Finance and Financial Management Commons^™

Tax Professionals' Perceptions Of Small Business Tax Law Complexity, Laura R. Ingraham, S. S. Karlinsky

Faculty Publications

The author’s report in this article on their study in questionnaire format that tested the perception of 89 small-business tax practitioners regarding the com- plexity of 37 tax provisions. They found overwhelming consistency on the five most complex and five least complex small-business tax provisions with partner- ships, estate and gift valuations, tax-deferred ex- changes, frequency of law changes, and retirement plans topping the hit parade. Progressive tax rates, estimated taxes, Social Security/self-employment taxes, corporate capital gain provisions, and cash ver- sus accrual method were uniformly and consistently perceived as the least complex. These results have tax policy implications. According …

Are Empowerment And Education Enough? Underdiversification In 401(K) Plans, James J. Choi, David Laibson, Brigitte C. Madrian

Faculty Publications

At the end of 2000, current and former employees of the energy trading company Enron Corporation held $2.1 billion in the firm’s 401(k) retirement savings plan. Sixty-two percent of that money was invested in Enron stock, then trading at $83 a share. In October 2001 Enron’s finances began to unravel as its accounting improprieties came to light. Enron stock plummeted over the next several weeks, and on December 2, 2001, the company declared bankruptcy, rendering its shares worthless. Thousands of Enron employees lost their jobs and a large fraction of their retirement wealth simultaneously.

Property Taxation Of Multifamily Housing: An Empirical Analysis Of Vertical And Horizontal Equity, Gary C. Cornia, Barrett A. Slade

Faculty Publications

This paper analyzes the uniformity of the property appraisal outcome for multifamily apartment complexes in Phoenix, Arizona. Specifically, it investigates vertical and horizontal equity and equity across assessment methods. Apartment transactions and assessed valuations are examined over a fiveyear period (1998–2002). Once possible bias in model specification is accounted for, no evidence of vertical inequity in the sample is found. However, there is modest evidence of horizontal inequity: the results suggest that complex size and geographic location are more difficult for the assessor to value uniformly. There is also inequity between small and large properties, as represented by two different …

The Persistence Of Earnings And Corporate Governance In Ipo Firms, Mary F. Calegari, H. A. Maretno

Faculty Publications

In this study, we investigate the earnings persistence in IPO firms by examining the two components of earnings: accruals and cash flows. We also analyze the impact of corporate governance on earnings and the two earnings components. In our comparison of the top and bottom quartiles based on the firms' earnings at the IPO year, we find that although the top quartile firms have a significantly positive accrual component in the IPO year, they eventually have the same negative accrual component of earnings as the bottom quartile firms in the second year after the IPO. In contrast, we find that …

Use Tax Collections, Laura R. Ingraham, K. R. Nunez, L. M. Wright

Faculty Publications

The article reports on a study which investigated the level of compliance with U.S. state use tax laws and the techniques employed by the states in order to enforce use tax. Most states utilize either of two forms of tax reporting and collection. These are: the introduction of a separate use tax form/return; or the use of a separate line on the state income tax return. It was observed that utilizing a separate line item on the state income tax return might cause a rise in the number of taxpayers.

Passive Decisions And Potent Defaults, James J. Choi, David Laibson, Brigitte C. Madrian, Andrew Metrick

Faculty Publications

Default options have an enormous impact on household choices. Such effects have now been extensively documented in the literature on 401(k) plans (Madrian and Shea 2001; Choi et al. 2002b, 2004). Defaults have been shown to affect participation, savings rates, rollovers, and asset allocation. For example, Choi et al. (2004) study three firms that use automatic enrollment. When employees at these firms are automatically enrolled in their 401(k) plan, only a tiny fraction opt out, producing participation rates exceeding 85 percent regardless of tenure. But when employees at these firms were not automatically enrolled, participation rates were significantly lower, ranging …

Can Individual Investors Beat The Market?, Joshua D. Coval, David A. Hirshleifer, Tyler Shumway

Faculty Publications

We document strong persistence in the performance of trades of individual investors. The correlation of the risk-adjusted performance of an individual across sample periods is about 10 percent. Investors classified in the top performance decile in the first half of our sample subsequently outperform those in the bottom decile by about 8 percent per year. Strategies long in firms purchased by previously successful investors and short in firms purchased by previously unsuccessful investors earn abnormal returns of 5 basis points per day. These returns are not confined to small stocks nor to stocks in which the investors are likely to …

Perceptions Of The Teacher–Leader In Modern Society: Insights From The Master Teacher’S Pedagogy, Stanley E. Fawcett, James C. Brau, Amydee M. Fawcett

Faculty Publications

Meeting the challenges of a modern era, including corporate scandal, government gridlock, and societal turmoil, requires a high level of effective leadership. In such an environment, the teacher–leader plays a critical role in cultivating the knowledge worker and learning organization. After all, the teacher–leader leverages the human resource by challenging and inspiring people to bring forth their best efforts and ideas in the quest to identify and implement creative solutions to society’s dilemmas. To understand the opportunities and challenges encountered in the teacher–leader paradigm, the pedagogy of a prototypical teacher was modeled and evaluated. As the ideal model of the …

Equilibrium Underdiversification And The Preference For Skewness, Todd Mitton, Keith Vorkink

Faculty Publications

We develop a one-period model of investor asset holdings where investors have heterogeneous preference for skewness. Introducing heterogeneous preference for skewness allows the model's investors, in equilibrium, to underdiversify. We find suppport for our model's three key implications using a dataset of 60,000 individual investor accounts. First, we document that the portfolio returns of underdiversified investors are substantially more positively skewed than those of diversified investors. Second, we show that the apparent mean-variance inefficiency of underdiversified investors can be largely explained by the fact that investors sacrifice mean-variance efficiency for higher skewness exposure. Furthermore, contrary to the asset-pricing predictions of …

Stock Market Liberalization And Operating Performance At The Firm Level, Todd Mitton

Faculty Publications

I use firm-specific measures of openness to foreign investors to study the impact of stock market liberalization on firm-level operating performance. In a sample of over 1,100 firms from 28 countries, firms with stocks that are open to foreign investors experience higher growth, greater investment, greater profitability, greater efficiency, and lower leverage. Strategies to address potential endogeneity suggest that the observed relationship, at least in part, reflects a causal effect of openness on operating performance.

Real And Illusory Value Creation By Insurance Companies, David F. Babbel, Craig B. Merrill

Faculty Publications

One of the fundamental tenets of financial economics is that insurance companies, just as other financial and non-financial firms, have a very strong incentive to maximize current shareholder value.1 This seemingly simple observation leads to a wide variety of managerial behavior.2 In this article we will review a simple decomposition of the value of an insurance company. The decomposition illuminates the motivation for a variety of strategies that can be observed in practice. These strategies run the gamut from accounting manipulation through risk transfer schemes to positive net present value (NPV) “project” selection. We will review these in some detail …

Early Decisions: A Regulatory Framework, John Beshears, James J. Choi, David Laibson, Brigitte C. Madrian

Faculty Publications

We describe a regulatory framework that helps consumers who have difficulty sticking to their own long-run plans. Early Decision regulations help long-run preferences prevail by allowing consumers to partially commit to their long-run goals, making it harder for a momentary impulse to reverse past decisions. In the cigarette market, examples of Early Decision regulations include restricting the locations or times at which cigarettes are sold, delaying the receipt of cigarettes following purchase, and allowing a consumer to choose in advance the legal restrictions on her own cigarette purchases. A formal model of Early Decision regulations demonstrates that Early Decisions are …

The Dynamics Of Market Entry: The Effects Of Mergers And Acquisitions On Entry In The Banking Industry, Allen N. Berger, Seth D. Bonime, Lawrence G. Goldberg, Lawrence J. White

Faculty Publications

We study the dynamics of market entry following mergers and acquisitions (M&As) using banking industry data. The findings suggest that M&As are associated with statistically and economically significant increases in the probability of entry. The data suggest that M&As affect the proportion of the markets with entry by about 10-20%. These findings also suggest that entry may be part of an "external" effect of M&As that helps supply credit to some relationship-dependent small business borrowers. Our results are robust to the use of alternative econometric methods, changes in specifications of the exogenous variables, and alteration of the data samples.

Employee Investment Decisions About Company Stock, James J. Choi, David Laibson, Brigitte C. Madrian, Andrew Metrick

Faculty Publications

Recent high-profile cases have illustrated the dangers of employee investment in company stock. These debacles are unlikely to be the last ones, or even the most severe. Companies with more than 50 percent of retirement assets in company stock are common, and fractions over 80 percent continue to prevail at such large companies as Procter & Gamble, Anheuser- Busch, and Pfizer.¹

The concentration of retirement wealth in company stock is a clear violation of diversification principles. Recently, several studies have quantified the economic costs of this concentration. Muelbroek (2002) uses a Sharperatio approach and finds that the average diversification …

Health Insurance, Labor Supply, And Job Mobility: A Critical Review Of The Literature, Jonathan Gruber, Brigitte C. Madrian

Faculty Publications

This paper provides a critical review of the empirical literature on the relationship between health insurance, labor supply, and job mobility. We review over 50 papers on this topic, almost exclusively written in the last 10 years. We reach five conclusions. First, there is clear and unambiguous evidence that health insurance is a central determinant of retirement decisions. Second, there is fairly clear evidence that health insurance is not a major determinant of the labor supply and welfare exit decisions of low income mothers. Third, there is fairly compelling evidence that health insurance is an important factor in the labor …

Surveying Cost Growth, Michael A. Greiner, Vince Sipple, Edward D. White

Faculty Publications

Cost growth that weapon systems incur throughout their acquisition life cycle concerns those who work in the acquisition environment. One way to reduce the amount of unexpected cost growth is to develop better cost estimates. In attaining better cost estimates though, it is often helpful to understand and account for potential cost drivers. Several cost studies, some of which specifically focus on the aircraft industry, have been performed documenting and investigating these growth factors. Overviews of these various cost growth studies are presented as other tools for the cost estimators and program managers.

Risky Loss Distributions And Modeling The Loss Reserve Pay-Out Tail, J. David Cummins, James B. Mcdonald, Craig B. Merrill

Faculty Publications

Although an extensive literature has developed on modeling the loss reserve runoff triangle, the estimation of severity distributions applicable to claims settled in specific cells of the runoff triangle has received little attention in the literature. This paper proposes the use of a very flexible probability density function, the generalized beta of the 2nd kind (GB2) to model severity distributions in the cells of the runoff triangle and illustrates the use of the GB2 based on a sample of nearly 500,000 products liability paid claims. The results show that the GB2 provides a significantly better fit to the severity data …

Plan Design And 401(K) Savings Outcomes, James J. Choi, David Laibson, Brigitte C. Madrian

Faculty Publications

We assess the impact of 401(k) plan design on four different 401(k) savings outcomes: participation in the 401(k) plan, the distribution of employee contribution rates, asset allocation, and cash distributions. We show that plan design can have an important effect on all of these savings outcomes. This suggests an important role for both employers in determining how to structure their 401(k) plans and government regulators in creating institutions that encourage or discourage particular aspects of 401(k) plan design.

For Better Or For Worse: Default Effects And 401(K) Savings Behavior, James J. Choi, David Laibson, Brigitte C. Madrian, Andrew Metrick

Faculty Publications

Seemingly minor changes in the way a choice is framed to a decision maker can generate dramatic changes in behavior. Automatic enrollment provides a clear example of such effects. Under automatic enrollment (also called negative election), employees are automatically enrolled in their company’s 401(k) plan unless the employees elect to opt out of the plan. This contrasts with the usual arrangement in which employees must actively choose to participate in their employer’s 401(k).

Do Venture Capitalists Add Value To Small Manufacturing Firms? An Empirical Analysis Of Venture And Nonventure Capital-Backed Initial Public Offerings, James C. Brau, Richard A. Brown, Jerome S. Osteryoung

Faculty Publications

We examine a set of small, venture capital (VC)-backed manufacturing firms and compare it to a control sample of nonVC-backed manufacturing firms going public between 1990 and 1996. We use the degree of underpricing, three-year sales growth, three-year cumulative stock return, and three-year survivability as measures of success. First, we test if the presence of VC backing results in significant differences in success between the two samples. Next, we test if certain VC and deal characteristics are discriminators within the VC-backed sample of firms. Despite previous literature, which argues for either inferior or superior VC post-initial public offering (IPO) performance, …

Microfinance: A Comprehensive Review Of The Existing Literature, James C. Brau, Gary M. Woller

Faculty Publications

Although the word finance is in the term microfinance, and the core elements of microfinance are those of the finance discipline, microfinance has yet to break into the mainstream or entrepreneurial finance literature. The purpose of this article is to introduce the finance academic community to the discipline of microfinance and microfinance institutions (MFIs). We provide a comprehensive review of over 350 articles and address the issues of MFI sustainability, products and services, management practices, clientele targeting, regulation and policy, and impact assessment.

Market Reaction To The Expiration Of Ipo Lockup Provisions, James C. Brau, David A. Carter, Stephen E. Christophe, Kimberly G. Key

Faculty Publications

Initial public offering (IPO) lockup agreements prevent insider sale of shares for specified periods of time (often 180 days). This study investigates share price reactions at and around the time the lockup agreements expire. Results indicate statistically significant negative abnormal returns in the event window surrounding the expiration date. The results are consistent with informational asymmetries and decreasing incentive alignment between insiders and general shareholders. In addition, multivariate analysis identifies several variables that help explain these abnormal returns.

Do Out-Of-State Buyers Pay More For Real Estate? An Examination Of Anchoring-Induced Bias And Search Costs, Val E. Lambson, Grant R. Mcqueen, Barrett A. Slade

Faculty Publications

We explore the questions of whether and why out-of-state buyers pay more for real estate than their in-state counterparts. Theoretically, we develop a model capable of explaining a premium if out-of-state buyers have high search costs, upwardly biased beliefs about prices or an unusually short time horizon to purchase. Empirically, we find that out-of-state buyers pay a statistically significant and economically meaningful premium for apartment complexes in the Phoenix area. We also find some evidence consistent with the premium being driven by high search costs, biased beliefs (anchoring) and haste associated with out-of-state buyers.

Employee Stock Purchase Plans, Gary V. Engelhardt, Brigitte C. Madrian

Faculty Publications

Employee stock purchase plans (ESPPs) are designed to promote employee stock ownership broadly within the firm and provide another tax-deferred vehicle for individual capital accumulation in addition to traditional pensions, 401(k)s, and stock options. We outline the individual and corporate tax treatment of ESPPs and the circumstances under which ESPPs will be preferred to cash compensation from a purely tax perspective. We then examine empirically ESPP participation using administrative data from 1997-2001 for a large health services company that employs approximately 30,000 people. The picture that emerges from the analysis of these data suggests that there is substantial non-participation in …

The Effect Of Transaction Size On Off-The-Run Treasury Prices, David F. Babbel, Craig B. Merrill, Mark F. Meyer, Meiring De Villiers

Faculty Publications

A price pressure effect is implied by segmentation in the market for a security. An empirical property of a segmented market is that the price of the security is sensitive to supply and demand conditions for that specific security, absent changes in risk and absent any new information. This paper examines intra-day trading data from the inter-dealer broker market for U.S. Treasury securities and finds that there is a price pressure effect in the off-the-run Treasury market. Thus, securities that would appear to be very close substitutes, i.e., on-the-run and off-the-run Treasury bonds, behave as if there is some degree …

Initial Public Offerings: An Analysis Of Theory And Practice, James C. Brau, Stanley E. Fawcett

Faculty Publications

We survey 336 CFOs to compare practice to theory in the areas of IPO motivation, timing, underwriter selection, underpricing, signaling, and the decision to remain private. We find the primary motivation for going public is for acquisition purposes. CFOs base IPO timing on overall market conditions, are well-informed regarding expected underpricing, and feel underpricing compensates investors for taking risk. The most important positive signal is past historical earnings, followed by underwriter certification. CFOs have divergent opinions about the IPO process depending on firm-specific characteristics. Finally, we find the main reason for remaining private is to preserve decision-making control and ownership.

Asset Pricing Theory And The Valuation Of Canadian Paintings, Douglas J. Hodgson, Keith Vorkink

Faculty Publications

The valuation of Canadian paintings is analysed empirically. Using a sample of auction prices for major Canadian painters for the period 1968–2001, we run hedonic regressions to analyse the influence of various factors, including painter identity, on auction prices, as well as to construct a market price index. This index is used in a second-stage analysis in which we analyse the properties of Canadian art viewed as an investment asset. We apply standard asset pricing theory, as incorporated in the capital asset pricing model (CAPM), to the analysis of price movements in the market for Canadian paintings.

Whence Garch? A Preference-Based Explanation For Conditional Volatility, Grant Mcqueen, Keith Vorkink

Faculty Publications

We develop a preference-based equilibriumasset pricing model that explains low frequency conditional volatility. Similar to Barberis, Huang, and Santos (2001), agents in our model care about wealth changes, experience loss aversion, and keep a mental scorecard that a¤ects their level of risk aversion. A new feature of our model is that when perturbed by unexpected returns, investors become temporarily more sensitive to news. Gradually, investors become accustomed to the new level of wealth, restoring prior levels of risk aversion and news sensitivity. The state-dependent sensitivity to news creates the type of volatility clustering found in low frequency stock returns. We …

Corporate Governance And Dividend Policy In Emerging Markets, Todd Mitton

Faculty Publications

In a sample of 365 firms from 19 countries, I show that firms with stronger corporate governance have higher dividend payouts, consistent with agency models of dividends. In addition, the negative relationship between dividend payouts and growth opportunities is stronger among firms with better governance. I also show that firms with stronger governance are more profitable, but that greater profitability explains only part of the higher dividend payouts. The positive relationship between corporate governance and dividend payouts is limited primarily to countries with strong investor protection, suggesting that firm-level corporate governance and country-level investor protection are complements rather than substitutes.

Return Distributions And Improved Tests Of Asset Pricing Models, Keith Vorkink

Faculty Publications

We compare and contrast some existing ordinary least squares (OLS)- and generalized method of moments (GMM)-based tests of asset pricing models with a new more general test. This new test is valid under the assumption that returns are elliptically distributed, a necessary and sufficient assumption of the linear capital asset pricing model (CAPM). This new test fails to reject the CAPM on a dataset of stocks sorted by market valuations, whereas similar tests constructed from OLS and GMM estimation methods reject the linear CAPM. We also find that outliers reduce the OLSestimated mispricing of the linear CAPM on monthly returns …