Should we worry about the decline of the public corporation? A brief survey of the economics and external effects of the stock market

In recent years, the number of listed companies has been declining in many countries across the world. This paper provides a selective survey of the literature on the real economic effects of the stock market to assess the potential effects of this decline and determine whether it is likely to continue. The leading economic role of the stock market’s primary market, in which firms raise capital by issuing new shares, is to help growing firms secure financing. We discuss providing and certifying information, coordinating investors, and easing the redeployment of capital as the means through which capital allocation can be efficiently achieved. The main economic roles of the stock market’s secondary market, the trade in existing shares, is to provide liquidity to shareholders, to aid in price discovery and to provide diversification opportunities. Positive external effects from an active stock market may arise for consumers, labor and private firms due to increased corporate investment, more socially responsible business strategies and a more positive business climate. Negative external effects on capital allocation and productivity can arise from short-termism, market mispricing, and increased cross-ownership. Local stock markets can spur innovation and foreign direct investment (FDI) and reduce the risk of early cross-border acquisitions. Given the myriad of useful economic functions the stock market performs, a future entirely absent of public companies is difficult to imagine and the decline is therefore likely at some point to come to an end. Whether we need to worry about the decline depends on the relative importance of the positive and negative external effects, a topic we feel warrants more research.     

Stock liquidity and managerial short-termism

We examine whether stock liquidity exacerbates or mitigates managerial short-termism. Utilizing earnings management as a proxy for managerial short-termism, we establish three major findings. First, firms with liquid stocks engage in less accrual-based and real earnings management. Second, the effect of stock liquidity on earnings management is amplified for firms with high levels of managerial pay-for-performance sensitivity. Third, the positive association between the intensity of earnings management and firm cost of capital is evident only for firms with low stock liquidity. Our findings are consistent with the threat of blockholder exit as the main governance channel through which stock liquidity discourages opportunistic earnings management and mitigates managerial short-termism.     

Financing Technological Innovation: Evidence from Patent-Intensive Firms

ABSTRACT

Equityholders of firms with high debt loads have an incentive to underinvest, a distortion that can be most costly for firms with attractive growth options. Using a novel patent-based measure of a firm's growth options, we find that firms issue more equity and shy away from debt financing when they have larger investment opportunities sets. The results are more pronounced among firms in patent-intensive industries. The findings suggest the existence of conflicts of interest between debtholders and equityholders. Our results are consistent with the use of conservative debt policies by technology-intensive firms to mitigate the debt overhang associated with their future growth options.     

Resurrecting the size effect: Evidence from a panel nonlinear cointegration model for the G7 stock markets

Firm size is known to be an important factor affecting stock returns. This study proposes a panel threshold cointegration model to investigate the impact of the size effect on stock returns for the panel of G7 countries: Canada, France, Germany, Italy, Japan, the U.K., and the U.S. over the period 1991:1–2012:12. The empirical analysis is based upon the nonlinear cointegration framework using the asymmetric ARDL cointegration methodology (Shin et al., 2011). This methodological approach permits a much richer degree of flexibility in the dynamic adjustment process toward equilibrium, than in the classical linear model. Our findings indicate the presence of asymmetric adjustment around a unique long-run equilibrium. In particular, the empirical analysis provides evidence of asymmetric effects between stock returns and the size effect, while controlling for the book-to-market ratio and the price-to-earnings ratio.     

Structural breaks in the mean of dividend-price ratios: Implications of learning on stock return predictability

In their out-of-sample predictions of stock returns in the presence of structural breaks, Lettau and Van Nieuwerburgh (2008) implicitly assume that economic agents’ perception of the regime-specific mean for the dividend-price ratio is time-invariant within a regime. In this paper, we challenge this assumption and employ least squares learning with constant gain (or constant-gain learning) in estimating economic agents’ time-varying perception for the mean of dividend-price ratio. We obtain better out-of-sample predictions of stock returns than in Lettau and Van Nieuwerburgh (2008) for both the U.S. and Japanese stock markets. Our empirical results suggest that economic agents’ learning plays an important role in the dynamics of stock returns.     

Unconventional monetary policy and stock repurchases: Firm-level evidence from a comparison between the United States and Japan

This paper is the first comparative study examining the determinants of stock repurchases during the period of unconventional monetary policy. By constructing a vast firm-level dataset of the U.S. and Japan and conducting multivariate Tobit and probit analyses, this paper presents evidence that during the period of unconventional monetary policy, in both the U.S. and Japan, firms with more free cash flow and lower borrowing costs are more likely to repurchase stock, firms with higher financial leverage are more likely to abstain from stock repurchases, and firms coordinate dividends and stock repurchases to please shareholders. I also find striking contrasts between the results of U.S. and Japanese firms, and show the importance of financial structure in explaining the contrasting results. From a micro perspective, this paper provides new insight and evidence to support the view that financial structure should be thought of as an important factor determining the effects of unconventional monetary policy.     

Semitractability of optimal stopping problems via a weighted stochastic mesh algorithm

In this paper, we propose a Weighted Stochastic Mesh (WSM) algorithm for approximating the value of discrete‐ and continuous‐time optimal stopping problems. In this context, we consider tractability of such problems via a useful notion of semitractability and the introduction of a tractability index for a particular numerical solution algorithm. It is shown that in the discrete‐time case the WSM algorithm leads to semitractability of the corresponding optimal stopping problem in the sense that its complexity is bounded in order by with being the dimension of the underlying Markov chain. Furthermore, we study the WSM approach in the context of continuous‐time optimal stopping problems and derive the corresponding complexity bounds. Although we cannot prove semitractability in this case, our bounds turn out to be the tightest ones among the complexity bounds known in the literature. We illustrate our theoretical findings by a numerical example.     

Price gap anomaly in the US stock market: The whole story

This paper analyses the price gap anomaly in the US stock market (comprised of the DJI, S&P 500 and NASDAQ) covering the period 1928 to 2018. This paper aims to investigate whether or not price gaps create market inefficiencies. Price gaps occur when the current day’s opening price is different from the previous day’s closing price due orders placed before the opening of the market. Several hypotheses are tested using various statistical tests (Student’s t-test, ANOVA, Mann-Whitney test), regression analysis, and special methods, that is, the modified cumulative returns and the trading simulation approaches. We find strong evidence in favour of abnormal price movements after price gaps. We observe that during a gap day prices tend to change in the direction of the gap. A trading strategy based on this anomaly was efficient in that its results were not random, indicating that this market was not efficient. The momentum effect was found to be temporary and no evidence of seasonality in price gaps was found. Lastly, our results were also contrary to the myth that price gaps tend to get filled.     

Valuation of VIX and target volatility options with affine GARCH models

In this paper we propose semiclosed-form solutions, subject to an inversion of the Fourier transform, for the price of VIX options and target volatility options under affine GARCH models based on Gaussian and Inverse Gaussian distributions. We illustrate the advantage of the proposed analytic expressions by comparing them with those obtained from benchmark Monte–Carlo simulations. The empirical performance of the two affine GARCH models is tested using different calibration exercises based on historical returns and market quotes on VIX and SPX options.     

Does Investor Sentiment Affect the Value Relevance of Accounting Information?

We investigate whether investor sentiment affects the relationships between accounting variables and contemporaneous stock returns. Using price-relevant accounting variables identified by Chen and Zhang (2007) and the investor sentiment index constructed by Baker and Wurgler (2006), we find that the value relevance of accounting variables is collectively lower in high sentiment periods than in low sentiment periods. More importantly, earnings yield appears to be more related to contemporaneous stock returns in high sentiment periods, while other accounting variables are more related to stock returns in low sentiment periods. The effect of investor sentiment on the value relevance of accounting information is stronger for firms that are more difficult to value and to arbitrage.