Knowledge that Transforms

Abstract We compile a comprehensive international dividend and capital gains tax data set to study tax-based explanations of corporate payout for a panel of 6,035 firms from 25 countries for the period 1990–2008. We find robust evidence that the tax penalty on dividends versus capital gains corresponds closely with firms’ propensity to pay dividends and repurchase shares, and with the amount of dividends and shares repurchased. Our coefficient estimates suggest a smaller tax effect than reported in recent single-country, single-event studies. Instead, our results correspond more closely with historic long-term estimates of the elasticity of dividends.

Abstract Asymmetric information models suggest that a borrower’s choice of debt maturity depends on its private information about its default probabilities, that is, borrowers with favorable information prefer short-term debt while those with unfavorable information prefer long-term debt. We test this implication by tracing the evolution of debt issuers’ default risk following debt issuances. We find that short-term debt issuance leads to a decline inborrowers’ asset volatility and an increase in their distance to default. The opposite is true for long-term debt issues. The results suggest that borrowers’ private information about their default risk is an important determinant of their debt maturity choices.

Abstract The large deviation of the actual return of a leveraged exchange-traded fund (LETF) from the leveraged multiple of the underlying index return has drawn considerable attention from investors, regulators, and the financial media. Despite this attention, the sources and fundamental determinants of the LETF return deviation remain unidentified. This study constructs a clear, unified, objective, and executable framework that addresses the behaviors, sources, and determinants of the LETF compounding and noncompounding deviations. Our theoretical predictions and empirical results hold the promise of guiding investors, regulators, financial advisors, and portfolio managers toward a thorough understanding of the return behavior of LETFs.

Abstract We consider whether sentiment affects the profitability of momentum strategies. We hypothesize that news that contradicts investors’ sentiment causes cognitive dissonance, slowing the diffusion of such news. Thus, losers (winners) become underpriced under optimism (pessimism). Short-selling constraints may impede arbitraging of losers and thus strengthen momentum during optimistic periods. Supporting this notion, we empirically show that momentum profits arise only under optimism. An analysis of net order flows from small and large trades indicates that small investors are slow to sell losers during optimistic periods. Momentum-based hedge portfolios formed during optimistic periods experience long-run reversals.

Abstract In this paper, we document that an application of a moving average timing strategy of technical analysis to portfolios sorted by volatility generates investment timing portfolios that substantially outperform the buy-and-hold strategy. For high-volatility portfolios, the abnormal returns, relative to the capital asset pricing model (CAPM) and the Fama-French 3-factor models, are of great economic significance, and are greater than those from the well-known momentum strategy. Moreover, they cannot be explained by market timing ability, investor sentiment, default, and liquidity risks. Similar results also hold if the portfolios are sorted based on other proxies of information uncertainty.

Abstract We use UK data to show that firms that sponsor a defined-benefit pension plan are less likely to be targeted in an acquisition and, conditional on an attempted takeover, they are less likely to be acquired. Our explanation is that the uncertainty in the value of pension liabilities is a source of risk for acquirers of the firm's shares, which works as a takeover deterrent. In support of this explanation we find that these same firms are more likely to use cash when acquiring other firms, and that the announcement of a cash acquisition is associated with positive announcement effects.

Abstract We classify a unique and comprehensive data set of corporate press releases into topics and study the market reaction to various types of news. While confirming prior findings regarding strong stock price responses to financial news, we also document significant reactions to news about corporate strategy, customers and partners, products and services, management changes, and legal developments. Consistent with regulators' expectations, the level of informational asymmetry in the market declines following most types of press releases. At the same time, return volatility frequently increases in the post-announcement period, which we show can be attributed to higher levels of valuation uncertainty.

Abstract We examine the relation between the shareholder base and payout policy. Consistent with the idea that the shareholder base is related to the cost of external financing, we find that firms with small shareholder bases have lower payout levels and maintain higher cash holdings. We show that undertaking an open market repurchase results in a significant reduction in the size of the shareholder base. Consequently, we find that firms with small shareholder bases are less likely to undertake a repurchase (reduce the shareholder base even further) and are more likely to pay special dividends.

Abstract We examine the 2007 stock market bubble in China. Using multiple measures of bubble intensity for each stock, we find significantly smaller bubbles in stocks for which there is greater analyst coverage. We further show that the abating effect of analyst coverage on bubble intensity is weaker when there is greater disagreement among analysts. This suggests that, in line with resale option theories of bubbles, one channel through which analyst coverage may mitigate bubbles is by coordinating investors’ beliefs and thus reducing its dispersion. Stock turnover provides further evidence consistent with this particular information mechanism.

Abstract Stock market average returns and Sharpe ratios are significantly higher on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. The average announcement-day excess return from 1958 to 2009 is 11.4 basis points (bp) versus 1.1 bp for all the other days, suggesting that over 60% of the cumulative annual equity risk premium is earned on announcement days. The Sharpe ratio is 10 times higher. In contrast, the risk-free rate is detectably lower on announcement days, consistent with a precautionary saving motive. Our results demonstrate a trade-off between macroeconomic risk and asset returns, and provide an estimate of the premium investors demand to bear this risk.