Ronald W. Best

Prior Information and the Market Reaction to Dividend Changes

We investigate two hypotheses regarding the information content of dividend change announcements. The first is that the “importance” of information signaled by a dividend change depends on the reliability of earnings forecasts existing before the dividend announcement. The second hypothesis is that the stock price reaction to dividend change announcements is related to earnings forecast error as of the time of the dividend announcement. Our results reveal that dividend increases convey more information for firms in which financial analysts least accurately predict earnings. The results also indicate that dividend increase and decrease announcements provide market participants with information which, on average, allows them to differentiate between firms on the basis of future earnings realizations. These differential information effects are shown to be robust to price, size, dividend yield, and overinvestment effects.

Value stocks and market efficiency

We form portfolios based on firm book-to-market equity ratios and apply stochastic dominance tests. Value (high book-to-market) portfolios dominate low book-to-market portfolios. Thus, value stocks are not rationally priced by the market and the book-to-market ratio is not an efficiently priced proxy for equity risk. We also find that the superior performance of value stocks is not due to the January effect.

The Sharpe Ratio and Long-Run Investment Decisions

We investigate the empirical relationship between the Sharpe ratio and the investment horizon for portfolios of small stocks, large stocks, and corporate bonds. Sharpe ratios are calculated for holding periods of one through 25 years using returns generated by a simulation procedure that preserves serial correlation present in actual returns. We show that relative portfolio rankings vary with the investment horizon and portfolio rankings for autocorrelated returns are different from those for independent returns. Our results indicate that Sharpe ratios computed by investment advisory services such as Morningstar Mutual Funds that are based on short-term return intervals must be interpreted with care by long-term investors.

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with “windows of opportunity” arguments since they suggest that SEOs are “timed” to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.

Optimal Asset Allocation Across Investment Horizons

We investigate the optimal portfolio mix of bonds and stocks across investment horizons. Sharpe ratios are computed using simulated returns for portfolios ranging from 100% bonds to 100% stocks where the portfolio mix is varied in increments of five percentage points. Holding periods from one to 25 years are examined under alternate return correlation assumptions. The optimal mix of bonds and stocks is identified as the portfolio with the highest Sharpe ratio for each holding period. The results show that optimal asset allocation varies across investment horizons and depends on whether security returns are independent or autocorrelated. If returns are independent over time, the weight of bonds increases as the investment horizon lengthens. If returns are autocorrelated over time, the weight of stocks increases as the investment horizon grows longer.

Swiss Security Return Performance and the Investment Horizon

Investors often hold foreign securities in order to diversify their portfolios. This raises the issue of whether there are unique risks associated with long-term investments in non-domestic securities. The authors investigate the empirical relationship between the Sharpe ratio and the investment horizon for portfolios of Swiss stocks and bonds and then compare these results to U.S. stock and bond portfolios. Sharpe ratios are calculated for holding periods of one to 25 years under the contrasting assumptions that returns are independent or auto-correlated. The results for Swiss securities are very similar to those for U.S. securities. Under independent returns, bonds outperform stocks for longer time horizons, while for auto-correlated returns, equities outperform bonds for all holding periods.