Arnold R. Cowan

Nonparametric Event Study Tests

This paper provides the first documentation of the power and specification of the generalized sign test, which is based on the percentage of positive abnormal returns in an estimation period. In simulations using daily stock return data, the generalized sign test is well specified with both exchange listed and NASDAQ stocks. A rank test is more powerful under ideal conditions. However, the rank test is more sensitive to increases in the length of the event window, to increases in return variance, and to thin trading. The generalized sign test is a viable alternative to the rank test under these conditions.

Stock Returns before and after Calls of Convertible Bonds

Ofer and Natarajan (1987) report negative, statistically significant cumulative average abnormal returns over five years following convertible bond calls. We show that these results are obtained only if returns preceding the call dates are used for market model parameter estimation. Returns preceding calls tend to be positive and unusually large. This means that predicted post-call returns, based on pre-call parameter estimates, are biased upward. Consequently, the corresponding abnormal returns are biased downward. We also discuss a corrected test statistic. We conclude that the evidence does not indicate market inefficiency in the stock price reaction to convertible calls.

Underwritten calls of convertible bonds

Abstract Common-stock prices fall a statistically significant 2 percent in response to underwritten convertible debt call announcements. We find that the significant negative price reaction is confined to underwritten calls — stock-price responses to non-underwritten calls average an insignificant −0.84 percent. The results support the idea that managers are more likely to use underwriters the more unfavorable the information they possess about future firm cash flows. An agency cost interpretation of underwritten calls is also consistent with the results, but is not supported by management ownership and corporate liquidity evidence.

Do Dividends Signal Earnings? The Case Of Omitted Dividends

Abstract Considerable evidence exists to support the hypothesis that the payment of dividends provides information that helps investors and analysts value the firm. We find that dividend omissions precede increases in return variance, beta and the dispersion of analyst forecasts of earnings. However, the variance of actual earnings also increases after dividend omissions. An increase in the variance of earnings implies a decrease in the predictability of earnings even if there is no change in information availability. The evidence is consistent with the hypothesis that managers omit dividends because earnings become inherently less predictable. In other words, managers use dividends as a signaling mechanism. We also report a negative association between stock-price reactions to omission announcements and changes in beta, but not changes in total return variance or earnings variance, consistent with increases in priced estimation risk.

Explaining the NYSE Listing Choices of NASDAQ Firms

Traditionally, financial theory has offered little guidance to managers who must choose whether to list their stock on an exchange or allow it to continue trading over-the-counter. Recent developments in market microstructure theory allow a more careful analysis of the exchange listing decision. Market microstructure theory implies that firms list their stocks on exchanges to reduce transaction costs to their investors. A major component of the cost of trading common stocks is the bid-ask spread. Several differences exist between the trading arrangements, or microstructure, of the New York Stock Exchange and NASDAQ that may contribute to differences in bid-ask spreads for a given stock depending on where it is traded.

Calls of Out-of-the-Money Convertible Bonds

We examine calls of convertible bonds in which the effective cash call price exceeds the value of the common stock into which investors can convert the bond. In option pricing terms, the conversion option available to the convertible bondholder is out-of-the-money. Following the announcement of out-of-the-money calls, the common stock prices of the firms calling their convertible bonds increase an average of 1.43%. The increase occurs over the two-day period in which the firm announces the call, and reflects adjustments for the risk of the stock and market wide price movements.

Tests for cumulative abnormal returns over long periods: Simulation evidence

Abstract The usual test of cumulative abnormal returns for multiple-day periods assumes that abnormal returns are serially independent. The assumption imparts an upward bias to test statistics even when raw returns are serially independent. In simulation, the usual test rejects true null hypotheses too frequently in the longest cumulation periods and in shorter periods when events are clustered in calendar time. Excessively frequent rejection implies that the nominal significance level understates the actual significance level. A corrected statistic, derived without the serial independence assumption, rejects true null hypotheses with a frequency less than or equal to the nominal significance level. However, the corrected test is not very powerful in the longest event periods.

Underwriting calls of convertible securities *1: A note

Abstract Average common stock price responses to convertible preferred stock calls are significantly negative only when firms employ underwriters to assure conversion. Previous work reports similar results for convertible bond calls; we find that the stock price reaction does not depend upon the type of convertible security being called. The results support the idea that managers are more likely to have calls underwritten the more unfavorable their private information about firm value.

Wealth Effects of Banks' Rights to Market and Originate Annuities

We examine wealth effects, for banks and insurers, of bank rights to sell and underwrite annuities. The stock-price reactions to four court and regulatory decisions are consistent with expectations of bank gains at insurers’ expense. Cross-sectionally, smaller, riskier insurers with higher distribution costs and substantial annuity business sustain larger wealth losses. Larger, riskier bank holding companies with fee-based and consumer business gain most, consistent with the extension of federal safety-net guarantees as a source of gains. Banking stock-price reactions to the Supreme Court’s decision are opposite other findings, possibly reflecting unfulfilled expectations of a broader mandate for expanded bank rights.

Underwriting and Calls of Convertible Bonds

We model convertible bond calls under asymmetric information where, unlike Harris and Raviv (1985), we consider a nonzero call price and a call notice period. In the model, the use of underwriters conveys negative information. Consequently, the stock price decline is greater for underwritten calls than for nonunderwritten calls. Furthermore, underwritten calls are made earlier and when the conversion option is less deep in the money. Underwriting commissions and the stock price decline associated with a call are negatively related to the extent that the conversion option is in the money before the call. Empirical evidence in this paper and Singh, Cowan, and Nayar (1991) are consistent with the models predictions.