Working Papers
Flight-to-Quality- and Liquidity-Related Variation in the Correlations and Mean Returns across Stocks and T-Bonds
Naresh Bansal, Bob Connolly, and Chris Stivers — December 2007
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Cross-sectional Return Dispersion and the Payoffs of Momentum, Longer-run Contrarian, and Book-to-Market Strategies
Chris Stivers, Licheng Sun — October 2008
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Competing With the NYSE
William O. Brown Jr., J. Harold Mulherin and Marc Weidenmier – June 2006
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Do Managers Listen to the Market?
James B. Kau, James S. Linck and Paul H. Rubin – June 2006
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Divergence of Opinion, Arbitrage Costs and Stock Returns
Ginger Wu – June 2006
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Short Selling, Informed Trading, and Stock Returns
Tyler Henry – May 2006
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Effects and Unintended Consequences of the Sarbanes-Oxley Act on Corporate Boards
James S. Linck, Jeffry M. Netter, and Tina Yang – May 2006
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Information Asymmetry and Acquirer Returns
Micah S. Officer, Annette B. Poulsen and Mike Stegemoller – May 2006
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Do Takeover Auctions Induce a Winner's Curse? New Evidence from the Corporate Takeover Market
Audra L. Boone and J. Harold Mulherin – March 2006
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Moving From Private to Public Ownership: Selling Out to Public Firms vs. Initial Public Offerings
Annette B. Poulsen and Mike Stegemoller – January 2006
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The Valuation Consequences of Voluntary Accounting Changes
James S. Linck, Thomas J. Lopez and Lynn L Rees – October 2005
View Abstract | View Paper
Suitable-Portfolio Investors, Nondominated Frontier Sensitivity, and the Effect of Multiple Objectives on Standard Portfolio Selection
R. E. Steuer, Y. Qi and M. Hirschberger – October 2004
View Abstract | View Paper (PDF | 255 KB)
Multicriteria Decision Aid/Analysis in Finance
J. Spronk, R. E. Steuer and C. Zopounidis – September, 2003
View Abstract | View Paper (PDF | 411 KB)
Multiple Criteria Decision Making Combined with Finance: A Categorized Bibliographic Study
P. Na and R. E. Steuer – September 16, 2003
View Abstract | View Paper (PDF | 135 KB)
Privatization and the Market for Corporate Control
J. Harold Mulherin, Jeffry M. Netter and Mike Stegemoller – August 2004
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Randomly Generating Portfolio-Selection Covariance Matrices with Specified Distributional Characteristics
M. Hirschberger, Y. Qi and R. E. Steuer – May 2004
View Abstract | View Paper (PDF | 252 KB)
Quadratic Parametric Programming for Portfolio Selection with Random Problem Generation and Computational Experience
M. Hirschberger, Y. Qi and R. E. Steuer – March 2004
View Abstract | View Paper (PDF | 280 KB)
Boundaries of the Firm: Evidence from the Banking Industry
James A. Brickley, James S. Linck, and Clifford W. Smith, Jr. – February 2003
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Boundaries of the Firm: Evidence from the Banking Industry
James A. Brickley, James S. Linck, and Clifford W. Smith, Jr. – February 2003
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Long-run Performance Following Private Placements of Equity
Michael G. Hertzel , Michael L. Lemmon , James S. Linck and Lynn L Rees – December 2001
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Abstracts
Flight-to-Quality- and Liquidity-Related Variation in the Correlations and Mean Returns across Stocks and T-Bonds
Naresh Bansal, Bob Connolly, and Chris Stivers – December 2007
Abstract
Over the crisis-rich 1997 to 2005 period, we document new time-series and cross-sectional evidence which suggests a sizable flight-to-quality- and liquidity-related variation in the correlations and mean returns across stocks and T-Bonds. Our collective results support the premise of a "searching" in the relative valuation of stocks and bonds during times of market stress. First, higher levels of stock implied volatility (IV) and stock illiquidity and higher time-series variability in stock IV are associated with both: (1) a much lower correlation in the subsequent returns of stock and T-bond returns, and (2) much greater time-series variability in the subsequent stock IV and illiquidity values. Second, daily stock returns are negatively and appreciably related to the contemporaneous stock IV change, and more-liquid stocks exhibit both: (1) greater responsiveness to the IV change, and (2) a more negative stock-bond correlation in stressful times. Third, stock IV changes are positively related to the T-bond returns. Finally, when stock IV is relatively high, the subsequent mean returns and turnover are relatively greater for portfolios of more-liquid stocks, as compared to portfolios of less-liquid stocks.
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Cross-sectional Return Dispersion and the Payoffs of Momentum, Longer-run Contrarian, and Book-to-Market Strategies
Chris Stivers, Licheng Sun – October 2008
Abstract
We document a striking new regularity in the payoffs of momentum, longer-run contrarian, and book-to-market (B/M) stock strategies. Over our 1962 to 2005 sample, we find that the several month trend in the stock market's cross-sectional return dispersion (RD) is substantially related: (1) negatively, to the subsequent change in 6-month momentum payoffs, (2) positively, to the subsequent change in 36-month contrarian payoffs; and (3) positively, to the subsequent change in both 6-month and 36-month high-minus-low B/M strategies. When decomposing each payoff-change into the forward-looking payoff and the lagged reference payoff, we find that the RD-trend is generally reliably related to both the forward-looking payoff (in the same direction as for the respective payoff-change) and the lagged reference payoff (in the opposite direction as for the respective payoff-change). We offer an interpretation which suggests that RD is a leading indicator of market-state changes and that market-state transitions are important for understanding the payoffs of momentum, contrarian, and book-to-market strategies.
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Competing With the NYSE
William O. Brown Jr., J. Harold Mulherin and Marc Weidenmier – June 2006
Abstract
We study the stock exchange rivalry between the New York Stock Exchange (NYSE) and the Consolidated Stock Exchange (Consolidated) from 1885 to 1926 using a new database of bid-ask spreads and stock data collected from The New York Times and other primary sources. The magnitude of this important, but largely forgotten rivalry was substantial. From 1885 to 1895, the ratio of Consolidated to NYSE volume averaged 40 percent and reached as high as 60 percent. The market share of the Consolidated averaged 23 percent for approximately 40 years. The Consolidated focused on the relatively liquid securities on the NYSE as measured by bid-ask spreads and trading volume. Our results suggest that NYSE bid-ask spreads fell by more than 10 percent when the Consolidated began to trade NYSE stocks while bid-ask spreads for our quasicontrol group of stocks trading on the Boston Stock Exchange remain unchanged. The effect persisted over the entire history of the stock market rivalry until a series of scandals and investigations of the Consolidated by state regulators led to the demise of the exchange in the 1920s. The analysis suggests three conclusions: (1) the NYSE has faced significant long-run competition (2) the NYSE may be susceptible to a similar level of competition in the future and (3) that the Consolidated may have improved the efficiency of stock prices by contributing to the price discovery process.
Do Managers Listen to the Market?
James B. Kau, James S. Linck and Paul H. Rubin – June 2006
Abstract
Stock prices may provide valuable information for a public firm's managers. In this paper, we examine whether managers listen to the market in making major corporate investments, and whether agency costs and corporate governance mechanisms help explain managers' propensity to listen. We find that, on average, managers listen to the market: they are more likely to cancel investments when the market reacts unfavorably to the related announcement. Further, while we have some difficulty identifying precisely which governance mechanisms are most important, we find some evidence consistent with the notion that managers' propensity to listen is related to agency costs. We find that firms tend to listen to the market more when more of their shares are held by large blockholders, and when their CEOs have higher pay-performance sensitivities.
Divergence of Opinion, Arbitrage Costs and Stock Returns
Ginger Wu – June 2006
Abstract
We develop a new proxy for divergence of opinion to use in examining how this phenomenon affect cross-sectional asset returns for different stocks with different arbitrage costs. We generalize Tauchen and Pitts' (1983) well-known Mixture of Distribution Hypothesis (MDH), which links asset volume and volatility in a way that derives a proxy for divergence of opinion among all individual investors. This new measure can more directly capture the information of divergence of opinion among all individual investors than other proxies, such as the dispersion in analyst's earnings forecasts and turnover. In our empirical asset pricing analysis, we incorporate the crucial role of divergence of opinion in determining cross-sectional asset returns and establish that when divergence of opinion is high, stock prices tend to be biased upward, resulting in lower future returns. These effects are especially pronounced for stocks with higher arbitrage costs, such as idiosyncratic risks, short sale costs, and other transaction costs, which are more difficult and costly to short sell. Our results support Miller's (1977) view that, given short-sale constraints, observed prices overweight optimistic valuations. The predictions of recent theoretical work, such as Hong and Stein (2003), are valid only for stocks with lower arbitrage costs. Also, our results suggest that idiosyncratic risk, relative to other arbitrage cost measures, incrementally explains the effect of the divergence of opinion on stock returns.
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Short Selling, Informed Trading, and Stock Returns
Tyler Henry – May 2006
Abstract
This paper considers the effect of private information on the returns to stocks with high levels of short interest. I use a measure from the market microstructure literature to proxy for levels of asymmetric information. Among highly shorted firms, portfolios with high levels of informed trading generally underperform, while those with low levels of informed trading do not. The results suggest that the underperformance of high short interest stocks is driven by firms that have high levels of informed trading. However, this negative relationship between informed trading and returns is reversed for stocks with low to moderate short interest levels.
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Effects and Unintended Consequences of the Sarbanes-Oxley Act on Corporate Boards
James S. Linck, Jeffry M. Netter, and Tina Yang – May 2006
Abstract
We provide the first comprehensive study on the impact of the Sarbanes-Oxley Act (SOX) on corporate boards using broad sample evidence from more than 7,000 public companies as well as detailed analysis of smaller subsamples. Post-SOX boards are larger and more independent. Director workload and risk increased: audit committees meet more than twice as often post SOX as they did pre SOX, and Director and Officer (D&O) insurance premiums more than doubled. SOX also had a dramatic affect on the makeup of the corporate director pool: more post-SOX directors are lawyers/consultants, financial experts and retired executives and fewer are current executives. These changes drove a large increase in the cost of the board, particularly for small firms. For example, small firms paid $3.19 in director fees per $1,000 of net sales in 2004, which is $0.84 more than they paid in 2001 and $1.21 more than in 1998. In contrast, large firms paid $0.32 in director fees per $1,000 of net sales in 2004, seven cents more than they paid in 2001 and ten cents more than in 1998. Overall, our evidence suggests that SOX had a dramatic impact on corporate boards and the cost thereof.
Information Asymmetry and Acquirer Returns
Micah S. Officer, Annette B. Poulsen and Mike Stegemoller – May 2006
Abstract
This paper shows that acquirer returns are significantly positively associated with target-specific factors that make the target more difficult to value and that increase the information asymmetry between the acquirer and target about the target's value. However, this is true only when the acquirer uses the optimal acquisition contract in the face of one-sided information asymmetry. We demonstrate that acquirer announcement returns in a sample of acquisitions of privately held targets, where information asymmetry is likely to be a considerable problem, are significantly higher when acquirers use stock as the method of payment and the target firm is in a development stage or has a balance sheet laden with intangible and difficult-to-value assets. While our sample only contains acquisitions of privately held target firms, our results have broader implications for the relation between the value of acquisitions for acquirers and the degree of opacity of the target's information environment.
Do Takeover Auctions Induce a Winner's Curse? New Evidence from the Corporate Takeover Market
Audra L. Boone and J. Harold Mulherin – March 2006
Abstract
We test for the winner's curse in the corporate takeover market by studying the effect of takeover competition on bidder returns. Our measure of takeover competition comes from a unique data set on the private auction process that occurs prior to the public announcement of a takeover. For a sample of 308 takeovers announced in the 1989 to 1999 period, we find that the returns to bidders are not significantly related to takeover competition. The results hold after controlling for size and deal characteristics that have been shown to affect bidder returns and are also robust to a variety of proxies for takeover competition. Our findings do not support the existence of a winner's curse in the corporate takeover market. Related analysis indicates that prestigious investment banks temper any tendency toward overbidding.
The Determinants of Board Structure
James S. Linck, Jeffry M. Netter and Tina Yang – March 2006
Abstract
Using a comprehensive sample of nearly 7,000 firms from 1990 to 2004, this paper examines corporate board structure, its trends and its determinants. We study how board structure has evolved over time and, more importantly, we compare board structure across small and large firms in ways suggested by new theoretical work. Overall, our evidence suggests that firms structure their boards in response to the costs and benefits of board monitoring and advising. Our models explain as much as 45% of the observed variation in board structure. Further, small and large firms have dramatically different board structures. In addition, while board size was falling in the 1990s, this trend was reversed after the implementation of mandated reforms.
Moving From Private to Public Ownership: Selling Out to Public Firms vs. Initial Public Offerings
Annette B. Poulsen and Mike Stegemoller – January 2006
Abstract
We study the movement of assets from private to public ownership through two alternative means: the acquisition of private companies by firms that are public (sellouts) or by initial public share offerings (IPOs). We consider firm-specific characteristics for 1,074 IPOs and 735 sellouts from 1995 through 2004 to identify differences in growth, capital constraints and asymmetric information between the two types of transactions. Our results suggest that firms move to public ownership through an IPO when they have greater growth opportunities, more capital constraints and are easier to value. Previous analyses of U.S. companies have focused on broad aggregate and industry-level trends while our work allows a better understanding of the firm-specific characteristics leading to firms choosing to go public through an IPO and the costs of accessing the public capital markets.
The Valuation Consequences of Voluntary Accounting Changes
James S. Linck, Thomas J. Lopez and Lynn L Rees – October 2005
Abstract
Firm management typically claims that voluntary accounting method changes (VACs) are made to enhance the informativeness of earnings by better matching accounting practices with economic reality. In contrast, skeptics argue that managers adopt new accounting procedures to opportunistically manage earnings and influence their firm's stock price. In this paper, we investigate whether VACs temporarily drive equity prices away from their fundamental values by examining the long-run stock price performance for a sample of firms that voluntarily change accounting methods. In contrast to prior research, we find little evidence that a strategy based solely on the earnings effect of a VAC can generate abnormal returns. While we do find some weak evidence of post-VAC abnormal returns for extreme VACs, our evidence suggests that this result is driven by the accruals anomaly as documented in Sloan (1996).
Privatization and the Market for Corporate Control
J. Harold Mulherin, Jeffry M. Netter and Mike Stegemoller – August 2004
Abstract
The most important development in international corporate governance in the past 20 years has been the privatization of state-owned enterprises. There is evidence that privatization has resulted in improved firm performance but the source of this improvement is difficult to isolate. We argue that one of the most important results of privatization for corporate governance is the potential entry of those firms into the market for corporate control as targets and bidders, which can result in improved firm performance for numerous reasons. We document the magnitude and the wealth effects of the mergers of privatized firms, attempting to find every privatized firm that was either a target or a bidder in a merger. We find 52 privatized firms that subsequently become targets of takeovers and 90 privatized firms that became bidders in 341 mergers. In general, we find that privatized firms operate very much as non-privatized firms have in the market for corporate control. Target firms experience a 12 percent increase in equity value at the announcement of a merger. Bidding firms experience a positive but insignificant change in equity value at merger announcement. The results indicate that mergers result in net wealth creation for privatized firms and are indicative that one effect of privatization is wealth-creating mergers.
Boundaries of the Firm: Evidence from the Banking Industry
James A. Brickley, James S. Linck, and Clifford W. Smith, Jr. – February 2003
Abstract
Agency theory implies that asset ownership and decision authority are complements. Using 1998 data from Texas commercial banks, we test whether the likelihood of local ownership of bank offices increases with the importance of granting local managers greater decision authority (for example, due to location or customer base). Our empirical evidence is consistent with this hypothesis. It suggests that complementarities between strategy and organizational structure can foster differentiation among firms in terms of location, customers, and products. It also supports the growing view that small locally-owned banks have a comparative advantage over large banks within specific environments.
Long-run Performance Following Private Placements of Equity
Michael G. Hertzel , Michael L. Lemmon , James S. Linck and Lynn L Rees – December 2001
Abstract
Public firms that place equity privately experience positive announcements effects, with negative post-announcement stock-price performance. This finding is inconsistent with the underreaction hypothesis. Instead, it suggests that investors are overoptimistic about the prospects of firms issuing equity, regardless of the method of issuance. Further, in contrast to public offerings, private issues follow periods of relatively poor operating performance. Thus, investor overoptimism at the time of private issues is not due to the behavioral tendency to overweight recent experience at the expense of long-term averages.
Suitable-Portfolio Investors, Nondominated Frontier Sensitivity, and the Effect of Multiple Objectives on Standard Portfolio Selection
R. E. Steuer, Y. Qi and M. Hirschberger – October 2004
Abstract
In standard portfolio theory, an investor's only goal is to pursue a portfolio return maximization strategy. But in this paper, we consider another type of investor whose goal is to build, more broadly, a suitable portfolio taking additional factors into account. For instance, in addition to portfolio return, such an investor may wish to monitor his or her portfolio with regard to the proportion of portfolio return derived from dividends, the maximum amount invested in any security, short selling, the number of securities involved, social responsibility, and so forth. To accommodate such an investor, we develop a multiple criteria portfolio selection formulation, corroborate its appropriateness by examining the sensitivity of the nondominated frontier to various factors, and observe the conversion of the nondominated frontier to a nondominated surface. Furthermore, multiple criteria enable us to provide an explanation as to why the market portfolio," so often found deep below the nondominated frontier, is roughly where one would expect it to be with multiple criteria. After commenting on approaches for searching nondominated surfaces, the paper concludes with the idea that what is the modern portfolio theory"
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Quadratic Parametric Programming for Portfolio Selection with Random Problem Generation and Computational Experience
M. Hirschberger, Y. Qi and R. E. Steuer – March 2004
Abstract
For researchers intending to investigate mid- to large-scale portfolio selection, good, inexpensive and understandable quadratic parametric programming software, capable of computing the efficient frontiers of problems with up to two thousand securities without simplifications to the covariance matrix, is hardly known to be available anywhere. As an alternative to Markowitz's critical line method, a full explication of a simplex-based quadratic parametric programming procedure, utilizing well-known components, is coded in Java for public domain use on modern desktops and laptops. The advantage of the different design is to provide an algorithm that can ultimately be extended (not a part of this paper) to portfolio problems with objectives beyond mean and variance. Using the code, aspects of portfolio selection problems are investigated and computational experience is reported.
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Randomly Generating Portfolio-Selection Covariance Matrices with Specified Distributional Characteristics
M. Hirschberger, Y. Qi and R. E. Steuer – May 2004
Abstract
In portfolio selection, there is often the need for procedures to generate \realistic" covariance matrices for security returns, for example to test and benchmark optimization algorithms. For application in portfolio optimization, such a procedure should allow the entries in the matrices to have distributional characteristics which we would consider realistic" for security returns. Deriving motivation from the fact that a covariance matrix can be viewed as stemming from a matrix of factor loadings, a procedure is developed for the random generation of covariance matrices (a) whose o-diagonal (covariance) entries possess a pre-specified expected value and standard deviation and (b) whose main diagonal (variance) entries possess a likely different pre-specified expected value and standard deviation. The paper concludes with a discussion about the futility one would likely encounter if one simply tried to invent a valid covariance matrix in the absence of a procedure such as in this paper.
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Multicriteria Decision Aid/Analysis in Finance
J. Spronk, R. E. Steuer and C. Zopounidis – September, 2003
Abstract
Over the past decades, the complexity of financial decisions has increased rapidly, thus highlighting the importance of developing and implementing sophisticated and efficient quantitative analysis techniques for supporting and aiding financial decision making. Multicriteria decision aid (MCDA), an advanced branch of operations research, provides financial decision makers and analysts with a wide range of methodologies well suited for the complexity of modern financial decision making. The aim of this chapter is to provide an in-depth presentation of the contributions of MCDA in finance focusing on the methods used, applications, computation, and directions for future research.
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Multiple Criteria Decision Making Combined with Finance: A Categorized Bibliographic Study
P. Na and R. E. Steuer – September, 2003
Abstract
This paper provides a categorized bibliography on the application of the techniques of multiple criteria decision making (MCDM) to problems and issues in finance. A total of 265 references have been compiled and classified according to the methodological approaches of goal programming, multiple objective programming, the analytic hierarchy process (AHP), etc., and to the application areas of capital budgeting, working capital management, portfolio analysis, etc. The bibliography provides an overview of the literature on "MCDM combined with finance," shows how contributions to the area have come from all over the world, facilitates access to the entirety of this heretofore fragmented literature, and underscores the often multiple criterion nature of many problems in finance.
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