Oded Palmon

New Evidence on Property Tax Capitalization

The notion of property tax capitalization was first formally developed and tested by Oates (1969). Full capitalization is said to occur when, after one controls for all other housing characteristics (structure, neighborhood, and public services), differences in housing prices exactly equal the present value of variations in expected tax liabilities. The large volume of empirical literature that followed Oates’s study largely documents that property values are negatively affected by future property tax liabilities but fails to reach a consensus regarding the ‘‘extent’’ of such capitalization. For example, Wales and Wiens (1974), Chinloy (1978), and

Layoff Announcements: Stock Market Impact and Financial Performance

Announcing a layoff decision could trigger either an increase or decrease in firm value, depending upon whether adverse market conditions or efficiency improvement are motivating it. Layoff announcements often contain information that indicates the motivation. This article finds that the layoff announcement is a useful signal for investors. There are significantly positive (negative) abnormal stock returns around the announcement date for firms that cite efficiency improvements (demand declines) as the reason for the layoffs.

Are Two Heads Better than One? The Impact of Changes in Management Structure on Performance by Firm Size

Abstract We investigate how switching between two alternative management structures affects firms, and how this impact varies with firm size. Under one structure a single executive serves as both chief executive officer (CEO) and chairman of the board (COB). Under the alternative structure two separate executives fill these positions. In order to evaluate which management structure is optimal, we examine the impact of a change in management structure on firm performance. A change from one to two executives induces negative abnormal returns for small firms, but positive abnormal returns for large firms. These impacts are also evident with accounting profitability measures of returns. Our results are consistent with the hypothesis that small firms benefit more from the clarity and decisiveness of decision-making under a single executive, while large firms benefit more from the checks and balances of having two executives in the CEO and COB positions.

The Impact of the 1986 Tax Reform Act on Corporate Financial Policy

Moshe Ben-Horim is an Associate Professor of Finance at theGraduate School of Business, Hebrew University of Jerusalem.Shalom Hochman is an Associate Professor of Finance at the Collegeof Business Administration, University of Houston. Oded Palmon isan Assistant Professor of Economics, Department of Economics,University of Houston.

On the Relationship between Accounting Risk and Return: Is There a (Bowman) Paradox?

Bowmans (1980, 1982, 1984) finding of a negative relationship between the means and variances of accounting returns (the Bowman Paradox) spurred a considerable literature analyzing this phenomenon. The sign of the relationship between the mean return on equity (ROE) and its standard deviation remains unresolved. Concerns were raised about ROE measurement and statistical techniques used in establishing the paradox. The papers critiquing (and supporting) it were mostly limited in scope, studied only short periods of time and provided limited robustness checks. In addition, no paper considered the effect of issuances and repurchase of stocks on the measurement of ROE. This study revisits the Paradox and addresses the above mentioned deficiencies in prior research. We use data from longer periods, control for size and leverage and provide additional robustness checks. We conclude that a positive relationship between mean ROE and its standard deviation is far more likely than a negative one.

Risk-Taking, Financial Distress and Innovation

We use our numerical technique to explore the optimality of risk-taking under financial distress. In our model, cash reserves are represented by a Brownian processes that includes an innovation parameter. When this innovation parameter goes to zero, our results show that risk-taking is optimal only when distress costs are extremely high. Thus, non-innovators need a hefty penalty to optimally take risks under financial distress. As the level of innovation increases however, it becomes optimal for innovators to undertake risky investments under financial distress without hefty penalties. The implications of our analysis might partially explain the financial crisis of 2007-2009.

Expected Inflation and the Real Rates of Interest on Taxable and Tax-Exempt Bonds

This paper analyzes the impact of inflation on rates of return on taxable corporate bonds and tax-exempt municipal bonds. The paper considers a differential tax system, where the tax rate depen ds on both the identity of the investor and the source of income. It also consid ers the possibility that inflation may induce investors to switch from holding one asset to holding another. It is demonstrated that while inflation should increase the (pre-personal tax) real rate of interest on taxable bonds, it should reduce the real rate of interest on tax-exempt bonds. Copyright 1987 by Ohio State University Press.

Dividends Versus Reinvestments in Continuous Time: A More General Model

We present a continuous-time model of asset valuation in which the generated income follows a stochastic process, and the asset-owner allocates this income between reinvestment and payout. The income generating process is identical to the processes in the multiplicative (e.g., Black-Scholes-Samuelson-Merten) and the additive (e.g., Bachelier-Radner-Shepp) models for two alternative extreme values of the capital marginal productivity parameter. For all other values of this parameter, our process exhibits diminishing marginal productivity of capital. Thus, the model is more appropriate than both the multiplicative and the additive models for modeling the valuation of physical assets. Similar to the additive model, and in contrast to the multiplicative model, our model permits bankruptcy and does not allow unbounded growth of asset values. We demonstrate the existence of, and solve for, the optimal threshold company size level for paying dividends. When company size is above this level income is paid out as dividends, and when it is below this level all income is reinvested in the company. We also find the expected time until bankruptcy.

Are Tails Fat Enough to Explain Smile

It has been well documented that using the Black-Scholes model to price options with different strikes generates the so-called volatility smile. Many previous papers have attributed the smile to the normality assumption in the Black-Scholes model. Hence, they generalize the Black-Scholes model to incorporate a richer distribution. In contrast to previous studies, our model allows for not only a richer distribution, but also the relaxation of another crucial assumption in the Black-Scholes – continuous trading. We show, using S&P 500 call options, how relaxation of continuous trading explains a non-trivial change in the volatility. When an empirical distribution is considered, the smile is almost completely removed. Market prices of options that differ only in their strike prices are inconsistent with a single volatility for the underlying asset, and this well-known feature is called the volatility smile or smirk. The volatility smile is often attributed to either the non-normality of stock returns or to the impossibility of performing costless arbitrage (rebalancing) in continuous time. In this paper, we consider option pricing models that incorporate no rebalancing and/or a nonparametrically estimated density. We attempt to empirically identify which of these two factors contributes more to the smile bias. Using S&P 500 index options, we find that the model with no rebalancing but with normality has a somewhat diminished smile, and the model with a nonparametric density, but with continuous trading, has a slight smile. Only the model with both a nonparametric density and no rebalancing has no perceptible smile bias.