Knowledge that Transforms

A number of authors have found that firm size and book-to-market-value capture the cross-sectional variation in average stock returns. More importantly, these variables have been shown to out-perform the CAPM's β coefficient in explaining the cross-section of US stock returns. However, these studies all employ variants of the two-step estimator due to Fama and MacBeth (Fama, E.F., MacBeth, J.D., 1973. Risk, return and equilibrium: Empirical tests. Journal of Political Economy 71, 607–636), which impose implicitly the restriction that idiosyncratic returns are uncorrelated. In this paper we use a one-step estimator due to McElroy et al. (McElroy, M.B., Burmeister, E., Wall, K.D., 1985. Two estimators for the APT model when factors are measured. Economics Letters 19, 271–275) and find a highly significant role for β risk in the UK stock market when we allow for correlation amongst idiosyncratic returns.

We provide evidence on the costs and profitability of relationship lending by banks. We derive bank-specific measures of loan rate smoothing for small business borrowers in response to exogenous shocks to their credit risk and to interest rates, and then estimate cost and profit functions to examine how smoothing affects bank costs and profits. Our results suggests that, in general, loan rate smoothing in response to a credit risk shock is not part of an optimal long-term contract between a bank and its borrower, while loan rate smoothing in response to an interest-rate shock is.

This paper measures the impact of option introductions on the return variance of underlying stocks. Past research generally finds a significant reduction in stock return variance following the listing of options through 1986. Using a more extensive sample, I compare changes in the return variance of optioned stocks to changes in the return variance of a control group. Since the average change in the control group is statistically indistinguishable from the average change in the optioned stocks, I conclude that option introductions do not significantly affect stock return variance.

We investigate the abnormal returns and market-based risk effects of four Federal Reserve Board decisions to allow bank holding companies to engage in investment banking through Section 20 subsidiaries. Positive abnormal returns for commercial banks were observed for initial, limited powers granted by the Federal Reserve. However, authorization to engage in underwriting corporate debt and equity and subsequent expansion of potential revenues from underwritings produced negative abnormal returns and increases in risk.

Within the past few years, public efforts have sought to encourage individual, or “angel”, investors. This article provides an overview of the motivations for these efforts. It assesses the underlying challenges that the financing of young growth firms pose, the ways that specialized financial intermediaries address them, and the rationales for public efforts to encourage angel investors. The final section raises a set of questions about the practical implementation of these efforts.

The widespread Italian practice of multiple borrowing has been studied with respect to the continuity of bank lending and to the interest rates charged to individual borrowers. However, there is a lack of empirical evidence on the effects of multiple credit relationships over the fragility of the corporate borrowers. Two theses are competing: one asserts that multiple borrowing results in a desirable sharing of risks; the other, that the parcellization of loans substantially weakens the discipline exercised by the banks and makes corporate borrowers more fragile. Through multivariate techniques, we check whether the indicators describing the structure of lending relationships can help, along with balance-sheet variables, to separate healthy from failed firms. This exercise shows that multiple banking relationships are associated with a higher riskiness of the borrowers, even though the impact is moderate in comparison with the importance of real and financial variables derived from balance sheets.

We empirically document a strategy through which corporations avoid state income taxes. Examining aggregated American state and Canadian provincial data from 1983–1991, we find corporate income tax revenues are concave in corporate tax rates, consistent with firms shifting their tax bases to more favourably taxed jurisdictions. Additional tests exploit unique features of state formula apportionment systems and find manufacturing shipments from states that tax outside their borders (throwback states) are decreasing in corporate income tax rates on sales.

We investigate whether banks with low capital ratios use accounting accruals for capital ratio management. We focus on a time where we expect a change in bank managers behavior regarding certain accruals. In 1989 regulatory changes created (removed) incentives to depress loan loss provisions (write-offs) after (before) 1989. Our results show that banks with low capital ratios reduced their loan loss provisions and increased write-offs during the 1990–1992 period compared to the 1985–1988 period. Banks with high capital ratios exhibited no difference in loss provisions, but did significantly increase loan write-offs during 1990–92.