The Stock Market and Corporate Investment: A Test of Catering Theory

We test a catering theory describing how stock market mispricingmight influence individual firms' investment decisions. We usediscretionary accruals as our proxy for mispricing. We finda positive relation between abnormal investment and discretionaryaccruals; that abnormal investment is more sensitive to discretionaryaccruals for firms with higher R&D intensity (opaque firms)or share turnover (firms with shorter shareholder horizons);that firms with high abnormal investment subsequently have lowstock returns; and that the larger the relative price premium,the stronger the abnormal return predictability. We show thatpatterns in abnormal returns are stronger for firms with higherR&D intensity or share turnover.     

State‐Level Business Cycles and Local Return Predictability

This study examines whether local stock returns vary with local business cycles in a predictable manner. We find that U.S. state portfolios earn higher future returns when state‐level unemployment rates are higher and housing collateral ratios are lower. During the 1978 to 2009 period, geography‐based trading strategies earn annualized risk‐adjusted returns of 5%. This abnormal performance reflects time‐varying systematic risks and local‐trading induced mispricing. Consistent with the mispricing explanation, the evidence of predictability is stronger among firms with low visibility and high local ownership. Nonlocal domestic and foreign investors arbitrage away the predictable patterns in local returns in 1 year.     

The Asset Growth Effect and Investor Protection in Emerging Markets: The Role of the Global Financial Crisis

The previous evidence shows that firms experience lower returns after a period with higher growth in assets. Two alternative explanations have been raised to explain this effect: mispricing and optimal investment. This study examines this effect in 26 emerging markets over the period of 2005–2013 with a special attention to the recent global financial crisis. We find a stronger asset growth effect during the crisis years relative to other years. This effect is stronger in firms with small or medium stock turnover ratio and firms operating in industries with low R&D intensity. We also investigate the heterogeneity across countries and find that a stronger asset growth effect during the crisis years exists only for emerging markets with low protection of shareholders and creditors. We argue that this evidence is in line with the mispricing hypothesis.     

Are carry,momentum and value still there in currencies?

We show that carry, momentum and value predictability in currencies is associated with mispricing. Specifically, investment performance disappears subsequent to published evidence showing portfolio returns are not fully explained by risk. Replicating these studies, we show that the average out-of-sample Sharpe ratio decreases from +0.39 to −0.32. Cross sectional tests show that currencies no longer respond to interest rate and real exchange rate differentials. During this period currency excess returns do not exhibit autocorrelation. Our results are consistent with investors learning about mispricing from academic research.     

Firm Valuation,Earnings Expectations,and the Exchange-Rate Exposure Effect

Consistent with previous research, we fail to find a significant correlation between the abnormal returns of our sample firms with international activities and changes in the dollar. We investigate the possibility that this failure is due to mispricing. Lagged changes in the dollar are a significant variable in explaining current abnormal returns of our sample firms, suggesting that mispricing does occur. A simple trading strategy based upon these results generates significant abnormal returns. Corroborating evidence from returns around earnings announcements as well as errors in analysts' forecasts of earnings is also provided.     

Equity issues when in distress

We investigate the role of financial distress in the seasoned equity market. We find that distressed firms comprise about 40% of SEOs and these distressed issuers have worse abnormal announcement returns than non‐distressed issuers. Stock return volatility is an important determinant for announcement returns for non‐distressed SEO issuers but not for distressed SEO issuers. Signals of firm quality are associated with better announcement returns, larger issues, increased investment, improved operating performance, and lower likelihood of delisting for distressed SEO firms as compared to non‐distressed firms. Our findings suggest equity finance is valuable for financially distressed firms with strong growth prospects.     

Finding diamonds in the rough: Analysts’ selective following of loss‐reporting firms

Investors face greater difficulty valuing loss‐reporting than profit‐reporting firms: losses may be due to very different reasons (e.g., poor operating performance or investments in intangibles, and financial accounting information is of more limited use for valuing loss‐making firms than profit‐making firms. Because of increased uncertainty about loss firms’ future financial and business viability, we hypothesize that financial analysts will be more selective when choosing to follow loss firms than profit firms, with the result that “abnormal” analyst following will be more informative to investors regarding the future performance of loss firms than profit firms. Consistent with this prediction, we find that abnormal analyst coverage is useful for predicting firms’ future prospects, and is more strongly associated with future performance (stock returns and ROA) for loss firms than for profit firms. The market, however, does not seem to use this useful information when pricing loss firms: for loss firms a portfolio investment strategy based upon abnormal analyst following can generate positive excess returns over 1‐ to 3‐year holding periods. These results are stronger for persistent‐loss firms than for occasional‐loss firms. We conclude that abnormal analyst following contains useful information about firms’ future prospects, and even more so for loss firms than for profit firms.     

A Dynamic Model of Characteristic‐Based Return Predictability

We present a dynamic model that links characteristic‐based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy‐wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic‐sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic‐sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic‐based anomalies.     

Limits-to-arbitrage, investment frictions, and the asset growth anomaly

We empirically evaluate the predictions of the mispricing hypothesis with limits-to-arbitrage suggested by Shleifer and Vishny (1997) and the q-theory with investment frictions proposed by Li and Zhang (2010) on the negative relation between asset growth and average stock returns. We conduct cross-sectional regressions of returns on asset growth on subsamples split by a given measure of limits-to-arbitrage or investment frictions. We show that: (i) proxies for limits-to-arbitrage and proxies for investment frictions are often highly correlated; (ii) the evidence based on equal-weighted returns shows significant support for both hypotheses, while the evidence from value-weighted returns is weaker; and (iii) in direct comparisons, each hypothesis is supported by a fair and similar amount of evidence.     

Mispricing firm-level productivity

This paper provides a mispricing-based explanation for the negative relation between firm-level productivity and stock returns. Investors appear to underprice unproductive firms and overprice productive firms. We find evidence consistent with the speculative overpricing of productive firms driven by investor sentiment and short sale constraints. Investors erroneously extrapolate past productivity growth and its associated operating performance and stock returns, despite their subsequent reversals. Such mispricing is perpetuated because of limits to arbitrage and is partially corrected around earnings announcements when investors are surprised by unexpected earnings news. Decomposition analysis indicates that extrapolative mispricing and limits to arbitrage explain most of the return predictability of firm-level productivity.     

Cross-Listing and Operating Performance: Evidence from Exchange-Listed American Depositary Receipts

Abstract:  In this paper we examine the operating performance of non-US firms that enter major US stock exchanges using American Depositary Receipt (ADR) programs. Our dataset consists of 108 capital-raising and non-capital-raising firms from twenty four countries, cross-listed on major US stock exchanges during the period 1994–2004. We provide evidence that capital-raising cross-listed firms experience improvements in their operating performance after the listing, relative to a non-cross-listed matched sample of firms and relative to the pre-listing period, whereas non-capital-raising cross-listed firms out-perform a non-cross-listed matched sample of firms for both the pre-listing and the post-listing periods. These results suggest that the type of ADR program conveys information about changes in the post-listing operating performance. Moreover, both capital-raising and non-capital-raising cross-listed firms have positive abnormal returns due to the cross-listing and these abnormal returns are positively related with the post-listing abnormal changes in operating performance, suggesting that the market anticipates the post-listing abnormal changes in operating performance. Results are robust after adjusting for various firm and country risk characteristics.     

上市公司综合盈利水平与股票收益

本文基于2000-2017年上市公司的财务及股票交易数据,研究了上市公司综合盈利水平与股票收益之间的关系。我们使用目前资产定价文献中较新的偏最小二乘法和组合预测法,从12个衡量公司盈利能力的指标中提取了一个测度上市公司综合盈利水平的指标。研究结果显示,上市公司综合盈利水平能够显著预测未来股票收益。使用单因子偏最小二乘法、取12个月斜率的平均值构造的综合盈利水平最有效,以其构建的多空对冲投资组合能产生15%的年平均收益,夏普比率达到0.75。与此对应,组合预测法提取的上市公司综合盈利水平的预测能力稍低,但依然显著。在控制了其他公司特征变量后,综合盈利水平对于股票收益的解释能力依然稳健。本文还从经济机制的角度出发,探讨了综合盈利水平对收益的预测来源。我们发现,上市公司综合盈利水平与股票预期回报的正向关系在投资摩擦更低的组中更高,而在错误定价程度更高的组通常更低。这些结果支持了基于投资摩擦的Q理论,而与行为金融的错误定价理论相悖。     

Does q-theory with investment frictions explain anomalies in the cross section of returns?

Q-theory predicts that investment frictions steepen the relation between expected returns and firm investment. Using financing constraints to proxy for investment frictions, we show only weak evidence that the investment-to-assets and asset growth effects in the cross section of returns are stronger in financially more constrained firms than in financially less constrained firms. There is no evidence that q-theory with investment frictions explains the investment growth, net stock issues, abnormal corporate investment, or net operating assets anomalies. Limits-to-arbitrage proxies dominate q-theory with investment frictions in explaining the magnitude of the investment-to-assets and asset growth anomalies in direct comparisons.     

Return predictability and the real option value of segments

Theory suggests that firm value should include the value of real options; that is, firms have the option to expand more profitable businesses and liquidate less profitable businesses. In a diversified firm, each segment has its own real options. Applying real options theory to a diversified firm at the firm level neglects the value of segment-level options. If investors overlook segment-level options, mispricing will occur. Using data from 1981 to 2013, we find that a hedge portfolio buying diversified firms in the highest decile of the estimated real option value of segments (RVS) and selling those in the lowest RVS decile earns a significant 0.79% size-adjusted monthly return. The hedge returns are more significant for firms whose growth opportunities mainly lie in the more profitable segments. We also find that the predictive power of RVS is stronger for firms with high growth, lower analyst coverage, and stronger corporate governance. Further investigation links improved operating performance to the exercise of segment-level real options.     

中国A股市场存在品质溢价吗?

本文从价值投资的核心理念出发,基于盈利性、成长性、安全性、分红能力四个维度构建复合品质指标,并通过分析品质溢价在中国A股市场中的存在性来探讨价值投资的可行性和有效性。实证结果表明:(1)中国A股市场上存在显著为正的品质溢价,且品质溢价在控制其他相关变量后依然稳健存在;(2)高品质股票具有大市值、高成长特征,且品质溢价在大市值、高盈利的分组中更加显著;(3)品质溢价在不同时期下均能稳定存在;(4)中国A股市场上的品质溢价并非源于高风险承担,相反,由正向反馈偏好、博彩偏好、套利限制引起的错误定价有助于解释品质溢价。本文结论佐证了价值投资策略在中国A股市场的可行性和有效性,为培育良好投资理念、抑制过度投机、促进中国股市合理健康发展等提供了经验证据。     

Loss persistence and returns in the UK

In this study, we examine whether estimated loss reversal probabilities are fully reflected in UK stock market prices. Overall, we provide evidence of varying degrees and types of loss firm mispricing with respect to estimated loss reversal probabilities. In particular, a significant and positive relationship between loss reversal probability and annual returns is found only for firms with higher trading costs. When looking at monthly returns, however, especially for the financial statement release month subsequent to the loss year, a significant and positive relationship is found for all firms. Thus, the evidence is consistent with UK market participants not fully incorporating relevant information into the pricing of loss firms and, as a consequence, being surprised by the content of the earnings for many or all UK loss firms.     

Cross‐firm return predictability and accounting quality

We test the hypothesis that if poor accounting quality (AQ) is associated with poor investor understanding of firms’ revenue and cost structures, then poor AQ stocks likely respond more slowly than good AQ stocks to new non‐idiosyncratic information that affects both sets of firms. Consistent with this, results indicate that stock returns of good AQ firms significantly positively predict one‐month‐ahead stock returns to industry‐ and size‐matched poor AQ firms. In testing a delayed‐information‐processing mechanism behind the cross‐firm return predictability, we find that: (i) analyst earnings forecast revisions (FR) mimic the return patterns, as FR of good AQ firms significantly positively predict one‐month‐ahead FR of matched poor AQ firms; (ii) cross‐firm return predictability is concentrated in months with substantial news arrival, including months with Federal Open Market Committee (FOMC) rate announcements, but not in no‐news months; (iii) cross‐firm return predictability is stronger when the good AQ predictor firms have a richer information environment than poor AQ firms as proxied by analyst following, institutional ownership, and the presence of a Big 4 auditor. Collectively, the results uncover a new relation between accounting quality and stock return dynamics.     

Governance Mechanisms and Equity Prices

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of “high” vulnerability to takeovers. The complementarity effect exists for firms with lower industry‐adjusted leverage and is stronger for smaller firms.     

Excess Returns to R&D-Intensive Firms

Recent studies indicate that both current R&D investment levels and current or recent changes in R&D investment are positively associated with subsequent excess (risk-adjusted) stock returns. The tentative explanation offered for these results is that shares of R&D-intensive firms are mispriced because investors fail to see through earnings distortions caused by conservative accounting for R&D costs. However, an alternative explanation is that conventional controls for risk do not completely capture the riskiness of R&D-intensive firms, causing measured excess returns for these firms to be biased upward. This study provides evidence useful for distinguishing between the mispricing and risk explanations for R&D-related excess returns. Overall, our empirical results suggest that the positive association between R&D investment levels and excess returns is more likely to result from failure to control adequately for risk than from mispricing. On the other hand, our results do not rule out the possibility of a second source of excess returns that are due to mispricing and that are associated with changes in the level of R&D investment.