The Journal of Finance

Interest Rate Swaps and Corporate Financing Choices

Published: 09/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04667.x

SHERIDAN TITMAN

This paper describes the firm's decision to borrow short‐term versus long‐term and shows how the introduction of interest rate swaps affects this choice. The model shows that in the absence of a swap market, interest rate uncertainty can lead firms to substitute long‐term for short‐term financing. However, when swaps exist, there is a tendency for firms that expect their credit quality to improve to borrow short‐term and use swaps to hedge interest rate risk. The model suggests that, while the demand for fixed for floating swaps is enhanced, the demand for floating for fixed swaps is reduced by the presence of asymmetric information.

The Effects of Anticipated Inflation on Housing Market Equilibrium

Published: 06/01/1982   |   DOI: 10.1111/j.1540-6261.1982.tb02226.x

SHERIDAN TITMAN

An increase in the anticipated rate of inflation causes distortions in the housing market due to a nonindexed tax system. Since nominal rather than real interest payments are tax deductible, an increase in inflation decreases the aftertax cost of capital for homeowners, which in turn increases the demand for housing and increases its real price. This tax gain is shown to be larger for rental housing than for owner‐occupied housing. In a competitive market, this implies that although the real price of housing increases with a rise in anticipated inflation, real rental rates fall.

Financial Markets and Investment Externalities

Published: 07/16/2013   |   DOI: 10.1111/jofi.12072

SHERIDAN TITMAN

This address explores the link between financial market shocks, investment choices, and various externalities that can arise from these choices. My analysis, which emphasizes differences between shocks to debt and equity markets, provides insights about some stylized facts from the macro finance literature. These insights are illustrated with a discussion of the technology boom and bust in the late 1990s and early 2000s, and the housing boom and bust in the mid‐2000s.

The Determinants of Capital Structure Choice

Published: 03/01/1988   |   DOI: 10.1111/j.1540-6261.1988.tb02585.x

SHERIDAN TITMAN, ROBERTO WESSELS

This paper analyzes the explanatory power of some of the recent theories of optimal capital structure. The study extends empirical work on capital structure theory in three ways. First, it examines a much broader set of capital structure theories, many of which have not previously been analyzed empirically. Second, since the theories have different empirical implications in regard to different types of debt instruments, the authors analyze measures of short‐term, long‐term, and convertible debt rather than an aggregate measure of total debt. Third, the study uses a factor‐analytic technique that mitigates the measurement problems encountered when working with proxy variables.

Valuing Commercial Mortgages: An Empirical Investigation of the Contingent‐Claims Approach to Pricing Risky Debt

Published: 06/01/1989   |   DOI: 10.1111/j.1540-6261.1989.tb05061.x

SHERIDAN TITMAN, WALTER TOROUS

This paper empirically investigates a contingent‐claims model of commercial mortgage pricing. We find that the magnitude of the observed default premia for a sample of nonprepayable fixed rate bullet mortgages can be explained by the contingent‐claims model. In addition, the model explains a significant proportion of the period‐to‐period changes in the default premia. However, given an assumed negative correlation between building value changes and interest rate changes, the model's risk structure tends to increase less steeply with increasing maturity than the observed risk structure.

Profitability of Momentum Strategies: An Evaluation of Alternative Explanations

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00342

Narasimhan Jegadeesh, Sheridan Titman

This paper evaluates various explanations for the profitability of momentum strategies documented in Jegadeesh and Titman (1993). The evidence indicates that momentum profits have continued in the 1990s, suggesting that the original results were not a product of data snooping bias. The paper also examines the predictions of recent behavioral models that propose that momentum profits are due to delayed overreactions that are eventually reversed. Our evidence provides support for the behavioral models, but this support should be tempered with caution.

The Persistence of Mutual Fund Performance

Published: 12/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04692.x

MARK GRINBLATT, SHERIDAN TITMAN

This paper analyzes how mutual fund performance relates to past performance. These tests are based on a multiple portfolio benchmark that was formed on the basis of securities characteristics. We find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns.

The Going‐Public Decision and the Development of Financial Markets

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00136

Avanidhar Subrahmanyam, Sheridan Titman

This paper explores the linkages between stock price efficiency, the choice between private and public financing, and the development of capital markets in emerging economies. Generally, the advantage of public financing is high if costly information is diverse and cheap to acquire, and if investors receive valuable information without cost. The value of public firms generally depends on public market size, which implies that there can be a positive externality associated with going public, so that an inferior equilibrium can exist where too few firms go public. The model is consistent with empirical observations on financial market development.

A Dynamic Model of Characteristic‐Based Return Predictability

Published: 08/08/2019   |   DOI: 10.1111/jofi.12839

AYDOĞAN ALTI, SHERIDAN TITMAN

We present a dynamic model that links characteristic‐based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy‐wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic‐sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic‐sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic‐based anomalies.

The Determinants of Leveraged Buyout Activity: Free Cash Flow vs. Financial Distress Costs

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05138.x

TIM OPLER, SHERIDAN TITMAN

This paper investigates the determinants of leveraged buyout (LBO) activity by comparing firms that have implemented LBOs to those that have not. Consistent with the free cash flow theory, we find that firms that initiate LBOs can be characterized as having a combination of unfavorable investment opportunities (low Tobin's q) and relatively high cash flow. LBO firms also tend to be more diversified than firms which do not undertake LBOs. In addition, firms with high expected costs of financial distress (e.g., those with high research and development expenditures) are less likely to do LBOs.

Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency

Published: 03/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04702.x

NARASIMHAN JEGADEESH, SHERIDAN TITMAN

This paper documents that strategies which buy stocks that have performed well in the past and sell stocks that have performed poorly in the past generate significant positive returns over 3‐to 12‐month holding periods. We find that the profitability of these strategies are not due to their systematic risk or to delayed stock price reactions to common factors. However, part of the abnormal returns generated in the first year after portfolio formation dissipates in the following two years. A similar pattern of returns around the earnings announcements of past winners and losers is also documented.

Leverage and Corporate Performance: Evidence from Unsuccessful Takeovers

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00117

Assem Safieddine, Sheridan Titman

This paper finds that, on average, targets that terminate takeover offers significantly increase their leverage ratios. Targets that increase their leverage ratios the most reduce capital expenditures, sell assets, reduce employment, increase focus, and realize cash flows and share prices that outperform their benchmarks in the five years following the failed takeover. Our evidence suggests that leverage‐increasing targets act in the interests of shareholders when they terminate takeover offers and that higher leverage helps firms remain independent not because it entrenches managers, but because it commits managers to making the improvements that would be made by potential raiders.

Feedback from Stock Prices to Cash Flows

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00409

Avanidhar Subrahmanyam, Sheridan Titman

Feedback from financial market prices to cash flows arises when a firm's nonfinancial stakeholders, for example, its customers, employees, and suppliers, make decisions that are contingent on the information revealed by the price. Complementarities across stakeholders result in cascades, wherein relatively small stock price moves trigger substantial changes in asset values. This paper analyzes the relation between such feedback effects and parameters such as the information cost, the volatility of existing projects, the risk aversion of liquidity suppliers, and the precision of managerial information.

Market Reactions to Tangible and Intangible Information

Published: 08/03/2006   |   DOI: 10.1111/j.1540-6261.2006.00884.x

KENT DANIEL, SHERIDAN TITMAN

The book‐to‐market effect is often interpreted as evidence of high expected returns on stocks of “distressed” firms with poor past performance. We dispute this interpretation. We find that while a stock's future return is unrelated to the firm's past accounting‐based performance, it is strongly negatively related to the “intangible” return, the component of its past return that is orthogonal to the firm's past performance. Indeed, the book‐to‐market ratio forecasts returns because it is a good proxy for the intangible return. Also, a composite equity issuance measure, which is related to intangible returns, independently forecasts returns.

Approximate Factor Structures: Interpretations and Implications for Empirical Tests

Published: 12/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb02388.x

MARK GRINBLATT, SHERIDAN TITMAN

This paper provides some new insights about approximate factor structures, as defined by Chamberlain and Rothschild [2], and their implications for empirical tests. First, we show that any economy that satisfies an approximate factor structure can be transformed, in a manner that does not alter the characteristics of investor portfolios, into an economy that satisfies an exact factor structure, as defined by Ross [9]. Second, we show that principal components analysis represents just one of many methods of forming groups of well‐diversified portfolios with no idiosyncratic risk in large samples. Correct factor loadings will be obtained by regressing security returns on any group of these portfolios. Our interpretations of the Chamberlain and Rothschild results also provide additional insights into the testability of the Arbitrage Pricing Theory. We show that securities cannot be repackaged to hide factors in the manner suggested by Shanken [10] without the variance of some of the repackaged securities approaching infinity in large economies.

Evidence on the Characteristics of Cross Sectional Variation in Stock Returns

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb03806.x

KENT DANIEL, SHERIDAN TITMAN

Firm sizes and book‐to‐market ratios are both highly correlated with the average returns of common stocks. Fama and French (1993) argue that the association between these characteristics and returns arise because the characteristics are proxies for nondiversifiable factor risk. In contrast, the evidence in this article indicates that the return premia on small capitalization and high book‐to‐market stocks does not arise because of the comovements of these stocks with pervasive factors. It is the characteristics rather than the covariance structure of returns that appear to explain the cross‐sectional variation in stock returns.

Security Analysis and Trading Patterns When Some Investors Receive Information Before Others

Published: 12/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb04777.x

DAVID HIRSHLEIFER, AVANIDHAR SUBRAHMANYAM, SHERIDAN TITMAN

In existing models of information acquisition, all informed investors receive their information at the same time. This article analyzes trading behavior and equilibrium information acquisition when some investors receive common private information before others. The model implies that, under some conditions, investors will focus only on a subset of securities (“herding”), while neglecting other securities with identical exogenous characteristics. In addition, the model is consistent with empirical correlations that are suggestive of oft‐cited trading strategies such as profit taking (short‐term position reversal) and following the leader (mimicking earlier trades).

Equilibrium Exhaustible Resource Price Dynamics

Published: 08/14/2007   |   DOI: 10.1111/j.1540-6261.2007.01254.x

MURRAY CARLSON, ZEIGHAM KHOKHER, SHERIDAN TITMAN

We develop equilibrium models of exhaustible resource markets with endogenous extraction choices and prices. Our analysis demonstrates how adjustment costs can generate oil and gas forward price dynamics with two factors, consistent with the behavior these commodities exhibit in the Schwartz and Smith (2000) calibration. Our two‐factor model predicts that stochastic volatility will arise in these markets as a natural consequence of production adjustments, however, and we provide supporting empirical evidence. Differences between endogenous price processes from our general equilibrium model and exogenous processes in earlier papers can generate significant differences in both financial and real option values.

Financial Distress and Corporate Performance

Published: 07/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb00086.x

TIM C. OPLER, SHERIDAN TITMAN

This study finds that highly leveraged firms lose substantial market share to their more conservatively financed competitors in industry downturns. Specifically, firms in the top leverage decile in industries that experience output contractions see their sales decline by 26 percent more than do firms in the bottom leverage decile. A similar decline takes place in the market value of equity. These findings are consistent with the view that the indirect costs of financial distress are significant and positive. Consistent with the theory that firms with specialized products are especially vulnerable to financial distress, we find that highly leveraged firms that engage in research and development suffer the most in economically distressed periods. We also find that the adverse consequences of leverage are more pronounced in concentrated industries.

Market Imperfections, Investment Flexibility, and Default Spreads

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00630.x

Sheridan Titman, Stathis Tompaidis, Sergey Tsyplakov

This paper develops a structural model that determines default spreads in a setting where the debt's collateral is endogenously determined by the borrower's investment choice, and a demand variable with permanent and temporary components. We also consider the possibility that the borrower cannot commit to taking the value‐maximizing investment choice, and may, in addition, be constrained in its ability to raise external capital. Based on a model calibrated to data on office buildings and commercial mortgages, we present numerical simulations that quantify the extent to which investment flexibility, incentive problems, and credit constraints affect default spreads.