Nandkumar Nayar

Stock Returns before and after Calls of Convertible Bonds

Ofer and Natarajan (1987) report negative, statistically significant cumulative average abnormal returns over five years following convertible bond calls. We show that these results are obtained only if returns preceding the call dates are used for market model parameter estimation. Returns preceding calls tend to be positive and unusually large. This means that predicted post-call returns, based on pre-call parameter estimates, are biased upward. Consequently, the corresponding abnormal returns are biased downward. We also discuss a corrected test statistic. We conclude that the evidence does not indicate market inefficiency in the stock price reaction to convertible calls.

Product Quality and Payment Policy

This paper provides a theoretical explanation for the choice of payment terms under which a company sells its products. In our model, these terms are chosen to permit sellers or buyers to specialize at repairing defects if they are equally well-informed about quality or if one has significantly lower repair costs than the other. Otherwise, the terms are chosen to signal product quality. We also develop the empirical implications of this theory by predicting a sellers choice of payment terms based on the characteristics of its product market.

Underwritten calls of convertible bonds

Abstract Common-stock prices fall a statistically significant 2 percent in response to underwritten convertible debt call announcements. We find that the significant negative price reaction is confined to underwritten calls — stock-price responses to non-underwritten calls average an insignificant −0.84 percent. The results support the idea that managers are more likely to use underwriters the more unfavorable the information they possess about future firm cash flows. An agency cost interpretation of underwritten calls is also consistent with the results, but is not supported by management ownership and corporate liquidity evidence.

Record Date, When-Issued, and Ex-Date Effects in Stock Splits

Negative abnormal stock returns of about 1% occur near record dates of stock splits. Further, the lower the returns, the more positive are ex-date returns and when-issued premiums. A possible explanation of these related phenomena is that trading hindrances associated with record dates create trading inconvenience that is reflected in lower prices near record dates. In turn, anomalous positive ex-date returns arise in part from the abnormally low prices of unsplit shares caused by the negative record date returns.

Calls of Out-of-the-Money Convertible Bonds

We examine calls of convertible bonds in which the effective cash call price exceeds the value of the common stock into which investors can convert the bond. In option pricing terms, the conversion option available to the convertible bondholder is out-of-the-money. Following the announcement of out-of-the-money calls, the common stock prices of the firms calling their convertible bonds increase an average of 1.43%. The increase occurs over the two-day period in which the firm announces the call, and reflects adjustments for the risk of the stock and market wide price movements.

Financial Implications of the Decision to Increase Reliance on Contingent Labor

This paper provides the first systematic examination of the financial implications associated with increased reliance on contingent (i.e., temporary/part-time) labor. Using measures of performance from income statement and balance sheet data, and stock returns, we find that the adoption of this labor practice is associated with superior subsequent performance. Concurrently, no increase in systematic risk and standard deviation of stock returns is observed. The increase in performance with no concurrent increase in systematic risk and standard deviation of returns perhaps explains the increasing popularity of this labor practice.

The information content of commercial paper rating downgrades: Further evidence

In this paper, we study the association between commercial paper rating downgrades and expectations of the level and variability of future earnings. Our examination shows that such rating downgrades are associated with a significant reduction in analyst forecasts of near-term earnings. We document a tendency by financial analysts at the Value Line Investment Survey to progressively revise their estimates of quarterly earnings downward on average and implement two methods to control for the resulting bias. The reduction in earnings estimates is robust to these controls. In addition, we observe an increase in systematic risk for a subset of firms for which the downgrade implies exit from the commercial paper market. Analysis of stock price changes around the downgrade announcement dates shows that although the information on lower future earnings reflected in mild rating downgrades merely confirms market beliefs, the information on lower level and/or higher variability of future earnings associated with severe downgrades constitutes new information unavailable to the market prior to the rating change announcement.

Underwriting calls of convertible securities *1: A note

Abstract Average common stock price responses to convertible preferred stock calls are significantly negative only when firms employ underwriters to assure conversion. Previous work reports similar results for convertible bond calls; we find that the stock price reaction does not depend upon the type of convertible security being called. The results support the idea that managers are more likely to have calls underwritten the more unfavorable their private information about firm value.

Market Reaction to Control Deficiency Disclosures Under the Sarbanes-Oxley Act: The Early Evidence

Sections 302 and 404 of the landmark Sarbanes-Oxley Act require firms to periodically assess and report control deficiencies to the audit committee as well as to the SEC. Section 302 specifically directs company management to identify and report control deficiencies while Section 404 provides the discipline that forces companies to take the control assessment and reporting task seriously. Importantly, external auditors are required to opine separately on the effectiveness of their clients system of internal control over financial reporting and issue an adverse opinion on internal control in the presence of even a single material weakness. Prior to being mandated by the Sarbanes-Oxley Act, management was not required to assess and report on the state of internal controls in their company. Statement on Auditing Standards (SAS) #60, which provided guidance to the external auditors on these matters, afforded them a great deal of flexibility and judgment not only in determining what constituted a reportable condition but also limited their disclosure only to the audit committee of the board. In a recent speech, Donald T. Nicolaisen, the SECs Chief Accountant, remarks that these new requirements are not only a major financial but also a significant cultural endeavor for registrants in the U.S. and abroad. Consequently, these new requirements have drawn uproar and concern from companies of all sizes and market capitalization. Given the outcry from companies and regulatory assertions that these disclosures are the best thing that has ever happened to the capital markets, we examine whether such control deficiency disclosures convey valuation-relevant information to the market. This issue is important because increasing disclosure requirements without any attendant effect on valuation would impose unnecessary deadweight costs. The disclosures employed in our study were not mandatory under Section 404 at the time our sample firms made them. While there may be many reasons why our sample firms report these deficiencies early, these disclosures may portend the effect to be faced by other firms when the Section 404 rule becomes binding. Consistent with the regulatory assertions, we find that such disclosures are associated with a negative stock price reaction, on average, indicating that such disclosures do indeed convey valuation-relevant information. This reaction is mitigated to some extent, but not fully, if management also discloses that remediation steps have been taken to correct the weaknesses identified in the disclosures. Additionally, the price reaction is less negative for firms employing a Big Four auditing firm. Conversely, the reaction is more negative for firms with larger current liabilities relative to total assets, which suggests that control weaknesses may have implications for increased default risk.

Asymmetric information, voluntary ratings and the Rating Agency of Malaysia☆

Abstract In Malaysia, corporate debt securities are fairly ‘new’ and in 1990, the Rating Agency of Malaysia (RAM) was established to rate them. Initially, issuers were allowed to seek ratings voluntarily. This policy was the topic of an editorial in the November 1–15, 1991 issue of the publication Malaysian Business. The editorial recommended that debt securities in Malaysia should be mandatorily rated by RAM, thus providing investors with information about the likelihood of default by issuers. This paper presents an opposite view to the editorial and develops a model to justify a voluntary rating policy.