Knowledge that Transforms

This paper considers how estimates of the market model beta parameter can be biased by friction in the trading process (information, decision, and transaction costs) that (a) leads to a distinction between observed and ‘true’ returns; (b) causes observed returns to be generated asynchronously for a set of interdependent securities; and (c) thereby introduces serial cross-correlation into security returns. Several propositions are derived from which consistent estimators of beta are obtained, and the effect of differencing interval length on beta estimates is specified. The formulation is contrasted with the related analyses of Scholes-Williams (1977) and Dimson (1979).

The Arbitrage Pricing Theory is extended to a setting where investors possess information about future asset returns. A no-arbitrage pricing restriction is obtained with arbitrage conditioned on an investor's information. The pricing restriction contains unconditional factor loadings and either conditional or unconditional expected returns. Thus, tests of the theory can be based solely on time-series estimates of unconditional moments. Additional tests based on conditional expected returns are also appropriate.

We measure the impact of acquisitions activity on firm value by differentiating between specific merger events and programs of acquisition activity. Based on a sample of conglomerate acquirers, we find significantly positive abnormal performance associated with the announcement of acquisitions programs and significantly negative performance associated with certain institutional changes of 1967–1970 relating to acquisition activity (the Williams Amendments, the 1969 Tax Reform Act, and APB Opinions 16 and 17). Our results support the hypotheses that acquisitions activity had a favorable ex ante impact on the value of firms announcing an intention to engage in acquisitions, and that some of the institutional changes reduced the expected profitability of future acquisitions activity. The basic results of studies of mergers and tender offers are reviewed and their consistency with our findings highlighted.

This paper studies the net effects of the long-run sequence of events leading to merger, and of merger per se, on shareholder wealth. The appropriate measure of the wealth effect is shown to be the abnormal dollar return cumulated over time. Using this measure, the long-run wealth effect of the event sequence culminating in merger is significantly negative for acquiring firms. For acquired firms, the effect is negative, but not significant. The immediate impact of merger per se is positive and highly significant for acquired firms but larger in absolute value, and negative for acquiring firms. The evidence also reveals that measured abnormal rates of return to acquiring firms are sensitive to a slight variation in model specification and dependent on firm size, with smaller firms earning significantly negative post-merger returns.

Stoll and Whaley (1983) suggest large transaction costs may be responsible for the large risk-adjusted returns earned by small firm stocks. This study, using data from the AMEX as well as the NYSE, shows that investors can earn risk-adjusted excess returns after transaction costs by holding small firms for relatively short holding periods. Other literature that provides evidence that is inconsistent with the transaction costs hypothesis is cited.

This paper tests the hypothesis that the future distribution of payoffs provided by a common stock depends upon whether ownership of the stock also conveys control over the firm's activities. For 26 firms that had two classes of common stock outstanding, the class with superior voting rights traded at a premium relative to the other class. However, in four firms where the ownership structure of the firm also included a class of voting preferred stock, the class of common with superior voting rights traded at a significant discount relative to the class of common with inferior voting rights. The analysis suggests that there are both benefits and costs of corporate control.

The mean return computational method has a substantial effect on the estimated small firm premium. The buy-and-hold method, which best mimics actual investment experience, produces an estimated small-firm premium only one-half as large as the arithmetic and re-balanced methods which are often used in empirical studies. Similar biases can be expected in mean returns when securities are classified by any variable related to trading volume.