Conditional conservatism and cost of capital

We empirically test the association between conditional conservatism and cost of equity capital. Conditional conservatism imposes stronger verification requirements for the recognition of economic gains than economic losses, resulting in earnings that reflect losses faster than gains. This asymmetric reporting of gains and losses is predicted to lower firm cost of equity capital by increasing bad news reporting precision, thereby reducing information uncertainty (Guay and Verrecchia 2007) and the volatility of future stock prices (Suijs 2008). Using standard asset-pricing tests, we find a significant negative relation between conditional conservatism and excess average stock returns over the period 1975–2003. This evidence is corroborated by further tests on the association between conditional conservatism and measures of implied cost of capital derived from analysts’ forecasts.     

Inflation,earnings forecasts,and post-earnings announcement drift

We examine whether financial analysts fully incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies, such as lagged inflation and inflation forecasts from the Michigan Survey of Consumers, predict the future earnings change of a portfolio long in high inflation exposure firms and short in low or negative inflation exposure firms, but analysts do not fully adjust for this relation. Analysts’ earnings forecast errors can be predicted using expected inflation proxies, and these systematic forecast errors are related to future stock returns. Overall, our evidence is consistent with the Chordia and Shivakumar (J Account Res 43(4):521–556, 2005) hypothesis that the post-earnings announcement drift is related to investor underestimation of the impact of expected inflation on future earnings change.     

Transparency,Liquidity, and Valuation: International Evidence on When Transparency Matters Most

We examine the relation between firm‐level transparency, stock market liquidity, and valuation across countries, focusing on whether the relation varies with a firm's characteristics and economic environment. We document lower transaction costs and greater liquidity (as measured by lower bid‐ask spreads and fewer zero‐return days) for firms with greater transparency (as measured by less evidence of earnings management, better accounting standards, higher quality auditors, more analyst following, and more accurate analyst forecasts). The relation between transparency and liquidity is more pronounced in periods of high volatility, when investor protection, disclosure requirements, and media penetration are poor, and when ownership is more concentrated, suggesting that firm‐level transparency matters more when overall investor uncertainty is greater. Increased liquidity is associated with lower implied cost of capital and with higher valuation as measured by Tobin's Q. Finally, a mediation analysis suggests that liquidity is a significant channel through which transparency affects firm valuation and equity cost of capital.     

The stock price effects of changes in dispersion of investor beliefs during earnings announcements

Existing research provides competing theories about how dispersion of investor beliefs might affect stock prices. We measure changes in dispersion of investor beliefs around earnings announcements using changes in the dispersion of individual analysts’ forecasts. We find that the 3-day market response to earnings announcements is negatively associated with changes in dispersion, consistent with the cost of capital hypothesis. The results hold after controlling for the current earnings surprise, forecast revisions of future earnings, and reported earnings relative to various earnings thresholds. Our study provides new insight about the information contained in earnings announcements that is incremental to the magnitude and timing of cash flows.     

Bank Employee Incentives and Stock Purchase Plans Participation

We investigate which factors influence 44,649 employees’ decision to invest in a top retail banking group in France. We have two objectives: (i) to explore factors associated with the amount invested in the plan, and (ii) to explore whether these factors have same associations with the probability of investing more than the incentive pay i.e. being an active investor. Specifically, we focus on four parameters that have been shown to affect participation: liquidity constraints, imperfect knowledge of the plan, asset choice, and transaction costs. We confirm Engelhardt and Madrian (Natl Tax J 57:385–406, 2004) assumptions according to which such factors contribute to explain non-participation. We show that ESPP contributors have very specific and unobserved motivations, as shown with the positive correlations between error terms in the two steps of investment decisions. The existence of unobservable investment motives can be explained by a lower risk aversion, a higher time preference, or a strong willingness to participate to corporate governance.     

Neutral Property Taxation Under Uncertainty

In a framework where no uncertainty arises, Arnott (J Publ Econ Theor 7:27–50, 2005) investigates a neutral property taxation policy that will not affect a landowner’s choices of capital intensity and timing of development. We investigate the same issue, but allow rents on structures to be stochastic over time. We assume that a regulator implements taxation on capital, vacant land, and post-development property so as to expropriate a certain ratio of pre-tax site value as well as to achieve neutrality. We find that the optimal taxation policy is to tax capital and subsidize properties before and after development. We also investigate how this optimal policy changes in response to changes in several exogenous forces related to demand and supply conditions of the real estate market.

Government Debt, Reputation and Creditors' Protections: The Tale of San Giorgio

San Giorgio (1407–1805) was a formal association aimed at protecting creditors’ rights and reducing the risk of debt repudiation by the Republic of Genoa. The behavior of this institution is broadly consistent with debt models that predict lending if lenders can impose big penalties on debtors, and models in which lenders can differentiate between excusable and inexcusable defaults. San Giorgio shareholders enjoyed low credit risk but also lower returns on capital than those prevailing on comparable foreign assets for which creditors’ protection mechanisms were lacking. The Republic’s quid pro quo was a low cost of financing. Differences in credit risk were an important explanation of differences in long-term interest rates across countries in 16th and 17th century Europe, a point not sufficiently emphasized by the literature.     

Does Inclusion in a Smaller S&P Index Create Value?

This study finds overall increases in equity value surrounding addition to the S&P SmallCap and MidCap indexes from 1996 to 2003 and investigates sources of the value gains. Following addition, there are significant increases in proxy variables for stock liquidity and investor recognition, and changes in these variables are impounded into the permanent component of announcement share price revisions. We also find that changes in capital investment intensity are increasing in changes in stock liquidity, consistent with a reduction in the cost of capital following index addition.     

Herding,momentum and investor over-reaction

In this paper we study the impact of noise or quality of prices on returns. The noise arises from herding by market participants beyond what is justified by information. We construct a firm-quarter-specific measure of speculative intensity (SPEC) based on autocorrelation in daily trading volume adjusted for the amount of information available, and find that speculative intensity has a significant positive impact on returns. Both cross-sectional and time series variation in SPEC are consistent with conventional wisdom, and with implications of theories of herding as in DeLong et al. (1990, J Political Econ 98(4):703–738). We find that high-SPEC firms drive the returns to momentum trading strategies and that investor over-reaction is significant only in the case of high-SPEC firms.

Issuers’ incentives and tests of Baron’s model of IPO underpricing

This paper reexamines the validity of Baron’s (J Financ 37:955–976, 1982) model of IPO underpricing, in which IPO underpricing is caused by asymmetric information between issuers and investment bankers. Muscarella and Vetsuypens (J Financ Econ 24:125–135, 1989) find that lead-manager IPOs are significantly more underpriced than non-self-marketed IPOs and conclude that their empirical results do not support Baron’s model. We compare self-marketed underwriters’ IPOs with non-self-marketed underwriters’ IPOs and with IPOs they lead. Our empirical results show that it is premature to reject Baron’s model of IPO underpricing when we take issuer incentives into account.     

A note on portfolio choice for sovereign wealth funds

The current vast account surpluses of commodity-rich nations, combined with record account deficits in developed markets (the United States, Britain) have created a new type of investor. Sovereign wealth funds (SWF) are instrumental in deciding how these surpluses will be invested. We need to better understand the investment problem for an SWF in order to project future investment flows. Extending Gintschel and Scherer (J. Asset Manag. 9(3):215–238, 2008), we apply the portfolio choice problem for a sovereign wealth fund in a Campbell and Viceira (Strategic Asset Allocation, 2002) strategic asset allocation framework. Changing the analysis from a one to a multi-period framework allows us to establish a three-fund separation. We split the optimal portfolio for an SWF into speculative demand as well as hedge demand against oil price shocks and shocks to the short-term risk-free rate. In addition, all terms now depend on the investor’s time horizon. We show that oil-rich countries should hold bonds and that the optimal investment policy for an SWF as a long-term investor is determined by long-run covariance matrices that differ from the correlation inputs that one-period (myopic) investors use.

Multiple Regimes and Volatility Transmission in Securitized Real Estate Markets

We examine the dynamics and transmission of conditional volatilities with multiple structural changes in return volatility using Bai and Perron (2003)’s methodology, across five major securitized real estate markets as well as employing a multivariate regime-dependent asymmetric dynamic covariance methodology (MRDADC) that allows the conditional matrix to be both time- and state-varying. Our results imply that a multiple-regime time varying asymmetric variance and covariance approach is important in modeling real estate securities valuation and selection and portfolio optimization, and is consistent with popular beliefs that market volatility changes over time. Our MRDADC models detect the presence of significant mean-volatility linkages across the five major securitized real estate markets under different volatility regimes and would have implications for global investor in terms of estimating a dynamic risk-minimizing hedge ratio in international portfolio management.     

Momentum in Residential Real Estate

This paper examines whether there is return momentum in residential real estate in the U.S. Case and Shiller (American economic review 79(1):128–137, 1989) document evidence of positive return correlation in four U.S. cities. Similar to Jegadeesh and Titman’s (Journal of finance 56:699–720, 1993) stock market momentum paper, we construct long-short zero cost investment portfolios from more than 380 metropolitan areas based on their lagged returns. Our results show that momentum of returns in the U.S. residential housing is statistically significant and economically meaningful during our 1983 to 2008 sample period. On average, zero cost investment portfolios that buy past winning housing markets and short sell past losing markets earn up to 8.92% annually. Our results are robust to different sub-periods and more pronounced in the Northeast and West regions. While zero cost portfolios of residential real estate indices is not a tradable strategy, the implications of our results can be useful for builders, potential home owners, mortgage originators and traders of real estate options.     

Quality &; Time-on-the-Market in Residential Markets

We empirically examine Taylor’s (1999) theoretical prediction that longer time on the market is associated with a perception of lower quality. Our most robust result is from an ordered-logit model that provides evidence that an increase in marketing time is negatively related to property quality. Results from a time on the market duration model indicate that higher quality properties take less time to market and lower quality properties take longer to market relative to a typical property in the sample. We also estimate a probit model that indicates higher quality properties are more likely to sell and lower quality properties are less likely to sell. The empirical results from the models support Taylor’s theoretical model predictions that buyers perceive a longer time on the market as a signal of poor quality or the presence of a defect and thus, properties that remain on the market longer have a lower probability of selling.     

ESG preferences,risk and return

There are two primary factors that affect expected returns for companies with high ESG (environmental, social and governance) ratings—investor preferences and risk. Although investor preferences for highly rated ESG companies can lower the cost of capital, the flip side of the coin is lower expected returns for investors. Regarding risk, the jury remains out on whether there is an ESG-related risk factor. However, to the extent, ESG is a risk factor it also points towards lower expected returns for investments in highly rated companies. Though ESG investing may have social benefits, higher expected returns for investors are not among them.     

Customer satisfaction and the cost of capital

Using a sample of U.S. firms from 1995 through 2015 and the customer satisfaction scores from the American Customer Satisfaction Index, we find strong evidence that firms with higher customer satisfaction scores enjoy lower cost of equity capital, even after controlling for other factors that determine the cost of equity. In addition, results from a propensity score matched sample analysis, a difference-in-differences analysis, and instrumental variable regressions suggest that our findings are robust to accounting for endogeneity. We also document that customer satisfaction is positively related to investor recognition and financial report quality. The effect of customer satisfaction on the cost of equity increases with the level of information asymmetry, consistent with customer satisfaction mitigating information asymmetry. Overall, our findings suggest that customer satisfaction lowers a firm’s risk and significantly attenuates its financing costs.

     

Re-examining the investment-uncertainty relationship in a real options model

The main purpose of this paper is to re-examine the investment-uncertainty relationship in a real options model, and demonstrates that the Sarkar (J Econ Dyn Control 24:219–225, 2000) model is a special case of our model. This paper uses a general dynamic process, which incorporates mean reversion and jumps in a firm’s project earnings. We further derive a quasi-analytical form solution for the critical investment value and investment probability of a firm’s projects. From the simulation results, we find that an increase in uncertainty can always lead to an increase in the probability of investment, and thus has a positive impact on investment. These results, which differ from the findings of Sarkar (J Econ Dyn Control 24:219–225, 2000), could be explained by the mean-reversion and jump effects on a firm’s earnings.     

Does acquirer cash level predict post-acquisition returns?

This paper investigates whether an acquirer’s pre-announcement cash level can predict post-acquisition returns. Harford (1999, Journal of Finance, 54, 1969–1997) shows that some cash-rich acquirers have lower announcement period returns than other acquirers, suggesting the market partially anticipates poor future performance. This paper shows that the acquirer’s cash level is also strongly and negatively predictive of post-acquisition returns, indicating that the announcement response is incomplete. Post-acquisition return on net operating assets (RNOA) is significantly decreasing in acquirer cash, suggesting that the market responds to subsequent poor operating performance as it is reported. Overall, these results are consistent with the market’s inattention to a less prominent accounting signal (acquirer cash) but attentiveness to a more prominent accounting signal (RNOA), as proposed by Hirshleifer and Teoh (2003, Journal of Accounting Economics, 36, 337–386).

Insider trading in an equilibrium model with default: a passage from reduced-form to structural modelling

We study, in the framework of Back [Rev. Financial Stud. 5(3), 387–409 (1992)], an equilibrium model for the pricing of a defaultable zero coupon bond issued by a firm. The market consists of a risk-neutral informed agent, noise traders, and a market maker who sets the price using the total order. When the insider does not trade, the default time possesses a default intensity in the market’s view as in reduced-form credit risk models. However, we show that, in equilibrium, the modelling becomes structural in the sense that the default time becomes the first time that some continuous observation process falls below a certain barrier. Interestingly, the firm value is still not observable. We also establish the no expected trade theorem that the insider’s trades are inconspicuous.      

Is Investor Attention for Sale? The Role of Advertising in Financial Markets

Prior research documents capital market benefits of increased investor attention to accounting disclosures and media coverage; however, little is known about how investors and markets respond to attention‐grabbing events that reveal little nonpublic information. We use daily firm advertising data to test how advertisements, which are designed to attract consumers' attention, influence investors' attention and financial markets (i.e., spillover effects). Exploiting the fact that firms often advertise at weekly intervals, we use an instrumental variables approach to provide evidence that print ads, especially in business publications, trigger temporary spikes in investor attention. We further find that trading volume and quoted dollar depths increase on days with ads in a business publication. We contribute to research on how management choices influence firms' information environments, determinants and consequences of investor attention, and consequences of advertising for financial markets.