Christopher B. Malone

Stock market political cycles in a small, two-party democracy

Real stock market returns in New Zealand are lower when the left-leaning Labour party is in power than under National party governments, in contrast to the USA where returns are higher under Democratic presidents than under right-leaning Republicans. The difference in real stock market returns between National and Labour is not reversed even when account is taken of the effect of the US political cycle and returns on New Zealand. The results of the study therefore suggest that the presidential puzzle does not transfer directly to other countries with two similar party democracies.

Intangible Assets and Firm Diversification

Purpose – To re-examine empirically internalisation and transaction cost theories of firm FDI. Design/methodology/approach – Empirical analysis based on cross sectional multivariate regressions and the Fama-French three factor event study procedure. In addition to the key explanatory variables the paper introduces and models several important control variables. Findings – The paper finds evidence consistent with the internalisation and transaction cost hypotheses. Firms classified with internalisation advantages earn event period abnormal returns of 6.84 percent above firms that are classified without such advantages. In support of transaction cost theory the paper finds that FDIs generate an average abnormal event period return of -2.36 percent. Further, in line with transaction cost theory firms classified with intangible asset advantages also tend to engage in the more complex forms of foreign and industrial diversification. Research limitations/implications – The paper does not determined if the effect linked to the possession of intangible asset advantages is temporary or permanent. FDI is costly, but firms that enjoy high market valuations tend to do well in M&A or FDI activity. Originality/value – The study provides new and strengthened support for internalisation theory. The study provides new evidence in support of transactions cost theory.

Fraud and Firm Performance: Evidence from Fraud on the Market and Securities Class Action Lawsuits

We investigate the argument that securities frauds are preceded by surprisingly good firm performance but are followed by rapid negative investor response by studying the long-term stock performance of a sample of 430 firms that disclosed securities fraud and experienced class action lawsuits filed between 1989 and 1999. Estimating Fama-French (F-F) three-factor model-based monthly abnormal returns for three events, alleged fraud commission (FC), fraud disclosure (FD), and initial class action filing (CA), we find significant upward price drift during the five-year pre-FC horizon and weak evidence of a negative drift for up to five years following CA. The observed pre- and post-event abnormal returns cannot be explained by changes in systematic risk (F-F factor loadings), suggesting that the effects of fraud are confined primarily to changes in expected cash flows rather than changes in discount rates. Further, we find positive abnormal trading volume and return volatility during the pre-FC horizon but a significant deterioration in market quality, as evidenced by a persistent negative abnormal drift in relative trading volume and a sustained increase in return volatility, for up to five years following CA.

Fraud and firm performance: Keeping the good times (apparently) rolling

Purpose - – The purpose of this paper is to examine the hypothesis that a period of sustained supernormal firm performance (for up to five years before fraud commission) creates financial pressure on actors/agents so they have a propensity to behave fraudulently to keep the good times (apparently) rolling. Design/methodology/approach - – Applying the Fama and French (1993) three-factor model using a range of calendar time portfolio methodologies, the authors measure abnormal drifts in stock performance in periods up to five years before alleged fraud commission dates. The authors examine a sample of 561 US firms subject to enforcement actions initiated by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) over 1968-2009. Findings - – The authors find that sustained firm-specific positive stock price performance for up to five years followed by the almost inevitable adverse shock, which eventually brings the good times to an end, generally precedes corporate fraud. Fraud occurs when firm managers engage in misconduct in a misguided attempt to keep the good times (apparently) rolling despite the negative shock. Research limitations/implications - – The sample is restricted to firms with trading histories on the stock market prior to the misconduct, and to firms contained in the Federal Securities Regulation database of US firms subject to enforcement actions initiated by the SEC and the DOJ over 1968-2009. Practical implications - – The desire to keep the good times rolling appears to be a very important driver of fraudulent behavior, even after controlling for the executive compensation incentive effects and business cycle effects emphasized in prior studies. The robust findings of positive abnormal returns for up to five years preceding initial fraud commission suggest that regulators and investors would be well-advised to scrutinize the behavior of firms that exhibit surprisingly persistent superior performance over an extended period. If the financial results appear too good to be true, a closer examination might just reveal that they indeed are. Social implications - – While most investors generally like to see the “good times keep rolling” this pressure can create ethical dilemmas for managers. Originality/value - – Unlike most other papers in this area of the literature, which concentrate on the pre-fraud disclosure, the authors investigate the firm’s performance in the pre-fraud commission period. The authors find that the commission of the alleged fraud is preceded by a sustained period of surprisingly good performance of up to five years in length. The authors believe that the paper provides empirical evidence that supports the hypothesis that a period of sustained supernormal firm performance (for up to five years before fraud commission) creates financial pressure on actors/agents so they have a propensity to behave fraudulently to keep the good times (apparently) rolling.

Time Diversification in Developed and Emerging Markets

Time in the market substantially reduces the risk of loss resulting from holding both stocks and bonds. By focusing on a downside VaR risk proxy in 25 emerging and 24 developed markets, we show that the downside risk of both stocks and bonds is greatly reduced as the investment horizon is increased beyond 10 years, but the risk reduction is more pronounced in stocks. We also show that emerging markets have substantially greater downside risk than developed markets. The results suggest that investors should be aware of their investment horizon when making asset allocation decisions, particularly into stocks in emerging markets. JEL Classification: G14, G15

Australasian cash flow reporting regulation: value relevant?

Purpose – This paper provides empirical support for the introduction of cash flow disclosure regulation issued by Australasian accounting bodies, AASB and NZICA (formerly NZSA), between 1987 and 1992.Design/methodology/approach – The empirical analysis uses a long window event study format on a panel of 5,368 firm‐year observations between 1996 and 2005.Findings – The cash flow disclosures required in the regulation are associated with significant abnormal return responses. These effects are robust to the inclusion of other factors linked to abnormal returns such as movements in profitability, size and leverage. We also find support for the proposition that the cash flow effects are conditioned on the quality of the firm, as proxied by q. The market is better and more easily informed with the information required under the revised reporting regime.Research limitations/implications – The analysis would have been improved with better access to pre‐reform period data.Originality/value – There is no other stu...

Acquisition actions in Australia: a test of acquisitions theory

Purpose - To examine Australian corporate acquisitions data in the context of contemporary acquisitions theory. Design/methodology/approach - Empirical analysis using event study procedures. Findings - The study of Australian acquisitions shows that domestic acquisitions are more likely to produce favourable market responses for acquirers than foreign direct investment actions. Companies with recent upwards price momentum are also more likely to engage in successful acquisitions. However, the relative “valuation” of acquirers appears to be unimportant in the Australian acquisitions process. The results are linked to the smaller, more isolated, nature of the Australian economy. Research limitations/implications - A long horizon event study methodology could be used. Alternative treatments could be used to assess relative value and competitive advantage. Other smaller isolated markets, similar to Australia, could be considered. Originality/value - The use of international corporate acquisitions data, from Australia, supports both Competitive Advantage Theory and Market Driven Acquisitions Theory. There is little evidence to suggest that Cheap Capital motivates a large number of acquisition actions. The results are linked to the smaller, more isolated, nature of the Australian economy, and show that recent price momentum and the location of the investment are important. This latter finding suggests a form of market segmentation still prevails.

Firm size and the political cycle premium

Purpose - – The purpose of this paper is to use firm-level data to examine whether the political cycle differentially relates to small vs large firms in New Zealand; a country that operates a unicameral political system has a short three-year political term and a right-of-centre stock market premium exists. Design/methodology/approach - – Using firm-level data from 1972 to 2010, the authors examine monthly returns during right-of-centre National governments and left-of-centre Labour governments. The authors apply Santa Clara and Valkanov (2003) regression analysis approach to examine the political cycle impact on firm returns. Findings - – Like in the USA, New Zealand’s political cycle premium is driven by small firms; however, the results are opposite. In New Zealand, periods governed by the right of the political spectrum produce significantly higher stock returns than those from the left and this finding is primarily driven by small firms who perform particularly poorly under left-of-centre governments. Research limitations/implications - – Small firms were relatively heavily affected by the move to an open, deregulated economy; they were also less able to cope with tight monetary conditions, and periods of sharply falling inflation. New Zealand’s three-year political term may encourage newly formed governments to implement relatively fast moving shifts in policy where a more reasoned and steady approach would be warranted. Originality/value - – This is the first paper to use firm-level data outside of the USA to examine the political cycle impact.