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The European Financial Management was founded in 1994 by Dr. John Doukas to serve as a high quality refereed publication outlet that publishes significant new research as it relates to European corporations, financial institutions and capital markets. The EFM journal is published in five issues per year [January, March, June, September and November ] and its acceptance rate is about 3%. The June issue is based on the Keynote Address and a small set of articles selected from the papers presented at the Annual Meetings of the European Financial Management Association. The articles published in the EFM journal are indexed and abstracted in the Social Science Citation Index.

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Newly Accepted Papers

Managerial Incentives for Attracting Attention

María Gutiérrez, Nino Papiashvilia, Josep A. Tribó Gine

This paper studies the mechanisms which motivate managers to engage in cheap talk and attract market’s attention in a credible way. We consider stock splits announcements, voluntary earnings forecasts and press releases issued by firms to the media as proxies for managerial cheap talk. We show that: (i) managerial performance-related pay contracts incentivize executives to attract attention; (ii) analysts increase their coverage of firms following cheap talk; (iii) chief executive officers are punished for attracting attention when market prices do not increase following cheap talk. The results are stronger for firms which are most in need for attention.

Keywords: Voluntary Disclosures, Attracting Attention, Cheap Talk, CEO Compensation, Managerial Incentives.

JEL Classification: G30, G32, G34

Keeping it Real or Keeping it Simple? Ownership Concentration Measures Compared

Taylan Mavruk,Conny Overland,Stefan Sjogren.

We analyze the distributional properties of ownership concentration measures and find that measures come from different underlying statistical distributions. Consistent with theory, some measures that are classified to represent a monitoring dimension have a positive influence on firm performance; other measures that are interpreted to represent a shareholder conflict dimension are negatively related to firm performance. However, other measures deviate from this pattern, and therefore, we cannot conclude that simple measures can replace complicated measures. Some measures are more suitable for analyzing the relationship between management and owners, whereas other measures are more suitable for analyzing the relationships among owners.

Keywords: Ownership concentration measures, distributional properties, monitoring dimension, shareholder conflict dimension.

JEL Classification: C18, C46, C81, D74, G34, L25

Why Do Stock Repurchases Change Over Time?

Yuan-Teng Hsu*, Chia-Wei Huang**

Recent studies have shown the time trends of firm stock repurchase behavior. We examine these time changes for stock repurchase through the lens of real activities earnings management. Managers appear more likely to manipulate earnings through stock repurchases since the passage of the Sarbanes–Oxley Act (SOX) in 2002. Furthermore, suspect firms that just missed analyst earnings per share forecasts have higher incentives to manipulate earnings through stock repurchases. The results are not driven by changes in corporate governance associated with the passage of SOX. Overall, our results suggest earnings management can be a significant determinant of the dynamics of stock repurchases.

Keywords: Stock repurchase, earnings management, Sarbanes–Oxley Act

JEL Classification: G18; G31; G35; G38

Investment and asset securitization with an option-for-guarantee swap

Zhaojun Yang

Thispaperaddressestheinvestmentandfinancingdecisionsofentrepreneursenteringintooptionfor-guaranteeswaps(OGSs). OGSssignificantlyincreaseinvestmentoptionvalue. Entrepreneurs initially accelerate their investments and then postpone them as funding gaps grow. Guarantee costs increase with project risks when the funding gap is sufficiently small or large, but the opposite holds true otherwise. Investments are postponed when project risks, effective tax rates, or bankruptcy costs increase. Surprisingly, the higher the project risk, the more the entrepreneur will borrow, with a much higher leverage than predicted by classic models. Entrepreneurs can use OGSs to securitize their assets.

Keywords: Credit default swap, real options, capital structure, asset securitization.

JEL Classification: G12, G23

Trust, Regulation, and Contracting Institutions

Brandon N. Cline John “Nutie” and Edie Dowdle

This paper demonstrates that trust directly influences contracting efficiency. We document that trust reduces demand for contract regulation and positively relates to a high-quality contracting environment, supporting a substitution hypothesis. Furthermore, contract regulation no longer leads to poor contracting outcomes. These findings suggest that lack of trust significantly explains inefficient contracting institutions. Based on interaction effects, we note that trust could complement formal enforcement in countries with weak regulation. As regulation increases, trust substitutes for contract regulation. Overall, trust positively promotes efficient contracting by reducing burdensome regulation and providing an alternative to formal contract enforcement.

Keywords: Contract enforcement, efficiency, trust, regulation

JEL Classification: F2; O17; K2

Estimating Portfolio Risk for Tail Risk Protection Strategies

David Happersberger, Harald Lohre, Ingmar Nolte

We forecast portfolio risk for managing dynamic tail risk protection strategies, based on extreme value theory, expectile regression, Copula-GARCH and dynamic GAS models. Utilizing a loss function that overcomes the lack of elicitability for Expected Shortfall, we propose a novel Expected Shortfall (and Value-at-Risk) forecast combination approach, which dominates simple and sophisticated standalone models as well as a simple average combination approach in modelling the tail of the portfolio return distribution. While the associated dynamic risk targeting or portfolio insurance strategies provide effective downside protection, the latter strategies suffer less from inferior risk forecasts given the defensive portfolio insurance mechanics.

Keywords: Tail Risk Protection, CPPI, DPPI, Risk Modelling, Value-at-Risk, Expected Shortfall, Forecast Combination, Return Synchronization.

JEL Classification: C13, C14, C22, C53, G11.

Innovations in Financing: The Impact of Anchor Investors in Indian IPOs

Arnab Bhattacharya, Binay Bhushan Chakrabarti, Chinmoy Ghosh, Milena Petrova

In 2009, the Securities Exchange Board of India allowed qualified institutional investors to anchor initial public offerings (IPOs) by participating in the issue at a price and allocation publicly disclosed preceding the issue. We study anchor investor (AI) in Indian IPOs during 2009–2017. We find the share allotment and the number of AIs separately have significant impacts on valuation and underpricing; however, the net effect is non-significant. Further, AIs significantly influence other institutional investors’ participation in the IPO, and induce lower aftermarket volatility. Overall, our evidence suggests that AIs boost demand for and mitigate ex-ante information uncertainty of IPOs.

Keywords: IPOs, anchor investors, certification, information uncertainty

JEL Classification: G14, G24


Onur Kemal Tosun

I examine the influence of large and small institutional investors on different components of chief executive officer (CEO) compensation, using U.S. data for 2006–2015. An increase in large institutional ownership reduces total pay and current incentive compensation (i.e. options, stocks, bonus pay), whereas small institutional investors lower long-term incentive pay (i.e. pension, deferred pay, stock incentive pay). These findings are consistent with managerial agency theory and the substitution of incentive pay by institutional monitoring. The effects are stronger for higher ownership levels and firms with weak governance, less financial distress, long-tenured CEOs, multiple segments, and more free cash flow.

Keywords: Large institutional ownership, small institutional ownership, short-term incentive pay, long term incentive pay, CEO compensation.

JEL Classification: C33, C36, G32, J33, M12

Forecasting the Volatility of Bitcoin: The Importance of Jumps and Structural Breaks

Dehua Shen, Andrew Urquhart, Pengfei Wang

This paper studies the volatility of Bitcoin and determines the importance of jumps and structural breaks in forecasting volatility. We show the importance of the decomposition of realized variance in the in-sample regressions using eighteen competing heterogeneous autoregressive (HAR) models. In the out-of-sample setting, we find that the HARQ-F-J model is the superior model, indicating the importance of the temporal variation and squared jump components at different time horizons. We also show that the HAR models with structural breaks outperform models without structural breaks across all forecasting horizons. Our results are robust to an alternative jump estimator and estimation method.

Keywords: Volatility Forecasting; Bitcoin; Realized Volatility; Jumps; Structural Breaks

JEL Classification: C53; G15; G17.

Bank Credit Constraints for Women-Led SMEs: Self-Restraint or Lender Bias?

Emma Galli, Danilo V. Mascia, Stefania P.S. Rossi

We test the existence of possible gender biases affecting the firm behaviour in demanding and obtaining bank credit using a cross-country sample of European SMEs. We show consistent evidence that female-led firms are more likely than their male counterparts to refrain from applying for loans. When they apply, apparently female-led enterprises do not seem to face gender discrimination from the lender. Interestingly, however, signs of gender bias appear to arise during the upside phase of the economy. Overall, our study provides support for policy actions aimed at reducing the frictions faced by women-led SMEs when accessing credit markets.

Keywords: Access to finance, Bank lending, SMEs, self-restraint, gender discrimination

JEL Classification: D22, G21, G32, J16.

Banks’ Home-Bias in Government Bonds Holdings. Will Banks in Low-Rated Countries Invest in European Safe Bonds (ESBies)?

Jean Dermine

This paper offers two new explanations for banks’ home bias in government bond holdings: a sovereign-based rating cap on corporates and the existence of a ‘bank tax’. These are complementary to the four explanations offered in the literature: risk shifting, gambling for resurrection, moral suasion, and a means to store liquidity for financing future investment. Collectively, they cast doubt on the European Union’s demand-led approach to investment in European safe bonds (ESBies) by banks in low-rated countries. Bank regulations such as constraints on large exposure or risk-based capital on credit risk concentration will be needed if the objective is to break the so-called “deadly embrace”.

Keywords: European banking, Bank regulation, Basel capital, Banks’ home-bias.

JEL Classification: F34, G21, G28

CEO Influence on the Board of Directors: Evidence from Corporate Spinoffs

Duong T. Pham

We utilize a sample of spinoff firms that need to form a new board of directors, to shed light on the chief executive officer (CEO) influence hypothesis. We find spinoff boards with a CEO who was the parent firm CEO to be similarly structured to the boards of industry and size-matched peers, whereas spinoff boards with non-parent CEOs are structured for greater monitoring. Consistent with our board structure results, the CEO compensation and replacement decisions of parent CEO spinoff boards are more lenient toward spinoff CEOs, whereas those of non-parent CEO spinoff boards are more consistent with protecting shareholder benefits.

Keywords: Spinoff, CEO influence, board of directors, CEO compensation, CEO turnover

JEL Classification: G34

Economies or Diseconomies of Scope in the EU Banking Industry?

Elena Beccallia, Ludovico Rossib

Banks’ business models are assumed to affect efficiency, as documented in the banking supervisory priorities of the European Union (EU) for 2016–2018 and the 2014 structural reform proposal for the EU banking sector. We investigate evidence of economies and diseconomies of scope for EU. We find cost economies of scope and revenue diseconomies of scope, resulting in profit diseconomies of scope. Separating commercial from investment activities generates economic inefficiencies on costs but efficiencies on revenues and profits. Economies of scope are affected by bank size, liquidity, competition in the banking industry, and the European sovereign debt crisis.

Keywords: Economies of scope; economies of scale; bank business model; stochastic frontier analysis; European banking industry; banking regulation

JEL Classification:

Market Discipline on Bank Bond Issues Through the Lens of a New Forward – Looking Measure of Loan Quality

Elisa Cavezzali, Siva Nathan, Ugo Rigoni, and Giorgia Simion

Banks’ business models are assumed to affect efficiency, as documented in the banking supervisory priorities of the European Union (EU) for 2016–2018 and the 2014 structural reform proposal for the EU banking sector. We investigate evidence of economies and diseconomies of scope for EU. We find cost economies of scope and revenue diseconomies of scope, resulting in profit diseconomies of scope. Separating commercial from investment activities generates economic inefficiencies on costs but efficiencies on revenues and profits. Economies of scope are affected by bank size, liquidity, competition in the banking industry, and the European sovereign debt crisis.

Keywords: Economies of scope; economies of scale; bank business model; stochastic frontier analysis; European banking industry; banking regulation

JEL Classification:

Do foreign stocks substitute for international diversification?

Vicente J. Bermejo Jose M. Campa Rodolfo G. Campos§ Mohammed Zakriya

Using a novel sample of foreign securities available for trade in 42 countries during the last four decades (1979-2018), we examine the rise in importance of foreign stocks for investors in their host countries and its implications for diversification across industries and countries. The availability of foreign stocks allows domestic investors to increase their international diversification from home by investing in these stocks. We conclude that including foreign stocks in portfolio investments offers an effective substitute for international diversification, and significantly contributes towards increasing the integration of global markets.

Keywords: International diversification; country/industry effects; foreign stocks; international capital markets

JEL Classification: G11; G15; F36

Betas versus Characteristics: A Practical Perspective

Gregory Nazaire, Maria Pacurar, and Oumar Sy

We apply a new dummy-variable method to examine which factor exposures (betas) and characteristics provide independent information for U.S. stock returns in the context of the multifactor models of Hou, Xue, and Zhang (2015) and Fama and French (2015, 2018). We find that betas related to market, size, value, momentum, investment, and profitability factors are not priced. In contrast, firm characteristics related to size, value, investment, and profitability have significant and independent explanatory power, suggesting that they are important in determining expected returns. Finally, the cross-sectional effect of momentum is subsumed when the return on equity is factored in.

Keywords: betas, characteristics, dummy-variable model, asset allocation, multifactor models

JEL Classification: G10; G11; G12

Portfolio Optimization in the Catastrophe Space

Carolyn W. Chang,a Jack S.K. Chang,b Min-Teh Yu,c and Yang Zhaod

In today’s global catastrophe space, the role of insurance-linked securities has evolved from that of a threatened reinsurance substitute to now being a viable complementary reinsurance product, underpinning the convergence of the two markets. This study constructs a two-agent sequential optimization framework to mimic the economics of the reinsurance/insurance markets and shows how NPV-maximizing reinsurers and hedging-cost-minimizing insurers can optimally allocate default-risky catastrophe reinsurance and default-free catastrophe bonds at the interface of these two markets. We analyze paremetric impacts considering interest rate risk, financial leverage, basis risk, differential markup, catastrophe arrival intensity and severity, as well as other relevant characteristics.

Keywords: Catastrophe space; Traditional reinsurance; Catastrophe bonds; Default risk.

JEL Classification:

How to Build a Factor Portfolio: Does the Allocation Strategy Matter?

Hubert Dichtl , Wolfgang Drobetz ,*, and Viktoria-Sophie Wendt

Factor-based allocation embraces the idea of factors, as opposed to asset classes, as the ultimate building blocks of an investment portfolio. 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: G11, G23

Firm Vertical Boundaries, Internal Capital Markets, and Firm Performance

Jaideep Shenoy

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 towards 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, Vertical integration, Product market relations, Firm performance

JEL Classification: G30, L25, L22

Is Faster or Slower Trading Better? An Examination of Order Type Execution Speed and Costs

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

Regulatory Stress Testing and Bank Performance

Lukas Ahnert, Pascal Vogt, Volker Vonhoff, and Florian Weigert

This paper investigates the impact of stress testing results on bank's equity and CDS performance using a large sample of twelve tests from the US CCAR and the European EBA regimes in the time period from 2010 to 2018. Passing banks experience positive abnormal equity returns and tighter CDS spreads, while failing banks show strong drops in equity prices and widening CDS spreads. We also document strong market reactions at the announcement date of the stress tests. We complement existing studies by investigating the predictability of stress test outcomes and evaluating strategic options for affected banks and investors.

Keywords: Banks, Stress Testing, Equity Performance, CDS Performance

JEL Classification: G00, G21, G28

Banks’ Non-Interest Income and Securities Holdings in a Low Interest Rate Environment: The Case of Italy

Philip Molyneux, Alessio Reghezza†, Chiara Torriero* and 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