Abstracts
Do Takeover Targets Underperform? Evidence from Operating and Stock
Returns
Anup Agrawal and Jeffrey F. Jaffe
Financial economists seem to believe that takeovers are partly motivated
by the desire to improve poorly performing firms. However, prior empirical
evidence in support of this inefficient management hypothesis is rather
weak. We provide a detailed re-examination of this hypothesis in a large
scale empirical study. We find little evidence that target firms were
performing poorly before acquisition, using either operating or stock
returns. This result holds both for the sample as a whole and for
subsamples of takeovers that are more likely to be disciplinary. We
conclude that the conventional view that targets perform poorly is not
supported by the data.
Unpublished
Appendix
The Value of Trading Consolidation: Evidence from the Exercise of
Warrants
Yakov Amihud, Beni Lauterbach, and Haim Mendelson
We study the effect of trading consolidation by examining the response of
liquidity and stock price to the exercise of deep in-the-money corporate
warrants. This enables a relatively clean test of the value of trading
consolidation. The exercise at the warrant expiration is fully anticipated
and has no information content. An effect can come from the value of
trading consolidation that improves liquidity. Indeed, we find that
liquidity and stock prices both increase significantly at warrant
expiration. Further, the price increase is positively related to the
pre-exercise extent of fragmentation, to post-exercise improvement in
stock liquidity, and to the proportional increase in the number of shares
following the warrant exercise.
Trade Execution Costs and Market Quality after Decimalization
Hendrik Bessembinder
This study assesses trade execution costs and market quality for NYSE and
Nasdaq stocks before and after the 2001 change to decimal pricing. Several
theoretical predictions are confirmed. Quoted bid-ask spreads declined
substantially on each market, with the largest declines for heavily traded
stocks. The percentage of shares receiving price improvement increased on
the NYSE, but not on Nasdaq. However, those trades completed at prices
within or outside the quotes were improved or disimproved by smaller amounts
after decimalization, and trades completed outside the quotes saw the
largest reductions in trade execution costs, as a class. Effective bid-ask
spreads as a percentage of share price, arguably the most relevant measure
of execution costs for smaller trades, averaged 0.33{\%} on a
volume-weighted basis after decimalization for both NYSE and Nasdaq stocks.
There is no evidence of systematic intraday reversals of quote changes on
either market, as would be expected if decimalization had damaged liquidity
supply.
Agency Costs of Controlling Minority Shareholders
Henrik Cronqvist and Mattias Nilsson
This paper estimates the agency costs of controlling minority shareholders
(CMSs), who have control of a firm's votes, while owning only a minority of
the cash flow rights. Analyzing a panel of 309 listed Swedish firms during
1991-1997, for which we have complete and detailed data on ownership and
corporate control instruments, we provide these results; families employ
CMS structures, via dual-class shares and other corporate control
instruments, about 1.5-2 times more often than other categories of owners
(corporations, financial institutions). Estimated agency costs of
controlling shareholders are 6%-25% of firm value (Tobin's q) for the
median firm among the different categories of controlling owners, ceteris
paribus. Family CMSs are associated with the largest discount on firm value.
The source of the discount seems to be partly what such owners/firms
do: return on assets is significantly lower for firms with
concentrated vote control. It also seems as if the discount is related to
what such owners/firms do not do. Family CMSs seem to hang on to the control
too long from the non-controlling shareholders' perspective; e.g., firms with
family CMSs are about 50% less likely to be taken over compared to other
firms.
Errors in Implied Volatility Estimation
Ludger Hentschel
Estimating implied volatility by inverting the Black-Scholes formula is
subject to considerable error when option characteristics are observed
with plausible errors. Especially for options away from the money, large
changes in volatility produce small changes in option prices. Conversely,
small errors in option prices and other option characteristics produce
large errors in implied volatilities. In the presence of small measurement
errors, unobserved truncation of option prices that violate lower bounds
for absence of arbitrage can also lead to systematic volatility smiles.
The paper proposes feasible GLS estimators that reduce the noise and bias
in implied volatility estimates.
A Multifactor Spot Rate Model for the Pricing of Interest Rate
Derivatives
Sandra Peterson, Richard C. Stapleton, and Marti G.
Subrahmanyam
We propose a multifactor model in which the spot rate, LIBOR, follows a
lognormal process, with a stochastic conditional mean, under the
risk-neutral measure. In addition to the spot rate factor, the second
factor is related to the premium of the first futures rate over the spot
LIBOR. Similarly, the third factor is related to the premium of the second
futures rate over the first futures rate. We calibrate the model to the
initial term structure of futures rates and to the implied volatilities of
interest rate caplets. We then apply the model to price interest rate
derivatives such as European- and Bermudan-style swaptions, and
yield-spread options. The model can be employed to price more complex
interest rate derivatives such as path-dependent derivatives or
multi-currency-dependent derivatives because of its Markovian property.
An Examination of the Performance of the Trades and Stock Holdings of
Fund Managers: Further Evidence
Matt Pinnuck
Recent research has examined the performance of stocks held by U.S. mutual
funds and found they realize abnormal returns. The result is significant
as it stands in contrast to the general consensus from traditional
performance studies that mutual funds do not possess superior information.
Employing a unique dataset, I examine the performance of the monthly stock
holdings and trades of a sample of Australian fund managers. When stock
holdings are observable, performance measures can be constructed that are
more precise than traditional fund manager performance measures. I find
the stocks held by fund managers realize abnormal returns consistent with
some stock selection ability across fund managers. Examining the
performance of their individual trades, I find that the stocks they buy
realize abnormal returns whereas for sell trades I find no evidence of
abnormal returns. Overall, the results suggest fund managers have the
ability to select stocks that realize positive abnormal returns thus
providing out-of-sample support for similar recent findings for U.S.
mutual funds.
On Inferring the Direction of Option Trades
Robert Savickas and Arthur J. Wilson
To sign option trades as buys and sells, researchers often employ stock trade
classification rules including the quote, the Lee and Ready (1991), the
Ellis, Michaely, and O'Hara (2000), and the tick methods. Using a proprietary
CBOE dataset that reports trade direction, we find that these four rules sign
correctly 83%, 80%, 77%, and 59% of all classifiable trades, respectively.
These rates are based on separate classifiable samples because each of the
four rules fails to classify some trades (e.g., the quote rule cannot classify
midspread trades). Outside-quote and reversed-quote trades are highly
misclassified by all four rules. The probability of such trades is related to
trading frequency, trade size, moneyness, and maturity. Underlying asset
price changes around the time of the trade improve classification precision.
We find that the components of index option complex trades not executed on the
Retail Automated Execution System are misclassified almost 50% of the
time by any method. The elimination of these trades (15% of the sample)
results in a success rate of over 87% for the quote rule.