|January 2021, VOL 27:1||March 2021, VOL 27:2||June 2021, VOL 27:3||September 2021, VOL 27:4||November 2021, VOL 27:5|
European Financial Management, VOL 27:1, January 2021
Eugene F. Fama
This is a compendium of notes on taxes. Section 2 presents a general tax scheme. It is a tax on value added by labor and capital that does not favor one or the other. Section 3 contrasts taxation of business income for pass-through entities and corporations. Section 4 discusses property taxes as taxes on housing services and so a form of income tax. Section 5 turns to wealth taxes. The closing Section 6 attempts to explain why people donate to nonprofits but minimize tax payments to governments, even though governments and nonprofits engage in many of the same activities.
Keywords: H2, business tax, nonprofits, value added tax, wealth tax.
There are two primary factors that affect expected returns for companies with high ESG (environmental, social and governance) ratings—investor preferences and risk. Although investor preferences for highly rated ESG companies can lower the cost of capital, the flip side of the coin is lower expected returns for investors. Regarding risk, the jury remains out on whether there is an ESG‐related risk factor. However, to the extent, ESG is a risk factor it also points towards lower expected returns for investments in highly rated companies. Though ESG investing may have social benefits, higher expected returns for investors are not among them.
Keywords: ESG, expected returns, investor preferences, risk.
JEL Classification: G0, G1
Hubert Dichtl, Wolfgang Drobetz, Viktoria‐Sophie Wendt
Factor‐based allocation embraces the idea of factors, as opposed to asset classes, as the ultimate building blocks of investment portfolios. We examine whether there is a superior way of combining factors in a portfolio and provide a comparison of factor‐based allocation strategies within a multiple testing framework. Factor‐based allocation is profitable beyond exploiting genuine risk premia, even when applying multiple testing corrections. Investment portfolios can be efficiently diversified using factor‐based allocation strategies, as demonstrated by robust economic performance over various economic scenarios. The naïve equally weighted factor portfolio, albeit simple and cost‐efficient, cannot be outperformed by more sophisticated allocation strategies.
Keywords:factor‐based allocation, multiple testing
JEL Classification: G20, G21, G22, G23
We investigate how vertical relatedness between business segments of firms affects capital allocation within internal capital markets. Using a battery of tests including exogenous import tariff reductions, we show that investments flow toward segments with better investment opportunities in firms with significant vertical relatedness between segments. This benefit of vertical relatedness is more pronounced in economic environments prone to information problems and in imperfectly competitive industries. Firms with significant inter‐segment vertical relatedness also exhibit superior productivity and operating profitability. Overall, we show that superior capital allocation is a channel through which vertical integration impacts real outcomes of firms.
Keywords:internal capital markets, firm boundaries, firm performance, product market relations, vertical integration.
JEL Classification: G30, L25, L22
Philip Molyneux, Alessio Reghezza, Chiara Torriero, Jonathan Williams
Using a sample of 440 Italian banks over 2007-2016, we find low interest rates motivate banks to expand their fee and commission income and to restructure their securities portfolios. A granular breakdown suggests banks grow non-interest income in various ways including portfolio management, brokerage and consultancy services and increase fee income from current account and payment services. In addition, banks re-balance securities portfolios away from those ‘held-for-trading’ to securities ‘available-for-sale’ and ‘held-to-maturity’. Our findings allude to different behaviour between large and small banks: while larger banks increase brokerage, consultancy and portfolio management services, smaller banks generate fees from customer current accounts.
Keywords: Fee and Commission Income; Securities; Low Interest Rates; Unconventional Monetary Policy; Italian Banking Sector
JEL Classification: E43; E44; E52; G21; F4
Patrick Augustin, Jan Schnitzler
We disentangle asset‐specific, market, and funding liquidity in the CDS–bond basis outside and during the 2007–9 global financial crisis. Our findings stress the importance of separating different types of liquidity, since all three measures have independently negative impacts on the basis. Funding liquidity emerges as the economically most important liquidity metric. While asset‐specific liquidity is cross‐correlated in both the cash and derivative markets, funding and market liquidity only matter for the cash market. We exploit the decomposition of the basis to test predictions of limits‐to‐arbitrage theories. We find strong evidence in favor of margin‐based asset pricing and flight‐to‐quality effects.
Keywords: Arbitrage, Basis, Credit Default Swaps, Corporate Bonds, Credit Risk, Counterparty Risk, Liquidity.
JEL Classification: C1, C23, G01, G12, G14
George Chalamandaris, Leonidas S. Rompolis
We propose a consistent approach for the estimation of the market risk premium. As a first step, we define the broadest possible set of ex ante estimators from the viewpoint of a power utility optimiser holding the market portfolio. We then employ an evaluation framework to optimise the parametrisation of the methodology. We show that this theoretical framework can still produce reasonable market risk premium estimates, even when the representative agent is not a power utility optimiser. Our results show that the inclusion of higher‐order moment risk premia improves the accuracy of the method.
Keywords: Ex ante market risk premium; risk aversion coefficient; physical cumulants; risk-neutral cumulants
JEL Classification: G12, G17, C51, C53
European Financial Management, VOL 27:2, March 2021
Eugene F. Fama
Observed contract structures are competitive solutions to the problem of maximizing stakeholder welfare when contracting is costly. Winning contract structures typically set fixed payoffs for most stakeholders, with residual risk borne by shareholders, who then get most of the decision rights. With rising interest in environmental, social, and governance (ESG) issues, there is sentiment for replacing the max shareholder wealth decision rule with max shareholder welfare. This view does not recognize that investors view max welfare in terms of their overall consumption‐investment portfolios. Since firms are not privy to the total ESG exposures of shareholders, max shareholder wealth is the appropriate decision rule.
Keywords:contract structures, decision rules, stakeholders
Bradford Cornell, Alan C. Shapiro
In addition to explicit contracts, corporations issue their stakeholders implicit claims, including fair treatment of employees and the promise of continuing service to customers. Corporate value is created by selling these implicit claims for more than it costs to honor them. Recently, a new class of non-investor stakeholders, related to ESG issues, has arisen. Although many ESG advocates stress their role in creating shareholder value, they do not explain how this value creation occurs. This paper shows that implicit claims provide a critical link that ties non-investor stakeholders and ESG to shareholder value, both its creation and its possible destruction
Keywords:ESG, Non-Investor Stakeholders, Contracting, Implicit Claims
JEL Classification: G0, G1
John A. Doukas, Xiao Han
This study explores the conditional version of the capital asset pricing model on sentiment to provide a behavioural intuition behind the value premium and market mispricing. We find betas (β) and the market risk premium to vary over time across different sentiment indices and portfolios. More importantly, the state β derived from this sentiment‐scaled model provides a behavioural explanation of the value premium and a set of anomalies driven by mispricing. Different from the static β–return relation that gives a flat security market line, we document upward security market lines when plotting portfolio returns against their state βs and portfolios with higher state βs earn higher returns.
Keywords:conditional CAPM, market anomalies, security market line, state beta, stochastic discount factor, time‐varying risk premium, value premium.
Hamed Ghanbari, Michael Oancea, Stylianos Perrakis
We compare equilibrium jump diffusion option prices with endogenously determined stochastic dominance (SD) option bounds. We use model parameters from earlier studies and find that most equilibrium model prices consistent with SD bounds yield economically meaningless results. Further, the implied distributions of the SD bounds exhibit a tail risk comparable to that of the underlying return data, thus shedding light on the dark matter of the inconsistency of physical and risk‐neutral tail probabilities. Since the SD bound assumptions are weaker, we conclude that these bounds should either replace or be used to verify the equilibrium model results.
Keywords:jump diffusion; option pricing; stochastic dominance; risk aversion; tail risk; incomplete markets
JEL Classification: G12; G13
Marc Arnold, Dustin Schuette, Alexander Wagner
We investigate the compensation of counterparty exposure in the prices of structured products. Our analysis reveals that product issuers did not compensate retail investors for counterparty exposure before the Lehman default. Post‐Lehman, retail prices have no longer neglected this risk. We also measure retail investor attention towards issuer credit risk. For a given level of issuer credit risk, counterparty exposure is compensated more when attention is higher. Furthermore, issuers tend to construct products with larger counterparty exposure. Overall, our results shed light on the conditions under which financial engineering generates neglected risk.
Keywords:Neglected risk, structured products, counterparty risk, investor attention
JEL Classification: D8, G34, M52
Ryan Garvey, Tao Huang, Fei Wu
We examine order type execution speed and costs for U.S. equity traders. Marketable orders that execute slower exhibit lower execution costs. Those who remove liquidity faster and pay higher trading costs transact in smaller size, spread trading across more venues, take more liquidity, and are better informed. Non-marketable limit orders that execute slower exhibit greater adverse selection; and, larger, uninformed traders who concentrate their trading in fewer venues submit them. Our findings suggest that slowing down the trading process, when faster options exist, can benefit certain market participants who seek to cross the bid-ask spread.
Keywords:Trading, U.S. Equities, Execution Speed, Execution Costs
JEL Classification: G10
Edoardo Ferrucci, Roberto Guida, Valentina Meliciani
We study the impact of measures devoted to relieving financial constraints for the growth and survival of Italian innovative start-ups. Using balance sheet data on innovative start-ups and information on the use of the Italian Central Guarantee Fund for small and medium-sized enterprises, we evaluate whether access to the fund, relieving financial constraints, helps innovative start-ups survive and grow. We find innovative start-ups benefit significantly more than similar control firms. We shed light on the relevance of policies aimed at reducing financial constraints for the growth and survival of innovative start-ups, an issue receiving increasing attention at the European level.
Keywords:: innovative start-ups, financial constraints, growth, survival
JEL Classification: D45, G14, G21, G32
European Financial Management, VOL 27:3, June 2021
JESSE M. FRIED and CHARLES WANG.
Investor-driven “short-termism” is said to harm EU public firms’ ability to invest for the long term, prompting calls for the EU to better insulate managers from shareholder pressure. But the evidence offered—rising levels of repurchases and dividends—is incomplete and misleading: it ignores large offsetting equity issuances that move capital from investors to EU firms. We show that, over the last 30 years and the last decade, net shareholder payouts have been moderate, and investment and cash balances have increased. In sum, the data provide little basis for the view that short-termism in the EU warrants corporate governance reforms.
Keywords:Short-termism; EU; payout policy; investment; innovation.
JEL Classification: G15, G32, G35, G38,O52
Rules that restrict information required in negotiatedprivate transactions have spurred a vast increase in thescope of anonymous financial markets, particularly inthe United States. The subtle costs of the informationrestricting rules raise questions about the social valueof “completing” anonymous markets that would notnaturally survive and did not historically exist.
Keywords:information asymmetry, liquidity, regulation, securities markets,securitization.
JEL Classification: G10; G18; G28; G38; K22; N2
ERIK DEVOS, HE LI
Operating leases are used extensively for financing, but their ability to separate ownership and use also creates hedging opportunities. We investigate whether firms recognize such opportunities by examining the relation between CEO risk-taking incentives and the use of operating leases. Consistent with firms using operating leases to hedge, we find higher CEO risk-taking incentives lower operating lease intensity. To address endogeneity, we use the adoption of Statement of Financial Accounting Standards 123R as an exogenous shock to option compensation, dynamic panel generalized method of moments, simultaneous equations, and change regressions. Our results are robust to placebo and alternative tests.
Keywords:Corporate leasing, corporate hedging, executive compensation, risk-taking incentives, option pricing theory.
JEL Classification: G32; G34
Doriana Cucinelli, Lorenzo Gai, Federica Ielasi.
With a sample of 4,065 bonds issued by 63 banks from 12 euro area countries during 2013–2017, the study investigates how introducing bail-in regulation has influenced bond yields in secondary markets, by distinguishing between non–bail-inable- and different classes of bail-inable bonds. The bail-in risk premium does not follow the hierarchy of risk: it is stronger for less risky bonds. The effect on the spread between senior unsecured and non–bail-inable bonds is much higher than for subordinated bonds. Regarding subordinated bonds, the impact is higher for securities excluded from regulatory capital than for those included.
Keywords:Bail-in regulation; difference-in-difference; subordinated unsecured bonds; senior unsecured bonds; market discipline.
JEL Classification: G20; G21
FREDERICK DAVIS, HAMED KHADIVAR, KUNTARA PUKTHUANTHONG and THOMAS J. WALKER.
We examine insider trading surrounding takeover rumors in a sample of 1,642 publicly traded U.S. firms. Using difference-in-differences regressions, we find that insider net purchases increase within the year prior to the first publication of a takeover rumor, particularly when rumor articles are either accurate (lead to a takeover announcement) or informative (provide substantial justification for the rumor’s publication). Moreover, we find abnormal insider trading to be a significant predictor of takeover announcements occurring within the following year. Finally, passive net purchasing (i.e., selling less rather than buying more) is more pronounced among managing insiders than among non-managing insiders.
Keywords:Insider trading, takeover rumors, information asymmetry, takeover announcements, mergers and acquisitions.
JEL Classification: G14; G18; G34; K22
KWABENA A. BOASIAKO and Michael O'Connor Keefe.
This paper investigates the effects of data breach disclosure laws and the subsequent disclosure of data breaches on the cash policies of corporations in the United States. Exploiting a series of natural experiments regarding staggered state-level data breach disclosure laws, we find that the passage of mandatory disclosure laws leads to an increase in cash holdings. Our finding suggests that mandatory data breach disclosure laws increase the risks related to data breaches. Further, we find firms that suffer data breaches adjust their financial policies by holding more cash as well as decreasing external finance and investment.
Keywords:Data Breach, Disclosure Laws, Cash Holdings.
JEL Classification: G32.
European Financial Management, VOL 27:4, September 2021
Ambrus Kecskés, Phuong-Anh Nguyen
Prior research shows that technology spillovers across firms increase innovation, productivity and value. We study how firms finance their own growth stimulated by technology spillovers from their technological peer firms. We find that greater technology spillovers lead to higher leverage. This is the result of technology spillovers increasing asset redeployability, as evidenced by more collateralized borrowing and asset transactions. Borrowing costs also decrease. Exogenous variation in the research and development tax credits of other firms allows us to identify the causal effect of technology spillovers on a given firm.
Riccardo Calcagno, Eric de Bodt, Irina Demidova.
We study the relations between takeover negotiations duration, competition and learning, focusing on the private phase of bidder-initiated transactions. While the negotiation goes on, both parties learn about true deal synergies. At any moment, rival bidders can show up and compete for the target. Using a discrete-time finite-horizon dynamic programming approach, we derive the equilibrium relations between the negotiation duration, the pressure of potential competition and the learning process. Next, we perform a calibration exercise on a large sample of merger negotiations with hand-collected data from the Securities and Exchange Commission filings. Our results provide evidence of a very competitive M&A (Mergers and acquisitions) market.
Christian Lohmann, Thorsten Ohliger.
The cure of a defaulted company has important implications for the estimation of the loss given default. In this study, we estimate the probability of a defaulted company being cured using data on a large international sample of defaulted companies. More specifically, we examine whether historic accounting information on a defaulted company and loan-related information are associated with that company's probability of being cured. The main finding of our analysis is that both accounting-based and loan-related independent variables increase the validity of cure prediction models.
Ye Wang, Sirui Yin
More than 10% of the S&P 1500 companies have hired a CEO who starts the job near or above the conventional retirement age of 65 years old. This phenomenon exists among all industries and persists over time. Firms are more likely to hire retiring CEOs when the CEO job risk is high and when the firm is in distress. Retiring CEOs receive lower total compensation, the compensation structure puts a higher weight on nonequity-based compensation, and have a shorter tenure. Retiring CEOs can be beneficial to shareholders when they are hired for the right purpose.
Keywords:CEO, Retirement Age, Distress.
JEL Classification: G30, G32, J24, J26
Markus Leippold,Roger Rueegg.
There is ample evidence that factor momentum exists in the standard long–short mixed approach to factor investing. However, the excess returns are put under scrutiny due to the high implementation costs. We present a novel real-life approach that relies on the long-only integrated approach to factor investing. Instead of exploiting the potential momentum in factor portfolios, our strategy builds on the momentum of the optimal factor score weights in the integrated approach, which allows us to additionally profit from the serial dependence in the factors’ interaction effects. One limitation of short-term timing strategies is their high turnover. By including the information of the covariance matrix and minimizing the strategy’s risk to the market portfolio, we can substantially reduce turnover. The resulting timing alpha remains significant even after transaction costs in a robust statistical test framework across the major stock markets.
Keywords:Factor timing, equity style timing, integrated approach, momentum.
JEL Classification: G1, G11, G14, G17.
Seth Armitage, Ronan Gallagher.
We study payout by U.K. listed companies during 1993-2018. Regular dividends remain the dominant channel, but flexible payouts (special dividends and repurchases) have grown, and they make total payout more responsive to earnings. Flexible payouts are used to augment regular dividends: few companies pay out by flexible means only, and tests indicate that they augment rather than replace regular dividends. Comparison with U.S. evidence shows that U.K. companies make greater use of dividends (including specials) in relation to repurchases, and have a greater willingness to change regular dividend per share.
Feifei Wang, Xuemin (Sterling) Yan, Lingling Zheng.
We find strong evidence of time-series and cross-sectional momentum in the long-short returns of a comprehensive sample of anomalies. Strategies that exploit such persistence deliver significant abnormal returns that are robust to the stock momentum effect, cannot be explained by traditional asset-pricing models, and are more pronounced when arbitrage capital is scarcer or market liquidity is lower. Momentum in anomaly returns dissipates, but doesn’t reverse, in the long-run. Our findings are consistent with limits-to-arbitrage and slow-moving capital causing mispricing to persist. Supporting this explanation, we find that both the level and persistence of anomaly returns are positively related to idiosyncratic-volatility.
Keywords:momentum, anomalies, limits to arbitrage, idiosyncratic volatility.
JEL Classification: G10, G11, G14
European Financial Management, VOL 27:5, November 2021
Douglas Cumming,Bryce C. Tingle QC,Feng Zhan.
The proper object of the fiduciary duties of corporate directors and officers is frequently described as the central question in all corporate law. We use the adoption of constituency statutes, which shift the loci of corporate managers' duties from shareholders to a wide range of stakeholders, as a quasi‐natural experi- ment to determine the actual impact of fiduciary du- ties. We find that though the adoption of constituency statutes has no significant effect on measures of earn- ings management, it has a robust effect on firms' ef- fective tax rate, which increases in a range between 0.570% and 1.903%. These results are robust in terms of various measures of the firm's effective tax rate. We provide explanations for why fiduciary duties appar- ently do not influence manager behaviours in relation to shareholders but do affect their behaviours in rela- tion to the taxing authority. We argue that a change to fiduciary duties does not appear to alter the motivation of managers to maximize shareholder welfare outcomes, but rather it allows them to eschew short‐ term strategies that often impair long‐term outcomes.
Keywords:Fiduciary duties, tax aggressiveness
JEL Classification: H26, G34
Florian Eugster,Jenni Kallunki,Henrik Nilsson,Hanna Setterberg.
We examine how corporate insiders’ cognitive ability (IQ) affects their decisions to time insider and outsider trading before abnormal stock price changes. Our analysis of ar- chival data on male corporate insiders in Sweden shows they are less prone to time their insider selling and to sell in larger amounts, before abnormal stock price declines as IQ increases. We also find that insiders with a higher IQ are better at timing their outsider buying. Taken together, our results show that corporate insiders’ IQ affects their trading decisions differently, depending on whether they are trading in their insider or outsider stocks.
Keywords:Insider trading, IQ, abnormal returns, reputational risk
JEL Classification: G14; G30; G40; K42
Linyin Cheng,Guojun Wang,Yuetang Wang,Dan Yang.
Dividend policies can predict changes in capital structure. We focus on a unique setting, namely, divi- dend commitment emerging from a new dividend policy in China, and explore its relation to leverage. We find a commitment to increase dividends is associated with a subsequent reduction in leverage, and this ne- gative relation is enhanced in firms without pre- liminary conditions specified for their commitments or with greater dividend smoothing in previous periods. Robustness tests support the main findings. Further analysis addresses four internal mechanisms that play essential roles in the above link, and we provide further details about how leverage is reduced.
Keywords:capital structure, China, dividend commitment, dividend policy, leverage
JEL Classification:G32; G35
Dimitris Andriosopoulos,Amedeo De Cesari,Konstantinos Stathopoulos.
Firms that follow excessive payout policies (over‐payers) are higher on the financial distress spectrum and have lower survival rates than under‐payers. In addition, over‐ payers endure lower future sales and asset growth than under‐payers and experience negative abnormal returns in the bond and stock markets. Exogenous import tariff reductions and commodity price jumps reduce the like- lihood of overpayment. We interpret this as evidence consistent with financial flexibility considerations, rather than risk‐shifting, explaining the decision to overpay. We also find that CEO overconfidence and catering incentives affect overpayment.
Keywords:Financial distress, financial flexibility, firm survival, over‐payers, payout policy
JEL Classification: G32; G33; G35
Xiang Gao,Chen Gu, Kees Koedijk.
This paper examines the equity market return pre- dictability of institutional investor sentiment, in com- parison to individual investor sentiment. Our findings suggest that institutional traders are informed and that their sentiment helps to tilt stock prices towards the intrinsic value. This is because the sentiment of in- stitutions encompasses news regarding expectations on future cash flows of underlying firms that impounds itself into future price expectations. In this study, we add to the large number of studies that investigate the role and implications of investor sentiment, which has long been viewed as a pure behavioural phenomenon, on market efficiency and price discovery.
Keywords:Cash flows, institutional investors, retail traders, return predictability, sentiment.
JEL Classification: G14; G40; G41
Iram F. Ansari,Marc Goergen,Svetlana Mira.
This paper studies reappointment of a chief ex- ecutive officer (CEO) and succession events in listed family firms with an incumbent family CEO. We explore whether family firms with a founder CEO are more likely to engage in earnings man- agement preevent than other family firms. We find evidence of preevent upward earnings manage- ment for firms that reappoint their founder CEO but no for other family firms. These findings suggest that the costs and benefits from earnings management change around founder CEO re- appointments in family firms. Investors, auditors, policymakers and regulators should be aware of the temptation of founder CEOs to inflate earnings preceding their reappointment.
Keywords:Earnings management, family firms, founders, socioemotional wealth, CEO turnover, CEO successions
JEL Classification:G32; G34; M41
Sylvia Maxfield,Liu Wang.
This study complements and extends prior research on the risk mitigation role of sustainable investing. We use a continuous measure of funds' sustainability traits, rather than a categorical approach, and assess impact on risk directly rather than by looking at fund performance in up versus down markets. We find that sustainable investing plays a significant role in mitigating total, systematic, and idiosyncratic risk of equity funds, even after controlling for other fund characteristics. Further evidence indicates that the explanation for the risk reduction role of sustainable funds largely runs through traits of the firms held in the funds.
Keywords:Mutual funds, portfolio risk, sustainable investing.
JEL Classification: G11.
Anna Battauz,Stefano Gatti,Annalisa Prencipe,Luca Viarengo.
Earnout agreements link part of the payment for an ac- quired company to its future performance. Despite their option‐like features, they cannot be valued using vanilla option‐pricing methods. Two peculiar sources of risk affect these contracts: Bidder default before the earnout expira- tion (default risk) and potential litigation associated with earnouts (litigation risk). We developed an option‐pricing model that encompasses these sources of risk, showing that counterparty and litigation risk can have a remarkable impact on earnout values. Our model's relevance is further enhanced by recent accounting standards that require contingent payments to be valued at fair value.
Keywords:Default, default risk, earnout, litigation, M&A, real options.
JEL Classification: G12, G13, G33, G34, K41.