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Volume 58: Issue 3 (June 2003)


Front Matter

Pages: i-v  |  Published: 6/2003  |  DOI: 10.1111/j.1540-6261.2003.tb00487.x  |  Cited by: 0


Fellow of the American Finance Association for 2003: Kenneth J. Arrow

Pages: vi-vii  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00553  |  Cited by: 0


Back Matter

Pages: viii-xxxi  |  Published: 6/2003  |  DOI: 10.1111/j.1540-6261.2003.tb00488.x  |  Cited by: 0


Corporate Financing: An Artificial Agent-based Analysis

Pages: 943-973  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00554  |  Cited by: 28

Thomas H. Noe, Michael J. Rebello, Jun Wang

We examine corporate security choice by simulating an economy populated by adaptive agents who learn about the structure of security returns and prices through experience. Through a process of evolutionary selection, each agent gravitates toward strategies that generate the highest payoffs. Despite the fact that markets are perfect and agents maximize value, a financing hierarchy emerges in which straight debt dominates other financing choices. Equity and convertible debt display significant underpricing. In general, the smaller the probability of loss to outside investors, the more likely the firm is to issue the security and the smaller the security's underpricing.


Idiosyncratic Risk Matters!

Pages: 975-1007  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00555  |  Cited by: 567

Amit Goyal, Pedro Santa-Clara

This paper takes a new look at the predictability of stock market returns with risk measures. We find a significant positive relation between average stock variance (largely idiosyncratic) and the return on the market. In contrast, the variance of the market has no forecasting power for the market return. These relations persist after we control for macroeconomic variables known to forecast the stock market. The evidence is consistent with models of time‐varying risk premia based on background risk and investor heterogeneity. Alternatively, our findings can be justified by the option value of equity in the capital structure of the firms.


Good Day Sunshine: Stock Returns and the Weather

Pages: 1009-1032  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00556  |  Cited by: 611

David Hirshleifer, Tyler Shumway

Psychological evidence and casual intuition predict that sunny weather is associated with upbeat mood. This paper examines the relationship between morning sunshine in the city of a country's leading stock exchange and daily market index returns across 26 countries from 1982 to 1997. Sunshine is strongly significantly correlated with stock returns. After controlling for sunshine, rain and snow are unrelated to returns. Substantial use of weather‐based strategies was optimal for a trader with very low transactions costs. However, because these strategies involve frequent trades, fairly modest costs eliminate the gains. These findings are difficult to reconcile with fully rational price setting.


Internal versus External Financing: An Optimal Contracting Approach*

Pages: 1033-1062  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00557  |  Cited by: 64

Roman Inderst, Holger M. Müller

We study optimal financial contracting for centralized and decentralized firms. Under centralized contracting, headquarters raises funds on behalf of multiple projects. Under decentralized contracting, each project raises funds separately on the external capital market. The benefit of centralization is that headquarters can use excess liquidity from high cash‐flow projects to buy continuation rights for low cash‐flow projects. The cost is that headquarters may pool cash flows from several projects and self‐finance follow‐up investments without having to return to the capital market. Absent any capital market discipline, it is more difficult to force headquarters to make repayments, which tightens financing constraints ex ante. Cross‐sectionally, our model implies that conglomerates should have a lower average productivity than stand‐alone firms.


Long-run Performance after Stock Splits: 1927 to 1996

Pages: 1063-1085  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00558  |  Cited by: 76

Jinho Byun, Michael S. Rozeff

We measure the postsplit performance of 12,747 stock splits from 1927 to 1996 using two methods to measure abnormal returns: size and book‐to‐market reference portfolios with bootstrapping, and calendar‐time abnormal returns combined with factor models. Between 1927 and 1996, neither method applied to splits 25 percent or larger finds performance significantly different from zero. Over selected subperiods, subsamples of 2–1 splits restricted by book‐to‐market availability requirements display positive abnormal returns using some methods. However, these samples show small or negligible abnormal returns using the calendar‐time method. Overall, the stock split evidence against market efficiency is neither pervasive nor compelling.


Too Busy to Mind the Business? Monitoring by Directors with Multiple Board Appointments

Pages: 1087-1111  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00559  |  Cited by: 603

Stephen P. Ferris, Murali Jagannathan, A. C. Pritchard

We examine the number of external appointments held by corporate directors. Directors who serve larger firms and sit on larger boards are more likely to attract directorships. Consistent with Fama and Jensen (1983), we find that firm performance has a positive effect on the number of appointments held by a director. We find no evidence that multiple directors shirk their responsibilities to serve on board committees. We do not find that multiple directors are associated with a greater likelihood of securities fraud litigation. We conclude that the evidence does not support calls for limits on directorships held by an individual.


DotCom Mania: The Rise and Fall of Internet Stock Prices

Pages: 1113-1137  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00560  |  Cited by: 391

Eli Ofek, Matthew Richardson

This paper explores a model based on agents with heterogenous beliefs facing short sales restrictions, and its explanation for the rise, persistence, and eventual fall of Internet stock prices. First, we document substantial short sale restrictions for Internet stocks. Second, using data on Internet holdings and block trades, we show a link between heterogeneity and price effects for Internet stocks. Third, arguing that lockup expirations are a loosening of the short sale constraint, we document average, long‐run excess returns as low as −33 percent for Internet stocks postlockup. We link the Internet bubble burst to the unprecedented level of lockup expirations and insider selling.


Convertible Securities and Venture Capital Finance

Pages: 1139-1166  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00561  |  Cited by: 278

Klaus M. Schmidt

This paper offers a new explanation for the prevalent use of convertible securities in venture capital finance. Convertible securities can be used to endogenously allocate cash‐flow rights as a function of the state of the world and the entrepreneur's effort. This property can be used to induce the entrepreneur and the venture capitalist to invest efficiently into the project. The result is robust to renegotiation and to changes in the timing of investments and information flows. The model is consistent with the observations that conversion is often automatic and that convertible securities are rarely used by outside investors.


Integration of Lending and Underwriting: Implications of Scope Economies

Pages: 1167-1191  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00562  |  Cited by: 44

George Kanatas, Jianping Qi

Informational scope economies provide a cost advantage to universal banks offering “one‐stop shopping” for lending and underwriting that enables them to “lock in” their clients' subsequent business. This market power reduces universal banks' incentive, relative to that of specialized investment banks, to apply costly underwriting efforts; consequently, universal banks are less successful in selling their clients' securities. Our results suggest that an integrated financial services market is less innovative than one with specialized intermediaries. Our analysis also identifies economy, intermediary, and firm characteristics that motivate either the integration or segmentation of bank lending and underwriting.


Managerial Incentives and Internal Capital Markets

Pages: 1193-1220  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00563  |  Cited by: 31

Adolfo de Motta

Capital budgeting in multidivisional firms depends on the external assessment of the whole firm, as well as on headquarters' assessment of the divisions. While corporate headquarters may create value by directly monitoring divisions, the external assessment of the firm is a public good for division managers who, consequently, are tempted to free ride. As the number of divisions increases, the free‐rider problem is aggravated, and internal capital markets substitute for external capital markets in the provision of managerial incentives. The analysis relates the value of diversification to characteristics of the firm, the industry, and the capital market.


What if Trading Location Is Different from Business Location? Evidence from the Jardine Group

Pages: 1221-1246  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00564  |  Cited by: 79

Kalok Chan, Allaudeen Hameed, Sie Ting Lau

We examine the price behavior and market activity of the Jardine Group companies after they were delisted from Hong Kong in 1994. Although the trading activity of the Jardine Group moved to Singapore, the core businesses remained in Hong Kong and Mainland China. Evidence indicates the Jardine stocks are correlated less (more) with the Hong Kong (Singapore) market after the delisting. This result cannot be explained by various hypotheses, such as relocation of core business, time‐varying betas, migration of trading activity, and currency and tax distortions. We conclude that price fluctuations are affected by country‐specific investor sentiment.


Market Maker Quotation Behavior and Pretrade Transparency

Pages: 1247-1267  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00565  |  Cited by: 78

Yusif Simaan, Daniel G. Weaver, David K. Whitcomb

We examine the impact of differing levels of pretrade transparency on the quotation behavior of Nasdaq market makers. We find that market makers are more likely to quote on odd ticks, and to actively narrow the spread, when they can do so anonymously by posting limit orders on Electronic Communication Networks (ECNs). From a public policy perspective, our findings suggest that making the level of pretrade transparency on Nasdaq more opaque by allowing anonymous quotes could improve price competition and narrow spreads further.


The Impact of Jumps in Volatility and Returns

Pages: 1269-1300  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00566  |  Cited by: 875

Bjørn Eraker, Michael Johannes, Nicholas Polson

This paper examines continuous‐time stochastic volatility models incorporating jumps in returns and volatility. We develop a likelihood‐based estimation strategy and provide estimates of parameters, spot volatility, jump times, and jump sizes using S&P 500 and Nasdaq 100 index returns. Estimates of jump times, jump sizes, and volatility are particularly useful for identifying the effects of these factors during periods of market stress, such as those in 1987, 1997, and 1998. Using formal and informal diagnostics, we find strong evidence for jumps in volatility and jumps in returns. Finally, we study how these factors and estimation risk impact option pricing.


Founding-Family Ownership and Firm Performance: Evidence from the S&P 500

Pages: 1301-1328  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00567  |  Cited by: 2086

Ronald C. Anderson, David M. Reeb

We investigate the relation between founding‐family ownership and firm performance. We find that family ownership is both prevalent and substantial; families are present in one‐third of the S&P 500 and account for 18 percent of outstanding equity. Contrary to our conjecture, we find family firms perform better than nonfamily firms. Additional analysis reveals that the relation between family holdings and firm performance is nonlinear and that when family members serve as CEO, performance is better than with outside CEOs. Overall, our results are inconsistent with the hypothesis that minority shareholders are adversely affected by family ownership, suggesting that family ownership is an effective organizational structure.


Miscellanea

Pages: 1329-1330  |  Published: 5/2003  |  DOI: 10.1111/1540-6261.00568  |  Cited by: 0