Although IL bonds once had definite diversification power, they are now highly correlated with nominal bonds and have reached similar volatility levels. As a result, the two asset classes are practically substitutable. This seems to be due to more stable inflation expectations and to a more liquid IL bond market. Although diversification was a valuable reason for introducing IL bonds in a global portfolio before 2003, this is no longer the case. Dynamic portfolio optimization using our estimates of conditional correlations and volatilities clearly demonstrates that the optimal weight of IL bonds in a portfolio decreased sharply in 2003 in favor of nominal bonds and equities.
Keywords: inflation-linked bonds, optimal allocation, portfolio choice, conditional volatility, conditional correlation
JEL Classification: G11, G12
Portfolio Performance Measurement: A No Arbitrage Bounds Approach
Dong-Hyun Ahn, H. Henry Cao, Stephane Chretien
Abstract
This paper presents a new method to examine the performance evaluation of mutual funds in incomplete markets. Based on the no arbitrage condition, we develop bounds on admissible performance measures. We suggest new ways of ranking mutual funds and provide a diagnostic instrument for evaluating the admissibility of candidate performance measures. Using a monthly sample of 320 equity funds, we show that admissible performance values can vary widely, supporting the casual observation that investors disagree on the evaluation of mutual funds. In particular, we cannot rule out that more than 80% of the mutual funds are given positive values by some investors. Moreover, we empirically demonstrate that potential inference errors embedded in existing parametric performance measures can be of important magnitude.
Keywords: portfolio performance measurement, mutual funds
JEL Classification: G12, G23
Does Hedge Fund Performance Persist? Overview and New Empirical Evidence
Martin Eling
Abstract
The contribution of this paper is to provide an overview and new empirical evidence on hedge fund performance persistence, which has been a controversial issue in the academic literature during the last several years. In the first step, we review recent studies and put them into a joint evaluation of hedge fund performance persistence. In the second step, the methodological framework developed in the overview is used to present new empirical evidence. We find different levels of performance persistence depending on the statistical methodology and the hedge fund strategy employed. In our study, performance persistence cannot be explained by the use of option-like strategies, but it can be partially explained by survivorship and backfilling bias. Differences among hedge fund strategies might be explained by return smoothing. Finally, we develop a rationale for choosing between different methodologies to measure performance persistence and conclude that the multi-period Kolmogorov-Smirnov test is the most useful for evaluating performance persistence of hedge funds.
Keywords: Performance Measurement, Performance Persistence, Hedge Funds
JEL Classification:
* * * * * * * * * * *Insider Trading and Corporate Governance: The Case of Germany
André Betzer and Erik Theissen
Abstract
We analyze transactions by corporate insiders in Germany. We find that insider trades are associ-ated with significant abnormal returns. Insider trades that occur prior to an earnings announce-ment have a larger impact on prices. This result provides a rationale for the UK regulation that prohibits insiders from trading prior to earnings announcements. Both the ownership structure and the accounting standards used by the firm affect the magnitude of the price reaction. The position of the insider within the firm has no effect, which is inconsistent with the informational hierarchy hy-pothesis.
Keywords: Insider trading, directors' dealings, corporate governance
JEL Classification: G14, G30, G32
Predicting European Takeover Targets
Gurvinder Brar, Daniel Giamouridis, Manolis Liodakis
Abstract
This article extends Palepu (1986) acquisition likelihood model by incorporating measures of technical nature, e.g. momentum, trading volume as well as a measure of market sentiment. We use the proposed model to predict takeover targets in a large sample of European and cross-border Merger and Acquisition deals and validate its performance on an in- and out-of –sample basis. The robustness of the proposed model is investigated across several dimensions. In addition we explore the ability of the model to form the basis of successful takeover timing investment strategies. The results of our empirical analysis suggest that the proposed model predicts European takeover targets with relatively high accuracy and is able to determine portfolios that earn significant returns which are not explained by conventional risk factors.
Keywords: Takeovers; Prediction; Investment decisions
JEL Classification: G11; G34; C21
The Euro and the changing face of European Banking: Evidence from Mergers and Acquisitions
M. Ekkayokkaya , Krishna Paudyal and Phil Holmes
Abstract
During the last fifteen years, the European banking industry has experienced considerable consolidation through mergers and acquisitions against the background of the introduction of the single currency and reductions in cross-border barriers. This paper investigates whether these changes impacted on announcement period gains of the banks acquiring targets by examining the pre-euro, run-up to the euro and post euro eras. Evidence suggests bidders’ gains have fallen with the development of economic and monetary union. It also reveals significant differences in the gains from acquisitions within and outside the eurozone. These results are consistent with increased competition among bidders and increased integration of the market in the eurozone area in the post-euro era. However, differing results relating to focused and diversifying bids suggest that the level of market integration is sector dependent.
Keywords: G21, G34
JEL Classification: European banking, integration, single currency, euro, acquisitions
European Financial Management, VOL 15:3 June 2009
Is CEO Pay Really Inefficient? A Survey of New Optimal Contracting Theories
Alex Edmans and Xavier Gabaix
Abstract Bebchuk and Fried (2004) argue that executive compensation is set by CEOs themselves rather than boards on behalf of shareholders, since many features of observed pay packages may appear inconsistent with standard optimal contracting theories. However, it may be that simple models do not capture several complexities of real-life settings. This article surveys recent theories that extend traditional frameworks to incorporate these dimensions, and show that the above features can be fully consistent with e¢ ciency. For example, optimal contracting theories can explain the recent rapid increase in pay, the low level of incentives and their negative scaling with ?rm size, pay-for-luck, the widespread use of options (as opposed to stock), severance pay and debt compensation, and the insensitivity of incentives to risk.
Keywords:executive compensation, CEO incentives, optimal contracting
JEL Classification: D2, D3, G34, J3
The Impact of Managerial Entrenchment on Agency Costs: An Empirical Investigation Using UK Panel Data
Chrisostomos Florackis and Aydin Ozkan
Abstract This paper empirically investigates the relationship between managerial entrenchment and agency costs for a large sample of UK firms over the period 1999-2005. To measure managerial entrenchment, we use detailed information on ownership and board structures and managerial compensation. We develop a managerial entrenchment index, which captures the extent to which managers have the ability and incentives to expropriate wealth from shareholders. Our findings, which are based on a dynamic panel data analysis, show that there is a strong negative relationship between managerial entrenchment and our inverse proxy for agency costs, namely asset turnover ratio. There is also evidence that short-term debt and dividend payments work as effective corporate governance devices for UK firms. Finally, our findings reveal that agency costs are persistent over time. The results are robust to a number of alternative specifications, including varying measures of managerial entrenchment and agency costs.
Keywords: Agency costs; Managerial entrenchment; Corporate governance mechanisms; Panel data.
JEL Classification: G3; G32
The Co-movement of Credit Default Swap, Bond and Stock Markets: An Empirical Analysis
Lars Norden and Martin Weber
Abstract We analyze the relationship between credit default swap (CDS), bond and stock markets during 2000-2002. Focusing on the intertemporal co-movement, we examine monthly, weekly and daily lead-lag relationships in a vector autoregressive model and the adjustment between markets caused by cointegration. First, we find that stock returns lead CDS and bond spread changes. Second, CDS spread changes Granger cause bond spread changes for a higher number of firms than vice versa. Third, the CDS market is more sensitive to the stock market than the bond market and the strength of the co-movement increases the lower the credit quality and the larger the bond issues. Finally, the CDS market contributes more to price discovery than the bond market and this effect is stronger for US than for European firms.
Keywords: credit risk; credit spreads; credit derivatives; lead-lag relationship
JEL Classification: G10, G14, G21
Why Do Western European Firms Issue Convertibles Instead of Debt or Equity?
Marie Dutordoir and Linda Van De Gucht
Abstract Unlike their US counterparts, European convertible debt issuers tend to be large companies with small debt- and equity-related financing costs. Therefore, it is puzzling why these firms issue convertibles instead of standard financing instruments. This paper examines European convertible debt issuer motivations by estimating a security choice model that incorporates convertibles, straight debt, and equity. We find that European convertibles are used as sweetened debt, not as delayed equity. This motivation is reflected in the debt-like design of most European convertible issues.
Keywords: convertible debt; security choice; security design; Western Europe.
JEL Classification:G14; G32
Market Feedback, Investment Constraints, and Managerial Behavior
Paula Hill and David Hillier
Abstract This paper examines the joint role of market feedback and investment constraints on managerial behavior. Using a sample of UK fixed price initial public offerings, we show that underperformance of share returns at the IPO significantly affects managerial investment decisions in the period after the offering. Firms with better investment opportunities and proportionately lower fixed (higher intangible) assets are more sensitive to negative market feedback. Over the longer term, the more responsive firms perform significantly better than their non-responsive counterparts. The findings contribute to the debate on the informational advantage of managers over investors and present strong evidence that the market, on aggregate, can provide a superior assessment of a firm’s opportunities. Managers who are able to respond to negative market feedback can significantly improve their firm’s future prospects.
Keywords:Market Feedback; Managerial Behavior; Investment; Financing; Book to Market;
JEL Classification:G32
Foreign Currency Derivatives versus Foreign Currency Debt and the Hedging Premium
Ephraim Clark and Amrit Judge
Abstract This paper compares the effect on firm value of different foreign currency (FC) financial hedging strategies identified by type of exposure (short or long term) and type of instrument (forwards, options, swaps and foreign currency debt). We find that hedging instruments depend on the type of exposure. Short term instruments such as FC forwards and/or options are used to hedge short term exposure generated from export activity while FC debt and FC swaps into foreign currency (but not into domestic currency) are used to hedge long term exposure arising from assets located in foreign locations. Our results relating to the value effects of foreign currency hedging indicate that foreign currency derivatives use increases firm value but there is no hedging premium associated with foreign currency debt hedging, except when combined with foreign currency derivatives. Taken individually, FC swaps generate more value than short term derivatives.
Keywords:International Finance; Risk Management; Foreign Currency Hedging; Foreign Currency Derivatives; Foreign Currency Debt; Foreign Currency Swaps.
JEL Classification: G15; G30; G32
What Drives Private Equity Returns?-Fund Inows, Skilled GPs, and/or Risk?
Christian Diller and Christoph Kaserer
Abstract This paper analyzes the determinants of returns generated by mature European private equity funds. It starts from the presumption that this asset class is characterized by illiquidity, stickiness, and segmentation. Given this presumption, Gompers and Lerner (2000) have shown that venture deal valuations are driven by overall fund inflows into the industry that yield the putative 'money chasing deals' phenomenon. It is the aim of this paper to show that this phenomenon explains a significant part of the variation in private equity funds' returns. This is especially true for venture funds, as they are a ected more by illiquidity and segmentation than buy-out funds. In the context of a WLS-regression approach the paper reports a highly signifi- cant impact of total fund in ows on fund returns. It can also be shown that private equity funds' returns are driven by GP's skills as well as stand-alone investment risk. In a bootstrapping context we can show that most of these results are quite stable.
Keywords: Private equity funds; performance measurement; venture capital; buyout; IRR; PME; 'money chasing deals' phenomenon .
JEL Classification:G24
A Retrospective Evaluation of the European Financial Management (1995-2008)
Kam C. Chan, Chih-Hsiang Chang and Y. Ling Lo
Abstract We provide a retrospective evaluation of the European Financial Management (EFM) from 1995-2008. In 14 years, EFM has published a total of 333 articles, with 564 authors from 399 academic and non-academic institutions. The authors and institutions represent 26 different countries. Two interesting results emerge from this analysis. First, although EFM is a young finance journal, it has achieved a highly respectable status among all finance journals. In fact, EFM has surpassed a number of well-established finance journals in its research impact. Second, consistent with its mission, EFM has published articles whose authors have European affiliations and research content. Nonetheless, we find that EFM is the publication outlet of authors outside the European region as well. The rising readership and variety of articles published suggest that EFM is a general finance journal that has done very well in serving the interests of the finance profession for the last 14 years.
Keywords: journal evaluation; Google; citations
JEL Classification:G00
European Financial Management, VOL 15:4 September 2009
Initial Public Offerings: Introduction
Guest Editor: Tim Jenkinson
Universal Banking, Asset Management, and Stock Underwriting
William C. Johnson and Marietta-Westberg
Abstract
This paper examines institutions that underwrite IPOs and have asset management divisions from 1993 through 1998. We provide evidence that these firms use asset management funds as vehicles to help them earn more equity underwriting business. We also show that asset managers affiliated with IPO underwriters use their superior information about their own institution’s IPOs to earn annualized market adjusted returns 7.6% above asset managers of firms who did not underwrite the IPO. Superior future returns by asset managers who trade affiliated IPOs are dependent on the information environment for the IPO and the underwriter reputation rank.
Keywords:
JEL Classification: G24
Competitive IPOs
Tim Jenkinson and Howard Jones
Abstract Competition between investment banks for lead underwriter mandates in IPOs is fierce, but having committed to a particular bank, the power of the issuer is greatly reduced. Although information revelation theories justify giving the underwriters influence over pricing and allocation, this creates the potential for conflicts of interest. In this clinical paper we analyse an interesting innovation that has been used in recent European IPOs whereby issuers separate the preparation and distribution roles of investment banks, and keep competitive pressure on the banks throughout the issue process. These 'competitive IPOs' allow the issuer greater control and facilitate more contingent fee structures that help to mitigate against 'bait and switch.' But unlike more radical departures from traditional bookbuilding – such as auctions – the competitive IPO is an incremental market-based response to potential conflicts of interest that retains many of the advantages of investment banks' active involvement in issues.
Keywords:IPO, bookrunners, syndicate, underpricing
JEL Classification: G3, G24
Conflicts of Interest and Research Quality of Affiliated Analysts in the German Universal Banking System: Evidence from IPO Underwriting
Wolfgang Bessler and Matthias Stanzel
Abstract The quality of equity research by financial analysts is a prerequisite for an efficient capital market. This study investigates the quality of earnings forecasts and stock recommendations for initial public offerings (IPOs) in Germany. The empirical study includes 12,605 earnings forecasts and 6,209 stock recommendations of individual analysts for the time period from 1997 to 2004. The focus of this study is on analyzing the potential conflicts of interest that arise when the analyst is affiliated with the underwriter of an IPO. In a universal banking system these conflicts of interest are usually more pronounced and therefore interesting to investigate. The empirical findings for the German financial market suggest that earnings forecasts and stock recommendations of the analysts belonging to the lead-underwriter are on average inaccurate and biased, indicating some conflicts of interest. Moreover, the stock recommendations of the analysts that are affiliated with the lead-underwriter are often too optimistic resulting in a significant long-run underperformance for the investor. In contrast, unaffiliated analysts provide better earnings forecasts and stock recommendations that would have resulted in a superior performance for the investor
Keywords:initial public offerings, analyst behavior, conflicts of interest, research quality, earnings forecasts and stock recommendations
JEL Classification: G14; G24
How much does investor sentiment really matter for equity issuance activity?
Francois Derrien and Ambrus Kecskes
Abstract
We study the extent to which investor sentiment matters for aggregate equity issuance activity. We focus on firms that are susceptible to investor sentiment and for which accurate measures of economic fundamentals are available. While sentiment on its own matters for equity issuance, it matters relatively little once we control for accurately measured fundamentals. Collectively, proxies for sentiment explain roughly 10 percentage points of the time-series variation of equity issuance beyond the roughly 40 percent explained by fundamentals. We conclude that investor sentiment does not seem to matter very much for aggregate equity issuance activity.
Keywords: IPOs; capital demands; economic fundamentals; investor sentiment
JEL Classification: G32
Security Choice and Corporate Governance
Brett Olsen and John Howe
Abstract The most efficient corporate governance structure will vary by firm depending on the costs and benefits of different governance mechanisms. For IPO firms, warrants might act as a substitute for other governance mechanisms (Schultz, 1993). Alternatively, warrants might serve as a signal of high quality, and thus effectively governed, firms (Chemmanur and Fulghieri, 1997), in which case they would act as a complement to other governance mechanisms. We test these competing hypotheses by examining a sample of unit IPO firms (firms issuing warrants with shares) matched to a comparable sample of shares-only firms and show that warrants act as a substitute for other governance mechanisms. The research is also of interest because it shows an interaction between the financing decisions of firms and their corporate governance that has not been documented previously.
Keywords:corporate governance, agency costs, IPOs, warrants, board of directors
JEL Classification: G34, L22
Why do European Firms Go Public?
Franck Bancel and Usha Mittoo
Abstract We survey chief financial officers (CFOs) from 12 European countries regarding the determinants of going public and exchange listing decisions. Most CFOs identify enhanced visibility and prestige and financing for growth as the most important benefits of an IPO, but other motivations for IPOs differ significantly across firms, countries and legal systems. We find strong support for the IPO theories that emphasize financial and strategic considerations, such as enhanced reputation and credibility, and financial flexibility as a major advantage of an IPO. At the same time, we find moderate support for theories that focus on exit strategy, balance of power with creditors, external monitoring, and mergers and acquisitions motivations. European CFOs’ views on the major benefits of an IPO are generally similar to those of U.S. managers as reported in Brau and Fawcett (2006), but differ significantly on outside monitoring; outside monitoring is considered a major benefit by European CFOs but a major cost by U.S. CFOs. Our evidence suggests that the decision to go public is a complex one, and cannot be explained by one single theory because firms seek multiple benefits in going public. These motivations are influenced by the firm’s ownership structure, size and age as well as by the home country’s institutional and regulatory environment.
Keywords: going public, European firms, IPO, survey, financing, exit, ownership
JEL Classification: F30, G32, G34, G30
European Financial Management, VOL 16:1 January 2009
Property Derivatives for Managing European Real-Estate Risk
Frank J. Fabozzi, Robert J. Shiller and Radu Tunaru
Abstract: Although property markets represent a large proportion of total wealth in developed countries, the real-estate derivatives markets are still lagging behind in volume of trading and liquidity. Over the last few years there has been increased activity in developing derivative instruments that can be utilised by asset managers. In this paper, we discuss the problems encountered when using property derivatives for managing European real-estate risk. We also consider a special class of structured interest rate swaps that have embedded real-estate risk and propose a more efficient way to tailor these swaps.
Keywords:real-estate markets, property derivatives, balance guaranteed swaps
JEL Classification: G15, G20
The Cross-Section of Expected Stock Returns: What Have We Learnt from the Past Twenty-Five Years of Research?
Avanidhar Subrahmanyam
Abstract: I review the recent literature on cross-sectional predictors of stock returns. Predictive variables used emanate from informal arguments, alternative tests of risk-return models, behavioral biases, and frictions. More than fifty variables have been used to predict returns. The overall picture, however, remains murky, because more needs to be done to consider the correlational structure amongst the variables, use a comprehensive set of controls, and discern whether the results survive simple variations in methodology.
Keywords:market efficiency, cross-section of stock returns
JEL Classification: G12, G14
The CAPM is alive and well:A review and Synthesis
Haim Levy
Abstract: Mean-Variance (M-V) analysis and the CAPM are derived in the expected utility framework. Behavioral Economists and Psychologists (BE&P) advocate that expected utility is invalid, suggesting Prospect Theory as a substitute paradigm. Moreover, they show that the M-V rule, which is the foundation of the CAPM, is not always consistent with peoples' choices. Thus, BE&P cast doubt on the validity of expected utility paradigm and of the M-V rule, hence the CAPM is theoretically questionable. In addition, there is very little empirical support to the CAPM. We show in this study that the CAPM is theoretically valid even when one accepts the BE&P framework and even when expected utility is invalid. Moreover, within the BE&P framework there is a strong experimental support for the CAPM
Keywords:CAPM, M-V, expected utility, Prospect Theory
JEL Classification: D81, C91
Keeping Up with the Joneses: A Model and a Test of Collective Accounting Fraud
Nuno Fernandes and José Guedes
Abstract This paper explains the variations in incidence of accounting fraud across economic settings by putting the behaviour and motivation of managers under the microscope. To safeguard their reputation in the managerial labour market, managers of firms that perform poorly are prone to fraudulently inflate earnings if they expect the economy to be strong, since that raises the likelihood of peers reporting high performance. A realised level of economic activity, on the other hand, counteracts this tendency on the part of managers to overstate earnings, by reducing the number of firms that actually perform poorly. We term these two effects the incentive effect and the need effect, respectively. The two effects yield a distinctive relationship between the incidence of accounting fraud and macroeconomic conditions. Specifically, the fraction of firms fraudulently overreporting earnings is positively related to expected economic performance and negatively related to realised economic performance. The incentive and need effects on collective fraud are examined empirically by relating proxies of the aggregate incidence of accounting fraud to expected and realised GDP growth rates. The results unambiguously support the predicted influence of macroeconomic performance.
Keywords: earnings manipulation, fraud, corporate governance
JEL Classification: G19, G30, G34, G38
Corporate Governance in China: A Step Forward
Yan-Leung Cheung, Ping Jiang, Piman Limpaphayom and Tong Lu
Abstract
Recently, the presumed benefits of corporate governance have become one of the most contentious issues
especially for emerging markets in Asia where institutional settings are quite different from other parts
of the world. Using an internationally accepted benchmark (OECD’s Principles of Corporate Governance, OECD, 2004), this study evaluates the progress of corporate governance practice of Chinese listed companies. A corporate governance index (CGI) is constructed to measure the quality of corporate governance practices of the 100 largest listed firms in China during 2004-2006. The results show that Chinese companies have been making progress in the corporate governance reform. The findings also show a positive relation between market valuation and overall corporate governance practices, as measured by the CGI, among these Chinese listed companies. Additional investigation reveals that the rights of shareholders are the main driver in the relationship.
Keywords: corporate governance; China
JEL Classification:G3; G34
Interest Rate Risk Rewards in Stock Returns of Financial Corporations: Evidence from Germany
Marc-Gregor Czaja, Hendrik Scholz and Marco Wilkens
Abstract
The interest rate sensitivity of stock returns of financial and non-financial corporations is a well-known
phenomenon. However, only little is known about the part of total stock returns that is attributable to the
compensation an investor receives for being exposed to interest rate risk when investing in equity securities.
We pursue here a benchmark portfolio approach, constructing benchmark portfolios having the same interest rate
risk exposure as a particular stock. By studying the time series of returns of these asset-specific benchmarks, we find: i) Regardless of the industry considered, the interest rate risk benchmarks of German corporations have mostly earned a signif¬icantly positive reward. ii) Returns of interest rate risk benchmarks of financial institutions exceeded significantly those of non-financial corporations. iii) An investor willing to bear nothing but the average interest rate risk of German financial institutions would have earned a mean return of about or even exceeding 70% of the corresponding total stock returns. iv) Returns of the interest rate risk benchmarks of the German insurance sector were significantly higher than those of German banks,
which seems to contradict conventional market wisdom that insurances hedge interest rate risks.
Keywords: interest rate risk; risk rewards; Nelson-Siegel approach; German financial corporations; benchmark portfolio approach
JEL Classification: : G12; G21; G22
European Financial Management, VOL 16:2 March 2010
Conditional Asset Pricing and Stock Market Anomalies in Europe
Rob Bauer, Mathijs Cosemans and Peter C. Schotman
Abstract
This study provides European evidence on the ability of static and dynamic specifications of the Fama-French (1993) three-factor model to price 25 size-B/M portfolios. In contrast to US evidence, we detect a small-growth premium and find that the size effect is still present in Europe. Furthermore, we document strong time variation in factor risk loadings. Incorporating these risk fluctuations in conditional specifications of the three-factor model clearly improves its ability to explain time variation in expected returns. However, the model still fails to completely capture cross-sectional variation in returns as it is unable to explain the momentum effect.
Keywords: conditional asset pricing, time-varying risk, stock market anomalies
JEL Classification: G12, G14
Passive Hedge Fund Replication – Beyond the Linear Case
Noel Amenc, Lionel Martellini, Jean-Christophe Meyfredi and Volker Ziemann
Abstract
In this paper we extend Hasanhodzic and Lo (2007) by assessing the out-of-sample performance of various non-linear and conditional hedge fund replication models. We find that going beyond the linear case does not necessarily enhance the replication power. On the other hand, we find that selecting factors on the basis on an economic analysis allows for a substantial improvement in out-of-sample replication quality, whatever the underlying form of the factor model. Overall, we confirm the findings in Hasanhodzic and Lo (2007) that the performance of the replicating strategies is systematically inferior to that of the actual hedge funds.
Keywords: Hedge funds, passive replication, Kalman filter, conditional factor models.
JEL Classification: G10.
PIP Transactions, Price Improvement, Informed Trades and Order Execution Quality
Nabil Khoury, Stylianos Perrakis and Marko Savor
Abstract
This study focuses on innovations in order execution processes within the context of the Boston Option Exchange (BOX). More specifically, it examines the impact of the Price Improvement Process (PIP) on options quoted, effective and realized proportional spreads. We consider the PIP as a mechanism that allows the market maker to “internalize” the transaction. We show that PIP transactions are associated with wider bid/ask proportional quoted spreads than non-PIP transactions, in spite of the temporary narrowing of the effective proportional spread during PIP. We identify informed traders by focusing on the direction of trade. Using an original data set, we show that PIP transactions follow signals in the form of buy/sell orders by informed traders. We also show that PIP is a mechanism that allows the market maker to internalize a position in the same direction as that of the informed trader. We conclude that PIP does not improve the efficiency of the market but simply allows the market maker to benefit at the expense of uninformed traders.
Keywords: market microstructure, bid-ask spreads, options markets, market efficiency
JEL Classification: G13, G14
The Sophisticated and the Simple: the profitability of contrarian strategies
Gishan Dissanaike and Kim-Hwa Lim
Abstract
A variety of variables have been used to form contrarian portfolios, ranging from relatively simple measures, like book-to-market, cash flow-to-price, earnings-to-price and past returns, to more sophisticated measures based on the Ohlson model and residual income model (RIM). This paper investigates whether: (i) contrarian strategies based on RIM perform better or worse than those based on the Ohlson model; (ii) contrarian strategies based on more sophisticated valuation models (e.g. Ohlson and RIM) perform much better than the relatively simpler ranking variables that have been used so extensively in the finance literature. Given that the RIM and Ohlson models require greater information inputs and technical know-how, and make different implicit assumptions on future abnormal earnings, it is important to ascertain if they offer significantly greater contrarian profits to outweigh the increased costs that they entail. Indeed, our surprising finding is that simple cash flow-to-price measures appear to do almost as well as the more sophisticated alternatives. One would have expected the sophisticated models to significantly outperform the simple cash flow to price model for the reasons given by Penman (2007).
Keywords: ; evaluation, market efficiency
JEL Classification: M41, G12, G14
Conference Calls and Stock Price Volatility in the Post-Reg FD Era
Alberto Dell Acqua, Francesco Perrini and Stefano Caselli
Abstract
Past research has documented that the utilization of conference calls is greater in the high tech sector than in other industries. Do high tech firms benefit from that? This study attempts to answer this question by examining the impact of “post-Reg FD” conference calls on the price volatility of high tech firms listed in the US market. We find evidence that more open conference calls results in lower idiosyncratic volatility.
Keywords: stock volatility, conference calls, high tech stocks, voluntary disclosure
JEL Classification: G14, G32.
Large Shareholders, the Board of Directors and the Allocation of Cash Proceeds from Corporate Asset Sell-offs
Ali Ataullah, Ian Davidson and Hang Le
Abstract
Recent finance literature suggests that managers of divesting firms may retain cash proceeds from corporate asset sell-offs in order to pursue their own objectives, and, therefore, shareholders’ gains due to these deals are linked to a distribution of proceeds to shareholders or to debtholders. We add to this literature by examining the role of various corporate governance mechanisms in the context of the allocation of sell-off proceeds. Specifically, we examine the impact of directors’ share-ownership and stock options, board composition and external large shareholdings on (1) shareholders’ abnormal returns around asset sell-off announcements, and (2) managers’ decision to either retain or distribute (to shareholders or to debtholders) sell-off proceeds. We find that non-executive directors’ and CEO’s share-ownership and stock options are related to shareholders’ gains from sell-offs for firms that retain proceeds. However, corporate governance mechanisms are not significantly related to shareholders’ gains for firms that distribute sell-off proceeds. Furthermore, we find that the likelihood of a distribution of proceeds, relative to the retention decision, is increasing in large institutional shareholdings, executive and non-executive directors’ share-ownership and non-executive representation in the board.
Keywords: asset sell-offs, large shareholders, institutional investors, boards of directors, board composition
JEL Classification: G32, G34, G35
NEWLY ACCEPTED PAPERS
Why Do Price Limits Exist in Stock Markets? A Manipulation-Based Explanation
Kenneth A. Kim and Jungsoo Park
Abstract
Numerous stock market regulators around the world impose daily price limits on individual stock price movements. We derive a simple model that shows that price limits may deter stock market manipulators. Based on our model’s implications, we predict that regulators impose price limit rules for markets where the likelihood of manipulation is high. We present empirical evidence consistent with this hypothesis. Our study is the first to formally propose a manipulation-based rationale for the existence of price limits in stock markets.
Keywords: price limits, stock market manipulation, stock market volatility
JEL Classification: G10; G15; G18
Internal capital markets and capital structure: bank versus internal debt
Nico Dewaelheyns and Cynthia Van Hulle
Abstract
We argue that domestic business groups are able to actively optimize the internal/external debt mix across their subsidiaries. Novel to the literature, we use bi-level data (i.e. data from both individual subsidiary financial statements and consolidated group level financial statements) to model the bank and internal debt concentration of non-financial Belgian private business group affiliates. As a benchmark, we construct a size and industry matched sample of non-group affiliated (stand-alone) companies. We find support for a pecking order of internal debt over bank debt at the subsidiary level which leads to a substantially lower bank debt concentration for group affiliates as compared to stand-alone companies. The internal debt concentration of a subsidiary is mainly driven by the characteristics of the group’s internal capital market. The larger its available resources, the more intra-group debt is used while bank debt financing at the subsidiary level decreases. However, as the group’s overall debt level mounts, groups increasingly locate bank borrowing in subsidiaries with low costs of external financing (i.e. large subsidiaries with important collateral assets) to limit moral hazard and dissipative costs. Overall, our results are consistent with the existence of a complex group wide optimization process of financing costs.
Keywords: internal capital markets; capital structure; debt source concentration; ownership structure; bank debt
JEL Classification: G32, G21
A Dynamic Approach to Accounts Receivable: A Study Of Spanish Smes
Pedro J. García-Teruel and Pedro Martínez-Solano
Abstract
The main objective of this paper is to extend the literature on the granting of trade credit. The focus is to test whether the accounts receivable decisions follow a model of partial adjustment. To do that, we use a sample of 2,922 Spanish SMEs. Using a dynamic panel data model and employing the GMM method of estimation we control for unobservable heterogeneity and for potential endogeneity problems. The results reveal that firms have a target level of accounts receivable and take decisions in order to achieve that level. In addition, we find that sales growth (if positive), the size of the firms, their capacity to generate internal funds and get short term financing, and economic growth are important in determining trade credit granted by firms.
Keywords: accounts receivable, trade credit, SMEs, partial adjustment model, endogeneity
JEL Classification: G31, G32
A High-Frequency Investigation of the Interaction between Volatility and DAX Returns
Philippe Mass and Martin Wallmeier
Abstract
One of the most noticeable stylized facts in finance is that stock index returns are negatively correlated with changes in volatility. The economic rationale for the effect is still controversial. The competing explanations have different implications for the origin of the relationship: Are volatility changes induced by index movements, or inversely, does volatility drive index returns? To differentiate between the alternative hypotheses, we analyze the lead-lag relationship of option implied volatility and index return in Germany based on Granger causality tests and impulse-response functions. Our dataset consists of all transactions in DAX options and futures over the time period from 1995 to 2005. Analyzing returns over 5-minute intervals, we find that the relationship is return-driven in the sense that index returns Granger cause volatility changes. This causal relationship is statistically and economically significant and can be clearly separated from the contemporaneous correlation. The largest part of the implied volatility response occurs immediately, but we also observe a smaller retarded reaction for up to one hour. A volatility feedback effect is not discernible. If it exists, the stock market appears to correctly anticipate its importance for index returns.
Keywords: implied volatility; granger causality; leverage effect; feed-back effect; asymmetric volatility
JEL Classification: G10; G12; G13
Dividends and Market Signaling: An Analysis of Corporate Insider Trading
Esther del Brio and Alberto de Miguel
Abstract
This study tests the multiple-signal theory of dividends of John and Lang (1991) in the context of a European market. Our evidence shows that investors are more sensitive to insider trading signals than to signaled changes in existing dividends. In effect, the insider sales signal is universally understood as bad news. After controlling for the quality of a firm’s investment opportunities, investors are found to penalize dividend outflows by mature firms that exhibit more informed insider sales activity. Finally, we offer an innovative exploration of the role of earnings announcements in market reaction to the dividend signal.
Keywords: dividend announcements, insider trading, information-based signaling theory of dividends, cash flow signaling theory, earnings announcements.
JEL Classification: G14; G35
The effect of venture capital financing on the sensitivity to cash flow of firm’s investments
Fabio Bertoni, Massimo G. Colombo and Annalisa Croce
Abstract
This work studies the effect of venture capital (VC) financing on firms’ investments in a longitudinal sample of 379 Italian unlisted new-technology-based firms (NTBFs) observed over the 10-year period from 1994 to 2003. We distinguish the effects of VC financing according to the type of investor: independent VC (IVC) funds and corporate VC (CVC) investors. Previous studies argue that NTBFs are the firms most likely to be financially constrained. The technology–intensive nature of their activity and their lack of a track record increase adverse selection and moral hazard problems. Moreover, most of their assets are firm-specific or intangible and hence cannot be pledged as collateral. In accordance with this view, we show that the investment rate of NTBFs is strongly positively correlated with their current cash flows. We also find that after receiving VC financing, NTBFs increase their investment rate independently of the type of VC investor. However, the investments of CVC-backed firms remain sensitive to shocks in cash flows, whereas IVC-backed firms exhibit a low and statistically not significant investment–cash flow sensitivity that we interpret as a signal of the removal of financial constraints.
Keywords: investments, new-technology-based firms, financial constraints, venture capital, corporate venture capital.
JEL Classification: G32, D92, G23
The Consequences of Issuing Convertible Bonds: Dilution and/or Financial Restructuring?
Roland Gillet and Hubert de La Bruslerie
Abstract:
Historically, most convertible bond (CB) issues have been converted to equity
sooner or later. The announcement of a CB issue will bring about a future dilution
of the firm’s capital, and is often followed by a drop in share price. However,
a CB issue by itself creates future value for the shareholders if it enables the
firm to make profitable investments. It can also issue a positive signal regarding
the restructuring of the firm’s financial liabilities and its attempts to optimise its
financial structure. These positive effects, if they occur, will develop gradually
after the issue, and cannot be identified by a simple short-term event analysis of
a CB issue announcement. In this paper, we test the significance of the dilution
effect, coupled with a possible value creation effect, using data from the French
stock market. We introduce a comparison between dilutive convertibles and nondilutive
exchangeable bonds. By integrating different corrections and by selecting
a window of analysis over a longer period after the announcement of the issue, we
show that the negative cumulative average abnormal returns generally observed
in previous studies become non-significant. This absence of global incidence is
indicative of large differences in individual behaviour by issuers of CBs, and
leads us to take into account the strategic choices linked to the issue of a CB.
Two goals, often described as ‘investment financing’ or ‘financial restructuring’,
may exist when issuing, and may appear to explain the size of the abnormal
returns.
Keywords: convertible bonds, debt leverage, corporate financing decision, stock market efficiency, event studies.
JEL Classification: G14, G32
The Impact of Terrorist Attacks on International Stock Markets
Dirk Brounen and Jeroen Derwall
Abstract:
We examine the effects of terrorist attacks on stock markets, using a dataset that covers all significant events and that directly relate to the major economies of the world. Our event study suggests that terrorist attacks produce mildly negative price effects. We compare these price reactions to those from an alternative type of unanticipated disaster, earthquakes, and find that price declines following terror attacks are more pronounced. However, in both cases prices rebound within the first week of the aftermath. We also compare price responses internationally and for separate industries, and find that reactions are strongest for local markets and for industries that are directly affected by the attack. Our results suggest that financial markets react strongly to terror events but then recover swiftly and soon return to business as usual. The September 11th attacks turn out to be the only event that caused long-term effects on financial markets, especially in terms of industries’ systematic risk.
Keywords: event study, terrorist attacks, earthquakes, abnormal returns
JEL Classification: G14,G15
Liquidity and Optimal Market Transparency
Ariadna Dumitrescu
Abstract:
In this paper I explore some of the consequences of greater market transparency for
market performance in the presence of a strategic specialist. Although numerous studies
have dealt with this issue, previous work has only considered either fully transparent
or fully opaque markets. My model allows for different levels of transparency, and
therefore sheds light on how transparency affects market performance. I show that an
intermediate level of transparency can improve market performance relative to the more
extreme cases of full transparency or no transparency at all.
Keywords: market liquidity, market transparency, strategic specialist.
JEL Classification: D82, G12, G14
Diversification, Refocusing and Firm Value
Gonul Colak
Abstract:
At any point in time a firm faces three restructuring choices: diversify, refocus, or do nothing. This study analyzes the causes and the consequences of these actions in a unified framework using the appropriate methodologies. Various factors, such as firm’s characteristics and multinational nature, its industry’s characteristics, its exchange and index inclusion, and divested (or acquired) segment(s)’ industry conditions, are considered as the determinants of the diversifying and the refocusing decisions. The estimation results from the corresponding multinomial logit model suggest that refocusing occurs generally due to firm-specific reasons, and diversification due to outside factors, such as industry and economic conditions. Added or dropped segment’s industry profitability, its relationship to the core business of the firm, and its relatedness to the businesses of the conglomerate’s other segments have a nontrivial effect on either decision. In a related analysis, the paper explicitly models and estimates the valuation consequences that are sustained by the firm after it undertakes a refocusing or a diversification action. To isolate the changes in firm’s value that are due to these decisions only, a 2SLS estimation is used to control for endogeneity that arises because the factors that affect a firm’s value are likely to have also induced the firm to make the corresponding decision. The novelty of my approach is in its inclusion of variables measuring the consequences due to both actions, the diversification and the refocusing, in the same valuation equation. Contrary to some earlier findings, I find no evidence of ‘diversification discount’ or ‘refocusing premium.’ The choice of this paper to analyze all corporate restructuring decisions in a unified framework yields valuable business insights into the reasons for undertaking such corporate events.
Keywords: diversification discount; refocusing; excess value; simultaneity bias
JEL Classification: G10, G30, G34, G39
Impact of Imperfect Information on the Optimal Exercise Strategy for Warrants
Christian Koziol
Abstract:
In this paper, we determine the optimal exercise strategy for corporate
warrants if investors su®er from imperfect information and we evaluate the
impact of this friction on the value of a warrant. For this purpose, we address
both exercises at maturity, where imperfect information about the ¯rm value
is present, and exercises before maturity which are impacted by imperfect
information about the size of the dividend. We model imperfect information so
that all warrant holders know that they obtain biased signals of the true state
without observing the signals of other warrant holders. The optimal exercise
strategy follows from a complex game among warrant holders in which every
individual warrant holder must account for the potential signals of the other
warrant holders and their resulting exercise decisions. The main ¯ndings are
that due to imperfect information warrant holders optimally start to exercise
their warrants later than without imperfect information. Moreover, a simple
block exercise strategy is always an equilibrium strategy for a high degree of
imperfect information before maturity, even though a partial exercise can be
the unique strategy without imperfect information. Remarkably, imperfect
information does not necessarily result in a lower warrant value. As long as
a warrant holder has a signal that allows for correct exercise decisions, then
imperfect information enhances the warrant value due to suboptimal exercises
by other investors.
Keywords: warrant exercise; block exercise; imperfect information;global games
JEL Classification: G13, C70
Information Transmission in the World Money Markets
Bruce G. Resnick and Gary L. Shoesmith
Abstract:
Using 1,966 daily observations since the introduction of the euro, we apply cointegration and error correction tests to examine information transmission in the major world money markets as represented by the domestic CD markets and the Eurocurrency market for the U.S. dollar, euro, Japanese yen, and British pound sterling. Our inter-market tests show a high degree of integration and interdependency among inter-market interest rates. Our intra-market results show that $ LIBOR and ¥ LIBOR rates drive € LIBOR and £ LIBOR. Application of Johansen’s (1988) multivariate test procedure and Gonzalo and Granger’s (1995) long-memory components technique confirms and reinforces our intra-market findings that the system of four LIBOR rates is fully integrated (i.e., three cointegrating vectors), with the single common trend driven by $ LIBOR and ¥ LIBOR. These results are consistent with the strength of the dollar and yen relative to the pound sterling and the euro during the developing world financial crisis in late 2008.
Keywords: Eurocurrency, money market, information transmission, cointegration, error correction
JEL Classification: C32, F36, G12, G15
The Choice of Target’s Advisor in Mergers and Acquisitions: the Role of the Banking Relationship
Gianfranco Forte, Giuliano Iannotta and Marco Navone
Abstract:
We analyze the factors influencing the target companies’ choice of bank advisor in mergers and acquisitions. We first examine the choice of hiring an advisor, which is non-trivial as in our sample target companies do not hire an advisor in one-third of transactions. We also analyze the choice to hire, as advisor, a bank with a strong prior relationship with the company (i.e. the main bank). Using data on 473 European M&A transactions completed in the 1994–2003 period, we find evidence that the decision to hire an advisor depends on three main factors: i) the intensity of the previous banking relationship, ii) the reputation of the bidder company’s advisor, and iii) the complexity of the deal. We also investigate the impact of a bank advisor on shareholders’ wealth. We find that the abnormal return of target companies’ shareholders increases with the intensity of the previous banking relationship, thus indicating a “certification role” of investment banks.
Keywords: relationship banking, investment banking, mergers, acquisitions
JEL Classification: G21
CEO Compensation and Firm Performance: An Empirical Investigation of UK Panel Data
Neslihan Ozkan
Abstract: This paper examines the link between CEO pay and performance employing a unique, hand-collected panel data set of 390 UK non-financial firms from the FTSE All Share Index for the period 1999-2005. We include both cash (salary and bonus) and equity-based (stock options and long-term incentive plans) components of CEO compensation, and CEO wealth based on share holdings, stock option and stock awards holdings in our analysis. In addition, we control for a comprehensive set of corporate governance variables. The empirical results show that in comparison to the previous findings for US CEOs, pay-performance elasticity for UK CEOs seems to be lower; pay-performance elasticity for UK CEOs is 0.075 (0.095) for cash compensation (total direct compensation), indicating that a ten percentage increase in shareholder return corresponds to an increase of 0.75 % (0.95 %) in cash (total direct) compensation. We also find that both the median share holdings and stock-based pay-performance sensitivity are lower for UK CEOs when we compare our findings with the previous findings for US CEOs. Thus, our results suggest that corporate governance reports in the UK, such as the Greenbury Report (1995) that proposed CEO compensation be more closely linked to performance, have not been totally effective. Our findings also indicate that institutional ownership has a positive and significant influence on CEO pay-performance sensitivity of option grants. Finally, we find that longer CEO tenure is associated with lower pay-performance sensitivity of option grants suggesting the entrenchment effect of CEO tenure.
Keywords: CEO compensation; corporate governance
JEL Classification: G3
The Performance of the European Market for Corporate Control: Evidence from the 5th Takeover Wave
Marina Martynova and Luc Renneboog
Abstract:
This paper presents an in-depth analysis of the performance of large, medium-sized, and small
corporate takeovers involving Continental European and UK firms during the fifth takeover wave.
We find that takeovers are expected to create takeover synergies as their announcements trigger
statistical significant abnormal returns of 9.13% for the targets and of 0.53% for bidding firms.
The characteristics of the targets and bidding firms and of the bid itself are able to explain
a significant part of these returns: (i) deal hostility increases the target’s but decreases bidder’s
returns; (ii) the private status of the target is associated with higher bidder’s returns; and (iii)
an equity payment leads to a decrease in both bidder’s and target’s returns. The takeover wealth effect
is however not limited to the bid announcement day but is also visible prior and subsequent to the bid.
The analysis of pre-announcement returns reveals that hostile takeovers are largely anticipated and associated
with a significant increase in the bidder’s and target’s share prices. Bidders that accumulate a toehold stake
in the target experience higher post-announcement returns. A comparison of the UK and Continental European
M&A markets reveals that: (i) the takeover returns of UK targets substantially exceed those of Continental
European firms. (ii) The presence of a large shareholder in the bidding firm has a significantly positive
effect on takeover returns in the UK and a negative one in Continental Europe. (iii) Weak investor protection
and low disclosure in Continental Europe allow bidding firms to adopt takeover strategies enabling them to act
opportunistically towards the target’s incumbent shareholders.
Keywords: takeovers, mergers and acquisitions, diversification, hostile takeovers, means of payment, cross-border acquisitions, private target, partial acquisitions, blockholder, toehold, investor protection, UK, Continental Europe
JEL Classification:G34
Collateral in Monetary Policy Operations
Francisco Jose Callado Munoz and Fernando Restoy Lozano
Abstract: We present a portfolio decision model for banks that permits us to estimate the costs associated with the need to collateralize loans from the central bank. This allows us to calibrate the difference between a restrictive collateral eligibility framework for open market operations, such as that applied by the FED, with a more flexible approach such as that of Eurosystem. We also document that there could potentially appear relevant cost differences between the various collateral mobilization procedures (pooling and earmarking) that currently coexist in the eurozone.
Keywords:collateral, monetary policy, cost
JEL Classification: E52, E58
Product Market Competition, Managerial Incentives, and Firm Valuation
Gabrielle Wanzenried,Markus Schmid and Stefan Beiner,
Abstract: This paper contributes to the very small empirical literature on the effects of competition on managerial incentive schemes. Based on a theoretical model that incorporates both strategic in-teraction between firms and a principal agent relationship, we analyze the relationship between product market competition, incentive schemes and firm valuation. The model predicts a nonli-near relationship between the intensity of product market competition and the strength of managerial incentives. We test the implications of our model empirically based on a unique and hand-collected dataset comprising over 600 observations on 200 Swiss firms over the 2002 to 2005 period. Our results suggest that, consistent with the implications of our model, the relation between product market competition and managerial intensive schemes is convex indicating that above a certain level of intensity in product market competition, the marginal effect of competition on the strength of the incentive schemes increases in the level of competition. Moreover, competition is associated with lower firm values. These results are robust to accounting for a potential endogeneity of managerial incentives and firm value in a simultaneous equations framework.
Keywords:product market competition,strategic interaction, principal agent relationship, managerial incentives, firm valuation
JEL Classification: G30, J33, L1
Intraday Seasonalities and Macroeconomic News Announcements
Kari Harju and Syed Mujahid Hussain
Abstract: Using a data set consisting of more than five years of 5-minute intraday stock index returns for major European stock indices and US macroeconomic surprises, conditional means and volatility behavior in European markets were investigated. The findings suggest that the opening of the US stock market significantly raises the level of volatility in Europe, all markets responding in an identical fashion. Furthermore, US macroeconomic surprises exert an immediate and major impact on both the European stock markets’ intraday returns and volatilities. Thus, high frequency data appear to be critical for the identification of news impacting the markets.
Keywords:conditional mean, conditional volatility, information spillover, intraday seasonality, Flexible Fourier Form, macroeconomic surprises
JEL Classification: G14, G15
Optimal Investment Decisions for Two Positioned Firms Competing in a Duopoly Market With Hidden Competitors
Manuel Rocha Armada,Lawrence Kryzanowski and Paulo Jorge Pereira
Abstract: This paper extends the literature dealing with the option to invest in a duopoly market for a leader-follower setting. A restrictive assumption embodied in the models in the current literature is that investment opportunities are semi-proprietary in that the two identified or positioned firms are guaranteed to hold at least the follower’s position. More competition is realistically captured in our model by introducing the concept of hidden rivals so that the places in the market can be taken not only by positioned firm but also by these hidden competitors. The value functions and the optimal triggers for the positioned firms differ materially in settings with(out) the presence of hidden rivals. Unlike existing models, our model allows for (a)symmetric market shares and investment costs for the leader and the follower. Cooperative entrance by the two positioned firms is also modeled.
Keywords:real options, hidden competition, duopoly, investment costs.
JEL Classification: C73, D81, G31, L13
Market and Model Credit Default Swap Spreads: Mind the Gap!
Mascia Bedendo, Lara Cathcart and Lina El-Jahel
Abstract: Structural models of default establish a relation across the fair values of various as- set classes (equity, bonds, credit derivatives) referring to the same company. In most circumstances such relation is veri¯ed in practice, as di®erent ¯nancial assets tend to move in the same direction at similar speed. However, occasional deviations from the theoretical fair values occur, especially in times of ¯nancial turmoil. Understand- ing how the dynamics of the theoretical fair values of various assets compares to that of their market values is crucial to a number of market participants. This paper in- vestigates whether a popular structural model, the CreditGrades approach proposed by Finger (2002), Stamicar and Finger (2005), succeeds in explaining the dynamic relation between equity / option variables and Credit Default Swap (CDS) premia at individual company level. We ¯nd that CDS model spreads display a signi¯cant correlation with CDS market spreads. However, the gap between the two is time varying and widens substantially in times of ¯nancial turbulence. The analysis of the gap dynamics reveals that this is partly due to episodes of decoupling between equity and credit markets, and partly due to shortcomings of the model. Finally, we observe that model spreads tend to predict market spreads.
Keywords:equity volatility, credit spreads, structural models
JEL Classification: G21, C22, G10
Habit Formation in an Overlapping Generations Model with Borrowing Constraints
Amadeu DaSilva, Mira Farka and Christos Giannikos
Abstract: We introduce habit-formation in the three-period OLG borrowing-constraint framework of Constantinides, Donaldson, and Mehra (2002) by allowing the utility of the middle-aged (old) to depend on consumption when young (middle-aged). This specification enables us to separate the effect of the two habit parameters (middle-aged and old) since each representative age-group can face different levels of habit persistence. The two-habit setup underlines some important issues with regards to savings and security returns which do not always conform to the standard findings in the literature. In addition,the model produces equity premium consistent with U.S. data for relatively small levels of risk aversion.
Keywords:Equity premium puzzle, Overlapping generations model, Habit formation, Risk aversion.
JEL Classification: G0, G12, D10, E21
Demographic Change and Pharmaceuticals’ Stock Returns
Manuel Ammann, Rachel Berchtold and Ralf Seiz
Abstract: We analyze how demographic change affected pro fits and returns across pharmaceutical industries over the last twenty years. Fluctuations in different age group sizes influence the estimated demand changes for age-sensitive drugs, such as antibacterials for young, antidepressants for middle-aged, and antithrombotics for old people. These demand changes are predictable as soon as a speci fic age group is born. We use consumption and demographic data to forecast future consumption demand growth for drugs caused by demographic changes in the age structure. We find that long-term forecasted demand changes predict abnormal annual pharmaceutical stock returns for more than 60 firms over the time period from 1986 to 2008. An increase by one percentage point of annual demand growth due to demographic changes predicts an increase in abnormal yearly stock returns in the size of 3-5 percentage points. Short-term forecasted demand change does predict negative abnormal stock returns for a time horizon below 5 years. A trading strategy taking advantage of the demographic information earns a signi cant abnormal return between 6 and 8 percentage points per year. Our results are consistent with the model by DellaVigna and Pollet (2007), where investors are inattentive with extrapolation in the distant future and overreact to information in the near future.
Keywords:Demographic Change, Demand Growth, Abnormal Stock Returns, Pharmaceutical Companies, Panel Regression, Investor Attention, Trading Strategies
JEL Classification: C23, J10, J11
Does it Pay to be Socially Responsible? Evidence from Spanish Retail Banking Sector
Francisco Jose Callado Munoz and Natalia Utrero Gonzalez
Abstract: This paper extends the research on the relation between financial performance and corporate social responsibility in two respects. First, it develops a model of strategic competition that includes consumer perceptions with respect to firm social performance. It is shown that in the presence of a positive valuation of social responsibility practices by consumers, a firm that endorses this responsible behavior may obtain a better strategic position in the market, along with higher margin, demand, and profit. Second, the model's predictions are tested with a sample of Spanish banking firms. The empirical analysis confirms that consumers significantly value other features apart from price in making deposit and mortgage decisions, particularly a financial institution's social responsibility. A more disaggregated analysis shows first, that not every CSR dimension has relevance for consumers and second, that customers equally value activities that can have a direct impact on their well-being (e.g., culture and leisure), as well as other activities that can be viewed more generally as public goods (e.g., heritage and the environment). These conclusions are of interest in the debate about a firm’s social or ethical activities. It is shown that, provided that consumers value corporate social responsibility activities, firms can improve both their competitive position in the market and their profits by behaving in a socially responsible manner. Therefore, the design and implementation of corporate social responsibility practices could confer upon firms an initial competitive advantage over their competitors.
Keywords:strategic competition, Hotelling´s model, Spanish banking, corporate social responsibility.
JEL Classification: D83, G21, D21.
The Economic Value of Corporate Eco-Efficiency
Nadja Guenster, Jeroen Derwall, Rob Bauer and Kees Koedijk
Abstract: This study adds new insights to the long-running corporate environmental financial performance debate by focusing on the concept of eco-efficiency. Usinga new database of eco-efficiency scores, we analyse the relation between ecoefficiency and financial performance from 1997 to 2004. We report that ecoefficiency relates positively to operating performance and market value. Moreover, our results suggest that the market’s valuation of environmental performance has been time variant, which may indicate that the market incorporates environmental information with a drift. Although environmental leaders initially did not sell at a premium relative to laggards, the valuation differential increased significantly over time. Our results have implications for company managers, who evidently do not have to overcome a tradeoff between eco-efficiency and financial performance, and for investors, who can exploit environmental information for investment decisions.
Keywords:
JEL Classification:
Bank Relationships and Firms' Financial Performance: The Italian Experience
Analisa Castelli, Gerald Dwyer and Iftekhar Hasan
Abstract: We examine the relationship between the number of bank relationships and firms’ performance, evaluating possible differential effects related to firms’ size. Using an unique data set of Italian small firms for which bank debt is a major source of financing, we find that return on equity and return on assets decrease as the number of bank relationship increases, with a stronger relationship for small firms than for large firms. We also find that interest expense over assets increases as the number of relationships increases. Particularly for small firms, our results are consistent with analyses indicating that fewer bank relationships reduce information asymmetries and agency problems which outweigh negative effects connected to hold-up problems.
Keywords:bank relationships, small business lending, firms’ performance
JEL Classification: D21, G21, G32
Exchange Rate Changes and the 'Operating' Performance of Multinationals
Jungwon Suh and Bong-Soo Lee
Abstract: Using a sample of 261 U.S. multinationals over the period 1984 to 2002, we examine the relation between exchange rate changes and the profitability of foreign operations. We find that the impact of exchange rate changes on foreign operations’ profitability is not statistically significant in the majority of industries. Furthermore, according to our variance components analysis, exchange rate changes explain less than two percent of the variation in foreign operations’ profitability for most industries. We also find that the impact of exchange rate changes on foreign operations’ profitability is generally weak for non-U.S. multinationals from Australia, Canada, Japan and the U.K. Our evidence is consistent with the finding of prior studies that the impact of exchange rate changes on firm value is not significant for most multinationals.
Keywords:exchange rate exposure; operating performance; multinational companies
JEL Classification: : F23, F31, G32
Option-adjusted Delta Credit Spreads: A Cross-country Analysis
Leonardo Becchetti, Andrea Carpentieri and Iftekhar Hasan
Abstract: This study analyzes the determinants of the variation in option-adjusted credit spreads (OASs) using a unique database and enlarges the traditional analysis to include disaggregated indexes, new variables, and a complete set of markets (U.S., UK, and the Eurozone). An extended set of regressors explains almost half the variability of OASs in the three markets. We find that institutional trading activity significantly affects corporate bond spreads, signaling either variation in perceptions of risk or the existence of an indirect measure of liquidity. We also find that U.S. business cycle indicators significantly affect the variability of OASs in the UK and the Eurozone. Finally, we find evidence that stock returns have more influence on high-yield bonds in the Eurozone than in the U.S.
Keywords:option adjusted credit spread, corporate bonds.
JEL Classification: G11, G12.
In Defence of Capitalization Weights: Evidence from the FTSE 100 and S&P 500 Indices
Isaac T. Tabner
Abstract:
A simple method for decomposing the variance covariance matrix of portfolio returns at
the level of individual stocks is applied to the FTSE 100 Index. During extreme negative
shocks, the largest index constituents exhibit lower than average covariance, thereby
reducing the volatility of the capitalization-weighted index. The risk-adjusted returns
of the capitalization-weighted FTSE 100 Index exceed those of an equally-weighted version
of the same index and the outperformance is robust to the method of risk adjustment applied.
The equally-weighted index also exhibits greater systematic (market) risk than the capitalization-weighted
version.
Keywords:FTSE 100 Index, S&P 500 Index, benchmark portfolios, capitalization weights, stock indices, portfolio diversification, performance measurement.
JEL Classification: G10, G11, G12, G14, G15, C63, L11
What Governance Mechanisms Promote Efficiency in Reaching Poor Clients? Evidence from Rated Microfinance Institutions
Valentina Hartarska and Roy Mersland
Abstract:
This paper evaluates the effectiveness of several governance mechanisms on microfinance institutions’
(MFI) performance. We first define performance as efficiency in reaching many poor clients.
Following the literature on efficiency in banks, we estimate a stochastic cost frontier and
measure output by the number of clients. Therefore, we capture the cost minimization goal and
the goal of serving many poor clients, both of which are pursued by MFIs. We next explore the
impact of measurable governance mechanisms on the individual efficiency coefficients. The results
show that efficiency increases with a board size of up to nine members and decreases after that.
MFIs in which the CEO chairs the board and those with a larger proportion of insiders are less
efficient. The evidence also suggests that donors’ presence on the board is not beneficial. We
do not find consistent evidence for the effect of competition, and we find weak evidence that
MFIs in countries with mature regulatory environments reach fewer clients, while MFIs regulated by an
independent banking authority are more efficient.
Keywords:microfinance institutions, board, governance, performance, efficiency
JEL Classification: G21, G30
The Agency Effect of Repurchases on Closed-End Funds
Jingfeng An, Gordon Gemmill and Dylan C Thomas
Abstract:
Share prices rise after companies announce repurchases, but there are differing views as to why this
happens. Repurchases are announced by closed-end funds when their discounts are widening (market-to-book is falling). The immediate post-announcement effect is a small jump in a fund’s share price, but the main effect occurs over the next four years during which time there is significant outperformance both of the fund’s price and of its investment portfolio. Liquidity of the shares does not change. Repurchases, if executed, reduce the size of a fund and therefore the manager’s fees. Our findings are consistent with directors using the threat of repurchases to discipline managers
whose investment performance has been poor, leading to a closer alignment of pay and performance
Keywords:repurchases; agency problem; closed-end funds
JEL Classification: G30, G23, G14
Modeling the Blind Principal Bid Basket Trading Cost
Christos Giannikos, Hany Guirguis and Tin Shan Suen
Abstract:
A blind principal bid (BPB) is one of the mechanisms for simultaneously trading a basket of stocks at
a pre-determined execution price. In a BPB, asset managers auction a basket of stocks directly to liquidity
providers who do not know the identities of the individual stocks in the basket. Unlike other methods of trading,
the cost and composition of the BPB basket are not reported in a standard and timely manner. Complete basket
data are available only to the asset manager and the broker who won the auction. The current literature contains very little information on the BPB phenomenon, largely due to a lack of public data for research. This paper analyzes a unique dataset of 140 executed baskets, building on the seminal papers of Kavajecz and Keim (2005) and Stoll (1978a, 1978b) to develop empirical and structural models of BPB trading costs. Our research provides novel insights into the dynamics of pricing BPB trading costs, a topic that has rarely been examined in the literature. The research reported here also has significant practical applications. Asset managers obtain a benchmark for
evaluating the lowest bid, and brokers obtain qualitative insights that can aid them in formulating their bids.
Keywords: Blind principal Bids, Basket Trading, Asset Pricing
JEL Classification: G1, G10, G11 and G12
Benchmark Bonds Interactions Under Regime Shifts
Dimitris A. Georgoutsos, Petros M. Migiakis
Abstract: In the present paper we examine the interactions among five benchmark ten year government bonds, namely those of the US, Germany, France, Italy and the Netherlands. Our aim is to illustrate empirically a net of interactions existing among the major bond markets of Europe and the US market taking into account shifts in the underlying stochastic processes. For this purpose, differing from the rest of the relevant empirical literature, after specifying the long run equilibrium relations we estimate the linkages between the bond markets as subject to hidden Markov chains, by applying the Markov Switching Vector Error Correction framework (MS-VECM). This formulation is found to efficiently reflect the shifts brought about by significant economic events, such as the European monetary unification. As a result we illustrate different short-run relations referring to the periods before and after the monetary union. Overall, our empirical results indicate that stronger interactions among the markets of the system exist in the period after the EMU. Also, by means of a variance decomposition analysis we assess leader-follower relations which indicate that the benchmark status of bonds has changed since the introduction of the common monetary policy framework in Europe.
Keywords:Financial integration; bond markets; benchmarks; Markov Switching
JEL Classification: F21, F37, G12, G15
How Does Cross-Border Activity Affect the EU Banking Markets?
Ana Lozano-Vivas and Laurent Weill
Abstract:
Cross-border activity in the EU is widely viewed as a necessary condition for the implementation of
a single banking market and therefore as a positive factor for the enhancement of competition and cost
performance in the region. In this paper, we analyze the relevance of this view by investigating whether
cross-border activity really promotes competition and cost efficiency in EU banking markets. We also
consider the potential role of a bank’s mode of entry by comparing existing domestic banks that foreign banks take over (mergers and acquisitions) with new branches created by foreign banks, often through subsidiaries (greenfield operations). We consider the impact of cross-border banks on cost efficiency (measured by the stochastic frontier approach), profitability (assessed through return on assets) and competition (measured by the Lerner index). We find that greenfield banks enhance cost efficiency and competition, while mergers and acquisitions hamper competition and cost efficiency. Therefore,
our results suggest that EU authorities should promote only greenfield banks rather than all cross-border entries.
Keywords:: banks, competition, cross-border entry, efficiency, European integration
JEL Classification: G21
The Stochastic Seasonal Behavior of Natural Gas Prices
Andres Garcia Mirantes, Javier Poblacion and Gregorio Serna
Abstract:
Previous studies have explored the seasonal behavior of commodity prices as a deterministic factor.
This paper goes further by proposing a general (n+2m)-factor model for the stochastic behavior of
commodity prices, which nests the deterministic seasonal model by Sorensen (2002). We consider
seasonality as a stochastic factor, with n non-seasonal and m seasonal factors. The non-seasonal
factors are as defined in Schwartz (1997), Schwartz and Smith (2000) and Cortazar and Schwartz (2003).
The seasonal factors are trigonometric components generated by stochastic processes. The model has been
applied to the Henry Hub natural gas futures contracts listed by NYMEX. We find that models allowing for
stochastic seasonality outperform standard models with deterministic seasonality. We obtain similar results
with other energy commodities. Moreover, we find that stochastic seasonality implies that the volatility
of futures returns follows a seasonal pattern. This result has important implications in terms of option pricing.
Keywords:Stochastic calculus, seasonality, commodity prices, Kalman filter, natural gas
JEL Classification: C32, C51, C60, G13.
False Discoveries in UK Mutual Fund Performance
Keith Cuthbertson, Dirk Nitzsche and Niall O'Sullivan
Abstract:
We use a multiple hypothesis testing framework to estimate the false discovery rate (FDR) amongst
UK equity mutual funds. Using all funds, we find a relatively high FDR for the best funds of 32.8%
(at a 5% significance level), which implies that only around 3.7% of all funds truly outperform
their benchmarks. For the worst funds the FDR is relatively small at 7.6% which results in 22%
of funds which truly underperform their benchmarks. For different investment styles, this pattern
of very few genuine winner funds is repeated for all companies, small companies and equity income
funds. Forming portfolios of funds recursively for which the FDR is controlled at a “acceptable” value, produces
no performance persistence for positive alpha funds and weak evidence of persistence for negative alpha funds.
Keywords:Mutual fund performance, false discovery rate
JEL Classification: C15, G11, C14
Evaluating Natural Resource Investments Under Different Model Dynamics: Managerial Insights
Andrianos E. Tsekrekos Mark B. Shackleton and Rafal Wojakowski
Abstract:
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Risk-adjusted Measures of Value Creation in Financial Institutions
Alistair Milne and Mario Onorato
Abstract:
Measuring value creation by comparing the RAROC of an exposure (the return on risk capital) with
a single institution-wide hurdle rate is inconsistent with the standard theory of financial valuation.
We use asset pricing theory to determine the appropriate hurdle rate for such a RAROC performance measure.
We find that this hurdle rate varies with the skewness of asset returns. Thus the RAROC hurdle rate should
differ substantially between equity which has a right skew and debt which has a pronounced left skew and also between different qualities
of debt exposure. We discuss implications for both financial institution risk management and supervision.
Keywords:G22, G31
JEL Classification: asset pricing, banking, capital allocation, capital budgeting, capital management, corporate finance, downside risk, economic capital, economic value added, performance measurement, RAROC, risk management, hurdle rate, value at risk
The Dependency of the Banks' Assets and Liabilities: Evidence from Germany
Christoph Memmel and Andreas Schertler
Abstract:
Two decades of developments in risk-transfer instruments may have fundamentally changed the extent to which banks practice on-balance sheet term and liquidity transformation. These changes should be deliberated in on-balance sheet asset-liability dependencies. By using correlation analyses, we investigate asset-liability dependency for all three sectors of German universal banks from 1994 to 2007 and find that it declined over our sample period. We also investigate whether asset-liability dependency varies systematically with a bank’s affinity for using risk-transfer instruments, regulatory capital, and profitability and document several differences between the three sectors of German universal banks.
Keywords:Asset-liability dependency, correlation analysis
JEL Classification: G21, G32
Do Firms Decouple Corporate Governance Policy and Practice?
Nasha Ananchotikul, Roy Kouwenberg and Visit Phunnarungsi
Abstract:
We test whether Thai listed firms with higher levels of good governance policy adoption are less likely to violate listing rules and laws designed to protect shareholders. Our results suggest that firms on average implement, substantively as opposed to symbolically, recommended governance policies, as violations occur less frequently among firms with higher governance policy adoption scores. However, we also find evidence of symbolic governance among a small group of “talk-only” firms that issue statements about
governance while lagging in the adoption of policies related to shareholder rights and the board of directors
Keywords:corporate governance, violations, fraud, cheap talk
JEL Classification: G3, G38, K42
Can Stock Markets Predict M&A Failure? A Study of European Transactions in the Fifth Takeover Wave
Katrien Craninckx, Nancy Huyghebaert
Abstract:
In this paper we develop various measures of M&A failure for an intra-European sample during the
fifth takeover wave: inferior long-term stock performance, inferior operating performance, and target divestment. After documenting the extent of M&A failure, we test the relation between short-term abnormal returns at deal announcement and M&A failure. We examine a sample where listed bidders acquire listed targets (267 deals) as well as privately-held targets (336 deals). Our results indicate M&A failure rates up to 50% in both samples. When acquirers and targets are listed, lower M&A announcement returns are consistently and significantly associated with higher M&A failure probabilities
and long-term losses. In contrast, when targets are privately held, we find no evidence of such an association.
Keywords:Mergers and acquisitions, Europe, fifth wave, announcement effect, failure
JEL Classification: G34
European Corporate Governance: A Thematic Analysis of National Codes of Governance
Stephen Ferris, James Cicon, Armin Kammel and Greg Noronha
Abstract:
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Long Term Performance of Greek IPOs
Stavros Thomadakis, Christos Nounis and Dimitrios Gounopoulos
Abstract:
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External Financing, Growth and Stock Returns
Gikas Hardouvelis, Georgios Papanastasopoulos, Dimitrios Thomakos and Tao Wang
Abstract:
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