View All Issues

Volume 52: Issue 2 (June 1997)

Front Matter

Pages: i-vii  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb00274.x  |  Cited by: 0


Pages: viii-ix  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04806.x  |  Cited by: 0


Pages: x-xi  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04807.x  |  Cited by: 0

Back Matter

Pages: xii-xxxviii  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb00275.x  |  Cited by: 0


Pages: 447-447  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04808.x  |  Cited by: 0

Good Timing: CEO Stock Option Awards and Company News Announcements

Pages: 449-476  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04809.x  |  Cited by: 534


This article analyzes the timing of CEO stock option awards, as a method of investigating corporate managers' influence over the terms of their own compensation. In a sample of 620 stock option awards to CEOs of Fortune 500 companies between 1992 and 1994, I find that the timing of awards coincides with favorable movements in company stock prices. Patterns of companies' quarterly earnings announcements are consistent with an interpretation that CEOs receive stock option awards shortly before favorable corporate news. I evaluate and reject several alternative explanations of the results, including insider trading and the manipulation of news announcement dates.

How Much Do Taxes Discourage Incorporation?

Pages: 477-506  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04810.x  |  Cited by: 66


The double taxation of corporate income should discourage firms from incorporating. We investigate the extent to which the aggregate allocation of assets and taxable income in the United States between corporate and noncorporate firms responds to the size of this tax distortion during the period 1959–1986. In theory, profitable firms should shift out of the corporate sector when the tax distortion is large, and conversely for firms with tax losses. Our empirical results provide strong support for these forecasts, and imply that the resulting excess burden equals 16 percent of business tax revenue.

Analyst Following of Initial Public Offerings

Pages: 507-529  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04811.x  |  Cited by: 336


We examine data on analyst following for a sample of initial public offerings completed between 1975 and 1987 to see how they relate to three well‐documented IPO anomalies. We find that higher underpricing leads to increased analyst following. Analysts are overoptimistic about the earnings potential and long term growth prospects of recent IPOs. More firms complete IPOs when analysts are particularly optimistic about the growth prospects of recent IPOs. In the long run, IPOs have better stock performance when analysts ascribe low growth potential rather than high growth potential. These results suggest that the anomalies may be partially driven by overoptimism.

Strategic Debt Service

Pages: 531-556  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04812.x  |  Cited by: 283


When firms experience financial distress, equity holders may act strategically, forcing concessions from debtholders and paying less than the originally‐contracted interest payments. This article incorporates strategic debt service in a standard, continuous time asset pricing model, developing simple closed‐form expressions for debt and equity values. We find that strategic debt service can account for a substantial proportion of the premium on risky corporate debt. We analyze the efficiency implications of strategic debt service, showing that it can eliminate both direct bankruptcy costs and agency costs of debt.

Assessing Specification Errors in Stochastic Discount Factor Models

Pages: 557-590  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04813.x  |  Cited by: 306


In this article we develop alternative ways to compare asset pricing models when it is understood that their implied stochastic discount factors do not price all portfolios correctly. Unlike comparisons based on χ2 statistics associated with null hypotheses that models are correct, our measures of model performance do not reward variability of discount factor proxies. One of our measures is designed to exploit fully the implications of arbitrage‐free pricing of derivative claims. We demonstrate empirically the usefulness of our methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.

Assessing Goodness-of-Fit of Asset Pricing Models: The Distribution of the Maximal R2

Pages: 591-607  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04814.x  |  Cited by: 54


The development of asset pricing models that rely on instrumental variables together with the increased availability of easily‐accessible economic time‐series have renewed interest in predicting security returns. Evaluating the significance of these new research findings, however, is no easy task. Because these asset pricing theory tests are not independent, classical methods of assessing goodness‐of‐fit are inappropriate. This study investigates the distribution of the maximal R2 when k of m regressors are used to predict security returns. We provide a simple procedure that adjusts critical R2 values to account for selecting variables by searching among potential regressors.

Are There Tax Effects in the Relative Pricing of U.S. Government Bonds?

Pages: 609-633  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04815.x  |  Cited by: 49


We investigate the impact of the Tax Reform Act of 1986 on the relative pricing of U.S. Treasury bonds. We obtain positive statistically and economically significant estimates for the implicit tax rates of a “representative” investor in the late 1970s and early 1980s. After the 1986 Tax Reform, the point estimates for the tax rate are close to zero. Tests for a regime shift associated with the 1986 Tax Reform support the hypothesis that this event largely eliminated tax effects from the term structure. We discuss both institutional and statutory explanations for this change.

On Stock Market Returns and Monetary Policy

Pages: 635-654  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04816.x  |  Cited by: 452


Financial economists have long debated whether monetary policy is neutral. This article addresses this question by examining how stock return data respond to monetary policy shocks. Monetary policy is measured by innovations in the federal funds rate and nonborrowed reserves, by narrative indicators, and by an event study of Federal Reserve policy changes. In every case the evidence indicates that expansionary policy increases ex‐post stock returns. Results from estimating a multi‐factor model also indicate that exposure to monetary policy increases an asset's ex‐ante return.

Tick Size, Share Prices, and Stock Splits

Pages: 655-681  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04817.x  |  Cited by: 194


Minimum price variation rules help explain why stock prices vary substantially across countries, and other curiosities of share prices. Companies tend to split their stock so that the institutionally mandated minimum tick size is optimal relative to the stock price. A large relative tick size provides an incentive for dealers to make markets and for investors to provide liquidity by placing limit orders, despite its placing a high floor on the quoted bid‐ask spread. A simple model suggests that idiosyncratic risk, firm size, and visibility of the firm affect the optimal relative tick size and thus the share price.

When It's Not The Only Game in Town: The Effect of Bilateral Search on the Quality of a Dealer Market

Pages: 683-712  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04818.x  |  Cited by: 30


We report results from experimental asset markets with liquidity traders and an insider where we allow bilateral trade to take place, in addition to public trade with dealers. In the absence of the search alternative, dealer profits are large—unlike in models with risk‐neutral, competitive dealers. However, when we allow traders to participate in the search market, dealer profits are close to zero. Dealers compete more aggressively with the alternative trading avenue than with each other. There is no evidence that price discovery is less efficient when the specialists are not the only game in town.

Institutional Equity Trading Costs: NYSE Versus Nasdaq

Pages: 713-735  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04819.x  |  Cited by: 71


We compare execution costs (market impact plus commission) on the New York Stock Exchange (NYSE) and Nasdaq for institutional investors. The differences in cost generally conform to each market's area of specialization. Controlling for firm size, trade size, and the money management firm's identity, costs are lower on Nasdaq for trades in comparatively smaller firms, while costs for trading the larger stocks are lower on NYSE. The cost differences estimated from a regression model are, however, sensitive to the choice of time period.

A Survey of Corporate Governance

Pages: 737-783  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04820.x  |  Cited by: 7515

Andrei Shleifer, Robert W. Vishny

This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.

The Valuation of Complex Derivatives by Major Investment Firms: Empirical Evidence

Pages: 785-798  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04821.x  |  Cited by: 31


This article examines the auction of a portfolio of collateralized mortgage obligations (CMOs) to major broker dealers and institutional investors. The unique data set allows us to analyze a number of important empirical questions related to the valuation of CMOs by the bidders and the elasticity of demand for the securities. The results reveal that the valuations differ substantially implying a significant elasticity of demand.

Equilibrium Valuation of Foreign Exchange Claims

Pages: 799-826  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04822.x  |  Cited by: 61


This article studies the equilibrium valuation of foreign exchange contingent claims. Within a continuous‐time Lucas (1982) two‐country model, exchange rates, interest rates and, in particular, factor risk prices are all endogenously and jointly determined. This guarantees the internal consistency of these price processes with a general equilibrium. In the same model, closed‐form valuation formulas are presented for currency options and currency futures options. Common to these formulas is that stochastic volatility and stochastic interest rates are admitted. Hedge ratios and other comparative statics are also provided analytically. It is shown that most existing currency option models are included as special cases.

The Valuation of American Options with Stochastic Interest Rates: A Generalization of the Geske-Johnson Technique

Pages: 827-840  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04823.x  |  Cited by: 19


The Geske–Johnson approach provides an efficient and intuitively appealing technique for the valuation and hedging of American‐style contingent claims. Here, we generalize their approach to a stochastic interest rate economy. The method is implemented using options exercisable on one of a finite number of dates. We illustrate how the value of an American‐style option increases with interest rate volatility. The magnitude of this effect depends on the extent to which the option is in the money, the volatilities of the underlying asset and the interest rates, as well as the correlation between them.

The Implications of Equity Issuance Decisions within a Parent-Subsidiary Governance Structure

Pages: 841-857  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04824.x  |  Cited by: 28


We provide evidence about the motivation for a parent–subsidiary governance structure by analyzing valuation effects of seasoned equity offerings by publicly traded affiliated units. Our results support Nanda's (1991) theoretical model which predicts equity offerings convey differential information about subsidiary and parent value. Subsidiary equity issuance has negative valuation effects on issuing subsidiaries and positive effects on parents, while parent equity issuance reduces issuing parent wealth and increases subsidiary wealth. Our evidence suggests that a parent–subsidiary organizational structure enhances corporate financing flexibility and mitigates underinvestment problems identified by Myers and Majluf (1984). There is no evidence of subsidiary wealth expropriation.

Good News for Value Stocks: Further Evidence on Market Efficiency

Pages: 859-874  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04825.x  |  Cited by: 438


This article examines the hypothesis that the superior return to so‐called value stocks is the result of expectational errors made by investors. We study stock price reactions around earnings announcements for value and glamour stocks over a 5‐year period after portfolio formation. The announcement returns suggest that a significant portion of the return difference between value and glamour stocks is attributable to earnings surprises that are systematically more positive for value stocks. The evidence is inconsistent with a risk‐based explanation for the return differential.

Firm Size, Book-to-Market Ratio, and Security Returns: A Holdout Sample of Financial Firms

Pages: 875-883  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04826.x  |  Cited by: 144


Fama and French (1992) document a significant relation between firm size, book‐to‐market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book‐to‐market ratios, and security returns is similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book‐to‐market premiums in returns. Our results indicate data‐snooping and selection biases do not explain the size and book‐to‐market patterns in returns.

Price Limit Performance: Evidence from the Tokyo Stock Exchange

Pages: 885-901  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04827.x  |  Cited by: 202


Price limit advocates claim that price limits decrease stock price volatility, counter overreaction, and do not interfere with trading activity. Conversely, price limit critics claim that price limits cause higher volatility levels on subsequent days (volatility spillover hypothesis), prevent prices from efficiently reaching their equilibrium level (delayed price discovery hypothesis), and interfere with trading due to limitations imposed by price limits (trading interference hypothesis). Empirical research does not provide conclusive support for either positions. We examine the Tokyo Stock Exchange price limit system to test these hypotheses. Our evidence supports all three hypotheses suggesting that price limits may be ineffective.

Book Reviews

Pages: 903-919  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04828.x  |  Cited by: 0

Book reviewed in this article:


Pages: 921-922  |  Published: 6/1997  |  DOI: 10.1111/j.1540-6261.1997.tb04829.x  |  Cited by: 0