Raj Varma

Contracting in the investment management industry: *1: evidence from mutual funds

Abstract We investigate the option to invest in derivative securities using a large sample of mutual funds. We find that those funds with the greatest transaction-cost benefit tend to permit investment in derivatives, and that funds tend to permit investment only in those derivatives that offer transaction-cost benefits. Our results indicate that a funds decision to permit investment in derivatives is driven by increased efficiency rather than advisor opportunism.

Board Composition and Corporate Fraud

The study reported here examined how various characteristics of the board of directors and other governance features affected the occurrence of U.S. corporate fraud in the 1978-2001 period. The findings suggest that board composition and the structure of a boards oversight committees are significantly correlated with the incidence of corporate fraud. In the sample, as the number of independent outside directors increased on a board and in the boards audit and compensation committees, the likelihood of corporate wrongdoing decreased.The study reported here examined how various characteristics of the board of directors and other governance features affected the occurrence of U.S. corporate fraud in the 1978-2001 period. The findings suggest that board composition and the structure of a boards oversight committees are significantly correlated with the incidence of corporate fraud. In the sample, as the number of independent outside directors increased on a board and in the boards audit and compensation committees, the likelihood of corporate wrongdoing decreased.

Bond rating agencies and their role in bank market discipline

This study examines whether changes in the ratings of bank debt have any information content. Bank holding companies are monitored both by bank regulators and by debt rating agencies, leading to the view that duplication of effort may render superfluous the monitoring service of rating agencies. However, our results show that downgrades of bank debt are associated with statistically significant wealth losses, irrespective of whether the rating change is across rating classes or within a rating class. Moreover, the results hold even when observations with potentially confounding events are removed from the sample. These results suggest that rating agencies provide valuable information to the capital market regarding the risk exposure of bank holding companies.

Closed-end versus open-end: the choice of organizational form

Abstract We investigate the choice of organizational form for investment funds. We find that funds that hold less liquid securities with less transparent prices are more likely to be closed-end. The relation is economically meaningful as well as statistically significant. Our results are consistent with Fama and Jensens [J. Law Econ. 26 (1983a) 327; J. Law Econ. 26 (1983b) 301] prediction that redeemable shares are not efficient when assets are relatively illiquid and asset prices are difficult to observe.

On the Integration of International Capital Markets: Evidence from Euroequity Offerings

Euroequity, a new financial instrument, is a new issue of stock by a U.S. firm that is sold simultaneously to investors domestically as registered shares and offshore as bearer shares. In perfectly integrated capital markets, whether Euroequity or domestic equity is issued should not have differential effects on a firms stock price. Like past studies of domestic equity-financing announcements, we find negative stock-price responses for announcements of equity offers. Our findings are consistent with the hypothesis that, during their infancy, new financial instruments which reduce previously effective barriers to investment across national borders enable firms to capitalize on beneficial financing opportunities in overseas markets.

Voluntary vs. Forced Financial Restatements: The Role of Board Independence

Using a sample of companies that restated their earnings over the period 1997–2002, this study finds that the probability of voluntary as opposed to forced restatements is positively related to the independence of both the board of directors and the audit committee. Following both voluntary and forced earnings restatements, companies increase the proportion of independent directors on both the board and the audit committee; three years after restatements, both types of restating companies attain similar levels of director independence. Moreover, the study finds comparable postrestatement long-run stock performance for all restating and matched companies, which suggests that postrestatement enhancements to internal control systems help restore companies’ blemished reputations. This article reports the results of our investigation of the role of corporate governance in monitoring earnings manipulation in which we examined the independence of boards of directors and audit committees in companies that restated their earnings. Extant empirical evidence on board independence and the incidence of accounting irregularities is mixed. Our investigation of 187 restatements from 1997 to 2002 finds that director independence is not associated with a lower incidence of earnings restatements. Companies that make voluntary restatements, however, have greater board and audit committee independence than do companies forced to restate earnings by the U.S. SEC and other external agencies. Moreover, the probability of voluntary restatements is positively related to board and audit committee independence. Our results also show that restating companies, especially those forced to restate, increase the independence of their boards and audit committees after restatements. And long-run stock performance after both voluntary and forced restatements is similar to that of matched companies. Our findings point to the importance of independent boards of directors and audit committees in improving the accuracy of financial reporting. Although director independence does not ensure a lower incidence of earnings restatements, it increases the probability that a company will initiate a restatement instead of waiting for outsiders to force it to restate. These findings are relevant to the current controversy surrounding the rising number of restatements since 2001 and support the requirements for greater board and audit committee independence mandated by the Sarbanes–Oxley Act and the rules of major exchanges. Our findings suggest that greater director independence is associated with more efficient internal monitoring of financial reporting and results in a greater number of voluntary restatements. Consequently, the recent increase in restatements may indicate that the corporate governance laws enacted in this decade have taken root rather than the contrary, as some observers believe. The restating companies in our sample responded to the significant cost imposed on them by financial markets by making reputation-enhancing changes to their internal monitoring systems, changes that are evidenced by the increase in the independence of their boards and audit committees. The incentive that restating companies have to maintain their reputations with investors in the capital markets ensures that the negative impact of restatements is short-lived. Our results indicate comparable postrestatement long-run stock performance for all restating and matched companies, which suggests that postrestatement enhancements to internal control systems help restore both blemished reputations and investor confidence. Thus, concerns that the current increase in restatements will erode investor confidence may be unwarranted.

An analysis of exchangeable debt offers

Abstract Exchangeable debt is convertible into the common stock of a target firm in which the issuing firm has an ownership position. It signifies a potential change in the issuing firms asset composition through the divestiture of the ownership stake in the target firm. We find that announcements of exchangeable debt offers are associated with insignificant abnormal returns for the shareholders of issuing firms. The target firms share price declines, however, when an exchangeable debt offer is announced. This result is consistent with the offers potential to reduce the ownership concentration of the target firms common stock.

The role of financial innovation in raising capital Evidence from deep discount debt offers

Abstract We investigate the markets reaction to original-issue deep discount (OID) bonds, which are issued at prices well below par and with coupons set below the market rate. Until July 1982 OID debt offered large tax advantages. Before that date stock-price responses to announcements of OID debt are significantly positive, in contrast to the negative, albeit insignificant, responses associated with par debt announcements. No stock-price gains are observed for OID debt issued after the tax advantages are removed. We conclude that in 1981–82 opportunities provided by financial innovation offset the negative information effects typically associated with debt-financing announcements.

“Too big to downgrade”: the response of financial analysts to bond downgrades of money center banks

Outlines previous research on the effects of bond rating changes on the share prices of US banks, noting opposing views on whether they contain new information. Examines revisions in analysts’ earnings forecasts for downgraded and non‐downgraded banks (separating regional banks from large money centres) to test the value of this information using 1981‐1991 data on 14 downgrades of money centre banks; and explains the methodology used. Shows that downgrades affected forecasts for the downgraded banks and other money centre banks but not for regional banks. Concludes that bond rating agencies assist market discipline by providing useful information on risk.

Pollution control revenue bond sales and public utility share prices

Abstract This article examines the effect of pollution control revenue bond offerings on public utility common stock prices. These securities provide a unique case in which public utilities were permitted to issue a limited quantity of debt offerings investors an income stream exempt from federal taxes with the proceeds from the issue targeted for a specific capital investment. Significant negative stock price effects are reported around the announcement of these securities. However, the stock price response to pollution control revenue bond sales is more favorable than that reported in earlier studies for straight debt offerings used to finance a utilitys investment program.