Knowledge that Transforms

This paper examines firm performance around announcements of common stock issues. We study the banking industry in which some stock issues are made voluntarily by managers, and other issues are involuntary. We find that banks that voluntarily issue common stock experience a significant drop in the matched adjusted operating performance following the issue, a significant drop in benchmark firms' adjusted stock prices following the issue, and systematically negative market reactions to post-issue quarterly earnings announcements. Banks that issue common stock involuntarily experience values for these measures that are not significantly different from those of the benchmark firm(s).

We provide evidence of private information in the foreign exchange market. The evidence comes from the introduction of trading in Tokyo over the lunch hour. Lunch-return variance doubles with the introduction of trading, which cannot be due to public information since the flow of public information did not change with the trading rules. We then exploit microstructure theory to discriminate between the two alternatives: private information and mispricing. Four key results support the predictions of private-information models. Three of these involve changes in the intraday volatility U-shape. The fourth is that opening trade causes mispricing's share in variance to fall.

This study proposes a managerial discretion hypothesis of equity carve-outs in which managers value control over assets and are reluctant to carve out subsidiaries. Thus, managers undertake carve-outs only when the firm is capital constrained. Consistent with this hypothesis, firms that carve out subsidiaries exhibit poor operating performance and high leverage prior to carve-outs. Also consistent with this hypothesis, in carve-outs wherein funds raised are used to pay down debt, the average excess stock return of + 6.63 percent is significantly greater than the average excess stock return of −0.01 percent for carve-outs wherein funds are retained for investment purposes.

Why does stock volatility increase when output declines? The theory of investment under uncertainty implies that political uncertainty may simultaneously increase volatility and reduce output. Though cause and effect are typically hard to separate, the transition from Imperial to Weimar Germany offers a natural experiment because major political events left clear traces on stock prices. Current and past increases in volatility are associated with output declines, consistent with U.S. experience. However, political events are more clearly the source of volatility, and the results support the view that the relationship between volatility and output reflects the joint effects of political factors.

This paper develops static hedges for several exotic options using standard options. The method relies on a relationship between European puts and calls with different strike prices. The analysis allows for constant volatility or for volatility smiles or frowns.

This paper studies the flows of funds into and out of equity mutual funds. Consumers base their fund purchase decisions on prior performance information, but do so asymmetrically, investing disproportionately more in funds that performed very well the prior period. Search costs seem to be an important determinant of fund flows. High performance appears to be most salient for funds that exert higher marketing effort, as measured by higher fees. Flows are directly related to the size of the fund's complex as well as the current media attention received by the fund, which lower consumers' search costs.

This paper studies thirty-one highly leveraged transactions (HLTs) that become financially, not economically, distressed. The net effect of the HLT and financial distress (from pretransaction to distress resolution, market- or industry-adjusted) is to increase value slightly. This finding strongly suggests that, overall, the HLTs of the late 1980s created value. We present quantitative and qualitative estimates of the (direct and indirect) costs of financial distress and their determinants. We estimate financial distress costs to be 10 to 20 percent of firm value. For a subset of firms that do not experience an adverse economic shock, financial distress costs are negligible.

Implicit in the prices of traded financial assets are Arrow–Debreu prices or, with continuous states, the state-price density (SPD). We construct a nonparametric estimator for the SPD implicit in option prices and we derive its asymptotic sampling theory. This estimator provides an arbitrage-free method of pricing new, complex, or illiquid securities while capturing those features of the data that are most relevant from an asset-pricing perspective, for example, negative skewness and excess kurtosis for asset returns, and volatility “smiles” for option prices. We perform Monte Carlo experiments and extract the SPD from actual S&P 500 option prices.

Prior to the Tax Reform Act of 1986 (TRA '86), long-term capital gains were taxed at a lower rate than short-term gains, presenting investors with an opportunity to increase their after-tax return by delaying the sale of appreciated assets until after they qualified for long-term status and selling depreciated assets prior to long-term qualification. Using a sample of Initial Public Offerings, I find that stocks that appreciated prior to long-term qualification exhibit increased volume and decreased returns just after their qualification date, while stocks that depreciated prior to long-term qualification exhibit these effects just prior to their qualification date.

We compare dividend policies of U.S. and Japanese firms, partitioning the Japanese data into keiretsu, independent, and hybrid firms. We examine the correlation between dividend changes and stock returns, and the reluctance to change dividends. Results are consistent with the joint hypotheses that Japanese firms, particularly keiretsu-member firms, face less information asymmetry and fewer agency conflicts than U.S. firms, and that information asymmetries and/or agency conflicts affect dividend policy. Japanese firms experience smaller stock price reactions to dividend omissions and initiations, they are less reluctant to omit and cut dividends, and their dividends are more responsive to earnings changes.