Inflation,real returns and capital investment

We find evidence for the hypothesis of Mundell (1963) and Tobin (1965) that the expected real return component of interest rates is negatively related to the expected inflation component. In the Mundell-Tobin model, the variation in expected real returns is caused by the variation in expected inflation. Our evidence suggests, however, that the variation in expected real returns is more fundamentally an outcome of the capital expenditures process. Equilibrium expected real returns vary directly with capital expenditures in order to induce equilibrium allocations of resources between consumption and investment. This positive relation between expected real returns and real activity, which comes out of the real sector, combines with a negative relation between expected inflation and real activity, which is traced to the monetary sector, thus inducing the negative relation between expected inflation and expected real returns predicted by Mundell and Tobin but explained in terms of a model much different from theirs.     

Productivity,restructuring, and the gains from takeovers

This paper investigates how takeovers create value. Using plant-level data, I show that acquirers increase targets' productivity through more efficient use of capital and labor. Acquirers reduce capital expenditures, wages, and employment in target plants, though output is unchanged. Acquirers improve targets' investment efficiency through reallocating capital to industries with better investment opportunities. Moreover, changes in productivity help explain the merging firms' announcement returns. The combined announcement returns are driven by improvements in target's productivity. Targets with greater productivity improvements receive higher premiums. These results provide some first empirical evidence on the relation between productivity and stock returns in takeovers.     

Dynamics of Asset Prices and Transaction Activity in Illiquid Markets: the Case of Private Commercial Real Estate

This paper investigates the relationship between capital flows, turnover and returns for the UK private real estate market. We examine a number of possible implications of capital flows and turnover on capital returns testing for evidence of a price pressure effect, ‘return chasing’ behaviour and information revelation. The main tool of analysis is a panel vector autoregressive (VAR) regression model in which institutional capital flows, turnover and returns are specified as endogenous variables in a two equation system in which we also control for macro-economic variables. Data on flows, turnover and returns are obtained for the ten market segments covering the main UK commercial real estate sectors. Our results do not support the widely-held belief among practitioners that capital flows have a ‘price pressure’ effect on property prices. However, we do find a significant positive relationship between lagged turnover and contemporaneous capital returns, suggesting that asset turnover provides increased price revelation which, in turn, reduces investment risk and increases property values.     

Transaction Frequency and Commercial Property

Metrics using repeat sale data assume that frequently and infrequently sold properties are similar in capital expenditures, maintenance and other characteristics. Value-added investors concentrate on repositioning properties which requires capital investment and managerial skills. Returns using repeat sales likely overstate appreciation by misattributing this investment. Present results show that frequently and infrequently traded properties represent different property populations. The first sale of a repeat transaction sells at a significant discount compared to single sale properties while the second sale transacts at a premium. The results suggest that repeat sale indices may overstate price appreciation and represent returns for a different, relatively small cohort of properties when compared to the large number of properties that transact only once during a specific time period.     

Corporate capital expenditure decisions and the market value of the firm

This paper is an ‘event-time’ study of the common stock prices of a sample of 658 corporations around the dates on which they publicly announced their future capital expenditure plans. For industrial firms, announcements of increases (decreases) in planned capital expenditures are associated with significant positive (negative) excess stock returns. For public utility firm, neither increases nor decreases in planned capital expenditures are associated with significant excess stock returns. We interpret the evidence as being consistent with the hypothesis that managers seek to maximize the market value of the firm in making their corporate 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.     

Government financing decisions and asset returns

This paper presents an empirical investigation of the relation between government financing decisions and asset returns. In particular, the focus is on whether a substitution of debt financing for tax financing of a given level of expenditures is associated with an increase in interest rates. The paper brings a different perspective to empirical investigations of government fiscal policies by examining the response of asset prices in an efficient capital market to such policies rather than focusing on aggregate consumption behavior. The results are consistent with the idea that asset prices are unrelated to how the government finances its expenditures. The results, however, also indicate that the capital market is not indifferent with respect to the level of government expenditures as higher interest rates are associated with increases in government purchases.     

R&D expenditures and implied equity risk premiums

This study investigates the relationship between research and development (R&D) expenditures and risk premiums implied in the costs of equity capital. We posit that R&D expenditures represent an information risk factor resulting from both information asymmetry about R&D between investors and managers and low-quality R&D reporting that impairs the coordination between investors and managers with respect to managers’ investment decisions. Our results support our position by showing a positive association between R&D expenditures and implied equity risk premiums. From this research along with prior studies, investors can have better knowledge about the risky nature of R&D expenditures that drive up implied risk premiums and at the same time provide opportunities to earn excess returns in a short to long horizon. Accounting standard setters can benefit from this study’s findings that R&D expenditures represent an off-balance-sheet risk factor and thus warrant reconsidering SFAS No. 2 for potential capitalization of R&D expenditures.     

A Test of the Debt-Monitoring Hypothesis: The Case of Corporate R&D Expenditures

Studies that test for shareholder wealth effects of announcements of plans to increase R&D expenditures find an average positive effect, but also a significant cross-sectional variation. This study determines whether the effect can be predicted when the announcing firm's capital structure is considered. Results suggest a positive relation between the debt ratio and the R&D induced abnormal stock returns. These results are robust using different industry-adjusted and unadjusted measures of capital structure and while controlling for several potentially influential variables. In addition, the gains to shareholders do not seem to be wealth transfers from bondholders. This evidence provides support to the debt-monitoring hypothesis.     

How Firms Make Capital Expenditure Decisions: Financial Signals, Internal Cash Flows, Income Taxes and the Tax Reform Act of 1986

This paper empirically assesses the determinants of future net capital expenditures for a broad cross-section of COMPUSTAT firms from 1973 to 1989. We explore three general categories of factors expected to affect investment: (1) external equity financing, (2) internally generated accounting information, and (3) tax incentives. We find that external financing and information plays a role in that both positive stock returns and equity issuances indicate future increases in investment. The results suggest that high stock prices not only lower the cost of capital, but also signal good investment opportunities. Accounting information about internal sources and uses of funds are also important in the investment decision. In particular, net income and depreciation are positive indicators of future investment while there is a tradeoff between the payment of dividends and investment. Further, positive changes in available cash liquidity also motivate future investment. While taxes are not important in the investment decision on average, we find that firms with previously higher income taxes invested substantially more in 1985 and 1986. This coincides with the repeal of the investment tax credit and the accelerated depreciation schedules in the Tax Reform Act of 1986. We view this as evidence that federal tax policy in the 1980's induced firms with high income tax obligations to accelerate capital expenditures just before the favorable tax treatment of capital expenditures was eliminated.     

The Relationship between Energy Taxation and Business Environmental Protection Expenditures in the European Union

Businesses are often subject to energy taxes that impose a charge on greenhouse gas emissions. Theoretically, energy taxes should motivate business spending on emissions abatement up to the point that, at the margin, the cost of reducing emissions equals the amount of the tax that is avoided. We use European Union (EU) data from 2001 to 2008 to test the hypothesized positive relationship between energy taxes and business spending on abatement initiatives for the protection of ambient air and climate. We find that while overall business spending and business investment expenditures are positively related to energy tax rates, current period expenditures are not related to energy tax rates.Supplemental analyses indicate that the imposition of the EU Emissions Trading Scheme (ETS) in 2005 affected these relationships. In the pre-ETS period, energy taxes were not related to overall business spending or to current period expenditures, but there was a significant positive relationship between energy taxes and investment expenditures. After the ETS was introduced, there was a significant positive relationship between energy tax rates and both overall business spending and business current period abatement expenditures, but the relationship between business investment spending and energy tax rates was not significant.Our results indicate that energy taxes are effective in motivating business spending on emissions abatement. However, the nature of the effect varies across investment spending and current period expenditures. As both long-term and current initiatives are necessary to meet abatement goals, policymakers should be aware of these differences.     

The Vote Is Cast: The Effect of Corporate Governance on Shareholder Value

This paper investigates whether improvements in the firm's internal corporate governance create value for shareholders. We analyze the market reaction to governance proposals that pass or fail by a small margin of votes in annual meetings. This provides a clean causal estimate that deals with the endogeneity of internal governance rules. We find that passing a proposal leads to significant positive abnormal returns. Adopting one governance proposal increases shareholder value by 2.8%. The market reaction is larger in firms with more antitakeover provisions, higher institutional ownership, and stronger investor activism for proposals sponsored by institutions. In addition, we find that acquisitions and capital expenditures decline and long‐term performance improves.     

On the relation between expected returns and implied cost of capital

We examine the relation between implied cost of capital and expected returns under an assumption that expected returns are stochastic, a property supported by theory and empirical evidence. We demonstrate that implied cost of capital differs from expected return, on average, by a function encompassing volatilities of, as well as correlation between, expected returns and cash flows, growth in cash flows, and leverage. These results provide alternative explanations for findings from empirical studies employing implied cost of capital on the magnitude of the market risk premium; predictability of future returns; and the relations between cost of capital and a host of firm characteristics, such as growth, leverage, idiosyncratic risk and the firm’s information environment.     

Do Tax Law Changes Influence Ex-Dividend Stock Price Behavior? Evidence from 1926 to 2005

We test the Elton and Gruber model of ex-dividend stock pricing over a period spanning all US tax law changes since 1926. Our results indicate that price drop ratios (ΔP/D) and ex-day returns are related to dividend and capital gains tax rates in the theorized manner. Consistent with tax clienteles, we also find that ex-day price movements of higher dividend yield stocks are driven more by corporate tax rates, while lower yield stocks are more influenced by personal rates. Finally, we demonstrate that the positive relationship between ΔP/D and the dividend yield becomes stronger as the tax differential | t_d− t_cg | widens.     

Stock Liquidity and Investment Opportunities: Evidence from Index Additions

We examine the relation between stock liquidity and investment opportunities in a sample of firms experiencing an exogenous liquidity shock. We find a positive relation between changes in capital expenditures and changes in stock liquidity, indicating that stock liquidity influences corporate investment decisions. This relation is robust to alternative measures of growth opportunities, and is consistent with a liquidity premium in equity returns. That is, an increase in liquidity effectively expands the set of positive NPV projects because it reduces the cost of capital. The results suggest that liquidity-enhancing events benefit shareholders by increasing the pool of viable growth opportunities.     

Drug approval decisions: A note on stock liquidity effects

We analyze the relationship between positive stock returns, changes in trading activities, and liquidity improvements following drug approval announcements. Using a unique hand-collected data set on approval decisions in Europe, we find that stock liquidity does change. Stocks temporarily exhibit strong abnormal trading volume, lower spreads, and permanently become more liquid. Our results suggest that the initial positive wealth effect of a new drug release reflects both positive information content and liquidity improvements.     

Does Idiosyncratic Risk Matter for Individual Securities?

This paper investigates the relationship between idiosyncratic risk and returns for individual securities within a generalized autoregressive conditional heteroskedascticity (GARCH)‐in‐mean framework. We demonstrate that, on average, 15% of stocks exhibit a significant relationship between returns and risk, of which 9% are positive. These proportions vary over time and with model specifications. Some characteristics influence the probability of a positive and a negative relationship, while others appear to affect only one, but not the other. This evidence implies that the factors that explain a positive connection between idiosyncratic risk and returns are different from the factors that explain a negative connection.     

Improving the Health of Healthcare Companies

The healthcare sector has been extremely effective in improving human health while at the same time delivering outstanding returns to shareholders, at least on average. But averages can hide a lot of poor performance, and careful examination of the sector shows a sizable disparity between the long‐run productivity and value added of the top companies and the rest. To better understand the reasons for this disparity, the authors undertook a comprehensive study of how differences in capital deployment strategies, financial policies, and measures of corporate operating performance such as sales growth and return on capital are associated with returns to shareholders. Perhaps the most striking finding is the strong positive correlation in the healthcare industry between higher rates of reinvestment, especially in the form of spending on R&D and acquisitions, and stock price performance. And given the importance of such reinvestment, it is not surprising that maintaining financial flexibility by paying down net debt and otherwise limiting corporate leverage—and even issuing significant equity—are all associated with higher stock returns. When it comes to operating performance, moreover, it's not enough just to be good; it takes growth and improvement in cash flow and earnings to drive share prices higher. Measures of changes in performance such as increases in EBIT and ROIC, and high rates of growth in sales, all show consistently strong and positive relationships with stock returns while measures of levels of performance, especially EBIT margins and EBITDA margins, demonstrate relationships that are weak and in some cases even negative. Last, and consistent with the findings reported above, despite often vocal investor demands to pay dividends and buy back shares, in the case of healthcare as a whole such distributions have a clearly inverse relationship with share price performance. That is to say, the larger the payouts to shareholders, the lower the shareholder returns.     

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.     

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.