Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 CAPITAL BUDGETING ANALYSIS IN WHOLLY OWNED SUBSIDIARIES Christine Hsu California State University, Chico Abstract Since the common stock of a wholly owned subsidiary contributes to the holding parent's debt capacity, the value of the parent's debt-related tax shields must be considered when evaluating new investments at the subsidiary level. If financial managers fail to consider the subsidiary's equity risk, resources will be misallocated across subsidiaries and firm value will decline. If financial managers treat the subsidiary as if it were an independent firm and fail to recognize the tax shields, new investments with positive net present value will be rejected and firm value will not be maximized. With the objective to improve capital budgeting analysis for wholly owned subsidiaries, this paper proposes an equity hurdle rate that accounts for not only the subsidiary's equity risk, but also the value of debt capacity created by the subsidiary's common stocks. This risk-adjusted cost of equity is derived in such a way that it is consistent with the goal of value maximization in financial management.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 ESTIMATING SYSTEMATIC RISK: THE CHOICE OF RETURN INTERVAL AND ESTIMATION PERIOD Phillip R. Daves The University of Tennessee Michael C. Ehrhardt The University of Tennessee Robert A. Kunkel University of Wisconsin at Oshkosh The authors thank Ray DeGennaro, Ron Shrieves, and Jim Wansley for helpful comments. Abstract Capital budgeting is one of the most important strategic decisions that face financial managers. It is the process where the firm identifies, analyzes, and selects long-term projects. One popular technique to evaluate whether the project should be undertaken is the net present value method. A key ingredient of net present value is an accurately estimated weighted-average-cost-of-capital that is used to discount the future cash flows. The most difficult component of the weighted-average-cost-of-capital to calculate is the cost of equity. One approach to estimate the cost of equity is the Capital Asset Pricing Model approach where the financial manager estimates the firm's beta. A time-series regression is often used to estimate the beta and requires the financial manager to select both a return interval and an estimation period. This study examines the return interval and estimation period the financial manager should select when estimating beta. The results show that the financial manager should select the daily return interval and an estimation period of three years or less.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 HISTORICAL RETURN DISTRIBUTIONS FOR CALLS, PUTS, AND COVERED CALLS Gary A. Benesh Florida State University William S. Compton Eastern Illinois University Abstract Historical return distributions are useful for assessing the risks and potential rewards associated with investing in different financial instruments. While an abundance of such information exists for stocks and bonds, historical return information for common option strategies is limited and often difficult to interpret as presented. This paper attempts to fill this void by providing historical return distributions for calls, puts, and covered calls in an easily interpretable format. The information provided should prove useful to prospective investors as well as in a pedagogical setting.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 AN EMPIRICAL ANALYSIS OF REACTIONS TO DIVIDEND POLICY CHANGES FOR NASDAQ FIRMS Patricia A. Ryan Colorado State University Scott Besley University of South Florida Hei Wai Lee University of Michigan-Dearborn Patricia A. Ryan would like to express gratitude to her dissertation committee: Scott Besley (Chair), Richard Meyer, Kenneth Wieand, George Kanatas, and Sang Sub Lee for their assistance and support. Abstract This study further examines the information content of dividend policy by concentrating on the rationale for the initiation or omission of dividend payments for NASDAQ firms. Cross-sectional weighted least squares regression provides strong support for the dividend signaling hypothesis, and only limited support for the free cash flow argument, in explaining stock price reactions to announcements of dividend policy changes. The use of an improved event study methodology that controls for fluctuations in idiosyncratic risk around the announcement, documents significant wealth and variance effects upon the initiation or omission of dividends by NASDAQ firms.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 THE TEMPORAL BEHAVIOR OF RISK AND REQUIRED RETURN FOLLOWING ANNOUNCEMENTS OF LEVERAGE-CHANGING SECURITY TRANSACTIONS James E. Pawlukiewicz Xavier University Julie A.B. Cagle Xavier University Shelly E. Webb Xavier University Abstract Brown, Harlow and Tinic (BHT [8]) examine the relationship between risk and expected returns of common stock in the aftermath of large price movements. They find support for the hypothesis that when temporary changes in uncertainty follow seemingly major financial events, subsequent stock returns are positively correlated with the shift in return volatility. The also find support for the notion that ex ante stock returns incorporate a premium for increases in parameter (i.e. beta) uncertainty associated with these events. The price changes considered in the BHT study were determined by spikes exceeding 2.5% in the market-model residual series. The specific information events causing these spikes were unknown. This research extends that of BHT by examining the risk-return relationship following known information events: common stock sales, debt sales, and repurchases of common stock and debt. The results suggest that common stock sales, debt sales, and common stock repurchases are typically followed by a reduction in common stock return variability and that at least a part of this risk reduction is persistent. There is some evidence that the post-announcement cumulative prediction errors are positively related to changes in systematic risk and that the precision with which systematic risk is estimated is also priced by the market.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 THE SIGNALLING EFFECTS OF BANK LOAN-LOSS RESERVE ADDITIONS Gay Hatfield University of Mississippi Carol Lancaster University of Richmond The authors would like to thank the referee and participants at the annual Eastern Finance Association meeting. Hatfield recognizes the partial support of a Business School summer research grant. We assume responsibility for all errors. Abstract This study examines the market's reaction to announcements of additions to the Loan Loss Reserve (LLR) account resulting from diverse problems in a bank's loan portfolio which are unrelated to an international debt crisis. For the overall sample, with no division by type of loan, the reaction to an increase in LLRs is negative and statistically significant before the announcement; however, it turns positive and remains statistically significant for several days afterwards. Viewing each category individually, the results vary. The largest statistically significant results are for Lesser Developed Country Loans and Foreign and Domestic Loans (positive reaction) and combination Real Estate and Energy Loans (negative reaction). A division of the data into two sub-samples, before and after 1987, indicates that investors appear to be more discerning of individual BHCs' circumstances surrounding announcements after 1987.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 THE PERFORMANCE OF GLOBAL AND INTERNATIONAL MUTUAL FUNDS Arnold L. Redman The University of Tennessee-Martin N.S. Gullett The University of Tennessee-Martin Herman Manakyan Western Kentucky University Abstract This study examines the risk-adjusted returns using Sharpe's Index, Treynor's Index, and Jensen's Alpha for five portfolios of international mutual funds and for three time periods: 1985 through 1994, 1985-1989, and 1990-1994. The benchmarks for comparison were the U. S. market proxied by the Vanguard Index 500 mutual fund and a portfolio of funds that invest solely in U. S. stocks. The results show that for 1985 through 1994 the portfolios of international mutual funds outperformed the U. S. market and the portfolio of U. S. mutual funds under Sharpe's and Treynor's indices. During 1985-1989, the international fund portfolio outperformed both the U. S. market and the domestic fund portfolio, while the portfolio of Pacific Rim funds outperformed both benchmark portfolios. Returns declined below the stock market and domestic mutual funds during 1990-1994.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 A STATISTICAL COMPARISON OF VALUE AVERAGING VS. DOLLAR COST AVERAGING AND RANDOM INVESTMENT TECHNIQUES Paul S. Marshall Widener University Abstract As the title suggests, this paper compares two "formula" or mechanical investment techniques, dollar cost averaging and a relatively new proposal, value averaging, to a form of random investing to determine if any technique yields superior investment performance. Results indicate that value averaging does provide superior expected investment returns when investment prices are quite volatile and over extended investment time horizons with little or no increase in risk. These results are quite surprising based on other research supporting the Efficient Market Hypothesis and the fact that any actual performance attributed to value averaging does not result from any temporary inefficiency in market prices.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 THE EFFICACY OF EVENT-STUDY METHODOLOGIES: MEASURING EREIT ABNORMAL PERFORMANCE UNDER CONDITIONS OF INDUCED VARIANCE Michael J. Seiler Hawaii Pacific University Abstract Several papers have identified the hazards associated with event-induced variance, yet event studies continue to ignore the problem. This study demonstrates that the most commonly used abnormal return detection methods reject the null hypothesis of zero abnormal returns too often. This causes researchers to conclude the detection of abnormal performance when none is present. Two easy to employ alternative methods are proposed that are relatively unaffected by event-induced variance.

Journal of Financial and Strategic Decisions Volume 13, Number 1   Spring 2000 THE STOCK MARKET REACTION OF GERMAN AND AMERICAN COMPANIES TO A POTENTIAL GERMAN UNIFICATION Oliver Schnusenberg Florida Atlantic University The author wishes to thank Jeff Madura, Terry Skantz, and two anonymous referees for helpful comments and suggestions. Abstract This paper examines the abnormal returns associated with German firms and with American MNCs with a presence in Germany in response to the fall of the Berlin Wall on November 9, 1989. German firms exhibit a positive abnormal return of 2.69 percent in the week immediately following the event and negative abnormal returns of 0.67 percent in the year following the event, indicating an initial overestimation of their ability to profit from newly arising opportunities. Applying an SUR methodology, American firms with a presence in Germany exhibit negative abnormal returns of 0.52 percent on the event day. These abnormal returns are inversely related to firm size, and are not attributable to increases in either systematic or bankruptcy risk. I hypothesize that negative abnormal returns of American MNCs operating in Germany are attributable to a potential competitive disadvantage of American versus German firms resulting from information asymmetries or a “first-mover” advantage.

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