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Abstract:
We study the stock market reaction to aggregate earnings news. Previous research shows that, for individual firms, stock prices react positively to earnings news but require several quarters to fully reflect the information in earnings. We find that the relation between returns and earnings is substantially different in aggregate data. First, returns are unrelated to past earnings, suggesting that prices neither underreact nor overreact to aggregate earnings news. Second, aggregate returns are negatively correlated with concurrent earnings; over the last 30 years, stock prices increased 6.5% in quarters with negative earnings growth and only 1.9% otherwise. This finding suggests that earnings and discount rates move together over time, and provides new evidence that discount-rate shocks explain a significant fraction of aggregate stock returns.

Abstract:
This article surveys the seventeen papers in this special issue of the Journal of Financial Economics, and related work. The major findings are: (1) patterns of stock ownership by insiders and outsiders can influence managerial behavior, corporate performance, and stockholder voting in election contests; (2) corporate leverage, inside stock ownership by managers, and the control market are interrelated; (3) departures from one share/one vote affect firm value and efficiency; (4) takeover resistance through defensive restructurings or poison pill provisions is associated with declines in share price; and (5) top management turnover is inversely related to share price performance.

Agency Costs, Managerial Stock Ownership, Insiders, Outsiders, Control Market, Corporate Performance, One Share/One Vote, Restructuring, Poison Pill Provisions, Performance

Abstract:
We study standard mutual fund performance measures, using simulation procedures combined with random and random-stratified samples of NYSE and AMEX securities. We track simulated fund portfolios over time. These portfolios? performance is ordinary, and well-specified performance measures should not indicate abnormal performance. Our main result, however, is that the performance measures are badly misspecified. Regardless of the performance measure, there are indications of abnormal fund performance, including market-timing ability, when none exists.

Abstract:
The number of published event studies exceeds 500, and the literature continues to grow. We provide an overview of event study methods. Short-horizon methods are quite reliable. While long-horizon methods have improved, serious limitations remain. A challenge is to continue to refine long-horizon methods. We present new evidence that properties of event study methods can vary by calendar time period and can depend on event sample firm characteristics such as volatility. This reinforces the importance of examining event study statistical properties for non-randomly selected samples.

Event studies, econometrics, surveys, accounting, corporate finance, market efficiency

Abstract:
Junk bonds have been portrayed as an important alternative source of debt finance for high-growth firms that rely extensively on bank debt. We investigate the role of junk bonds in corporate finance, using a sample of firms that issued junk bonds to pay down bank loans. Bank debt paydowns are the most frequent reason firms issue junk bonds. Sample firms are extremely fast growing, and the junk bond issues typically follow operating earnings declines. Our tests indicate that the looser contractual restrictions in junk bonds enable the firms to maintain financial flexibility, defined as a capital structure's ability to support activities at low transaction and opportunity cost. Alternative explanations for the bond issues have no support. For example, we find no evidence that managers reduced their reliance on bank debt to avoid monitoring by banks. Sample firms obtained most of their bank debt through revolvers, which can also provide flexibility, and firms typically reborrowed from banks to finance continued high growth.


See also the related papers "Information Effects of Spin-offs, Equity Carve-outs, and Targeted Stock Offerings" by Stuart Gilson, Paul Healy, Christopher Noe, and Krishna Palepu; and "Valuation of Bankrupt Firms" by Stuart Gilson, Edith Hotchkiss, and Richard Ruback

Abstract:
We study firms that reduced private debt by repaying bank loans with proceeds from junk bonds. The debt contracts differ dramatically, and the contractual restrictions in bank debt are tighter. Sample firms are profitable, but experience operating earnings declines just prior to the junk bond issues. The earnings declines further tighten restrictions in bank debt, and the firms have limited borrowing capacity under their existing bank revolvers. Our tests indicate that bank debt paydowns enabled the firms to maintain their ability to grow rapidly. Alternative explanations for the paydowns, such as managers' desire to avoid bank monitoring, have little support.

Abstract:
This issue of the Journal of Financial Economics contains the first set of studies in the new Clinical Papers section. The objective of this section is to provide a high-quality professional outlet for scholarly studies of specific cases, events, practices, and specialized applications. By supplying insights about the world, challenging accepted theory, and using unique sources of data, clinical studies stand on their own as an important medium of research. Like the medical literature from which the term 'clinical' is borrowed, these articles will frequently deal with individual situations or small numbers of cases of special interest. The JFE intends to take a leading role in encouraging clinical studies, guided by the confidence that expanding our research agenda and providing an outlet for this work will enliven and enrich professional knowledge. We expect these clinical studies to stimulate new high-quality empirical and theoretical research,

Innovation in financing techniques, deregulation, reregulation, and changes in the organization and conduct of commerce are proceeding at a rapid rate. New products and practices are appearing constantly, and the roles and activities of financial institutions are changing dramatically. New ways to communicate these interesting changes to the scientific community are required because the changes provide tests of leading theories and suggest new problems of theoretical interest. Clinical papers, inspired primarily by actual events, can play an important role in this discovery and communication process and, therefore, in the evolution of the science of finance.

The advantages of specialization imply that different groups of researchers will tend to concentrate on theory, empirical tests, and clinical studies. These three groups complement each other. Theory provides logical discipline and precise hypotheses for both empirical and clinical research. Empirical tests direct theorists by identifying irrelevant models and suggest where clinical research might find counterexamples. Clinical studies help set the agenda for both theory and empirical work. Because of this complementarity and the importance of communication between these groups, the Journal of Financial Economics is committed to publishing all three types of research.

Clinical Papers, case studies, perfect and imperfect markets

Abstract:
We study the relation between market returns and unexpected aggregate flow into U.S. equity funds, using semi-weekly and daily flow data. The reaction of flow and return --whether it be one reacting to the other, or both reacting to a third factor -- is fast and strong. The flow-return relation is mainly concurrent, but flow also follows returns with a one-day lag. The lagged response of flow indicates either a common response of both returns and flow to new information, or positive feedback trading. Additional tests suggest that the concurrent relation reflects flow driving returns.

Abstract:
We study the connection between momentum portfolio returns and shifts in factor loadings on the growth rate of industrial production. Winners have temporarily higher loadings than losers. The loading spread derives mostly from the high, positive loadings of winners. Small stocks have higher loadings than big stocks, and value stocks have higher loadings than growth stocks. Using standard multifactor tests, we present evidence that the growth rate of industrial production is a priced risk factor. In most of our tests, however, the combined effect of factor pricing and risk shifts does not explain a large fraction of momentum returns.

Momentum, the growth rate of industrial production, macroeconomic risk, the expected-growth risk

Abstract:
We study empirically the changes in economic fundamentals for firms with recent stock price momentum. We find that: (i) winners have temporarily higher dividend, investment, and sales growth rates, and losers have temporarily lower dividend, investment, and sales growth rates; (ii) the duration of the growth rate dispersion matches approximately that of the momentum profits; (iii) past returns are strong, positive predictors of future growth rates; and (iv) factor-mimicking portfolios on expected growth rates earn significantly positive returns on average. This evidence is consistent with the theoretical predictions of Johnson (2002), in which momentum returns reflect compensation for temporary shifts in risk associated with expected growth. Additional tests do not provide much support for a risk-based explanation, however.

Expected Growth, Momentum, Risk, Event Study

Abstract:
We examine changes in equity mutual funds' investment advisory contracts. Contracts generally pay the advisor a fee which is a percentage of the fund's total net assets. We find that high asset growth increases the likelihood of a contract change. Advisory rate changes occur in both directions and are substantial, with typical percentage fee shifts exceeding one-fourth. Our tests show that rate increases are associated with superior past market-adjusted fund performance, whereas rate decreases reflect economies of scale associated with growth. Fund and fund family market power variables also explain cross-sectional variation in the likelihood and magnitude of rate changes. We also provide new evidence on a fund's choice between linear and piece-wise linear advisory contracts and the likelihood of switches.

Abstract:
We study put option sales undertaken by corporations during their repurchase programs. Put sales' main theoretical motivation is market timing, providing an excellent framework for studying whether security issues reflect managers' ability to identify mispricing. Our evidence is that these bets reflect timing ability, and are not simply a result of overconfidence. In the 100 days following put option issues, there is roughly a 5% abnormal stock price return, and the abnormal return is concentrated around the first earnings release date following put option sales. Longer term effects are generally not detected. Put sales also appear to reflect successful bets on the direction of stock price volatility.

Abstract:
We study put option sales undertaken by corporations during their repurchase programs. Put sales' main theoretical motivation is market timing, providing an excellent framework for studying whether security issues reflect managers' ability to identify mispricing. Our evidence is that these bets reflect timing ability, and are not simply a result of overconfidence. In the 100 days following put option issues, there is roughly a 5% abnormal stock price return, and much of the abnormal return follows the first earnings release date after the put sale. Longer term effects are generally not detected. Put sales also appear to reflect successful bets on the direction of stock price volatility.

options, marketing timing, stock price

Abstract:
We examine changes in equity mutual funds' investment advisory contracts. Contracts generally pay the advisor a fee which is a percentage of the fund's total net assets. There are substantial advisory fee rate changes in both directions, with typical percentage fee shifts exceeding one-fourth. Our tests show that rate increases are associated with superior past market-adjusted performance, whereas rate decreases reflect economies of scale associated with growth. Consistent with family-level influences, there is clustering in the timing and direction of fee rate changes for funds in a given family. Economies of scale from family-level asset growth are reflected in lower advisory fees for individual funds. Superior (e.g., star) performance for individual funds has spillover effects and is associated with rate increases for a family's other funds. We also provide new evidence on fund and fund family choice between linear and piece-wise linear advisory contracts.

Abstract:
Previous work shows that the growth rate of industrial production is a common macroeconomic risk factor in the cross-section of expected returns. We demonstrate the connection between momentum profits and shifts in factor loadings on this macroeconomic variable. Winners have temporarily higher loadings on the growth rate of industrial production than losers. The loading dispersion derives mostly from the high, positive loadings of winners. Depending on model specification, this loading dispersion can explain up to 40% of momentum profits.

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:
This paper studies the association between a firm's stock returns and subsequent top management changes. Consistent with internal monitoring of management, there is an inverse relation between the probability of a management change and a firm's share performance. This relation can result from monitoring by the board, other top managers, or blockholders. However, unless share performance is extremely good or bad, logit models have no predictive ability. No average stock reaction is detected at announcement of a top management change.

Management changes, stock price performance, governance

Abstract:
New issues of public high yield debt, or junk bonds, reached record levels in the 1990s. This paper studies transactions where firms issue junk bonds and use the proceeds to repay their bank debt. These substitutions represent the most frequent use of junk bonds. Our analysis suggests that firms undertake these substitutions to preserve financial flexibility--a capital structure's ability to support activities at low transaction and opportunity cost. Junk bond substitutions typically occur around negative earnings surprises. Since junk bonds contain substantially fewer and less restrictive covenants than bank debt, and also mature later, these substitutions reduce the probability of default and increase the range of activities in which firms can engage. The earnings surprises are short-term, and firms eventually reborrow from banks. Junk bond issues convey negative information about sample firms' prospects and cause stock prices to fall, but the decline is less severe for firms that benefit more from the increased financial flexibility. While giving managers increased flexibility could also harm shareholders (by allowing them to take actions that reduce firm value) our evidence does not strongly support this possibility.

Abstract:
This paper studies the specification of tests for long-horizon (i.e., multiyear) abnormal security returns around firm-specific events, using samples of randomly selected securities and simulated event dates. The main result is that typical long-horizon tests are misspecified. The tests have a severe tendency to indicate abnormal performance when none is present, with rejection frequencies sometimes exceeding 5 to 10 times the significance level of the test. The result is not sensitive to the specific model used for estimating abnormal returns. The parametric test statistics do not satisfy their assumed properties. We identify several sources of misspecification.

Abstract:
We study standard mutual fund performance measures, using simulation procedures combined with random and random-stratified samples of NYSE and AMEX securities. We track simulated fund portfolios over time. These portfolios' performance is ordinary, and well-specified performance measures should not indicate abnormal performance. Our main result, however, is that the performance measures are badly misspecified. Regardless of the performance measure, there are indications of abnormal fund performance, including market-timing ability, when none exists.