Dismantling internal capital markets via spinoff: effects on capital allocation efficiency and firm valuation

We investigate the linkage between changes in firm value and changes in capital allocation efficiency resulting from dismantling internal capital markets via spinoffs. We find no evidence of wholesale misallocation of capital pre-spinoff. On the average, excess value increases following spinoffs. Furthermore, changes in excess value are positively linked to changes in capital allocational efficiency following spinoff. We find that spinoff announcement returns are greater (smaller) when the parent allocates capital to the unit to be spun off in a seemingly less (more) efficient manner. Divested division capital expenditures move toward industry levels after spinoff, regardless of their relative investment opportunities.     

Investment opportunities and market reaction to capital expenditure decisions

In this study, we argue that share price reaction to a firm's capital expenditure decisions depends critically on the market's assessment of the quality of its investment opportunities. We postulate that announcements of increases (decreases) in capital expenditures positively (negatively) affect the stock prices of firms with valuable investment opportunities. Contrarily, we predict that announcements of increases (decreases) in capital spending negatively (positively) affect the share prices of firms without such opportunities. Our empirical results are generally consistent with these predictions. Overall, empirical evidence supports our conjecture that it is the quality of the firm's investment opportunities rather than its industry affiliation which determines the share price reaction to its capital expenditure decisions.     

Accruals,Investment, and Future Performance

It is well documented that accounting measures of investment, such as working capital and capital expenditures, negatively predict future stock returns. The earnings fixation hypothesis suggests that investors overestimate and overvalue the persistence of the accrual component of earnings. Another stream of the literature argues that since accruals capture growth, the accruals anomaly can be explained by the investment anomaly, which finds that firms that grow their assets tend to have lower future returns. As empirical proxies for accruals and investment are either positively correlated or interchangeably used, it is difficult to distinguish between the competing hypotheses in empirical tests. This study contributes to the debate by identifying two special economic settings in which the two explanations offer diverging predictions. First, investment in research and development (R&D) represents an investment expenditure that reduces earnings but is not subject to accrual accounting. Thus, the earnings fixation hypothesis predicts a positive relation between increases in R&D investments and future returns, whereas the investment anomaly predicts a negative relation. Second, firms operating with negative working capital have working capital accruals that are negatively correlated with other forms of investment and growth. Therefore, while the earnings fixation hypothesis still predicts a negative relation between accruals and future returns in this setting, the investment explanation predicts a positive relation. For both sets of tests, the empirical evidence supports the earnings fixation hypothesis for the accruals anomaly and is inconsistent with the notion that the investment anomaly subsumes earnings fixation in explaining future stock returns.     

Creditor control rights and firm investment policy

We present novel empirical evidence that conflicts of interest between creditors and their borrowers have a significant impact on firm investment policy. We examine a large sample of private credit agreements between banks and public firms and find that 32% of the agreements contain an explicit restriction on the firm's capital expenditures. Creditors are more likely to impose a capital expenditure restriction as a borrower's credit quality deteriorates, and the use of a restriction appears at least as sensitive to borrower credit quality as other contractual terms, such as interest rates, collateral requirements, or the use of financial covenants. We find that capital expenditure restrictions cause a reduction in firm investment and that firms obtaining contracts with a new restriction experience subsequent increases in their market value and operating performance.     

The information content of cash dividend announcements in a unique environment

Due to its distinctive institutional background, Oman offers a valuable opportunity to examine stock price reactions to dividend announcements. In Oman, (1) there are no taxes on dividends and capital gains, (2) there is a high concentration of share ownership, (3) there is low corporate transparency, and (4) firms frequently change their dividends. Our results show that announcements of dividend increases are associated with increased stock prices, while announcements of dividend decreases cause decreases in stock prices. Firms that do not change their dividends experience insignificant negative returns. These results contradict tax-based signaling models, which argue that higher taxes on dividends relative to capital gains are a necessary condition for dividends to be informative.     

Industry concentration,excess returns and innovation in Australia

This paper examines market concentration and stock returns on the Australian Securities Exchange. We find that dominant companies operating in concentrated industries in Australia are able to generate significant risk‐adjusted excess stock returns. Our results for Australian data are opposite to that found by Hou and Robinson (2006) for United States market data. Hou and Robinson reason that United States firms which operate in concentrated industries are insulated from competitive pressures, have lower levels of innovation (Arrow, 1962) and therefore experience lower profitability and stock returns. By contrast, the Australian data show a significant and positive relationship between concentration and innovation expenditure. Therefore, the excess stock returns of dominant companies in Australia are consistent with previous research linking innovation expenditure with excess stock returns. We hypothesize that the apparent contradiction of our results compared with Hou and Robinson (2006) for the United States market is resolved by an examination of the differences in size and competition in United States and Australian industries and the consequent differential ability of dominant companies in the two countries to generate monopoly rents and invest in ‘Schumpeterian’ (Schumpeter, 1942) innovation.     

Oil and stock market activity when prices go up and down: the case of the oil and gas industry

We examine the asymmetric effects of daily oil price changes on equity returns, market betas, oil betas, return variances, and trading volumes for the US oil and gas industry. The responses of stock returns associated with negative changes in oil prices are higher than that associated with positive changes in oil prices. Stock risk measured by market beta is influenced more due to oil price decreases than due to oil price increases. On the other hand, oil risk exposures (oil betas) and return variances are more influenced by oil price increases than oil price decreases. The results of our study indicate that oil and gas firm returns, market betas, oil betas, return variances respond asymmetrically to oil price changes. We also find that relative changes in oil prices along with firm-specific factors such as firm size, ROA, leverage, market-to-book ratio (MBR) are important in determining the effects of oil price changes on oil and gas firms’ returns, risks, and trading volumes.     

Managerial ability and firm risk-taking behavior

In this study, we show that managerial heterogeneity plays an important role in firm decisions. Our view is that in addition to the effects of previously examined determinants, firm decisions are affected not just by the managers’ explicit mandate to maximize firm value, but also by the ability of the manager in managing the firm. We find that high-ability managers and low-ability managers have opposite effects on firm behavior and firm value. High-ability managers are receptive to risk-taking whereas low-ability managers refrain from risk-taking. High-ability managers cut capital expenditures but spend significantly more on research and development projects; low-ability managers reduce both capital expenditures and research and development expenses significantly. High-ability managers are associated with higher levels of firm focus than low-ability managers. Managerial ability is negatively associated with firm leverage. In addition, our results show that high-ability managers are associated with increases in firm value whereas low-ability managers are associated with decreases in firm value.     

Are Multiple Directorships Beneficial in East Asia?

We posit that the benefits and costs of multiple directorships are conditional on firm characteristics. We find firm valuation is positively associated with multiple directorships in (i) firms with high advising needs and (ii) firms with high external financing needs. These beneficial effects of multiple directorships are generally stronger in countries with weak shareholder rights and in firms that are widely held. However, when controlling shareholder hold high voting‐rights to cash‐flow rights, multiple directorships reduce firm valuation, especially in countries with weak shareholder rights and in closely held firms. As multiple directorships increases, cash holdings (capital expenditures) contribute less to shareholder value. The negative association between value of cash (capital expenditure) and busy boards is mitigated in firms with (i) high advising needs, (ii) high external financing needs and (iii) less entrenched ownership structures.     

The Impact of Capital Expenditures on Property Performance in Commercial Real Estate

Using a sample of 47,260 annual and 12,276 unique property observations during 2000–2011 we analyze the relationship between capital expenditures and performance by employing 2SLS models, in which capital expenditures are modeled as a function of property characteristics (age, square footage, occupancy rate, leverage, leasing commissions, lagged returns and property type), market conditions (interest rates, credit spread and standard deviation of cap rates) and property fixed effects. Our results reveal that while capital expenditures are mostly idiosyncratic and related to unique property characteristics, they are a significant determinant of property returns. We find persistently strong positive relationship between capital expenditures and excess NPI returns when controlling for the endogeneity of capital expenditures for industrial, office and retail properties. A further analysis reveals that this relationship is driven by the positive impact of building improvements and building expansions, while returns in all property types do not fully adjust to account for tenant improvements.     

The Economic Impact of Capital Expenditures: Environmental Regulatory Delay as a Source of Competitive Advantage?

This study tests the proposal that by undertaking voluntary capital expenditures that are subject to lengthy environmental regulatory delays, listed companies can gain a competitive advantage. The stock market is found to react positively to new capital expenditure announcements when projects are expected to experience long delays in obtaining environmental regulatory approval. Two sources of potential competitive advantage are firm learning and first mover advantages. Lengthy delays in regulatory processes and high compliance costs incurred for environmentally‐sensitive projects may allow firms opportunities to develop specialised capabilities and/or to deter industry competitors and new entrants, resulting in greater expected project NPVs. The findings also underscore the importance of non‐financial environmental information to investors in their assessment of firm value.     

Empirical Evidence on Capital Investment, Growth Options, and Security Returns

Growth in capital expenditures conditions subsequent classification of firms to portfolios based on size and book‐to‐market ratios, as in the widely used Fama and French (1992, 1993) methods. Growth in capital expenditures also explains returns to portfolios and the cross section of future stock returns. These findings are consistent with recent theoretical models (e.g., Berk, Green, and Naik (1999)) in which the exercise of investment‐growth options results in changes in both valuation and expected stock returns.     

Intangible Assets and Corporate Signaling

Research and development (R&D) and advertising expenditures often result in patents, technologies and brand names which are difficult to accurately value. Under current generally accepted accounting principles (GAAP) these intangible assets are generally not recognized in the financial statements, but instead are expensed in the period that they occur. Prior studies note that the market-to-book ratios of firms with significant levels of R&D and advertising expenditures suggest that investors, at least partially, value these assets. Researchers and practitioners argue that current GAAP, by not recognizing these intangible assets, reduces the usefulness and relevance of accounting reports.We investigate whether companies with significant levels of intangible assets are more likely to emphasize dividend increases and stock repurchases (which are generally perceived as signaling favorable investment opportunities), instead of traditional accounting disclosures, as a means of overcoming adverse selection. Because these assets are difficult to measure, cash distributions may be viewed as a more credible means of signaling firm value to investors. Using analysts' ratings of firms' accounting disclosures, we find that companies with higher levels of R&D and advertising expenditures are less likely to provide extensive accounting disclosures and instead tend to employ dividend and stock repurchase signals. We obtain these results even after controlling for other firm attributes, such as size, stock returns performance, leverage, liquidity and investors' expectations of growth opportunities. We also find that the market reaction to dividend increase and stock repurchase announcements is greater for firms with higher levels of R&D and advertising expenditures, indicating that these announcements are more informative for such firms.     

Did the 1986 Tax Reform Act Affect Market Reactions to Stock Splits?: A Test of the Tax-Option Hypothesis

This paper tests the prediction of the tax-option hypothesis that the market impact of stock splits would be reduced by the 1986 Tax Reform Act which eliminated the difference between long- and short-term capital gains tax rates. The results show significant excess returns on stock split announcement and ex-days even after 1986. The announcement and ex-day excess returns are similar in different periods before and after the Act. Further, there is no significant relationship between announcement excess returns and increase in returns volatility following splits. These findings are inconsistent with the tax-option hypothesis.     

Are red or blue companies more likely to go green? Politics and corporate social responsibility

Using the firm-level corporate social responsibility (CSR) ratings of Kinder, Lydenberg, Domini, we find that firms score higher on CSR when they have Democratic rather than Republican founders, CEOs, and directors, and when they are headquartered in Democratic rather than Republican-leaning states. Democratic-leaning firms spend $20 million more on CSR than Republican-leaning firms ($80 million more within the sample of S&P 500 firms), or roughly 10% of net income. We find no evidence that firms recover these expenditures through increased sales. Indeed, increases in firm CSR ratings are associated with negative future stock returns and declines in firm ROA, suggesting that any benefits to stakeholders from social responsibility come at the direct expense of firm value.     

Are publicly held firms less efficient? Evidence from the US property-liability insurance industry

This paper studies the performance of publicly held firms in the US property-liability insurance industry by analyzing companies that issued initial public offerings (IPOs) from 1994 to 2005, using private firms as the benchmark. I investigate ex ante determinants and ex post effects of IPOs on firm efficiency, operating performance, and other financials. I also analyze stock returns and follow-on SEO and acquisition activities to provide further information on IPO motivation. The paper finds that the likelihood of an IPO significantly increases with firm size and premium growth. IPO firms experience no post-issue underperformance in efficiency, operations, or stock returns; register improvement in allocative and cost efficiency; and reduce financial leverage and reinsurance usage. Moreover, IPO firms are active in follow-on SEO issues and acquisition activities. The findings are mostly consistent with the theory that firms go public for easier access to capital and to ease capital constraints.     

On the relationship between concentration of prospect theory/mental accounting investors,cointegration, and momentum

We examine the role of cointegration between stock prices and their estimated fundamental values in return momentum. We find that the positive relationship between capital gains overhang and future stock returns in Grinblatt and Han (2005) is significantly stronger among the “non-cointegrated” group of stocks as compared with the “cointegrated” group of stocks. Further, for the cointegrated stocks, the slower the speed of adjustment to the cointegrating equilibrium, the greater (smaller) is the future return of stocks with unrealized capital gains (losses). These findings are robust to various firm characteristics including firm size, book-to-market ratio, past returns, idiosyncratic volatility, dispersion in analysts’ earnings forecasts, turnover, individual investor ownership, and industry returns.     

Ownership Restrictions and Stock Prices: Evidence from Chinese Markets

In this paper, I test a one-period capital asset pricing model (CAPM) under share ownership restrictions to explain differences in prices and expected excess returns between the classes of shares that can be bought and traded by domestic and foreign investors, respectively, in the Chinese stock markets. I find that cross-sectional variability in the spread between the expected domestic and foreign share excess returns is related to differences in individual shares' market betas. The empirical results are by and large consistent with the CAPM. After the betas are controlled for, idiosyncratic variance and firm size have no effect.     

Risk and Return Around Bond Rating Changes: New Evidence From the Spanish Stock Market

Abstract:  This study analyzes the effect of corporate bond rating changes on stock prices in the Spanish stock market. We explore their effects on excess of returns and systematic risk. Rating changes by Moody's, Standard and Poor's and FitchIBCA are analyzed. On an efficient market, these changes will only have some effect if they contain some new information or if they are associated to a redistribution of wealth between shareholders and bondholders. We use an extension of the event study dummy approach. Our results support the redistribution of wealth hypothesis in the abnormal returns behavior. We also find that changes in both directions cause a rebalancing effect in the total risk of the firm, with significant reductions on their systematic component.     

An Empirical Investigation of the Role of Signalling in the Valuation of Unseasoned Equity Issues

This paper investigates the role of signalling in the valuation of unseasoned equity issues on the Unlisted Securities Market (USM) in the UK. It extends the existing US literature by considering a wider range of signals and by taking note of the complexities of the issuing process. From the signals considered, firm value is significantly and positively related to the percentage of equity retained by the pre-offering entrepreneurs, the level of planned capital expenditures, the degree of underpricing, the quality of the reporting accountants and the relative costs of flotation. Additional results indicate that firm size and the motivations behind the seeking of a stock market listing affect firm valuations.