Journal of Financial and Quantitative Analysis
Vol. 32, No. 3, September 1997


Contents

Book-to-Market across Firm Size, Exchange, and Seasonality: Is There an Effect?
Tim Loughran

Optimal Financial Contracts for a Start-Up with Unlimited Operating Discretion
S. Abraham Ravid and Matthew Spiegel

A Comparison of Trade Execution Costs for NYSE and NASDAQ-Listed Stocks
Hendrik Bessembinder and Herbert M. Kaufman

Ownership Studies: The Data Source Does Matter
Ronald C. Anderson and D. Scott Lee

Reciprocally Interlocking Boards of Directors and Executive Compensation
Kevin F. Hallock

Predictable Patterns after Large Stock Price Changes on the Tokyo Stock Exchange
Marc Bremer, Takato Hiraki, and Richard J. Sweeney

Herding on Noise: The Case of Johnson Redbook's Weekly Retail Sales Data
Joseph Golec

Abstracts

Book-to-Market across Firm Size, Exchange, and Seasonality: Is There an Effect?
Tim Loughran

Fama and French (1992) report that size and the book-to-market ratio capture the cross-sectional variation of average stock returns for the universe of NYSE, Amex, and Nasdaq securities. This paper, in providing an exhaustive exploration of book-to-market across the dimensions of firm size, exchange listing, and calendar seasonality, reports that Fama and French's empirical findings are driven by two features of the data: a January seasonal in the book-to-market effect, and exceptionally low returns on small, young, growth stocks. In the largest size quintile of all firms (accounting for 73% of the total market value of all publicly traded firms), book-to-market has no significant explanatory power on the cross-section of realized returns during the 1963-1995 period. Thus, book-to-market as such would have less importance to money managers than the literature would have led us to believe.


Optimal Financial Contracts for a Start-Up with Unlimited Operating Discretion
S. Abraham Ravid and Matthew Spiegel

The model presented here shows that extreme uncertainty between an entrepreneur and potential investors can lead to the exclusive use of equity and riskless debt for small business financing. The paper derives these results without any restrictions on the available contract space, the distribution function governing a project's payoff, or the risk aversion of most potential entrepreneurs. In addition, the model produces predictions regarding the "underpricing'' of securities to outside financiers, the order in which firms will issue securities, and the relationship between the types of securities a firm will issue and its available collateral.


A Comparison of Trade Execution Costs for NYSE and NASDAQ-Listed Stocks
Hendrik Bessembinder and Herbert M. Kaufman

We compare average trade execution costs during 1994 for sets of large, medium, and small capitalization stocks listed on the New York and NASDAQ stock markets. All measures of execution costs examined, including quoted bid-ask spreads, effective spreads (which allow for executions within the quotes), and realized spreads (which measure price reversal after trades), are larger for NASDAQ-listed than for NYSE-listed stocks. The differentials in average trading costs across exchanges are greater for medium and small capitalization issues than for large capitalization stocks and are greater for small compared to large trades. These differentials cannot be attributed to cross-exchange differences in the adverse selection costs of market-making. Furthermore, we find no evidence that average execution costs on NASDAQ declined after the publicized events of May 1994.


Ownership Studies: The Data Source Does Matter
Ronald C. Anderson and D. Scott Lee

We examine the fit between the ownership data provided by four surrogate databases and the data collected from proxy statements. We discover an unambiguous pecking order among the surrogates relative to the benchmark ownership statistics of corporate proxy statements. Corporate Text is first, followed in descending order by Compact Disclosure, Value Line, and Spectrum. Further tests show that reporting discrepancies in the Value Line and Spectrum databases could affect economic inferences drawn from regressions using their ownership data. A field guide describing each data source's reporting conventions, formats, and strategies for data aggregation may be downloaded from the Journal of Financial and Quantitative Analysis' web site (http://weber.u.washington.edu/~jfqa/hold/andeapdx.pdf).


Reciprocally Interlocking Boards of Directors and Executive Compensation
Kevin F. Hallock

Is executive compensation influenced by the composition of the board of directors? About 8% of chief executive officers (CEOs) are reciprocally interlocked with another CEO--the current CEO of firm A serves as a director of firm B and the current CEO of firm B serves as a director of firm A. Roughly 20% of firms have at least one current or retired employee sitting on the board of another firm and vice versa. I investigate how these and other features of board composition affect CEO pay by using a sample of 9,804 director positions in America's largest companies. CEOs who lead interlocked firms earn significantly higher compensation. Also, interlocked CEOs tend to head larger firms. After controlling for firm and CEO characteristics, the pay gap is reduced dramatically. However, when firms that are interlocked due to documented business relationships are considered not interlocked, the measured return to interlock is as high as 17%. There also is evidence that the return to interlock was higher in the 1970s than in the early 1990s.


Predictable Patterns after Large Stock Price Changes on the Tokyo Stock Exchange
Marc Bremer, Takato Hiraki, and Richard J. Sweeney

This paper extends to Japanese stocks recent research on short-term stock price adjustment to new information. Using standard methodologies, we find that stock returns of firms included in the Nikkei 300 tend to be significantly positive after large price decreases. This is similar to the pattern observed for American stocks in other research. The pattern remains when returns are adjusted for market movements, and exists independently of the October 1987 market break. We find little evidence of significant patterns following large stock price increases. We also find little evidence that non-transaction prices explain the persistent, significant returns observed following large price decreases on the Tokyo Stock Exchange. We conjecture that broker/dealers and TSE member firms respond to large price decreases not by trading for their own profit, but rather by selectively supplying liquidity to their preferred retail customers. We conclude that ordinary investors probably cannot earn economic profits from these statistically significant patterns.


Herding on Noise: The Case of Johnson Redbook's Weekly Retail Sales Data
Joseph Golec

Recent models of herding suggest that speculators may rationally trade on information unrelated to fundamentals when their trading horizons are short. This study provides an empirical example where this appears to be the case. Johnson Redbook's weekly retail sales figures predicted bond returns for a short time after a significant number of bond traders began purchasing and trading on the data. The significant relationship between the data and bond returns disappeared just after the Wall Street Journal started to report it. Meanwhile, there was little or no change in the relationship between the data and retailers' stock returns, perhaps because the data have long been followed by retail stock analysts, Johnson Redbook's original investor clientele.