Knowledge that Transforms

Forward rates in the term structure of interest contain predictions of future spot rates plus (possibly) term premia. Realized spot rates contain predicted spot rates plus forecast errors. Under rational expectations forecast errors are not predictable. By forecasting spot rates using publicly available information, bounds on the variation of forecast errors, and term premia are obtained. For one-month treasury bill rates, one to two thirds of the variation in the difference between forward rates and realized spot rates is due to variation in term premia.

The macro literature presents conflicting evidence on the effects of price controls. In this study, the fact that the macro-economic effect of wage and price controls is the aggregation of the micro-economic effects is used to implement a different approach to measure the effects of price controls. The effect of price controls is inferred from examining the impact of discretionary regulatory decisions on the equity values of individual firms during Phase II of Nixon's Economic Stabilization Program. The empirical results indicate that violators of the regulations incurred significant abnormal losses that were unrelated to the explicit penalties. This suggests that implicit penalties were imposed on offending firms. The analysis of price increase decisions provides weak evidence that these Price Commission decisions had an impact on equity values.

The potential performance of an asset set may be obtained by choosing the portfolio proportions to maximize the Sharpe (1966) performance measure. If a portfolio has a Sharpe measure equivalent to the potential performance of the underlying set of assets, then it is efficient. Multivariate statistical procedures for comparing potential performance and testing portfolio efficiency are developed and then evaluated using simulations. Two likelihood ratio statistics are then used to compare stock and bond indices against sets of 20 and 40 portfolios. The procedures are also compared to the Gibbons (1982) methodology for testing financial models.

In his article Determinants of Corporate Borrowing, Myers (1977) says that it is not guaranteed that the maximum value of the firm is reached before the maximum value of the debt is utilized in the case in which the interest payment is fully tax deductible, but the tax shield is lost if the firm goes bankrupt. I have shown here that even in such a case the maximum value of the firm will always be achieved before the maximum available debt is utilized.

The purpose of this paper is to reexamine Reinganum's study which indicates that abnormal returns could not be earned unexpected quarterly earnings information, and to document precisely the response of stock prices to earnings announcements. This study, using a very large sample of stocks and daily returns, represents the most complete and detailed analysis of quarterly earnings reports that has been performed to date. Our results are contrary to those of Reinganum and show that abnormal returns could have been earned almost any time during the 1970's. Our analysis also indicates that risk adjustments matter little in this type of work. Finally, we find that roughly 50% of the adjustment of stock returns to unexpected quarterly earnings occurs over a 90-day period after the earnings are announced.

In the Sixties, the qualified stock option was the predominant form of long-term incentive compensation contract for major industrial firms in the U.S. In the early Seventies these same firms replaced their tax-qualified stock option plans with non-qualified sttock options and later modified these plans to include a variety of new contingent compensation arrangements, some of which were based on accounting numbers instead of stock prices. This paper develops the hypothesis that tax considerations play an important role in explaining the form of compensation contracts. The pattern and timing of changes in the compensation plans of the top 100 industrial firms provides evidence consistent with the tax hypothesis.

This paper presents evidence that petroleum firms whose financial statements were adversely affected by Statement of Accounting Standards No. 19 (SFAS-19) increased the rate at which they changed auditors during the full cost/successful efforts controversy. Firms relatively unaffected by SFAS-19 experienced no such increase in auditor change rates. While some important theoretical and empirical limitationns are encountered, the evidence is generally inconsistent with the accounting irrelevancy view that SFAS-19 had no economic consequences for petroleum firms. Auditor-client disagreement on this accounting standard appears to be an important determinant of the decision to change auditors. However, there is no observed tendency for firms to switch to auditors with whom they agree on petroleum accounting.

Procedural flexibility can have a substantial impact on reported costs, revenues, expenses, and balance sheet valuations. Until 1978 oil and gas companies had considerable flexibility in applying full cost and successful efforts. A unique opportunity to measure the income effect of firms' procedural choices occurred when the SEC specified the exact procedures that must be followed by oil and gas producers when they account for exploratory and development costs under both the full cost and successful efforts methods. In complying with the new rules firms were required to adjust retained earnings retroactively to reflect what it would have been if the new procedures had been in effect all along. These retained earnings adjustments provide a measure of the income effect of procedural choices. This study shows that economic incentives influence the procedural accounting choices which were made by oil and gas producers. The same economic incentives also influence the choice of full cost or successful efforts. Finally, the discriminatory ability of firms' economci incentives is most powerful when firms' reporting strategies are defined in terms of both choice of accounting methods and procedural applications within those methods.

This study tests Chicago Board Options Exchange efficiency by examining option price behavior in the weeks surrounding a firm's quarterly earnings announcement. The evidence presented here suggests that a first-order autoregressive seasonal process describes quarterly earnings behavior and demonstrates that the information content of an earnings announcement is fully incorporated in option prices by the end of the announcement week.

Abnormal returns (market model prediction errors) are the subject of many event studies in accounting and finance literature. Conditional on the event of interest, researchers have recently used cross-sectional regressions to examine relations between abnormal returns and firm specific variables. This paper demostrates that non-constant variences and covariances in market model residuals across firms introduced bias in the estimated slope coefficients of the independent variables, i.e., the expected signs of the estimated slope coefficients can be predicted a priori. A method is develope to removed the bias in the estimated slope coefficiets and is found to be effective. This method explicitly takes the dependence among abnormal returns across firms into account. Methods that assume abnormal returns across firms to be independent do not control for such bias.