Incremental Information Content of the Change in the Percent of Production Added to Inventory*

Abstract. Manufacturing firms can manipulate income by producing in excess of the quantity needed to meet current period demand, thereby allocating part of current period fixed manufacturing overhead costs from cost of goods sold to inventory. Because it is subject to manipulation, the component of earnings due to producing in excess of sales may be of lower quality than the remaining component of earnings. We investigate this possibility using a regression of security returns on unexpected income and an estimate of the change in percent of production added to inventory (CPAI). An analytical model indicates that CPAI determines the “earnings surprise” subject to manipulation by overproducing. Assuming the market recognizes this, the coefficient on CPAI should be negative because this low quality component must be deducted from the total “good news” conveyed by the change in reported earnings. Alternatively, CPAI may convey good or bad news to the market that is unrelated to the manipulation of current period earnings. Firms may increase the percent of production added to inventory in anticipation of high levels of future sales. In this case, the estimated coefficient on CPAI should be positive. Or, if the increase in the percent of production added to inventory reflects anticipation of a strike or an unexpected downturn in current sales, the estimated coefficient should be negative. Cross-sectional tests using a large sample of manufacturing firms indicate a significant positive relation between security returns and CPAI. This finding is consistent with market participants viewing CPAI as a leading indicator of firm performance. Although the results are most supportive of CPAI conveying good news, there is some evidence that CPAI is used by managers to smooth earnings and, for firms classified as smoothing earnings, there is weak evidence that the component of earnings related to CPAI is viewed by market participants to be of lower quality.     

Short-Sales Constraints and Price Discovery: Evidence from the Hong Kong Market

Short‐sales practices in the Hong Kong stock market are unique in that only stocks on a list of designated securities can be sold short. By analyzing the price effects following the addition of individual stocks to the list, we find that short‐sales constraints tend to cause stock overvaluation and that the overvaluation effect is more dramatic for individual stocks for which wider dispersion of investor opinions exists. These findings are consistent with Miller's (1977) intuition and other optimism models. We also document higher volatility and less positive skewness of individual stock returns when short sales are allowed.     

Subprime Mortgage Defaults and Credit Default Swaps

We offer the first empirical evidence on the adverse effect of credit default swap (CDS) coverage on subprime mortgage defaults. Using a large database of privately securitized mortgages, we find that higher defaults concentrate in mortgage pools with concurrent CDS coverage, and within these pools the loans originated after or shortly before the start of CDS coverage have an even higher delinquency rate. The results are robust across zip code and origination quarter cohorts. Overall, we show that CDS coverage helped drive higher mortgage defaults during the financial crisis.     

ARE LONGER SCHOOL SESSIONS A GOOD INVESTMENT?

Educational reform for elementary and secondary schools has become a major industry in the past three years. At the national and state levels, commissions and legislatures have begun to act (e.g., National Commission on Excellence in Education 1983; Task Force on Education for Economic Growth 1983; Griesemer and Butler 1983; U.S. Department of Education 1984). One central recommendation of these reports is to adopt longer school days and longer school years. The most publicized of the reports, "A Nation at Risk," called for seven-hour school days in place of the present five to six hours, and 200-to-220-day school years in place of the typical 180 days at present (National Commission on Excellence in Education 1983, 29). In response, some states have increased already both daily and annual school sessions (U.S. Department of Education 1984). For example, California appropriated $257 billion in 1984 to increase the amount of instruction by about 5 percent.     

Optimal Hedging under Intertemporally Dependent Preferences

This paper examines optimal hedging behavior in a market where preferences for current consumption are partly determined by the consumer's past consumption history. The model considers an individual exposed to price risk, who allocates wealth between consumption and futures contracts over a (continuous-time) finite planning horizon. The speculative component of the hedge ratio is shown to be smaller and the consumption path smoother than in models where preferences are separable over time. Some comparative-static properties of the hedge ratio are also examined.     

Partial Identification in Monotone Binary Models: Discrete Regressors and Interval Data

We investigate identification in semi-parametric binary regression models, y = 1( x β +υ+ε > 0) when υ is either discrete or measured within intervals. The error term ε is assumed to be uncorrelated with a set of instruments z , ε is independent of υ conditionally on x and z , and the support of − ( x β +ε) is finite. We provide a sharp characterization of the set of observationally equivalent parameters β . When there are as many instruments z as variables x , the bounds of the identified intervals of the different scalar components β _k of parameter β can be expressed as simple moments of the data. Also, in the case of interval data, we show that additional information on the distribution of υ within intervals shrinks the identified set. Specifically, the closer the conditional distribution of υ given z is to uniformity, the smaller is the identified set. Point identified is achieved if and only if υ is uniform within intervals.