Knowledge that Transforms

The purchase of insurance provides a potentially finer informational partition over the distribution of post-loss resolution wealth that may allow favorable adaptation of intermediate consumption, investment, or other decisions. Such a positive informational value does not require consumer risk aversion. Lines of insurance with longer resolution periods should impact relatively more decisions and have higher informational value. Under standard assumptions on preferences, in the absence of informational value, risk premiums paid for insurance by risk averse consumers should not increase as the loss resolution period increases. Empirical tests using data from the property-liability insurance market suggest that the willingness to pay per dollar of coverage (as measured by relative market demand across lines of insurance) is greater for lines of insurance with longer resolution periods consistent with a positive informational value of insurance. The results suggest that other financial assets may also have differential informational value.

The Pension Benefit Guaranty Corporation (PBGC), which insures private defined benefit pension plans, is facing mounting deficits. The main cause of this predicament for PBGC can be traced down to the misuse of the insurance by a few companies. We therefore propose an active intervention policy - which would result in termination of severely underfunded plans — for the PBGC. A continuous-time model is provided to help determine the point of intervention, if necessary, using option-pricing techniques. A clear exposition of the intervention doctrine is thus obtained via this model. We also provide a numerical illustration of the working of the model on a hypothetical pension plan.

New evidence is provided on price and volatility spillovers among the Danish, Norwegian, Swedish, and Finnish stock markets. The impact of good news (market advances) and bad news (market retreats) is described by a multivariate Exponential Generalized Autoregressive Conditionally Heteroskedastic (EGARCH) model. Volatility transmission is asymmetric, spillovers being more pronounced for bad than good news. Significant price and volatility spillovers exist but they are few in number.

The market for credit cards has been the subject of recent attention and controversy because of ‘high’ profits earned on credit cards and substantial premiums on the resale of credit-card receivables. This paper estimates risk—return profiles for credit-card banks and explores the role of intangible assets in determining resale premiums on credit-card receivables. In addition, the effects on the resale market of securitization and the opportunity cost of acquiring new accounts are analyzed. Using alternative measures of risk and alternative control groups, we find, for the years 1989 to 1995, that credit-card banks earned significantly higher returns on assets but that these returns were associated with greater risk-taking. Analysis of premia for the years 1993 to 1995 suggest that acquiring banks pay higher premia for mid-sized regional accounts than for larger, national portfolios, perhaps because of richer cross-selling opportunities.

After 1983, Medicare paid hospitals for inpatient services at fixed rates, but continued to reimburse outpatient services based on reported cost. Using data from Washington State we find that hospitals responded by increasing outpatient services to Medicare patients compared to non-Medicare patients-the ratio of Medicare outpatient revenues as a percentage of total Medicare revenues increased after 1983 to a significantly greater extent than for non-Medicare patients. We also find that allocations of overhead costs to outpatient departments increased after 1983. These findings suggest that hospitals change their patient mix and cost allocations to maximize hospital cash flows.

This paper provides evidence on whether managers can reduce stockholder litigation costs by disclosing adverse earnings news ‘early’. Inconsistent with this idea, I find that voluntary disclosures occur more frequently in quarters that result in litigation than in quarters that do not. However, this result occurs because managers' incentives to predisclose earnings news increase as the news becomes more adverse, presumably because this reduces the cost of resolving litigation that inevitably follows in bad news quarters. After controlling for these incentives using estimated stockholder damages, I find some evidence that more timely disclosure is associated with lower settlement amounts.

This study tests political costs theory by examining the cable television industry during periods of Congressional scrutiny. Earnings management is measured using discretionary accruals, and data are consistent with managerial incentives to mitigate the effects of political scrutiny and potential industry reregulation. Tests are also done using within-sample comparisons of firms. Firms for which proposed regulations are expected to be more harmful have greater income-decreasing accruals, and for some tests, firms for which cable television operations are more important have greater income-decreasing accruals. Test results are robust to the inclusion of control variables for firm performance and size.

The price-earnings relation can be characterized as a system of simultaneous equations. Earnings and prices can behave as if they are both endogenously determined because they are jointly affected by information that is difficult to specify explicitly. Specification tests provide evidence that both earnings changes and price changes are endogenous. The price and earnings coefficients increase from OLS to joint estimation and, under a restrictive set of assumptions, provide increasingly similar estimates of the permanent component of earnings. The evidence is consistent with the contention that a portion of the single-equation bias can be mitigated via joint estimation.

I investigate stock price behavior associated with the allowance of LIFO for tax purposes. The analysis is structured as an event study of the Revenue Acts of 1938 and 1939. The results indicate a positive net market reaction to legislative events leading to LIFO's incorporation into the US tax code for the sample firms having the largest estimated LIFO tax benefits. I conclude the market revised its probabilities that firms most likely to benefit would avail themselves of the opportunity to use LIFO and defer taxes on inventory profits.

We demonstrate the value-relevance of foreign earnings for US multinational firms by examining the associations between annual abnormal stock performance and changes in firms′ domestic and foreign incomes. For 2570 tirm-year observations between 1985 and 1993, both foreign and domestic earnings changes have significant positive associations with annual excess return measures: however, the association coefficient on foreign income is significantly larger than the association coefficient on domestic income. We demonstrate this larger association coefficient for foreign income is consistent with differences in growth opportunities between domestic and foreign operations.