Short term real earnings management prior to stock repurchases

This study examines whether firms engage in income-decreasing real earnings management before open market stock repurchases to reduce the cost of stock buybacks. In the short run, managers have the ability to underproduce inventory and increase discretionary expenditures, thus decreasing current period earnings. We find that managers engage in both of these activities before repurchasing their firms’ shares, especially the latter. Also, companies increase their discretionary spending before making repurchases to a greater extent following the passage of the Sarbanes–Oxley Act of 2002 as well as when they are financially healthy and have high marginal tax rates. Finally, we document that firms with the most income-decreasing real earnings management experience the largest positive abnormal returns during the subsequent period. Our findings highlight the importance of considering firms’ use of real operating decisions, as opposed to just opportunistic disclosure practices, around significant corporate events, such as the repurchase of their own stock.     

Measuring the effect of watch-preceded and direct rating changes: a note on credit markets

This paper analyzes the importance of distinguishing between watch-preceded and direct rating changes for the credit default swap (CDS) market by examining a total of 2991 rating change announcements, 1526 watchlist placement announcements, and 430 rating affirmations following watchlist placements. The results show that watch-preceded downgrades do not lead to significant CDS market reactions, while direct downgrades are associated with a significant increase in CDS spread levels. Likewise, we document that watchlist placements for downgrade lead to increases in firms’ CDS spreads. CDS markets do not react to rating upgrades but watchlist placements for upgrade result in an immediate decrease in CDS spreads. Rating affirmations following watchlist placements for downgrade lead to slight reductions in CDS spreads, while affirmations following watchlist placements for upgrade have no effect on CDS spreads. These findings demonstrate the importance for empirical research on the interaction between credit markets and rating announcements to differentiate between watch-preceded and direct rating changes, particularly for rating downgrades.     

Financial statements based bank risk aggregation

One of the major challenges involved in risk aggregation is the lack of risk data. Recently, researchers have found that mapping financial statements into risk types is a satisfactory way to resolve the problem of data shortage and inconsistency. Nevertheless, ignoring off-balance sheet (OBS) items has so far been regarded as the usual practice in risk aggregation, which may lead to deviations in conclusions. Hence, we improve the financial statements based risk aggregation framework by mapping OBS items into risk types. Based on 487 quarterly financial statements from all 16 listed Chinese commercial banks over the period 2007–2014, we empirically study whether the overall impact of OBS activities and the individual impact of each of the OBS risk types on total risk depend on bank size. Moreover, this research divides the sample into two subsets, during and after the subprime crisis, to find out how the subprime crisis affects risks of Chinese banks. Our empirical results show that although OBS credit risk is positively linked to total risk while OBS operational risk is negatively linked to total risk for both large and small banks, the overall impact of OBS activities on total risk depends on bank size. The overall OBS activities are positively related to the large bank’s total risk while they are negatively related to the small bank’s total risk. Besides, we also found that it is the increase of liquidity risk and market risk that leads to the larger total risk of Chinese banks during the subprime crisis.     

Stock price informativeness on the sensitivity of strategic M&A investment to Q

Using a strategic merger sample that covers the period from 1985 to 2011, we find that the acquirer’s stock price firm-specific information, the new information created by investors about the value of firm fundamentals, increases the positive sensitivity of strategic merger investment to the acquirer’s Q; the target’s stock price firm-specific information increases the negative sensitivity of merger investment to the target’s Q. These results suggest that managers learn from financial markets in identifying strategic merger investment opportunities by transferring assets from poorly managed firms to well managed firms. In addition, the target’s stock price firm-specific information itself increases the acquisition size, indicating that informed acquirer managers are more likely to take out large merger investment. Last but not the least, stock price informativeness increases merger synergies and post-merger performance, suggesting that informed managers make better merger investment that increases shareholder value. Our study contributes to the recent increasing stream of studies on managerial learning from the market.     

The pricing of common exchange rate factors in the U.S. equity market

We extend Lustig et al. (Rev Financ Stud 24:3731–3777, 2011) and Brusa et al. (The International CAPM Redux, 2014) by examining if the common exchange rate factors, the dollar and carry factors, are priced in the US equity market. Our results suggest that while the carry factor has incremental pricing information relative to the US market factor, the dollar factor (or the trade-weighted exchange rate index) is redundant. Our results have important theoretical as well as practical implications. Theoretically, we suggest that financial economists take an endogenous perspective of exchange rates. Practically, we suggest that practitioners incorporate in the carry factor to measure the exposure of exchange rate risk.     

The dispersion anomaly and analyst recommendations

The main objective of this study is to distinguish whether the forecast dispersion anomaly is due to Miller’s (J Finance 32(4):1151–1168, 1977) overpricing hypothesis or idiosyncratic risk, by conditioning the sample on “buy” and “sell” consensus recommendations. Observations on the long and short possibilities provided to the investors by the analyst stock recommendations can help us infer on the impact of short sale constraints even though they are not directly observed. This study provides strong evidence that the impact of analyst forecast dispersion is more pronounced in the group of stocks that receive the least favorable recommendations in a given period, even after controlling for the idiosyncratic risk, Fama–French factors (J Financ Econ 33(1):3–56, 1993; J Financ Econ 116(1):1–22, 2015) and even short-sale constraints. These results are consistent with Miller’s (1977) hypothesis, according to which if short-sale constraints bind, high opinion divergence stocks become overpriced and hence have low subsequent returns.     

The effects on investment incentives of an allowance for corporate equity tax system: the Belgian case as an example

The Modigliani–Miller theorem serves as the standard finance paradigm on corporate capital structure and managerial decision making. Implicitly, it is assumed that the market possesses full information about the firm. However, if firm managers have insider information, they may attempt to ‘signal’ changes in the firm’s financial structure and, in competitive equilibrium, shareholders will draw deductions from such signals. Empirical work shows that the value of underlying firms rises with leverage because investors expect such firms to implement positive NPV projects. We empirically examine this view using a sample of debt issue announcements by publicly traded firms listed on the London Stock Exchange. We argue that the timing of debt issues is fundamental in determining the relationship between leverage and risk-adjusted returns. We show that an announcing firm’s intrinsic value may not rise depending on when management publicly ‘signals’ changes in their firm’s capital structure. Specifically, we show that risk-adjusted returns rise positively for firms that make debt announcements during normal economic conditions while they tend to decline for firms making debt announcements during recessionary periods. During recessionary periods, market risk and loss aversion rise and investors focus less on the potential growth of debt announcing firms and focus more on potential losses instead. We conclude that the timing of new debt is of paramount importance and managers’ inability to prudently time such announcements can lead to exacerbated levels of systematic risk coupled with a significant erosion in shareholder wealth.     

Leading the herd: evidence from mutual funds’ buy and sell decisions

This article investigates whether a mutual fund’s performance is related to its herding behavior. Using the methodology of Sias (Rev Finance Stud 17:165–206, 2004), we develop a measure to capture the magnitude that a fund’s buy (sell) decisions are leading other funds’ buys (sells), and find that a fund’s performance is positively (negatively) related to its “buy leading” (“sell leading”). We interpret these findings as evidence that “buy leaders” (“sell leaders”)’ performance benefits (suffers) from the positive (negative) price effect associated with buy (sell) herds. Additionally, we find a positive relationship between fund performance and valuation-motivated “buy leading”, while we find weak evidence on the relationship between performance and valuation-motivated “sell leading”. We interpret these results as evidence that leading funds’ outperformance is due, in part, to their ability to value stocks.     

On the Earnings and Price Momentum Strategies: Evidence from European Real Estate Firms

We test the performance and interaction between earnings and price momentum for European real estate companies by first making use of decile portfolios sorted on the previous 3- to 12-month returns, standardized unexpected earnings and a combination of both. Then, the relation is tested on a risk-adjusted basis employing a 3-factor asset pricing model and Fama and Macbeth (1973) cross-sectional regression analyses. Our analyses reveal several critical findings: (1) both price and earnings momentum are effective for European firms, the effect being stronger for the UK than EU firms; (2) unlike U.S. REITs, price momentum seems to dominate drift for European firms; (3) there is weak evidence for positive interaction between drift and price momentum, contrary to the U.S. evidence; (4) the performance of momentum strategies depends on the state of the economy, while controlling for systematic factors; (5) idiosyncratic risk of real estate property firms may influence the returns on drift and momentum factors.     

A Reexamination of Housing Price and Household Consumption in China: The Dual Role of Housing Consumption and Housing Investment

It is important to investigate the correlation between housing price and household consumption to gain an understanding of the behavior of the economy and effectively handle the consequences of economic development. In the last two decades, the accumulation of housing wealth by Chinese households has not been effectively transmitted to their final consumption. We discovered that the sustained increase in household wealth and housing-ownership rate in China has been accompanied by a decrease in consumption rate. We also identified a negative correlation between housing price and household consumption for both the homeowners who own one housing unit and those who own two units of housing. We investigated this phenomenon in China both theoretically and empirically by capturing the dual nature of housing as a consumption good and an investment vehicle. We found that the demand for second housing units is motivated by increasing housing consumption demand rather than pure investment needs. To explain the mechanisms that drive household-consumption behavior, we also explored the effects on household consumption of China’s educational system, marriage market and ageing society, as well as future housing-market uncertainty. The implications of government intervention in the housing market are discussed.