This paper shows that short debt maturities commit equityholders to leverage reductions when refinancing expiring debt in low-profitability states. However, shorter maturities lead to higher transaction costs since larger amounts of expiring debt need to be refinanced. We show that this trade-off between higher expected transaction costs against the commitment to reduce leverage in low-profitability states motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress and risky cash flows benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt. Evidence supports the model’s predictions.
{"title":"Debt Maturity and the Dynamics of Leverage","authors":"Thomas Dangl, J. Zechner","doi":"10.2139/ssrn.890228","DOIUrl":"https://doi.org/10.2139/ssrn.890228","url":null,"abstract":"\u0000 This paper shows that short debt maturities commit equityholders to leverage reductions when refinancing expiring debt in low-profitability states. However, shorter maturities lead to higher transaction costs since larger amounts of expiring debt need to be refinanced. We show that this trade-off between higher expected transaction costs against the commitment to reduce leverage in low-profitability states motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress and risky cash flows benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt. Evidence supports the model’s predictions.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"6 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-06-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126049646","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investors and academics increasingly criticize that features of employee stock option (ESO) programs reflect rent-extraction by managers (managerial power view). We use a unique European data set to investigate the relationship between the design of ESO programs and corporate governance structures. We find that ownership structures are related to the ESO design in a way that is consistent with the managerial power hypothesis: when ownership concentration is low and the exposition to the U.S. capital market is little, executives extract rents by designing poor ESO plans. Moreover, firms with weak creditor rights more often have badly designed option plans. Our findings also suggest that ineffective board structures (insider-dominated boards) are related to ESO design in a way that supports the arguments of the self-dealing view.
{"title":"Corporate Governance and the Design of Stock Option Contracts","authors":"Z. Sautner, Martin Weber","doi":"10.2139/ssrn.825429","DOIUrl":"https://doi.org/10.2139/ssrn.825429","url":null,"abstract":"Investors and academics increasingly criticize that features of employee stock option (ESO) programs reflect rent-extraction by managers (managerial power view). We use a unique European data set to investigate the relationship between the design of ESO programs and corporate governance structures. We find that ownership structures are related to the ESO design in a way that is consistent with the managerial power hypothesis: when ownership concentration is low and the exposition to the U.S. capital market is little, executives extract rents by designing poor ESO plans. Moreover, firms with weak creditor rights more often have badly designed option plans. Our findings also suggest that ineffective board structures (insider-dominated boards) are related to ESO design in a way that supports the arguments of the self-dealing view.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"30 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-02-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129812663","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We investigate the optimal investment and consumption choice of individual investors with uncertain future labor income operating in a financial market with stochastic interest rates. Since the present value of the individual's future income is a main determinant of the optimal behavior and this present value depends heavily on the interest rate dynamics, the joint stochastics of income and interest rates will have consequences beyond the separate effects of stochastic income and stochastic interest rates. We study both the case where income risk is spanned and there are no portfolio constraints and the case with non-spanned income risk and a constraint ruling out borrowing against future income. For the spanned, unconstrained problem we study a special case in which we obtain closed-form expressions for the optimal policies. For the unspanned, constrained problem we implement a numerical solution technique and compare the solutions to the spanned, unconstrained problem. We also allow for typical life-cycle variations in labor income.
{"title":"Dynamic Asset Allocation with Stochastic Income and Interest Rates","authors":"Claus Munk, Carsten Sørensen","doi":"10.2139/ssrn.676021","DOIUrl":"https://doi.org/10.2139/ssrn.676021","url":null,"abstract":"We investigate the optimal investment and consumption choice of individual investors with uncertain future labor income operating in a financial market with stochastic interest rates. Since the present value of the individual's future income is a main determinant of the optimal behavior and this present value depends heavily on the interest rate dynamics, the joint stochastics of income and interest rates will have consequences beyond the separate effects of stochastic income and stochastic interest rates. We study both the case where income risk is spanned and there are no portfolio constraints and the case with non-spanned income risk and a constraint ruling out borrowing against future income. For the spanned, unconstrained problem we study a special case in which we obtain closed-form expressions for the optimal policies. For the unspanned, constrained problem we implement a numerical solution technique and compare the solutions to the spanned, unconstrained problem. We also allow for typical life-cycle variations in labor income.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"82 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-03-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134271731","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We test whether short-sellers in U.S. stocks are able to predict future returns based on new SEC-mandated data for 2005. There is a tremendous amount of short-selling activity during the sample: short-sales represent 24 percent of NYSE and 31 percent of Nasdaq share volume. Short-sellers increase their trading following positive returns and they correctly predict future negative abnormal returns. These patterns are robust to controlling for voluntary liquidity provision and for opportunistic risk-bearing by short-sellers. The results are consistent with the hypothesis that short-sellers are trading on short-term overreaction in stock returns. A trading strategy based on daily short-selling activity generates significant positive returns during the sample period.
{"title":"Can Short-Sellers Predict Returns? Daily Evidence","authors":"Karl B. Diether, Kuan-Hui Lee, Ingrid M. Werner","doi":"10.2139/ssrn.761724","DOIUrl":"https://doi.org/10.2139/ssrn.761724","url":null,"abstract":"We test whether short-sellers in U.S. stocks are able to predict future returns based on new SEC-mandated data for 2005. There is a tremendous amount of short-selling activity during the sample: short-sales represent 24 percent of NYSE and 31 percent of Nasdaq share volume. Short-sellers increase their trading following positive returns and they correctly predict future negative abnormal returns. These patterns are robust to controlling for voluntary liquidity provision and for opportunistic risk-bearing by short-sellers. The results are consistent with the hypothesis that short-sellers are trading on short-term overreaction in stock returns. A trading strategy based on daily short-selling activity generates significant positive returns during the sample period.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"62 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-05-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116589918","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
"We show that multifactor performance estimates for mutual funds suffer from systematic biases and argue that these biases are a result of miscalculating the factor premiums. Because the factor proxies are based on hypothetical stock portfolios and do not incorporate transaction costs, trade impact, and trading restrictions, the factor premiums are either over- or underestimated. We argue that factor proxies based on mutual fund returns rather than on stock returns provide better benchmarks to evaluate professional money managers." Copyright (c) 2009 Financial Management Association International..
{"title":"On the Use of Multifactor Models to Evaluate Mutual Fund Performance","authors":"Marno Verbeek, J. Huij","doi":"10.2139/ssrn.906723","DOIUrl":"https://doi.org/10.2139/ssrn.906723","url":null,"abstract":"\"We show that multifactor performance estimates for mutual funds suffer from systematic biases and argue that these biases are a result of miscalculating the factor premiums. Because the factor proxies are based on hypothetical stock portfolios and do not incorporate transaction costs, trade impact, and trading restrictions, the factor premiums are either over- or underestimated. We argue that factor proxies based on mutual fund returns rather than on stock returns provide better benchmarks to evaluate professional money managers.\" Copyright (c) 2009 Financial Management Association International..","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"90 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-04-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133106848","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper, we investigate the effects of legal protection of investors and the equity-financing channel on the relationship between corporate investment and stock prices in an international setting. We find that firms in countries with stronger legal protection of investors have investments that are more sensitive to their stock prices. In addition, equity-dependent firms display a higher investment-to-price sensitivity than do nonequity-dependent firms, which is consistent with the equity-financing channel argument. Finally, the positive relation between legal protection and the investment-to-price sensitivity is more pronounced for equity-dependent firms than for nonequity-dependent firms. Overall, our evidence complements the earlier finding by Baker et al. (2003) and suggests that both legal protection of investors and the equity-financing channel influence managers' corporate investment decisions with respect to changes in stock prices.
{"title":"Legal Protection, Equity Dependence and Corporate Investment: Evidence from Around the World","authors":"K. Wei, Yuanto Kusnadi","doi":"10.2139/ssrn.890181","DOIUrl":"https://doi.org/10.2139/ssrn.890181","url":null,"abstract":"In this paper, we investigate the effects of legal protection of investors and the equity-financing channel on the relationship between corporate investment and stock prices in an international setting. We find that firms in countries with stronger legal protection of investors have investments that are more sensitive to their stock prices. In addition, equity-dependent firms display a higher investment-to-price sensitivity than do nonequity-dependent firms, which is consistent with the equity-financing channel argument. Finally, the positive relation between legal protection and the investment-to-price sensitivity is more pronounced for equity-dependent firms than for nonequity-dependent firms. Overall, our evidence complements the earlier finding by Baker et al. (2003) and suggests that both legal protection of investors and the equity-financing channel influence managers' corporate investment decisions with respect to changes in stock prices.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"34 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132685832","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper we examine how divergence of opinion affect cross-sectional asset returns for different stocks with different arbitrage costs by employing a new proxy for divergence of opinion. 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 is a more reliable proxy for divergence of opinion among all individual investors than the existing proxies such as dispersion in analysts' earnings forecasts and turnover. We then use this measure of divergence of opinion in an empirical asset pricing analysis. In particular, we incorporate the crucial role of divergence of opinion in the determination of cross-sectional asset returns, establishing that when divergence of opinion is high, stock prices tend to be biased upwardly, resulting in lower future returns. These effects are especially pronounced for stocks with higher arbitrage costs including idiosyncratic risks, short sale costs, and other transaction costs, which are more difficult and costly to short sell. Hence the evidence for these stocks 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 less arbitrage costs. Also, our results suggest that the idiosyncratic risk, relative to other arbitrage cost measure, incrementally explain the divergence of opinon's effect on stock returns.
{"title":"Divergence of Opinion, Arbitrage Costs and Stock Returns","authors":"Jin Wu","doi":"10.2139/ssrn.890151","DOIUrl":"https://doi.org/10.2139/ssrn.890151","url":null,"abstract":"In this paper we examine how divergence of opinion affect cross-sectional asset returns for different stocks with different arbitrage costs by employing a new proxy for divergence of opinion. 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 is a more reliable proxy for divergence of opinion among all individual investors than the existing proxies such as dispersion in analysts' earnings forecasts and turnover. We then use this measure of divergence of opinion in an empirical asset pricing analysis. In particular, we incorporate the crucial role of divergence of opinion in the determination of cross-sectional asset returns, establishing that when divergence of opinion is high, stock prices tend to be biased upwardly, resulting in lower future returns. These effects are especially pronounced for stocks with higher arbitrage costs including idiosyncratic risks, short sale costs, and other transaction costs, which are more difficult and costly to short sell. Hence the evidence for these stocks 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 less arbitrage costs. Also, our results suggest that the idiosyncratic risk, relative to other arbitrage cost measure, incrementally explain the divergence of opinon's effect on stock returns.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2006-10-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130732638","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We estimate the parameters of pricing kernels that depend on both aggregate wealth and state variables that describe the investment opportunity set, using FTSE 100 and S&P 500 index option returns as the returns to be priced. The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernal, and across the two markets. The results provided further strong evidence, which is consistent with Merton's (1973a) Intertemporal Capital Asset Pricing Model, that state variables in addition to market risk are priced.
{"title":"Option Pricing Kernels and the Icapm","authors":"Xiaoquan Liu, M. Brennan, Yihong Xia","doi":"10.2139/ssrn.917911","DOIUrl":"https://doi.org/10.2139/ssrn.917911","url":null,"abstract":"We estimate the parameters of pricing kernels that depend on both aggregate wealth and state variables that describe the investment opportunity set, using FTSE 100 and S&P 500 index option returns as the returns to be priced. The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernal, and across the two markets. The results provided further strong evidence, which is consistent with Merton's (1973a) Intertemporal Capital Asset Pricing Model, that state variables in addition to market risk are priced.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"133 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2006-07-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125056840","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper demonstrates the relative importance of default and liquidity risks in equity returns. While previous studies have shown that both default and liquidity risks affect equity returns, none, to our knowledge, has examined their interrelation and relative importance for equity returns. We consider three alternative liquidity measures: the Pastor-Stambaugh measure, the turnover measure, and the illiquidity ratio measure. The default measure of choice is the one based on Merton's (1974) contingent claims approach. The alternative liquidity measures are very different from each other, but they are all related to our default measure. While we know from past research that low liquidity stocks earn higher returns than high liquidity stocks, we demonstrate here that this is the case only when these stocks also have high default risk, and in no other case. In contrast, high default risk stocks always earn higher returns than low default risk stocks, independently of their liquidity level. Vector autoregressive tests reveal the existence of a two-way causal relation between default risk and stock market returns, which is not present in the case of liquidity. Liquidity risk does not affect the future path of stock market returns. The robustness of these relations remains unaltered when we take into account the correlation of the default and liquidity measures with aggregate stock market volatility. Consistent with previous evidence, the inclusion of default and liquidity variables in popular asset pricing specifications improves a model's performance. However, the improvement is much larger when the included variable is default, rather than liquidity. In the presence of the default variable, the inclusion of a liquidity proxy in an asset pricing specification results in only a marginal improvement of the model's performance. The opposite is not true.
{"title":"The Relation between Liquidity Risk and Default Risk in Equity Returns","authors":"Maria Vassalou, J. Chen, Lihong Zhou","doi":"10.2139/ssrn.922622","DOIUrl":"https://doi.org/10.2139/ssrn.922622","url":null,"abstract":"This paper demonstrates the relative importance of default and liquidity risks in equity returns. While previous studies have shown that both default and liquidity risks affect equity returns, none, to our knowledge, has examined their interrelation and relative importance for equity returns. We consider three alternative liquidity measures: the Pastor-Stambaugh measure, the turnover measure, and the illiquidity ratio measure. The default measure of choice is the one based on Merton's (1974) contingent claims approach. The alternative liquidity measures are very different from each other, but they are all related to our default measure. While we know from past research that low liquidity stocks earn higher returns than high liquidity stocks, we demonstrate here that this is the case only when these stocks also have high default risk, and in no other case. In contrast, high default risk stocks always earn higher returns than low default risk stocks, independently of their liquidity level. Vector autoregressive tests reveal the existence of a two-way causal relation between default risk and stock market returns, which is not present in the case of liquidity. Liquidity risk does not affect the future path of stock market returns. The robustness of these relations remains unaltered when we take into account the correlation of the default and liquidity measures with aggregate stock market volatility. Consistent with previous evidence, the inclusion of default and liquidity variables in popular asset pricing specifications improves a model's performance. However, the improvement is much larger when the included variable is default, rather than liquidity. In the presence of the default variable, the inclusion of a liquidity proxy in an asset pricing specification results in only a marginal improvement of the model's performance. The opposite is not true.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"20 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2006-07-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126136205","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper finds a significant positive relation between illiquidity and conditional variance of stock returns, both at the individual and aggregate levels. For each of the largest two hundred stocks on the NYSE and NASDAQ, we estimate a GARCH model in which share turnover and proportional spread enter the conditional variance equitation. We find that, for 75% of the stocks examined, proportional spread is a significant and positive determinant of conditional heteroscedasticity after orthogonalization against share turnover and return. Alternative measures of illiquidity also have a strong positive effect on the variability of aggregate market return. In support of these findings, we present a simple market microstructural model in which conditional return variance is a positive and nonlinear function of stochastic Kyle's lambda.
{"title":"Liquidity and Conditional Heteroscedasticity in Stock Returns","authors":"Akiko Watanabe, M. Watanabe","doi":"10.2139/ssrn.906327","DOIUrl":"https://doi.org/10.2139/ssrn.906327","url":null,"abstract":"This paper finds a significant positive relation between illiquidity and conditional variance of stock returns, both at the individual and aggregate levels. For each of the largest two hundred stocks on the NYSE and NASDAQ, we estimate a GARCH model in which share turnover and proportional spread enter the conditional variance equitation. We find that, for 75% of the stocks examined, proportional spread is a significant and positive determinant of conditional heteroscedasticity after orthogonalization against share turnover and return. Alternative measures of illiquidity also have a strong positive effect on the variability of aggregate market return. In support of these findings, we present a simple market microstructural model in which conditional return variance is a positive and nonlinear function of stochastic Kyle's lambda.","PeriodicalId":308975,"journal":{"name":"EFA 2006 Zurich Meetings (Archive)","volume":"8 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2006-06-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124260819","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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