Higher Idiosyncratic Risk Research Articles

Cash versus Share Payouts in Relative Performance Plans

ABSTRACT This study examines the risk taking properties associated with incentive plans that use relative performance evaluation, with a focus on the form of payout, whether in cash or shares. By analyzing determinants and consequences of payout form choice, I find that share-based plans offer risk-averse managers weaker incentives to pursue projects with idiosyncratic risk compared with cash plans. This occurs because share plans—unlike cash plans—expose managers to systematic performance trends, as payout values are linked to stock prices. Additionally, I document that the variation in risk taking incentives depends on expected relative performance and the strength of the incentives. Overall, this study’s findings suggest that commonly used share-based relative performance plans might not always motivate managers to pursue innovative projects with high idiosyncratic risk when projects with systematic risk are available. Data Availability: All data are available from the sources identified in the text. JEL Classifications: G30; J33; J41; M12; M41.

Testing the boundaries of applicability of standard Stochastic Discount Factor models

We provide a joint non-parametric test to gather insights on the boundaries of applicability of Stochastic Discount Factor (SDF) models. We find that a non-trivial class of models cannot price the U.S. stock market equally weighted portfolio, implying non-monotonic SDFs, especially over the last 50/60 years in (recessionary) periods characterized by higher market volatility. Stocks responsible for this rejection mostly belong to the smallest NYSE market cap decile, are characterized by high idiosyncratic risk, and typically cannot be priced via SDF models where the aggregate level of risk aversion is bigger then 9 or 10. Excluding these stocks increases the ability to explain the cross-section of returns without impairing the ability to span the mean–variance frontier.

When school ties meet geography: Education-province bias in mutual fund portfolios

Fund managers tilt towards stocks from the location of their tertiary education (education province). We find that, compared with their peers, fund managers overweight stocks headquartered in their education provinces. This overweighting differs from other biases, such as local bias, hometown bias, and educational ties, and is detrimental to fund performance. Funds with more education-province bias have poorer fund performance and higher idiosyncratic risk than those with less bias. Further analysis shows that education-province bias is more evident during poor market times, among underperforming funds, for stocks with less information asymmetry, in economically depressed provinces, and when fund managers are educated at lower-ranked institutes. Overall, our findings suggest that education-province bias is largely attributed to fund managers’ familiarity bias.

When Do Marketing Ideation Crowdsourcing Contests Create Shareholder Value? The Effect of Contest Design and Marketing Resource Factors

Firms often use crowdsourcing contests to develop marketing ideas and solutions. Despite the prevalence—and unique aspects—of marketing ideation crowdsourcing contests (MICCs), there has been little examination of these contests’ shareholder wealth implications. Adopting a signaling perspective, the authors conduct an event study of 508 MICC announcements and find that they are associated with higher returns, but also higher idiosyncratic risk, indicating that investors hold a mixed view of such contests. Further, the authors consider how contest design factors and firm marketing resources may signal the cultivation of intellectual and relational market-based assets to shape their stock market impact, providing firms guidance to better design their MICCs. Specifically, they find that returns are enhanced when firms use professional (vs. general public) contests, specifically scoped contests, and contests using crowd judging (vs. expert panels), and for firms with stronger marketing capabilities. However, brand factors have mixed effects on returns, with a brand's relevant stature having a positive effect and its energized differentiation having a negative effect on returns. Product MICCs and generally scoped contests heighten the negative effects on risk, whereas marketing resources have no impact. Results offer implications for practitioners, including the finding that many MICC design choices commonly used in practice (i.e., general public contests and expert panels) are viewed less favorably by investors.

Visualizing environmental management: Corporate environmental images information disclosure and idiosyncratic risk

Enterprises pay more attention to the online visual communication of environmental information. Images significantly contribute to attracting the attention of stakeholders and enhancing the readability and understandability of information. This study collected 20,699 images of environmental information published on social media by environmentally sensitive Chinese enterprises from 2016 to 2020. Large-scale automatic image content analysis technology based on a computer vision algorithm was used to mine the disclosure characteristics of the environmental images. We further used a regression analysis to explore the effect of environmental images information disclosure on idiosyncratic risk. Our results show that enterprises are more willing to publish environmental management awareness images than renewable energy, environmental protection facilities, environmental certificates, and greening images. Enterprises with higher idiosyncratic risk and negative environmental events may disclose more environmental image information for impression management. The regression results show that environmental image disclosure can reduce idiosyncratic risk. However, this negative correlation no longer exists when idiosyncratic risk is high and negative environmental events occur. In conclusion, this study proposes a new perspective for examining the characteristics and effects of environmental information.

Does Idiosyncratic Risk Affect Earnings Quality? Evidence from Indonesia

This study examines whether idiosyncratic risk significantly affects earnings quality in non-financial companies listed on the Indonesia Stock Exchange. Research on developing countries, especially Indonesia, which links idiosyncratic risk and earnings quality, has not been widely conducted. This is interesting because the characteristics of the markets in developing countries are different from those in developed countries. This study uses the dependent variable of earnings quality, which is the residual value of the Kasznik and Dechow–Dichev model, and idiosyncratic risk, which is measured based on the Capital Assets Pricing and Fama–French models. The overall results indicate that high idiosyncratic risk is associated with low earnings quality (large residual value). Robustness tests are also conducted based on groups of positive and negative profit companies, as well as industry groups. The same results were obtained for each earnings component, namely, innate and discretionary factors. These findings contribute to the development of firm-specific risk literature as an additional analytical tool to assess earnings quality based on accrual rates. This allows regulators and standard-setters to provide more relevant information regarding investment decisions.

Size, conditional idiosyncratic risk and price momentum: an international study

PurposeThis paper jointly examines how firm size and idiosyncratic risk impact momentum returns.Design/methodology/approachUsing regression analysis, the authors investigate how firm size and idiosyncratic risk impact price momentum. The authors review firm price data in 25 country markets in the Thomson Financial Datastream database from 1979 to 2009.FindingsThis study’s findings suggest price momentum is more significant among stocks with smaller size and higher idiosyncratic risk. The authors find that winner and loser portfolios have significantly smaller size and higher idiosyncratic risk than portfolios in the middle quintiles.Research limitations/implicationsThis study’s results are consistent with the notion that firm size matters in price momentum and mispricing is greatest for small firms because of the greater risk potential to arbitrageurs. In addition, this finding that firms with higher idiosyncratic risk have greater price momentum supports the idea that investors underreact to firm-specific information.Practical implicationsThis work finds evidence that investors underreact to firm-specific information. As such, these findings are of particular interest for investors looking to exploit opportunities for abnormal returns through price momentum trading.Originality/valueThis paper jointly examines the effects of firm size and idiosyncratic risk on momentum returns. This investigation considers these effects in the global markets. This work adds to the research base by illustrating that both winner and loser portfolios have significantly smaller size and higher idiosyncratic risk than portfolios in the middle quintiles. Also unique to this study, the authors capture the time-variation of expected IdioRisk and the asymmetric effects of volatility by using an exponential general autoregressive conditional heteroskedastic (EGARCH) model to calculate conditional idiosyncratic risk.

Determinants of idiosyncratic risk: evidence from BRICS countries

PurposeThis study examines the determinants of idiosyncratic risk (IR) or unsystematic risk. The study also examines the determinants of IR by dividing the firms into different categories: beta-based firms, liquid and illiquid firms and financially constrained (FC) and unconstrained (FUC) firms.Design/methodology/approachThe fixed effects static panel data model specifications are formulated based on Hausman (1978) test for BRICS (Brazil, Russia, India, China, and South Africa) member countries over the period 2000–2019. Moreover, the t-test is applied to see whether the returns of different types of portfolios are significantly different.FindingsThe portfolio analysis results show that, on average, high IR firms tend to be small in size, highly leveraged, have low competitiveness, low profitability, less dividend yield and low returns for all the sampled countries. The sample paired t-test also confirms that a significant difference exists between extreme portfolios: small and large size and low IR and high IR portfolios. The panel regression results show that firm size, market power, price-to-earnings ratio, return on equity (ROE) and dividend yield negatively relates to IR. Yet, both leverage and liquidity are positively related to IR. However, the sign of momentum returns is mostly positive for the entire sample. The coefficient values for high-beta, FC and illiquid firms are more significant and large than the firms' counterparts for all BRICS member countries. These results support the hypothesis of an under-diversified portfolio and suggest that the above-mentioned firm-specific variables are the significant determinants of unsystematic risk.Practical implicationsThe securities exchange commission, as the supervisor of the public limited companies, needs to increase its role in investor protection related to the uncertainty of investment in the capital market. Accordingly, in making investment decisions in a stock exchange, investors can use the information that captures unsystematic risk for investment decision-making.Originality/valueThis study is the first to explore the determinants of IR in top emerging countries. Second, none of the existing studies has focused on the determinants of the IR based on different categories of firms.

Managerial commitment and heterogeneity in target-date funds

How a portfolio manager allocates own investment in a target date fund (TDF) series is informative about managerial commitment to the TDF investment principle. We find that TDFs whose managers choose to have positive ownership are associated with less idiosyncratic risk taking. In addition, TDFs with managers investing in remote funds and diversifying across TDFs exhibit high idiosyncratic risk taking. Overall, managerial commitment helps explain TDF heterogeneity; the impact of managerial discretion on fund investment strategies demonstrates externalities to 401(k) participants using TDFs as their default option.

CEO inside debt and mutual fund investment decisions

I show equity mutual funds invest less in companies with higher CEO inside debt, whereas corporate bond funds invest more in such companies. The effect persists after accounting for endogeneity using first-time mandatory disclosure of inside debt in 2007 as a quasi-natural experiment, and using state-level personal income tax rates as instruments for inside debt. This finding suggests that fund managers pay attention to incentive implications of inside debt when making portfolio decisions. The effect of inside debt on portfolio allocation is stronger in firms with higher likelihood of default and higher idiosyncratic risk, firms suffering from debt overhang, and firms with lower credit ratings. Lastly, equity funds that underweight high-inside debt firms and bond funds that overweight them deliver positive alphas.

Impact of macroeconomic and idiosyncratic uncertainty on firms' financing decisions: Evidence from SADC countries

Purpose of Study: The purpose of this study is to investigate the impact of idiosyncratic and macroeconomic risks on financing decision on SADC countries. Methodology: Employing data from the African Financials database, the analysis is conducted over a ten-year period spanning from 2008 - 2019 for 309 companies. Unit Root Fisher Chi- Square Test and Granger Causality test were employed to test for unidirectional and bidirectional relationships cross-sectionally. Pooled Regression Analysis- (Fixed and Random effect) was employed as main topology for panel regression analysis. Findings: The study confirmed that companies become risk averse when there is an increase in idiosyncratic and macroeconomic risk and therefore take less leverage whichever type of financing decision is opted. In other words, when there are high idiosyncratic risks, debt to equity ratio is low. Banking and financial institutions charge a higher risk premium for companies having a high-risk profile. Due to this, the cost of debt financing augments. Therefore, companies employ internal financing and reduce debts due to high bankruptcy risk and costs. This finding is in line with the pecking order theory (Myers and Majluf, 1984). Conversely, a significant positive linkage is reported in Namibia and South Africa. This estimate posits that these companies use more debts during periods of high idiosyncratic risk which corresponds to the trade- off theory. Originality: The study is among one of the pioneering works underpinning the idiosyncratic risk and macroeconomic risk on capital structure and relying on a large number of companies across the SADC region. In this respect, it adds contribution to the existing literature on risks and capital structure to the socio-economic goals of the SADC region.

The Capitalization Effect of Imputation Credits on Expected Stock Returns

This paper develops an equilibrium model featuring heterogeneity in investor risk tolerance across different risk sources. Using Australian data, it confirms the theoretical predictions of the model by showing that a higher imputation credit yield in one year leads to a lower stock return in the next year. This negative relationship between imputation credit yield and stock return is weaker for stocks with higher idiosyncratic risk, larger size, and higher trading turnover. Our theoretical and empirical evidence favours the aggregation approach in explaining the capitalization effect of imputation credits over the marginal investor approach.

이사의 손해배상책임 감경규정 도입의 효과

This paper investigates the effect of adoption of the Liability Limitation Provisions(LLP) on managerial behavior and future firm performance, and studies what role the corporate governance plays in this context. Our findings are summarized as follows. First, we document that LLP adopters spend more R&D expenditures, have higher idiosyncratic risk, and have greater volatility in operating performance than non-LLP adopters. Second, there is no significant difference in firm performance between LLP adopters and non-LLP adopters. This implies although LLP adoption lets managers take more risk, it does not immediately lead to better performance due to certain offsetting factors. Third, however, when an analysis is conducted on subsamples divided based on the effectiveness of corporate governance, we find that LLP adopters exhibit better operating performance than non-LLP adopters in a subsample of firms with good governance. This suggests the better the governance structure, the more effectively the negative effects of LLP are suppressed and the better the positive effects of LLP are manifested. Overall, this study shows that LLP adoption can promote bold managerial behavior, and lead to better firm performance, especially in firms with good governance. The findings of this study provide empirical support to justify the LLP in Korea.

Salience theory and the cross-section of stock returns: International and further evidence

Motivated by existing evidence of the salience theory (ST) effect in the United States, we investigate its importance in 49 countries over the past three decades. Initial results suggest a negative relationship between the ST measure and future returns. The underperformance of low ST stocks is the strongest in countries with high idiosyncratic risk. However, the salience effect has three vital limitations. First, a substantial part of the anomaly can be attributed to the short-term return reversal. Second, it is priced primarily among microcaps. Third, the premium is realized predominantly following severe down markets and volatility spikes. Outside of microcaps and extreme market conditions, the salience effect does not exist.

IPO underperformance and the idiosyncratic risk puzzle

We investigate the relationship between IPO long-run underperformance ( Ritter, 1991 ; Loughran and Ritter, 1995 ) and the idiosyncratic risk puzzle ( Ang, Hodrick, Xing, and Zhang, 2006 ) or the phenomenon of abnormally low returns for stocks with high idiosyncratic risk. We find that IPO long-run underperformance is a manifestation of surprisingly low returns for high idiosyncratic risk stocks. IPO underperformance disappears after we control for idiosyncratic risk. On the other hand, we find that the idiosyncratic risk puzzle is magnified by IPO underperformance. Our results are robust to various specifications or sample requirements. We evaluate a couple of potential common causes for the two puzzles and conclude that investors’ preferences for stocks with lottery features is the primary mechanism linking the two puzzles.

Do internet stock message boards influence firm value? evidence from China

ABSTRACT This study examines whether Internet stock message boards influence firm value in China. By analyzing data on online posts manually collected from a Chinese stock message board over the period from 2007 to 2018, we find that more online posts lead to greater firm value. Besides, the impact of stock message boards on firm value is more pronounced for firms with higher idiosyncratic risk. We further examine the mechanisms underlying the positive association between online posts and firm value. We find that more online posts contribute to a larger shareholder base and more retail investors’ trading, which potentially increases the degree of investor recognition and therefore enhances firm value. The results are robust to instrumental variable approaches and alternative model specifications. Overall, this study provides a new understanding of the effect of social media on financial market.

Nordic stock market performance of the travel and leisure industry during the first wave of Covid-19 pandemic

This article investigates the performance of the stock market and its volatility in the travel and leisure industry for three Nordic countries using daily data from June 2018 to June 2020, a period that includes the first wave of Covid-19 pandemic. The methodology is based on the Markov regime switching model that allows unobservable regime shifts in the stock return relationship between the travel and leisure industry and the overall market in the period before the outbreak of Covid-19 crisis and during the recovery period at the end of the first wave. The results provide strong evidence of regime switching behaviour in the form of idiosyncratic risk as measured by volatility. The period before Covid-19 corresponds to a low/medium idiosyncratic risk, while the period of the pandemic is characterized by a regime with high idiosyncratic risk. Overall, the timing, likelihood and duration of this crisis regime depend on the composition of the travel and leisure firms. Those with a large proportion of online gambling firms perform better, while those consisting of international transportation firms, hotels and restaurants perform negatively. This study shows that the high-frequency data and the model chosen here can provide timely information on the impact of the pandemic on various tourism and leisure businesses that could be useful for policymaking.

Zombie Firms: Prevalence, Determinants, and Corporate Policies

Using a comprehensive dataset of firms from seventy-nine countries, we document the incidence, determinants, and corporate policies of zombie firms from 2005 through 2016. Zombie firms account for roughly 10% of our observations. Using logit regressions, we find strong and robust evidence that countries with more efficient debt enforcement environments tend to have fewer zombie firms. In contrast, we find no evidence that the prevalence of zombie firms is related to national culture. We further find that zombie firms have conservative dividend and investment policies, aggressive leverage policies, and higher idiosyncratic risk. We conclude that zombie firms may impose a cost on the economy by impeding efficient resource allocation.

Zombie firms: Prevalence, determinants, and corporate policies

Using a comprehensive dataset of firms from seventy-nine countries, we document the incidence, determinants, and corporate policies of zombie firms for the 2005–2016 period. Zombie firms account for roughly 10% of our observations. We find that countries with more efficient debt enforcement environments tend to have fewer zombie firms. We find no evidence that the prevalence of zombie firms is related to national culture. We further find that zombie firms have conservative dividend and investment policies, aggressive leverage policies, and higher idiosyncratic risk. We conclude that zombie firms may impose a cost on the economy by impeding efficient resource allocation.

Strategic Risk Shifting and the Idiosyncratic Volatility Puzzle: An Empirical Investigation

We find strong empirical support for the risk-shifting mechanism to account for the puzzling negative relation between idiosyncratic volatility and future stock returns. First, equity holders take on investments with high idiosyncratic risk when their firms are in distress and receive less monitoring from institutional holders as well as when the aggregate economy is in a bad state. Second, the strategically increased idiosyncratic volatility decreases equity betas, particularly in bad states when the market risk premium is high. The negative covariance between the equity beta and the market risk premium causes low and negative returns and alphas in firms with high idiosyncratic volatility. This paper was accepted by Tomasz Piskorski, finance.