A Note on The Cost of Capital and Investment Evaluation For Companies Under the Imputation Tax

The 25 May, 1988, Statement of the Federal Treasurer indicated that superannuation funds are to be taxed at 15% from 1 July, 1988. Also, it has become increasingly clear that the cost of tax arbitrage is not so great that it is going to inhibit or prevent those receiving franked dividends, such as offshore investors, from selling the tax credits associated with such dividends. The net result is that franked dividends have the potential for benefitting all investors irrespective of their tax status. The outcome could substantially reduce company tax for Australian companies which in turn can be expected to have an effect on their before-tax cost of capital and on the after-tax cash flows but not on their before-tax cash flows or their after-tax cost of capital. This effect will increase the value of companies paying franked dividends.     

Tax Shields,Sample-Selection Bias,and the Information Content of Conversion-Forcing Bond Calls

The information content of conversion-forcing bond calls depends on the after-tax cash flow to bondholders. If the dividend after conversion exceeds the after-tax coupon but is less than the before-tax coupon, the call reveals unanticipated decreases in dividends and/or earnings that reduce the tax shield from interest payments. In contrast, a call when the dividend is less than the after-tax coupon reveals the timing of an anticipated shift from exceptional firm-specific positive growth to the industry norm. Efforts to document properties of convertible calls are subject to sample-selection bias because calls are disproportionately associated with positive pre-call firm-specific growth.     

The influence of international status and operating segments on firms’ choice of bonus plans

This paper investigates why firms select different accounting measures of performance when determining executive bonus compensation. Specifically, we investigate whether firms with a greater multinational presence and with more operating segments are more likely to use after-tax bonus plans. Newman (1989) investigated the relation between multinational status and bonus plan choice for the mid-1970s and did not find strong results. However, given the increased global implications of business decisions over the last two decades, it should be beneficial to investigate this issue for a more recent time period. We obtained financial information from 266 firms, 70 with after-tax compensation plans, 186 with before-tax compensation plans, and 10 with hybrid compensation plans. Logistic regression analysis suggests that large firms reporting a large number of operating segments and having a high level of multinational operations are more likely to select after-tax rather than before-tax compensation plans.     

Personal taxes and the time variation of stock returns – evidence from the UK

A potential explanation for the time-series predictability of market returns with dividend yields is the differential tax treatment of capital gains and dividends. This article investigates to what extent the predictability of long-horizon returns can be explained by this tax effect. Assuming that after-tax expected returns are constant, we test the derived relationships between pretax returns and lagged dividend yields with UK data. We also compare the predictability of before-tax long-horizon returns with that of after-tax returns. The results indicate that the tax treatment of dividends does not significantly contribute towards the predictability of stock returns.     

Tax-Efficient Asset Management: Evidence from Equity Mutual Funds

We investigate the relation between tax burdens and mutual fund performance from both a theoretical and an empirical perspective. The theoretical model introduces heterogeneous tax clienteles in an environment with decreasing returns to scale and shows that the equilibrium performance of mutual funds depends on the size of the tax clienteles. Our empirical results show that the performance of U.S. equity mutual funds is related to their tax burdens. We find that tax-efficient funds exhibit not only superior after-tax performance, but also superior before-tax performance due to lower trading costs, favorable style exposures, and better selectivity.     

Are Investors Reluctant to Realize Their Losses?

I test the disposition effect, the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. Their behavior does not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. For taxable investments, it is suboptimal and leads to lower after-tax returns. Tax-motivated selling is most evident in December.     

Capital market equilibrium with heterogeneous investors

As a two-parameter model that satisfies stochastic dominance, the mean-extended Gini model is used to build efficient portfolios. The model quantifies risk aversion heterogeneity in capital markets. In a simple Edgeworth box framework, we show how capital market equilibrium is achieved for risky assets. This approach provides a richer basis for analysing the pricing of risky assets under heterogeneous preferences. Our main results are: (1) identical investors, who use the same statistic to represent risk, hold identical portfolios of risky assets equal to the market portfolio; and (2) heterogeneous investors as expressed by the variance or the extended Gini hold different risky assets in portfolios, and therefore no one holds the market portfolio.     

THE MEASUREMENT OF A FIRM'S COST OF CAPITAL

The relevance of a firm's cost of capital in its investment decisions is widely recognised. The concept and associated issues have been and are likely to be increasingly important in the regulatory activities of government and semi-government bodies, e.g. prices regulation, profit regulation for semi-government enterprises, antitrust and takeover regulation. This paper outlines the principles involved in estimating a firm's before-tax and after-tax cost of capital. The paper also suggests practical approaches that may be taken when difficulties arise in estimating parameters to the problem.     

Direct evidence of dividend tax clienteles

The paper is the first to evaluate the dividend tax clientele hypothesis using a data set of all domestic stock portfolios in the market. We find that investment funds that face a higher effective tax rate on dividend income than on capital gains tilt their portfolios away from dividend-paying stocks. These investors consequently earn a dividend yield that is about 35 basis points lower than that of investors who are tax neutral between dividends and capital gains (pension funds, unit-linked insurance, life insurance). Consistent with tax rules and charter provisions, we also find that private corporations prefer growth stocks, that foundations exhibit strong dividend preferences, and that partnerships rarely hold stocks portfolios.     

Comparison of Mean-Risk Efficient Portfolios in Asia-Pacific Capital Markets

In order to analyze the performance of mean-risk efficient portfolios, several methods of portfolio comparison have been developed. In this paper we analyze the second-order stochastic dominance efficiency of portfolios on the mean-risk efficient frontier assuming that the risk is represented by standard deviations and concordance matrices set up on the basis of Pearson's linear correlation, Spearman's rho, or Kendall's tau. Empirical analysis of the market returns of selected Asia-Pacific stock markets is carried out considering both the U.S. dollar and euro as reference currencies, and different periods: before and during the subprime crisis. Measures and portfolios on the mean-risk efficiency frontier that should be of interest to at least one risk-averse investor are empirically documented.     

Market timing for the individual investor: Using the predictability of long-horizon stock returns to enhance portfolio performance

Recent research indicates that dividend yield and earnings-price ratio can partially predict long-horizon stock returns. We examine whether individual investors can successfully construct timing portfolios based on either of these variables or a measure of the expected market risk premium. The out-of-sample tests in this study require that investors rely only on information that was available at the time of the market-timing decision. Timing portfolios based on the market risk premium show the strongest ability to time the market. We present an economic rationale for the results that is consistent with efficient markets.     

Efficiency and Dynamics of Islamic Investment: Evidence of Geopolitical Effects on Dow Jones Islamic Market Indexes

This paper analyzes both the market quality and price dynamics of a sample group of Islamic indexes. Our results highlight that efficient investment allocation is not compromised by the application of Shariah criteria. However, although few indexes impose an additional liquidity cost on investors, a vast majority of indexes present degrees of liquidity that are similar to conventional indexes. Ultimately, investors whose investment decisions are guided by religious principles do not bear significant additional costs of inefficiency but may have to accept that their portfolios are more sensitive to geopolitical events. However, Islamic indexes may contribute to the international diversification of investors' portfolios.     

Market liberalization and foreign equity portfolio selection in Korea

This study reports that before and after the complete opening of the Korean stock market, foreign equity portfolio selections deviate not only from the market portfolio but also from the portfolio held by domestic institutions. The divergence between foreign investors and domestic institutions is a finding different from that of a previous study on the Swedish market. This study also presents evidence consistent with the view that in the post-crisis deregulation period, foreign investors are most likely fundamental value investors with long-term investment horizons and well diversified portfolios, rather than short-term speculative stock-pickers.     

财务分析师盈利预测的投资价值:来自深沪A股市场的证据

本文研究了中国股票市场上财务分析师的盈利预测信息对投资者是否有价值。我们发现,可以利用公开的盈利预测制定可获利的套头交易策略。套头交易的回报率不仅在统计意义上显著大于零,而且在经济意义上也是显著的。这些结果不受不同的检验方法影响,也无法为我们所考虑到的风险因素所解释。本文的发现说明了中国的股票市场尚未达到Fama(1970)意义上的半强式有效,投资者在投资决策时可以利用分析师的盈利预测以提高其投资的回报。此外,本文的结果也有助于回答中国的财务分析师是否具有专业胜任能力这一颇有争议的问题。     

Weather Risk Hedging in the European Markets and International Investment Diversification

This article analyses weather risk hedging efficiency in three European countries using weather derivatives traded at Chicago Mercantile Exchange (CME) and explores the potential of weather derivatives as a new investment asset to further diversify investors’ portfolios. The results document that the CME European weather contracts are generally effective in hedging the temperature risk in the three European countries. However, for a specific country, weather risk hedging using other countries’ weather indexes is generally not effective. Zero or little correlation among international weather indexes and stock market indexes indicates that weather derivatives should be an efficient investment diversifier. This research provides important insights to both weather risk hedgers and investors.     

Do ETFs provide effective international diversification?

Global investments have been a hot issue for years. Investors can diversify risks and obtain benefits from foreign markets by investing directly in the foreign security market or indirectly in Exchange-Trade Funds (ETFs). Because direct investments are not always feasible, we investigate whether indirect investments can replace direct investments. We create different regional optimal portfolios containing ETFs and ensure optimal asset portfolio allocation. In addition to mean-variance approach, the Sharpe index, we also adopt the Campbell et al. (2001) method to have the efficient frontier under control risks, the Value at Risk. We apply both normal and non-normal distributions for comparisons and find that different assumptions of return distributions affect the results of efficient frontier. The results show that international diversification is a reasonable strategy. In addition, when comparing ETFs and target market index portfolios, ETFs have higher Sharpe measures than target market indices especially in the emerging markets. However, there are no significant performance differences between direct and indirect methods even if we use different performance measures. We also find that the diversification benefits are the same before and after the Subprime crisis. We conclude that it is effective for investors to use indirect methods to create internationally diversified portfolios.     

Mean-variance versus utility maximization revisited: The case of constant relative risk aversion

We examine if mean-variance (M-V) is a good proxy for portfolios based on the Constant Relative Risk Aversion (CRRA) utility function. M-V portfolios are considered good proxies for portfolios from several utility functions which is why they are routinely used in the portfolio theory literature as the benchmark. Our results clearly show this is not the case. Low risk CRRA portfolios are in many cases very different to M-V portfolios, especially with respect to downside risk. If a risk-free asset is available, in many cases, no M-V portfolio is an adequate proxy for CRRA portfolios. The implications of our findings are that: i) M-V portfolios are a poor proxy for investors with CRRA preferences, ii) CRRA portfolios are more suited to investors who care about downside risk than M-V portfolios, and iii) the efficacy of M-V to proxy for utility maximization should be examined more thoroughly.     

DIVERSIFICATION AND SKEWNESS IN OPTION PORTFOLIOS

Skewness in returns is relevant to option investors. Because options possess positively skewed distributions, the traditional maxim of diversification, which can destroy positive skewness, is not necessarily consistent with investment objectives. The results indicate that the majority of skewness in option portfolios is diversified with a relatively small portfolio size, suggesting a strategy of antidiversification for option investors. Even though the investment performance of options is inferior to stocks on a risk-return basis, the data indicate the suitability of option portfolios in an environment where an investor's utility is measured by the return, risk, and skewness of the return distribution.     

Orthogonal Frontiers and Alternative Mean-Variance Efficiency Tests

This paper catalogues properties of minimum norm orthogonal portfolios: portfolios which minimize a quadratic objective function and have returns uncorrelated with those of a candidate portfolio that is not mean-variance efficient. The analysis shows that the dollar versions of these portfolios correspond to estimators of zero beta rates based on alternative statistical criteria and grouping procedures while costless orthogonal portfolios represent candidate mean-variance efficiency tests. It also develops inference procedures for zero and unit net investment portfolios of individual securities (instead of grouped portfolios) that have zero expected betas. The resulting mean-variance efficiency tests are reasonably insensitive to the underlying statistical assumptions.     

Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off

This paper proposes a portfolio choice model in which investors are subject to liquidation risk and (endogenously) face higher costs in the event of joint liquidation (as was observed during the crisis of 2008 to 2009). The risk of joint liquidation creates an incentive for investors to choose heterogeneous portfolios and to rationally forgo diversification benefits. Joint liquidation risk is also reflected in asset prices, resulting in (1) assets with high idiosyncratic risk having low expected returns, and (2) assets that display high correlation with the portfolios of (liquidation‐prone) investors having high expected returns.