2011 - Working Papers: Finance, Accounting and Insurance
The Diminishing Liquidity Premium, 65 pp.
A. Ben-Rephael, O. Kadan and A. Wohl
(Working Paper No. 3/2011)
Previous evidence suggests that less liquid stocks yield higher average returns. Using common-stock data, we present evidence that both the sensitivity of stock returns to liquidity and liquidity premia have significantly declined over the past four decades. Furthermore, the profitability of trading strategies, based on buying illiquid stocks and selling liquid stocks, has significantly declined over this time period. Our results are robust to several conventional liquidity proxies related to volume, are not driven by size effects, and apply strongly to NYSE and NASDAQ, and weakly to AMEX. We offer possible explanations for these results, related to the proliferation of index funds and exchange-traded funds, and to enhancements in markets that facilitate arbitrage activity. Consistent with this view, we find no trend in the liquidity premium for non-common stocks and for “penny stocks,” and identify an increasing difference between the average holding periods of liquid vs. illiquid stocks.
Is conditional persistence fully priced? 39 pp.
E. Amir and I. Kama
(Working Paper No. 13/2011)
Amir, Kama and Livnat (2011) argue that the market reaction to an accounting variable should depend not on its unconditional persistence (a variable’s autocorrelation coefficient), but on its conditional persistence (the power of a variable’s persistence to explain the persistence of a variable higher in the hierarchy). They provide evidence supporting this argument using the DuPont decomposition of ratios. We conjecture that equity investors do not fully price accounting information based on their conditional persistence, but instead are fixated on the traditional concept of unconditional persistence in valuing stocks, leading to predictable post-SEC filing stock returns. First, we show that conditional persistence is reflected in contemporaneous stock returns. Then, we construct a trading strategy based on the distance between the conditional and the unconditional persistence of operating profit margins (OPM) and asset turnover (ATO). We find that buying stocks of firms with relatively high conditional persistence of OPM, and selling stocks of firms with relatively low conditional persistence of OPM, earns positive and significant abnormal stock returns for buy-and-hold periods of 90, 180, and 365 days starting after SEC filings. Furthermore, when the conditional persistence of OPM is relatively low, the post-announcement drift related to earnings surprises diminishes substantially, and post-announcement drift related to revenue surprises largely disappears. Our findings suggest that conditional persistence is not fully priced and may provide a plausible explanation for earnings and revenue surprise drifts.
Do firms buy their stock at bargain prices? Evidence from actual stock repurchase disclosures, 71 pp.
A. Ben-Rephael, J. Oded and A. Wohl
(Working Paper No. 15/2011)
We use new data from SEC filings to investigate how S&P 500 firms execute their open-market repurchase programs. We find that smaller S&P 500 firms repurchase less frequently than larger firms, and at a price which is significantly lower than the average market price. Their repurchase activity is followed by a positive and significant abnormal return which lasts up to three months after the repurchase. These findings do not hold for large S&P 500 firms. Our interpretation is that small firms repurchase strategically, whereas the repurchase activity of large firms is more focused on the disbursement of free cash. Consistent with this interpretation, we show that the market response to the disclosure of actual repurchase data is positive and significant only for small firms, and that insider trading is positively related to actual repurchases.
Do managers’ deliberate decisions induce sticky costs?, 45 pp.
I. Kama and D. Weiss
(Working Paper No. 16/2011)
This study explores motivations underlying managers’ resource adjustments. We focus on the impact of incentives to meet earnings targets on resource adjustments and the ensuing cost structures. Findings indicate that facing incentives to avoid losses and earnings decreases or to meet financial analysts’ earnings forecasts managers expedite downward adjustments of slack resources when sales fall. These deliberate decisions lessen the degree of cost stickiness rather than induce cost stickiness. The results suggest that efforts to understand determinants of firms’ cost structures should be made in light of the managers’ motivations, particularly agency-driven incentives underlying resource adjustment decisions.
Agency and corporate purchase of insurance, 33 pp
P. Ehling, A. Kalay and S. Pant
(Working Paper No. 18/2011)
Consistent with the agency cost rational, this paper documents that managers having large private benefits of control purchase more insurance to reduce their own exposure to the probability of left-tail outcomes and hence the volatility of the firm's cash flows. Private benefits of control are estimated as the difference between the price of the stock, and an equivalent synthetic stock (constructed with options) that provides claims on the same cash flows but gives its owners no voting rights. Consistent with the Jensen (1986) free cash flow hypothesis we also find that firms with larger private benefits of control tend to use more debt.
Voluntary disclosures, corporate control, and investment, 45 pp.
P. Kumar, N. Langberg and K. Sivaramakrishnan
(Working Paper No. 19/2011)
We examine the valuation and capital allocation roles of voluntary disclosure when managers have private information regarding the firm’s investment opportunities, but an efficient market for corporate control influences their investment decisions. For managers with long-term stakes in the firm, the equilibrium disclosure region is two-tailed: only extreme good news and extreme bad news is disclosed in equilibrium. Moreover, the market’s stock price and investment responses to bad news disclosures are stronger than the responses to good news disclosures, which is consistent with the empirical evidence. We also find that myopic managers are more likely to withhold bad news in good economic times when markets can independently assess expected investment returns.
The market value of corporate votes: Theory and evidence from option prices, 61 pp.
A. Kalay, O. Karakas and S. Pant
(Working Paper No. 22/2011)
This paper quantifies the market value of the right to vote as the difference in the prices of the stock and the corresponding synthetic stock. Votes are found to have positive value that increases in the time to expiration of synthetic stocks. The value of vote increases around special meetings, for meetings with a high-ranking agenda, and where the proposal discussed has close votes. The value of the vote increases around M&A events and periods of hedge fund activism. Note that our estimate suffers from two conflicting biases. It is underestimated due to the early exercise possibility of American style options, and overestimated due to short selling constraints unrelated to voting. While our measure is likely useful in cross-sectional studies, we stop short of implying that it captures the exact value of the right to vote.
Information manipulation, rational exuberance and investment booms, 32 pp.
P. Kumar and N. Langberg
(Working Paper No. 24/2011)
We present a model of investment booms in rational and frictionless capital markets where there is systematic overinvesting (relative to the efficient capital allocation) in low productivity firms even asymptotically because of strategic information manipulation by privately informed insiders. However, such an allocation is constrained-efficient with respect to the informational imperfections and limited commitment by capital markets regarding investment policies that are inefficient ex post. For an open set of parameters investors endogenously get "stuck" at an overoptimistic level of (posterior) expectations on the industry productivity, and the useful information of managers of newly entering firms ceases to get incorporated in their investment decisions, even though there is optimal incentive contracting through optimal wage contracts and renegotiation-proof investment plans. Then, even in the limit, learning on the true industry productivity may not be complete. Our model helps explain in a Bayes-rational framework the historically observed confluence of innovations, strategic information manipulation by insiders, and investment booms that result, in the long run, in industry-wide overcapacity.
