Hamid Rahman

Earnings Quality and Corporate Cash Holdings

Poor earnings quality exacerbates information asymmetry between internal and external stakeholders of a firm. Agency considerations then persuade investors to discount the value of corporate cash holdings out of concern about the inappropriate use of funds. In this study, we show that poor earnings quality has a negative impact on the value of corporate cash holdings and a positive impact on the level of cash reserves. We find that the negative effect of poor earnings quality either neutralizes or more than offsets the positive effect of excess cash on firm value. Our results are robust to several measures of earnings quality and model specifications.

Atlantic and Pacific stock markets--correlation and volatility transmission

The relationship between stock returns in international capital markets has excited the curiosity of researchers for a long time. Two recent stimuli for this research have been the progressive integration of international capital markets and the globalization of investor portfolios with the concomitant need for effective portfolio diversification strategies. These stimuli have provided the impetus to understand the dynamics of stock prices across national boundaries. The development of increasingly sophisticated statistical techniques and the continued growth of data handling capabilities by ever more powerful computers have established an impressive record of literature which traverses from the simple and mundane to the exotic and esoteric. Most of the earlier literature on this topic only explores the contemporaneous or the lead/lag relationship among international stock markets and seldom questions the underlying sources of interdependence among international capital markets. Some recent papers, which are discussed a little later and which provide the motivation for this study, have begun to address this issue. The objective of this paper is to expand the knowledge of the relationship among international capital markets by examining both their correlations and sources of interdependence. To be specific, this study first examines the correlations (comovements) between six international stock markets, three from the Atlantic region (i.e., New York, London, and Frankfurt) and three from the Pacific region (i.e., Japan, Singapore, and Hong Kong), using stock price data between 1984 and 1989. Selecting three stock markets from each region allows us to examine interregional as well as intraregional correlations. The underlying cause of the comovements among the six international stock markets is then investigated by examining the international transmission of stock returns volatility. An understanding of the structure of interdependence and source of comovements among international capital markets has important implications for formulating international portfolio strategies and forecasting. The Generalized Autoregressive

The effect of US individual investor sentiment on industry-specific stock returns and volatility

Purpose - This paper examines the effect of rational and irrational investor sentiment on the stock return and volatility of US auto, finance, food, oil and utility industries. Design/methodology/approach - The American Association of Individual Investors Index (AAII) is used as a proxy for US individual investor sentiment. The US market fundamentals are regressed on investor sentiment in order to capture the effect of macroeconomic risk factors on investor sentiment. Then impulse response functions (IRFs) are generated from a VAR model to investigate the effect of unanticipated movements in US investor sentiment on both industry-specific stock return and volatility. Findings - The results show a significant impact of investor sentiment on stock return and volatility in all the industries. We find that the positive rational component of US individual investor sentiment tends to increase the stock return in these industries. We also document that unanticipated increase in the rational component of US individual investor sentiment has a significant negative impact only on the industry volatilities of US auto and finance industries. Research limitations/implications - The results are based only on the 1999 – 2010 US industry-specific stock return and volatility data and are confined to these industries. Practical implications - The findings of this paper can help investors to improve their asset return generating models by incorporating investor sentiment. The findings can also help policymakers to design policies that stabilize sentiment and reduce volatility and uncertainty in the stock markets. Originality/value - This paper adds to the growing literature on behavioral finance by filling a gap and addressing the impact of investor sentiment in the various US industries.

Intertemporal risk–return relationship in the Asian markets around the Asian crisis

Abstract This study investigates the risk–return relationship in nine Asian capital markets and the U.S. before, during, and after the Asian financial crisis. Using a state-dependent approach in a TGARCH(1,1)-M framework, we investigate a contemporaneous version of the CAPM by accounting for negative and positive market price of variance risk. We find a significant positive relationship between risk premium and variance in all markets in upstate, as well as a significant negative relationship in downstate. Also, we validate our findings by showing that implied state-dependent market prices of variance risk explain risk premia across markets. Finally, we investigate how the model can be used to uncover overreaction and improve the number of correct directional calls in a tactical asset allocation strategy. Our results provide support for a contrarian strategy that individual investors can follow.

Capital Control Premium and Investable Risk in Emerging Capital Markets

This article surmises the presence of an investable premium in emerging equity markets segmented by foreign investment restrictions and validates its existence in 26 emerging markets. Principal Component Analysis and stepwise regression are employed in tandem to whittle down from 22 political, economic, and financial country risk factors, to the one factor that best explains the investable premium. The political, economic, and financial risk measures that load on this factor are determined. We use a multifactor CAPM model to investigate whether country investable risk drives cross-sectional expected returns in investable emerging market stocks in addition to established firm-specific risk components such as beta, size, and price-to-book-value ratio. We document a significant positive investable premium for the aggregate sample. This finding supports our research hypotheses that investable risk is priced. We also find a significant positive relationship between risk premium and size at the aggregate level. Our findings suggest that these two risk metrics, investable premium and size, are important to price emerging market firms.

On market price of risk in Asian capital markets around the Asian flu

Abstract This study investigates a contemporaneous relationship between realized market risk premia, and conditional variance and covariance in nine Asian markets and the US. The time period for this study is before, during, and after the Asian financial crisis. A contemporaneous state-dependent capital asset pricing model (CAPM) that allows for negative and positive market prices of variance and covariance risk is investigated. In the light of significant upstate and downstate reward to local and world variance risk for all markets and all periods, we conclude that a market return-generating process is a piecewise function of local and world variance over time. Furthermore, a cross-sectional analysis of upstate and downstate market prices of variance and covariance risk indicates that reward to risk is a mix of reward to local and world variance, depending on the ever-changing correlation with the world market. Our findings are consistent with the one-factor conditional international CAPM.

Acquirer's earnings quality and the choice of payment method in mergers and acquisitions

Purpose - The purpose of this paper is to investigate the role of acquirers earnings quality on the choice of payment method in mergers and acquisitions (M&A). Design/methodology/approach - The paper applies a simultaneous equations model to address the concern of endogeneity between earnings quality and payment method in corporate acquisitions. In addition, a propensity score matching model is used for robustness purpose. Findings - Previous studies imply that short-term accruals have a significant impact on the choice of payment method in M&A. In this study, This paper shows that acquisition financing is not significantly affected by short-term earnings quality once control variables are considered. Instead, this paper finds that it is the long-term earnings quality of the acquirer that matters. Acquiring firms with poor (good) long-term earnings quality prefer lower (higher) cash payment in acquisitions. Their results are robust to different definitions of earnings quality. Research limitations/implications - Researchers should consider the effect of long-term earnings quality in their future investigations. Practical implications - Investors should be aware of this issue when evaluating corporate mergers. Originality/value - This is the first study to examine the impact of long-term quality of earnings on the choice of payment method in M&A.

Aborted stock repurchases and earnings quality

Purpose - – The purpose of this paper is to try to identify the motivation of firms that announce share repurchase but do not follow it up with the actual purchase. The authors conjecture that the long-term earnings quality of such firms is low, which makes them poor candidates for actual stock repurchase. Their intention is to mimic actual repurchasers and their motivation appears to be just to get a bounce in their stock price normally associated with such announcements. Design/methodology/approach - – The authors use probit analysis to ascertain whether earnings quality can predict the subsequent repurchase behavior of firms that announce share repurchase. As Gong Findings - – The results show that non-carry-through firms have lower earnings quality than carry-through firms in the pre-announcement period in all of the metrics the authors use to measure earnings quality. In the post-announcement period, the earnings quality of the non-carry-through firms declines still further and the difference in the quality becomes more pronounced. The results of probit regression show that lower earnings quality increases the likelihood of becoming a non-carry-through company. Research limitations/implications - – The finding has interesting implications for investment management as investors can differentiate non-carry-through firms from carry-through repurchasers by examining the firms earnings quality. Originality/value - – The analysis shows that poor long-term earnings quality increases the chance of not carrying through on the repurchase announcement. The authors also find that the poor earnings quality of non-carry-through firms limits their ability to manage earnings downward prior to the repurchase announcement.

Anatomy of Aborted Stock Repurchases

The motivation and characteristics of firms that announce stock repurchase programs but do not carry them out are poorly understood. We conjecture that the long-term earnings quality of such firms is low, which makes them poor candidates for subsequent stock purchase. Their announcement is just a bluff, possibly to get a short-term bounce in their stock price. We find evidence of poor long-term earnings quality in these firms in the pre-purchase period with further deterioration in the post-purchase period. A probit model confirms that poor long-term quality of accruals, a proxy for earnings quality, increases the chance of not carrying through on the repurchase announcement. We find a significant relationship between long-term earnings quality and subsequent performance for firms that carry through on their purchase plans but no such evidence for firms that do not.