Research in Finance: Volume 20

Eleven papers in this volume present some current interesting and important research in finance. Based upon the CAPM, Chen and Kane show that double taxation and differential tax rates on personal and capital-gains income affect corporate stock values and financial policies in nonneutral ways. Sengupta shows tax evasion decisions of a monopolist in a price-ceiling regulatory environment. In their paper, Osterberg and Thomson empirically examine the impact of state-level depositor preference laws on resolution type and costs for all operating FDIC-BIF insured commercial banks that were closed or required FDIC financial assistance from January 1986 through December 1992. Peek and Wilcox show that during periods of international financial crises or of domestic economic stress, the government-sponsored enterprises (GSEs) are well suited to stabilize mortgage markets. In their paper, Chen, Robinson and Siems empirically show the association between banks’ subordinated debt and their loan sales activities and its implications in the transmission mechanism of monetary policy.

This paper uses the capital asset pricing model to show that, in realistic circumstances, double taxation and differential tax rates on personal and capital-gains income affect corporate stock values and financial policies in non-neutral ways. This non-neutrality holds whenever inflation is uncertain and tax-avoidance activity is neither costless nor riskless. The model also allows us to explore how a series of frequently proposed changes in the interplay of corporate and personal taxes would affect corporate dividend payouts and debt usage. Our analysis clarifies that conscientious efforts to integrate corporate and personal tax rates must make supporting changes in the size and character of capital-gains tax preferences built into the tax code.

This paper uses a simple analytic model to analyze the problem of tax evasion by a monopolist subject to price ceiling regulation. Prior research had explored tax evasion decisions of a monopolist in a non-regulatory environment. However, since monopolies often operate in a regulatory environment, it is important to examine how a regulated monopolist makes its tax reporting decisions. This paper shows that under certain conditions, an increase in the effective price ceiling increases tax evasion. The production decision of the monopolist however is unaffected by tax evasion parameters. A social planner, attempting to maximize social welfare, subject to a revenue constraint, can achieve optimality in a number of ways; with or without full compliance.

The Omnibus Budget Reconciliation Act of 1993 included depositor preference legislation intended to reduce Federal Deposit Insurance Corporation (FDIC) resolution costs. However, depositor preference might induce an offsetting reaction by general creditors and may affect resolution type.

We examine the empirical impact of state-level depositor preference laws on resolution type and costs with call-report data and FDIC data for all operating FDIC-BIF insured commercial banks that were closed or required FDIC financial assistance from January 1986 through December 1992. Our major findings are that depositor preference has: (1) tended to increase resolution costs; and (2) induced the FDIC to choose assisted mergers over liquidations.

In recessions, depository institutions accounted for most declines in mortgage flows. Recently, they partially offset their withdrawals from primary markets with accumulations of mortgage-backed securities. Increases in direct flows into agency and private pools also countered the declining flows elsewhere. As the less-procyclical secondary mortgage markets grew and matured, they increasingly stabilized mortgage flows. During periods of international financial crises or of domestic economic stress, GSEs may have been particularly effective in stabilizing mortgage markets and moderating business cycles.

While subordinated debt can be used to increase market discipline on banks by playing a corporate governance role in the presence of a federal safety net that encourages risk taking, it also has implications for banks’ loan sales. Using two measures of banks’ loan sales activity, we find greater proportions of subordinated debt increase the likelihood that banks engage in loan sales activity, and are associated with greater proportions of loan sales. Our results have implications about banks’ lending efficiency as well as their transparency and disclosure policies that could play a role in the transmission mechanism of monetary policy.

In this paper the techniques of zero-non-zero (ZNZ) patterned vector autoregressive modelling are utilized to examine two issues associated with the European single currency – the euro. First, “Granger causality” is employed to examine the causal linkages between the euro exchange rate, the euro area money supply and the gross domestic product (GDP) growth in the euro area. Second, we examine the hypothesis that the euro has become a major influence on international stock markets by testing for the causal relationships between movements in the euro exchange rate, the U.K. pound exchange rate and the London stock market index.

Our paper presents an extension of the Diamond-Dybvig (1983) model of bank runs to an open market economy. We examine domestic banks that are subject to potential runs by domestic depositors who worry that they will not be able to be repaid in full, because the domestic banks may not be able to refinance in the international financial markets. A loss in confidence in the banking system might precipitate a bank run. A bank run might be costly to safety net guarantors, for example, the central bank. Further, a bank run might lead to a breaking of the fixed exchange rate. Our model shows that adding central bank and International Monetary Fund guarantees, increasing long term debt as well as more equity financing reduces financial fragility, but consistent with economic intuition, these policy levers cannot eliminate the possibility of a bank run or a banking crisis leading to a currency crisis.

This study employs a new time series representation of persistence in conditional mean and variance to test for the existence of the long memory property in the currency futures market. Empirical results indicate that there exists a fractional exponent in the differencing process for foreign currency futures prices. The series of returns for these currencies displays long-term positive dependence. A hedging strategy for long memory in volatility is also discussed in this article to help the investors hedge for the exchange rate risk by using currency futures.

We develop a model to estimate salary-based premiums for pension benefit guarantees by simultaneously considering a stochastic interest rate and three practical pension plan termination conditions. We show the relationship among premium rates, a plan’s funding level, sponsoring firm’s capital position, early lapse, and a participant’s years of service. We also show how the regulatory intervention policy interacts with a plan’s funding level and a sponsor’s capital position and how it affects the pension insurance cost.

This paper explores dividend announcements based on information hypothesis. We explore in particular whether or not information signaling theory existed in Taiwan. We also explore the free cash flow hypothesis. In order to eliminate affecting factors, we target companies with irregular dividends as research samples, just like those with specially designated dividends (SDD). We examine whether or not those proceeds may be deemed as future earnings prospection. In this paper we study mainly dividend announcements made during stockholder’s meetings of the companies listed in the Taiwan Stock Exchange (TSE) or R.O.C. Over-the-Counter Securities Exchange (ROSE). We apply event study as means of analyzing abnormal returns of the companies. In addition we use the GARCH model with traditional ordinary least square to estimate the market model. The results indicate that SDDs are considered positive signals by the national exchange, TSE. In addition, we also show that the first-time SDD does transmit a positive signal to the market regarding the firm’s future cash flow, and that the SDD of no payment in the previous three years is negative. Furthermore, we prove that low Q firms have greater market reaction than high Q firms in announcement period. The free cash flow hypothesis and firm size effects could not be verified in Taiwan.

In this study, we produce mean-variance efficient portfolios for various universes in the U.S. equity market, and show that the use of a composite of analyst earnings forecast, revisions, and breadth variable as a portfolio tilt variable and an R&D quadratic term enhances stockholder wealth. The use of the R&D screen creates portfolios in which total active return generally rise relative to the use of the analyst variable. Stock selection may not necessarily rise as risk index and sector index returns are affected by the use of the R&D quadratic term. R&D expenditures of corporations may be integrated into a mean-variance efficient portfolio creation system to enhance stockholder returns and wealth. The use of an R&D variable enhances stockholder wealth relative to the use of capital expenditures or dividends as the quadratic term. The stockholder return implications of the R&D quadratic variable are particularly interesting given that most corporations allocate more of their resources to capital expenditures than R&D.