Option Backdating and Board Interlocks with John Bizjak and Michael Lemmon, Review of Financial Studies, 2009, 22, 4821-4847.
We examine the role of board connections in explaining how the controversial practice of backdating employee stock options spread to a large number of firms across a wide range of industries. The increase in the likelihood that a firm begins to backdate stock options that can be explained by having a board member who is interlocked to a previously identified backdating firm is approximately one-third of the unconditional probability of backdating in our sample. Our analysis provides new insight into how boards function and the role that they play in providing managerial oversight and determining corporate strategy.
Evidence of Motives and Market Reactions to Sale and Leasebacks with Kyle Wells, Journal of Applied Finance, 2011, 2, 1-14.
A sale and leaseback is an alternative to traditional financing in which the owner of an asset contracts to sell the asset and then to lease it from the buyer. This paper focuses on some of the motivations behind this decision. We find evidence supporting the primary theoretical reason for leasing, namely taxes. We also find evidence supporting liquidity needs and capital constraints as motivators. Results are mixed for financial distress and there is little support for asymmetric information motivations.
Price Discovery in the Treasury-Bill When-Issued Market with Jeffrey M. Mercer, Mark E. Moore, and Drew B. Winters, Financial Review, 2013, 48, 1-24.
When-issued (i.e., forward) trading in T-bills yet to be auctioned provides a unique environment for examining price discovery. T-bills are auctioned in a sealed-bid process so participants in concurrent when-issued trading cannot observe a spot market price, yet the forward price ultimately must converge on the auction outcome price. While the evidence in this study indicates that traders in the when-issued market “discover” the ultimate auction price, little evidence is found showing that standard order flow variables contribute to price discovery. Instead, the ability to observe a few trades with relatively small volume in the when-issued market is sufficient to learn the ultimate auction price from the sealed-bid process.
Market Responses to Sale-and-Leasebacks, Real Estate Finance, 2013, 29(6).
A sale-and-leaseback occurs when an asset that was previously purchased by a company is sold to a third party and then simultaneously leased back from the third party. Historically, the majority of sale-and-leaseback transactions have involved real estate. This paper examines the market response of publicly traded firms that announce a sale-and-leaseback transaction. Transactions are also separated by the type of asset, the declared motive, and the property type involved. The market responds more favorably to transactions involving real estate and especially to real estate associated with manufacturing, retail, and hotels. Furthermore, the market also responds more favorably to transactions motivated by debt reduction compared to alternative motives.
Do Leases Expand Debt Capacity? with James Schallheim and Kyle Wells, Journal of Corporate Finance, December 2013, 23, 368-381.
Theoretically and empirically, debt and leases have been shown to be both substitutes and complements. To explore the relation, we divide our sample into two subsets: those that exhibit a complementary relation (43% increase debt after increasing leases), and those that exhibit a substitutionary relation (57% decrease debt after increasing leases). For complement firms, we find a significant negative relation between leasing and the firm’s size, marginal tax rate, and z-score, consistent with “complementary” theories. For substitute firms, we find a positive and significant relation between leasing, the marginal tax rate and changes in cash. We also find a significant positive stock market reaction to the announcement of the SLB, which is stronger for the complement subset of firms.
Human and Social Capital in the Labor Market for Directors with George D. Cashman and Stuart L. Gillan, Advances in Financial Economics, 2013, 16, 137-164.
To better understand the role of individual directors on corporate boards, we examine how director attributes affect the likelihood of receiving additional board seats. We find evidence that general skills are valued in the director labor market, as individuals with an MBA, S&P 500 board experience, and more connections to other corporate boards are more likely to receive additional board seats. At the same time, replacement directors tend to have greater financial expertise and individuals with financial backgrounds are less likely to lose board seats. We also find evidence that who a director knows is more important than what they know in that connected directors, regardless of skill, are more likely to receive an additional appointment while highly skilled, unconnected directors are not. Additionally, we find that only director connections mitigate the negative consequences associated with serving on the board of firms that restate their financials.
REIT Momentum and Characteristic-Related REIT Returns with Paul R. Goebel, David M. Harrison, and Jeffrey M. Mercer, Journal of Real Estate Finance and Economics, Forthcoming.
Recent evidence confirms that in factor-model examinations of the cross- section of REIT returns, REIT momentum emerges as the dominant driver. Acknowledging the importance of momentum, the current study explores whether and how REIT return patterns are linked to the underlying characteristics of the REITs themselves, in the manner of Daniel and Titman’s (1997) characteristics model. Over the period 1993 through 2009, we find that after controlling for momentum, book-to- market, institutional ownership, and illiquidity are all strongly associated with REIT returns while size and analyst coverage are not. We further extend prior research by examining the influence of changes in interest rate cycles on REIT returns, and find that the characteristic-return relationships are heavily influenced by interest rates.
Speculative Trading in REITs with Ben Blau, Journal of Financial Research, Forthcoming.
The role of speculative trading in markets is often debated. The recent extremes in the real estate economic cycle has created an ideal setting to investigate the role of speculative trading in the marketplace. Specifically, we focus on speculative trading in REITs during the recent boom and bust in real estate. While we find a strong relationship between speculative trading in REITs and the economic cycle, we do not find evidence that speculative trading is related to future returns. Increased speculative trading is apparent in REITs during the boom years, but the level of speculative trading in REITs is unrelated to the negative returns in REITs exhibited after the bust.
The Information Content of Option Ratios with Ben Blau and Nga Nguyen Journal of Banking and Finance, Forthcoming.
A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put-Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. Our comparison of the return predictability contained in these ratios yields some new results. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at both the weekly and monthly levels, respectively.
Call Options, Preferences for Lotteries, and the Stability of Underlying Stock Prices (2013) with Ben Blau and T. Boone Bowles Journal of Finance and Quantitative Analysis, Forthcoming.
Despite assumptions of mean-variance efficiency that underlie most asset pricing models, investors have shown a penchant for lottery-type stocks or stocks that exhibit skewness in returns. In this paper, we test whether the proportion of option trading volume made up from call options (i.e. the call ratio) is greater for stocks with return distributions that resemble lotteries. We find that call ratios are highest for stocks with lottery characteristics, suggesting that investors’ preferences for lottery-type stocks are reflected in the level of call option volume. We also test whether these preferences affect future spot price volatility. Consistent with our expectation, we find that preferences for lotteries by call option traders directly affect future spot price volatility. To the extent that higher call ratios in lottery-type stocks represent speculative activity in the options market, these results are consistent with theory in Stein (1987), which posits that speculative trading activity in the derivatives market can lead to increased volatility.
Kurtosis and Stock Returns (2014) with Ben Blau and Abdullah Masud
The recent financial turmoil in markets has been a reminder that stock returns tend to be leptokurtic, or have fait tails. The outcomes associated with a fat tailed distribution are similar to those of a distribution with a larger standard deviation or more risk. All else equal, investors should prefer less kurtosis to more kurtosis, given the same expected return. Thus, assets that increase the kurtosis of a portfolio are less desirable and should have higher expected returns. We find that the average stock has a leptokurtic distribution and that the kurtosis of a stock is negatively related to size and positively related to volatility and turnover. However, while the raw returns of stocks that have fatter tails is indicative of a kurtosis premium, once we control for size, fat tails do not appear to be priced.
The Volatility of Bid-Ask Spreads (2014) with Ben Blau (Financial Management - Revise and Resubmit)
While prior research documents a negative relation between the volatility of liquidity and expected stock returns, we find that the volatility of bid-ask spreads is positively related to future returns. After controlling for the market-risk factors, we find that the average risk-adjusted return for stocks in the highest spread volatility quintile is 1.7 percent per month. In a variety of multivariate tests, we find evidence of a return premium associated with spread volatility. Using other more traditional measures of liquidity volatility, we are able to confirm the previously documented negative relation between liquidity volatility and future returns. However, after including these controls, we are still able to observe a spread volatility return premium that is both statistically significant and economically meaningful.
Undisclosed Central Bank Lending and Stock Returns (2014) with Ben Blau and Scott Hein
Many central banks around the world have recently made policy changes to increase their transparency. The U.S. Federal Reserve is no exception and has attempted to become more transparent by stating a specific inflation target and giving more detailed explanations regarding policy decisions. However, the Fed was reluctant to immediately release the names of those firms that borrowed from the emergency loan facilities during the financial crisis. The Fed purposely waited to release this information, hoping that borrowing institutions would not be penalized by financial markets upon disclosure. Nevertheless, the evidence provided in this study shows that stock returns for borrowing institutions declined significantly and almost immediately after the borrowing was initiated. Further, our results show that the underperformance of borrowing institutions was greatest for those that received the largest loans or had the largest amount of loans outstanding. This evidence is consistent with the idea that some investors were able to trade on the information about the Fed’s emergency loan program despite the lack of the program’s transparency.
Network Connections in REIT Markets (2014) with George Cashman, Stuart Gillan, and David Harrison. (Journal of Real Estate Research - Revise and Resubmit)
Relationships play a central role across the spectrum of real estate deals. Whether negotiating prices, securing funding, or acquiring permits, knowing the right people provides multiple channels to facilitate deal making. To better understand the role of relationships in real estate markets, we examine how the connectedness of REIT directors is associated with deal making, growth, and profitability. We find strong evidence that REIT connections are positively associated with both deal making and accounting based measures of profitability, however, those relations do not translate into better market returns or higher valuations. One explanation of these somewhat contradictory results is that connections also increase firm risk. Preliminary support for this conjecture is found through our examination of each firm’s cost of equity capital, as connectedness is associated with higher cost of equity capital, which appears to offset some of the advantages associated with connectedness. Thus, connections appear to offer both advantages and disadvantages to REIT managers and shareholders.
Skewness and the Asymmetry of Earnings Announcement Returns (2014) with Ben Blau and J. Michael Pinegar
Much of traditional asset pricing theory relies on the assumption of normality in the return distribution. However, empirical tests show return skewness at both the market level and for individual stocks. In this study, we examine the relationship between short interest and skewness and find that, after controlling for other factors – including short sale constraints – short interest reduces return skewness. Additional tests identify a mechanism through which short selling reduces skewness. Consistent with the theoretical literature, we find that price responses to earnings announcements are more convex for stocks with tighter short sale constraints and less short interest. We find that this price convexity, which results from a lack of short selling, is a key determinant in contemporaneous skewness. Combined, our findings are consistent with the notion that short selling can reduce post-announcement price convexity and the skewness in individual stock returns, thus helping to normalize return distributions.
The Distribution of REIT Liquidity (2014) with Ben Blau and Nga Nguyen (Journal of Real Estate Literature - Revise and Resubmit)
In this study, we examine the distribution of market liquidity for a broad sample of Real Estate Investment Trusts (REITs). While prior research has focused on the average liquidity of REITs, we extend our analysis to include both the variability and skewness of liquidity, both of which have important implications. In extreme cases, excess variability in liquidity could present future uncertainty about the level of liquidity for REIT investors and the increased skewness of liquidity is indicative of increased competition among market makers. Our multivariate tests show that, consistent with prior literature, average bid-ask spreads are higher for the REITs than for non-REITs. We also find that the variability of bid-ask spreads is larger for REITs than for non-REITs. In addition, we find that the skewness of REIT bid-ask spreads has not only increased across time, but has also increased at a greater rate than the skewness of non-REIT spreads.
Nominal Stock Prices, Ex-Dividend Day Price Responses, and Stock Splits (2014) with Keith Jakob
In this paper we examine whether nominal stock price can help to explain the ex-dividend day anomaly. We find that stocks with lower nominal prices have ex-dividend day price drops that are more consistent with theoretical predictions based on an efficient market. After controlling for factors that have been previously documented to influence ex-dividend day stock price behavior, price-drop-to-dividend ratios are closer to one for lower priced stocks. To further explore this phenomenon, we examine the change in the price-drop-to-dividend ratio around stock splits. Firms that split their shares have price-drop-to-dividend ratios significantly closer to one after the split. Our evidence indicates that ex-dividend day stock price behavior is influenced by the nominal price of a share and that this relation could also influence the decision to split a firm’s shares.
Maximum Bid-Ask Spreads and Stock Returns (2014) with Ben Blau
The return premium associated with the illiquidity of stocks is well documented. In this study, we focus our attention on the uncertainty of liquidity. We test whether potential liquidity droughts, as measured by the maximum daily bid-ask spread during a particular month, are associated with the commonly discussed illiquidity premium. Results show a robust return premium associated with stocks with the largest maximum bid-ask spread. In various tests, we find that stocks with the largest maximum spreads generate alphas of approximately 1% per month. These results are distinct from premiums associated with the bid-ask spread and hold in a multi-factor setting after controlling for the Pastor-Stambaugh liquidity risk factor. Our results are also robust to controls for firm-specific characteristics in a number of Fama–MacBeth (1973) regressions.
Stock Lotteries and Option Listing Decisions (2014) with Ben Blau
The decision to list options for stocks is made by exchanges with the intention of selecting stocks that will generate the most option trading activity. This study hypothesizes that exchanges will list options for stocks with positive skewness. The motivation for our tests is based on the idea that some investors have preferences for skewness and the payoff structure of options is conducive for these types of preferences. Results show that the likelihood of option listing is increasing in the level of return skewness. We also find that stocks with the most pre-listing skewness generate the most post-listing option volume.
Skewness, Short Interest, and the Efficiency of Stock Prices (2014) with Ben Blau
In this study, we examine the relationship between return skewness, short interest, and the efficiency of stock prices. First, we find that stocks with positive skewness and/or idiosyncratic skewness are less efficient than other stocks, which might be explained by overvaluation caused by investor preferences for positive skewness. Second, we document that short interest reduces both total skewness and idiosyncratic skewness. Finally, while prior research has shown that short selling can improve the efficiency of markets generally, we show that short interest’s ability to improve market efficiency is strongest in stocks with the highest skewness.
Stock Lotteries and Expected Returns: International Evidence (2014) with Ben Blau and Jason Hsu
This paper examines the relationship between gambling attitudes and investor preferences for lottery-like stocks across 44 developed and emerging countries. We find negative return premium associated with lottery stocks in 25 of the 44 countries. Additionally, we find that countries with more adults who gamble, countries with more gambling institutions, and countries which allow online gambling tend to display the most significant (negative) lottery premiums. We also show that countries with the highest Catholic-to-Protestant ratio have more significant (negative) lottery premium. In additional tests, we find that countries with higher economic development tend to be those with lottery premiums although the size of the economy is not a necessary condition for the observed relation between a country’s attitude towards gambling and the lottery return premium.
Beta Dispersion and the Opacity of Banks (2014) with Ben Blau
This paper examines what we denote as beta dispersion, which is the absolute difference between firm betas and the average industry betas. This measure captures how closely the prices of stocks within a particular industry move together. Our tests show that banks generally have less beta dispersion than other types of firms particularly during the most recent financial crisis. This finding might be explained by the argument that banks are more opaque than other types of firms (Morgan (2002)). In other tests, we find that banks with the most opacity, as approximated by market microstructure characteristics generally have the least beta dispersion suggesting that stock prices of the most opaque banks are most likely to move the most closely to the industry average. To the extent that bank loans are informationally opaque, our final set of tests show that those banks with the most assets made up of real estate loans have the least beta dispersion.
Works In Progress
Speculative Trading, Market Liquidity, and the Efficiency of Stock Prices (with Ben Blau)
Systematic Liquidity Risk (with Ben Blau)
The Illiquidity Premium and Short Sale Constraints (with Ben Blau)
Negative Lotteries and the Cross-Section of Returns (with Ben Blau and Bradley Cannon)
Return Skewness and the Cost of Capital (with Ben Blau)
Single Stock Futures and Market Quality (with Ben Blau and Cuyler Strong)
Idiosyncratic Volatility and Investor Sentiment (with Ben Blau and Bradley Cannon)
Preferences for Lotteries and Option Listing Decisions (with Ben Blau)
The Relative Information Content of Option Volume and Implied Volatilities (with Ben Blau and Nga Nguyen)
Frictions, the Flow of Information, and the Distribution of Liquidity (with Ben Blau and Spencer Montgomery)
Timing the Value Premium (with Jason C. Hsu, Vitali Kalesnik, and Brett Myers)
The Impact of Dynamic and Static Allocation Skill (with Jason C. Hsu, Vitali Kalesnik, and Brett Myers)
Momentum Echoes in REITs (with Paul Goebel, David Harrison, and Jeffrey Mercer)
Powerful Politicians, Political Connections, & Firm Performance (with Stuart Gillan and Brett Myers)
Industry Regulation & Its Effects on Capital Structure (with Brett Myers)
Price Efficiency in IPO Stocks (with Jack Cooney and Junyoup Lee)
Exploring Your Strategic Alternatives (with Josh Fairbanks, Yung-Yu Ma, and Michael Stegemoller)