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Are CEOs unable to learn? This surprising question deserves to be raised in the light of the declining pattern of cumulative abnormal returns observed in M&A programs. This paper shows that this pattern is the expected ex post empirical evidence for rational risk averse CEOs. Our theoretical argument is that from deal to deal, rational CEOs become more aggressive in the bidding process. They concede increasing fractions of expected synergies to the target shareholders in order to win the bidding game. For CEOs infected by hubris, the learning process should allow them to progressively correct over-optimism and overconfidence, if they survive.

Since arbitrage involves trading, it is potentially impeded by market frictions and costs. We study whether stock market liquidity is related to the efficacy of arbitrage. Specifically, we examine the joint time-series of the NYSE Composite index futures basis and aggregate liquidity on the NYSE for a relatively long time-period, over 3000 trading days, and find that the basis and liquidity are jointly determined. Contemporaneous innovations in the absolute basis and in bid-ask spreads are positively correlated. There is also evidence of two-way Granger causality between short-term absolute bases and effective spreads. Impulse response functions indicate that shocks to the absolute basis are significantly informative in predicting spreads.

During 2002 and 2003, 140 publicly traded U.S. firms announced their intention to recognize an accounting expense when stock options are granted to employees. Many similar firms elected not to expense options. We study the stock market’s reaction. There is no evidence whatsoever that expensing options reduces the stock price. To the contrary, around announcement dates, we find significant price increases for firms electing to expense options and significant price declines for industry/size/performance-matched firms that did not announce expensing at the same moment. The average relative change in market values is 3.65% during a six-day window around the announcement. The magnitude of the market’s reaction to expensing depends on agency costs, the magnitude of option expenses, and financial reporting costs. The market’s reaction does not seem to be affected by contracting costs (e.g., induced by debt covenants), growth opportunities, or potential political repercussions. Moreover, the decision to expense and the magnitude of the market’s reaction are not signals of future operating performance. The market seems to react favorably to transparent reporting while it penalizes firms that give the appearance of having something to hide.

Asset pricing theory has traditionally made predictions about risk and return, but has been silent on the actual process of investment. Today most investors delegate major investment decisions to financial professionals. This suggests that the instructions given by investors to their delegated agents and the compensation of those agents might be important determinants of capital market equilibrium. In the extreme when all investment decisions are delegated, the preferences and beliefs of individuals would be completely superseded by the objective functions of agent/managers. A provocative illustration of the difference between direct and delegated investing is provided based on active asset management relative to a benchmark index, a common objective function in practice. With the growing preponderance of delegated investing, future asset pricing theory will not only have to describe risk and return but, to be complete, must also be able to explain the observed objective functions used by professional managers.

Why do regulatory authorities scrutinize mergers and acquisitions? The authorities themselves claim to be combating monopoly power and protecting consumers, but the last two decades of empirical research has found little supporting evidence for such laudatory motives. An alternative is that M&A regulation is actually designed to protect privileged firms. In this paper, we provide a test of protectionism by studying whether European regulatory intervention is more likely when European firms are harmed by increased competition. Our findings are unambiguous: European regulation is protectionist. The results are robust to a variety of statistical difficulties, including endogeneity between investor valuations and regulatory actions.

The number of merger and acquisition (M&A) transactions paid fully in stock in the U.S. market declined sharply after 2001, when pooling and goodwill amortization were abolished by the Financial Accounting Standards Board. Did this accounting rule change really have such far reaching implications? Using a difference-in-differences test and Canada as a counterfactual, this study reveals that it did. We also report several other results confirming the role of pooling abolishment, including (i) that the decrease in full stock payment relates to CEO incentives and (ii) that previously documented determinants of the M&A mode of payment cannot explain the post-pooling abolishment pattern. These results are also robust to controls for various factors, such as the Internet bubble, the exclusion of cross-border deals, the presence of Canadian cross-listed firms, the use of a constant sample of acquirers across the pooling and post-pooling abolishment periods, the use of Europe as an alternative counterfactual, and controls for the SEC Rule 10b-18 share repurchase safe harbor amendments of 2003. History: Accepted by Shivaram Rajgopal, accounting. Keywords: mergers and acquisitions * method of payment * pooling of interest * purchase method, 1. Introduction Over the past 25 years, U.S. merger and acquisition (M&A) transactions that have been fully paid in stock have displayed a striking pattern: from half of all transactions [...]

U.S. Treasury Inflation Protection Securities (TIPs) were first issued in January 1997. Through the end of 2002, eleven TIPs have been issued with maturities ranging from a few years through thirty years. One TIP bond has already matured. Returns on TIPs have been positively correlated with returns on nominal bonds and negatively correlated with equity returns over the past five years. TIPs real durations are longer than nominal bonds because their real yields are low. However, their effective nominal durations are much shorter because they are not as sensitive to changes in expected inflation. TIPs volatility has displayed marked variation over time. It was relatively low during 1999- 2000 and considerably higher during 2001-2002. This suggests that real interest rate volatility has increased recently. TIPs can be used to estimate the real yield curve. The real and nominal yield curves can then be combined to estimate the term structure of anticipated inflation. Because of their taxation, TIPs yields may not be entirely independent of inflation. Given plausible assumptions about future expected returns, an investment portfolio diversified across equities and nominal bonds would be improved by the addition of TIPs.

We provide a novel method for extracting estimates of realized pure price inflation from stock returns. The key is recognizing that pure price inflation should a®ect nominal returns of all traded assets by exactly the same amount. The popular Fama- French three-factor model is employed to purge stock returns of real economic factors. We uncover evidence that purchasing power parity holds quite well using the extracted inflation measures.

During the 1990s, the richest quintile of a country had an average income per capita approximately ten times that of the poorest quintile. We find that the poor of a country are better off relatively, and absolutely, when the country ranks higher in average income, union participation, taxation, government spending, education, and property rights. Under these same conditions, the wealthy of a country also have more absolute per capita income, just not a higher percentage relative to the poor.Countries with substantial black market activity, high levels of international trade (as a percentage of GDP), and former Spanish colonies have greater income disparity; these features also coincide with lower incomes for both rich and poor.Key features of democracy such as political and voting rights, civil liberties and freedom of the press, while important for economic growth, are not independently associated with income inequality.We find little empirical support for a tradeoff between a high level of prosperity and greater equality. Above a very low level of development, appropriate policies are associated with both higher average and more equal income.

Asian stock markets are compared with European markets before and during the 1997 Asian crisis. The clinical issue is whether regional inter-dependence became larger around the crisis, fomenting investor fears of contagion and reducing asset values because of lower diversification potential. Statistical measures are developed to aid in this inquiry. We find that European and East Asian countries were not susceptible to volatility contagion in the pre-crisis era but that susceptibility increased significantly in Asia with the onset of the crisis. Covariances, correlations, and volatilities increased from the pre-crisis to the crisis period in both regions, but the percentage increases were much larger in Asia. Diversification potential was better in Asia than in Europe before the crisis; this was reversed during the crisis. The observed decline in diversification potency in Asia is reason enough for large declines in asset values though one cannot prove, of course, that it was the cause rather than the effect of the crisis.

Daily returns for stocks listed on the New York Exchange (NYSE) are not serially dependent. In contrast, order imbalances on the same stocks are highly persistent from day to day. These two empirical facts can be reconciled if sophisticated investors react to order imbalances within the trading day by engaging in countervailing trades sufficient to remove serial dependence over the daily horizon. How long does this actually take? The pattern of intra-day serial dependence, over intervals ranging from five minutes to one hour, reveals traces of efficiency-creating actions. For the actively traded NYSE stocks in our sample, it takes longer than five minutes for astute investors to begin such activities. By thirty minutes, they are well along on their daily quest.

Acquisitions, mergers and other business agreements are facing increasing regulatory scrutiny, even when they are among firms domiciled outside the territory of the regulatory authorities. Some noteworthy recent examples involve mergers between American firms that were prohibited by regulators from the European Commission. Reciprocation by regulators from other jurisdictions seems a likely future trend. There are obvious consequences for the successful completion of proposed global business arrangements. This paper explains the regulatory procedures of the European Commission with respect to business combinations. It documents the price reactions of subject firms on various dates from the initial announcement to the final regulatory decision. It tests the hypothesis that European regulators are actually motivated by protectionism of European Community (EC) firms against foreign competition. Finally, it studies the market’s anticipation of regulatory outcomes at the initial announcement of the proposed business combination. The empirical results are: (1) the market clearly reacts to European regulatory intervention; (2) the probability of intervention is not related to the nationality of the bidder. However, (3) when intervention does occur, the market anticipates that it is more costly when the bidder is a non-EC firm, so protectionism cannot be rejected outright. Finally, (4) the market incorporates regulatory intervention into its initial evaluation of the proposed business combination. The initial market reaction is a wealth effect conditioned by the probability and costs of intervention.

Data from the Taiwan Stock Exchange identify the originator of each submitted order, and there are no designated dealers or specialists. We study marketable order imbalances, i.e., the net order flow resulting from trades that demand immediacy. We distinguish imbalances by trader type (individuals, domestic institutions, foreign institutions) and by the usual size of each trader’s order. Day-to-day persistence in order imbalance is strongest for small foreign institutions and weakest for large individual traders. Such persistence emanates both from splitting orders over time and from herding, and there is little evidence that aggregate price pressures from such persistence last beyond a trading day, indicating that de facto market-making is quite effective. We attempt to discern which types of traders are de facto liquidity-providers, which are likely to be informed, and which trade for liquidity reasons. The evidence indicates that all trader classes are successful market-makers, large domestic institutions conduct the most informed trades, and large individuals are noise or liquidity traders.

Traditionally, volume has provided the link between trading activity and returns. We focus on a hitherto unexplored but intuitive measure of trading activity: the aggregate daily order imbalance on the New York Stock Exchange. Signed order imbalances increase (decrease) following market declines (rises), which reveals that investors are contrarians on aggregate. Order imbalances in either direction, either excess buy or sell orders, reduce liquidity. Market-wide returns are strongly affected by contemporaneous and lagged order imbalances. Market-wide returns reverse themselves after high negative imbalance, large negative return days; the magnitude of this reversal is partially predictable from the level of the imbalance and return. Even after controlling for aggregate market volume and liquidity, market returns are affected by order imbalance.