Organized equity markets in Germany

The German financial system is the archetype of a bank-dominated system. This implies that organized equity markets are, in some sense, underdeveloped. The purpose of this paper is, first, to describe the German equity markets and, second, to analyze whether it is underdeveloped in any meaningful sense. In the descriptive part we provide a detailed account of the microstructure of the German equity markets, putting special emphasis on recent developments. When comparing the German market with its peers, we find that it is indeed underdeveloped with respect to market capitalization. In terms of liquidity, on the other hand, the German equity market is not generally underdeveloped. It does, however, lack a liquid market for block trading. Klassifikation: G 51 . Revised version forthcoming in "The German Financial System", edited by Jan P. Krahnen and Reinhard H. Schmidt, Oxford University Press

Do Investors Value Insider Trading Laws? International Evidence

The article presents a simple agency model of the relationship between corporate valuation and insider trading laws. The article then investigates the model’s three testable hypotheses using firm-level data from a cross-section of developed countries. I find that more stringent insider trading laws and enforcement are associated with greater corporate valuation among the sample firms in common countries, while they are generally irrelevant to corporate valuation for the sample firms in civil law countries. This puzzling dichotomy is robust to various alternative specifications and to controlling for a wide range of potentially omitted variables. The result for the firms in common law countries is consistent with the claim that insider trading laws can help to reduce corporate agency costs. I also find that insider trading laws and cash flow ownership appear to be complementary means to reduce agency costs, contrary to my hypothesis that they are substitute mechanisms for controlling agency costs; however, this result is generally statistically insignificant. Finally, I confirm prior findings of an “incentive effect” of greater cash flow ownership by controlling shareholders.http://deepblue.lib.umich.edu/bitstream/2027.42/57217/1/wp837 .pd

When an event is not an event : the curious case of an emerging market

Shares trading in the Bolsa mexicana de Valores do not seem to react to company news. Using a sample of Mexican corporate news announcements from the period July 1994 through June 1996, this paper finds that there is nothing unusual about returns, volatility of returns, volume of trade or bid-ask spreads in the event window. This suggests one of five possibilities: our sample size is small; or markets are inefficient; or markets are efficient but the corporate news announcements are not value-relevant; or markets are efficient and corporate news announcements are value-relevant, but they have been fully anticipated; or markets are efficient and corporate news announcements are value-relevant, but unrestricted insider trading has caused prices to fully incorporate the information. The evidence supports the last hypothesis. The paper thus points towards a methodology for ranking emerging stock markets in terms of their market integrity, an approach that can be used with the limited data available in such markets

Differential Informativeness of Accrual Measures to Analysts’ Forecast Accuracy

This paper evaluates whether analysts incorporate formal measures of earnings quality into their earnings forecasts. It examines whether the accrual ratio and abnormal accruals, measured with the Modified Jones (1991) Model of discretionary accruals, differentially inform analysts’ earnings forecasts. It uses the accuracy of analysts’ forecast as a context in which to evaluate how well analysts incorporate effects of the information contained in accrual ratio and abnormal accruals. The results indicate that the accrual ratio is negatively related to the absolute value of analysts’ forecast errors while the Modified Jones (1991) Model of discretionary accruals have virtually no economic effect on analysts’ forecast error. The insignificant effect of discretionary accruals on analysts’ forecast may be attributed to analysts having already incorporated the information therein in their earnings forecasts, effect of the accrual anomaly having been largely arbitraged away by market participants or both. This paper contributes to the research on analysts’ earnings forecast and earnings quality and helps bridge the gap between practice and theory by demonstrating the differential impact of discretionary accruals (favored by academics) and the accrual ratio (favored by analysts) on analysts’ forecast accuracy. This study informs researchers and policy makers interested in better understanding how analysts affects the financial markets including how they may have learned from previously documented market anomalies such as the accrual anomaly. This is important as ultimately, efficient economy-wide capital allocation decisions are based partly on outputs of analysts’ forecasting processes

Financing Constraints and Corporate Investment

Most empirical models of investment rely on the assumption that firms are able to respond to prices set in centralized securities markets (through the "cost of capital" or "q"). An alternative approach emphasizes the importance of cash flow as a determinant of investment spending, because of a "financing hierarchy," in which internal finance has important cost advantages over external finance. We build on recent research concerning imperfections in markets for equity and debt. This work suggests that some firms do not have sufficient access to external capital markets to enable them to respond to changes in the cost of capital, asset prices, or tax-based investment incentives. To the extent that firms are constrained in their ability to raise funds externally, investment spending may be sensitive to the availability of internal finance. That is, investment may display "excess sensitivity" to movements in cash flow. In this paper, we work within the q theory of investment, and examine the importance of a financing hierarchy created by capital-market imperfections. Using panel data on individual manufacturing firms, we compare the investment behavior of rapidly growing firms that exhaust all of their internal finance with that of mature firms paying dividends. We find that q values remain very high for significant periods of time for firms paying no dividends, relative to those for mature firms. We also find that investment is more sensitive to cash flow for the group of firms that our model implies is most likely to face external finance constraints. These results are consistent with the augmented model we propose, which takes into account different financing regimes for different groups of firms. Some extensions and implications for public policy are discussed at the end.

Productivity and equity returns: A century of evidence for 9 OECD countries

The share market boom in the 1990s is often linked to the acceleration in labour productivity over the same period. This paper explores the suggestions that labour productivity may be an inaccurate measure of firm’s cash flow which underlies equity valuations, and that innovations in productivity in the 1990s may have had only have temporary effects on capital productivity, the key element of the more correct measure of cash flow. Using a century of data for the OECD countries it is shown empirically that the link of productivity to share returns is indeed strongest for capital productivity, but generally the link is weaker that is sometimes maintained in the literature

How efficiency shapes market impact

We develop a theory for the market impact of large trading orders, which we call metaorders because they are typically split into small pieces and executed incrementally. Market impact is empirically observed to be a concave function of metaorder size, i.e., the impact per share of large metaorders is smaller than that of small metaorders. We formulate a stylized model of an algorithmic execution service and derive a fair pricing condition, which says that the average transaction price of the metaorder is equal to the price after trading is completed. We show that at equilibrium the distribution of trading volume adjusts to reflect information, and dictates the shape of the impact function. The resulting theory makes empirically testable predictions for the functional form of both the temporary and permanent components of market impact. Based on the commonly observed asymptotic distribution for the volume of large trades, it says that market impact should increase asymptotically roughly as the square root of metaorder size, with average permanent impact relaxing to about two thirds of peak impact.Comment: 34 pages, 3 figure