Knowledge that Transforms

This study examines the variance of returns on common stocks around the time exchange-traded options are listed on these stocks. The evidence indicates that stock return variance declines after options listing, and that this phenomenon is not fully explained by contemporaneous shifts in market volatility. In addition, stock market trading volume increases, on average, after options are listed on firms' stocks. I examine the hypothesis that the variance changes are related to changes in ‘trading noise” in the stock, but find little direct support for this explanation.

In 1970, France introduced disclosure rules governing public tender offers without changing an existing four-week minimum offer period. We document a substantial increase in total offer premiums thereafter. Post-1970 premiums are also significantly higher in public than in private tender offers, where information disclosure is not required, and in all-cash than in all-stock offers. The impact of the payment method is evident in minority buyouts as well as in offers for voting control. The component of the total premium reflecting the value of the option to tender appears to be unaffected by either disclosure regulations or the payment method.

We provide an explanation of why convertibles are called long after the conversion value exceeds the call price. Delaying the call benefits the firm if enough investors are expected to delay their voluntary conversions. Consistent with this theory, we document that a substantial number of investors do not voluntarily convert when the common dividend exceeds the convertible's dividend plus its premium over conversion value. We find that firms would not have increased common stock returns by switching to the strategy of calling to force conversion as soon as possible. Surprisingly, we find that convertible preferreds frequently sell below conversion value.

Researchers investigating the possibility of mean reversion in stock prices with statistics based on multiyear returns have noted difficulties in drawing inferences from these statistics because the approximating asymptotic distributions perform poorly. We develop an alternative asymptotic distribution theory for statistics involving multiyear returns. These distributions differ markedly from those implied by the conventional theory. The alternative theory provides substantially better approximations to the relevant finite-sample distributions. It also leads to empirical inferences much less at odds with the hypothesis of no mean reversion.

This paper proposes tests of asset pricing models that allow for time variation in conditional covariances. The evidence indicates that the conditional covariances do change through time. Estimates of the expected excess return on the market divided by the variance of the market (reward-to-risk ratio) are presented for the Sharpe-Lintner CAPM, as well as a number of tests of the model specification. The patterns of the pricing errors through time suggest the model's inability to capture the dynamic behavior of assets returns.

This paper examines the effects of over 1,800 U.K. takeovers on shareholder wealth in the period 1955–1985. It shows that around the merger announcement date targets gain 25 to 30 percent and bidders earn zero or modest gains. The U.K. data allow independent tests of many issues addressed in studies of U.S. takeovers. Target gains are higher in the U.K. after 1968, suggesting that increases in U.S. target gains at the same time may not be attributable to the Williams Act. Postmerger share-price performance suggests that acquisitions follow favorable developments in bidder's equity prices.

We demonstrate that analysts revise their forecasts of net operating income downward following the announcement of an equity-for-debt swap. Their revisions are positively correlated with the size of the stock-price reaction to the swap announcement. This evidence supports the hypothesis that announcements of equity-for-debt swaps convey information about the expected level of cash flows of the firm. We also provide evidence that this information is about transitory changes in the expected cash flows.

We examine the rationality of investor exercise behavior by analyzing two years' tendered exercise notices for Treasury bond futures options. We conclude that exercise behavior is generally rational, but document numerous failures to exercise as well as some exercises that should not have occured, both at and prior to expiration. The most frequent type of error is failing to exercise, suggesting that traders do not monitor their positions with sufficient care. Finally, we show that investors use information arriving after trading closes, but before exchange-imposed exercise deadlines, in forming their exercise decisions.

Latent variable tests of asset pricing models make assumptions about the joint distribution of observable returns and unobservable benchmark returns. These tests can falsely accept models when a mean-variance efficient portfolio other than the benchmark satisfies the distributional assumptions imposed on the benchmark portfolio. Also, because the assumptions are untestable, there is no way to discover whether a model is being rejected because the assumptions are false. Without these assumptions, however, latent variable tests can be viewed only as tests of distributional hypotheses about mean-variance efficient portfolios of unknown composition.

I analyze the acquisition of Federated Department Stores by Campeau Corporation and find that after the purchase the value of Federated assets increased by more than 1.8 billion. Federated and Campeau defaulted on the debt used to finance the acquisition because Campeau paid a premium of 3.4 billion for Federated, an overpayment of $1.6 billion, financed 97% of the purchase with debt, and did not have enough other assets to make up the shortfall. The Federated purchase illustrates that a highly leveraged transaction can increase value, but still not be able to make its debt payments.