ContentsIs the Market Optimistic about the Future Earnings of Seasoned Equity Offering Firms?Peter A. Brous, Vinay Datar, and Omesh Kini
The Market Demand Curve for Common Stocks:
Evidence from Equity Mutual Fund Flows
Can the Treatment of Limit Orders Reconcile the Differences
in Trading Costs between NYSE and Nasdaq Issues?
Is the Market Surprised by Poor Earnings Realizations
following Seasoned Equity Offerings?
Corporate Hedging and Speculative Incentives:
Implications for Swap Market Default Risk
Are Treasury Securities Free of Default?
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Abstracts
Is the Market Optimistic about the Future Earnings of Seasoned Equity
Offering Firms? The leading explanation for the post-issue long-run stock return underperformance of seasoned equity offering firms is that investors have optimistic expectations regarding future earnings and the underperformance occurs as these expectations are corrected over time. To directly test this hypothesis, we examine investors' reaction to quarterly earnings announcements over a five-year period following the offering for a large sample of seasoned equity issuing firms. In general, our evidence suggests that investors are not disappointed by earnings announcements that follow seasoned equity offerings. This result is not sensitive to widening the window over which earnings announcement returns are computed. This result also holds true for subsets of equity issuing firms classified as glamour issuing firms, Nasdaq listed issuing firms, and hot market issuing firms. The choice of these three subsets is predicated by extant evidence that these firms are likely to convey relatively more unfavorable information through their earnings announcements. Overall, our findings are inconsistent with the optimistic expectations hypothesis.
The Market Demand Curve for Common Stocks:
Evidence from Equity Mutual Fund Flows We examine whether the market demand curve for equities is downward sloping. Unlike previous studies that examine individual stocks' demand curves, we look at the aggregate demand curve. As a proxy for aggregate demand, we employ equity mutual fund flows. Unlike previous studies that focus on events that are unlikely to convey new information to the market, we devise an empirical framework that disentangles the price-pressure effect and the information effect. We do not find evidence for the price-pressure effect that equity fund flows directly affect stock market prices in the presence of fundamentals of firms. Instead, we find that equity fund flows seem to be influenced by the performance of the stock market and that investors try to forecast fundamentals of firms and change their demand for stocks accordingly. Overall, these findings are consistent with a horizontal market demand curve for equities.
Can the Treatment of Limit Orders Reconcile the Differences
in Trading Costs between NYSE and Nasdaq Issues? In this paper, we determine whether each bid (ask) quote reflects the trading interest of the specialist, limit order traders, or both for a sample of NYSE stocks in 1991. We then compare Nasdaq spreads with NYSE spreads that reflect the trading interest of the specialist. Our empirical results show that the average Nasdaq spread is significantly larger than the average NYSE specialist spread. We find that, on average, 49% of the difference between Nasdaq and specialist spreads is due to the differential use of even-eighth quotes between Nasdaq dealers and NYSE specialists. We also find that the NYSE specialist spread is significantly larger than the limit order spread, although NYSE specialists and limit order traders are similar in their use of even-eighth quotes.
Is the Market Surprised by Poor Earnings Realizations
following Seasoned Equity Offerings? We examine the stock price reaction to earnings announcements in the five years following seasoned equity offerings (SEOs). On average, post-SEO earnings announcements are met with a significantly negative abnormal stock price reaction. Although this negative reaction accounts for a disproportionately large portion of long-run post-SEO abnormal stock returns, on average, abnormal stock price reactions to post-SEO earnings announcements are reliably negative only within the smallest quartile of equity issuers. For small firms, therefore, these findings are broadly consistent with the hypothesis that firms issue equity when the market overestimates the firm's future earnings performance.
Corporate Hedging and Speculative Incentives:
Implications for Swap Market Default Risk This paper demonstrates a tradeoff between the risk-shifting and hedging incentives of firms and identifies conditions under which each dominates. A firm may have the incentive to hedge in a multi-period context, even if no such incentive exists in a single-period one. Unrestricted access to swaps in the presence of asymmetric information about firm type and the swapping motive would lead to unbounded speculation resulting in breakdowns in swap and debt markets. Price-based methods are unable to control this and market makers have to rely upon additional exposure information or credit enhancement devices to preserve equilibrium.
Are Treasury Securities Free of Default? The chain of events that led to the disagreement between the White House and Congress over the increase of the federal debt limit from mid-October 1995 to March 1996 caused a default potential for Treasury securities. We examine the effect of this event chain on the yield spread between commercial paper and Treasury bills and find that both the three- and six-month yield spreads were reduced during the event period. The results suggest that the market charged a default risk premium to the Treasury securities. There is no evidence that these events had a sustained effect on T-bill rates since the yield spread during the post-event period resumed its pre-event level.
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