Kenneth M. Eades

On interpreting security returns during the ex-dividend period

In this paper we examine the ex-dividend day returns of several taxable and non-taxable distributions. The ex-dividend day returns for the taxable common stocks are consistent with the hypothesis that dividends are taxed more heavily than capital gains. However, the cx-dividend day returns of preferred stocks suggest that preferred dividends are taxed at a lower rate than capital gains; non-taxable stock dividends and splits are priced on ex-dividend days as if they are fully taxable; and non-taxable cash distributions are priced as if investors recetve a tax rebate with them. We also find that each of these distributions exhibits abnormal return behavior for several days surrounding the ex-dividend day. We investigate several possible explanations for this anomaly, but none is capable of explaining the phenomenon.

Market rationality and dividend announcements

Abstract We investigate stock market rationality by examining the timeliness and unbiasedness of the markets response to dividend announcements. Our initial findings for market timeliness show a sluggish market reaction to dividend announcements; however, when the ex-dividend effect is controlled for, we find no evidence of a sluggish market reaction. We examine the unbiasedness of the markets response by testing whether the net announcement effect across a sample that is devoid of ex-post selection bias sums to zero. We observe a significant positive net announcement effect and examine several plausible conjectures for this puzzling phenomenon, but none provides a satisfactory explanation.

Empirical Evidence on Dividends as a Signal of Firm Value

The role of dividends in firm valuation continues to be a theoretical puzzle as well as an empirical obsession with economists. The pioneering work by Modigliani and Miller (MM) ([32], [29]) is the archetype of the theoretical dilemma. Whereas the authors proved convincingly the irrelevance of dividend policy to firm value within a perfect capital market, they tempered their irrelevance proposition with what is usually referred to as the “information content of dividends†(ICD) hypothesis. In a more scientific sense, this hypothesis should be labeled as a conjecture, since it is essentially an ad hoc observation that dividends may convey information to the capital market concerning a firms future earnings potential. Even though the ICD hypothesis was not derived from a well-specified economic model, it has, nevertheless, been subjected to a plethora of empirical studies. In general, these studies have focused upon the precise influence of dividend changes upon a firms common stock price. Overall, the results can be described as being supportive of the notion that stock price movements are positively correlated with cash dividend changes. This correlation, of course, is consistent with the ICD hypothesis.

Voluntary conversion of convertible securities and the optimal call strategy

Abstract We provide an explanation of why convertibles are called long after the conversion value exceeds the call price. Delaying the call benefits the firm if enough investors are expected to delay their voluntary conversions. Consistent with this theory, we document that a substantial number of investors do not voluntarily convert when the common dividend exceeds the convertibles dividend plus its premium over conversion value. We find that firms would not have increased common stock returns by switching to the strategy of calling to force conversion as soon as possible. Surprisingly, we find that convertible preferreds frequently sell below conversion value.

The Crash of the Revco Leveraged Buyout: The Hypothesis of Inadequate Capital

The bankruptcy of Revco Drug Stores is one of the most notable in the history of highly leveraged transactions. This study considers the allegation that the leveraged buyout of Revco left it without adequate capital to survive. We use Monte Carlo simulation to determine Revcos financial coverage ratios and the expected probability of financial survival. The simulation finds a very low probability that Revco would survive the heavy debt and preferred stock obligations during the first three years following the buyout. The simulation approach provides a useful perspective on the efficacy of the insolvency and capitalization tests as evaluated by the courts. We argue that capital adequacy on the day of going private is extremely difficult to prove using a point-estimate valuation; a simulation-based test provides the more appropriate statistic - i.e., a probabilistic assessment of survival.

Predicting Defined Benefit Pension Returns: The Impact of SFAS 132 Required Disclosure of Asset Allocation Information

We evaluate the impact of Financial Accounting Standard 132 by measuring how well its required asset allocation information predicts next year’s pension returns. We compare the predictive capability of several different models, including Sharpe’s style model and survey data by Pensions & Investments. Predictions based on SFAS 132 data are no better than the empirically based STYLE model predictions and statistically inferior to the SURVEY predictions. We recommend that pension returns be reported quarterly to bolster the power of the STYLE model and that additional asset classes be required, such as international equity, private equity and hedge funds. We also show the importance of reporting exposure to individual securities such as the company’s own stock to enhance predictive capability as well as to inform analysts about the risk profile of pension assets.