Tainted portfolios: How impairment accounting rules restrict security sales

Contrary to claims that fair value accounting exacerbated banks’ securities sales during the recent financial crisis, we present evidence that suggests – if anything – that the current impairment accounting rules served as a deterrent to selling. Specifically, because banks must provide evidence of their ‘intent and ability’ to hold securities with unrealized losses, there are strong incentives to reduce, rather than increase, security sales when market values decline to avoid ‘tainting’ their remaining securities portfolio. Validating this concern, we find that banks incur greater other‐than‐temporary impairment (OTTI) charges when they sell more securities. We then find that banks sell fewer securities when their security portfolios have larger unrealized losses (and thus larger potential impairment charges), and these results are concentrated in banks with homogenous securities portfolios, expert auditors, more experienced managers, and greater regulatory capital slack. Overall, our results suggest that – contrary to critics’ claims – the accounting rules appear to have reduced banks’ propensity to sell their securities during the financial crisis.     

Reference Point Theory and Pursuit of Deals

Target and bidder reference points have separate and joint effects on merger deals. A firm whose stock price is more distant from its 52‐week high reference point is less likely to attract bids but has a greater likelihood of being acquired by its own managers (vs unaffiliated bidders). Firm propensity to submit a bid increases if its prevailing stock price is closer to its 52‐week high. When both parties’ reference points are close to their current stock prices, they are more willing to complete a deal. Hostile deals result when the bidder's stock price is closer to its reference point.     

Thou shalt buy and hold

An investor holding a stock needs to decide when to sell it over a given investment horizon. It is tempting to think that she should sell at the maximum price over the entire horizon, which is however impossible to achieve. A close yet realistic goal is to sell the stock at a time when the expected relative error between the selling price and the aforementioned maximum price is minimized. This problem is investigated for a Black–Scholes market. A stock ‘goodness index’ α, defined to be the ratio between the excess return rate and the squared volatility rate, is employed to measure the quality of the stock. It is shown that when the stock is good enough, or to be precise when α ≥ 1/2, the optimal strategy is to hold on to the stock, selling only at the end of the horizon. Moreover, the resulting expected relative error diminishes to zero when α goes to infinity. On the other hand, one should sell the stock immediately if α ≤ 0. These results justify the widely accepted financial wisdom that one should buy and hold a stock – if it is good, that is.     

The anomalous stock market behavior of small firms in January: Empirical tests for tax-loss selling effects

Small firms experience large returns in January and exceptionally large returns during the first few trading days of January. The empirical tests indicate that the abnormally high returns witnessed at the very beginning of January appear to be consistent with tax-loss selling. However, tax-loss selling cannot explain the entire January seasonal effect. The small firms least likely to be sold for tax reasons (prior year ‘winners’) also exhibit large average January returns, although not unusually large returns during the first few days of January.     

Bank holding company affiliation and market share performance

This study examines the effect of bank holding company affiliation on the market share performance of banks acquired from 1968–1978. The principal focus of the analysis is on banks acquired in markets without other representation by the parent holding company. Among such banks, holding company affiliation appears to have increased the market share of ‘foothold’ banks (i.e., those with relatively small market share) but reduced the market share of large banks. In both cases, however, the quantitative effect of affiliation is estimated to be very small. Thus, bank regulators may not wish to distinguish on the basis of expected market share performance between ‘foothold’ entry and acquisition of a dominant bank when ruling on market-extension acquisition/merger cases.     

Margin trading,short selling,and bond yield spread

Using a quasi-natural experiment, this study examines the effects of margin trading and short selling on bond yield spread in China. It finds that both margin trading and short selling can reduce bond yield spread. Additionally, it finds that margin trading lowers firms’ debt ratios and increases their credit ratings, which explains the reduced spread. In other words, margin trading can impact investors’ decisions by revealing positive information about a firm. Another finding is that short selling lowers the bond yield spread by decreasing earnings management, suggesting that short selling has an impact on investors’ decisions through its effect on corporate governance. Our results suggest that margin trading transmits positive information and short selling impacts firms’ policies. These results provide support for future regulations of margin trading and short selling.     

Excess cash holdings and shareholder value

We examine the determinants of corporate cash holdings in Australia and the impact on shareholder wealth of holding excess cash. Our results show that a trade‐off model best explains the level of a firm’s cash holdings in Australia. We find that ‘transitory’ excess cash firms earn significantly higher risk‐adjusted returns compared to ‘persistent’ excess cash firms, suggesting that the market penalises firms that hoard cash. The marginal value of cash also declines with larger cash balances, and the longer firms hold on to excess cash. The results are consistent with agency costs associated with persistence in excess cash holdings.     

A revised option pricing formula with the underlying being banned from short selling

An important issue in derivative pricing that hasn't been explored much until very recently is the impact of short selling to the price of an option. This paper extends a recent publication in this area to the case in which a ban of short selling of the underlying alone is somewhat less ‘effective’ than the extreme case discussed by Guo and Zhu [Equal risk pricing under convex trading constraints. J. Econ. Dyn. Control, 2017, 76, 136–151]. The case presented here is closer to reality, in which the effect of a ban on the underlying of an option alone may quite often be ‘diluted’ due to market interactions of the underlying asset with other correlated assets. Under a new assumption that there exists at least a correlated asset in the market, which is allowed to be short sold and thus can be used by traders for hedging purposes even though short selling of the underlying itself is banned, a new closed-form equal-risk pricing formula for European options is successfully derived. The new formula contains two distinguishable advantages; (a) it does not induce any significantly extra burden in terms of numerically computing option values, compared with the effort involved in using the Black–Scholes formula, which is still popularly used in finance industry today; (b) it remains simple and elegant as only one additional parameter beyond the Black–Scholes formula is introduced, to reflect the dilution effect to the ban as a result of market interactions.     

Institutional ownership changes and returns around analysts’ earnings forecast release events: Evidence from Taiwan

Traditional data sources do not have institutional holding data on a daily basis. Because of this, most prior empirical studies of institutional herding have focused on quarterly or annual data. The problem, however, with using quarterly or annual data on institutional holdings is that these data may not reveal institutional herding if it occurs over a shorter time interval. For this study, we make use of data from the Taiwan Stock Exchange (TSE). Unlike traditional data sources, the TSE provides daily institutional holdings information. The use of this detailed data allows us to make more interesting analysis and inferences. In this study, we examine the relationship between institutional ownership changes and returns localized around analysts’ earnings forecast release events. Analysis of institutional ownership and return data around the earnings release event allows us to investigate institutional herding and feedback behavior in a different level. Our major results are as follows: (1) there exists a relation between company specific attributes and institutional herding, (2) observed changes in institutional ownership and contemporaneous return are mainly the results of inter-day price impact of herding, (3) institutional investors show evidence of being informed traders in buying but not selling.     

Market manipulation by rumormongers: Evidence from insiders’ stock selling

Using a large sample of data on insiders’ stock selling and rumors about A-share listed companies in China, this study empirically tests whether and how rumors about companies are used to manipulate the market in the context of insiders’ stock selling. We find that the probability of a rumor’s occurrence, especially that of a favorable rumor, significantly increases in the 30 days before the first transaction in a round of insiders’ stock selling and remains high for 30 days afterward, showing clear signs of manipulation. These results are robust to several endogeneity tests. The probability of manipulation via rumor increases with a company’s degree of information asymmetry. In addition, large-scale stock selling, centralized bidding, and transactions involving CEOs or chairmen (or their relatives) have a significantly higher probability of manipulation via rumor, while transactions made by directors, supervisors, or senior executives (but not their relatives) have a significantly lower probability of manipulation via rumor. Further examination shows that using rumor to manipulate the market increases insiders’ transaction returns but leads to stock price reversal in the long term.     

Testing the fire-sale FDI hypothesis for the European financial crisis

Using a panel of corporate transactions in 27 EU countries from 1999 to 2012, we investigate the impact of the financial crisis on the market for corporate assets. In particular, we test the ‘fire-sale FDI’ hypothesis by analyzing the number of cross-border transactions, the price of corporate assets and the impact of credit and macroeconomic conditions. According to the fire-sale FDI hypothesis, countries affected by a crisis attract foreign buyers selling assets at a discount. We find a dampening effect of the crisis on cross-border transactions in all EU countries. Although countries with higher sovereign default risk and lower economic demand attracted more foreign buyers in the crisis, lower domestic credit is associated with less cross-border transactions. Corporate assets in crisis countries are cheaper, particularly if domestic credit is low; however, these findings are not limited to the crisis period. This pattern is strikingly different from the East Asian and Latin American financial crises. Overall, we find little evidence for ‘fire-sale FDI’ suggesting an integrated European market without significant frictions.     

Banking integration and growth: Role of banks' previous industry exposure

Using U.S. interstate banking deregulations, we identify the effect of market-entering banks’ prior industry exposures on the manufacturing sector growth in the new state that they enter. We create banking integration and industry specialization measures that consider both direct (state-pair) as well as indirect (tertiary-state) links created by expanding multi-bank holding company networks. First, consistent with the economic mechanism we have in mind, we observe that banks’ home state's industrial specialization is positively correlated with their lending specialization when participating to in-state as well as out-of-state syndicated loan markets. Then, focusing on industry value added at the state-industry-level, we find evidence consistent with the positive impact of market-entering banks’ prior exposure to a sector on the growth of that industry in the newly-entered state. The observed effect is larger when the state-pair-level discrepancy in sector-specialization is greater. Our findings are robust and hold in capital-related components of industry-level value added. We observe that the above results are more prominent in sectors that are more external finance dependent, have lower amounts of physical capital that can be pledged as collateral, generate more valuable patents, are durables-producers, and have a higher risk. Our findings suggest that a bank integration channel helps shape states’ industrial landscape.     

The determinants of short selling: evidence from the Hong Kong equity market

While most financial regulators agree that short sellers have an important role to play in ensuring an efficiently functioning market, it is interesting to note that many did not hesitate to ban short selling during the recent financial crisis. This apparent contradiction most likely stems from a lack of understanding about what motivates short trading. In this paper, we focus on the determinants of short selling during ‘normal’ trading in the Hong Kong stock market. We find that dividend payments, company fundamentals, risk, option trading, the interest rate spread and past returns and short selling are all significant determinants of short selling.     

Does investor sentiment really matter?

We examine the role sentiment plays and its manifestation in the trading behavior of investors in the U.S. stock market. Our findings support the notion that sentiment-induced buying and selling is an important determinant of stock price variation. While ‘classical’ asset pricing categorizes investors who trade in ways not consistent with mean-variance optimization as ‘irrational,’ we show that this traditional view should not hastily be evoked to characterize sentiment-driven investing. We instead show that sentiment-driven investors can trade against the herd and sell when prices are overinflated as a result of over-bullishness and vice versa. The asset pricing implications of this paper are that sentiment is linked to shifts in risk tolerance and this triggers contrarian-type behavior. In sum, we uncover the following regarding the behavior of sentiment-driven investors; firstly, they are more apt to trade on survey-based indicators rather than market-based indicators. Secondly, they trade on the basis of information extracted from individual, rather than institutional, investor surveys. Thirdly, they respond asymmetrically to shifts in sentiment and trade more aggressively during periods of declining sentiment. Finally, there is asymmetry in the role of sentiment with respect to business conditions whereby such buying and selling is more pronounced during bear markets.     

The unintended consequence of collateral-based financing: Evidence from corporate cost behavior

This paper examines how real estate appreciation correspondingly changes collateral value, which affects debt structure choices and consequent operating decisions. Specifically, we explore whether collateral-based financing provides a link between real estate values and corporate cost behavior. Our baseline results show that an appreciation of a firm’s real estate assets alleviates its cost stickiness. A further analysis shows that this influence is stronger for firms with less prior bank debt, less dependence on external financing, and a lower leverage ratio. We also observe that the impact of collateral shocks on cost stickiness is more pronounced when selling, general and administrative (SG&A) costs create less future value for mature firms and for firms with weaker external governance. Collectively, our results support the argument that an increase in bank debt arising from collateral value appreciation mitigates agency problems and thus lessens cost stickiness.     

Providing liquidity in an illiquid market: Dealer behavior in US corporate bonds

We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers’ holding periods do not decline with a bond's prior trading activity and in fact are lowest for some of the least active bonds. As a result, cross-sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.     

U.S. Audit partner identification and auditor reporting

After a lengthy and protracted debate, the Public Company Accounting Oversight Board (PCAOB) adopted new rules requiring disclosure of the engagement partner’s name and information about other accounting firms on the new PCAOB Form AP, Auditor Reporting of Certain Audit Participants. We investigate the impact of this regulation on auditor behavior in the context of the auditor’s going concern report modification propensity. We document an increase in the propensity to issue a going concern report modification in the disclosure regime, accompanied by a corresponding increase in the Type I (‘false positives’) error rate. Thus, an unintended consequence of Rule 3211 is the potential reduction in the audit report's informativeness. Conceivably, a more significant repercussion is that going concern modifications can hasten bankruptcy for firms since financial institutions may be reluctant to lend money to firms with modified audit reports. An unjustified increase in the going concern modification rate as evinced in our paper may make U.S. capital markets potentially less attractive to young, upstart, albeit financially-distressed, companies.     

Accountants’ Whistle‐Blowing Intentions: The Impact of Retaliation,Age, and Gender

Accounting practices and the role of auditors have been widely implicated in many corporate scandals. Accountants are likely to witness serious wrongdoings at their workplace, presenting them with a difficult choice as to whether or not to whistle‐blow. This study reports online survey results of whistle‐blowing intentions of the members of Certified Practising Accountants of Australia. The study provides data on the effect of threat of retaliation, age and gender on accountants’ propensity to blow the whistle. The results show a complex interaction effect of retaliation, participants’ age, and gender on their propensity to blow the whistle. Among the early career accountants, male accountants are more likely than female accountants to blow the whistle. Accountants in the mid‐age group are not only likely to whistle‐blow when there is retaliation but also tend to be more willing to do so when that retaliation involves a direct personal loss rather than a loss to their associates. Accountants in the age group of 45 years or above respond to retaliation differently depending on their gender. Specifically, female accountants’ propensity to blow the whistle in this age group tends to decline as the retaliation threat increases from weak to strong, yet the change in retaliation threat has little impact on male accountants’ propensity to blow the whistle. These results and their implications are discussed.     

Explaining long waves of capitalist development

Although basic innovations are bunched in a ‘countercyclical’ manner during the depressive phases of long waves, they do not themselves cause the transition to an expansionary boom phase. Explanation of the turning points must be sought elsewhere. Eong-term changes in the average rate of profit are the main cause of fluctuations in the system, but these are related to other fundamental features of the capitalist mode of production. Whereas the upper turning points from the boom to the depressive phase are determined largely by endogenous factors, especially the rise in the organic composition of capital (growth of capital intensity), this is not true of the lower turning points. Exogenous ‘system shocks’ of various kinds are needed to propel the system out of the depressive phase. This is the arena of acute social and political struggles, whose outcome is by no means mechanistically predetermined.     

Short‐selling pressure and last‐resort debt finance: evidence from 144A high‐yield risk‐adjusted debt

This study examines why non‐financial publicly traded firms knowingly issue wealth destroying Rule 144A debt, which is associated with a negative announcement return and a higher yield. We provide a plausible ‘demand‐side’ explanation (i.e. last‐resort debt financing) for the motivation for issuing such debt. We also provide evidence as to what drives this negative reaction. Our findings suggest that the negative market impact is mainly driven by short‐selling pressure from convertible bond arbitrageurs.