Michael J. Gombola

Financial Ratio Patterns in Retail and Manufacturing Organizations

A bewildering array of potentially useful financial ratios is available for use. The user, however, will usually want to make decisions based on only a few ratios. For example, Chen and Shimerda [3] identify 41 different ratios that apparently serve some useful predictive or explanatory purpose. This set of 41 ratios is obtained by reviewing 26 previous studies in which a total of 100 ratios are examined. A set of 100 or even 41 financial ratios would be much too cumbersome to be employed in a decision model. Consequently, in several studies [4, 5, 8, 10, 11, 12, 13] an attempt is made to reduce the dimensionality of a variable set by developing patterns among financial ratios via factor analysis. The purpose of this study is to extend previous studies of financial ratio patterns by examining cross-industry stability of financial ratio patterns. A secondary purpose of this paper is to assess the sensitivity of these patterns to differences in accounting constructs, for example, using net income plus depreciation as a proxy for cash flow. The motivation behind developing financial ratio patterns is discussed in the next section.

The Information Content of Plant Closing Announcements: Evidence From Financial Profiles and the Stock Price Reaction

This study demonstrates that a plant closing announcement provides information not just for the plant being closed but also for other operations and the firm as a whole. An examination of changes in firm financial condition following the announcement indicates problems that are firm-wide, not just plant-specific. Firms announcing plant closings experience a decline in profitability during the announcement year and the following year as well as declines in employment, asset acquisition, and dividend growth for the years following the announcement. The stock price reaction to closing announcements is found to be negative and statistically significant with a greater negative reaction for plants that are more closely related to firm operations, and for plants that comprise a larger portion of the firms operations.

Evidence of Selling by Managers after Seasoned Equity Offering Announcements

Significant insider selling continues after a seasoned equity offering (SEO) is announced. This finding is consistent with earlier studies that equity offerings are undertaken by companies whose stock is overpriced. The study also suggests that the stock of firms that employ SEOs stays overpriced for several months after the offering.

Further Evidence on Insider Selling Prior to Seasoned Equity Offering Announcements: The Role of Growth Opportunities

Previous research documents significant abnormal net selling by insiders prior to seasoned equity offering announcements. This study documents that the abnormal net selling is significantly greater for growth firms than for mature firms. It also shows that growth firms experience poorer post-issue long-term price performance, which suggests greater overpricing for growth firms. Further analysis shows that greater insider selling prior to the offering announcement is associated with a greater price run-up prior to the announcement and is not associated with a more negative market reaction to the announcement. Overall, the results suggest that investors may be overly optimistic about future prospects of growth firms. Copyright Blackwell Publishers Ltd 1999.

Managerial Overoptimism and the Choice Between Debt and Equity Financing

This paper compares long-run stock performance following debt financing and equity financing for a sample of rapidly growing firms. If managers are subject to overly optimistic predictions for their asset acquisitions, they are more likely to finance asset growth by debt rather than by equity. The managerial overoptimism hypothesis predicts worse long-term performance for debt-financed asset acquisitions than equity-financed asset acquisitions. If, on the other hand, managers take advantage of “windows of opportunity” for issuing equity, we expect worse performance following equity issuance than following debt issuance. Consistent with the managerial overoptimism hypothesis, we find that debt financing is followed by significantly worse stock performance than equity financing. Managerial overoptimism seems to be a significant factor affecting the choice between debt and equity financing and post-financing stock performance.

The signaling power of specially designated dividends

We distinguish among the signaling, free cash flow, and wealth transfer hypotheses in explaining the stock price reaction to specially designated dividend (SDD) announcements. In a direct test of the signaling power of SDDs, we find both a larger stock price reaction and a significant upward revision of earnings forecasts for firms with Tobins q less than one, but not for other firms. Our results support the conditional signaling hypothesis, which predicts greater effects of favorable information for low q firms. Taken together, our results for stock price effects and earnings forecast revisions do not support either the free cash flow or wealth transfer hypotheses.

Time-Series Processes of Utility Betas: Implications for Forecasting Systematic Risk

bility, the forecaster needs alternatives for forecasting a time-varying relationship, such as the general Bayesian adjustment process [25] or its specific variations employed by Merrill Lynch [18]. The appropriateness of a given procedure depends on the particular time-series properties of the beta being forecast. Information on the time-series properties of utility betas, including the variability of beta and the tendency of utility betas to auto-regress toward an underlying mean, is presented here. The degree of difficulty in forecasting beta depends on both of these properties. Since the basis of Bayesian adjustment lies in betas tendency to return to an underlying mean, if betas follow a random walk process then Bayesian adjustment will be fruitless.

Target Capital Structure and Transitory Debt: Evidence from Reverse LBOs

Traditional target structure theories predict that all financing decisions move firms towards target capital structures. On the other hand, transitory debt hypothesis predicts that firms deliberately but temporarily deviate from target capital structures to fund a particular corporate action and then de-lever to re-build debt capacity. In a leveraged buyout, the maximum possible amount of debt is used to acquire the assets or stock of the target firm. This disruption in financial policy provides a laboratory to test the prediction of the transitory debt hypothesis. Our results show that firms quickly reduce their debt ratios to levels near target ratios at the time of the reverse LBO. A minority of firms in the sample increase debt significantly after the reverse LBO. In accordance with the transitory debt hypothesis, these firms value the option to borrow and decrease their debt levels accordingly so that they can preserve the option to borrow for future. When the firms have valuable investment options, they once again issue transitory debt deliberately but temporarily, they move away from their target leverage ratios, use the proceeds from the issue mainly for investment purposes, and they revert back to the target leverage levels gradually.

Market performance of options on the Chicago board options exchange

Abstract Unproven assertions about potential option returns have accompanied increased interest in option trading since formation of the CBOE. This paper presents an analysis of return distributions from buying and selling CBOE options. Generally, buying options resulted in returns that were negative and lower than returns from buying the underlying stocks. Average returns from writing covered options exceeded returns from buying both options and stocks. Commissions and taxes shifted location of return distributions for all three investments, particularly reducing returns from buying options.

Changes in Capital Structure: Asset Characteristics or Managerial Preferences

We examine leverage changes around mergers by similar-size firms. If asset characteristics drive leverage, both acquirer and target pre-merger leverage should predict long-term post-merger leverage. We find that only acquirer pre-merger leverage has a long-term effect. The effect of target pre-merger leverage, while highly significant right after the merger, disappears after two years. These findings cannot be explained by suboptimal pre-merger leverage of targets, sales of target assets, or corporate governance characteristics. As acquirer managers usually manage the merged firm, our findings support the hypothesis that managerial preferences have a strong effect on firm leverage.