Richard J. Dowen

Analyst Reaction to Negative Earnings for Large Well-Known Firms

RICHARD J. DOWEN is a professor in the department of finance at Northern Illinois University in DeKalb (IL 60015). o add to our understanding of the market performance of firms after the announcement of negative earnings, we investigate the T differences in security research analyst forecasts for firms with negative earnings and firms with non-negative earnings as well as the market reaction to those differences. There is a substantial literature in this area. Jaffe, Keim, and Westerfield [1989] find that firms with negative earnings tend to have positive abnormal returns. Ettredge and Fuller [1991] studied 4,294 individual annual observations of firms in the period from 1973 to 1982, of which 227 were negative earnings. They find that negative earnings firms had, on average, positive market model cumulative residuals. Their results are consistent with the market overreaction hypothesis developed by De Bondt and Thaler [1985, 19871. Ali and Klein [1994] observe that the abnormal returns do not exist when measured by market or size adjustment. They hypothesize that the market model excess returns could be explained by negatively biased alphas caused by the inclusion of the negative earnings announcement month in the estimation period for the market model parameters. In a rejoinder, Ettredge and Fuller [1994] speculate that the time period studied may be part of the cause of the different findings. They point out that the negative earnings companies reported large earnings increases in the subsequent year, but that the abnormal returns are unrelated to the increases.

Board of Director Quality and Firm Performance

This paper aims to shed light on the relationship between the quality of the individuals on a firms board of directors and performance. It reports the results of an empirical study of a sample of Fortune 1000 firms. The findings suggest that quality boards, as measured by the average number of board seats held by each director, are associated with quality firms, as measured by both accounting and market performance.

Economies of scope and scale in the mutual-fund industry

Purpose - The purpose of this paper is to examine market concentration, economies of scale, economies of scope, and the relative size of a particular fund, within a fund family, as determinants of mutual-fund expense ratio. This examination is focused at the asset-manager level and is based on the Morningstar equity and fixed-income style classifications. Design/methodology/approach - All data used in this study come from the July Morningstar Principia database for the years 1997 through 2006. One challenge of working with these data is that Morningstar treats each separate class of a fund as though it were an individual fund. As a result all Morningstar data items are reported for each fund class as though they are data items for a separate fund. The data are modified so that the items for separate classes of a fund are merged into data for a single fund. For example, assets in a fund become the total of the assets in each class of the fund. Findings - This study contributes to the literature on mutual-fund managers, and the literature on the structure of mutual funds, by showing that market concentration at the asset-manager level varies substantially across Morningstar styles, particularly for the fixed-income funds. The paper shows that increased market concentration is associated with greater expenses for the funds under management, within a given Morningstar-style box, for both equity funds and for fixed-income funds. We also show that increased costs are partially offset by economies of scope for the fixed-income funds. Originality/value - This paper extends the current literature in several ways. First, it confirms the existence of economies of scale at the fund level within Morningstar style classifications. Second, it documents the existence of varying levels of market concentration within different Morningstar style classifications. Third, the results demonstrate that there is a negative relation between the scope of funds handled across the Morningstar classifications by a particular fund manager and the expense ratio for particular funds. Finally, the results presented in this paper show that the largest funds within a family are associated with the highest expense ratios in the family.

Fundamental Information and Monetary Policy: The Implications for Earnings and Earnings Forecasts

Building on the work of Lev and Thiagarajan (1993) and Abarbanell and Bushee (1997 and 1998) this paper tests whether market-based information including dividend yield (Fama and French, 1998), firm size (Reinganum, 1981), and the ratio of book value to market value (Fama and French, 1992) add explanatory power to accounting data for predicting future earnings. The paper also tests whether earnings changes and the predictability of those changes are conditioned on monetary policy. It is found that the ratio of book value to market value is significantly related to earnings changes. Analyst forecast accuracy differs depending on monetary policy regime, but this difference is not due to differing interpretation of fundamental signals on financial statements appearing under differing monetary policy regimes. It is also found that there is a significant relation between monetary policy, earnings changes, and the level of signals concerning earnings changes. Copyright Blackwell Publishers Ltd 2001.

Poison pills and corporate governance

The decade of the 1980s witnessed the emergence of shareholder control as an issue of considerable interest to investors. The controversy surrounding hostile takeovers and anti-takeover provisions focuses attention on managerial motivation for adopting defensive measures such as poison pills. Whether the adoption of a poison pill is in the best interests of shareholders depends upon which of two competing theories best conforms to reality. Management entrenchment theorists argue that poison pills reduce shareholder wealth, while short-term myopia advocates claim that adoption of poison pills will not decrease and may increase shareholder wealth. Numerous studies have examined the markets reaction to the adoption of poison pills and they tend to support the management entrenchment hypothesis. This study expands upon previous investigations in that we investigate managerial behaviour in the context of O.E. Williamsons work on transaction cost economics (Corporate finance and corporate governance, Journal ...

Do Investors Benefit from 12b-1 Fees?

Under rule 12b‐1, mutual funds are allowed to charge a fee of up to 100 basis points per year to cover marketing and distribution costs. Under NASD rules, a fund may charge a 12b‐1 fee of up to 25 basis points per year and still advertise itself as a no load fund. This fee is used to make the funds charging it more visible to the investing public. The question explored here is very simple; are the investors in no load funds well served by investing in those funds that charge this fee? It is shown here that the no load funds charging 12b‐1 fees do not perform as well as the funds that do not charge the fee but that they experience greater cash inflows.

Do the Foxes Guard the Hen House? A Note on Agency Costs

It is a fairly common practice for the CEOs of onecorporation to serve on the Board of Directors of another corporation. The question addressed here is the effect that the presence of outside CEOs on the Board of Directors has on the compensation of the firm’s CEO. There are two alternative views that emerge from the literature. One view is that CEOs are selected to serve as directors because they will back management, including proposals for increased compensation. The other possibility is that a CEO knows the techniques that another CEO may use to obtain increased compensation and will thus serve as a better watch dog than a non‐CEO. Using a sample of the Fortune 1000, we find that for non regulated firms there is a negative relationship between the proportion of outside CEOs serving on the board and three different measures of CEO compensation after controlling for firm performance in four different ways.

Estimating Systematic Risk With Long‐Term Growth Forecasts and Analyst Following

According to the capital asset pricing model, a stockOs required rate of return is determined by systematic risk, otherwise known as beta. Usually betas are estimated using historic data. It is shown here that future betas have a stronger relationship to analystsO long-term growth forecast than to historic betas.

The dynamics of neglect and return: Comment

Richard 1. Dowen and W. Scott Bauman T L he excess returns that appear to belong to neglected firms and firms with high earnings yields have been the subject of much investigation. Arbel (1983 and 1985), Basu (1977), and Reinganum (1981) are among the leading researchers in this area. More recently, Edelman and Baker (1987) produced a study for this journal, reporting that a stock’s excess returns virtually disappear when the stock is owned by more than eight institutions. Further, they report that the earnings price ratio is a function of institutional holdings, going on to infer that, once a stock is held by more than eight investors, a measurable earnings yield anomaly would no longer exist. The purpose of this note is to investigate whether there is an excess return to high earnings yield stocks that are held by more than eight institutions. If an anomaly continues to exist for widely held firms, then the EP ratio effect is distinct from the institutional holding effect. Note that establishing a distinct effect differs from arguing that EP ratios and institutional holdings have no relationship. Edelman and Baker show that such a relationship exists. We ourselves (1986) also found a1 low but significant correlation between neglect and EP ratios. When we say that there is a distinct efflect, we are merely saying that, after one effect is accounted for, the other continues to be present. We chose our methodology with the specific purpose of making our results directly comparable with those found by Edelman and Baker. We selected a sample of 200 firms, using two criteria. First, the firrn hail to be listed continuously on the CRSP Daily Rei urns File from January 1,1980, through December 31,1984. Second, according to information in the Standard & F’OOY’S Stock Guides, each firm had at least twelve institutional holders in January of 1980 and December of 11984. We chose the number twelve because twelve is the number Edelman and Baker used to judge whether a firm had moved from the neglected category to the non-neglected category. Thus, ali the firms in the sample are non-neglected. After the sample was selected, we calculated quarterly returns for each firm using the CliSP Daily Returns File. Quarterly earnings yield data were taken from the COMPUSTAT Quarterly Intlustrial Tape. We then divided the sample into earnings yield quintiles and calculated the quarterly average portfolio return and standard deviation for each quintile. The results of the calculation appear in Table 1. Table 1 shows that there is a monotonic earnings yield anomaly within the group of non-neglected stocks. To confirm this result, we calculated quarterly excess returns using the Edelman and Baker definition:

Patterns of Error and Neglect in Security Analyst Forecasts

It is well documented that firms that are neglected by analysts and large institutions provide superior investment performance. This paper studies whether that effect is caused by an upward bias in analyst earnings forecasts. The idea is that the more popular firms are the ones with the greatest earnings estimation bias. It was found that after controlling for earnings estimation bias the neglect effect was considerably weakened. However, it was also found that there was no relation between analyst following and earnings estimation bias.