We show that the negative relation between realized idiosyncratic volatility, measured over the prior month, and returns is robust in non-January months. Controlling for realized idiosyncratic volatility, we show that the relation between returns and expected idiosyncratic volatility is positive and robust. Realized and expected idiosyncratic volatility are separate and important effects describing the cross-section of returns. We find the negative return on a zero-investment portfolio that is long high realized idiosyncratic volatility stocks and short low realized idiosyncratic volatility stocks is dependent on aggregate investor sentiment. In cross-sectional tests, we find the negative relation is weaker for stocks with a large analyst following and stronger for stocks with high dispersion of analyst forecasts. The positive relation between expected idiosyncratic volatility and returns is not due to mispricing.

Prior studies find that the CBOE volatility index (VIX) predicts returns on stock market indices, suggesting implied volatilities measured by VIX are a risk factor affecting security returns or an indicator of market inefficiency. We extend prior work in three important ways. First, we investigate the relationship between future returns and current implied volatility levels and innovations. Second, we examine portfolios sorted on book-to-market equity, size, and beta. Third, we control for the four Fama and French [Fama, E., French, K., 1993. Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3–56.] and Carhart [Carhart, M., 1997. On persistence in mutual fund performance. Journal of Finance, 52, 57–82.] factors. We find that VIX-related variables have strong predictive ability.

We hypothesize that managers who receive high equity-based compensation have greater incentive to avoid ownership dilution by timing their seasoned equity offers to periods when investors temporarily overvalue their stock. We provide empirical support for this hypothesis using a measure of equity-based compensation that reflects the sensitivity of the top five executives’ wealth (based on ownership of stock, options, and restricted shares) to a 1% change in stock price. We find that firms associated with high equity-based compensation for top executives experience abnormally low stock returns and relatively unfavorable changes in operating performance in the three-year period following the issue. Overall, the findings support the premise that managers whose wealth is most sensitive to stock price changes are more likely to act in the interest of current shareholders by issuing equity when they believe their stock is overvalued.

We analyze the changes in cash holding policies of S&P 500 firms from before to after their inclusion in the index. One year after inclusion, their mean industry-adjusted cash holdings decline by nearly 32% from the year before inclusion. Several factors explain this decline. The precautionary motive for cash subsides due to these firms becoming more visible, less uncertain, and less constrained to raise cheap external capital. Corporate governance deteriorates after inclusion due to increased managerial entrenchment, which leads to a reduction in cash as suggested by the free cash flow hypothesis. Most index firms face diminishing investment opportunities and decreasing capital expenditures, which implies a lesser need for cash holdings related to the transaction motive.

We use option prices to examine whether changes in stock return skewness and kurtosis preceding earnings announcements provide information about subsequent stock and option returns. We demonstrate that changes in jump risk premiums can lead to changes in implied skewness and kurtosis and are also associated with the mean and variability of the stock price response to the earnings announcement. We find that changes in both moments have strong predictive power for future stock returns, even after controlling for implied volatility. Additionally, changes in both moments predict call returns, while put return predictability is primarily linked to changes in skewness.