Knowledge that Transforms

This paper uses new data on the holdings of 769 tax-exempt (predominantly pension) funds, to evaluate the potential effect of their trading on stock prices. We address two aspects of trading by these money managers: herding, which refers to buying (selling) simultaneously the same stocks as other managers buy (sell), and positive-feedback trading, which refers to buying past winners and selling past losers. These two aspects of trading are commonly a part of the argument that institutions destabilize stock prices. The evidence suggests that pension managers do not strongly pursue these potentially destabilizing practices.

This study investigates the returns to acquiring-firm stockholders in federally assisted mergers in the savings and loan industry. It is unique in that (a) these mergers are arranged and subsidized by government regulators and (b) they occur in a single industry, one plagued by well-publicized financial difficulties. The contribution of resources by the federal government creates the possibility of wealth transfers from the government to owners of the acquiring firms. We find, consistent with the oversubsidization hypothesis, that shareholders of acquiring firms earn significant positive returns.

We examine post-acquisition performance for the 50 largest U.S. mergers between 1979 and mid-1984. Merged firms show significant improvements in asset productivity relative to their industries, leading to higher operating cash flow returns. This performance improvement is particularly strong for firms with highly overlapping businesses. Mergers do not lead to cuts in long-term capital and R&D investments. There is a strong positive relation between postmerger increases in operating cash flows and abnormal stock returns at merger announcements, indicating that expectations of economic improvements underlie the equity revaluations of the merging firms.

This paper reexamines existing evidence regarding the monotonicity of the term premium. Using a recently developed approach for testing inequality constraints, we propose and conduct tests for whether the term premium is monotonic and reach different conclusions from those implied by individual t-statistics on term premiums (even under a Bonferroni-type adjustment). Our results generally support McCulloch's (1987) view that the liquidity preference hypothesis remains unrefuted.

Examining 128 tender offer bids made from 1980 through 1987, we categorize outside directors as either independent of or having some affiliation with managers, and find that bidding firms on which independent outside directors hold at least 50% of the seats have significantly higher announcement-date abnormal returns than other bidders. However, the relationship between bidding firms' abnormal stock returns and the proportion of board seats held by independent outside directors is nonlinear, suggesting it is possible to have too many independent outside directors. All results are lost if the traditional inside-outside board classification method is used.

With grouping, a sample is sorted by an observable variable and the mean values of the dependent variable in the extreme-ranked groups are compared. We show that test power is maximized when the two extreme groups each contain 27% of the sample, a much larger percentage than that typically used in the literature. This result is not sensitive to the distribution of the dependent variable. We also show that regression is unambiguously more powerful than grouping, even when the independent variable is measured with error.

Most models of market volatility use either past returns or ex post volatility to forecast volatility. In this paper, the dynamic behavior of market volatility is assessed by forecasting the volatility implied in the transaction prices of Standard & Poor's 100 index options. We test and reject the hypothesis that volatility changes are unpredictable. However, while our statistical model delivers precise forecasts, abnormal returns are not possible in a trading strategy (based on daily out-of-sample volatility projections) which takes transaction costs into account, suggesting that predictable time-varying volatility is consistent with market efficiency.

We examine employee stock ownership plan (ESOP) announcements to study the effects of an increase in managerial voting rights without a proportional increase in the ownership of cash flow claims. Our finding that when managers initially control few votes firm value increases with the fraction of shares contributed to the ESOP supports the view that managerial vote control serves shareholder interests. Conversely, the decrease in firm value with larger contributions to the ESOP when managers initially control many votes reflects a divergence of incentives that increases the agency problems between managers and outside shareholders.