Knowledge that Transforms

Returns computed with closing bid or ask prices that may not represent ‘true’ prices introduce measurement error into portfolio returns if investor buying and selling display systematic patterns. This paper finds systematic tendencies for closing prices to be recorded at the bid in December and at the ask in early January. After changing bid and ask prices are controlled for. this pattern results in large portfolio returns on the two trading days surrounding the end of the year, especially for low-price stocks. Other temporal return patterns (e.g. weekend and holiday effects) are also related to systematic trading patterns.

Recent evidence reveals significant negative serial correlation in aggregate (market-wide) stock returns. We extend this result to relative (market-adjusted) returns, demonstrating negative serial correlation in five-year returns. We then test two competing explanations: (1) market mispricing and (2) changing expected returns in an efficient market. The tests are conducted using the capital asset pricing model to estimate relative returns. The evidence suggests that negative serial correlation in relative returns is due almost entirely to variation in relative risks, and therefore expected relative returns, through time. We document substantial relative risk shifts, particularly for extreme-performing stocks.

Cash tender, cash merger, and stock merger takeover premiums for 1974–1985 are approximately bouble those for 1963–1973. Cash tender repurchase premiums also rose in 1974. Thse upward shifts remain after we control for the business cycle and a possible time trend in premiums. The shift in both takeover and repurchase premiums in 1973–1974 is consistent with some event not unique to the takeover market affecting the capital markets in 1973–1974. We also investigate the possible effect on takeover premiums of the 1986 Williams Act and conclude that it does not explain the premium increase.

Discount dividend-reinvestment and stock-purchase plans allow shareholders to capture part of the underwriting fees incurred in new stock offerings and save sponsoring firms some of the usual underwriting costs. We tested the degree to which individual investors can profitably serve this investment banking function by implementing simple investment/trading strategies designed to capture the discounts and distribute the shares in the market. The large profits earned by our strategies raise serious questions about why it takes firms so long to raise the target level of capital and why many eligible shareholders do not participate in these discount plans.

Unique data availability and institutional arrangements for new issues in Singapore allow a direct test of the empirical implications of Rock's model of pricing unseasoned new issues. Our empirical results are consistent with the model. Specifically we find that the unseasoned new issues' anomaly disappears when the rationing associated with new issues is incorporated into the analysis. The winner's curse is evident in allocation patterns used in Singapore.

The paper provides evidence that tax attributes of target firms are significant in explaining the abnormal returns to shareholders of both target and acquiring firms following acquisition announcements. The most prominent tax attribute in tax-free acquisitions is the amount of net operating loss carryforwards and tax credits due to expire. The most important tax attribute in taxable acquisitions is the step-up in the acquired assets' basis. The findings also suggest that tax considerations motivate acquisitions. Specifically, obtaining tax-free status for the proposed acquisition increases its likelihood of completion.

We derive and test an alternative closed-form general equilibrium model of the term structure within the Cox, Ingersoll, and Ross theoretical framework in which yields are nonlinear functions of the risk-free rate. We show that equilibrium bond prices and the risk-free rate are not always inversely related and that bond risk need not be strictly increasing in maturity. Using Hansen's generalized method of moments to obtain parameter estimates, this nonlinear model outperforms the Cox, Ingersoll, and Ross square root model in describing actual Treasury bill yields for the 1964–1986 period.

We document managers' vote holdings in a large random sample of industrial firms, and test whether the degree of managerial control of shares affects how often a firm is the target of control events. The likelihood of successful acquisitions of firms is unrelated to managers' holdings. But this insignificant relation reflects two opposing effects. Lower managerial control is associated with a higher probability that a firm will receive a takeover offer, but a lower probability that a takeover attempt will lead to a change in control.

We examine a variety of models in which the variance of a portfolio's excess return depends on a state variable generated by a first-order Markov process. A model in which the state is known to economic agents is estimated. It suggests that the mean excess return moves inversely with the level of risk. We then estimate a model in which agents are uncertain of the state. The estimates indicate that agents are consistently surprised by high-variance periods, so there is a negative correlation between movements in volatility and in excess returns.

We investigate how investment bankers use indications of interest from their client investors to price and allocate new issues. We model the process as an auction constructed to induce asymmetrically informed investors to reveal what they know to the underwriter. The analysis yields a number of empirical implications, including that new issues will be underpriced and that distributional priority will be given to an underwriter's regular investors. We also find that tension between an underwriter's propensity to presell an issue and an issuing firm's desire to obtain maximum proceeds affects the type of underwriting contract chosen.