Knowledge that Transforms

Using quotations from two interest rate swap dealers with different credit ratings (AAA and A), we examine the effect of dealers' credit reputations on swap quotations and bid-offer spreads. The AAA offer rates are significantly higher than the A offer rates, and the AAA bid rates are significantly lower than the A bid rates. We also document the relation between swap rates and par bond yields estimated from London interbank offered rate (LIBOR) and bid rate (LIBID) data. We identify some of the problems in testing the implications of swap pricing theory.

This paper reconciles the relative pricing controversy between DeBondt and Thaler (1985, 1987), Chan (1988), and Ball and Kothari (1989). The negative autocorrelation in long-horizon index returns, along with the selection criterion of the contrarian strategy, can explain the positive covariance between time-varying betas and risk premiums. However, test-period beta estimates reflect the reversal of earnings expectations associated with underlying factors. The controversy thus reduces to the debate of Fama and French (1988) and Poterba and Summers (1988) over the source of the temporary price components in the market index. Rational changes in expected returns and cash flows explain most of the cross-sectional variation in returns.

This paper develops tests of inequality restrictions implied by conditional asset pricing models. The methodology is easy to implement, requires little knowledge of the conditional distribution of asset returns, and is valid under fairly weak assumptions. As an application, we test whether the ex ante risk premium is always positive. We report reliable evidence that the ex ante risk premium is negative in some states of the world; these states are related to periods of high expected inflation and especially to downward-sloping term structures.

Reinganum (1990) reports that small NYSE securities have average returns about 6% per year higher than those of similarly-sized NASDAQ securities during the 1973–1988 period. He attributes the return differential to market microstructure differences. In contrast, this paper demonstrates that differences in the characteristics of the companies listed on the two exchanges explain much of the disparity. About 60% of the return differential can be attributed to the poor performance of recent initial public offerings, which comprise a large portion of the firms on NASDAQ. On average, IPOs underperform during the six calendar years after going public.

This study examines price stabilization in new equity issues. Stabilizationtruncates the distribution of post-issue prices at a floor price, lowering the risk of adverse price moves and hence, in a competitive dealer market, reducing the bid-ask spread. Using 1.523 NASDAO-traded firm- commitment initial public offerings issued between 1982 and 1987, we find that spreads narrow when the market price is close to the offer price and stabilization is most likely. Moreover, significant negative returns are documented after the hypothesized termination of stabilizing activities, suggesting that stabilization, and its cessation, affect market prices.

Units are bundles of common stock and warrants. By selling initial public offerings (IPOs) of units, firms precommit to sell more stock in the future at the warrant's exercise price. Sequential offerings of this type reduce the agency costs of giving management a potential free cash flow at the IPO. Consistent with this theory, firms that choose unit IPOs are smaller, have less income and assets in relation to their IPO proceeds, and are less likely to survive than firms that issue shares.

The Myers and Majluf (1984) model predicts a nonpositive price reaction to an announcement of a new issue of equity. This paper shows that the Myers and Majluf result is a direct outcome of their assumption that all potential projects facing the firm have a nonnegative net present value. Refining the Myers and Majluf model, by allowing for the realistic possibility of potential projects having negative net present values, leads to different predictions. The refined model predicts positive as well as negative stock price responses, consistent with recent empirical evidence concerning the stock price effects of new stock issues.

This paper tests the relation between capital structure and a firm's response to short-term financial distress. In a sample of 358 firms that perform poorly for a year, higher predistress leverage increases the probability of operational actions, particularly asset restructuring and employee layoffs. Higher predistress leverage also increases the probability of financial actions such as dividend cuts. These results are consistent with Jensen's (1989) argument that higher predistress leverage increases the speed with which a firm reacts to poor performance. Interestingly, higher managerial holdings reduce the probability of operational actions, especially those that do not generate cash.

We evaluate the performance of alternative test statistics in event studies which include NASDAQ daily security returns. We document varying degrees of test statistic misspecification in NASDAQ samples. In particular, we find that the commonly used standardized test statistic is misspecified in most settings. Although less pervasive, misspecification is also evident in the portfolio test statistic estimated using the time series of portfolio mean abnormal returns. The nonparametric rank statistic [introduced in Corrado (1989)] performs the best overall in NASDAQ samples; we recommend its use with market model abnormal returns based on an equal-weighted NASDAQ market index.

Data for the 516 papers published in volumes 1–30 of the Journal of Financial Economics in the period 1974–91 are analyzed. 477 authors from 136 institutions contributed papers, and these papers received 16,231 citations according to the Social Science Citation Index. Lists of authors and institutions who have contributed the most papers to the JFE and a list of the mostly highly-cited JFE papers show why the Journal has been successful in influencing the finance and economics literature during its first 18 years.