Investing in a relationship

A principal can make an investment anticipating a repeated relationship with an agent, but the agent may appropriate the returns through ex post bargaining. I study how this holdup problem and efficiency depend on the contracting environment. When investment returns are observable, informal contracts ex post can be more efficient than formal contracts, as they induce higher investment ex ante: the principal invests not only to generate direct returns, but also to improve relational incentives. Unobservability of returns increases the principal's ability to appropriate the returns but reduces her ability to improve incentives. The optimal information structure depends on bargaining power.     

Ex ante performance from ex post models of global equity market correlations

Analysis of ex post returns reveals the time series properties of correlations, but ex ante correlations are required for efficient diversification. We find that a time-varying parameter model offers the best fit to ex post global equity market correlations, suggesting changing mean correlations and changing rates of adjustment back to the means. Nevertheless, we do not find improved forecast performance from time-varying parameter models in holdout periods. The added complexity of time-varying models does not translate into lower forecast errors.     

Mutual to Stock Conversion, Information Cost, and Thrift Performance

In the 1980s, a large number of thrifts converted from the mutual to the stock form of ownership. The literature has noted that investors in those conversions earned abnormally high short-term returns. However, over the long run the converters earned very poor returns. The major reason for the poor returns was the extra noninterest operational costs associated with the stock form of ownership. Since those extra operational costs were predictable, the stock offerings may have been overpriced, ex ante as well as ex post.     

The moderating role of board gender diversity on the relationship between firm opacity and stock returns

In this study, we examine the impact of board gender diversity on the association between firm opacity and stock price crash. We utilize the negative shock of the 2007–2008 financial crisis to capital markets to examine whether firms with gender-diverse boards witnessed lower stock price crashes due to their lower opacity ex ante. Using a sample of S&P 1500 firms spanning the period 2005–2008, we employ a difference-in-differences research design and find that firms with high opacity ex ante witness more negative returns ex post. We also find that gender-diverse firms ex ante witness less negative returns ex post. Finally, our analysis reveals the moderating role that board gender diversity plays in the association between firm opacity and stock returns around the financial crisis. We subject our results to a range of robustness checks, including instrumental variable regressions, matched-sample analyses, and a set of falsification and placebo tests. Overall, we provide evidence that board gender diversity is associated with increased transparency in financial reporting, which pays off in times of crisis.     

Bank risk and real estate: An asset pricing perspective

While a number of papers have investigated the time-series behavior ofex post bank stock returns and real estate returns, no study has comprehensively studied the relationship betweenex ante risk premiums on both assetsand the time-varying nature of such premiums in relationship to economic and real estate market conditions. In this study, we investigate how the changing nature of bank risk taking, especially in the real estate market, has affected theex ante pricing of risk in the market for bank stocks. We find that the time variation in bank risk premiums are partly determined by interest rate and real estate market conditions. We also discover that the real estate factor has been important for banks in the 1980s.     

The superiority and disciplining role of independent analysts

We show that although forecasts of independent analysts are less accurate ex post, they yield forecast errors that are more strongly associated with abnormal stock returns. This suggests that forecasts of independent analysts are superior to those of nonindependent analysts in representing ex ante market expectations. We also show that forecasts of nonindependent analysts become more accurate and less biased, and produce forecast errors more strongly associated with abnormal stock returns when independent analysts are following the same firms than when they are not. This suggests that the presence of independent analysts disciplines the behavior of nonindependent analysts.     

Accounting information,disclosure, and expected utility: Do investors really abhor uncertainty?

Investors are said to “abhor uncertainty,” but if there were no uncertainty they could earn only the risk‐free rate. A fundamental result in the analytical accounting literature shows that investors buying into a CARA‐normal CAPM market pay lower asset prices, gain higher ex‐ante expected returns, and obtain higher expected utility, when the market payoff has higher variance. New investors obtain similar “welfare” gains from risk under a log/power utility CAPM. These results do not imply that investors “abhor information.” To realize investors' ex‐ante expectations, the subjective probability distributions representing market expectations must be accurate. Greater payoff risk can add to investors' expected utility, but higher ex‐post(realized) utility comes from better information and more accurate ex‐ante expectations. An important implication for accounting is that greater disclosure can have the simultaneous effects of (i) exposing more fully or perceptibly firms' payoff uncertainty, thereby increasing new investors' expected utility, and (ii) improving market estimates of firms' payoff parameters (means, variances, covariances), thereby giving investors a better chance of realizing their expectations. Paradoxically, better information can be valuable to new investors by exposing more fully and more accurately the risk in firms' business operations and results–new investors maximizing expected utility want both more risk and better information.     

EVIDENCE ON THE EXISTENCE OF COMMON STOCK INFLATION HEDGES

Previous researchers have been unable to identify (on an ex ante basis) inflation hedge portfolios consisting of common stocks. This study demonstrates a procedure for forming common stock portfolios that offer returns that vary positively with unexpected inflation. The strategy could have been used to hedge against purchasing power risk during the 1974–1979 period. In addition to its practical value, the research has important implications for capital asset pricing theory since the existence of hedge portfolios is a necessary condition for the superiority of the multi-period CAPM over the single-period models.     

Anticipated information releases reflected in call option prices

This study captures the ex ante information content of a financial reporting event (the annual earnings announcement) by examining the behavior of call option prices on dates leading up to and passing through the disclosure date. This approach differs from most previous empirical security price research which has been ex post in nature. The hypothesis that investors anticipate that the future release of annual earnings numbers will affect security prices is empirically confirmed. In particular, systematic changes in variance rates implied by the Black-Scholes option pricing model are demonstrated.     

Marketing Period Risk in a Portfolio Context: Comment and Extension

This paper re-examines and extends the findings of Bond et al., Journal of Real Estate Finance and Economics, 34, 447–461, (2007) who consider the theoretical model of Lin and Vandell, Real Estate Economics, 35, 291–330, (2007) to determine the extent to which individual real estate asset return characteristics caused by marketing period risk disappear in a large, diversified real estate portfolio. The effects of marketing period risk are found to disappear in the limit with growth in the size of the portfolio, with ex ante variance approaching ex post variance, but only if the portfolio consists of nonsystematic risk alone, in which case both approach zero. The marketing period risk factor (MPRF), representing the ratio of ex ante to ex post variance, however, does not in general approach zero in the limit, in fact could increase or decrease depending upon the illiquidity characteristics of the individual assets and the magnitude and degree of correlation among individual property returns and marketing periods. The results suggest that even large institutional real estate portfolio managers must consider the illiquidity present in their portfolios and cannot assume that its effect will be diversified away.

Performance effects of setting targets and pay–performance relations before or after operations

This study investigates both theoretically and experimentally whether and how ex post use of relative performance evaluation (RPE) information in determining performance target levels and profit sharing ratio (PSR) levels affects employer profit performance. Our findings show that employers use RPE information, i.e. peer performance, to adjust performance target levels and PSR levels to reflect economic conditions. More importantly, we find that ex post use of RPE information, i.e. peer performance, improves profit performance. However, ex post adjustment of target levels and PSR levels based on peer performance have different performance implications. Specifically, we find that ex post target contracts improve employer residual profit over ex ante target contracts, while ex post PSR contracts do not improve employer residual profit over ex ante PSR contracts. Our supplemental analyses suggest that this difference is likely because employees are more sensitive to prior period compensation determined by ex post PSRs than ex post targets. Compared to ex post targets that are likely perceived to be fair based on peer performance, ex post PSRs based on the peer performance can be used opportunistically by employers and/or are perceived so by employees, which leads to future repercussions manifested in lower employee effort and employer residual profit.     

Exchange risk, exposure, and the option to trade

Rather than impeding trade, increased exchange rate uncertainty may on average create trade as it implies a higher probability that ex post deviations from Commodity Price Parity will exceed tariffs and transportation costs. We demonstrate such an effect in a small-country, short-term model, under the alternative assumptions of perfect competition and of a monopolist trader-producer. The proofs rely on the fact that such firms' exposures can be replicated (and hedged) by standard options. Under partial monopoly scenarios, the effect of volatility is ex ante unclear, though. (JEL F31)     

The Ex‐Ante Monitoring Role of Accounting Covenants in Public Debt

In contrast to what is known about accounting covenants in private debt, little empirical evidence on the role of accounting covenants in public debt exists. Diffuse ownership, arm's length monitoring, and collective action problems are unique to the public debt setting and raise the question of whether these covenants serve their intended role. As such, this study investigates whether including covenants reliant upon accounting inputs influences borrowers’ actions to prevent adverse credit events. Accounting covenants in the public debt setting provide firms with a disciplining mechanism to renegotiate ahead of costly technical default – a stark contrast to the ex‐post renegotiation ‘trip wire’ role covenants play in private debt. In particular, the results show that including accounting covenants in public debt is associated with an increased probability of ex‐ante renegotiation, that is, negotiation through consent solicitations ahead of covenant violation. This ex‐ante renegotiation, in turn, is associated with decreased adverse credit events. Cross‐sectional results support these findings as the ex‐ante renegotiation role of accounting covenants varies with bondholders’ and trustees’ monitoring ability.     

Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses

In this paper, we derive an equilibrium relationship between the yields on Eurodollar and Treasury bills based on equivalent martingale results derived by Harrison and Kreps (1979) and Harrison and Pliska (1981, 1983) as well as the corporate debt pricing model developed by Merton (1974). The derived equilibrium relationship incorporates the models used by Booth and Tse (1995) and Shrestha and Welch (2001) as special cases. The equilibrium relationship indicates that the conditional volatility of the yield on Eurodollars explains the variation in the TED spread. We empirically test the equilibrium relationship using a GARCH-M model and the concept of fractional cointegration. We use both the ex ante data implied by the respective futures contracts as well as the ex post spot data with daily, weekly and monthly frequencies. We find empirical support for the Equilibrium relationship.

The Market's Valuation of Fraudulently Reported Earnings

This study examines the market valuation of accounting earnings during the period before it is publicly revealed that the earnings are fraudulent. Using both cross‐sectional and time‐series valuation models, we first find that the market accords less weight to earnings when the accounting numbers are fraudulent. We also show that the market better anticipates the presence of fraud when there is information in the public domain indicating a high ex‐ante risk of fraud. Our findings suggest that investors are able to accurately assess the probability of fraud and that such assessments affect the market's valuation of earnings even before it is publicly announced that fraud has occurred.     

Asymmetric information consolidation and price discovery: Inferring bad news from insider sales

Due to the paucity of sources of negative firm‐specific information, US capital markets have more difficulty identifying and incorporating bad news into stock prices than they do good news. Even though insider selling is a potentially important proxy for undisclosed bad news, researchers have difficulty ex ante identifying information‐based sales due to an inability to separate liquidity‐motivated from information‐based insider trades. We hypothesize that when insiders in multiple firms sell shares of one firm in which they are insiders and at the same time buy shares of other insider portfolio firms, the sale is more likely to be information‐based, since the proceeds are reinvested. Conversely, when an insider sells one firm without purchasing others or sells multiple insider firms the sale is likely liquidity‐motivated. We find that insider sales identified as information‐based using this algorithm are followed by significant negative abnormal returns. Information‐based sales are also more likely to be associated with delistings, earnings declines and earnings restatements. Analysts are also more likely to revise their earnings forecasts downwards for these firms. It is thus possible to ex ante identify insider sales with information content. Our results will be of interest to investors and also to regulators designing insider trading rules.     

Dependent on one but vulnerable to another: opportunism threats and control solutions for customization providers

While economic theory suggests that identifying alternate customers is costlier than identifying alternate specialized employees for customization providers, substantial field research evidence indicates the opposite, where providers are reportedly more dependent on employees than customers. We inquire into this contrasting picture between theory and practice through an in‐depth case study that suggests that what begins as customer dependence transforms into vulnerability to employees. While perceived vulnerability to customers is efficiently removed through ex ante controls, the physical asset specificity in each customer order generates task uncertainty, specialization and teamwork, which become the new sources of opportunism threat for the customization providers. Compounded layers of ex ante and ex post controls with frequent iterations suggest a need for continuous management (as against removal) of vulnerability to employees.     

THE INFORMATION CONTENT OF DIVIDEND CHANGES

In this study, the open empirical question as to whether or not dividends contain information is investigated. The study involves 200 stocks and 376 dividend announcements over the 1971 to 1977 period; measures of unexpected dividends are related to measures of abnormal returns for dividend changing stocks. This study is important for three reasons:

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Search and herding effects in peer-to-peer lending: evidence from prosper.com

I examine loan data from Prosper.com—a website which allows borrowers to post loans and for lenders to bid on those loans. The Prosper market somewhat resembles the theoretical model of search, herding, and crowding in a large market described in Berkovich and Tayon (Phd. dissertation—Essays on search and herding. University of Pennsylvania, Pennsylvania, 2009). That model predicts that assets with high and low prices have high variance in the difference between price and true value. These extreme price regions of the asset-space are where private information provides excess returns. In the Prosper market, I find some evidence for the model since loans with low ex post returns show higher variance of the difference between price and ex post return. I also find that high-priced loans provide excess returns even after accounting for risk-aversion.     

Pure Versus Mutual Health Insurance: Evidence From Swedish Historical Data

Using data from voluntary Swedish health insurance societies 1902‐1910, this article analyzes the coexistence of pure and mutual insurance societies where pure societies are characterized by charging ex ante premiums only while mutuals in addition charge ex post assessments. On average, mutual insurance societies are found to be larger and to offer greater insurance coverage per member. Pure insurance societies have, on average, higher insurance coverage per day, greater mean levels of moral hazard controls, a higher mean number of policy categories, and greater longevity.