Ji-Chai Lin

Market Structure, Informed Trading, and Analysts' Recommendations

We examine stock price behavior in response to initial coverage, buy recommendations that are pre-released to important clients before the stock market opens, and find a strong positive valuation effect at the open. On average, it takes five minutes of trading for NYSE/AMEX stocks and 15 minutes for NASDAQ stocks to reflect the private information contained in these analyst recommendations, so when informational asymmetry is high, the centralized call market is more efficient than a competitive, but fragmented dealer market. Public news release leaves share prices unaltered. Overall, competition among informed traders causes private information to be rapidly incorporated into stock prices.

Trading patterns of big versus small players in an emerging market: An empirical analysis

Abstract This study uses a Vector Autoregressive (VAR) model to examine interdependencies among institutional investors, big individual investors, and small individual investors, and the effects of their trading on stock returns on the Taiwan Stock Exchange (TSE). The results imply that, during the sample period, big individual investors are the most well informed players; their trading affects not only stock returns but also small individual investors. Small individual investors are not well informed and are slow learners. Their orders to trade tend to provide liquidity to institutional and big individual investors, but there is no compensation for their liquidity services. We find that institutional investors follow neither positive-feedback nor negative-feedback trading strategies. Overall, the responses to shocks, except for those of small individual investors, decay quickly, indicating that the TSE can absorb shocks quickly and efficiently. Our analysis implies that small individual investors would be better off institutionalizing their investment decisions (e.g., by investing in mutual funds).

The Relation between Aggregate Insider Transactions and Stock Market Returns

A vector autoregressive (VAR) model is used to examine the relation between aggregate insider transactions and stock market returns. Consistent with the extant literature, there is some predictive content associated with aggregate insider transactions, but its magnitude is slight. In contrast, market returns have substantial influence on the aggregate purchases and sales of corporate insiders. The findings suggest that: 1) the degree of mispricing observed by insiders is small; 2) very little of the mispricing is associated with unanticipated macroeconomic factors; and 3) investors cannot use aggregate insider transactions to profitably predict future market returns over the following eight weeks.

Capital Market Behavior and Operational Announcements of Layoffs, Operation Closings, and Pay Cuts

This article examines the relation between stock returns and a set of operating decisions: layoffs, operation closings, and pay cuts. We find evidence that cost-cutting measures occur after significant stock price declines. Announcements of layoffs and temporary operation closings are associated with negative returns, while permanent operation closings do not have significant announcement effects.

Internalization and stock price clustering: Finnish evidence

Abstract Internalization, the practice of brokers executing trades in-house, is a significant phenomenon in the Helsinki Stock Exchange. During the continuous trading session, 97.5% upstairs market trades are internalized. The corresponding figure for after-hours upstairs market trades is 73.1%. The prices of internalized trades are somewhat more clustered than the prices of other trades during the continuous trading session, but they are not more clustered than the prices of negotiated trades in the after-hours upstairs market. This suggests that Finnish brokers do not use a more discrete set of prices for internalized trades than for other upstairs trades.

Clientele Effects and Cross-Security Market Making: Evidence from Calls of Convertible Preferred Securities

We examine trading activity, bid-ask spreads, and potential arbitrage opportunities for market makers in the period around conversion-forcing calls of convertible preferred securities. We find an increased turnover in the called convertible preferred stock, which is consistent with a clientele effect. We also find a decrease in the average bid-ask spread of the called convertible preferred and the underlying common stock. This suggests increased liquidity in the post-announcement period. We argue that the liquidity improvement is a consequence of profitable cross-security trading opportunities.

Price Adjustment Delays and Arbitrage Costs: Evidence from the Behavior of Convertible Preferred Prices

Price adjustment delays occur between in-the-money convertible preferred stock prices and common stock prices. Convertible preferred prices systematically deviate from the prices predicted from their conversion relations with common stocks. The price predictability stems from price changes in the underlying common stocks leading the price changes in the convertible preferred stocks by up to nine hours. Cross-sectionally, about 70 percent of the variation in the unsigned size of the price deviations is explained by proxies for costs of arbitrage.

Underwriting Fees and Shareholder Rights

Do firms’ governance provisions affect their terms of obtaining external financing? We hypothesize that it is more difficult for firms with more restrictions on shareholder rights to raise external equity, and that since analyst coverage is an important part of underwriting services, underwriters would use analyst recommendations to promote issuing firms with weaker shareholder rights more and charge them higher underwriting fees. Consistent with our hypothesis, we find that analyst recommendations on issuing firms with weak shareholder rights increase more than those with strong shareholder rights prior to SEOs, and that underwriting spreads are positively related to issuing firms’ shareholder rights as proxied by the G-index. Furthermore, consistent with Bebchuk et al. (2009), the effect of shareholder rights on underwriting fees is largely contained in the six provisions in the E-index.

Stock Prices, Investor Short-Termism, and Innovation

Firms can change their outstanding shares to manage their stock price levels. Those with lower stock prices tend to attract more speculative trading, which causes higher price volatility and may force their managers to excessively focus on short-term earnings at the expense of R&D and other long-term projects. Thus, we hypothesize that firms investing more in R&D prefer to set higher stock prices to mitigate investor short-termism and foster innovation. Indeed, we find that firms with more R&D capital tend to keep higher stock prices and are less likely to split their stocks to lower prices. Furthermore, high-priced firms are less likely to cut R&D to reverse an earnings decline, and less likely to fire their CEOs in the presence of poor earnings. More importantly, firms’ R&D productivity — in terms of generating patents and patent citations — tends to increase with their stock prices, even after controlling for firm valuation, stock returns, stock liquidity, and institutional ownership. For robustness checks, we examine stock splits, which allow mangers to re-set their stock price levels, and IPOs in which managers set an offering price range before shares are publicly traded. Consistent with our hypothesis, we find that IPO firms setting higher offering prices have more future innovation and that innovation declines after firms split their stocks. Thus, our results imply that managers of R&D firms actively set high stock prices to foster innovation, and support Warren Buffett’s wisdom that firms can use stock prices to attract preferred clientele.

Price Run-Ups, Portfolio Rebalancing Needs, and Stock Splits

After experiencing significant stock price run-ups, a firm becomes overweight in its shareholders’ portfolios, subjecting them to excessive firm-specific risk and creating portfolio rebalancing needs. If the firm cannot attract sufficient buying interests, selling pressure from rebalancing leads to undervaluation. The firm can resolve the undervaluation problem by splitting its shares to attract new investors to better facilitate shareholders’ portfolio rebalancing. Since undervaluation attracts informed trading and makes listed options more appealing, we analyze stock price behavior and relative trading of options over stock surrounding stock splits and find compelling evidence consistent with our portfolio-rebalancing hypothesis of stock splits.