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Abstract:
Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help toexplain a number of important financing and investment patterns. The survey closes with a list of open questions.

Abstract:
Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help to explain a number of important financing and investment patterns. The survey closes with a list of open questions.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help to explain a number of important financing and investment patterns. The survey closes with a list of open questions.

capital structure, IPO, SEO, dividend, investment, psychology, bias, optimism, overconfidence, heuristic

Abstract:
Economists have long argued that financial markets can improve the allocation of capital across an economy's investment opportunities, but empirical evidence to support this belief has been lacking. This paper presents evidence from 65 countries which suggests that financial markets do indeed play a crucial role in the capital allocation process. In particular, countries with developed financial markets increase investment more in growing industries, and decrease investment more in declining industries, than financially undeveloped countries.

Three additional results shed light on some of the mechanisms behind this result. Across countries, the efficiency of capital allocation is: (1) negatively correlated with the extent of state ownership in the economy; (2) positively correlated with the degree of firm-specific movement in domestic stock returns; (3) positively correlated with the legal protections of investors (which appear to be particularly useful for limiting overinvestment in declining industries).

Abstract:
Financial markets appear to improve the allocation of capital--across 65 countries, those with developed financial markets increase investment more in growing industries, and decrease investment more in declining industries, than financially undeveloped countries. The efficiency of capital allocation is also negatively correlated with the extent of state ownership in the economy, and positively correlated with the degree of firm-specific movement in domestic stock returns and the legal protection of investors (which appears to be particularly useful for limiting investment in declining industries).

Abstract:
It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to past market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.

capital structure, market timing, ipo, seo

Abstract:
It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to past market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.

Capital Structure, Market Timing

Abstract:
We examine how investor sentiment affects the cross-section of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the cross-section of subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with theoretical predictions and are unlikely to reflect an alternative explanation based on compensation for systematic risks.

Abstract:
We examine how investor sentiment affects the cross-section of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the cross-section of subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with theoretical predictions and are unlikely to reflect an alternative explanation based on compensation for systematic risks.

Abstract:
We examine how investor sentiment affects the cross-section of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the cross-sectionof subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with theoretical predictions and are unlikely to reflect an alternative explanation based on compensation for systematic risks.

Abstract:
We study how investor sentiment affects the cross-section of stock returns. We predict that a wave of investor sentiment has larger effects on securities whose valuations are highly subjective and difficult to arbitrage. Consistent with this prediction, we find that when beginning-of-period proxies for sentiment are low, subsequent returns are relatively high for small stocks, young stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme growth stocks, and distressed stocks. When sentiment is high, on the other hand, these stocks tend to earn relatively low subsequent returns.

sentiment, asset pricing, arbitrage, cross-section

Abstract:
We examine how investor sentiment affects the cross-section of stock returns. Theory predicts that a broad wave of sentiment will disproportionately affect stocks whose valuations are highly subjective and are difficult to arbitrage. We test this prediction by studying how the cross-section of subsequent stock returns varies with proxies for beginning-of-period investor sentiment. When sentiment is low, subsequent returns are relatively high on smaller stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme-growth stocks, and distressed stocks, consistent with an initial underpricing of these stocks. When sentiment is high, on the other hand, these patterns attenuate or fully reverse. The results are consistent with predictions and appear unlikely to reflect an alternative explanation based on compensation for systematic risk.

Abstract:
We study how investor sentiment affects the cross-section of stock returns. We predict that a wave of investor sentiment has larger effects on securities whose valuations are highly subjective and difficult to arbitrage. Consistent with this prediction, we find that when beginning-of-period proxies for sentiment are low, subsequent returns are relatively high for small stocks, young stocks, high volatility stocks, unprofitable stocks, non-dividend-paying stocks, extreme growth stocks, and distressed stocks. When sentiment is high, on the other hand, these stocks tend to earn relatively low subsequent returns.

sentiment, cross-section, arbitrage, asset pricing

Abstract:
A number of studies have identified patterns of positive correlation of returns, or comovement, among different traded securities. We distinguish three views of such co- movement. The traditional "fundamentals" view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash ows or discount rates. "Category-based" comovement occurs when investors classify different securities into the same asset class and shift resources in and out of this class in correlated ways. A related phenomenon of "habitat-based" comovement arises when a group of investors restricts its trading to a given set of securities, and moves in and out of that set in tandem.We present models of each of the three types of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock's category and investor clientele (habitat), but do not change its fundamentals. We find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results are broadly supportive of the category and habitat views of comovement, but not of the fundamentals view. More generally, we argue that these non-traditional views may help explain other instances of comovement in the data.

Abstract:
We consider two broad views of return comovement: the traditional view, derived from frictionless economies with rational investors, which attributes it to comovement in news about fundamental value, and an alternative view, in which market frictions or noise-trader sentiment delink it from comovement in fundamentals. Building on Vijh (1994), we use data on inclusions into the S&P 500 to distinguish these views. After inclusion, a stock's beta with the S&P goes up. In bivariate regressions which control for the return of non-S&P stocks, the increase in S&P beta is even larger. These results are generally stronger in more recent data. Our findings cannot easily be explained by the fundamentals-based view and provide new evidence in support of the alternative friction- or sentiment-based view.

Abstract:
A number of studies have identifed patterns of positive correlation of returns, or comovement, among different traded securities. We distinguish three views of such comovement. The traditional 'fundamentals' view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash flows or discount rates. 'Category-based' comovement occurs when investors classify different securities into the same asset class and shift resources in and out of this class in correlated ways. A related phenomenon of 'habitat-based' comovement arises when a group of investors restricts its trading to a given set of securities, and moves in and out of that set in tandem. We present models of each of the three types of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock's category and investor clientele (habitat), but do not change its fundamentals. We find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results are broadly supportive of the category and habitat views of comovement, but not of the fundamentals view. More generally, we argue that these non-traditional views may help explain other instances of comovement in the data.

Abstract:
A number of studies have identifed patterns of positive correlation of returns, or comovement, among different traded securities. We distinguish three views of such comovement. The traditional "fundamentals" view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash flows or discount rates. "Category-based" comovement occurs when investors classify different securities into the same asset class and shift resources in and out of this class in correlated ways. A related phenomenon of "habitat-based" comovement arises when a group of investors restricts its trading to a given set of securities, and moves in and out of that set in tandem.

We present models of each of the three types of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock's category and investor clientele (habitat), but do not change its fundamentals. We find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results are broadly supportive of the category and habitat views of comovement, but not of the fundamentals view. More generally, we argue that these non-traditional views may help explain other instances of comovement in the data.

Abstract:
We document a close link between fluctuations in the propensity to pay dividends and catering incentives. First, we use the methodology of Fama and French (2001) to identify a total of four distinct ends in the propensity to pay dividends between 1963 and 2000. Second, we show that each of these ends lines up with a corresponding fluctuation in catering incentives: The propensity to pay increases when a proxy for the stock market dividend premium is positive and decreases when it is negative. The lone disconnect is attributable to Nixon-era controls.

Abstract:
We document a close link between fluctuations in the propensity to pay dividends and catering incentives. First, we use the methodology of Fama and French (2001) to identify a total of four distinct trends in the propensity to pay dividends between 1963 and 2000. Second, we show that each of these trends lines up with a corresponding fluctuation in catering incentives: The propensity to pay increases when a proxy for the stock market dividend premium is positive and decreases when it is negative. The lone disconnect is attributable to Nixon-era controls.

Abstract:
We document a close link between fluctuations in the propensity to pay dividends and catering incentives. First, we use the methodology of Fama and French (2001) to identify a total of four distinct trends in the propensity to pay dividends between 1963 and 2000. Second, we show that each of these trends lines up with a corresponding fluctuation in catering incentives: The propensity to pay increases when a proxy for the stock market dividend premium is positive and decreases when it is negative. The lone disconnect is attributable to Nixon-era controls.

dividend, payout

Abstract:
We document a close link between fluctuations in the propensity to pay dividends and catering incentives. First, we use the methodology of Fama and French (2001) to identify a total of four distinct trends in the propensity to pay dividends between 1963 and 2000. Second, we show that each of these trends lines up with a corresponding fluctuation in catering incentives: The propensity to pay increases when a proxy for the stock market dividend premium is positive and decreases when it is negative. The lone disconnect is attributable to Nixon-era controls.

Dividend, Dividends, Dividend Policy, Catering, Repurchase, Repurchases

Abstract:
The share of equity issues in total new equity and debt issues is a strong predictor of U.S. stock market returns between 1928 and 1997. In particular, firms issue relatively more equity than debt just before periods of low market returns. The equity share in new issues has stable predictive power in both halves of the sample period, and after controlling for other known predictors. We do not find support for efficient market explanations of the results. Instead, the fact that the equity share sometimes predicts significantly negative market returns suggests inefficiency and that firms time the market component of their returns when issuing securities.

Abstract:
The share of equity issues in total new equity and debt issues is a strong predictor of U.S. stock market returns between 1928 and 1997. In particular, firms issue relatively more equity than debt just before periods of low market returns. The equity share in new issues has stable predictive power in both halves of the sample period, and after controlling for other known predictors. We do not find support for efficient market explanations of the results. Instead, the fact that the equity share sometimes predicts significantly negative market returns suggests inefficiency and that firms time the market component of their returns when issuing securities.

Abstract:
In the classic theory of Scholes (1972), demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. We develop a simple model of demand curves for stocks in which the risk inherent in arbitrage between imperfect substitutes deters risk-averse arbitrageurs from flattening demand curves. Consistent with the model, stocks without close substitutes experience higher price jumps upon inclusion into the S&P 500 Index. The results suggest that arbitrage is weaker, and mispricing is likely to be more frequent and more severe, among stocks without close substitutes.

Arbitrage

Abstract:
In textbook theory, demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. The risk inherent in arbitrage between imperfect substitutes may deter risk-averse arbitrageurs from flattening demand curves. Consistent with this suggestion and a simple model of demand curves for stocks, we find that stocks without close substitutes experience differentially higher price jumps upon inclusion into the S&P 500 Index. We conjecture that arbitrage forces are weakest, and other pricing anomalies are severest, among stocks without close substitutes (which include small stocks).

Abstract:
We use a simple model of corporate investment to determine when investment will be sensitive to non-fundamental movements in stock prices. The key cross-sectional prediction of the model is that stock prices will have a stronger impact on the investment of firms that are "equity dependent" - firms that need external equity to finance their marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales (1997), we find strong support for this prediction. In particular, firms that rank in the top quintile of the KZ index have investment that is two-and-a-half times as sensitive to stock prices as firms in the bottom quintile. We also verify several other predictions of the model.

Abstract:
We use a simple model to outline the conditions under which corporate investment is sensitive to non-fundamental movements in stock prices. The key prediction is that stock prices have a stronger impact on the investment of "equity dependent" firms - firms that need external equity to finance marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales [1997], we find support for this hypothesis. In particular, firms that rank in the top quintile of the KZ index have investment that is almost three times as sensitive to stock prices as firms in the bottom quintile.

Abstract:
We use a simple model of corporate investment to determine when investment will be sensitive to non-fundamental movements in stock prices. The key cross-sectional prediction of the model is that stock prices will have a stronger impact on the investment of firms that are 'equity dependent' - firms that need external equity to finance their marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales (1997), we find strong support for this prediction. In particular, firms that rank in the top quintile of the KZ index have investment that is almost three times as sensitive to stock prices as firms in the bottom quintile. We also verify several other predictions of the model.

Abstract:
We use a simple model to outline the conditions under which corporate investment is sensitive to non-fundamental movements in stock prices. The key prediction is that stock prices have a stronger impact on the investment of "equity dependent" firms - firms that need external equity to finance marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales [1997], we find support for this hypothesis. In particular, firms that rank in the top quintile of the KZ index have investment that is almost three times as sensitive to stock prices as firms in the bottom quintile.

Investment, Behavioral Finance

Abstract:
We develop a theory in which the decision to pay dividends is driven by investor demand.Managers cater to investors by paying dividends when investors put a stock price premium on payers and not paying when investors prefer non payers. To test this prediction, we construct four time series measures of the investor demand for dividend payers. By each measure, non payers initiate dividends when demand for payers is high. By some measures, payers omit dividends when demand is low. Further analysis confirms that the results are better explained by thecatering theory than other theories of dividends.

Abstract:
We propose that the decision to pay dividends is driven by prevailing investor demand for dividend payers. Managers cater to investors by paying dividends when investors put a stock price premium on payers, and by not paying when investors prefer nonpayers. To test this prediction, we construct four stock price-based measures of investor demand for dividend payers. By each measure, nonpayers tend to initiate dividends when demand is high. By some measures, payers tend to omit dividends when demand is low. Further analysis confirms that these results are better explained by catering than other theories of dividends.

Abstract:
We develop a theory in which the decision to pay dividends is driven by investor demand. Managers cater to investors by paying dividends when investors put a stock price premium on payers and not paying when investors prefer nonpayers. To test this prediction, we construct four time series measures of the investor demand for dividend payers. By each measure, nonpayers initiate dividends when demand for payers is high. By some measures, payers omit dividends when demand is low. Further analysis confirms that the results are better explained by the catering theory than other theories of dividends.

Abstract:
We propose that the decision to pay dividends is driven by prevailing investor demand for dividend payers. Managers cater to investors by paying dividends when investors put a stock price premium on payers, and by not paying when investors prefer nonpayers. To test this prediction, we construct four stock price-based measures of investor demand for dividend payers. By each measure, nonpayers tend to initiate dividends when demand is high. By some measures, payers tend to omit dividends when demand is low. Further analysis confirms that these results are better explained by catering than other theories of dividends.

Abstract:
We consider measures of stock-picking skill of mutual fund managers based on the earnings announcement returns of the stocks that they hold and trade. Relative to standard approaches, this approach focuses on an especially informative subset of the returns data, potentially increasing power to detect skilled trading, and also sheds light on the sources of skilled trading. We find that the average fund's recent buys significantly outperform its recent sells around subsequent earnings announcements. We find that mutual fund trades also forecast EPS surprises. The point estimates suggest that skilled trading around earnings announcements, deriving from an ability to forecast economic fundamentals, represents a disproportionate fraction of the total abnormal returns to skilled trading by mutual funds estimated in prior work.

Mutual fund, performance evaluation

Abstract:
Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The top down approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance - sentiment and the limits to arbitrage - to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.

Abstract:
Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The "top down" approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance - sentiment and the limits to arbitrage - to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.

sentiment, stocks returns, sentiment index, bubble, crash

Abstract:
Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The "top down" approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance - sentiment and the limits to arbitrage - to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.

stock market, sentiment, asset pricing, behavioral finance, behavioral economics

Abstract:
Empirical evidence of imperfect integration across world capital markets suggests a role for cross-border arbitrage by multinationals. Consistent with multinational arbitrage as a determinant of foreign direct investment (FDI) patterns, we find that FDI flows increase sharply with source-country stock market valuations-particularly the component of valuations that is predicted to revert the next year, and particularly in the presence of capital account restrictions that limit other mechanisms of cross-country arbitrage. The results suggest the existence of a cheap financial capital channel in which FDI flows reflect, in part, the use of relatively low-cost capital available to overvalued parents in the source country.

F15, F21, F23, G31, G34

Abstract:
Empirical evidence of imperfect integration across world capital markets suggests a role for cross-border arbitrage by multinationals. Consistent with multinational arbitrage as a determinant of foreign direct investment (FDI) patterns, we find that FDI flows increase sharply with source-country stock market valuations-particularly the component of valuations that is predicted to revert the next year, and particularly in the presence of capital account restrictions that limit other mechanisms of cross-country arbitrage. The results suggest the existence of a cheap financial capital channel in which FDI flows reflect, in part, the use of relatively low- cost capital available to overvalued parents in the source country.

Corporate investment, inefficient markets, behavioral finance, foreign direct investment, international finance

Abstract:
The use of judgmental anchors or reference points in valuing corporations affects several basic aspects of merger and acquisition activity including offer prices, deal success, market reaction, and merger waves. Offer prices are biased towards the 52-week high, a highly salient but largely irrelevant past price, and the modal offer price is exactly that reference price. An offer's probability of acceptance discontinuously increases when the offer exceeds the 52-week high; conversely, bidder shareholders react increasingly negatively as the offer price is pulled upward toward that price. Merger waves occur when high recent returns on the stock market and on likely targets make it easier for bidders to offer the 52-week high.

mergers, acquisitions, behavioral finance, behavioral corporate finance, psychology, reference point

Abstract:
The maturity of new debt issues predicts excess bond returns. When the share of long-term debt issues in total debt issues is high, future excess bond returns are low. This predictive power comes in two parts. First, inflation, the real short-term rate, and the term spread predict excess bond returns. Second, these same variables explain the long-term share, and together account for much of its own ability to predict excess bond returns. The results are consistent with survey evidence that firms use debt market conditions in an effort to determine the lowest-cost maturity at which to borrow.

bond, maturity, return, corporate, debt, issue, predictability, cost of capital, cost of debt

Abstract:
The maturity of new debt issues predicts excess bond returns. When the share of longterm debt issues in total debt issues is high, future excess bond returns are low. This predictive power comes in two parts. First, inflation, the real short-term rate, and the term spread predict excess bond returns. Second, these same variables explain the long-term share, and together account for much of its own ability to predict excess bond returns. The results are consistent with survey evidence that firms use debt market conditions in an effort to determine the lowest-cost maturity at which to borrow.

Bond, Maturity, Return, Corporate, Debt, Issue, Predictability, Cost of Capital

Abstract:
A number of studies claim that aggregate managerial decision variables, such as aggregate equity issuance, have power to predict stock or bond market returns. Recent research argues that these results may be driven by an aggregate time-series version of Schultz s (2003) pseudo market timing bias. We use standard simulation techniques to estimate the size of the aggregate pseudomarket timing bias for a variety of predictive regressions based on managerial decision variables. We find that the bias can explain only about one percent of the predictive power of the equity share in new issues, and that it is also much too small to overturn prior inferences about thepredictive power of corporate investment plans, insider trading, dividend initiations, or the maturity of corporate debt issues.

Abstract:
A number of studies claim that aggregate managerial decision variables, such as aggregate equity issuance, have power to predict stock or bond market returns. Recent research argues that these results may be driven by an aggregate time-series version of Schultz's (2003) pseudo market timing bias. We use standard simulation techniques to estimate the size of the aggregate pseudo market timing bias for a variety of predictive regressions based on managerial decision variables. We find that the bias can explain only about one percent of the predictive power of the equity share in new issues, and that it is also much too small to overturn prior inferences about the predictive power of corporate investment plans, insider trading, dividend initiations, or the maturity of corporate debt issues.

Abstract:
Many studies find that aggregate managerial decision variables, such as aggregate equity issuance, predict stock or bond market returns. Recent research argues that these findings may be driven by an aggregate time-series version of Schultz's (2003) pseudo market-timing bias. Using standard simulation techniques, we find that the bias is much too small to account for the observed predictive power of the equity share in new issues, corporate investment plans, insider trading, dividend initiations, or the maturity of corporate debt issues.

Predictability, market timing, bias

Abstract:
Broad waves of investor sentiment should have larger impacts on securities that are more difficult to value and to arbitrage. Consistent with this intuition, we find that when an index of investor sentiment takes low values, small, young, high volatility, unprofitable, non-dividend-paying, extreme growth, and distressed stocks earn relatively higher subsequent returns. When sentiment is high, the aforementioned categories of stocks earn relatively lower subsequent returns.

Sentiment, cross-section, prediction, index, behavioral

Abstract:
Broad waves of investor sentiment should have larger impacts on securities that are more difficult to value and to arbitrage. Consistent with this intuition, we find that when an index of investor sentiment takes low values, small, young, high volatility, unprofitable, non-dividend-paying, extreme growth, and distressed stocks earn relatively higher subsequent returns. When sentiment is high, the aforementioned categories of stocks earn relatively lower subsequent returns.

Sentiment, cross-section, prediction, index, behavioral

Abstract:
We construct indexes of investor sentiment for six major stock markets and decompose them into one global and six local indexes. Relative market sentiment is correlated with the relative prices of dual-listed companies, validating the indexes. Both global and local sentiment are contrarian predictors of the time series of major markets' returns. They are also contrarian predictors of the time series of cross-sectional returns within major markets: When sentiment from either global or local sources is high, future returns are low on various categories of difficult to arbitrage and difficult to value stocks. Sentiment appears to be contagious across markets based on tests involving capital flows, and this presumably contributes to the global component of sentiment.

Investor Sentiment

Abstract:
Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while mental accounting and other economic frictions predict that investors have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. We comment on several potential explanations for the results.

Abstract:
Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while naive "spend income, not principal" mental accounting rules and other economic frictions can cause investors to have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. Further analysis suggests that while several factors may be at work, mental accounting is perhaps the most credible single explanation for the results. Finally, our results imply some estimates of the effects of the 2003 dividend tax cut on aggregate consumption.

dividend, consumption, tax cut, CEX, mental accounting

Abstract:
Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while mental accounting and other economic frictions predict that investors have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. We comment on several potential explanations for the results.

Abstract:
Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while mental accounting and other economic frictions predict that investors have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. We comment on several potential explanations for the results.

Dividend, consumption, household

Abstract:
We study basic return comovement and predictability patterns in U.S. government bonds and the cross-section of stocks. Government bonds comove most strongly with bond-like stocks, i.e. stocks of large, mature, low-volatility, profitable, dividend-paying firms that are neither high growth nor distressed. Government bonds and bond-like stocks are also copredictable in the sense that time-series variables that predict returns on one asset class also predict returns on the other. In addition to traditional explanations for comovement and copredictability, the evidence is particularly consistent with the hypothesis that fluctuations in investor sentiment affect the demand for both bonds and bond-like stocks relative to the demand for speculative stocks.

Abstract:
We document that U.S. government bonds comove more strongly with â¬Sbond-like stocksâ¬? stocks of large, mature, low-volatility, profitable, dividend-paying firms that are neither high growth nor distressed. This pattern may be caused by common shocks to real cash flows, rationally required returns, or flights to quality in which drops in investor sentiment increase the demand for both government bonds and bond-like stocks. Consistent with both the required returns and sentiment channels, we find a common predictable component in bonds and bondlike stocks. Consistent with the sentiment channel, we find that bonds and bond-like stocks comove with inflows into government bond and conservative stock mutual funds.

Abstract:
We construct indexes of investor sentiment for six major stock markets and decompose them into one global and six local indexes. Relative market sentiment is correlated with the relative prices of dual-listed companies, validating the indexes. Both global and local sentiment are contrarian predictors of the time series of major markets' returns. They are also contrarian predictors of the time series of cross-sectional returns within major markets: When sentiment from either global or local sources is high, future returns are low on various categories of difficult to arbitrage and difficult to value stocks. Sentiment appears to be contagious across markets based on tests involving capital flows, and this presumably contributes to the global component of sentiment.

Abstract:
We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low-price firms, managers will maintain share prices at lower levels, and vice-versa. Using measures of time-varying catering incentives based on valuation ratios, split announcement effects, and future returns, we find empirical support for the predictions in both time-series and firm-level data. Given the strong cross-sectional relationship between capitalization and nominal share price, an interpretation of the results is that managers may be trying to categorize their firms as small firms when investors favor small firms.

Stock splits, catering, payout policy, investor demand, nominal share prices

Abstract:
We investigate the causes of time-series fluctuations in the propensity to pay dividends,including the post-1978 decline documented by Fama and French (2001). We consider explanations based on fluctuations in dividend clienteles, agency problems, information asymmetries, executive stock options, catering incentives, tax code awareness, and short-lived idiosyncratic factors. To evaluate these explanations, we conduct three styles of analysis. First, we count and classify influences on the propensity to pay that were noted in the financial press. Second, we examine time-series relationships between the propensity to pay and proxies for the driving influences in the candidate explanations. Third, we assess whether the candidate explanations are theoreticallycompatible with related time-series patterns involving dividend policy. Overall, theresults are most consistent with the catering explanation. Notably, catering incentives,as measured by the stock market "dividend premium," roughly line up with the four trends in the propensity to pay between 1963 and 2000 and are able to account for the observed magnitude of the post-1978 decline. There is also evidence that idiosyncratic factors, including the Nixon-era dividend controls and the recent growth in options, affected the propensity to pay in specific periods.

Abstract:
We investigate the causes of time-series fluctuations in the propensity to pay dividends, including the post-1978 decline documented by Fama and French (2001). We consider explanations based on fluctuations in dividend clienteles, agency problems, information asymmetries, executive stock options, catering incentives, tax code awareness, and short-lived idiosyncratic factors. To evaluate these explanations, we conduct three styles of analysis. First, we count and classify influences on the propensity to pay that were noted in the financial press. Second, we examine time-series relationships between the propensity to pay and proxies for the driving influences in the candidate explanations. Third, we assess whether the candidate explanations are theoretically compatible with related time-series patterns involving dividend policy. Overall, the results are most consistent with the catering explanation. Notably, catering incentives, as measured by the stock market dividend premium, roughly line up with the four trends in the propensity to pay between 1963 and 2000 and are able to account for the observed magnitude of the post-1978 decline. There is also evidence that idiosyncratic factors, including the Nixon-era dividend controls and the recent growth in options, affected the propensity to pay in specific periods.

Abstract:
Foreign direct investment offers a rich laboratory in which to study the broader economic effects of securities market mispricing. We outline and test two mispricing-based theories of FDI. The "cheap assets" or fire-sale theory views FDI inflows as the purchase of undervalued host country assets, while the "cheap capital" theory views FDI outflows as a natural use of the relatively lowcost capital available to overvalued firms in the source country. The empirical results support the cheap capital view: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate market-to-book-value ratio, but are strongly positively related to source countryvaluations and negatively related to future source country stock returns. The latter effects are most pronounced in the presence of capital account restrictions, suggesting that such restrictions limit cross-country arbitrage and thereby increase the potential for mispricing-driven FDI.

Abstract:
Foreign direct investment offers a rich laboratory in which to study the broader economic effects of securities market mispricing. We outline and test two mispricing-based theories of FDI. The 'cheap assets' or fire-sale theory views FDI inflows as the purchase of undervalued host country assets, while the 'cheap capital' theory views FDI outflows as a natural use of the relatively lowcost capital available to overvalued firms in the source country. The empirical results support the cheap capital view: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate market-to-book-value ratio, but are strongly positively related to source country valuations and negatively related to future source country stock returns. The latter effects are most pronounced in the presence of capital account restrictions, suggesting that such restrictions limit cross-country arbitrage and thereby increase the potential for mispricing-driven FDI.

Abstract:
We outline and test two theories of foreign direct investment based on capital market mispricing. The â¬Scheap assetsâ¬? or â¬Sfire-saleâ¬? theory considers FDI inflows as the purchase of undervalued host country assets, while the â¬Scheap financial capitalâ¬? theory views FDI outflows as a natural use of the relatively low-cost capital available to overvalued firms in the source country. The results are consistent with the cheap financial capital theory: FDI flows are unrelated to host country stock market valuations, as measured by the aggregate market-to-book-value ratio, but are strongly positively related to source country valuations and negatively related to future source country stock returns, especially when capital account restrictions limit cross-country arbitrage.

Abstract:
We test whether fund managers have stock-picking skill by comparing their holdings and trades prior to earnings announcements with the returns realized at those events. This approach largely avoids the joint-hypothesis problem with long-horizon studies of fund performance. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. Funds display persistence in our event return-based metrics, and those that do well tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.

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Abstract:
We measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.

Abstract:
We test whether fund managers have stock-picking skill by comparing their holdings and trades prior to earnings announcements with the returns realized at those events. This approach largely avoids the joint-hypothesis problem with long-horizon studies of fund performance. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. Funds display persistence in our event return-based metrics, and those that do well tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.

Abstract:
We document that firms tend to borrow at the lowest-cost maturity. In aggregate timeseries data, the share of long-term debt issues in total debt issues is negatively related to subsequent excess bond returns, meaning that firms substitute toward long-term debt when the cost of long-term debt is low relative to the cost of short-term debt. The longterm share is also contemporaneously negatively related to the components of the longterm interest rate that predict higher excess bond returns, including inflation, the real short-term rate, and the term spread. The results suggest that firms use predictable variation in excess bond returns in an effort to reduce the cost of capital.

Abstract:
We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low-price firms, managers will maintain share prices at lower levels, and vice-versa. Using measures of time-varying catering incentives based on valuation ratios, split announcement effects, and future returns, we find empirical support for the predictions in both time-series and firm-level data. Given the strong cross-sectional relationshipbetween capitalization and nominal share price, an interpretation of the results is that managers may be trying to categorize their firms as small firms when investors favor small firms.

Abstract:
We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low-price firms, managers will maintain share prices at lower levels, and vice-versa. Using measures of time-varying catering incentives based on valuation ratios, split announcement effects, and future returns, we find empirical support for the predictions in both time-series and firm-level data. Given the strong cross-sectional relationship between capitalization and nominal share price, an interpretation of the results is that managers may be trying to categorize their firms as small firms when investors favor small firms.

Abstract:
Empirical evidence of imperfect integration across world capital markets suggests a role for cross-border arbitrage by multinationals. Consistent with multinational arbitrage as a determinant of foreign direct investment (FDI) patterns, we find that FDI flows increase sharply with source-country stock market valuations-particularly the component of valuations that is predicted to revert the next year, and particularly in the presence of capital account restrictions that limit other mechanisms of cross-country arbitrage. The results suggest the existence of a cheap financial capital channel in which FDI flows reflect, in part, the use of relatively low- cost capital available to overvalued parents in the source country.

foreign direct investment, fdi, multinational, flow

Abstract:
Many studies find that aggregate managerial decision variables, such as aggregate equity issuance, predict stock or bond market returns. Recent research argues that these findings may be driven by an aggregate time-series version of Schultzs (2003) pseudo market-timing bias. Using standard simulation techniques, we find that the bias is much too small to account for the observed predictive power of the equity share in new issues, corporate investment plans, insider trading, dividend initiations, or the maturity of corporate debt issues.

Predictive regressions, market timing, small sample bias