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Volume 51: Issue 4 (September 1996)

Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry

Pages: 1097-1137  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04064.x  |  Cited by: 792


This article examines a new database that details corporate risk management activity in the North American gold mining industry. I find little empirical support for the predictive power of theories that view risk management as a means to maximize shareholder value. However, firms whose managers hold more options manage less gold price risk, and firms whose managers hold more stock manage more gold price risk, suggesting that managerial risk aversion may affect corporate risk management policy. Further, risk management is negatively associated with the tenure of firms' CFOs, perhaps reflecting managerial interests, skills, or preferences.

The Capital Budgeting Process: Incentives and Information

Pages: 1139-1174  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04065.x  |  Cited by: 239


We study the capital allocation process within firms. Observed budgeting processes are explained as a response to decentralized information and incentive problems. It is shown that these imperfections can result in underinvestment when capital productivity is high and overinvestment when it is low. We also investigate how the budgeting process may be expected to vary with firm or division characteristics such as investment opportunities and the technology for information transfer.

Bustup Takeovers of Value‐Destroying Diversified Firms

Pages: 1175-1200  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04066.x  |  Cited by: 152


We examine whether the value loss from diversification affects takeover and breakup probabilities. We estimate diversification's value effect by imputing stand‐alone values for individual business segments and find that firms with greater value losses are more likely to be taken over. Moreover, those acquired firms whose losses are greatest are most likely to be bought by LBO associations, which frequently break up their targets. For a subsample of large diversified targets: (1) higher value losses increase the extent of post‐takeover bustup; and (2) post‐takeover bustup generally results in divested divisions being operated as part of a focused, stand‐alone firm.

The Value of Diversification During the Conglomerate Merger Wave

Pages: 1201-1225  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04067.x  |  Cited by: 445


The current trend toward corporate focus reverses the diversification trend of the late 1960s and early 1970s. This article examines the value of diversification when many corporations started to diversify. I find no evidence that diversified companies were valued at a premium over single segment firms during the 1960s and 1970s. On the contrary, there was a large diversification discount during the 1960s, but this discount declined to zero during the 1970s. Insider ownership was negatively related to diversification during the 1960s, but when the diversification discount declined, firms with high insider ownership were the first to diversify.

The Method of Payment in Corporate Acquisitions, Investment Opportunities, and Management Ownership

Pages: 1227-1246  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04068.x  |  Cited by: 366


This article examines the motives underlying the payment method in corporate acquisitions. The findings support the notion that the higher the acquirer's growth opportunities, the more likely the acquirer is to use stock to finance an acquisition. Acquirer managerial ownership is not related to the probability of stock financing over small and large ranges of ownership, but is negatively related over a middle range. In addition, the likelihood of stock financing increases with higher pre‐acquisition market and acquiring firm stock returns. It decreases with an acquirer's higher cash availability, higher institutional shareholdings and blockholdings, and in tender offers.

Tax‐Exempt Debt and the Capital Structure of Nonprofit Organizations: An Application to Hospitals

Pages: 1247-1283  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04069.x  |  Cited by: 35


The availability of tax‐exempt financing provides nonprofit (NP) organizations with their own tax‐based incentives to issue debt. In this article, we develop a theoretical model in which NPs gain an indirect arbitrage from tax‐exempt debt issuance, constrained by: 1) the requirement that fixed investment exceed tax‐exempt debt flows (the project financing constraint), and 2) the constraint against share issuance. These constraints cause them to impute tax benefits to projects that afford access to the tax‐exempt bond market. Empirical tests indicate that NP hospitals behave as if they have target levels of tax‐exempt debt. Debt targeting is constrained by the availability of capital projects, while excess debt capacity stimulates investment.

Regulatory Incentives and the Thrift Crisis: Dividends, Mutual‐to‐Stock Conversions, and Financial Distress

Pages: 1285-1319  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04070.x  |  Cited by: 55


During the 1980s, insolvency of individual thrifts and the thrift deposit insurer created severe incentive problems. Lacking cash to close insolvent thrifts, regulators induced nearly $10 billion of private capital to flow into the industry through mutual‐to‐stock conversions. We test a theory of how regulators encouraged capital‐impaired mutual thrifts to convert by permitting them to pay dividends rather than rebuild capital. We estimate the costs of this policy and interpret the 1991 Federal Deposit Insurance Corporation Improvement Act as requiring regulators to impose restraints on depository institutions parallel to debt covenants that prevent capital distributions by nonfinancial firms experiencing distress.

Impact of the 1988 Basle Accord on International Banks

Pages: 1321-1346  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04071.x  |  Cited by: 63


The ostensible purpose of the Basle Accord was to standardize bank‐capital regulations among the twelve leading industrial countries. Its ulterior goal was to “level the playing field” by eliminating a funding‐cost advantage of Japanese banks that had allowed them to capture more than one‐third of international lending. The wealth gain for Japanese bank shareholders was 31.63 percent. Wealth effects for shareholders of non‐Japanese banks were not significant. These results suggest that the Basle Accord did not eliminate the pricing advantage of Japanese banks, challenging the non‐Japanese regulators' contention that the regulation would help level the playing field.

Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983–1991

Pages: 1347-1377  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04072.x  |  Cited by: 157


We examine debenture yields over the period 1983–1991 to evaluate the market's sensitivity to bank‐specific risks, and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

Equilibrium Analysis of Portfolio Insurance

Pages: 1379-1403  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04073.x  |  Cited by: 163


A martingale approach is used to characterize general equilibrium in the presence of portfolio insurance. Insurers sell to noninsurers in bad states, and general equilibrium requires that the risk premium rises to induce noninsurers to increase their holdings. We show that portfolio insurance increases price volatility, causes mean reversion in asset returns, raises the Sharpe ratio and volatility in bad states, and causes volatility to be correlated with volume. We also explain why out‐of‐the‐money S&P 500 put options trade at a higher volatility than do in‐the‐money puts.

Liquidity, Information, and Infrequently Traded Stocks

Pages: 1405-1436  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04074.x  |  Cited by: 921


This article investigates whether differences in information‐based trading can explain observed differences in spreads for active and infrequently traded stocks. Using a new empirical technique, we estimate the risk of information‐based trading for a sample of New York Stock Exchange (NYSE) listed stocks. We use the information in trade data to determine how frequently new information occurs, the composition of trading when it does, and the depth of the market for different volume‐decile stocks. Our most important empirical result is that the probability of information‐based trading is lower for high volume stocks. Using regressions, we provide evidence of the economic importance of information‐based trading on spreads.

Strategic Trading When Agents Forecast the Forecasts of Others

Pages: 1437-1478  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04075.x  |  Cited by: 293


We analyze a multi‐period model of trading with differentially informed traders, liquidity traders, and a market maker. Each informed trader's initial information is a noisy estimate of the long‐term value of the asset, and the different signals received by informed traders can have a variety of correlation structures. With this setup, informed traders not only compete with each other for trading profits, they also learn about other traders' signals from the observed order flow. Our work suggests that the initial correlation among the informed traders' signals has a significant effect on the informed traders' profits and the informativeness of prices.

Decision Frequency and Synchronization Across Agents: Implications for Aggregate Consumption and Equity Return

Pages: 1479-1497  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04076.x  |  Cited by: 77


This article examines a model in which decisions are made at fixed intervals and are unsynchronized across agents. Agents choose nondurable consumption and portfolio composition, and either or both can be chosen infrequently. A small utility cost is associated with both decisions being made infrequently. Calibrating returns to the U.S. economy, less frequent and unsynchronized decision‐making delivers the low volatility of aggregate consumption growth and its low correlation with equity return found in U.S. data. Allowing portfolio rebalancing to occur every period has a negligible impact on the joint behavior of aggregate consumption and returns.

Relative Pricing of Eurodollar Futures and Forward Contracts

Pages: 1499-1522  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04077.x  |  Cited by: 22


Past research explains observed spreads between futures and forward Eurodollar yields as being due to the futures contract's mark‐to‐market feature. We derive closed form solutions for this yield spread and show that, theoretically, it should be small. Also, differences in liquidity, taxation, and default risk cannot account for the large spreads observed. We also present evidence that the spreads, which are nonnegligible primarily in the first half of the sample period, are likely to be attributable to the mispricing of futures contracts relative to the forward rates and that the mispricing was gradually eliminated over time.

Earnings Announcements and the Components of the Bid‐Ask Spread

Pages: 1523-1535  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04078.x  |  Cited by: 208


This study investigates the behavior of the components of the bid‐ask spread around earnings announcements. We find that the adverse selection cost component significantly increases surrounding the announcements, while the inventory holding and order processing components significantly decline during the same periods. Our results suggest that the directional change in the total bid‐ask spread depends on the relative magnitudes of the changes in these three components. Specifically, the decreases in inventory holding costs and order processing costs imply that earnings announcements may have an insignificant impact on the total bid‐ask spread, even when they result in increased information asymmetry.

Noise Trading in Small Markets

Pages: 1537-1550  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04079.x  |  Cited by: 60


Considering noise traders as agents with unpredictable beliefs, we show that in an imperfectly competitive market with risk averse investors, noise traders may earn higher expected utility than rational investors. This happens when, by deviating from the Nash equilibrium strategy, noise traders hurt rational investors more than themselves. It follows that the willingness of arbitrageurs to exploit noise traders' misperceptions is lower relative to a perfectly competitive economy. This result reinforces the theory that noise trading may explain closed‐end fund discounts and small firms' returns, since these markets are less competitive than the market for large firms' stock.

Evidence of Discrimination in Lending: An Extension

Pages: 1551-1554  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04080.x  |  Cited by: 6


We generalize the model of Ferguson and Peters (1995) to allow for unequal recovery rates in the event of default by majority borrowers versus minority borrowers. This simple extension has two direct implications: (i) a uniform credit policy, as defined by Ferguson and Peters, entails cross‐subsidization across groups; and (ii) it is possible for a profit‐maximizing (and therefore economically nondiscriminatory) lending policy to generate lower average default rates among minority borrowers than among majority borrowers.

Book Reviews

Pages: 1555-1569  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04081.x  |  Cited by: 0

Book reviewed in this article:


Pages: 1571-1572  |  Published: 9/1996  |  DOI: 10.1111/j.1540-6261.1996.tb04082.x  |  Cited by: 0