M. H. Franco Wong

Estimating Exchange Rate Exposures: Issues in Model Structure

We show that both return measurement horizon and model specification have noticeable impacts on estimates of exposure from equity prices for U.S. firms. While increases in the return horizon leads to increases in the precision of the estimates, this effect is less significant than the impact of model structure. We demonstrate that the inclusion and of a market return variable and its particular construction has a dramatic influence on the sign and size of the exposures due to a strong relation between firm size and exposure for U.S. firms. We propose using CRSP cap-based portfolios as the control for market factors and show that this produces exposures with stronger relation to foreign cash flows and correlations with firm size.

Real Investment Implications of Employee Stock Option Exercises

This paper examines a real cost of awarding employee stock options. Based on the observation that managers are extremely concerned about earnings-per-share dilution in equity related compensation, we predict and find that firms experiencing significant employee stock option (ESO) exercises shift resources away from real investments towards the repurchase of their own stocks. We further find weak evidence of a decline in subsequent firm performance (as measured by return on assets) for several years following the cut in discretionary investments as a result of stock option exercises, though this result is sensitive to the metric used to measure performance. Collectively, our findings indicate that ESO exercises potentially impose a real cost on the firm in terms of foregone investment opportunities.

Anomalous Stock Returns Around Internet Firms' Earnings Announcements

This paper presents evidence of anomalies in internet firms’ stock returns surrounding their quarterly earnings announcements. There is a general runup in prices in the days prior to the earnings announcements, followed by a price reversal lasting for several days. The magnitude of the market-adjusted returns associated with these price movements exceeds 11 percent over a 10-day period. We find little evidence to suggest that these returns can be explained either by the earnings news disclosed or by risk changes. Additional analyses suggest that these return patterns are driven, at least in part, by price pressure. r 2002 Elsevier Science B.V. All rights reserved. JEL classification: M41; G14

Employee Stock Options, Equity Valuation, and the Valuation of Option Grants using a Warrant-Pricing Model

We investigate the use of a warrant-pricing approach to incorporate employee stock options (ESOs) into equity valuation and to account for the dilutive effect of ESOs in the valuation of option grants for financial reporting purposes. Our valuation approach accounts for the jointly determined nature of ESO and shareholder values. The empirical results show that our stock price estimate exhibits lower prediction errors and higher explanatory powers for actual share price than does the traditional stock price estimate. We use our valuation approach to assess the implications of dilution on the fair-value estimates of ESO grants. We find that the fair value is overstated by 6% if we ignore the dilutive feature of ESOs. Furthermore, this bias is larger for firms that are heavy users of ESOs, small, and R&D intensive, and for firms that have a broad-based ESO compensation plan.

Conflict-of-Interest Reforms and Investment Bank Analysts’ Research Biases

This study examines the consequences of the series of reforms targeting investment banking–related conflicts of interest. The authors compare and contrast optimism biases in analysts’ stock recommendations and earnings forecasts across different types of analyst firms in the postreform period of 2004 to 2007 versus the prereform period of 1998 to 2001. The authors document a significant reduction in the relative optimism of sanctioned investment bank analysts’ stock recommendations but not in their earnings forecasts. Moreover, the authors find little change in the profitability of their stock recommendations but detect a drop in the accuracy of earnings forecasts made by investment bank analysts. In sum, the reforms achieve the objective of mitigating the apparent optimism in investment bank stock recommendations, but they do not provide benefit to investors in terms of more profitable recommendations or more accurate earnings forecasts.

The Impact of Excluding Nonfinancial Exposure on the Usefulness of Foreign Exchange Sensitivity-Analysis Risk Disclosures

This paper investigates whether the exclusion of nonfinancial items from the scope of sensitivity-analysis disclosures hinders the usefulness of this quantitative information for predicting exchange rate exposure. We focus on foreign exchange (FX) risk because a large volume of nonderivatives FX exposures is in transactions that are nonfinancial in nature. We review the sensitivity-analysis disclosures of a sample of FX derivatives and find that more than half of these firms chose to exclude nonfinancial exposure from their quantitative disclosures. Hence, the reported sensitivity-analysis loss estimates include mainly the exposures of the derivatives positions and do not reflect the net exposure to FX risk. We further find that entity-level sensitivity, but not derivatives-level sensitivity, exhibits incremental predictive power for exchange rate exposure. This is consistent with the notion that exclusion hinders the usefulness of the sensitivity-analysis disclosures for predicting exchange rate exposure. These results are obtained after controlling for potential sample selectivity bias, traditional risk measures, lagged exchange rate exposure, and other derivatives-related disclosures.

Analyst Interest as an Early Indicator of Firm Fundamental Changes and Stock Returns

We posit that a change in analyst interest in a firm is an early indicator of the firm’s future fundamentals, capital market activities, and stock returns. We measure increases in analyst interest by observing analysts who do not cover a firm but participate in that firm’s earnings conference call, and we measure decreases in analyst interest by observing analysts who cover a firm yet are absent from that firm’s call. We find that increases in analyst interest are positively associated with future changes in firm fundamentals and capital market activities, while decreases in analyst interest are negatively associated with capital market activities. We also find that increases (decreases) in analyst interest are positively (negatively) correlated with future stock returns over the next three months and that a hedge portfolio yields a significant abnormal return. Overall, our study shows that analyst interest is a novel and early indicator of future firm fundamentals and capital market consequences.

CEO Optimism and Analyst Forecast Bias

We examine analysts’ forecast behavior in a setting in which CEOs are optimistic and analysts react rationally to CEO optimism. We document that the bias in analysts’ consensus forecasts is negatively related to the level of CEO optimism. The negative relation is stronger for small firms, firms with low analyst followings, and firms with high uncertainty. Analysts revise downward their forecasts for next year’s earnings less relative to their revision for current year’s earnings for firms with more optimistic CEOs, a result consistent with optimistic CEOs are subject to self-attribution bias. The stock price reactions to downward forecast revisions and missing analysts’ forecasts are less negative for firms with optimistic CEOs, indicating that investors understand the implications of CEO optimism for analysts’ forecast bias and subsequent revisions.

Analyst Following Along the Supply Chain and Forecast Accuracy

This study investigates whether analysts strategically construct their portfolios along the supply chain. We document four major findings. First, the likelihood of an analyst following a firm’s major customer increases with the strength of the economic tie along the supply chain, as measured by the percent of the firm’s sales to its customer. Second, analysts who follow the firms’ major customers incorporate the customers’ earnings news into their forecast revisions for the (supplier) firms, but other analysts do not. Third, by following the major customer firms, analysts can improve the accuracy of their earnings forecasts for the supplier firms. Fourth, the improvement in forecast accuracy attributed to following a firm’s customers is statistically as important as the effect of following the firm’s industry peers. We obtain these results while controlling for the analysts’ endogenous choice of covering a firm’s major customers.