Market Assessment Research Articles

The Market's Assessment of the Probability of Meeting or Beating the Consensus

AbstractWe investigate to what extent the market uses information that is predictive of whether earnings will meet or beat the analyst consensus forecast of earnings (MBE henceforth): measures of a firm's incentives to engage in MBE behavior, measures of constraints on MBE, measures of past MBE practices by firm and industry, and other variables. Using the Mishkin test framework and Bonferroni‐adjusted p‐values, we document that of a total of 21 variables, the market inefficiently uses information in one difficulty measure and four other predictors, suggesting that strong empirically and theoretically grounded relationships concerning MBE behavior are more likely to be unraveled by the market. We further show that a portfolio based on the difference between the objective MBE probability and the market‐assessed MBE probability generates significant abnormal returns. The documented return anomaly is distinct from other known anomalies and cannot be fully explained by arbitrage risk or transaction costs.

Market Reaction to Seasoned Offerings in China

AbstractThis study examines stock market reaction to the announcement of various forms of seasoned issues in China. Our empirical evidence demonstrates that market reactions differ in ways that suggest a difference between management's internal assessment and the market's assessment of the stock price. The market responds unfavourably to the announcement, notably in the case of rights issues and also with regard to open offers. Private placements experience an unfavourable pre‐announcement reaction, which contrasts with the favourable reaction after the event. Convertible bond issues generate positive excess returns consistent with the market's confidence that they can help to align management and shareholders’ interests. Further investigation shows that market reaction is related to factors specific to the issuer and issue by reference to the period immediately surrounding the issue. Specifically, ownership concentration, agency matters connected with equity offerings, investor protection connected with fund allocation and security pricing, and the influence of powerful moneyed interests together provide an instructive insight into market reaction. Institutional inefficiency pertaining to underwriting, auditing, analysts’ forecasts and credit ratings are found to have a weak association with market price, consistent with due public scepticism concerning management and their gatekeepers.

Do Analyst Stock Recommendations Piggyback on Recent Corporate News? An Analysis of Regular‐Hour and After‐Hours Revisions

ABSTRACTAnalysts often update their recommendations following corporate news. Questions have been raised regarding analysts’ ability to generate new information beyond recent corporate events. Employing a comprehensive database on corporate news, we show that only a small minority, or 27.9%, of all recommendation revisions directionally confirm the information in the preceding corporate events and even these “confirming revisions” facilitate the information discovery of corporate events and thus cannot simply be dismissed as “piggybacking.” Our analysis further shows that analysts not only facilitate price discovery to corporate news through issuing trending revisions but also help reverse prevailing market sentiments following corporate news by issuing contrarian revisions. Our study is the first to investigate short‐window intraday market reactions to revisions issued after hours, which account for 70% of all recommendation revisions in our sample period. Analysts’ incentives to issue revisions after hours appear to reflect demands from large institutional clients, who dominate after‐hours trading. More importantly, we show that the after‐hours revisions are associated with significantly greater price reactions and different price reaction patterns than revisions issued during regular trading hours. Collectively, our evidence indicates that analysts are a significant source of new information beyond recent corporate news and they also help shape the market's assessment of corporate disclosures.

Restatements: Do They Affect Auditor Reputation for Quality?

SYNOPSIS We examine whether an auditor's involvement with a financial statement restatement has a negative effect on their reputation as evidenced by both clients' and the market's assessments of audit firm quality. Specifically, we investigate the effect of auditor involvement with restatements on the non-restating clients' likelihood to dismiss their auditors in the year subsequent to restatement and on non-restating clients' market adjusted returns (MARs) around the restatement announcement date. We also investigate whether the severity of the restatements has a differential effect on both variables. We find non-restating clients are more likely to dismiss auditors as the number of restatements the auditor was involved with increases, and this likelihood increases with the number of restated items. In addition, non-restating clients' MARs are significantly negative around the restatement announcement date and are more negative with more severe restatements.

Blockholder Short-Term Incentives, Structures, and Governance

When blockholders are reputation-conscious fund managers facing short-term incentives and caring about investors' perception of their stock-picking ability, the consequent trading reduction in bad firms' stocks weakens the efficacy of governance via blockholder exit. Under a single blockholder structure, career concerns also weaken a fund manager's incentive to undertake (public and private) value-enhancing interventions in bad firms. With multiple blockholders with heterogeneous degrees of career concerns, a reputation-conscious fund manager's weakened incentive in public intervention strengthens a reputation-unconscious fund manager's intervention incentive. As for private intervention, career concerns provide a reputation-conscious fund manager stronger incentives to privately engage with management to improve firm value to reduce trading by a reputation-unconscious fund manager, thereby enhancing the market's assessment of the reputation-conscious fund manager's stock-picking ability. Thus, although (career-concerns-induced) blockholder short-term incentives weaken governance with a single blockholder, they may help ameliorate the free-rider problem under a multiple blockholder structure, and consequently enhance blockholder governance and encourage long-term corporate investment.

Bank risk factors and changing risk exposures: Capital market evidence before and during the financial crisis

We analyze the capital market assessment of bank risk factors in Europe and the United States for the 1990–2011 period. The focus is on bank stock returns in a multi-factor framework that includes interest rate risk and market risk as well as credit risk, real estate risk, sovereign risk, and foreign exchange risk. Our findings indicate that bank risk exposures are multi-dimensional and time-varying but well reflected in bank stock returns. Dynamic beta exposures and time-varying variance shares accompany structural changes in the banking industry and the recent financial crisis. During the last two decades, interest rate risk has changed but credit risk still represents a major factor for explaining bank stock returns. For the recent financial crisis we provide evidence of a change in the capital market's assessment of bank risk exposures with a significant revaluation of real estate and sovereign risks. Overall, our factor model offers a parsimonious approach for modeling the risk dynamics in the banking industry and provides evidence for the capital market's ability to assess bank risk exposures.

The Empirical Study of Electricity Market's Financial Risk Assessment Based on CVaR

When the electricity market brings the expected benefits to participants, the price fluctuations also make them to face the enormous financial risks, thus assessing the financial risks of electricity market has an important significance. In this article, the U.S. New England Pools average daily settlement price is used as the historical data. As for its transaction risk and financial management risk, adopting the effective financial risk assessment tools to evaluate the market risk, which results have a certain reference value.

Stock Market's Assessment of Bank Diversification: Evidence from Listed Public Banks in South Asian Countries

Using data for four South Asian countries over a twelve-year period, we examine how the stock markets in these recently liberalised economies assess diversification attempts of listed public banks. We find that the income diversification has a significant positive association with market to book value and a significant negative association with return volatility. However, the relationship observed between diversification and markets’ assessment of value and risk is non-linear. Relative to listed banks operating in India, the relationship observed remains less pronounced for the banks operating in Bangladesh, Pakistan and Sri Lanka.

The Cost of Carbon: Capital Market Effects of the Proposed Emission Trading Scheme (ETS)

In March 2008, the Australian Government announced its intention to introduce a national Emissions Trading Scheme (ETS), now expected to start in 2015. This impending development provides an ideal setting to investigate the impact an ETS in Australia will have on the market valuation of Australian Securities Exchange (ASX) firms. This is the first empirical study into the pricing effects of the ETS in Australia. Primarily, we hypothesize that firm value will be negatively related to a firm's carbon intensity profile. That is, there will be a greater impact on firm value for high carbon emitters in the period prior (2007) to the introduction of the ETS, whether for reasons relating to the existence of unbooked liabilities associated with future compliance and/or abatement costs, or for reasons relating to reduced future earnings. Using a sample of 58 Australian listed firms (constrained by the current availability of emissions data) which comprise larger, more profitable and less risky listed Australian firms, we first undertake an event study focusing on five distinct information events argued to impact the probability of the proposed ETS being enacted. Here, we find direct evidence that the capital market is indeed pricing the proposed ETS. Second, using a modified version of the Ohlson () valuation model, we undertake a valuation analysis designed not only to complement the event study results, but more importantly to provide insights into the capital market's assessment of the magnitude of the economic impact of the proposed ETS as reflected in market capitalization. Here, our results show that the market assesses the most carbon intensive sample firms a market value decrement relative to other sample firms of between 7% and 10% of market capitalization. Further, based on the carbon emission profile of the sample firms we imply a ‘future carbon permit price’ of between AUD$17 per tonne and AUD$26 per tonne of carbon dioxide emitted. This study is more precise than industry reports, which set a carbon price of between AUD$15 to AUD$74 per tonne.

FROM SMILE ASYMPTOTICS TO MARKET RISK MEASURES

The left tail of the implied volatility skew, coming from quotes on out-of-the-money put options, can be thought to reflect the market's assessment of the risk of a huge drop in stock prices. We analyze how this market information can be integrated into the theoretical framework of convex monetary measures of risk. In particular, we make use of indifference pricing by dynamic convex risk measures, which are given as solutions of backward stochastic differential equations (BSDEs), to establish a link between these two approaches to risk measurement. We derive a characterization of the implied volatility in terms of the solution of a nonlinear PDE and provide a small time-to-maturity expansion and numerical solutions. This procedure allows to choose convex risk measures in a conveniently parametrized class, distorted entropic dynamic risk measures, which we introduce here, such that the asymptotic volatility skew under indifference pricing can be matched with the market skew. We demonstrate this in a calibration exercise to market implied volatility data.

Equity Analysts and the Market's Assessment of Risk

ABSTRACTThe traditional view of equity analysts is that they are a source of new information about future cash flows. We broaden this view by demonstrating that equity analysts are also a substantive source of new information about priced risk. In particular, we document that, when announced, changes in analyst risk ratings distinctly and significantly affect equity returns, and are generally followed by significant changes in Fama–French factor loadings. Also, while less frequent than credit rating changes, equity risk rating changes are timelier, and with a larger overall stock price impact than credit rating changes.

From Smile Asymptotics to Market Risk Measures

The left tail of the implied volatility skew, coming from quotes on out-of-the-money put options, can be thought to reflect the market's assessment of the risk of a huge drop in stock prices. We analyze how this market information can be integrated into the theoretical framework of convex monetary measures of risk. In particular, we make use of indifference pricing by dynamic convex risk measures, which are given as solutions of backward stochastic differential equations (BSDEs), to establish a link between these two approaches to risk measurement. We derive a characterization of the implied volatility in terms of the solution of a nonlinear PDE and provide a small time-to-maturity expansion and numerical solutions. This procedure allows to choose convex risk measures in a conveniently parametrized class, distorted entropic dynamic risk measures, which we introduce here, such that the asymptotic volatility skew under indifference pricing can be matched with the market skew. We demonstrate this in a calibration exercise to market implied volatility data.

Toward a Bottom‐Up Approach to Assessing Sovereign Default Risk

The authors propose a new approach to assessing sovereign risk that focuses on the underlying profitability and financial condition of a nations private corporate sector. More specifically, the authors show how their new Z‐Metrics™ approach—an updated and expanded version of the Alt‐man Z‐score methodology—can be used to measure the (cumulative) median probability of default of the non‐financial sector for the next five years, both as an absolute measure of corporate vulnerability and a relative measure that can be compared to the risk of other sovereigns and to the market's assessment as reflected in the prices of credit default swaps.In testing their approach, the authors measure the default probabilities of listed corporate entities in nine European countries, as well as the U.S., at two different points in time: the start of 2009 (and thus prior to the recognition of the Euro crisis by markets and most credit professionals) and for the first four months in 2010 (essentially, the beginning of the recognition of the crisis). Based on these two observations, the authors suggest that their corporate health index of the private sector would not only have served as an effective early warning indicator, but provided a (mostly) useful hierarchy of relative sovereign risks. In addition to predicting sovereign default risk, another potentially valuable use of the authors' model is to remind policy makers of the importance of a profitable private sector to the financial health of sovereign governments.

Stock Prices and the Doctor Supply: Effect of Medicare Residency Policy on Healthcare Industry Firms

Funding for medical residencies has been capped by US Congress since the late 1997, and has resultantly become an increasingly limiting factor of the doctor supply in the US. The resulting impact of Medicare residency policy on managed care firms, especially private insurers has been unclear. Using equity price data for healthcare firms listed in the S&P Health Index, I use the surprise introduction of the Resident Physician Shortage Reduction Act of 2009 and its proposed amendment to a major healthcare overhaul bill, to evaluate the market's assessment of expanded medical residency programs on the healthcare industry. Using tight three-day event study periods to look at when the bill was unexpectedly introduced in Congress and amended to the overhaul bill, I find Cumulative Average Abnormal Returns for Managed Care Firms of 10.9% and 4.2%, respectively, corresponding to an increase in total market value of approximately $5.5 billion and $2 billion. I also find that roughly 27% of the cost of the bill is passed on to firms while the remaining 73% is either passed on to consumers or lost to static inefficiencies.

What Does Health Reform Mean for the Health Care Industry? Evidence from the Massachusetts Special Senate Election

We exploit the surprise election of Republican Scott Brown to the US Senate to evaluate the market's assessment of the impact of the recent US health reform legislation on the health care industry. We find that Brown's election was associated with abnormal returns of 2.1 percent and 6 percent for investments in the health care sector overall and managed care firms, respectively. Investments in the pharmaceutical sector experienced abnormal returns of 2.8 percent, while health care facilities (e.g., hospitals) experienced abnormal losses of 3.5 percent. Firms involved with Medicare Advantage benefitted more, while those involved with Medicaid Managed Care benefitted less from the election. (JEL D72, H51, I11, I18)

The Effect of Data Breaches on Shareholder Wealth

AbstractMany companies face the risk of a data breach exposing stored personal information of customers and employees. The frequency of such incidents has been increasing over time and can result in significant costs for the affected firm. This article examines the stock market's assessment of the cost of data breaches at publicly traded companies in which personal information such as customer and/or employee data are exposed. Using event study methodology on a sample of 77 events between the beginning of 2004 and the end of 2006, we find that the overall effect of a data breach on shareholder wealth is negative and statistically significant. Based on a cross‐sectional analysis of the cumulative abnormal returns, we find a negative association between market reaction and firms that are less forthcoming about the details of the breach. We also find that firms with higher market‐to‐book ratios experience greater negative abnormal returns associated with a data breach. Further, we find that firm size and subsidiary status mitigate the negative effect of a data breach on the firm's stock price and that the negative market reaction to a data breach is more significant in the most recent time periods of the sample.

Underinvestment vs. overinvestment: Evidence from price reactions to pension contributions

Mandatory contributions to defined benefit pension plans provide a unique identification strategy to estimate the market's assessment of the value of internal resources controlling for investment opportunities. The price decrease following a pension-induced drop in cash is magnified for firms that appear a priori more financially constrained, suggesting a negative effect of financing frictions on investment. In contrast, low control on managerial discretion attenuates the negative price reaction to contributions consistent with empire-building theories. While overinvestment seems to be the prevalent distortion in a panel of large firms, underinvestment appears to dominate in a sample that is more representative of the cross-section of listed companies.

Stock market reactions to third‐party complaints

Purpose – The purpose of this paper is to focus on the impact of third‐party complaints on firm performance. It aims to use a financial measurement of performance, the variation in firm share returns in the stock market following the publication of the Annual Complaints Service Report by the Bank of Spain. Building on modern theory of financial markets and resource‐based theory, it aims to propose that the release of information about third‐party complaints negatively influences firms' stock returns.Design/methodology/approach – The empirical research is conducted on a sample of Spanish banks to which complaints were made and which were quoted on the Spanish Stock Exchange between 1992 and 2002. It employs the event study methodology.Findings – The results of the study indicate that the release of the annual report of the Complaints Service of the Bank of Spain negatively affects the market's assessment of future cash flows.Research limitations/implications – Banks of a large size were selected, which res...

Government's Credit-Rating Concerns and the Evaluation of Public Projects

Public projects typically generate both monetary revenue and social benefits that cannot be monetized. We show that a government concerned with the credit rating of its debt should put different discount rates on these two aspects. The credit rating reflects the probability of default on the government's debt and thus affect its financing costs. Monetary revenues, which can be used in financial distress to repay debt, improve the credit rating and thus carry an additional credit-market compared to social benefits. However, informational problems -- dynamic inconsistency and adverse selection -- push the government to an excessive emphasis on social benefits, ignoring the external effect of monetary revenue on debtholders. Since the credit market anticipates this, the government's credit rating is adversely affected and it is thus unable to extract the full potential value of the projects. Privatization can sometimes alleviate these problems; However, the option to privatize has complex effects on the market's assessment of projects that remain in government's hands and thus might sometimes be harmful.

Eagle Finance Corp. (A)

This case and its companion (UVA-F-1102) provide comprehensive coverage of a firm's decision to undertake an initial public offering (IPO). The company is a nonregulated financial firm in a rapidly growing area of consumer finance (high credit-risk automobile loans). The A case follows the firm from its first meeting with investment bankers to the determination of a preliminary IPO price range. In the B case, the firm's road show encounters a cold-issue market, and Eagle is unable to sell its shares at a price near the preliminary file range. Management is confronted with the tough choice of whether to proceed with the IPO or cancel it. The cases provide a rich opportunity to compare management's internal valuation of the firm (derived from market multiples and discounted cash-flow analysis) with the market's assessment of value. Excel spreadsheet files are available for use with this case (UVA-S-F-1095) and its teaching note.