Aggregate Earnings and Asset Prices

A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross-sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.     

Embedding Sustainability Performance and Long‐Term Strategy in the Earnings Call

The practice of disclosing corporate Environmental, Social and Governance performance information continues to evolve, and the frequency of ESG disclosures in investor‐facing discussions, including Investor Day presentations and non‐deal roadshows, continues to grow. But even with these developments, the corporate‐investor dialogue about ESG and long‐term strategy, and their expected effects on long‐run profitability and value, has continued to lag. This seems particularly evident in the quarterly earnings call. In this article, the authors review the work of NYU's Center for Sustainable Business, in collaboration with Chief Executives for Corporate Purpose (CECP), in encouraging companies to work ESG themes and performance into their quarterly earnings calls. After discussing the reasons for the relatively slow progress in this important disclosure venue, including interviews with sell‐side analysts, the authors propose practical approaches that can guide companies, regardless of industry or market cap, in delivering this content in a way that is valuable to both buy‐side and sell‐side equity analysts.     

Attracting Long‐Term Shareholders

Corporate CEOs often say they don't hear enough from shareholders about strategic issues related to long‐term value creation. At the same time, they claim to hear with predictable regularity from short‐term investors about their success (or failure) in hitting consensus earnings targets. But as the authors of this article begin by noting, there is mounting evidence that companies get the shareholders they deserve—that companies that provide quarterly earnings guidance and otherwise focus investor attention on near‐term earnings targets tend to attract more transient investors. The authors go on to argue that companies with a compelling long‐term vision can expect to benefit not only from more farsighted managerial decision‐making, but also from building a base of longer‐term investors who share management's view of success, and how it can and ought to be achieved. Such a shift in strategic focus and disclosure toward longer‐run performance creates a virtuous cycle—one in which companies that gain the interest and backing of investors with longer horizons end up reinforcing management's confidence to undertake value‐adding investments in their company's future. Even if most companies can't pick their shareholders, they can develop an investor engagement strategy designed to attract long‐term investors. In this article, the chairman and president of FCLTGlobal outline the underlying strategy behind long‐term investor relations and the four key components of such an approach.     

Early Mover Advantages: Evidence From the Long‐Term Care Insurance Market

Researchers frequently question whether financial firms benefit by developing new products because barriers to entry common to other industries generally do not exist. Studies of early mover advantages for new financial products provide mixed evidence at best. We find evidence of early mover advantages in the relatively young market for long‐term care insurance (LTCI) using data that allow broad testing of financial performance. Product differentiation, individual lines exposure, firm size, and traditional health insurance experience also affect financial performance.     

The Long‐Term Effect of the Sarbanes‐Oxley Act on Cross‐Listing Premia

This paper uses a triple difference approach to assess whether the adoption of the Sarbanes‐Oxley Act predicts long‐term changes in cross‐listing premia of affected foreign firms. I measure cross‐listing premia as the difference between the Tobin's q of a cross‐listed company and a non‐cross‐listed company from the same country matched on propensity to cross‐list (first difference). I find that average premia for firms cross‐listed on levels 2 or 3 (subject to SOX) declined in the year of SOX adoption (2002) and remained significantly below their pre‐SOX level through year‐end 2005 (second difference). Firms listed on levels 2 or 3, which are subject to SOX, experienced larger declines in premia than firms listed on levels 1 or 4, which are not subject to SOX (third difference). The estimated decline is 0.15–0.20 depending on specification. Riskier firms and firms from high‐disclosing and high‐GDP countries suffered larger post‐SOX declines. Firm size predicts smaller declines in premia in well‐governed countries. Faster‐growing firms in poorly‐governed countries experienced smaller declines in premia. The results are robust to the use of different before‐and‐after periods; the use of annual, quarterly, or monthly data; the use of individual companies' Tobin's q's instead of matched pairs, and different regression specifications. The overall evidence is consistent with the view that SOX negatively affected cross‐listed premia, and particularly hurt riskier firms and firms from well‐governed countries, while perhaps helping high‐growth firms from poorly‐governed countries. At the same time, after‐SOX, level‐23 firms continue to enjoy a substantial premium, estimated at about 0.32.     

Risk‐Adjusted Long‐Term Contrarian Profits: Evidence from Non‐S&P 500 High‐Volume Stocks

Can trading volume help unravel the long‐term overreaction puzzle? With portfolios of non‐S&P 500 NYSE stocks, we show that (1) both the high‐ and low‐volume (abnormal volume) contrarian portfolios earn a much higher market‐adjusted excess return than the normal‐volume contrarian portfolio, (2) however, when leverage‐induced risk is factored in, excess returns from contrarian portfolios with normal‐ and low‐volume stocks are insignificant, (3) only excess returns from high‐volume contrarian stocks are significant and cannot be explained by the time‐varying risk and return framework, and (4) such high‐volume, risk‐adjusted excess returns arise mainly from winner (glamour) stocks.     

The Economic Significance of Long‐Term Plans

The authors summarize the findings of their event study of the capital market reactions to an inaugural set of 17 CEO presentations of their ‘long‐term plans’ to institutional investors. The findings show that, although sell‐side analysts appear unresponsive to such plans, both trading volumes and stock prices exhibit significant abnormal reactions to the presentations, providing suggestive evidence that the communication of such plans conveys ‘value‐relevant’ information to investors with longer time horizons. Although based on an admittedly small sample, these findings shed light on the promise of long‐term plans and have been corroborated by analysis of the market response to the presentations of 10 more companies since the study was conducted. The authors also provide the outlines of a ‘content framework’ designed to help companies put together effective corporate plans and other long‐term disclosures. The framework is organized around nine main ‘themes,’ including policies governing capital allocation, corporate governance, and human capital development, as well as the statement of corporate purpose. After applying this framework to the 17 CEO presentations, the authors find that the more specific and forward‐looking the information disclosed in these long‐term plans, the more positive the capital market reaction.     

Short‐ and Long‐Term Effects of Multimarket Trading

We analyze short‐ and long‐term effects of multimarket trading by examining the entries of multiple markets into transacting three ETFs, DIA, QQQ, and SPY. We find that large‐scale entries improve overall market quality, while small‐scale entries have ambiguous effects. Our results show that the competition effect dominates the fragmentation effect over a long horizon and that market fragmentation leads to a decline in trading costs. Further, we find that the order handling rules help mitigate the fragmentation effect and facilitate the competition effect. We do not find that multimarket trading harms price efficiency or increases price volatility.     

Long‐ and Short‐Term Cost Efficiency Frontier Evaluation: Evidence from Spanish Local Governments*

This paper analyses the efficiency of Spanish local governments using non‐convex frontier methods. More specifically, it analyses the total cost inefficiency and proposes its decomposition into three additive components: short‐term variable cost inefficiency; capacity utilisation of fixed inputs; and scale inefficiency. The second and third components correspond to the long‐term cost efficiency notion. The proposition is applied to a sample of Spanish municipal councils (municipalities with over 2,000 inhabitants located in Catalonia, the Spanish north‐eastern region). The results confirm the existence of significant cost inefficiency coefficients related to both the long and short term.     

The Determinants of Long‐Term Corporate Debt Issuances

A significant proportion of the debt issued by investment‐grade firms has maturities greater than 20 years. In this paper we provide evidence that gap‐filling behavior is an important determinant of these very long‐term issues. Using data on individual corporate debt issues between 1987 and 2009, we find that gap‐filling behavior is more prominent in the very long end of the maturity spectrum where the required risk capital makes arbitrage costly. In addition, changes in the supply of long‐term government bonds affect not just the choice of maturity but also the overall level of corporate borrowing.     

R&D Increases and Long‐Term Performance of Rivals

We examine how a firm's research and development (R&D) increases affect its intra‐industry competitors in the long run. Consistent with the R&D spillover hypothesis, when a firm unexpectedly increases its R&D spending, its intra‐industry competitors experience improvements in operating performance and analyst forecast revisions and earn positive abnormal stock returns in the long run. The industry concentration, which is related to the firm's strategic reaction, is crucial in determining the magnitude of the R&D spillover effect.     

Labor‐Market Institutions and Long‐Term Effects of Youth Unemployment

Graduating from a school during a time of adverse economic conditions has a persistent, harmful effect on workers’ subsequent employment opportunities. An analysis of panel data from OECD countries during the 1960–2010 periods reveals that a worker who experiences a 1 percentage point higher unemployment rate while the worker is 16–24 years old has a 0.14 percentage point higher unemployment rate at ages 25–29 years and 0.03 percentage points higher at ages 30–34 years. The persistence of this negative effect is stronger in countries with stricter employment protection legislation. A composite index for labor‐market rigidity is constructed and the index is shown to have positive correlation with the persistence. Moderating macroeconomic fluctuations is more important in countries that have more persistent labor‐market entry effects on subsequent outcomes.     

A Long‐Term Perspective on the Determinants of Treasury Bond Stripping Levels

We examine the proportion of individual Treasury bonds held as strips over the entire history of the STRIPS program. First, we document a secular decline in the Treasury bond stripping levels from 1985 to 2010, coincidental with the long‐term decline in the interest rates. This pattern suggests that investors purchase strips to avoid reinvestment risk and to lock in the high interest rates in the 1980s and 1990s. Second, higher coupon and longer maturity bonds are shown to be more heavily stripped. Third, the suspension of new issues of 30‐year bonds from 2001 through 2006 created a gap in the maturity structure of Treasury bonds and induced heavy stripping of 30‐year bonds issued post 2006. Our findings suggest that stripping is motivated by several factors, including interest rate risk management, tax concerns and market completion.     

The Time‐Varying Volatility of Earnings and Aggregate Consumption Growth

Time‐varying specifications for the conditional variance of earnings of U.S. households are estimated with micro data over the period 1968–92. The cross‐sectional mean of the estimated time‐varying uncertainty of individual households has a significant impact on aggregate consumption growth. As such, aggregate precautionary savings may be more important than what is suggested by the results of estimating standard regression equations for aggregate consumption growth that incorporate only lagged income growth and the real interest rate. The estimation of a buffer stock consumption model with time‐varying earnings uncertainty suggests that the precautionary savings motive is cyclical and has become less important in the 1980s.     

Institutional Trade Persistence and Long‐Term Equity Returns

Recent studies show that single‐quarter institutional herding positively predicts short‐term returns. Motivated by the theoretical herding literature, which emphasizes endogenous persistence in decisions over time, we estimate the effect of multiquarter institutional buying and selling on stock returns. Using both regression and portfolio tests, we find that persistent institutional trading negatively predicts long‐term returns: persistently sold stocks outperform persistently bought stocks at long horizons. The negative association between returns and institutional trade persistence is not subsumed by past returns or other stock characteristics, is concentrated among smaller stocks, and is stronger for stocks with higher institutional ownership.     

CEO Overconfidence and Long‐Term Performance Following R&D Increases

We examine the relation between Chief Executive Officer (CEO) overconfidence and significant increases in research and development (R&D) expenditures. Although prior studies reveal a significantly positive market reaction to increases in R&D expenditures in both the long and short run, we find that long‐run stock performance is positive only for firms whose CEOs are not overconfident. Our findings, which may be attributable to overinvestment and the overestimation of future cash flows, imply that R&D resulting from overconfident behavior does not provide any value to firms.     

Long‐Term Return Reversals: Overreaction or Taxes?

Long‐term reversals in U.S. stock returns are better explained as the rational reactions of investors to locked‐in capital gains than an irrational overreaction to news. Predictors of returns based on the overreaction hypothesis have no power, while those that measure locked‐in capital gains do, completely subsuming past returns measures that are traditionally used to predict long‐term returns. In data from Hong Kong, where investment income is not taxed, reversals are nonexistent, and returns are not forecastable either by traditional measures or by measures based on the capital gains lock‐in hypothesis that successfully predict U.S. returns.     

Information and Long‐Term Stock Performance Following Open‐Market Share Repurchases

We find that firm managers have private information when they decide on open‐market share repurchases, and that this information is significantly correlated with announcement period and post‐announcement abnormal returns. We further find that long‐term post‐announcement abnormal returns are related to private information differently for firms that actually repurchase shares when compared to firms that announce a repurchase program but do not acquire shares. Our results indicate that managers’ private information is only ambiguously revealed by the repurchase announcement, and that the market waits for the firm's subsequent actions, such as actual repurchase, to further interpret the private information.     

Estimating the Cost of Capital Using Stock Prices and Near‐term Earnings Forecasts

Earnings‐based valuation models, although long used by finance practitioners, have become increasingly popular among finance academics as well. Among the most important reasons for academics' increased acceptance of earnings‐based valuation is the well‐documented claim that earnings over a short (three‐ to four‐year) forecast horizon tend to capture a large fraction—as much as 80%—of today's value, much more than is captured by near‐term forecasts of free cash flow, the measure long advocated by finance theorists as the basis for DCF valuation. But most important for the purposes of this article, the recognition that such a large percentage of the current values of many public companies is captured within a short forecast horizon has led to a large academic literature that uses earnings‐based valuation models together with current stock prices to “back out” estimates of the companies' implied expected rates of return and costs of equity capital. The effectiveness and precision of such reverse engineering depend on the reliability of the forecasts both within a finite forecast horizon and beyond. And although the models tested in academic work, which are based on large samples of forecasts and hard‐to‐verify assumptions about earnings beyond the forecast horizon, often do not appear to provide useful estimates, the author argues that such reverse engineering of the valuation models should become straightforward and workable once reliable forecasts of earnings are obtained—say, from the corporate (or investment) analysts who are familiar with the operations of the companies they work for (or cover).