Roger C. Kormendi

Earnings Innovations, Earnings Persistence, and Stock Returns

This study designs and implements new tests of the information contained in accounting earnings. The authors examine whether the magnitude of the effect of unexpected earnings on stock returns is (positively) correlated with the presen t value of revisions in expected future earnings derived from a univa riate time-series model. By addressing the valuation implications of the time-series properties of earnings, they uncover a new dimension to the information content of earnings and, in the process, find no e vidence that the reactions of stock returns to unexpected earnings ar e excessively volatile. Copyright 1987 by the University of Chicago.

Mean Reversion in Annual Earnings and Its Implications for Security Valuation

This article documents the long-horizon mean reverting character of annual earnings and tests the implications of such mean reversion for security valuation. First, both theory-based and nonparametric measures of earnings persistence decrease as the estimation order increases, revealing 40 percent less long-horizon persistence than expected under the commonly used random walk model. Second, the return responses to the earnings shocks are more closely related across firms to the higher-order measures of persistence that reflect significant long-horizon mean reversion. Third, the persistence measure derived from classical valuation theory outperforms the generic measure in explaining the return responses. Taken as a whole, these results provide evidence for significant mean reversion in the higher-order properties of earnings and for the stock market incorporating these properties in a manner consistent with classical valuation theory.

Dividend policy and permanence of earnings

We examine managers’ adjustment of dividends to information about earnings. We base our analysis on a ‘permanent earnings’ model of dividend behavior, which implies that dividends are changed primarily in response to permanent changes in earnings; transitory earnings changes have little or no effect on dividends. Within the permanent earnings framework, the permanent component of earnings may be the predominant factor affecting dividend payouts, or it may be one of the important factors affecting dividends. In the former case earnings and dividends are co-integrated; in the latter they are not.Using a sample of 337 firms over the 40 year period from 1950–1989, we find the data to be strongly consistent with the permanent earnings model. We also find that the data are more consistent with a model that relates dividend and earnings changes rather than levels. Thus, we conclude that earnings and dividends are not co-integrated. This contrasts with the implicitly co-integrated (levels) dividend model of Lintner (1956), and indicates that factors other than the permanent component of earnings, such as tax policy, clientele effects, transaction costs, etc. may have a significant impact on the long-run behavior of dividends.

Contract Design for Problem Asset Disposition

As a result of declining real estate values and the receivership of numerous financial institutions, government regulators like the Resolution Trust Corporation (RTC) and Federal Deposit Insurance Corporation (FDIC) have large inventories of distressed assets. This paper develops a model of the principal/agent issues associated with management and disposition of problem assets. In the model, optimal contracts balance risk sharing with incentives for effort. We argue that the RTC will minimize the ultimate cost of the thrift crisis by placing managerial control of distressed assets in the private sector, while retaining full or partial ownership of the assets for risk-sharing purposes. Recoveries are maximized, however, only when an asset manager is incented to expend a first-best level of effort by indexing asset management and disposition contracts to market movements. Copyright American Real Estate and Urban Economics Association.

Resolution of Insolvent Thrifts: Fundamental Issues

Once insolvent thrifts are under its control, FSLIC must provide financial assistance to induce others to assume deposit liabilities. But how should FSLIC use its primary resolution alternatives -- assisted acquisition and liquidation -- to minimize the cost of meeting its obligations to depositors? Should FSLIC liquidate all insolvent thrifts? If only some, which ones? In this section we discuss principles that should guide the resolution process and thereby establish a basis for our substantive analysis in Chapters 4 through 6 that follow.

The Economic Function of Futures Trading

To evaluate properly the function of the delivery process, and therefore how changes in delivery specification influence the larger economy, it is necessary to understand the economic role of futures markets. We discuss that role in this chapter, paying special attention to the factors that differentiate futures markets from other forward markets.

The Economic Effect of Potential Grain Futures Contract Redesign

The preceding chapter noted that an expansion of the deliverable set can reduce the profitability—and hence the likelihood—of a long manipulation. An increase in the number of deliverable locations would also increase available delivery capacity, which would reduce the likelihood of pricing anomalies due to the exhaustion of regular space or quality problems. Those are beneficial objectives, but such an expansion will have other effects as well. An increase in the number of deliverable grades or delivery locations will, for example, change the basis risks faced by the hedgers of various grades in various locations. As noted in Chapter 2, the costs and benefits of any such change depend upon the geographic distribution of hedgers.

The Role of the Futures Delivery Process

The delivery terms of futures contracts specify the types and grades of deliverable goods, and denote the places and times of delivery that must be met to avoid default on an outstanding contract. It is exceedingly difficult to ascertain proper specifications for a futures contract. But if the contractual terms are improperly specified, too few buyers or too few sellers of the contract will appear in the market at any given price, and the contract will fail.

Maintaining the Integrity of Grain Futures Contracts: The Economics of Manipulation and Its Prevention

Since the birth of grain futures markets, considerable attention has been paid to the danger of manipulation of futures prices. During the early years of futures trading, attempts to exploit the delivery process in order to cause an artificial price change were alleged to be common.1 Even more recently there have been several allegations of attempted manipulation, but the allegations have become infrequent with the refinement of self-regulatory and governmental regulatory techniques.2

Futures Contracts as a Merchandising Tool: The Role of Delivery as a Means of Ownership Transfer

As noted above, many futures industry participants believe that grain futures contracts are not, and should not be, an important merchandising tool. There are three reasons for examining the evidence for that belief. First, the data upon which the belief is based are misleading. Second, an intention to take delivery is sometimes cited as a rationale by traders who are long, and who have carried unusually large positions into the delivery month. Consequently, the enforcement of rules against manipulation requires an understanding of the rationality of using the futures market for merchandising purposes.1 Third, theoretical work by Jeffrey Williams at Stanford’s Food Research Institute implies that futures markets are a means of borrowing and lending the commodities underlying the futures contracts. Williams argues that hedgers do not use futures contracts to avoid risk, but instead to obtain or dispose of supplies of the spot commodity. The delivery process plays a crucial role in his models. It is the means by which commodity loans implicitly created by combinations of futures and spot positions are repaid. In other words, according to Williams the delivery process is an important means of allocating the physical commodity among its high value users just as bank loans are an important means of allocating supplies of capital. Thus, his models imply that a substantial fraction of futures contracts should be offset by delivery.2 But that does not appear to happen in practice.