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The average FDIC loss to selling a failed bank is 28% of assets. We document that failed banks are predominantly sold to bidders within the same county, with similar assets business lines, when these bidders are well capitalized. Otherwise, they are acquired by less similar banks located further away. We interpret these facts within a model of auctions with budget constraints, in which poor capitalization of some potential acquirers drives a wedge between their willingness and ability to pay for failed banks. We document that this wedge drives misallocation, and partially explains the FDIC losses from failed bank sales. This article is protected by copyright. All rights reserved

Using a novel measure of contract strictness based on the ex-ante probability of a covenant violation, I investigate how lender-specific shocks impact the strictness of the loan contract that a borrower receives. Exploiting between-bank variation in recent portfolio performance, I find evidence that banks write tighter contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting borrowers are in different industries and geographic regions than the current borrower. The effects of recent defaults persist after controlling for bank capitalization, although compression in bank equity is also strongly associated with tighter contracts. The evidence is most consistent with lenders using their default experience to make inference about their screening ability and adjusting contracts accordingly. Finally, contract tightening is most pronounced for borrowers who are dependent on a relatively small circle of lenders, with a one standard deviation increase in lender defaults implying covenant tightening nearly equivalent to that of a two-notch downgrade in the borrower's own credit rating.

This paper demonstrates that the equilibrium impact of capital gains taxes reflects both the capitalization effect (i.e., capital gains taxes decrease demand) and the lock-in effect (i.e., capital gains taxes decrease supply). Depending on time periods and stock characteristics, either effect may dominate. Using the Taxpayer Relief Act of 1997 as our event, we find evidence supporting a dominant capitalization effect in the week following news that sharply increased the probability of a reduction in the capital gains tax rate and a dominant lock-in effect in the week after the rate reduction became effective. THIS PAPER JOINTLY TESTS two effects of capital gains taxation on equity trading: a demand-side capitalization effect and a supply-side lock-in effect. While previous studies have tested these effects separately, to the best of our knowledge this is the first study to evaluate them jointly and empirically document the relative dominance of each effect surrounding a change in a tax rate. Employing an equilibrium approach, we show that these effects’ net tax impact on asset prices is ambiguous. Evaluating returns and trading volume around the 1997 reduction in the capital gains tax rate, we find evidence that the capitalization and the lock-in effects jointly affect trading. In particular, the capitalization effect dominates the lock-in effect in the week following an increase in the probability of a reduction in the capital gains tax rate, as buyers respond to information that future capital gains tax rates will be lower. The lock-in effect, however, dominates the capitalization effect after the rate reduction actually becomes effective. Taxation is one of the most prevalent market frictions in financial markets, affecting investors’ decisions and distorting the valuation of assets. Capital gains taxes in particular play an important role in determining an investor’s trading strategies and can ultimately affect asset prices. Because investors

This paper provides direct evidence supporting the tax-loss selling hypothesis as an explanation of the January effect. Examining turn-of-the-year return and volume patterns for municipal bond closed-end funds, which are held mostly by tax-sensitive individual investors, we document a January effect for these funds, but not for their underlying assets. We provide evidence that this effect can be largely explained by tax-loss selling activities at the previous year-end. Moreover, we find that funds associated with brokerage firms display more tax-loss selling behavior, suggesting that tax counseling plays a role. AMONG THE NUMEROUS STOCK RETURN ANOMALIES, probably none has generated more interest than that of the "turn-of-the-year" or "January" effect, the phenomenon in which small capitalization stocks realize unusually high returns in early January.1 The literature offers a number of hypotheses to explain this phenomenon including the tax-loss selling hypothesis, the window dressing hypothesis, the insider trading (information release) hypothesis, and the seasonality of the risk-return relation hypothesis. Given existing evidence in some support for the first two hypotheses, the debate continues with respect to which of these, the tax-loss selling of individual investors or the window dressing of

This study examines the behavior of a small stock market with circuit breakers and with a one-hour preauction order imbalance disclosure during the October 1987 crash. The crash and its aftershocks lasted for a week and selling pressure was concentrated in higher beta, larger capitalization, and lower leverage firm stocks. Circuit breakers when implemented reduced the next-day opening order imbalance and the initial price loss; however, they had no effect on the long-run response. Some price overreaction and reversal phenomena also are documented. Copyright 1993 by American Finance Association.

We examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news. We find that a small firm portfolio contains a large proportion of marginal firms-firms with low production efficiency and high financial leverage. We construct two size-matched return indices designed to mimic the return behavior of marginal firms and find that these return indices are important in explaining the time-series return difference between small and large firms. Furthermore, risk exposures to these indices are as powerful as log(size) in explaining average returns of size-ranked portfolios. WHY DO SMALL CAPITALIZATION stocks earn higher mean returns than large capitalization stocks? One view is that small and large stocks have different sensitivities to the risk factors important for pricing assets (see Chan, Chen, and Hsieh (1985) and Huberman, Kandel, and Karolyi (1987)).1 This view emphasizes that the risk differences between small and large stocks arise from the differences in their time series responses to changes in the underlying risk factors. Chan, Chen, and Hsieh (1985) find that small firms are more exposed to production risk and changes in the risk premium. Huberman, Kandel, and Karolyi (1987) find that returns of firms within the same size range tend to respond to risk factors in similar ways, and their returns tend to move together. Although these studies have shown that there are risk differences between small and large firms, they do not suggest why. Smallness by itself does not necessarily imply higher risk, and differences in market capitalizations do not explain why small and large firms have different responses to economic news. This study suggests that the small firms examined in the empirical litera

IN September 1962 Charles Holt [1] published in the Journal of Finance an article entitled "The Influence of Growth Duration on Share Prices." In the article he put forth a model for determining the appropriate relative P/E ratio for a growth stock as compared to a standard stock. In December of the following year Burton Malkiel [2] published in the American Economic Review an article entitled "Equity Yields, Growth, and the Structure of Share Prices." Malkiel presented an independent approach for valuing a growth stock relative to a standard stock. Both articles have been widely quoted and reprinted. And both have provided a foundation and impetus for further research into share valuation. Perhaps an indication of the continued importance of this material to the finance field is the inclusion of one or the other of these articles in the equity valuation sections of the most recent editions of graduate level readings books [3, 4, 5]. Further, while both models were developed under conditions of certainty both have been used successfully to investigate the factors affecting stock values under uncertainty [1, 2, 6, 7]. Thus their analyses continue to be useful in providing a conceptual framework and an operational methodology for stock valuation. While the similarity of the Holt and Malkiel approaches to the valuation of growth stocks has long been recognized [2, footnote 20, p. 1020], this similarity has not been examined analytically. The purpose of this note is to show the algebraic equivalence of the Holt and Malkiel models. This demonstration is useful, given the continued significance of these models, as an aid to teachers and students in reconciling Holt and Malkiel's specific valuation concepts. Further in demonstrating that these models are equivalent, it is seen that both models have as their common foundation the dividend capitalization model of share valuation. (That the Malkiel model is based on the dividend capitalization model can be readily seen from inspection. However, this is not the case with the Holt model.) Finally it will be seen that both the Holt and Malkiel models yield the relationship between P/E multiples for any two successive time periods recently derived by Robichek and Bogue [8].

IN HIS FUNDAMENTAL WORKS [15] and [16] Douglas Vickers integrates the production, investment and financing decisions of the firm into a useful and illuminating model. He deals with uncertainty using riskadjusted capitalization and interest rates, assumes constant business risk and treats financial risk as a function of leverage. This paper extends Vickers' analysis by allowing business risk to depend on production and investment decisions.' In particular, it derives a criterion for investment decisions under general uncertainty and market organization conditions when business risk is subject to control. The effect of investment decisions on business risk has been studied by several authors (Hamada [4], Mossin [9], and Tuttle and Litzenberger [13]) under the conditions of idealized uncertainty assumed in the Sharpe-Lintner capital market theory. The investment criterion derived in this paper is shown to be generalization of theirs, and of the one obtained

THE FIRST THREE CHAPTERS of this thesis discuss capitalization in the perspective of the search for safety over the period of history of banking in the United States, the philosophy of the supervisory focus on capital based in depression experience, and the negligible effect of supervision on allocation of assets and capital. Analysis of the real factors influencing the quantity and quality of capital is similar to a study in econometrics with size, growth, and profitability as the independent variables and capitalization as the dependent variable on the first level. Independent variables on the first level become dependent variables on the second level with other independent variables influencing them. Quantitative and qualitative influences exist on both levels of analysis. Capitalization is a function of size and growth factors which vary in their influence according to growth conditions and policies affecting structure (Chapter IV). Profitability is also a function of size and growth. Although profitability fluctuates in the short run with given levels of capitalization, in the long run levels of capitalization adjust to achieve competitive rates of return regardless of differences in size and growth. The principle that secular changes in capitalization occur through changes in capital rather than through changes in deposits and assets is established by multiple correlation analysis for banks in the United States for the period 1953-62 (Chapter V). On the second level of analysis, two sets of independent variables influence size, growth, and profitability. One set includes local influences. A comparative case study of five commercial banks illustrates that, within size groups, variations in capitalization are associated with local and regional economic conditions, competitive conditions among banks and between banks and savings and loan associations, and philosophy of management in the individual bank. The local variables other than economic conditions are not weighted or designated as causes or effects since there is mutual interaction. The alternative choices of management in seeking to maximize profit are limited by bank history, existing competitive arrangements, and local economic conditions. The levels of capitalization which result are not the free choice of management (Chapter VI). The most pervasive set of independent variables on the second level of analysis includes the nature of the economy, the environment provided by government, and the nature of the banking system. Changes in public policies are causes and effects of this set of variables. Independent changes in the set induce changes in public policy, and vice versa. Historically the issues of policy portrayed a parallelism which no longer exists. The parallel issues included tight (sound) money versus easy (unsound) money, concentration of financial power (federal power) versus decentralization of financial power (states' rights), and safety versus competition. The disappearance of a strict parallelism is the result of the development of a nationwide interdependent economy and the transfer of political and economic power from the

s of Doctoral Dissertations 985 these samples were in the same suburb and were sold twice during the same years. There were 17 to 33 observations in each sample. The results of the statistical analysis do not support the capitalization hypothesis. The coefficients of A were almost entirely insignificant, the coefficients of S tended to be positive indicating a reverse capitalization, while the coefficients for Y varied considerably among suburbs reflecting different methods of reassessments. A variety of changes in the basic equation failed to alter these conclusions. The results probably are best explained by the small number of observations in the samples, by the differing circumstances surrounding sales of residential real estate, and by the differing assessment procedures. The positive coefficients for S, on the other hand, suggest that the use of the coefficients of variation may exaggerate the inequalities in the administration of the property tax. This content downloaded from 207.46.13.134 on Sun, 25 Sep 2016 04:38:00 UTC All use subject to http://about.jstor.org/terms

IN A RECENT ISSUE of this Journal, Professor Pearson Hunt suggested precise definitions for "trading on the equity" and "leverage."' While this objective is laudable, the article contains certain statements which appear to impede its achievement. In particular, the following remarks on the Hunt article will argue that (1) the measurement of trading on the equity is inappropriate; (2) the analysis employing the trading on the equity measurement is inadequate and misleading; and (3) the verbal and symbolic formulations of the leverage measurement are in minor disagreement; also the symbolic statement of this measure is not so general as it should be. The criticisms which follow, while representing substantial disagreement with Hunt on certain points, are intended to improve, not negate, his efforts to remedy terminological confusion. The reader will observe agreement concerning the definition, though not the measurement, of trading on the equity and agreement on the general, though not detailed, concept of leverage. 1. Hunt's measure of trading on the equity is inappropriate because it attempts to measure an effect, and a very incomprehensive one, rather than the act being defined. Hunt's definition and measurement are as follows: "It is proposed that trading on the equity be defined as: The use of fixed (or limited) charge securities in the capitalization of a company, measured by the ratio of (1) the rate of return on the existing common-stock equity to (2) the rate of return on the entire capitalization as it would have been if there were only common stock outstanding."' It is important to note that "trading on the equity" is an expression which designates an act (the use of ... .) which, in the context of Hunt's article and many others on business finance, is assigned the role of a causative factor. Measuring the act of trading on the equity by one of its effects blurs a necessary distinction. There is a direct way of measuring the act which is no more susceptible to error and subjectivity than measurement of the effect.