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Abstract:
This article studies the relative investment performance of several stock-valuation measures. The first is mispricing based on the valuation model developed by Bakshe and Chen (1998)and extended by Dong (1998) (hereafter, the BCD model). The BCD model relates, in closed form, a stock's fair value to (i) the firm's net earnings per share (EPS). (ii) the expected future EPS growth and (iii) long-term rate. The second is a value/ price (V/P) ratio based on the Lee-Myers-Swaminathan (1999) residual-income model. The other measures are all indirect valuation indicators, including book/market (B/M), earnings/price (E/P), size, and past return momentum. These measures are shown to possess distinct properties. For example, the B/M, E/P and V/P ratios are highly persistent over time: high (low) B/M stocks tend to maintain high (low) B/M ratios. But, the BCD model mispricing is highly mean-reverting: an overpriced group will eventually become underpriced (in about 1.5 years on average), and vice versa. More importantly, the BCD model mispricing, momentum, size V/P and B/M are, in decreasing order, significant ex ante predictors of future returns. The best investment strategy is to combine the BCD model mispricing with momentum rankings. Indeed, if one would hold an equally-weighted portfolio of stocks that are the most underpriced and that have top momentum, the average monthly return from 1979 to 1996 would have been 3.18 percent, with a monthly Jensen's alpha of about 1.5 percent.

Stock Valuation, Book/Market, Earnings/Price, Firm Size, Price Momentum, Stock Returns, Investment Management

Abstract:
This paper uses pre-offer market valuations to evaluate the misvaluation and Q theories of takeovers. Bidder and target valuations (price-to-book, or price-to-residual-income-model-value) are related to means of payment, mode of acquisition, premia, target hostility, offer success, and bidder and target announcement-period returns. The evidence is broadly consistent with both hypotheses. The evidence for the Q hypothesis is stronger in the pre-1990 period than in the 1990-2000 period, whereas the evidence for the misvaluation hypothesis is stronger in the 1990-2000 period than in the pre-1990 period.

takeovers, misvaluation, market efficiency, behavioral finance

Abstract:
This paper tests the hypothesis that irrational market misvaluation affects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the offer, the likelihood of offer success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis.

takeovers, misvaluation, market efficiency, behavioral finance

Abstract:
This paper provides a model for valuing stocks that takes into account the stochastic processes for earnings and interest rates. Our analysis differs from past research of this type in being applicable to stocks that have a positive probability of zero or negative earnings. By avoiding the singularity at the zero point, our earnings-based pricing model achieves improved pricing performance. The out-of-sample pricing performance of the generalized earnings valuation model (GEVM) and the Bakshi and Chen pricing model are compared on four stocks and two indices. The generalized model has smaller pricing errors and greater parameter stability. Furthermore, deviations between market and model prices tend to be mean-reverting using the GEVM model, suggesting that the model may be able to identify stock market misvaluation.

Abstract:
This paper provides a model for valuing stocks that takes into account the stochastic processes for earnings and interest rates. Our analysis differs from past research of this type in being applicable to stocks that have a positive probability of zero or negative earnings. By avoiding the singularity at the zero point, our earnings-based pricing model achieves improved pricing performance. The out-of-sample pricing performance of Generalized Earnings Valuation Model (GEVM) and the Bakshi and Chen (2001) pricing model are compared on four stocks and two indices. The generalized model has smaller pricing errors, and greater parameter stability. Furthermore, deviations between market and model prices tend to be mean-reverting using the GEVM model, suggesting that the model may be able to identify stock market misvaluation.

Stock valuation, negative earnings, asset pricing

Abstract:
The question of why individual investors want dividends is investigated by submitting a questionnaire to a Dutch investor panel. The respondents indicate that they want dividends partly because the cost of cashing in dividends is lower than the cost of selling shares. Their answers provide strong confirmation for the signaling theories of Bhattacharya (1979) and Miller and Rock (1985). They are inconsistent with the uncertainty resolution theory of Gordon (1961, 1962) and the agency theories of Jensen (1986) and Easterbrook (1984). The behavioral finance theory of Shefrin and Statman (1984) is not confirmed for cash dividends but is confirmed for stock dividends. Finally, our results indicate that individual investors do not tend to consume a large part of their dividends. This raises some doubt as to whether a reduction or elimination of dividend taxes will stimulate the economy.

dividends, individual investors, survey

Abstract:
We develop the Probability Scaling Method, which rescales short-window announcement period returns; and the Intervention Method, which uses returns associated with intervening events, to estimate value improvements from tender offers. These methods address biases in conventional techniques, which measure only a fraction of the total tender offer gain; and which include revelation about bidder stand-alone value. Perceived value improvements are much larger than traditional methods indicate, so that we cannot reject the hypothesis that bidders on average pay fair prices for targets. Furthermore, our new methods affect inferences about economic forces in the takeover market. We identify several effects (higher combined bidder-target stock returns for hostile offers, lower for equity offers, and lower for diversifying offers) that reflect differences in revelation about stand-alone value, not gains from combination.

Tender offers, value improvements, truncation dilemma, revelation bias, agency

Abstract:
We test the Miller (1977) prediction about IPO overvaluation in a sample of 7,212 U.S. IPOs from 1980 to 2003. According to Miller (1977), owing to the lack of short sales prior to the offer, IPO prices are determined by the most optimistic investors, leading to IPO overvaluation; this initial overvaluation is corrected in the years after the offer as the uncertainty of IPO firms subdues. We hypothesize that investors categorize IPOs by their industries, and we use an industry-level uncertainty measure - industry volatility in excess of the market volatility - as an ex ante proxy for investor heterogeneity of beliefs. We therefore predict that IPOs in volatile industries should have high initial returns, followed by low long-run returns.

Generally, IPOs in industries with high excess volatility have much higher initial returns and lower long-run returns in the following 2-3 years than IPOs in industries with low volatility. In time-series tests, we find that excess industry volatility explains half of the annual time-series variation in aggregate initial returns. In cross-sectional tests, when we sort IPOs into three portfolios by excess industry volatility, we find that over the full sample period, high excess industry volatility IPOs have 18% (7%) higher mean (median) initial returns, and 18% (31%) lower mean (median) style-adjusted returns over a 1.5-year period after the offer (skipping the initial 6-month aftermarket lockup period) than low excess industry volatility IPOs. These results are robust to various risk-adjustment procedures.

The effect of excess industry volatility on initial returns is about four times stronger during the "tech bubble" period (01/1997 - 03/2000) than during other periods, and the extreme bubble-period IPO initial returns in volatile industries are not reversed until about 4 years after the offer, consistent with the late 1990s' market being a market bubble fueled by investor euphoria.

We also find that firm age - our firm-level proxy for uncertainty and investor heterogeneity -affects both short- and long-run IPO performance, in coalition with industry volatility. Our results suggest that investor opinions are more diverse among young firms, as well as among firms in volatile industries. Adding age to industry volatility strengthens the return predictability of investor heterogeneity.

These findings lend strong support to Miller's hypothesis that in markets with restricted short-selling, valuations tend to reflect the most optimistic investor's appraisal in the short-run, and revert to the average appraisal in the long-run.

Investor heterogeneity; Divergence of opinion, IPOs, Overvaluation,; Industry volatility, Limited attention, Category investment

Abstract:
We apply an ex ante measure of heterogeneity in investor beliefs - excess industry volatility - to test the Miller (1977) prediction about IPO overvaluation in a sample of 7,212 IPOs from 1980 to 2003. Generally, IPOs in industries with high investor heterogeneity of beliefs have much higher initial returns and lower long-run returns in the following 2-3 years than IPOs in industries with low heterogeneity. The effect of investor heterogeneity on initial returns is about four times stronger during the tech bubble period than during other periods, and the extreme bubble-period initial returns are not reversed until about 5 years after the offer, consistent with the late 1990s' market being a market bubble fueled by investor euphoria. Excess industry volatility explains half of the annual time-series variation in aggregate initial returns. These findings support Miller's hypothesis that in markets with restricted short-selling, valuations tend to reflect the most optimistic investor's appraisal in the short-run, and revert to the average appraisal in the long-run.

investor heterogeneity, divergence of opinion, IPOs, overvaluation, industry volatility, limited attention, category investment

Abstract:
We apply an ex ante measure of heterogeneity in investor beliefs - excess industry volatility - to test the Miller (1977) prediction about IPO overvaluation in a sample of 7,212 IPOs from 1980 to 2003. Generally, IPOs in industries with high investor heterogeneity of beliefs have much higher initial returns and lower long-run returns in the following 2-3 years than IPOs in industries with low heterogeneity. The effect of investor heterogeneity on initial returns is about four times stronger during the tech bubble period than during other periods, and the extreme bubble-period initial returns are not reversed until about 5 years after the offer, consistent with the late 1990s' market being a market bubble fueled by investor euphoria. Excess industry volatility explains half of the annual time-series variation in aggregate initial returns. These findings lend strong support to Miller's hypothesis that in markets with restricted short-selling, valuations tend to reflect the most optimistic investor's appraisal in the short-run, and revert to the average appraisal in the long-run.

investor heterogeneity, divergence of opinion, IPOs, overvaluation, industry volatility, limited attention, category investment

Abstract:
We study determinants of public financing choice in relation to three security issuance theories: market timing (e.g., Stein, 1996), pecking order (Donaldson, 1961; Myers and Majluf, 1984), and investor-manager agreement (Dittmar and Thakor, 2007), in a sample of debt and equity issues and share repurchases of Canadian firms between 1998 and 2004. With respect to market timing, using the market-to-book equity ratio to measure valuation, we find that equity issuers are more overvalued than debt issuers and equity repurchasers. Recognizing that the market-to-book ratio may also indicate growth prospects, we further study the announcement and post-announcement (3-month) return performance. We find that short-run announcement period returns do not lead to a robust conclusion regarding the relation between market performance and market-to-book. However, the long-run returns are consistently lower for issuers with high market-to-book ratios, and this long-run return difference is an order of magnitude more significant than the difference in announcement period returns. These findings give support to the market timing theory of security issuance. With respect to pecking order, we find that a higher degree of financial constraints increases the probability of issuing equity compared to debt, but only after controlling for firm size. This result indicates that large firms use debt financing more than small firms do; after controlling for this size effect, firms' choice between debt and equity issuance is consistent with the pecking order theory that less constrained firms prefer debt to equity. Our finding indicates that pecking order and market timing theories are not mutually exclusive and can affect issuance decisions simultaneously. Lastly, we find no evidence that companies issue equity when agreement between outside investors and managers is high. On the contrary, we find that the probability of issuing equity increases in the level of "disagreement", as proxied by the dispersion of analyst earnings forecasts, and is unrelated to "agreement", as proxied by the discrepancy between actual and forecast earnings. Since these proxies are also measures of information asymmetry, our results are inconsistent with findings based on US studies that firms with high levels of information asymmetry tend to issue debt to avoid high informational costs. Therefore, the investor-manager agreement theory of Dittmar and Thakor (2007), and more broadly, the information asymmetry theory about debt-equity choice, are not robust to different capital markets.

security issuance choice, market timing, pecking order theory, investor-manager agreement

Abstract:
This paper documents that information production helps to explain the difference in long-run performance of IPOs. We hypothesize that greater information production in the book-building process reduces investor behavioral biases associated with IPO overvaluation, and therefore improves long-run IPO performance. Using three proxies for information production (the number of managing underwriters, underwriter reputation, and absolute price adjustment), we find that high information production predicts better long-run performance than low information production. The effect of information production on long-run returns remains strong when returns are value weighted, suggesting that this effect is not driven by the underperformance of small, low quality IPOs. Furthermore, information production has the greatest effect on IPOs with the most uncertainty, suggesting that information production mitigates the effect of firm uncertainty and thus improves long-run IPO performance.

information production, uncertainty, long-run performance, IPOs

Abstract:
We investigate market reactions and portfolio performance around the announcement of the January 2003 proposal to eliminate shareholder-level taxes on dividends. Although stock reactions during the period depend on dividend yield, we find momentum and book-to-market are also important in explaining cross-sectional stock returns. It appears that the dividend tax cut proposal triggered a market-wide re-valuation of stocks, which magnified the momentum and book-to-market effects, even for those stocks that were not paying dividends. Therefore, the period surrounding this announcement provides a unique opportunity to present new evidence on the causes for the momentum and book-to-market effects.

We examine portfolios formed on dividend yield, momentum, and B/M during a 26-day window that includes a 9-day sub-window. Our most striking finding is that the momentum effect is extremely sensitive to the holding period. There is strong return continuation during the long window but reversal during the short window. The momentum and reversal effects are not driven by dividend yield, because these effects are among the strongest across zero-yield stocks. The coexistence of strong momentum and reversal in the same sample over a short period with reinforcing news announcements suggests that time-varying risk premia cannot explain the momentum and reversal effects, because the probability of the risk premium flipping signs in 26 days is remote, and it is equally improbable to expect this strong pattern of returns to be caused by chance, especially in view of the fact that we observe the effect in portfolios of stocks, not individual equities.

We find that the B/M effect is not driven by dividend yield since, even for zero-yield stocks, high B/M portfolios outperform low B/M stocks in the 9-day window. After controlling for yield and momentum, we detect significant and positive B/M coefficients. While, in principle, the B/M effect could be driven by risk, the evidence does not appear to support such an explanation because (1) the B/M effect over the 26-day window is significant only when conditional on momentum, (2) the B/M effect is concentrated in the highest and lowest momentum stocks, (3) the reversal effect is strongest in high B/M stocks, and (4) we continue to find significantly positive B/M effects even after controlling for distress risk. Taken as a whole, our results are consistent with the notion that momentum and reversal are related to investor sentiment and the B/M effect a result of market's correcting its own misvaluation.

Momentum, reversal, book-to-market equity, the 2003 dividend tax cut, market efficiency