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Ebook Short Sale Constraints, Heterogeneous Interpretations, and Asymmetric Price Reactions to Earnings Announcements

Submitted by puput on Mon, 07/26/2010 - 06:30

Earnings announcements are among the most important information events by which firms disclose information to the market. Accounting research provides extensive evidence that earnings announcements convey important information for security valuation. It has also been well recognized that deriving the valuation implications of earnings signals is complicated, even for sophisticated financial analysts. This complexity leaves ample room for disagreement among investors in interpreting earnings signals. The effect of heterogeneous interpretations of earnings signals on the price reactions to earnings announcements has not received much attention. The lack of attention probably reflects the traditional view that, although disagreement on the public information generates trading activity, these trades are idiosyncratic and hence offset the effects of one another, thus having no consequences for average prices (Hong and Stein 2007). Building on the insights of recent theoretical literature on the pricing effects of short sale constraints, this study examines the effect of heterogeneous interpretations of earnings signals on the price reactions to earning announcements.

Two recent empirical studies have investigated the effects of short sale constraints on the price reactions to earnings announcements. Reed (2007) shows that stocks for which short selling is particularly costly have larger price reactions to earnings announcements, especially to bad news. He suggests that this evidence confirms Diamond and Verrechia’s (1987) hypothesis that short sale constraints reduce the speed with which prices adjust to private (especially negative) information. Berkman et al. (2009) document that stocks with a greater difference of opinion prior to earnings announcements earn lower returns around these announcements, and this pattern is more salient within the subsample of stocks that are more difficult for investors to sell short. Their evidence suggests that overvaluation exists under short sale constraints, which is consistent with Miller’s (1977) overpricing hypothesis, and earnings announcements narrow the differences of opinion, hence reducing overvaluation.

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Ebook International Real Business Cycles: Are Countercyclical Margins in Banking the Missing Transmission Mechanism?

Submitted by puput on Sat, 01/16/2010 - 03:05

A significant amount of research in international macroeconomics has been devoted to answer the question of what are the channels through which business cycles are transmitted across countries. Unfortunately and despite all this work, there is still no consensus on what determines business cycle comovement.

There are also important discrepancies between the data and what standard models predict regarding the international comovement of macroeconomic aggregates. These discrepancies were first identified by Backus, Kehoe and Kydland (1992) for the OECD countries. They have been labelled “anomalies” when proved robust to various changes to parameter values and model structures. The discrepancies are two. First, in the data, correlations of output across countries are larger than analogous correlations for consumption. With only a few exceptions, previous work obtains consumption cross-country correlations that significantly exceed output correlations. This inconsistency has been labelled the “consumption/output anomaly” or the “quantity anomaly”. Second, investment and employment comove across countries in the data, while most models predict negative values for their cross-country correlation. Many candidates have been suggested to propose a solution to these puzzles, but no agreement has been reached on what is the best way to solve them.

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PDF Ebook SOX, Corporate Transparency, and the Cost of Debt

Submitted by antoq on Fri, 02/05/2010 - 07:26

We propose a new market'based measure of corporate transparency calibrated from a popular model of Credit Default Swaps (CDS) pricing. Less transparent firms according to this measure tend to have lower S&P Transparency and Disclosure ratings, and lower KLD or ISS corporate governance ratings. We use the measure to investigate the impact of the Sarbanes'Oxley (SOX) Act on corporate transparency and the cost of debt. Our tests show that corporate opaqueness and the cost of debt decrease significantly after SOX. Specifically, the typical firm in our sample experiences a 19bp reduction on its five'year CDS spread as a result of lower opaqueness following SOX, amounting to total annual savings of $ 1.65 billion for all firms in our sample. Furthermore, the reduction of opaqueness tends to be stronger for firms that were more opaque before SOX.

The effect of corporate transparency on securities markets is a key topic for researchers, market participants, and regulators. Although for different purposes, all share the need to measure corporate transparency in a consistent and reliable manner. Current measures of transparency use either linear regressions involving financial statement variables (see Jones 1991 and Dechow, Sloan and Sweeney 1995), linear regressions involving equity returns and financial statement variables (see Berger, Chen and Li 2006), or scores relying on expert judgment (see Botosan 1997 and Francis, Nanda and Olsson 2008). We propose an alternative measure of corporate transparency derived from the price level of debt contracts (not changes in levels).

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