School Of Business Administration: Financial Review

This paper examines the motivations of firms that conduct seasoned equity offerings (SEOs) after splitting stocks. We find no difference in equity announcement and issue period returns between these firms and other equity-issuing firms suggesting that firms do not split stocks to reveal information and reduce adverse selection costs at the subsequent SEO. However, because investors react positively to split announcements, firms that issue equity after splitting stocks sell new shares at a higher price and raise more funds. We also find that firms split stocks to make the subsequent SEO more marketable to individual investors who are attracted to low priced stocks.

Keywords: seasoned equity issues; stock splits; marketability hypothesis

JEL Classifications: G14/G30/G32

Dividend Initiations and Asymmetric Information: A Hazard Model

Sanjay Deshmukh
Volume 38, No. 3, pp. 351-368

This paper investigates the dynamics of dividend policy using a hazard model. Specifically, the paper examines dividend initiations for a sample of firms that went public between 1990 and 1997. These dividend initiations are examined in the context of an alternative explanation based on the pecking order theory. The results indicate that the probability or the hazard rate of a dividend initiation is negatively related to both the level of asymmetric information and growth opportunities and positively related to the level of cash flow. These results are consistent with a pecking order explanation but inconsistent with a signaling explanation.

Keywords: dividend policy; dividend initiations; asymmetric information; pecking order theory; hazard model

JEL Classifications: G35

IPO Prospectus Information and Subsequent Performance

Harjeet S. Bhabra, Richard H. Pettway
Volume 38, No. 3, pp. 369-397

Initial public offerings underperform in the long run; however, there is very little evidence on their cross-sectional variation. Using a random sample of IPOs from 1987 through 1991 and gathering their prospectus data, we show that financial and operating characteristics as well as offering characteristics have a limited relation with the one-year stock returns. We also find that firms that subsequently reissue equity or merge outperform their matched-firm benchmarks over three years. Underperformance is most severe for the smaller and younger firms. We find that prospectus information is more useful to predict survival/failure compared to subsequent equity offerings or acquisitions.

Keywords: IPOs; prospectus; performance

JEL Classifications: G3/G32

A Reduced Form Coefficients Analysis of Executive Ownership, Corporate Value, and Executive Compensation

Marsha Weber, Donna Dudney
Volume 38, No. 3, pp. 399-413

Most simultaneous equations studies analyze the coefficients from the structural forms of the models, which provide estimates of the direct effects of independent variables on the dependent variables in each equation, but ignore the indirect effects these independent variables have on dependent variables in other equations. This paper modifies the work of Chung and Pruitt (1996) by extending the model to include board composition and institutional ownership variables and then estimating the structural and derived reduced form coefficients for the extended model. The signs and significance of the reduced form coefficients differ in several material respects from the results of the structural form coefficient analysis, which suggests that analysis of only the structural form coefficients is incorrect and potentially misleading.

Keywords: executive ownership; Tobin's Q; executive compensation; simultaneous equations

JEL Classifications: G30/G34/C30

Stock Splits and Liquidity: The Case of the Nasdaq-100 Index Tracking Stock

Patrick Dennis
Volume 38, No. 3, pp.415-433

In an attempt to disentangle the signaling effect from the liquidity effect of stock splits, I examine the liquidity changes following the two-for-one split of the Nasdaq-100 Index Tracking Stock. Since there can be no signaling with an index stock split, any difference between pre- and post-split trading may be driven by liquidity but not signaling effects. I find that though the post-split relative bid-ask spread is higher and daily turnover is unchanged, the frequency, share volume, and dollar-volume of small trades all increased after the split, indicating that the split improved liquidity for small trade-sizes.

Keywords: stock splits; signaling; liquidity; index-tracking stock

JEL Classifications: G15/G29

New Evidence on Optimal Asset Allocation

Gerald R. Jensen, Jeffrey M. Mercer
Volume 38, No. 3, pp. 435-454

Brocato and Steed (1998) showed that portfolio rebalancing based on NBER business cycle turning points substantially improves in-sample Markowitz efficiency. In a similar vein, we investigate potential improvements from rebalancing based on turning points in the monetary cycle. We find that the monetary cycle has greater influence than the business cycle on the variance/covariance structure of multiple asset classes. Furthermore, we find substantial improvements in in-sample efficiency beyond a buy-and-hold strategy and the business-cycle approach. Importantly, our indicator of monetary cycle turning points has a practical advantage over NBER business cycle turning points, in that it relies only on ex ante information. In out-of-sample tests, we continue to find superior portfolio performance after transactions costs using the monetary cycle to time portfolio rebalancing.

Keywords: asset allocation; variance/covariance structure; Markowitz efficiency

JEL Classifications: G11/G12/E32/E52

First and Second Moment Exchange Rate Exposure: Evidence from U.S. Stock Returns

Gregory Koutmos, Anna D. Martin
Volume 38, No. 3, pp. 455-471

This study investigates the impact of first- and second- moment exchange rate exposure on the daily returns of nine U.S. sectors from 1992 to 1998. In 17.8% of the cases we detect significant first-moment exposure when contemporaneous exchange rates are used. Moreover, 25.0% of the significant exposures are asymmetric. When the model utilizes one-day lags, 42.2% of the cases are significant and 79.0% are asymmetric. Regarding second-moment exposure, the financial sector displays pervasive sensitivity to exchange rate volatility when using contemporaneous and lagged models. This result is reasonable, assuming that revenues from the sale of derivative products increase with currency volatility.

Keywords: exchange-rate exposure; asymmetric exposure; second-moment exposure

JEL Classifications: F31

Profit Possibilities in Currency Markets: Arbitrage, Hedging, and Speculation

Dilip K. Ghosh, Augustine Arize
Volume 38, No. 3, pp. 473-496

This paper reviews and extends the existing literature on covered arbitrage, delineates the conditions for profitable arbitrage with the hedging instruments of forward and options contracts in the foreign exchange markets, and defines the maximum possible profits out of a given market environment. Next, the simple rules on speculation are articulated with and without transaction costs, and then we show how speculation can be covered with options and forwards. Finally, speculation is integrated with arbitrage and hedging, and further compounding of profit possibilities is illustrated.

Keywords: arbitrage; hedging; speculation

JEL Classifications: F310

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The University of Mississippi: School of Business Administration