The Financial ReviewAbstracts of Volume 40, 2005Tip: Hit Ctrl-f to search for the author, title or keyword you need Distinguishing Between Rationales for Short-Horizon Predictability of Stock Returns Avanidhar Subrahmanyam In this paper, we shed light on short-horizon return reversals. We show theoretically that a risk-based rationale for reversals implies a relation between returns and past order flow, whereas a reversion in beliefs of biased agents does not do so. The empirical results indicate that returns are more strongly related to own-return lags than to lagged order imbalances. Thus, the evidence suggests that monthly reversals are not completely captured by inventory effects and may be driven, in part, by belief reversion. We do find that returns are cross-sectionally related to lagged imbalance innovations at horizons longer than a month. Dividends, Corporate Monitors and Agency Costs Kenneth A. Borokhovich, Kelly R. Brunarski, Yvette Harman and James B. Kehr We report new evidence on the hypothesis that dividends reduce agency costs. Consistent with dividends as a mechanism to reduce agency costs, we find that, on average, firms with a majority of strict outside directors on their boards experience significantly lower mean abnormal returns around the announcements of sizeable dividend increases. Our results are robust to multivariate controls for firm size, leverage, ownership, growth options, and change in dividend yield. However, we find no evidence that dividend increases reduce agency costs as measured by poison pills or outside blockholdings. Leverage and the Complexity of Takeovers Tomas Jandik and Anil K. Makhija There is scant empirical evidence on how the leverage of target firms affects gains to their shareholders, although there are several widely-cited economic theories offered in the literature. The limited available evidence shows that shareholders of targets with greater leverage experience higher returns. However, even this observed effect of debt on takeovers can not be distinguished from a mere mechanical pure leveraging effect, leaving the economic explanations untested. Consequently, we adopt an alternative approach here to examine if targets’ debt truly matters in takeovers. We report that acquisition processes involving targets with higher leverage tend to be significantly more complex in several ways. We find that such acquisitions tend to take a longer time to consume, are more likely to be associated with multiple bidder auctions, and experience greater revisions in offer prices. Finally, we find that factors that make takeovers more complex also lead to greater target gains. Trade Duration: Information and Trade Disposition Peter R. Locke and Zhan Onayev We examine the relation between futures trade duration and profitability, volatility, and volume. The duration of unprofitable trades is longer than that for profitable trades across the day, which is evidence of the disposition effect. Our analysis of profitable and unprofitable trades shows strong intraday volume patterns. Greater proportions of profitable trades are offset at the open and close. During high-volume periods dealers may use a semi-fundamental informational advantage, based on their access to order flow signals. Dealers may be able to execute costly inventory-reducing trades at the end of the day, when their informational advantage is perhaps greatest. FX Dynamics, Limited Participation, and the Forward Bias Anomaly O. Miguel Villanueva Standard foreign exchange (FX) models with goods price stickiness and instantaneous asset market adjustments imply FX overshooting (Dornbusch, 1976), which can explain the forward bias anomaly. Lyons (2001) explained the anomaly via limited participation of FX speculators due to Sharpe ratios lower than equity market alternatives, which implies FX undershooting to interest differential shocks. I derive the time-series implications of over- and undershooting for the joint forward-spot FX dynamics in a vector error correction model. I use generalized impulse response analysis (Pesaran and Shin, 1998) to test those implications. All FX studied (pound, deutsch mark, French franc, yen, and Canadian dollar) have dynamics consistent with undershooting during the period from 1975 to 1998. Asymmetric Information in the IPO Aftermarket Mingsheng Li, Thomas H. McInish and Udomsak Wongchoti Using the adverse selection component of the spread as a measure of asymmetric information, we investigate how asymmetric information evolves after firms go public. We find that the level of asymmetric information is lower immediately after the initial public offering (IPO) compared with its level after a period of seasoning. In addition, we test the hypothesis that the greater the underpricing of an IPO, the more information is produced in its aftermarket, and the lower the aggregate level of asymmetric information. Our results are consistent with the hypothesis and are robust after controlling for other factors. Who’s Monitoring the Monitor? Do Outside Directors Protect Shareholders’ Interests? Eric Helland and Michael Sykuta The corporate governance literature is rich with empirical tests of the relation between board composition and firm performance. We consider the effect of board composition on a different measure of performance, the probability a firm will be sued by shareholders. We find firms that are defendants in securities litigation have higher proportions of insiders and of gray directors and have smaller boards than a matched group of firms that are not sued, even when controlling for firm value and industry. The results suggest that boards with higher proportions of outside directors do a better job of monitoring management Imperfect Information and Stock Market Volatility Jeffrey R. Gerlach The purpose of this paper is to (a) develop a model to show how imperfect information can create excess volatility in asset returns and (b) provide empirical evidence consistent with the model. In this framework, variations in information quality cause the market prices to fluctuate more than the corresponding economic fundamentals. Using high-frequency data from 1988 to 2002, the empirical evidence supports the predictions of the model by showing that economic volatility, defined as squared deviations of the quarterly gross domestic product growth rate from its long-run trend, can explain about half of the variation in S&P 500-stock index quarterly volatility. Price Movement Effects on the State of the Electronic Limit-order Book Yue-cheong Chan This paper investigates public-trader order-placement strategies by examining the relations between the state of the limit-order book and previous price movements. There is support for an information effect, as traders become more aggressive in buying and more patient in selling after previous positive stock returns. The widening of the bid-ask spread also causes traders to place less aggressive orders. However, there is no evidence of the options effect on limit-order trading. This study also reveals that orders at the best quotes react faster and complete the adjustment earlier than orders that are far away from the best quotes. Specialist Risk Attitudes and the Bid-Ask Spread Brian Prucyk This paper examines the relation between the bid-ask spread and the risk of the underlying stock. It provides evidence that the specialist is not only sensitive to the absolute level of volatility, but also to changes in the level of volatility. This sensitivity arises because of increased inventory risk for the specialist when volatility is changing. For the sample of very liquid stocks in this paper, the quoted spread and the inventory cost component of the spread are shown to increase significantly during trading periods when volatility is both increasing and decreasing. Director Quality and Firm Performance Lisa Fairchild and Joanne Li Many financial economists argue that the board of directors’ efficacy in the monitoring of managerial behavior depends upon the quality of the directors. Assuming that there is a link between the stock performance of target firms and the quality of their directors, we empirically categorize directors receiving additional directorships following a takeover as “above average” and “below average.” We then follow the stock performance of firms hiring new directors for three years after their hiring. We match the two categories of directors with the performance of hiring firms after a director’s appointment. Accounting for other contemporaneous effects, we regress the hiring firms’ post-performance on director quality and other attributes. The results indicate that directors of “above average” quality are related to hiring firms with “above average” post-performance. Nasdaq Trading and Trading Costs: 1993-2002 Bonnie F. Van Ness, Robert A. Van Ness and Richard S. Warr Nasdaq spreads decline from 1993 to 2002, largely independently of tick size reductions. Trade size declines, consistent with greater retail investor activity. Using the method of Chordia, Roll, and Subrahmanyam (2001), we find that concurrent market returns strongly affect liquidity and trading activity. Liquidity exhibits distinct day-of-the-week patterns. There is little evidence that macroeconomic announcements or changes in key interest rates affect Nasdaq stocks overall, but in the bear market we find a relation between some of these variables and effective spreads, which we interpret as consistent with Nasdaq participants’ paying greater attention to fundamentals after the market crash. Determinants of Bank Debt in a Continental Financial System. Evidence from Spanish Companies Pablo de Andrés Alonso, Félix J. López Iturriaga, Juan A. Rodríguez Sanz and Eleuterio Vallelado González We analyze hypotheses about the structure of corporate debt ownership and the use of bank debt by firms in a civil-law country (Spain). We focus on bank debt effects in the presence of information asymmetries and agency costs, and on efficient versus inefficient firm liquidation. We find that the relation between growth opportunities and bank financing is not as strong as the one found in common law countries, that there is a positive relation between firm size and the proportion of bank debt used, and that firms closer to bankruptcy and highly leveraged are more prone to using bank debt. Risk-adjusted Long-term Contrarian Profits: Evidence from Non-S&P 500 High Volume Stocks Udomsak Wongchoti, Chong Soo Pyun Can trading volume help unravel the long-term overreaction puzzle? With portfolios of non-S&P 500 NYSE stocks, we show that (a) both the high- and low-volume (abnormal volume) contrarian portfolios earn a much higher market-adjusted excess return than the normal-volume contrarian portfolio, (b) however, when leverage-induced risk is factored in, excess returns from contrarian portfolios with normal and low-volume stocks are insignificant, (c) only excess returns from high-volume contrarian stocks are significant and cannot be explained away by the time-varying risk and return framework, and (d) such high-volume, risk-adjusted excess returns arise mainly from winner (glamour) stocks. Capital Structure and the Ex-Dividend Day Return Dan W. French, Paula L. Varson and Kenneth P. Moon We propose the application of an option-pricing framework to the ex-dividend behavior of common stocks. The framework explains the observed behavior of positive returns on the ex-dividend day and predicts that ex-dividend day returns will be higher for firms with greater financial leverage. An empirical test using observed ex-day returns and firm financial data confirms that there is a positive relationship between leverage and the ex-day return. Tests also control for and confirm the importance of effects of other variables on ex-dividend day behavior. In contrast to results of prior studies, we find that dividend-capture activity has no significant impact on ex-dividend behavior, and we offer an explanation based on the importance of tick intervals. Asymmetric Volatility and Trading Activity in Index Futures Options Kam C. Chan, Louis T. W. Cheng, Peter P. Lung We examine the impact of option trading activity on implied volatility changes to returns in the index futures option market. Controlling for option moneyness, delta-to-option-premium ratio, and liquidity, we find that net buying pressure, profit-maximization behavior, and liquidity are interrelated and affect asymmetric responses of implied volatilities to returns. Implied volatilities of options with more liquidity, a higher exercise price, and a higher delta-to-option-premium ratio have the most profound asymmetric response. Underpricing, Share Overhang and Insider Selling in Follow-on Offerings Shaorong Zhang Prospect and information-momentum theories predict that insiders can offer fewer shares in an IPO to create informational momentum and obtain higher prices in follow-on offerings. I find that dilution and insider participation in the IPO are negatively related to the number and size of follow-on offerings, consistent with the prediction. However, insider selling in follow-on offerings is positively related IPO selling, contrary to the theories. Returns around follow-on offering announcements are more negative for newly public firms than older firms, but for newly public firms do not differ by whether the announcement comes before or after the lockup expiration date. Asset Pricing and the Illiquidity Premium Howard W. Chan and Robert W. Faff In this paper, we examine the asset-pricing role of liquidity (as proxied by share turnover) in the context of the Fama and French (1993) three-factor model. Our analysis employs monthly Australian data, covering the sample period from 1990 to 1998. The key finding of our research is that the main test is unable to reject the test of over-identifying restrictions, thus supporting the overall favorability of the liquidity augmented Fama-French model. In addition, we find that the asset-pricing performance of the liquidity factor is generally very robust to a wide range of sensitivity checks. Performance of Enhanced Index and Quantitative Equity Funds Parvez Ahmed, Sudhir Nanda We examine the performance of enhanced index and quantitative equity funds. Both types of funds use quantitative models in investment selection. Enhanced index funds set an explicit objective to outperform a benchmark index. Proponents of quantitative funds argue that their management style takes human emotions out of the investment decision-making process and leads to more objective stock selection. We find evidence of outperformance by quantitatively managed growth funds, especially those investing in small cap stocks. Optimal Number of Stock Holdings in Mutual Fund Portfolios Based on Market Performance Hany A. Shawky, David M. Smith Among the decisions most mutual fund portfolio managers make is the number of stocks to hold. We posit that there is an optimal number of stocks for each mutual fund, reflecting the trade-off between diversification benefits versus transactions and monitoring costs. We find a significant quadratic relation between number of stock holdings and risk-adjusted returns for U.S. equity mutual fund portfolios during 1992-2000. Moreover, we find that changes in the number of stocks held over time are more highly correlated with mutual fund flows than with funds’ investment returns. Marketing Closed-End Fund IPOs: An Analysis of the International Stock Funds David C. Leonard, Terry D. Nixon, David M. Shull Various studies argue that underwriting fees are excessive and investment bankers prolong the price stabilization period in aftermarket trading of closed-end fund (CEF) shares. The poor performance of these funds also raises questions about the financial sophistication of IPO buyers. In this study, we examine these issues for a sample of international stock CEFs. Our findings indicate that underwriting fees are not excessive relative to industrial issues, and we do not find that investment bankers prolong the stabilization period to camouflage the underwriting cost. Our findings are consistent with earlier studies that discounts contribute significantly to the poor performance during the first six months of aftermarket trading. Return Characteristics of State-owned and Non-state-owned Chinese A Shares Michael J. Seiler, David M. Harrison, Pim van Vliet, Kit Ching Yeung This study examines and compares stock returns and volatilities between state-owned and non-state owned firms on the Shanghai and Shenzhen stock exchanges. Results vary significantly by exchange. Returns for both firm types, on both exchanges, exhibit negative skewness and high kurtosis inconsistent with a normal distribution. Returns display significant autocorrelation, even after the removal of lower order effects. Granger causality tests reveal that Shenzhen returns significantly lead Shanghai returns. Within both exchanges, state-owned firms lead non-state-owned firms. Neither state-owned nor non-state owned firm shares are dominated in terms of second order stochastic dominance. Post-Merger Performance of Bank Holding Companies, 1987–1998 Morris Knapp, Alan Gart and David Becher This paper examines the results of material mergers between bank holding companies. Merged bank holding companies experience post-merger profitability below the industry average. The market reaction to the merger announcements is significantly negative. The most important causes of the poor post-merger performance are credit quality and the inadequate generation of fee income. Asset mix and capitalization also play a major part. The controllability of these items demonstrates the management challenge associated with a material merger. Do CRA-related Events Affect Shareholder Wealth? The Case of Bank Mergers Harold A. Black, Raphael W. Bostic, Breck L. Robinson, Robert L. Schweitzer This study explores how Community Reinvestment Act (CRA) protests and their resolution affect the market value of merging banks. We find, in contrast to earlier research, that CRA-related events are not associated with significant negative market reactions for either bidder or target institutions. Rather, the market does not seem to respond strongly to CRA-related events at all. The results appear to stem from the choice of an estimation period for establishing an institution’s baseline stock-market price dynamics that does not include abnormal security price movements induced by the merger announcement. Eastern Finance Association members and institutional subscribers have free access to the full text of articles published in The Financial Review (now starting from the first quarterly issue in 1969) at our Blackwell site. Join now at http://www.blackwellpublishing.com/memb.asp?ref=0732-8516). 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