Corporate Real Estate and Stock Market Performance

An interesting question in corporate real estate literature is whether real estate can improve the stock market performance of property-intensive non-real estate firms. Using a data set comprising 75 non-real estate corporations that own at least 20 percent properties, this paper empirically assesses and compares the pair-wise return, total risk, systematic risk and Jensen abnormal return performance of composite (with real estate) and hypothetical business (without real estate) firms. We employed Morgan Stanley Capital International world equity index instead of a local market index to provide some insights into the performance of the local market relative to the global market during the 1997–2001 volatile periods experienced by many Asian countries. Our results suggest the inclusion of real estate in a corporate portfolio appears to be associated with lower return, higher total risk, higher systematic risk and poorer abnormal return performance. It is therefore likely that non-real estate firms own properties for other reasons in addition to seeking improvement in their stock market performance. Further research is needed to explore the main factors contributing to corporate real estate ownership by non-real estate firms.     

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with windows of opportunity arguments since they suggest that SEOs are timed to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.     

Optimal Consumption Taxes and Social Security Under Tax Measurement Problems and Uncertainty

A representative individual lives for two periods; works when young and depends on savings and a government operated social security system when old—the returns on both sources of income, when old, are random. Due to administrative problems the returns to savings are observed with some measurement error. Two alternative consumption tax systems are considered; the Registered Asset Treatment (RAT) and the Non-Registered Asset Treatment (NRAT). The advantage of the RAT is that it can perform a social insurance role while the disadvantage is that it imposes measurement error risk. Correlation between the random return on saving and its measurement error can provide a risk-hedging role that can be further strengthened by the RAT version. The NRAT version neither provides social insurance nor imposes measurement error risk. Both tax systems hedge against the uncertainties in the social security system. The taxpayer engages in precautionary saving in response to future uncertainty.     

Detection of Financial Time Series Turning Points: A New CUSUM Approach Applied to IPO Cycles

This paper presents a new Cumulative Sum approach for the detection of turning points in financial time series that are subject to cyclical mean level and volatility regime shifts. The new CUSUM approach is applied to the problem of detecting turning points in hot issue markets for Initial Public Offerings (IPOs), thus providing a multi-dimensional characterization of states of the IPO cycle.     

Dual VATs and Cross-Border Trade: Two Problems, One Solution?

In recent years, two distinct but related questions have been raised with respect to value-added taxes (VATs). Concern has been expressed over whether it is desirable or even possible for both national and subnational governments in federal countries such as India, Argentina, and Russia to impose VATs. One reason for thinking that such subnational VATs are unlikely to be workable on a destination basis is the problem of cross-border trade. Of course, this same problem also arises within the European Union, where there is no EU VAT. Drawing upon Canadian experience, we argue that not only is it possible to have two-tier or dual VATs on a destination basis in a single country but that the existence of dual VATs may help deal with some of the problems of cross-border trade.     

Contracts for the sale of residential real estate

I propose a model where the terms of a real estate broker's contract influence both the broker's and theseller's choices. Given equal contract, higher quality, and thus higher priced on average, houses will sell in less time. Thus, simple conditions suffice to show that a competitively set commission rate should fall as the average price rises and, since a seller's cost of waiting are higher for higher quality houses, a cartel's commission rate should rise with the average price. Because this model studies the effects of alternate contracts on observable variables such as the price of a house and its time-till-sale, its implications are testable.     

The impact of settlement period on sales price

This study is an empirical investigation of the impact of settlement period on sales price while controlling for marketing period and standard explanatory variables. The hypothesized positive relationship between settlement period and sales price is confirmed by the results of this study. The estimated coefficient on settlement period is 0.0008 meaning that our market, on average, exacts a premium of 0.08 percent per day of settlement period beyond a norm of 60 days. The estimated coefficient on marketing period (a control variable) is –0.0003 meaning that our market, on average, requires a discount of 0.03 percent per day of marketing period. Our findings show the relative importance of settlement period in making real estate pricing decisions.     

Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting

We consider a setting where a firm delegates an investment decision and, subsequently, a sales decision to a privately informed manager. For both decisions corporate income taxes have real effects. We show that compensating the manager based on pre-tax residual income can ensure after-tax NPV-maximization (goal congruence) for each decision problem in isolation. However, this metric fails if both decisions are nontrivial, since it requires asset-specific hurdle rates and hence precludes asset aggregation. After-tax residual income metrics (e.g., EVA) allow the firm to consistently apply its after-tax cost of capital as the hurdle rate to its aggregate asset base. We show that existing tax depreciation schedules may explain why firms in practice use more accelerated depreciation schedules than those suggested by previous studies. Our findings also rationalize the widespread use of dirty surplus accounting for windfall gains and losses for managerial retention purposes.     

A Test of the Signaling Value of IPO Underpricing with REIT IPO-SEO Pairs

The asymmetric information hypothesis states that IPO underpricing signals superior firm value. During the post-IPO period, the market learns the firms true worth such that good quality firms issue seasoned equity at favorable prices and recoup the loss sustained at IPO. Since REITs have no special incentive to issue debt because of their tax-exempt status, and since they must pay out 95 percent of net income as dividends, REIT managers are hard pressed to raise capital through seasoned equity. Consequently, the signaling link between IPOs and SEOs is critical for REITs. Consistent with the signaling model, we find strong evidence that (1) REITs that underprice IPOs more are likely to sell seasoned equity sooner, (2) higher IPO underpricing results in larger joint amount of capital raised through an IPO-SEO pair, and (3) firms that underprice IPOs underprice SEOs as well. IPO underpricing does not mitigate the valuation loss associated with seasoned offerings, however.     

“Investor sentiment” and the closed-end fund puzzle: A 7 percent solution

Lee, Shleifer, and Thaler (1991) argue that the irrational noise trader model of DeLong, Shleifer, Summers, and Waldmann (1990) ... is consistent with the published evidence on closed-end fund prices. ... However, Lee, Shleifer, and Thaler provide no indication of how much of the variability of a closed-end fund's discounts and premiums is due to such investor sentiment. Using the signal extraction technique of French and Roll (1986) to measure noise, this article estimates that on average only 7 percent of the variance of a standardized measure of weekly changes in discounts and premiums can be attributed to noise-trading activity. Investor sentiment, therefore, seems to account for very little of a closed-end fund's discount and premium variability over time.     

The “Rent-To-Own” mortgage and prepayment risk

The most important risk factor in the mortgage and mortgage-backed security market has been prepayment risk. Various innovations have arisen to deal with it but none hedge it fully. The Rent-To-Own (RTO) mortgage discussed here is a mortgage instrument that reduces or even reverses prepayment risk. It does so by creating an incentive structure within the framework of the mortgage contract that penalizes prepayment when interest rates are low and rewards it when interest rates are high. This is the opposite of standard mortgages. The RTO incentive structure is based on a unique buyout feature. Borrowers who want to buy out the financial interest of the lender may do so whenever they want, but the buyout price is a negative function of the market interest rates prevailing currently, that is, at the time of the buyout. Hence the lower these rates, the higher the buyout price. Other advantages of the RTO mortgage are also described.     

Information Monopoly and Commitment in Intermediary-Firm Relationships

A bank may use the private information that it acquires through monitoring to hold up borrowers. This information monopoly of the bank may inefficiently distort the borrowers investment decisions in environments where moral hazard is prevalent. The paper analyses how this problem is resolved within bank-firm relationships. In the benchmark case when the bank can contractually commit to future actions, the optimal contract turns out to be ambiguous in nature. When commitment contracts cannot be written, firms have an incentive to develop multiple banking relationships in order to decrease the inside banks bargaining power. However, with costly monitoring, this may defeat the initial purpose for contracting with a financial intermediary, namely information production. The paper argues that when contractual commitment is not feasible, bank size may serve as an alternative commitment device that prevents the bank from holding up borrowers in the future.     

On Transitory Earnings

The paper develops a concept of transitory earnings and contrasts this source of earnings to core (or recurring) earnings. It is shown that any two of the following three attributes of transitory earnings imply the third: (i) forecasting irrelevance with respect to next-period aggregate earnings, (ii) value irrelevance, and (iii) unpredictability. The paper makes the case that the current dirty surplus items make sense, especially if one expands the valuation perspective to also allow for agency considerations.     

Coping with Technological Change: The Case of Retail

Functional obsolescence in real estate occurs because of technological change. A theoretical model suggests that the early years of building life are characterized by functional obsolescence that is undiminished by reinvestment (cures in appraisal terminology). Later, observable functional obsolescence is eliminated by cures. A national, proprietary data set consisting of department store sales is utilized to test these propositions. The test is structured within a hedonic model in which the effect of age represents functional obsolescence and technological change, while other variables control for physical condition and location quality. The empirical results do not permit the rejection of the hypotheses developed from the theory. The measured rate of techological change in retail real estate is 1.7 percent per annum.     

The Information Content of Bank Examinations

We identify three types of information from bank examinations—auditing information from verifying the honesty and accuracy of the bank's books, regulatory discipline information about the treatment of the bank by regulators, and private information about bank condition. We estimate these information effects by comparing the cumulative abnormal market returns associated with examinations in which the CAMEL rating remained unchanged, improved, and worsened. All three information effects are found to be greater for banks entering the examination process with unsatisfactory ratings from prior examinations. The only consistently strong effect found is that examination downgrades appear to reveal unfavorable private information about bank condition. The evidence also suggests that the information may reach the market in part through loan quality data released in quarterly financial statements.     

Diversified Portfolios in Continuous Time

We study a financial market containing an infinite number of assets, where each asset price is driven by an idiosyncratic random source as well as by a systematic noise term. Introducing asymptotic assets which correspond to certain infinitely well diversified portfolios we study absence of (asymptotic) arbitrage, and in this context we obtain continuous time extensions of atemporal APT results. We also study completeness and derivative pricing, showing that the possibility of forming infinitely well diversified portfolios has the property of completing the market. It also turns out that models where the all risk is of diffusion type are qualitatively quite different from models where one risk is of diffusion type and the other is of Poisson type. We also present a simple martingale based theory for absence of asymptotic arbitrage.     

Explaining intercity home price differences

This paper develops and tests an equilibrium model seeking to explain intercity variation in owner-occupied housing prices. Empirical tests with a reduced form equation using aggregated 1980 data on 94 SMSAs suggest explanation for 84% of this intercity home price variation. Intercity housing demand, based upon homeowner quality of life equilibrium, is successfully represented by the non-monetary income determinant of climate mildness in addition to several monetary income determinants that reflect household residual after-tax real income. Intercity housing supply was found to be influenced by intercity variation in construction costs and limitations upon the available supply of undeveloped urban land.     

On the Economics of Subprime Lending

US mortgage markets have evolved radically in recent years. An important part of the change has been the rise of the subprime market, characterized by loans with high default rates, dominance by specialized subprime lenders rather than full-service lenders, and little coverage by the secondary mortgage market. In this paper, we examine these and other stylized facts with standard tools used by financial economists to describe market structure in other contexts. We use three models to examine market structure: an option-based approach to mortgage pricing in which we argue that subprime options are different from prime options, causing different contracts and prices; and two models based on asymmetric information–one with asymmetry between borrowers and lenders, and one with the asymmetry between lenders and the secondary market. In both of the asymmetric-information models, investors set up incentives for borrowers or loan sellers to reveal information, primarily through costs of rejection.     

Conduit Entities: Implications of Indirect Tax-Efficient Financing Structures for Real Investment

As well known, companies shift income from high to low tax jurisdictions. Typically, profit shifting is achieved by direct financing structures whereby companies use debt finance in the high tax entity and equity finance in the low tax entity. However, certain tax policies can lead to indirect financing structures whereby a conduit entity provides an opportunity to achieve at least two deductions for interest expenses for an investment made in the host country. The effect of direct and indirect financing structures on real investment is compared.     

Supervisor and Market Analysts: What Should Research be Seeking?

This article is primarily directed towards examining the desirability of incorporating market signals in the process of supervision of commercial banks by regulators and insurers. But the ideas developed here can also be applied to the general problem of using market information to assess the solvency and safety of any financial or non-financial institution.Market prices and yields of securities anticipate actions by regulators, central banks, and other players due to the fact that such actions may materially influence the risk and the expected return associated with investment decisions pertaining to those securities. It is well known that the yield curve of government securities such as T-bills, T-notes and T-bonds reflect the market's consensus regarding the actions that the Federal reserve may take as they pertain to the valuation of such securities. The extent to which the market has already discounted the future actions of the central bank will no doubt play a role in the way in which the central bank may think about its actions, its actual effect and how it relates to its intended effects.The extent to which market prices can provide useful guides depends on the underlying market structure and the practices in the industry.While markets may do lot of the hard work in aggregating and incorporating future actions, the task of supervision and regulation can never be put on automatic pilot. Ideally, supervisory policies should effectively combine the market signals with initiatives that serve to maintain the safety and the soundness of the underlying markets. I will begin by exploring the extent to which equity prices may be used as a signal of bank credit risk. I will then explore the advantages and disadvantages of using subordinated debt securities to derive a market signal.