How does quasi-indexer ownership affect corporate tax planning?

We study whether, and more importantly, through what mechanisms, quasi-indexers affect portfolio firms’ tax planning by employing the discontinuity in quasi-indexer ownership around the Russell 1000/2000 index cutoff. Using a regression discontinuity design, we find that higher quasi-indexer ownership leads to greater tax saving. With respect to the mechanisms, we find that the greater tax saving is a result of a focus on improved overall firm performance, not a specific focus on improved tax planning. We further find that the documented tax saving effect is partially due to quasi-indexers’ influences on executive equity incentives, corporate governance, and information environment.     

How much cash does your company need?

In late 2001, the directors of Pfizer asked that very question. And with good reason. After its 2000 merger with rival Warner-Lambert, the New York-based pharmaceutical giant found itself sitting on a net cash position of $8 billion, which seemed extraordinarily conservative for a company whose products generated $30 billion in revenues. Most large companies with revenues that healthy would increase leverage, thereby unlocking tremendous value for shareholders. But knowledge-intensive companies like Pfizer, this author argues, are in a class apart. Because their largely intangible assets (like R&D) are highly volatile and cannot easily be valued, they are more vulnerable to financial distress than are firms with a preponderance of tangible assets. To insure against that risk, they need to maintain large positive cash balances. These companies' decisions to run large cash balances is one of the key reasons their shares sustain consistent premiums. Only by investing in their intangible assets can knowledge-based companies hope to preserve the value of those assets. A company that finds itself unable to do so because unfavorable market conditions reduce its operating cash flows will see its share price suffer almost as much as if it were to default on its debts. By the same token, with the right balance sheet, knowledge companies can profitably insure against the risk of failing to sustain value-added investments in difficult times. An optimal capital structure that calls for significant cash balances is certainly at odds with the results of a traditional capital structure analysis, the author demonstrates, but it explains the financial policies of many well-run companies, from Pfizer to Intel to ChevronTexaco.     

Asset allocation: How much does model choice matter?

This paper analyzes the optimal portfolio decision of a CRRA investor in models with stochastic volatility and stochastic jumps. The investor follows a buy-and-hold strategy in the stock, the money market account, and one additional derivative. We show that both the type of the model and the structure of the risk premia have a significant impact on the optimal portfolio, on the utility gain from having access to derivatives, and on whether the investor prefers to trade OTM or ATM options. We also show that model mis-specification results in significant utility losses. Omitting jumps in volatility can be devastating, in particular if the investor chooses the seemingly optimal OTM put options. A misestimation of the structure of the risk premia has a less devastating effect, but can still lead to a loss of around 4% in the annual certainty equivalent return.     

How predictable are precious metal returns?

This paper provides strong evidence of time-varying return predictability of three precious metals from January 1987 to September 2014. We use three variations of the variance ratio test, the nonlinear Brock, Dechert and Schieinkman test as well as the Hurst exponent to evaluate the time-varying return predictability of precious metals to reduce the risk of spurious results. Our full sample results report mixed findings where some tests indicate significant predictability while some suggest no predictability. However through a time-varying procedure, we show that each precious metal market goes through periods of significant predictability as well as periods of unpredictability. Therefore this finding suggests that return predictability does vary over time and is not a static, all-or-nothing condition and therefore is consistent with the adaptive market hypothesis. We also show that platinum is the most predictable of the three precious metals and silver the least predictable, which may be of great to investors who include precious metals in their investment portfolios.     

What expenditure does Anglosphere foreign borrowing fund?

This paper examines the extent to which foreign borrowing funds private investment, consumption and government expenditure in the United States, the United Kingdom, Australia, and New Zealand (the Anglosphere), advanced economies which have been the world's largest international borrowers since 1990. Using a bivariate predictive regression model, we estimate the relative importance of these expenditure aggregates as predictors of their external deficits, and hence foreign borrowing. Overall, based on quarterly macroeconomic data for the period 1990–2011, the evidence suggests that foreign borrowing has not financed higher household consumption in these economies over recent decades, with the possible exception of the United States. While results concerning government spending are mixed due to policy reaction, business cycle and public-private saving offset effects, strong results for private investment augur well for the sustainability of this grouping's foreign borrowing.     

When does investor sentiment predict stock returns?

We examine the asymmetry in the predictive power of investor sentiment in the cross-section of stock returns across economic expansion and recession states. We test the implication of behavioral theories and evidence that the return predictability of sentiment should be most pronounced in an expansion state when investors' optimism increases. We segregate economic states according to the NBER business cycles and further implement a multivariate Markov-switching model to capture the unobservable dynamics of the changes in the economic regime. The evidence suggests that only in the expansion state does sentiment perform both in-sample and out-of-sample predictive power for the returns of portfolio formed on size, book-to-market equity ratio, dividend yield, earnings-to-price ratio, age, return volatility, asset tangibility, growth opportunities, and 11 widely documented anomalies. In a recession state, however, the predictive power of sentiment is generally insignificant.     

How skilful are US fixed-income fund managers?

We develop a performance evaluation model that incorporates the factors proposed by Huij and Derwall (2008) and a fund-specific benchmark to analyse the performance of US fixed income funds. Using the full sample, and accounting for the possibility of false discoveries, we find that fund management companies extract most of any abnormal performance produced by their fund managers. Our sub-sample analysis indicates that after the Global Financial Crisis (GFC) there was a substantial increase in the number of bond funds with: both positive gross-of-fee alpha and positive net-of-fee alpha performance; and also a reduction in funds with negative-alpha performance. However, because the GFC was such a unique event, it would still be difficult to conclude that these managers offer value for money for investors compared to passive alternatives.     

Does program trading contribute to excess comovement of stock returns?

Daily returns of stocks with high program trading comove more with each other but less with others. This significant comovement is disconnected with market movements and news of fundamentals and becomes stronger when market uncertainty is higher. It can be explained by neither the hypotheses of gradual information diffusion and liquidity provision nor the effects of quantitative trading signals, earnings announcements and index fund trading. Its non-fundamental nature is further demonstrated by the observation of program trading stimulating return reversals. Underlying this comovement is the high persistence of program trading. Our findings support the theory of habitat investing and demonstrate program trading creates a distinct source of excess return comovement.     

How much should portfolios shrink?

This paper develops a portfolio model that penalizes the deviation from a reference portfolio. The proposed model renders a robust portfolio that performs superior under parameter uncertainty. Penalizing the deviation also improves the performance of existing shrinkage portfolio models that are suboptimal due to model parameter uncertainty. The equal-weight portfolio turns out to be a better reference portfolio than the currently holding portfolio even in the presence of transaction costs. A data-driven method for determining the degree of penalization is offered. Comprehensive simulation and empirical studies suggest that the proposed model significantly outperforms various existing models.     

What impact does a change of fund manager have on mutual fund performance?

Using a unique database of UK fund manager changes over the period from 1997 to 2011, we examine the impact of such changes on fund performance. We find clear evidence to suggest that a manager change does affect the benchmark-adjusted performance of UK mutual funds. In particular we find a significant deterioration in the benchmark-adjusted returns of funds that were top performers before the manager exit and, conversely, a significant improvement in the average benchmark-adjusted returns of funds that were poor performers before the manager exit. Our use of the Carhart's (1997) four-factor model reveals that the improvement in average post manager exit performance is accompanied by a reduction in market risk, a slight reduction in exposure to small cap stocks, and an increase in exposure to value and momentum stocks. Overall, our results suggest that UK fund management companies have been relatively successful in replacing bad managers with better managers, but relatively unsuccessful at finding equivalent replacements for their top performing managers. We believe that regulators should therefore try to ensure that all efforts are made by fund management companies to inform all of their investors about a change in management.     

Too much liquidity? Seemingly excess cash for innovative firms

We show that more cash allows innovative firms facing financing constraints to undertake more research and development projects and that this phenomenon has been more pronounced since 1980. In contrast to the secular increase in the level of cash holdings, average excess cash has not increased appreciably. We analyze excess cash disposition and document a strong relation between excess cash and research and development spending. Finally, our results suggest that increased difficulty in valuing research and development might be a source of financing frictions. These findings imply that “seemingly excess cash” has played an increasingly important role in mitigating underinvestment in innovation.     

How much discretion for risk regulators?

We analyze the regulation of firms that undertake socially risky activities but can reduce the probability of an accident inflicted on third parties by carrying out non verifiable effort. Congress delegates regulation to an agency, although these two bodies may have different preferences toward the industry. The optimal level of discretion left to the agency results from the following trade‐off: the agency can tailor discretionary policies to its expert knowledge about potential harm, but it implements policies that are too “pro‐industry.” The agency should be given full discretion when the firm is solvent; partial discretion is preferred otherwise. We then investigate how this trade‐off changes as the political and economic landscapes are modified.     

Why does IPO volume fluctuate so much?

IPO volume fluctuates substantially over time. This paper compares the extent to which the aggregate capital demands of private firms, the adverse-selection costs of issuing equity, and the level of investor optimism can explain these fluctuations. Empirical tests include both aggregate and industry-level time-series regressions using proxies for the above factors and an analysis of the relation between post-IPO stock returns and IPO volume. Results indicate that firms’ demands for capital and investor sentiment are important determinants of IPO volume, in both statistical and economic terms. Adverse-selection costs are also statistically significant, but their economic effect appears small.     

How do corporate tax bases change when corporate tax rates change? With implications for the tax rate elasticity of corporate tax revenues

We construct a new database of extensive margin changes to multiple aspects of corporate tax bases for OECD countries between 1980 and 2004. We use our data to systematically document the tendency of countries to implement policies that both lower the corporate tax rate and broaden the corporate tax base. This correlation informs our interpretation of previous estimates of the relationship between corporate tax rates and corporate tax revenues, which typically do not include comprehensive measures of the corporate tax base definition. We then re-examine the relationship between corporate tax rates and corporate tax revenues. We find that accounting for unobserved heterogeneity attenuates the relationship between corporate tax rates and corporate tax revenues, and increases the implied revenue-maximizing tax rate. Controlling for our new tax base measures does not substantively impact the magnitude of this relationship.     

How do financial institutions react to a tax increase?

This paper empirically highlights the role and significance of taxes for the capital structure decisions of banks. Using a difference-in-differences methodology, I show that an increase in the local U.S. state corporate tax rate affects the banks’ financing as well as their operating choices. Better-capitalized banks raise their long-term non-depository debt and thus benefit from an enlarged tax shield. Worse-capitalized banks instead reduce their lending because a higher tax rate increases the tax-adjusted cost of funding, which renders the marginal loan unprofitable.     

How does competition affect bank risk-taking?

A common assumption in the academic literature and in the supervision of banking systems is that franchise value plays a key role in limiting bank risk-taking. As market power is the primary source of franchise value, reduced competition in banking markets has been seen as promoting banking stability. A recent paper by Martínez-Miera and Repullo (MMR, 2010) shows that a nonlinear relationship theoretically exists between bank competition and risk-taking in the loan market. We test this hypothesis using data from the Spanish banking system. After controlling for macroeconomic conditions and bank characteristics, we find support for this nonlinear relationship using standard measures of market concentration in both the loan and deposit markets. When direct measures of market power, such as Lerner indices, are used, the empirical results are more supportive of the original franchise value hypothesis, but only in the loan market. Overall, the results highlight the empirical relevance of the MMR model, even though further analysis across other banking markets is needed.     

When does the dividend–price ratio predict stock returns?

If the dividend–price ratio becomes I(1) while stock returns are I(0), the unbalanced predictive regression makes the predictability test more likely to indicate that the dividend–price ratio has no predictive power. This might explain why the dividend–price ratio evidences strong predictive power during one period, while it exhibits weak or no predictive power at other times. Using international data, this paper demonstrates that the dividend–price ratio generally has predictive power for stock returns when both are I(0). However, this paper also shows that the dividend–price ratio loses its predictive power when it becomes I(1). The results are shown to be robust across countries.     

How does managed care do it?

Integrating the health services and insurance industries, as health maintenance organizations (HMOs) do, could lower expenditure by reducing either the quantity of services or unit price or both. We compare the treatment of heart disease in HMOs and traditional insurance plans using two datasets from Massachusetts. The nature of these health problems should minimize selection. HMOs have 30% to 40% lower expenditures than traditional plans. Both actual treatments and health outcomes differ little; virtually all the difference in spending comes from lower unit prices. Managed care may yield substantial increases in measured productivity relative to traditional insurance.