Issuers’ incentives and tests of Baron’s model of IPO underpricing

This paper reexamines the validity of Baron’s (J Financ 37:955–976, 1982) model of IPO underpricing, in which IPO underpricing is caused by asymmetric information between issuers and investment bankers. Muscarella and Vetsuypens (J Financ Econ 24:125–135, 1989) find that lead-manager IPOs are significantly more underpriced than non-self-marketed IPOs and conclude that their empirical results do not support Baron’s model. We compare self-marketed underwriters’ IPOs with non-self-marketed underwriters’ IPOs and with IPOs they lead. Our empirical results show that it is premature to reject Baron’s model of IPO underpricing when we take issuer incentives into account.     

Banks, markets, and efficiency

A competitive financial system can help reduce banks’ monopoly power and the associated inefficiencies. However, according to Diamond (J Polit Econ 105: 928–956, 1997) and Fecht (J Eur Econ Assoc 6(2), 2004) competition with the financial sector may also constrain the amount of liquidity insurance that banks can provide to households affected by unobservable idiosyncratic liquidity shocks. To study this trade-off, we model competition between banks and between banks and financial markets. Our analysis shows that competition between banks and financial markets can constrain the risk-sharing offered by deposit contracts. This effect is the same if competition between banks mainly affects the reallocation of deposits. However, if banking competition primarily affects new deposits, then such competition only limits inefficient monopoly rents without restraining risk-sharing. We would like to thank Diemo Dietrich, Phil Dybvig, Hans Peter Grüner, Martin Hellwig, Elu von Thadden, Uwe Vollmer, Wolf Wagner as well as seminar participants at the Bundesbank, at the University of Mannheim, at the University of Tilburg, at the 3rd Workshop on Monetary and Financial Economics in Halle, at the University of Lausanne, at the First ProBanker Symposium in Maastricht, at the Global Finance Conference 2005 in Dublin, at the European Economic Association Meeting 2005 in Amsterdam, at the International Finance Conference 2005 in Copenhagen, and at the German Economic Association Meeting 2005 in Bonn. We thank Mike Demott for editorial assistance. The views expressed here are those of the authors and not necessarily those of the Deutsche Bundesbank, the Federal Reserve Bank of New York, or the Federal Reserve System.     

The political origin of pension funding

The paper seeks to explain the huge cross country variation in private pension funding, shaped by historical choice made when universal pension systems were created after the Great Depression. According to Perotti and von Thadden [Perotti, E., von Thadden, E.-L., 2006. The political economy of corporate control and labor rents. J. Polit. Econ., 145–175], large inflationary shocks due to war damage devastated middle class savings in some countries in the first half of the XX century. This shaped political preferences over the role of capital markets and social insurance, and contributed to the Great Reversals documented by Rajan and Zingales [Rajan, R.G., Zingales, L., 2003. The great reversals: The politics of financial development in the 20th century. J. Finan. Econ. 69 (1), 5–50]. Wealth distribution shocks are indeed strongly related to private pension funding, as a large shock reduces the stock of private retirement assets by 58% of GDP. While the sample size is limited, the results are robust to other explanations, such as legal origin, original financial development, past and current demographics, religion, electoral voting rules, redistributive politics, national experiences with financial market performance, or other major financial shocks that were not specifically redistributive. Corroborating evidence indicates that such redistributive shocks help explain the cross country variation in social expenditures, state ownership of industry, financial development and employment protection measures as predicted by the political shift hypothesis.     

Re-examining the investment-uncertainty relationship in a real options model

The main purpose of this paper is to re-examine the investment-uncertainty relationship in a real options model, and demonstrates that the Sarkar (J Econ Dyn Control 24:219–225, 2000) model is a special case of our model. This paper uses a general dynamic process, which incorporates mean reversion and jumps in a firm’s project earnings. We further derive a quasi-analytical form solution for the critical investment value and investment probability of a firm’s projects. From the simulation results, we find that an increase in uncertainty can always lead to an increase in the probability of investment, and thus has a positive impact on investment. These results, which differ from the findings of Sarkar (J Econ Dyn Control 24:219–225, 2000), could be explained by the mean-reversion and jump effects on a firm’s earnings.     

Base independence in the analysis of tax policy effects: with an application to Norway 1992–2004

The analysis contrasts results of two recently expounded microlevel data approaches to derive robust intertemporal characterizations of redistributional effects of income tax schedules; the fixed-income procedure of Kasten et al. (Tax progressivity and Income Inequality, Cambridge University Press, 1994) and the transplant-and-compare method of Dardanoni and Lambert (J. Public Econ. 86:99–122, 2002). Our study is normative in that the Blackorby and Donaldson (Can. J. Econ. 17:683–694, 1984) index of tax progressivity is employed. This enables contributions from vertical redistribution and horizontal inequity also to be assessed, using for the latter one classical measure and one no reranking measure. When the competing methodologies are applied to Norwegian data for 1992–2004, their respective strengths and weaknesses are revealed. The transplant-and-compare procedure is found to have a number of advantages.      

To what extent are investment bank-differentiating factors relevant for firms floating moderate-sized IPOs?

One explanation provided for the relatively high and increasingly stable spreads for moderate-sized IPOs ($20–$80 million) documented in Chen and Ritter (J Finance 55:1105–1131, 2000) is that issuing firms focus less on price and more on a combination of investment bank-differentiating factors (such as underwriter prestige, analyst coverage, industry expertise, under-pricing, price stabilization activities, liquidity provision, and so on), and banks use industry-based differentiation as a source of market power. Using a new approach developed in a model of firm location choice due to Ellison and Glaeser (J Politi Econ 105:889–927, 1997), this paper presents some evidence on the combined relevance of such bank-differentiating factors, over and above bank size, for firms choosing investment banks for floating IPOs. For moderate-sized IPOs, there is a little, but not much evidence that such factors are a good explanation for high and increasingly stable spreads. Other than in a few of the largest industries, bank-differentiating factors are not significantly relevant for a large proportion of industries. Moreover, one aggregate measure of differentiation is declining over time. We are grateful to Preston McAfee for suggesting this approach to the problem, to Jay Ritter for providing an updated list of IPOs, and to Robert Anderson and anonymous referees for very helpful comments. We are grateful to seminar audiences at the University of Texas at Austin and Macalester College for helpful comments.     

Dancing in the dark: post-trade anonymity,liquidity and informed trading

We analyze the impact of post-trade anonymity on liquidity and informed trading in an order driven stock market. The German stock market introduced the Central Counterparty (CCP) in March 2003 for German equities traded on its anonymous electronic trading platform Xetra leading to a major change in its existing transparency regime. Before the introduction trader IDs were revealed to the counterparties of a trade, with the introduction of the CCP even after the transaction the traders remain anonymous. Previous theoretical and empirical research documents that pre-trade anonymity results in increased liquidity, while results on post-trade anonymity are mixed. We find a significant increase in liquidity measured through a reduction of 25% in implicit transaction costs. We also document that the arrival rate of informed traders is reduced in the anonymous setting. Following recent findings of Bloomfield et al. (J Finan Econ 75:165–199, 2005) that informed traders take on the role of liquidity providers we interpret our findings as indication that informed traders change their behavior in providing liquidity more aggressively in an anonymous environment.     

Liquidity and market incompleteness

This note shows that according to Lippman and McCall’s (Am Econ Rev 76, 43–55, 1986) operational definition of liquidity, incomplete markets are a necessary condition for illiquidity. This note is a revised subset of a larger paper that circulated under the name of “Liquidity as an Insurance Problem” (Zurita 2001). I am grateful to Luis Ahumada, David K. Levine, Raimundo Soto, Gert Wagner, Federico Weinschelbaum and seminar participants at UCLA, Summer Meeting of the Econometric Society, Banco Central de Chile, LACEA, Jornadas de Economía del Banco Central del Uruguay, and ILADES, for their helpful comments, as well as the feedback of an anonymous referee. Financial support from Vicerrectoría Académica de la Pontificia Universidad Católica de Chile is gratefully acknowledged.     

Advertising intensity,investor recognition,and implied cost of capital

The main purpose of this paper is to test Merton’s (J Finance 42(3):483–510, 1987) hypothesis that better investor recognition is correlated with lower expected returns. We measure investor recognition with the firms’ advertising intensity and offer consistent evidence that higher advertising intensity is associated with lower implied cost of capital, as derived from Value Line target prices and dividend forecasts. Investor recognition plays an important role in attracting investors, improving liquidity, and ultimately reducing the cost of capital. The findings shed light on the capital market implications of advertising expenditures and complement the extant research on investor recognition.     

A Quarterly Transactions-based Index of Institutional Real Estate Investment Performance and Movements in Supply and Demand

This article presents a methodology for producing a quarterly transactions-based index (TBI) of property-level investment performance for U.S. institutional real estate. Indices are presented for investment periodic total returns and capital appreciation (or price-changes) for the major property types included in the NCREIF Property Index. These indices are based on transaction prices to avoid appraisal-based sources of index “smoothing” and lagging bias. In addition to producing variable-liquidity indices, this approach employs the Fisher-Gatzlaff-Geltner-Haurin (Real Estate Econ., 31: 269–303, 2003) methodology to produce separate indices tracking movements on the demand and supply sides of the investment market, including a “constant-liquidity” (demand side) index. Extensions of Bayesian noise filtering techniques developed by Gatzlaff and Geltner (Real Estate Finance, 15: 7–22, 1998) and Geltner and Goetzmann (J. Real Estate Finance Econ., 21: 5–21, 2000) are employed to allow development of quarterly frequency, market segment specific indices. The hedonic price model used in the indices is based on an extension of the Clapp and Giacotto (J. Am. Stat. Assoc., 87: 300–306, 1992) “assessed value method,” using a NCREIF-reported recent appraised value of each transacting property as the composite “hedonic” variable, thus allowing time-dummy coefficients to represent the difference each period between the (lagged) appraisals and the transaction prices. The index could also be used to produce a mass appraisal of the NCREIF property database each quarter, a byproduct of which would be the ability to provide transactions price based “automated valuation model” estimates of property value for each NCREIF property each quarter. Detailed results are available at .     

Liquidity and bank capital structure

Bank capital requirements reduce the probability of bank failure and help mitigate taxpayers’ sharing in the losses that result from bank failures. Under Basel III, direct capital requirements are supplemented with liquidity requirements. Our results suggest that liquidity provisions of banks are connected to bank capital and that changes in liquidity indirectly affect the capital structure of financial institutions. Liquidity appears to be another instrument for adjusting bank capital structure beyond just capital requirements. Consistent with Diamond and Rajan (2005), we find that liquidity and capital should be considered jointly for promoting financial stability.     

Do pennies matter? Investor relations consequences of small negative earnings surprises

Anecdotal and survey evidence suggest that managers take actions to avoid small negative earnings surprises because they fear disproportionate, negative stock-price effects. However, empirical research has failed to document an asymmetric pricing effect. We investigate investor relations costs as an alternative incentive for managers to avoid small negative earnings surprises. Guided by CFO survey evidence from Graham et al. (J Account Econ 40:3–73, 2005), we operationalize investor relations costs using conference call characteristics—call length, call tone, and earnings forecasting propensity around the conference call. We find an asymmetric increase (decrease) in call length (forecasting propensity) for firms that miss analyst expectations by 1 cent compared with changes in adjacent 1-cent intervals. We find no statistically significant evidence that call tone is asymmetrically more negative for firms that miss expectations by a penny. While these results provide some statistical evidence to confirm managerial claims documented in Graham et al. (J Account Econ 40:3–73, 2005) regarding the asymmetrically negative effects of missing expectations, our tests do not suggest severe economic effects.     

Are the Fama–French factors proxying news related to GDP growth? The Australian evidence

Inspired by Vassalou (J Financ Econ 68:47–73, 2003), we investigate the contention that the Fama and French (J Financ Econ 33:3–56, 1993) model’s ability to explain the cross sectional variation in equity returns is because the Fama–French factors are proxying for risk associated with future GDP growth in the Australian equities market. To assess the validity of Vassalou’s findings, we augment the CAPM and the Fama–French model with a GDP growth factor and run system regressions of the GDP-enhanced models using the GMM approach. Our results suggest that news about future GDP growth is not priced in equity returns and that any ability that SMB and HML exhibit in explaining equity returns is not because they contain information about future GDP growth.

Nonparametric Estimation of Households’ Duration of Residence from Panel Data

In this paper we present a method that estimates the total duration of permanency for residential households starting from the lengths of stay declared by families in a micro panel survey. Throughout this study Spanish data are taken from the European Household Panel established between 1994 and 2001. The inference is based on those households surveyed in 1994 and onwards, including those who moved into their 1994-current residence after 1979. The follow-up of the household is conducted until the house is vacated or the sample observed in (year 2001) is finalized. We distinguish amongst owners, renters, and rent-free occupants or squatters (others), since these groups of households are known to exhibit a different pattern regarding residence time. Our approach for estimation is purely non parametric. This is an interesting feature, since we show that the renewal processes which represent the households’ mobility have a non-constant rate over the period 1980–1994 for owners and rent-free occupants. This fact invalidates the method of inference based on the equilibrium equation proposed by Anily et al. J Bus Econ Stat 17:373–381, 1999) in order to estimate the lengths of stay in each household.     

A Theory of Bank Capital

Banks can create liquidity precisely because deposits are fragile and prone to runs. Increased uncertainty makes deposits excessively fragile, creating a role for outside bank capital. Greater bank capital reduces the probability of financial distress but also reduces liquidity creation. The quantity of capital influences the amount that banks can induce borrowers to pay. Optimal bank capital structure trades off effects on liquidity creation, costs of bank distress, and the ability to force borrower repayment. The model explains the decline in bank capital over the last two centuries. It identifies overlooked consequences of having regulatory capital requirements and deposit insurance.     

On the calibration of structural credit spread models

Empirical findings are mixed about the performance of structural models for term structure of credit spreads. It is commonly believed that all structural models have equally poor performance after calibration. However, proper calibration is not a trivial issue, especially for highly structural models. This paper proposes a more accurate procedure for calibrating two models: Leland–Toft (J Finance 51:987–1019, 1996) and Collin-Dufresne and Goldstein (J Finance 56:2177–2208, 2001). Using rating-based bond data, we find that the Leland–Toft model has significantly greater explanatory power for credit spreads across rating categories than previously reported. We provide theoretical explanations for these findings, and further extend our empirical analysis to include 286 individual senior bonds. Our findings help clarify the controversies over the performance of structural models in general and that of the Leland–Toft model in particular. In addition, we offer a rigorous procedure that can be used for calibrating other structural models more effectively.      

Does knowing the volatility states affect the market risk premium?

Mayfield (J Financ Econ 73:465–496, 2004) has devised a method for estimating the market risk premium, based on a variant of Merton’s ICAPM wherein volatility is specified as a two-state Markov process. In this study, we assess Mayfield’s key assumption that investors know the current volatility state with certainty, via empirical testing of the assumption of exogenous Markov-switching in Mayfield’s model. We detect strong evidence of endogenous switching. This indicates that investors infer the current volatility state, as opposed to simply observing it. We also find that the risk premium estimates are affected by the switching type.     

An evasive topic: theorizing about the hidden economy

This paper reviews some central issues that arise in theorizing about tax evasion decisions and the hidden economy. It starts from the Allingham and Sandmo (J. Public Econ. 1:323–338, 1972) modeling of the tax evasion decision as a choice under uncertainty based on expected utility maximization and risk aversion. It goes on to discuss alternative specifications of the taxpayer’s preferences with particular regard to the explanation of the extensive margin, i.e. the decision on whether or not to engage in tax evasion. It extends the model to the case of variable labor supply with work in both official and black labor markets. It then considers the application of the theory to taxes on wealth and income from capital, indirect tax evasion, and smuggling. It also includes a consideration of general equilibrium effects and of the problems that evasion causes for the theory of optimal income and commodity taxes. It concludes with a brief discussion of the implications of tax evasion for economic policy in the welfare state.     

Labor markets and capital tax competition

Ogawa et al. (J. Urban Econ. 60:350, 2006) analyze capital tax competition in a fixed-wage approach and show that the original results of Zodrow and Mieszkowski (J. Urban Econ. 19:356, 1986) are not preserved in the presence of unemployment. In the present paper, we challenge this view and investigate capital tax competition for some arbitrary institutional setting of the labor market. We find that if the labor market is characterized by some efficient bargaining solution, the results of Zodrow and Mieszkowski (J. Urban Econ. 19:356, 1986) are preserved.     

The impact of the new OHADA accounting system on the judgments and decisions of Cameroonian bankers

Cameroon and 15 other African States belonging to the Organization for the Harmonization of Business Law in Africa (OHADA) adopted the Uniform Act Organizing and Harmonizing Undertakings' Accounting Systems on March 23, 2000, which scuttled the OCAM accounting plan in favor of the new OHADA accounting system (SYSCOHADA). Companies were required to adopt SYSCOHADA for company accounts and consolidated accounts beginning on January 1, 2001, and January 1, 2002, respectively. The goal of this study is to compare the impact of the presentation format and informational content of both accounting systems on the judgments and decisions of bankers, and, more specifically, to find out whether the information contributed by SYSCOHADA has changed the judgments and decisions bankers made under the old OCAM accounting plan. To that effect, a field experiment was conducted with Cameroonian bankers using a within-subjects design. Significant differences were noted in bankers' underlying judgments (operating income, net income, cash flow, leverage, liquidity, and ability to raise capital) as well as in their initial judgments about profitability and financial structure. Conversely, no significant differences were noted with respect to other judgments and decisions, i.e. principal judgments about the overall risk rating and overall risk trend, the loan decision, and the interest rate to charge (risk premium). Further, the new statement of sources and applications of funds (SSAF) influenced their underlying judgments about operating income, leverage, liquidity, and ability to raise capital, as well as their initial judgments about financial structure.