Jon A. Garfinkel

The Cost of Market Versus Regulatory Discipline in Banking

We present evidence that insured deposit financing shields banks from the full costs of market discipline. Banks experiencing Moodys downgrades exhibit abnormal equity returns that are increasing in the banks reliance on insured deposits. We also find that banks increase their use of insured deposits after downgrades, consistent with the joint hypothesis that the cost of regulatory discipline is less sensitive to risk changes than the cost of market discipline and banks attempt to minimize the aggregate cost of discipline borne by their shareholders. Our results cast doubt on the ability of capital market participants to effectively discipline bank behavior within the current regulatory environment. More generally, our findings highlight the potential for regulation to undermine market discipline in regulated industries.

IPO Underpricing, Insider Selling and Subsequent Equity Offerings: Is Underpricing a Signal of Quality?

Recent papers posit that a firm may deliberately underprice its IPO in order to inform the market that the firm is of high quality. These papers argue that underpricing is a vehicle whereby firms can signal their favorable private information and thereby increase the price received in subsequent securities offerings. Similarly, insiders may also recoup the costs of underpricing through subsequent open market sales of their shares at a more favorable price. I test the implications of these models and find evidence generally inconsistent with their predictions. Specifically, I examine the relationship between IPO underpricing and the likelihood of returning to the market with a seasoned equity offer or an open market insider sale. Overall, I find no significant relation between IPO underpricing and the probability of reissue, after controlling for factors that may affect both underpricing and the probability of reissue. In addition, I find no relationship between underpricing and the probability of an open market insider sale. Thus, it appears that firms are not underpricing in a deliberate effort to inform the market of their quality.

Market Structure and Trader Anonymity: An Analysis of Insider Trading

This paper examines the degree of anonymity—the extent to which a trader is recognized as informed—on alternative market structures. We find evidence that is consistent with less anonymity on the NYSE specialist system compared to the NASDAQ dealer system. Specifically, when corporate insiders trade medium-sized quantities (500–9,999 shares inclusive), NYSE listed stocks exhibit larger changes in proportional effective spreads than NASDAQ stocks. Taken together, these findings are consistent with Barclay and Warners (1993) contention that stealth (medium-sized) trades are more likely based on private information and insider trades are more transparent on the NYSE specialist system relative to the NASDAQ dealer system. The results support the hypothesis by Benveniste, Marcus, and Wilhelm (1992) that the unique relationship between specialists and floor brokers on the NYSE leads to less anonymity.

Are Bank Loans Special? Evidence on the Post-Announcement Performance of Bank Borrowers.

Unlike seasoned equity or public debt offerings, bank loan financing elicits a significantly positive announcement return, which has led financial economists to characterize bank loans as “special.” Here, we find that firms announcing bank loans suffer negative abnormal stock returns over the subsequent three years. In the long run, bank loans appear no different from seasoned equity offerings or public debt issues. Our evidence suggests that larger loans (relative to borrower equity) are followed by worse stock performance. We also find that lender protection is negatively related to borrower performance, suggesting the lender is somewhat shielded from the poor performance.

New evidence on the effects of federal regulations on insider trading: The Insider Trading and Securities Fraud Enforcement Act (ITSFEA)

Abstract This paper finds new evidence that the threat of legal sanctions significantly affects the trading behavior of insiders. Specifically, I examine the effects of the Insider Trading and Securities Fraud Enforcement Act (ITSFEA) on insider trading around earnings announcements. Given ITSFEAs stated concern with trading on private information prior to its release, I argue that insiders may respond to the Act by altering the timing of their trades. I find that, following ITSFEA, insiders are more likely to postpone liquidity sales until after negative earnings surprises. I also find that insiders increase their relative emphasis on post-event as opposed to pre-event information based trading. Finally, earnings announcements appear to be more informative in the post-ITSFEA period, consistent with less information based trading in front of earnings announcements, after the Act.

Measuring Investors' Opinion Divergence

Numerous proxies for divergence of investors’ opinions have been suggested in the empirical accounting and finance literatures. I offer a new proxy constructed from proprietary limit order and market order data. This allows me to capture additional information on investors’ private valuations. Proxies from the extant literature, based on publicly available data, do not contain such information. Given my new measure, I ask which of the extant proxies correlates best with it. In my regression analysis, unexplained volume is the best proxy for opinion divergence. Conditioning on various firm-specific and order-specific characteristics generally does not change this conclusion. The main exception is the sample of firms without IBES forecast dispersion data, for which bid-ask spread is the best proxy for opinion divergence. Factor analysis also suggests that unexplained volume is the preferred proxy for opinion divergence.

The Effect of Asymmetric Information on Product Market Outcomes

We explore how asymmetric information in financial markets affects outcomes in product markets. Difference-in-difference tests around brokerage house merger/closure events (which increase asymmetric information through reductions in analyst coverage) indicate worse industry-adjusted sales growth for shocked firms than for their peers. Our results are consistent with Bolton and Scharfstein’s (1990) tradeoff between investor agency concerns and predation risk. Further support is found in stronger treatment effects among firms with ex ante greater agency concerns, financing constraints, asymmetric information, and those operating in ex ante more competitive (fluid) product market spaces. Our results are concentrated in industries where we can clearly identify either net firm entry or exit.

Houses, Banks, and Financial Markets: Why the Crisis this Time?

The current global economic and financial crises are alarming in both severity and length. We study the anatomy of the collapse by comparing the current precipitant (housing crisis) with the previous U.S. housing crisis of the early 1990s. Our analysis suggests that the greater severity of this episode is driven by several factors: default proclivity (to typical triggers) and bank lending retrenchment are different across the previous and current episodes. Most importantly however, we document different linkages between the housing sector, the banking sector and stock market across the two episodes. We conclude that the duration of the current episode is likely to significantly exceed the duration of the prior episode.