Entry, exit, market makers, and the bid-ask spread

The probability of entry and exit of dealers on the NASDAQ NationalMarket (NNM) is significantly affected by trading intensity,volatility and the quoted bid-ask spread. Entry and exit ofmarket makers is a pervasive phenomenon. Large-scale entry (exit)is associated with substantial declines (increases) in quotedend-of-day inside spreads, even after controlling for the effectsof changes in volume and volatility. The spread changes arelarger in magnitude for issues with few market makers; however,even for issues with a large number of market makers, substantialchanges in quoted spreads take place. The results are consistentwith the competitive model of dealer pricing.     

Prestige,Promotion, and Pay

We develop a theory in which financial (and other professional services) firms design career structures to “sell” prestigious jobs to qualified candidates. Firms create less prestigious entry-level jobs, which serve as currency for employees to pay for the right to compete for the more prestigious jobs. In optimal career structures, entry-level employees (“associates”) compete for better-paid and more prestigious positions (“managing directors” or “partners”). The model provides new implications relating job prestige to compensation, employment, competition, and the size of the financial sector.     

Youth-led social change: Topics,engagement types,organizational types,strategies, and impacts

This paper provides a framework for evaluating youth-led social change. The framework considers: seven topics (e.g., environment, human health and safety, and education); nine engagement types (e.g., volunteerism, research and innovation, and political engagement); six organizational types (e.g., advisory body, social enterprise, and individual); three strategies (socialization, influence, and power); and three scales of impacts (individual, community/inter-organizational, and national/international). Using this framework, empirical research provides evidence of how youth – defined as young people 15–24 years of age – have been agents of change in Canada over the 35 years from 1978 to 2012. A media content analysis of 264 articles, combined with frequency and chi-square tests, were completed to study the factors and the relationships among them. The results show a strong relationship between the impact and the strategy, topic, engagement type, and organizational type. The results also show a strong relationship between the strategy and the impact, engagement type and organizational type. The findings have implications for youth leaders and those who advocate for, work with, support, and educate them, and for those interested in evaluating social change efforts.     

JRI, JF, and the Internet: Coauthors, New Authors, and Empirical Research

This article examines how the Internet has changed the work of academic researchers and addresses the question of how expanded Internet usage has affected Journal of Risk and Insurance (JRI) and Journal of Finance (JF) articles, including the shift to empirical research, joint authorship, and new authorship. Internet availability significantly increased joint authorship overall (more for JF than for JRI), shifting upwards a strong secular trend toward working with other researchers. Another big impact of the Internet has been to increase the number of new authors (more for JRI than for JF).     

Causal Relations Among Stock Returns,Interest Rates,Real Activity,and Inflation

Using a multivariate vector-autoregression (VAR) approach, this paper investigates causal relations and dynamic interactions among asset returns, real activity, and inflation in the postwar United States. Major findings are (1) stock returns appear Granger-causally prior and help explain real activity, (2) with interest rates in the VAR, stock returns explain little variation in inflation, although interest rates explain a substantial fraction of the variation in inflation, and (3) inflation explains little variation in real activity. These findings seem more compatible with Fama (1981) than with Geske and Roll (1983) or with Ram and Spencer (1983) .     

Capital taxation,investment, growth,and welfare

This paper formulates a model of economic growth to study the effects of broad capital taxation (of profits, dividends, and capital gains) on macroeconomic outcomes in small open economies. A framework of exogenous growth permits modeling countries in transition to a country-specific steady state and to discern steady-state and transitory effects of shocks on economic outcomes. The chosen framework is amenable to structural estimation and, in view of the parsimony of the model, fits data on 79 countries over the period 1996–2011 well. The counterfactual analysis based on the estimated model suggests that capital-tax reductions induce positive effects on output and the capital stock (per unit of effective labor) that are economically significant and are accommodated within time windows of 5 years without much further economic response after that. The responses of economic aggregates are found to be relatively strongest to changes in corporate-profit-tax rates and weaker for dividend and capital-gains taxes.     

Housing, Health, and Annuities

Annuities, long-term care insurance (LTCI), and reverse mortgages appear to offer important consumption smoothing benefits to the elderly, yet private markets for these products are small. A prominent idea is to combine LTCI and annuities to alleviate both supply (selection) and demand (liquidity) problems in these markets. This article shows that if consumers typically liquidate home equity only in the event of illness or very old age, then LTCI and annuities become less attractive and may become substitutes rather than complements. The reason is that the marginal utility of wealth drops when an otherwise illiquid home is sold, an event correlated with the payouts of both annuities and LTCI. Simulations confirm that demand for LTCI and annuities is highly sensitive to the liquidity and magnitude of home equity.     

Transactions, volume, and volatility

We show that the positive volatility-volume relation documentedby numerous researchers actually reflects the positive relationbetween volatility and the number of transactions. Thus, itis the occurrence of transactions per se, and not their size,that generates volatility; trade size has no information beyondthat contained in the frequency of transactions. Our resultssuggest that theoretical research needs to entertain scenariosin which (i) both the frequency and size of trades are endogenouslydetermined, yet (ii) the size of trades has no information contentbeyond that contained in the number of transactions.     

Sequential Sales,Learning, and Cascades

When IPO shares are sold sequentially, later potential investors can learn from the purchasing decisions of earlier investors. This can lead rapidly to “cascades” in which subsequent investors optimally ignore their private information and imitate earlier investors. Although rationing in this situation gives rise to a winner's curse, it is irrelevant. The model predicts that: (1) Offerings succeed or fail rapidly. (2) Demand can be so elastic that even risk-neutral issuers underprice to completely avoid failure. (3) Issuers with good inside information can price their shares so high that they sometimes fail. (4) An underwriter may want to reduce the communication among investors by spreading the selling effort over a more segmented market.     

Investment, Uncertainty, and Liquidity

We analyze the dynamic investment decision of a firm subject to an endogenous financing constraint. The threat of future funding shortfalls lowers the value of the firm's timing options and encourages acceleration of investment beyond the first‐best optimal level. As well as highlighting another way by which capital market frictions can distort investment behavior, this result implies that (1) the sensitivity of investment to cash flow can be greatest for high‐liquidity firms and (2) greater uncertainty has an ambiguous effect on investment.     

Accruals,Cash Flows,and Equity Values

We find, as predicted, that the differential ability of accrual and cash flow components of earnings to help forecast future abnormal earnings and the persistence of the components result in the components having different valuation implications. We base our tests on Ohlson (1999) applied to fourteen industries. We find: (1) Accruals and cash flows aid in forecasting future abnormal earnings incremental to abnormal earnings and equity book value. (2) Accruals and cash flows provide explanatory power for equity market value incremental to equity book value and abnormal earnings. (3) There is evidence that accruals and cash flows valuation coefficients are consistent with the Ohlson model.     

Stock returns,order imbalances,and commonality: Evidence on individual,institutional, and proprietary investors in China

Using a unique dataset from the Shanghai Stock Exchange, we study the relation between daily open-to-close stock returns and order imbalances, and the commonality in order imbalances across individual, institutional, and proprietary investors. We find that institutional (proprietary) order imbalances have a larger price impact, but account for a significantly smaller proportion of daily price fluctuations. Commonality is much stronger for individual, rather than institutional (proprietary), order imbalances. Institutional (proprietary) investors favor large capitalization stocks, and co-movement in institutional (proprietary) order imbalances is stronger for these stocks.     

Disappearing Dividends, Catering, and Risk

Fama and French (2001a) show that the propensity to pay dividendsdeclines significantly between 1978 and 1999. We examine this"disappearing dividends" puzzle through the lens of risk andreport two main findings: (i) Risk is a significant determinantof the propensity to pay dividends, and it explains roughly40% of disappearing dividends; (ii) We find little support forthe view that disappearing dividends reflects firms' cateringto transient fads for dividends. Absent risk controls, proxiesfor fads matter, but these proxies are insignificant once wecontrol for risk. Our results are robust to an extensive batteryof robustness tests that vary samples, time periods, proxiesfor fads, the types of empirical tests, and the nature of payoutdecisions made by firms.     

Investment,agency conflicts,debt maturity,and loan guarantees by negotiation

We consider an irreversible investment, of which the sunk cost is financed by a finite-term debt after entering into an option-for-guarantee swap (OGS) with negotiation. The OGS is a three-party agreement among a lender (bank), an insurer, and a borrower (entrepreneur), where the bank lends at a given interest rate to the entrepreneur and if the borrower defaults on debt, the insurer must pay all the principal and remaining interests to the lender instead of the borrower. In return for the guarantee, the borrower must allocate a perpetual American call option to purchase a fraction (guarantee cost) of his equity at a given strike price. We find that the investment threshold decreases but the exercise threshold of the insurer’s option increases with the borrower’s bargaining power. Both the investment and exercise threshold increase with debt maturity, but there is a U-shaped relation between the guarantee cost and debt maturity. The borrower postpones investment once the funding gap or project risk increases. The swap may overcome the inefficiencies from asset substitution and debt overhang, strongly depending on the debt maturity and borrower’s bargaining power.     

Banks, markets, and efficiency

A competitive financial system can help reduce banks’ monopoly power and the associated inefficiencies. However, according to Diamond (J Polit Econ 105: 928–956, 1997) and Fecht (J Eur Econ Assoc 6(2), 2004) competition with the financial sector may also constrain the amount of liquidity insurance that banks can provide to households affected by unobservable idiosyncratic liquidity shocks. To study this trade-off, we model competition between banks and between banks and financial markets. Our analysis shows that competition between banks and financial markets can constrain the risk-sharing offered by deposit contracts. This effect is the same if competition between banks mainly affects the reallocation of deposits. However, if banking competition primarily affects new deposits, then such competition only limits inefficient monopoly rents without restraining risk-sharing. We would like to thank Diemo Dietrich, Phil Dybvig, Hans Peter Grüner, Martin Hellwig, Elu von Thadden, Uwe Vollmer, Wolf Wagner as well as seminar participants at the Bundesbank, at the University of Mannheim, at the University of Tilburg, at the 3rd Workshop on Monetary and Financial Economics in Halle, at the University of Lausanne, at the First ProBanker Symposium in Maastricht, at the Global Finance Conference 2005 in Dublin, at the European Economic Association Meeting 2005 in Amsterdam, at the International Finance Conference 2005 in Copenhagen, and at the German Economic Association Meeting 2005 in Bonn. We thank Mike Demott for editorial assistance. The views expressed here are those of the authors and not necessarily those of the Deutsche Bundesbank, the Federal Reserve Bank of New York, or the Federal Reserve System.     

Law,Finance, and Economic Growth

This paper examines how the legal environment affects financial development, and then asks how this in turn is linked to long-run economic growth. Financial intermediaries are better developed in countries with legal and regulatory systems that (1) give a high priority to creditors receiving the full present value of their claims on corporations, (2) enforce contracts effectively, and (3) promote comprehensive and accurate financial reporting by corporations. The data also indicate that the exogenous component of financial intermediary development—the component defined by the legal and regulatory environment—is positively associated with economic growth. Journal of Economic Literature Classification Numbers: G21, K12, O16     

Accounting Practices and the Market Valuation of Accounting Numbers: Evidence from Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand

This study examines the relation between stock prices and accounting earnings and book values in six Asian countries: Indonesia, South Korea, Malaysia, the Philippines, Taiwan, and Thailand. The analysis is based on a residual earnings model that expresses the value of the firm in terms of book value and residual income. The model holds for any clean surplus accounting system. However, for finite time horizons, biased accounting may affect model estimates. The six countries examined in this study differ in faithfulness to clean surplus accounting as well as bias (conservatism). The study addresses two questions. First, are there systematic differences across countries in the value relevance of accounting, and are these differences related to accounting differences? Second, are there systematic differences in the incremental and relative information content of book value per share (BVPS) and abnormal (residual) earnings per share (REPS) across the countries, and are such differences related to accounting differences? We find differences across the six countries in the explanatory power of BVPS and REPS for firm values. Explanatory power for Taiwan and Malaysia is relatively low while that for Korea and the Philippines is relatively high. These differences are generally consistent with differences in accounting practice; however, since Korean accounting practice is strongly influenced by tax law, we did not expect the high association for Korea. Second, with respect to the incremental and relative explanatory power of BVPS and REPS, we find BVPS to have high explanatory power in the Philippines and Korea but little in Taiwan. In all six countries REPS has less explanatory power than BVPS in most years. Again, the evidence may be interpreted as suggesting accounting practice affects valuation (with Korea again as the exception). Finally, we provide evidence on the sensitivity of the timing of comparisons of stock prices and accounting values. We find that comparing prices at year-end (even though annual accounting information has not been released at that time), in general, provides the highest correlation between market and accounting numbers.     

Trade credit,collateral liquidation,and borrowing constraints

Assuming that firms’ suppliers are better able to extract value from the liquidation of assets in default and have an information advantage over other creditors, the paper derives six predictions on the use of trade credit. (1) Financially unconstrained firms (with unused bank credit lines) take trade credit to exploit the supplier's liquidation advantage. (2) If inputs purchased on account are sufficiently liquid, the reliance on trade credit does not depend on credit rationing. (3) Firms buying goods make more purchases on account than those buying services, while suppliers of services offer more trade credit than those of standardized goods. (4) Suppliers lend inputs to their customers but not cash. (5) Greater reliance on trade credit is associated with more intensive use of tangible inputs. (6) Better creditor protection decreases both the use of trade credit and input tangibility.     

Money,Bargaining, and Risk Sharing

We investigate the dual role of money as a self‐insurance device and a means of payment when perfect risk sharing is not possible, and when the two roles of money are disentangled. We use a variant of Lagos–Wright (2005) where agents face a risk in the centralized market (CM): in the decentralized market (DM) money’s main role is as a means of payment, while in the CM it is as a self‐insurance device. We show that state‐contingent inflation rates can improve agents’ ability to self‐insure in the CM, thereby improving the terms of trade in the DM. We then characterize the optimal monetary policy.