The proposed study will develop a goal-programming framework to facilitate implementation of Development Agencies [DA] policies for credit extension to and evaluation of micro credit banks [MCB] which in turn provide credit as well as rudimentary business training and basic social services to the poor lacking collateral. Because the hierarchy of and tradeoffs among goals embedded in these policies vary over time and in different places, it is expected that such a framework will provide valuable aid to the policy maker in the DA.

Microcredit banks [MCB] extend group-based credit to the poor needing funds to invest in home-based enterprises. The borrower is too poor to have collateral required for credit from formal sources such as commercial banks. Each member of a group is responsible for the loans to both him[her]self and other group-members. Credit extension is typically integrated with [a] a savings program, and [b] provision of rudimentary business training as well as basic social services related to health, nutrition, children’s education, and family planning. This integration improves loan repayment behavior, poverty alleviation, and social development along health, nutrition and education dimensions.

A MCB typically obtains funds from development agencies [DA] such as the USAID and the World Bank at subsidized interest rates, and loans these funds at or near the market rates. The spread between these two rates is around 10- 15%. A DA providing funds to a MCB on a recurrent basis requires assessment of the MCB on several dimensions:

It should be noted that measurement or quantification of the above criteria set and their targets is subject to varying degrees of difficulties. For instance, bad debt experience is easily measurable and can be readily assessed against the benchmark yielded by alternative forms of lending in similar environments or obtained from historical experience. On the other hand, the rate of migration to urban areas can only be observed in the long run and would require control of other factors that also influence migration. Leaving aside the measurement problems, the policy maker encounters several additional challenges pertaining to the above criteria sets and their benchmarks:

• It is extremely unlikely that the observed value of a target will coincide with the benchmark determined a priori. How should the deviations from the benchmark be viewed especially since deviations in either direction from benchmarks are unlikely to be symmetrically desirable or undesirable? A given magnitude of improvement in bad debt experience with respect to the benchmark may be only mildly desirable, whereas an equal magnitude of deterioration in bad debt experience may be strongly undesirable.

• It is also possible that deviation from the benchmark for a goal may be undesirable in itself; however, when it is viewed in light of higher achievement of a preferred goal, such a deviation may be tolerable. For instance, higher overhead leading to barely break-even profits may be acceptable due to improved sanitary conditions in a given community. But can such tradeoffs among criteria that are not necessarily inconsistent be identified a priori? More pertinently, can the benchmarks be modified at the planning stage in order to reflect goal hierarchy and potential conflicts among goals?

• It is highly unlikely that determination of optimal benchmarks reflecting priorities in a given situation will have general applicability over time or space. Thus, urban migration may be less of a concern in a sparsely populated country than in, say, Bangladesh or India. Or, enhanced living standards over time may lead to reduced fertility and hence less focus on birth control but greater concern for improved technology or better diet. Similarly, even when benchmarks targets are set, performance evaluation of a MCB may have to reflect a change in the environments. The Cambodian example of 30% bad debt experience in a given year may need to be assessed against the adverse impact on borrowers’ incomes because of changed intensity of the civil war.

Differing needs as well as varying environments in which a particular MCB is functioning suggests that a DA cannot utilize a set of uniform standards applicable to all MCBs seeking financial support. Customizing these standards both for financing initially and later assessing efficacy of the MCB becomes critical for a DA. This study proposes to help a DA in these tasks by developing a goal programming [GP] framework.

The goal programming [GP] framework requires a modified linear programming [LP] approach [Mehta, 1974, pp.160-4]. An initial LP formulation of the problem is as follows: Max CX subject to AX B; X where C, A, and B are vectors or matrices of parameters whose values are known and constant. X is the vector of decision variables to be determined. Specifically, the objective function CX may represent the benefits for the household, business and community due to credit extension as well as the contribution margin for the micro credit bank on credit extension. The constraints may represent the size of potential clientele, the maximum level of bad debt experience, minimum level of literacy, health, and nutrition standards to be achieved by the MCB. Obviously, greater benefits for the community are possible only through more extensive credit extension and larger overhead for the MCB that would reduce its profitability and require more funds from the DA.

The basic premise of the GP formulation is that not all constraints are inviolable, and some constraints that embody a policy makers goals can be modified; indeed, the policy maker knows the goals, their hierarchy, and their provisional targets [initially appearing in the LP formulation] as well as directional desirability of deviations from these target values .The GP formulation requires modification of both the policy constraints thus identified and the original objective function [CX] as equality constraints so as to include the initial target values as well as deviations from these targets. Knowledge of the hierarchy of goals and their directional desirability permits quantification of penalties [rewards being the negative penalties] for deviations from each target. The new objective function is then to minimize the penalties associated with deviations.

The solution to the problem cast in the GP framework yields optimal levels of targets for the identified goal set that reflects the hierarchy of the goals, interrelated targets and their permissible deviation ranges, as well as potential tradeoffs among them. To the extent that this hierarchy and the potential tradeoffs among goals vary for a MCB over time, the optimal target values will also be unique for a MCB at a given time. DAs that provide funds to MCBs functioning in different environments face the challenge of determining (a) what to expect realistically from a particular MCB if it is provided funds; (b) whether such funds allocation individually and aggregately is consistent with the DAs own mission; and (c) whether the actual performance of the MCB meets the expectations identified in (a). Because tasks in (a) and (c) are unique for a MCB, the research effort is aimed at undertaking a pilot project that addresses these tasks in a goal-programming framework.

• Khandker, Shahid, B. Khalily and Z. Khan, Is Grameen Bank Sustainable? working paper, 1994, World Bank. Washington, D.C.

• MkNelly, Barbara and C. Waterip, Impact Evaluation of Freedom from Hungers Credit with Education Program in Thailand, working paper (1993) Freedom from Hunger Foundation, CA.

Project financing is a specialized method of financing large projects. The projects are risky and capital-intensive infra structure or resource-based. This financing technique allocates financial risk among creditors, borrowers, investors, and operating companies involved in the project. It is a type of privately placed debt. The debt is tied to the fortunes of the project thus minimizing the risk exposure of the parent company. An example of Project Financing is the technique used by the British Petroleum (BP). In 1972, the BP needed to pay for the development of huge Forties Field in the North Sea. Other examples of ‘project financing’ have been the financing of Alaska Pipeline. This financing technique is being used extensively in developing countries because of the necessity of undertaking infrastructure development. For example, among non-Muslim nations, in 1995 there were 31 projects for $ 7 billion, 29 projects for $ 37 billion, and 120 projects for $ 96 billion under consideration in Mexico, India, and China respectively. Among the Muslim nations corresponding figures were 14 projects for $10.9 billion, 15 projects for $24 billion and 12 projects for $6.2 billion under consideration in Indonesia, Malaysia and Turkey respectively. An analysis of the large projects under consideration in the developing countries in 1995on the basis of project financing shows the 11% of the total number and 14% of the total dollar investment were located in the Muslim world.

All Muslim countries are included in the category of developing countries. Their infrastructure needs to be developed for their economic development. Project financing being an efficient financing technique for infrastructure development can play a significant role in the development of Muslim countries.

1. Project financing as practiced in the western world involves debt financing. This results in paying and receiving interest. Islam prohibits interest-based transactions. According to a verse in Quran, "Those who devour interest do not rise except as rises one who Satan has smitten with insanity. That is because they say: ‘Trade also is like interest; whereas Allah has made trade lawful and interest unlawful’."

his prohibition on interest has made the use of project financing difficult. Very few Muslim countries have been able to use project financing. Some examples are a power project in Pakistan, a real estate development project in Iran and a highway construction in Malaysia. A greater use of this method of financing will satisfy the financing needs for the infrastructure development of Muslim countries leading to their economic development. Islam does not permit the charging of interest. Western banks, because of risk, are not willing to provide funds on the basis of equity financing. Thus what is religiously acceptable to Muslims is not economically acceptable to the western lenders.

2. Islamic investors tend to have their money invested short-term. A large part of their profit-sharing deposits are used to finance trade and inventory. Thus Islamic banks have two alternatives: either to run a big gapping risk or leave the field of long-term financing business. Gapping risk is magnified by the fact that Islamic banks do not have an inter-bank market where they could swap short and medium tem deposits against long-term investments. Securitization of investment vehicles is another method of narrowing the gapping risk. However, as of now this technique has not been employed because of lack of an appropriate derivative security.

3. Islamic financing has to be approved by a Sharia board. Because of varying interpretation of Sharia, a certain type of security that is Islamically acceptable in one country may not be acceptable in another. This restricts the standardization of securities leading to designing different investment vehicles for projects in different countries.

1. To suggest an integral model for using project financing acceptable to both the lenders (mostly western) and the project sponsors who would not agree to interest based transactions, and

2. To suggest a new equity security that will have the characteristics of debt security for the lenders and an equity security from the point of view of a firm located in the Muslim world.

It is a theoretical paper. Not enough data are available to run any statistical techniques to prove or disprove the utility of the suggested model. Examples of some of the recent transactions, such as Hub River Project in Pakistan, Construction of an Airport in Malaysia, and A Housing Project in Iran culminating into some recent big projects in Muslim countries in conjunction with financial instruments Islamically acceptable have been used to arrive at the theoretical model. Innovative Securities used by various Muslim countries to circumvent the problem of paying interest, particularly the ones listed below are analyzed:

(a). Bonds with Warrants sold by Bank Islam Malaysia for Petrona , Malaysian Oil Co.

(b). Petroleum Securities Corporation issued Petroleum bonds in Islamic version. They carry no interest rate. They are paid dividends linked to the sale of oil by the issuing firm.

(c). Tehran municipality issued participation certificates for finance to support a commercial development project. The securities are linked to the project and a 20% return to a four-year bond is expected. The rate is considered to be comparable to the rate available on similar risk projects.

(d). Use of a simultaneously callable, puttable and convertible common stock designed in this paper to satisfy both the lenders and the borrowers religious and financial concerns.

Security: The security is callable at the discretion of the sponsors. The call will be deferred to a date when the amount invested by the investors (banks, etc.) has been fully amortized with a predetermined rate of return. The call price will equal the balance of the investment if it is partially amortized.

The security is puttable at the discretion of the investors. The put price will equal the original investment minus the principal amortized, again using a predetermined rate of return. This put will be exercised if the sponsors fail to pay according to the established pay out scheme. The security on putting will automatically convert to an interest-free loan to the sponsors. This debt will have a lien on the property of the project. It may also be guaranteed by the sponsors or the government. Guaranteeing a loan is permissible in Islam particularly when the guarantor is wealthier than the debtor. According to Quran, if a debtor is in a straitened position then he should by given reprieve. This implies that the debt should not be called immediately. However, if the sponsors have committed a fraud then the investors may take legal action and/or exercise their right to attach the property of the project. The security is convertible into interest free loan at the discretion of the investor to debt if the investors do not get their investment back with a predetermined rate of return. This is a common security. Investors will be stockholders in the project. They will have access to full information. The chances that the sponsors or the subsidiary created to develop the project will commit a fraud or deviate from the contractual obligations is minimized.

Pricing of the security: The cash flows are known with considerable degree of certainty. The product or the service is presold in many cases. Only a discount rate is needed to price the security. The security is callable only after all of the financial requirements of the investor have been met. This will mean no premium for this feature. The security being puttable at par and convertible to an interest free loan will be deemed less risky by the market. Hence a reduced discount rate should be used to price it. Another reason for a lower discount rate is the establishment of a sinking fund that is commonly required by banks for long-term loans.

Combination of solutions 1 and 2 is likely to overcome financial hindrances to the use of project financing.

3. Interpretation of Sharia: At present the possible solution to this problem is creation of a single religious board in a country or a group of like-minded countries. As more and more of the projects are analyzed on religious grounds it is expected that commonalties among various countries will emerge.

To overcome the gapping risk, Islamic Investment Companies could raise project-specific funds or create special pools of funds that are used for project financing. Since the investors know the purpose for which the funds are being raised, the gapping risk is minimized. Also it is logical to set up unit trust or mutual fund types of investment vehicles aimed at long-term investors. Kuwait Investment Company and some Islamic Financial institutions are in the process of testing these techniques. To tap the resources of western institutions the use of a puttable, callable and convertible security should be examined carefully. It is likely to be accepted by both the investors and Muslim firms.

Open Market Stock Repurchases The Canadian Experience

During the 1980s, U.S. firms announcing open market stock repurchase programs earned favorable long-run stock returns. Recently, concerns have been raised regarding the robustness of these findings. This comes at a time of explosive growth in the adoption of repurchase programs, both in the U.S. and worldwide. This study further investigates long-run performance following open market repurchase announcements using a recent sample of Canadian programs. Undervaluation appears as important factor in motivating Canadian repurchases as in the U.S. Moreover, as in the U.S. the Canadian stock market seems to discount the information contained in program announcements. Toronto Stock Exchange listed firms announcing programs between 1989 and 1995 show excess performance measured relative to Fama-French (1993) Three factor model of approximately .5% per month for a period of three years following the announcement. Canadian value stocks announcing repurchase programs as well as firms announcing large repurchase programs show particularly favorable abnormal long-run performance.

This paper investigates the announcement effects of both rights issues and cash offerings by the Dutch firms for the period 1985 -1996. We further test signaling and market feet back models. Finally, the long-term performance of firms the issued seasoned equity offerings is investigated.

From the total of 91 firms that went public, 31 firms issued seasoned equity or rights issue. The initial return for reissuing IPO firms is 8.89%; that is 1.67% higher than the equivalent return for non-reissuing firms. Reissuing firms are more likely to issue a larger proportion of their total equity. They issue on average 40.0% of their total equity as opposed to 32.1% offered by non-reissuing firm. Reissuing firms also offer a larger amount of equity at the IPO, Ÿ 1031.6million versus Ÿ 78.1million for non-reissuing firms.

The average return on a portfolio of all IPOs, bought on the first day of the calendar month following the IPO month and held until the 48th month, is 1.66%. The reissue group has an average holding period return of 29.65% against a return of -12.97% for the no-reissue group. The same trend is supported when we use the wealth relative, where the no-reissue firms perform 25% less than the market in the same period. The reissuing firms on average outperform the market by 7%. This results are opposite of what have been found in other countries.

We further investigate returns for the reissue group by splitting them into the firms that return to the market with rights issues and firms that return to the market with seasoned equity offers (SEOs). The latter group has an increasing return from the first month until the twelfth month after the IPO. This positive relation holds in relation to the market, where the SEOs outperform the market by 37%. After this period, the companies that issue rights perform better than the companies that issue seasoned equity. Moreover, we find the market reacts less unfavorable on the announcement of a right issue than on the news of a seasoned equity offering.

This paper develops a multi-period model of an international economy, in which a domestic country has restricted foreign ownership in domestic assets. Also, short selling is limited either explicitly (government regulations) or implicitly (stock exchange collateral requirements). Although Free and Restricted shares (within the same share class of the firm) are equivalent in every way with the exception of ownership eligibility, the combination of these two restrictions can result in a premium for the shares available to both foreign and domestic investors (Free shares) above the domestic investor-only-shares (Restricted shares). The bulk of the attention in the existing theoretical and empirical literature has focused on the premium on Free shares, whereas the resulting equilibrium asset holdings has received tangential treatment. This paper looks at equilibrium asset holdings of domestic and foreign investors.

Perhaps even more puzzling than the existence of premium-priced Free shares is the holding of these shares by domestic investors. Why would a domestic investor be willing to pay a premium for Free shares, given the availability of lower priced Restricted shares? Indeed, the equilibrium holdings of Free shares merits attention in its own right. On this issue, however, existing single period models are not capable of yielding rich, dynamic results. Within the multi-period model found in this paper, domestic investors will hold Free shares in the final decision period only if its price is identical to the Restricted share price. However in prior periods, domestic investors are observed holding the more expensive Free shares, despite the fact that identical dividend distributions and voting rights are obtained with either type of share. The former prediction provides a testable implication of the model, whereas the latter agrees with the empirically observed portfolio holdings of domestic investors.

In many regards, this work bridges frictional asset pricing theory with international investment theory to provide insights and evidence into both that cannot be obtained separately. Indeed, the short selling restriction breaks down the Euler equation into an inequality, such that asset prices are determined by the maximum valuation of the asset's payoffs across all investors eligible to invest in the asset. Due to the simple fact that only one price path is observed for a given payoff stream, the impact of short selling restrictions is hard to quantify or observe empirically. However with the existence of foreign ownership restrictions and separately traded Free and Restricted shares, we have the unique opportunity to observe the distinct prices assigned to a given payoff by foreign and domestic investors. The paper proceeds to explicitly relate the model to the expanding literature on frictional asset pricing. Although not necessary for a premium to develop, asset pricing within this model may be sub-linear, for example. That is, an investor with the maximum valuation of an asset's combined payoffs across all future states of nature will not necessarily have the maximum valuation of the asset's payoff in each individual state of nature. However, scaling an asset's payoffs will simply scale the asset's value.

To provide empirical evidence, this paper scrutinizes premiums on Free shares in Sweden for the period 1985 - 1993, at which time the Swedish government required firms to remove the foreign ownership barrier. Given the distinction between Free and Restricted shares no longer existed after 1993, the Stockholm Stock Exchange eliminated the dual listing of these shares. As a result, 1993 can be taken as the final period in the model, when domestic investors should have eliminated their holdings of premium priced Free shares. These premiums and the corresponding portfolio behavior of foreign and domestic investors provide support for this model, while raising additional questions for future research in the area.

Both academic and professional literature seem to agree that the netting clauses in a swap contract tend to reduce the credit (default) risk for both parties and therefore must be preferred over gross settlement. This risk reduction merit of netting has become a common understanding of academics, practitioners and regulators, and their feeling towards netting has been reinstated in headings such as "Happiness is a Full Net" (Tremble and Sarwa, Euromoney, April 1991). Its wider practice is also being promoted by International Swap Dealers Association, Inc. (ISDA) internationally and is endorsed by academic studies that analyze default risk implication of swaps.

The netting provision of the 1992 ISDA Master Agreement specifies that on any date due amounts in the same currency and in respect to the same transaction can be netted and only the difference be paid to the party who was to receive the larger amount. In case of more than one transaction, the net amount is to be determined in respect of all amounts due on the same date and in the same currency. It is the contention of the market that exchange of difference checks as a result of netting instead of gross amounts will result in risk reduction for the parties unambiguously.

The framework in the articles that have partially analyzed the implications of netting on default risk is an efficient and integrated world market where swaps are zero sum games (for example, Baz and Pascutti, the Journal of Derivatives, Winter 1996, Duffie and Huang, Journal of Finance, July 1996, Sorenson and Bollier, Financial Analyst's Journal, June 1994.) Usually, one of the parties to the swap is practically risk free (the dealer). Thus, the emphasis is on the risky party's chance of defaulting on its debt payments prior to the due payments on the swap. More importantly, when it comes to the comparison of default implications of gross versus net settlement, these authors fix the amount to be swapped. Naturally, the net settlement with lower probability of default given a notional amount fares better since default risk is to be avoided. Unfortunately, the models have not allowed the swapped amount (the notional principal) to be one of the endogenously determined decision variables.

On the other hand there is a line of study by Usmen (Financial Management, Summer 1994) which has looked at the default structure from a different perspective. The model in Usmen is cast in a mildly segmented capital market which has been empirically shown to be a closer approximation to the world capital markets of today (for example, Bonser-Neal, Brauer et al., (Journal of Finance, June 1990). Another distinction in Usmen’s study is that the amount to be swapped is determined along with the swap rate (price) in a value-maximizing framework where both parties are allowed to be risky. The result about default risk that emerged in that study was somewhat surprising. The default risk of swaps in a segmented capital market is a commodity of which more may be desirable to less. The desirability of default depends on market conditions (segmentation per se) and the firms' specific default structures. Usmen study dealt with currency swaps and analyzed gross settlement. The present paper extends that analysis to incorporate net settlement and compares it to gross settlement in a context where the optimal swapped amounts (notional amounts) are also determined.

The analysis is cast in a one-period, two-country state preference framework where the investors are risk neutral but have heterogeneous expectations. There are two value-maximizing firms that enter into a currency swap for their financing needs. Value differentials (the added value the firms create by entering into a swap contract) are computed under two different scenarios: gross settlement and net settlement. In either case, the resolution in insolvency is the limited-two-way payment method. With this resolution, the non-defaulting party is absolved from any payment if the other party is insolvent. The author favors this resolution method because of the shortcomings of the alternative full-two-way payment method. (In the full-two-way payment method the parties commit to their swap obligations irrespective of the other party's solvency, consequently, full-two-way payment may be biased against the higher credit party, in most cases a dealer.

In the value differential equations there are two decision variables, namely, the swap rate and the swapped amount (notional principal). Both firms are allowed to be risky. Examination of the value differential equations reveals that the difference net settlement brings over gross settlement is in the content of the default set (the set of states where the contract will be void because one or both firms are insolvent). Comparing the default sets resulting from each type of settlement, it is apparent that when the amount to be swapped is fixed the default set is smaller with net settlement implying lower probability of default. However, if swapped amounts (notional principal) are allowed to vary, the resulting changes in the contents of the two default sets are very different. Since there is more room to increase the notional amount (beyond the capacities of the counterparties), there is a greater chance of including states where exchange rate outcomes are favorable to both parties. This increases the chances of increasing the differential values beyond that of a default free swap. In this analysis what is important with risky swaps is not the number of states (the probability of default), but rather the particular states in which default occurs. Thus, selection of the method of settlement might be used to better position oneself in terms of choosing the states where default occurs.

A numerical example illustrates the above default implications of net versus gross settlement. Value differentials are computed under each scenario by using market and firm specific parameter values. In the computations the decision variables are varied to search for the optimal pair of the swap rate and the swapped amount that maximize the added values of the swap counterparties. When the swap rate is kept low and the swapped amount is varied, gross exchange is not viable since value differentials for both firms are always negative. However, with net settlement, the situation is reversed. At a certain notional amount both parties gain from the currency swap. It turns out that net exchange is preferred over gross exchange not because it is less risky at a certain level of notional amount but because it allows a different default structure (default set). Surprisingly, the reason for selecting the net settlement option is not its risk reduction attribute but rather the flexibility it gives in designing the default structure. It can do so because the notional amount is an imaginary value that can be extended beyond the earning capacity of the counterparties involved.

With the present paper, the author attempts to clarify an issue related to the net settlement provision of a swap contract. The common belief in the market that netting reduces the default risk and therefore should be desired is put into a different perspective. By choosing a mildly segmented capital market as a backdrop and by allowing the swapped amount (the notional principal) to vary (in contrast to the common analytical framework), the present paper demonstrates an additional merit of net settlement. While it is true that for a fixed swapped amount, net settlement necessarily reduces the probability of default over gross settlement, the risk reduction merit might not be desirable. By increasing the notional principal beyond the capacities of gross settlement, one can alter the default structure of the contract such that the overall gain to the counterparties supersedes those of risk free swaps as well as risky swaps with gross settlement. The gains are market and firm specific, therefore, in designing a swap contract, net versus gross settlement is another option to be evaluated along with the choice of the swap rate and the swapped amount.

The North American Freed Trade Agreement (NAFTA) is the most significant trade treaty in the history of the United States. Initially, the original agreement (implemented in 1989) included only the United States and Canada (the U.S.-Canada Free Trade Agreement). NAFTA was formed with the entry of Mexico on January 1, 1994. If California was a separate nation, it would be the seventh largest economy in the world. Therefore, the impact of NAFTA on California is significant within this three-nation Agreement. This study focuses on the impact of NAFTA on small California firms.

It is well known in the business and economic literature that most new job formation comes from small firms. In the late 1970s, Professor David Birch of MIT analyzed small businesses using information derived from Dunn and Bradstreet. With a sample of 5.6 million firms, he concluded: that companies will less than 100 employees created 80% of net new jobs in the United States economy during the 1970s (Gilder, 1984). This was later found to hold true for the early 1980s as well (Osteryound and Newman, 1993).

This project has two main objectives. The first objective is to determine the reasons why small California firms export goods and services to other countries. The literature cites several reasons why firms export (Czinkota, et al., 1995). For example, is the profit motive the only reason for exporting or are there other reasons? Does the firm export because it believes it is selling a unique product or do the firm's products have a technological advantage over competitors? Does the firm's management possess special knowledge about foreign customers or market situations? Is the firm exporting because it is close to foreign customers and ports?

Of most importance to this study is the relationship between the reasons firms export, generally, and the reasons they export to NAFTA countries. Since approximately 80 percent of the firms surveyed sell some of their exports to other NAFTA countries, do the reasons for exporting depend on the percentage of exports firms sell to Mexico and/or Canada? In other words, does NAFTA make a difference with respect to the firm's motivations to sell goods abroad. The second objective of this paper deals with the impact of NAFTA on small California firms. For example, have exports to Mexico increased because of NAFTA, and if so, by how much? Have sales to Canada increased because of NAFTA, and if so, by how much? Has the number of the firm's employees increased or decreased because of NAFTA? Have firms made direct investments in Mexico or Canada because of NAFTA or do they plan to do so in the future?

A questionnaire was sent to the Presidents and CEO's of 600 exporting firms listed in the California International Trade Register. Most of the responses in the survey instrument were based on a six-point Likert scale. These firms represent six SIC categories. Past experience has shown that it is better to sample many firms in a few industries than a few firms in a large number of industries. Also, because the great majority of new employment occurs in small firms, the firms that have been selected have 200 employees or less. The survey instrument was divided into three main sections:

1. General Information, (2) Reasons for Exporting, and (3) Firms that export to Canada and/or

The data was examined with respect to firm size, using the number of employees and asset size as the measures of size; and by SIC codes. Of most importance, the data was also examined according to the percentage of exports traded with NAFTA vs. non-NAFTA countries. Although this study deals exclusively with small California firms, do the "reasons" that companies have for exporting differ with respect to whether the firm has fewer employees (< 50 employees) or a greater number of employees; or according to SIC code? The strength of the "reason" to export have also been investigated with respect to the percentage of exports to Canada and Mexico. As mentioned before, are the "reasons" for exporting dependent on or do they change because of NAFTA?·

As another example, for small California firms that trade with other NAFTA countries, is the change in the number of employees hired related to the size of the firm? For example, have firms with < 50 employees been affected to a greater extent than firms with more than 50 employees. How does the number of employees hired differ with respect to SIC code? Also, how does the mix (or percentage) of exports to non-NAFTA vs. NAFTA countries impact these relationships? The data has been analyzed using one- and two-factor analysis of variance and other statistical procedures.

Trade agreements have been around from the beginning of civilizations. They have brought both prosperity and advances in civilizations as well as conflict and war. Although there are many trade agreements in the Americas, NAFTA, North American Free Trade Agreement, draws the most attention. The two main direction of NAFTA is free trade and free investment. The three countries involved are Canada, Mexico, and United Stated. It is assumed that Chile will be the next country to enter NAFTA.

Our question is how to develop a trade association of the Americas. This is referred to Free Trade Association of Americas (FTAA). How should this be accomplished? Should other countries in the Americas enter NAFTA or form other trade agreements? The author approach will be the application of an Input, Process, Output (IPO) model. The model is a static view the system. Great care is taken in identifying the system boundaries versus limited attention to the dynamic nature of the system.

Inputs are defined in three groupings: controllable, inputs, and uncontrollable. Controllable inputs are viewed as variables that can be changed in the near future. Inputs are the variables that go into the system. The uncontrollable variables are not changeable in the near future. It is important to mention that this model does not look at or consider the future in detail. The processes are centered on people, hardware, software, procedures, and data. For information systems, these areas can be quite extensive. For trade agreements, processes tend to identify conflicts. The outputs are what is desired. Generally it is quality, performance, and very measurable constructs.

The argument for trade agreements is similar to the global economy. If barriers to trade are removed then products will be manufactured where the costs are least. There will be a division of labor in the world and the ability for economies to specialize. Therefore, quality of life will improve for everyone. There are several assumptions in this systems approach example. First, it is assumed that competition and free trade is best for the consumer. Secondly, the leadership is forming trade agreements is not identified and it is assumed that favoritism does not exist. Of course, the systems approach could be applied for a specific country or region's point of view and this would lead to what is best for the stakeholders. However, the latter approach would be much harder since detailed preferences are needed as to what subgroup in the country or region should benefit and by how much.

The major input variable is the trade agreement. In the case of NAFTA, the agreement concerns trade and investment among the United States, Canada, and Mexico. (1) NAFTA also includes barriers to trade in agricultural products. Import sensitive sectors are protected up to 15 years. A major concern is sanitary and phytosanitary measures. Other issues are export subsidies, internal support and grade and quality standards. Another major issue is rules of origin. The controllable variables are viewed as something that can be negotiated. The author includes reduce tariffs and barriers, labor movement, one currency, export subsidies, rules of origin, and import sensitive outputs. To some extend retaliation and side agreements are controllable variables.

The uncontrollable variables are displacement, resistance, pollution, labor standards, health and safety, anti dumping rules, risk for investors, risk for nation, education, and tax structure. In many ways, the uncontrollable are the real problems to overcome for implementation of a trade agreement. As an example of resistance, let us consider Washington State apples shipped to Mexico. If they must go through a port of entry in Texas the cost of shipping is much higher then a port of entry in California.

Risk for investors and risk for nation is difficult to eliminate. The assumption with trade agreements is changes will take place in each country. Individuals or companies should invest in new products and services. If agree upon changes are not implemented or are prevented, the risk of loss to individuals and nations is great. The uncontrollable variables are major causes of risk and therefore risk can not be reduced.

1. People: A free market is best for the citizens given the risk issues are resolved. If only certain segment of society is to benefit, then a stakeholder's approach can be taken. 2. Hardware: The physical facilities and infrastructure should be viewed as hardware. Additionally, components of the agreement require new hardware especially the health and safety issues. 3. Software: Software to facilitate the trade agreement is needed. For example, rules of origin and anti dumping regulations require complex data collection and analysis. 4. Procedures: Procedures are the checks and balances. Most of the requirements in trade agreements are procedural based. The hope of course is that the future will have few procedures. 5. Data: Data is limited and the information derived from data is more limited. There are plenty of reports (2,3) but the information does not give a clear picture. For example, it is not clear what percent of the exports to Mexico from the US simple off set imports from Mexico to US of the same item. The information needed is a clear indication of net growth in production for a given economy.

The outputs include Investment movement and Trade movement; this is certainly true for NAFTA. The authors assume the following three outputs: 1) improved quality of life, 2) lower average cost, and 3) improved efficiency. The author feels that the system approach can be helpful in clarifying the issues and communication of the trade agreement. System theory assumes that controllable variables can become inputs variables with time. The author wonders how many people entering a trade agreement would want this. Secondly, the uncontrollable variables are the major barriers to successful implementation of trade agreements. It is unlikely that uncontrollable variables will ever become input variables. With this prospective, the author wonders if one major trade agreement is worth the effort. It would appear that a variety of more limited trade agreements would be the best strategy.

We propose filtering historical simulation by GARCH processes to model the future distribution of assets and swap values. Options’ price changes are computed by full re-evaluation on the changing prices of underlying assets. Our methodology takes implicitly into account assets’ correlations without restricting their values over time or computing them explicitly. VaR values for nonlinear portfolios are obtained without linearising them. Historical simulation assigns equal probability to past returns, neglecting current market conditions.

Current methods of evaluating the risk of portfolios of nonlinear securities are unsatisfactory. Delta-gamma hedging becomes unstable for large asset price changes or for options at the money with short maturities. Monte-Carlo simulations assume a particular distributional form, imposing the structure of risk that they were supposed to investigate. Moreover, they often use factorisation techniques that are sensitive to the ordering of the data.

To overcome the above limitations we propose to adapt the methodology of Barone-Adesi, Bourgoin & Giannopoulos (1997). We propose to model changes in asset prices to depend on current asset volatilities. Asset volatilities are simulated to depend on the most recently sampled portfolio returns. Our simulation is based on the combination of GARCH modelling (parametric) and historical portfolio returns (non-parametric). Historical returns are adapted to current market conditions by scaling them by the ratio of current over past conditional volatility.

The scaled returns are the basis of our simulation. To simulate a pathway of returns for each of a number of different assets over next 10 days we select randomly 10 past sets or "strips" of returns, each return in a strip corresponding to an asset’s price change which occurred on a day in the past. Thus each strip of returns represents a sample of the co-movements between asset prices. We then iteratively construct the daily volatilities for each asset that each these strips of returns imply according to our GARCH model.

The European banking system is experiencing a phase of vehement change. It is true that the effects of an implementation of a single European currency are in the centre of the current discussion. But the globalization of financial markets and the new banking technologies exert a far greater influence on the future European banking scene. They trigger extensive merger processes and revolutionise the marketing of standardised financial products.

For decades, the European banks have operated in an oligopolistic banking market with intuitive profit margins on interests and commissions as well as agreements on good behaviour in advertising policy. The time of tacit terms is now coming to its end and is being replaced by a growing international competition in which more and more often banks are forced to calculate the cost of their chosen loss leader products in such a way that they can just cover the marginal costs. From a bank internal point of view, the globalization and growing competition of conditions in the deposit and credit business may have a taste of cannibalism. In reality however, the European banking industry is now simply on its way to normality with regard to competition and adaptation of new technologies, a way that industry has long since gone. The fact that the banks are now forced to be more efficient and cost-conscious is of advantage to the bank clients and ultimately supports the European banking industry for international competition.

When canvassing new clients, the good manners will decline due to tighter competition in the banking industry. Banking terms and conditions are especially suitable for comparative advertising. It can be expected that in Europe as well the ban on comparative advertising will be questioned. Irrespective of that, in future the banks will increasingly criticise the competitors’ services, in order to present themselves in a positive way.

The already broken out merger fever in Europe will significantly change public finance. Following economic forces as well as the spirit of the globalization, strategic alliances will be formed, cost-reducing programmes will be developed, and branches will be closed and replaced by multifunctional terminals. The interdependencies and mergers are growing particularly in the insurance industry and banking industry. Due to synergy effects, many branches will be shut down so that the banks’ profitability will be increased. As a result of globalization in Europe the big Cultural Revolution in bank organisation has finally started. But the European banks should have learned from Mao’s Cultural Revolution. The idea of a Cultural Revolution in bank organisation is convincing, for all organisations, be it government, military, church, industry or banks, tend to petrify and therefore have to be questioned and restructured continuously. However, bank employees are not chess pieces that can be moved at will, that can be sacrificed and used again in the next game at the same position, which is why changes in the organisation structure as highly sensitive measures require intensive preparation.

The people are the bank’s most important resource. This is true for bank customers and bank employees. A reading device can be replaced, but it is very difficult to regain a lost bank customer and to re-motivate an employee whose self-esteem is hurt. In Europe, many people talk about the bank customers’ declining loyalty, but the bank employees’ loyalty will change as well because of the globalization and Americanisation of the bank organisation. The employee’s loyalty to the employer and the identification with the bank and the team will be replaced by a growing concentration on one’s own advantages. The intrinsic motivation will be displaced by financial motivation.

Far too long had the European banks allowed their organisation structure to become encrusted, they avoided and repressed competition in investment banking. When the globalization of the banking industry finally forced them to change their policy, they threw out their babies with the bath-water instead of providing fresh bath-water. Many European bank employees have lost their feeling of a bank-specific corporate identity. In general, managers of savings banks and cooperative banks that are strongly integrated in the regional social life and less influenced by globalization, identify more intensively with their institute than the branch managers of big banks.

Today, very different cultures collide in banks. This is not only because of regional differences and globalization but also because of functionally caused differences. We get an idea of the imminent cultural conflicts within the bank organisation if we compare e. g. conurbation to rural areas, traders to controllers, sales staff to back office staff, technology freaks to innovation sceptics.

The imperfect restructuring of the European banking industry that has already begun is far better than a continuation of the status quo. However, these measures could have been implemented more successfully if the banks had requested more flexibility from its staff earlier and if the management had been prepared to face innovative international changes. Instead, they defended positions that were not tenable such as the prohibition of money market funds and ways to prepare a balance sheet that are unfavourable to shareholders.

Corporate banking will become more significant, for big groups of companies, as money market players, will ask critically for the added value of bank services and in many cases will prefer corporate banking. International groups will further reduce the number of their bank relations and will increase their bargaining power over banks by setting up corporate banks as an alternative. Not only industrial producers but banks as well are facing the question of make or buy of financial services. This is especially true for smaller banks in investment banking but also in the field of the growing external payments which can partly be dealt with at more favourable prices by electronic banks.

Tighter price competition and the possibilities to reduce costs by means of new technologies strengthens the efforts to rationalise and lead to a mechanisation of major parts of the routine business. Expert systems and neural nets will dominate the credit rating that can be standardised. Image processing, Internet and flexible working hours lead to document handling partly done by home-workers and banking without office facilities. Together with an increased commission-based payment of bank employees, this results in the trade unions’ deprivation of power. In routine business, the lowest handling fees determine future customer orders which also results in a complete anonymity of more than seventy-five per cent of all bank services which, at the same time, causes problems with regard to customer loyalty. With the bank customers’ as well as the bank employees’ increased flexibility of working-hours, the importance of individual customer advice outside bank facilities and bank opening times is growing in the non-routine business. This results in an increased provision-based payment of front office employees that can hardly be granted to people working in the back office.

Bank stocks remain attractive because of rationalisation, concentration, staff reduction and a new performance orientation in the context of a shareholder value orientation. However, to the employees the bank’s attractiveness as an employer declines. Flexibility, mobility and capability of learning will become the employee’s most important assets in the competition for work.

Presently, the European direct banks are facing far higher obstacles to customer canvassing than initially expected. Therefore, they need more time with high expenditures on advertising to cross the break even point. If they finally get a return, the client will ask his branch for comparable online banking conditions. The electronic banking by direct banks will largely be integrated into their parent company and will only survive in some niches. However, meanwhile the customer will have become accustomed to pay market prices for advice and to pay for online transactions in accordance with activity-based criteria.

There is no structure of bank organisation that is the best possible ad infinitum, for organisation structures as well have to adjust to the requirements of the age. Therefore, it is pointless to discuss today whether the European banks’ strictly hierarchically-oriented line organisation of the past was a case of mismanagement. It was a sign of the time. Of importance is that with it the European banks earned well and achieved high growth rates. Today, they need new organisation and personnel structures.

International investing has been promoted by professional managers and academicians on the ground that low correlation among world equity markets allows for portfolio risk reduction. With the advances in communication technology and reduction of transaction cost, this paper hypothesizes that the benefits of diversification may be eroding due to increasing correlation among world markets. The question this paper addressed is whether the benefits to international investments still remains.

To determine whether the correlation among global stock markets has changed, we focus on the relationships among the following markets: the U.S stock market versus developed markets (Europe, Australia and Japan); the U.S stock market versus the emerging market (Asia, South American and Africa); the developed markets versus the emerging markets. This study spans twenty-three years from 1976 to 1997.

It has been suggested that during periods of high market volatility, the correlation among global stock markets appears to increase. If this is true, then the protection provided by diversification is reduced when it is most needed. This study therefore examines the relationships among world markets during periods of high volatility resulting from critical events in the global economy. These events could be political or economic. The intention is to learn the degree to which market reactions diverge or converge in response to these events. We hypothesize that the reaction among world markets could differ based on the nature of the events. The insights gained from this research should provide a better understanding of the benefits to international diversification.

Data Sources: Morgan Stanley Capital International (MSCI) data on emerging and developed markets for the past twenty-three years are used to test our hypothesis. MSCI indices cover over 1,400 securities in 23 emerging markets and 2,700 securities in 22 developed markets and include about 60% of all stocks trading in these markets. Similar criteria for selecting the indices are used for both emerging and developed markets, allowing for meaningful comparisons across all markets. Twenty countries, which best represent the characteristics of their groups, are employed to emulate the developed and emerging markets.

Methodology: In order to test the initial hypothesis of the changing correlation over time, the twenty-three year period are divided into five overlapping sub-periods to obtain moving averages. This process helps to isolate any significant changes in the trend of the correlation. Monthly data is used for this analysis. To test whether there are spillover effects to other markets from one market that is initially exposed to high volatility, the period surrounding critical events, both political and economic, are examined. The critical events are identified from the historic headlines in the yearly almanac. Some examples are the recent Asian market crash, the Mexico currency devaluation at the end of 1993, the Soviet Union's break-up of 1992 and the Gulf War of 1990.

To test the market sensitivity to critical events, weekly and daily data from MSCI are used. Thirty-six events, both political and economic, have been identified over the twenty-three year period. World market repercussions to these events are studied to determine whether markets diverged or converged in their reactions.

Currency exchange rates are closely tied to inter-country trade of goods and services as well as capital flows. The collapse of the Bretton Woods system or the fixed exchange rate system in 1973, along with the coinciding growth in global trade and greater mobility of capital have all contributed to an increase in exchange rate volatility. Concerns about exchange rate volatility have prompted central banks to actively intervene in foreign currency markets in an attempt to stabilize the exchange rate. An explicit assumption behind central bank intervention is that interventions can minimize deviations of the actual exchange rate from a target implied by fundamentals and/or that central banks can dampen the short-term volatility of exchange rates. Since the mid-1980s, governments of the major industrial countries have taken a very active role in the management of currencies. This policy shift has stimulated much debate about the feasibility and desirability of using intervention in foreign exchange markets to limit movements in exchange rates. Conflicting evidence has been amassed to support and oppose the efficacy of Federal Reserve (Fed) interventions in stabilizing exchange rates. For instance, Ballie and Humpage (1992) found that intervention between February 1987 and February 1990 was associated with an increase in dollar/Deutschemark ($/DM) and dollar/Japanese yen ($/Y) exchange rate volatility. On the other hand, Dominguez (1993) examined the impact of actual U.S. intervention for the period 1985 to 1991 and found that the Feds actions compressed the daily volatility associated with the $/DM and $/JY exchange rates. More recently, Bonser-Neal and Tanner (1996) provide empirical evidence suggesting that central bank intervention does not have any significant effect on volatility.

This study makes two important contributions to the existing literature on central bank intervention. First, previous studies examine the effect of intervention operations on volatility estimates derived from the spot currency market. This study, on the other hand, estimates conditional volatilities of $/DM and $/JY from foreign exchange futures prices. The strong dependence of futures prices on expectations suggests that the currency futures are a good candidate for a study of the interaction between volatility and new information on monetary policy contained in the Federal Reserve intervention operations. Second, the statistical approach in past studies raises a serious methodological issue. All of these studies make the a priori presumption that central bank actions influence exchange rate volatility, and none empirically test the direction of the relation between volatility and intervention. Under these circumstances, use of OLS estimation would yield biased and inconsistent estimates. Although there are strong theoretical reasons as to why intervention actions may influence volatility, there can also be some equally plausible reasons that central bank intervention is a response to the volatility conditions in the exchange rate market. For example, it is possible that central banks in an attempt to lessen the deleterious economic and financial consequences of increased volatility in the currency market step-up its intervention operations.

This paper addresses the shortcomings in previous studies by investigating the short-run dynamics between the Feds intervention actions and the conditional volatility in the $/DM and the $/Y futures prices for the period 1985 to 1993. The estimation technique employed, which is a definite departure from existing studies, places minimal restrictions on the explicit structure of the relationship between volatility and intervention activity. A two-step methodological procedure is undertaken. First, conditional variance is obtained from the GARCH (1,1) model for the return of the two currencies. In the second step, a time-series VAR model is employed to identify the dynamic relationship between the conditional volatility estimate (obtained from the GARCH (1,1) procedure) and the Fed=s intervention actions.

Results from the study indicate no relationship between Fed=s intervention activity against the DM, and the $/DM conditional volatility during the 1985 to 1993 period. However, intervention is associated with negative changes in the $/Y volatility during the 1985 to 1993 period as a whole, and specifically during the January 1, 1985 to February 21, 1987 Plaza period and the February 21, 1987 to December 31, 1989 Louvre period. This supports the signaling hypothesis which posits that interventions resolves uncertainty among market participant by providing information about future monetary policy. Furthermore, the results suggest a strong positive feedback effect (bi-directional causality) flowing from volatility to intervention. During the post-Louvre period (January 1, 1990 to December 31, 1993), we find Feds intervention to exacerbate the volatility in the $/Y, without a corresponding feedback relationship. The sign reversal may be attributed to the breakdown of the Louvre Accord, which brought about lower cooperation and coordination among central banks to achieve exchange rate stabilization.

Given the general lack of consensus among economists about the purpose and effect of central bank interventions, the issues surrounding this debate seem to be a promising area for further research in the futures arena. For instance, it will be interesting to (i) test whether the character of the spot/futures price relationship differs on intervention days from that on nonintervention days, and (ii) establish a link between the basis (futures and spot spread) and speculative trading behavior on the one hand, and Fed intervention actions on the other. These issues are left for further examination.

The emerging high growth economies of Asia such as Hong Kong, Taiwan, South Korea, Singapore, Malaysia, Thailand. Indonesia and the Philippines have attracted the international investors for portfolio diversification over the last several years. However, the current Asian foreign exchange crisis reflects the fickleness of International investors, who are eager to invest their money in Asian countries when the returns are high and quick to withdraw it at early signs of trouble. And it reflects a bow to the inevitable: economic growth at near-double-digit rates had to slow someday. The ongoing volatility in the global financial and the capital markets have originated from Thailand in July of 1997. Six months into the Asian financial crisis, there is still plenty of uncertainty about how big a mess it will ultimately generate. Asia, with 30% of the world economy, has weaker banks, weakening currencies and lower inflows of capital. In the month ahead, this trend of weakness in Asia and strength elsewhere could set the course of economic events. This weakness is partly the result of a drop in foreign investment. Also important is a drop in the flow of the countries huge domestic savings, often channeled through banks into major projects. Thus the Asian foreign exchange crisis along with its linkage highlights the crucial role that finance plays in capitalist.

While the linkages and intertemporal relationships among the developed financial and the capital markets have been examined extensively, no attention has been paid towards the linkage between the foreign exchange markets of the South and the Southeast Asian countries, especially with respect to current turmoil in these economies. The objective of this paper is to provide new evidence on the question of interdependence among the above eight countries of Asia and the Mexico on the basis of daily exchange rate series. Mexico has been included in our study because peso value has also been volatile for the last few years. We investigate whether there are co-movements and bi-directional linkages among these foreign exchange markets since the beginning of the present foreign exchange crisis in Asia. If such interdependence is detected between two markets, it will also be important to assess the respective role of the countries in these driving forces, and more generally try to investigate the dynamic interrelationships that might exist between the different foreign exchange markets. We are also concerned with the trending behavior of the nine markets, namely those of Hong Kong, Taiwan, the Philippines, Singapore, Malaysia, Thailand, South Korea , Indonesia, and Mexico. We try to explore the degree to which their respective market exchange rates exhibit common long-term stochastic trends and the degree to which these common trends are directed by one of these market rates.

Since cointegration implies that nonstationary times series such as exchange rates move stochastically together toward some long-run stable relationship, the existence of cointegrating relationships among various markets has a direct implication in terms of the existence of common trends among these rates. In other words, if the random walk component behavior is a realistic hypothesis for the rates of these various countries, do these components differ across the national markets, or are the various markets sharing random walk components? On the other hand, cointegration also implies the existence of a Granger causality property between the rates. This framework is attractive if the purpose is to study both co-movements and dynamic relationships.

Thus our study focuses on the eight foreign exchange markets of Asian countries and Mexico which got more international attention recently because of the ongoing currency crisis. The currencies are Hong Kong dollar, Singapore dollar, Malaysian ringgit, Taiwan dollar, Thailand baht, Indonesian rupia, South Korean won, The Phillippines peso, and the Mexican peso. The period of investigation covers from July 2 through December 2, 1997. All exchange rates are in per U.S. dollar and are obtained from the Wall Street Journal. Rates are quoted on the New York foreign exchange selling rates and are based on trading among banks in amounts of one million U.S dollar. The series were transformed into natural logs and are graphed in Figures.

Empirical results are comprised of Augmented Dicky-Fuller as well as the Phillips-Perron tests of stationarity, Johansen multi variate tests of cointegration, and the Granger causality tests. The level series are supportive to unit root hypothesis for all currencies because both the ADF and PP tests could not reject the null hypothesis of unit root. However, first differenced series are found to be stationary for all currencies except the South Korean won and the Taiwan dollar which converge to zero unit root after second difference. We then tested for cointegration by applying the Johansen multi variate test to these rates. We began the analysis with various stochastic trends in data by performing VARs of lags interval 1 to 4. The tests results show that the series are cointegrated up to 4 lags because the null hypothesis of no cointegration has been rejected at the conventional level of significance. This is the case with different assumptions about linear and quadratic trend or no trend in the data. We also tested the null hypothesis no ‘Granger Causality’ at the 1 percent and the 5 percent level of significance unto several lag intervals. Statistical results show that the null hypothesis of one market does not ‘Granger Cause’ other market has been rejected at the above levels of significance with 7 or 14 days lag.

Based on our findings, we found that there exists a rather highly integrated Pacific Rim foreign exchange markets. We also observe that there exists Granger causality between the Mexican peso and some of the Pacific Rim currencies such as the Hong Kong dollar, Taiwan dollar, Malaysian ringgit, Thai baht, and the South Korean won. It is not unlikely given the growing volume of their trading and investment relations and because of the governments efforts to liberalize their economies with reforms of financial and the capital markets. Based on our present analysis it reveals that Hong Kong dollar, Singapore dollar and the Malaysian ringgit are the dominant currencies in the region in terms of lead-lag relationships. In order to provide further information concerning the on going foreign exchange crisis in these countries, this research is extending the sample period and the final report will be available at the conference. It is expected that the findings out of this research will be helpful to international fund managers as well as individual investors willing to reduce their portfolio risks and enhance the expected returns.

One of the greatest obstacles in the development of emerging capital markets is the resolution of information uncertainty. Such markets have difficulty attracting debt and equity capital due to the fact that reliable information is not available to foreign investors. This problem is exacerbated by the fact that many of these developing countries have experienced periodic difficulties in their debt payments over the last two decades.

In the early 1990s many developing countries began the process of opening their financial markets to foreign investment. To mitigate the information uncertainty problem, these countries turned to Moody’s and Standard and Poor’s (S&P’s) rating agencies, which are considered credible external certifiers of government and private credit risk information (i.e., in the past these agencies only provided credit ratings in major industrial countries). In response to rating demand, Moody’s and S&P’s began publishing international ratings of firms’ credit quality in emerging market countries. Most of these countries already had domestic rating agencies; however, unlike domestic ratings, international bond ratings are based on comparisons to similar firms in different countries. Because they offer investors interested in international diversification valuable information that was not previously available, issuers gain access to funding sources worldwide and possibly more attractive financing terms.

To the authors’ knowledge no other research has been published on this relatively new international credit development. The present study seeks to fill this gap in the literature by focusing on the wealth and risk effects of these new international ratings on firms in Mexico. Mexico is interesting because it is a prime example of a developing country with previous debt problems that recently has made dramatic steps in opening its economy to international trade, privatizing business firms, and implementing market reforms to promote free enterprise. Additionally, the U.S. has historically been a major investor in Mexico and recently has increased its economic ties to Mexico. In 1989 Mexico rescheduled its debt to U.S. banks under the Brady Plan, and in an effort to attract foreign investment, it began negotiating a trade agreement with the U.S. in 1990. These negotiations culminated in the 1994 North American Free Trade Agreement (NAFTA) between Mexico, the United States, and Canada. NAFTA has greatly increased international scrutiny on financial market, as well as economic and political, events in Mexico. It has also motivated Moody’s and S&P’s to issue the largest number of international ratings in Mexico among the developing countries in Latin America (e.g., in 1995 there were 65 published ratings by S&P’s in Latin America, with 25 of these ratings going to Mexican entities and the remainder spread out among Argentina, Brazil, Chile, Columbia, Panama, Uruguay, Venezuela).

We hypothesize two potential information effects of the international ratings on private firms and government-owned entities in Mexico. First, due to the resolution of information uncertainty, demand on the part of international investors in these emerging market securities will increase and tend to tend to positively impact the prices of rated bonds, as well as the stock prices of rated firms. We will refer to this potential positive impact as the wealth effect hypothesis. Second, consistent with Ross (1989), an increase in the flow of information in an efficient market will tend to cause security price movements to become more frequent and therefore more volatile. This price risk hypothesis is particularly relevant to emerging markets in which information flows can be scarce and consequently infrequent trading occurs. In the present context security prices are expected to become more volatile after the introduction of Moody’s and S&P’s ratings in Mexico if information flows are enhanced by the ratings.

By implication, since firms in Mexico and other emerging market countries benefit from international ratings in terms of higher bond and stock prices, the new ratings not only attract foreign investment interest but also tend to lower costs of capital in developing countries.

The currency swap market has grown rapidly since its inception with the currency swap between IBM and the World Bank in 1981. Earlier literature has concluded that the rationale for the currency swap consisted in arbitraging the comparative advantages that different borrowers enjoyed in different capital markets. The basis for this conclusion was the segmentation of capital markets due to institutional constraints such as capital controls or unequal access to information across capital markets. During the last decade, however, such institutional and informational barriers across capital markets restricting capital flows have weakened with increasing integration of capital markets.

In this paper, we show that firms have reason to use currency swaps even when institutional and informational barriers vanish. When the cashflows are generated in foreign currency by a foreign project, firms could use foreign-currency debt. However, we show that if the firm's cashflows are sensitive to exchange rate changes, the financing alternative of combining the use of currency swaps with home currency debt to synthesize foreign currency debt is preferred by the firm. The sensitivity of the firm's cashflows to exchange rate changes is called economic exposure. The level of economic exposure of a firm is unobservable to the outside investors but known to the managers of the firm. We show that such asymmetry of information about economic exposure results in the dominance of currency swaps over foreign currency debt.

Suppose a U.S. company wanted to issue debt denominated in Japanese yen. It could either issue yen denominated debt directly or issue a dollar denominated debt and use a currency swap to exchange the dollar denominated debt for yen denominated debt. The role of the currency swaps can then be simply described as synthesizing foreign currency debt. To simplify the analysis, we assume that the firm only receives foreign-currency denominated cashflows. When the foreign-currency debt is synthesized using home currency debt and currency swaps, the default risk is established based on expected foreign currency cashflows which are translated in home currency terms. When currency swaps are used together with the home-currency debt, the home currency riskless interest rate is effectively replaced by the foreign currency riskless interest rate. Therefore, pricing the home currency debt will involve accounting for both default risk and exchange rate risk. Foreign-currency debt will be priced based only on default risk in foreign currency terms and the foreign currency riskless interest rate. The firms compare the total cashflows net of cost of debt in home currency terms to choose between the foreign currency debt and synthesized foreign debt.

In the presence of currency risk alone currency swaps do not dominate foreign currency debt. If there is currency risk but the cashflows of the firm are not sensitive to exchange rate changes (i.e., there is no economic exposure), the default risk assessed for both foreign currency debt and synthesized foreign debt is identical. Thus, both debts are identically priced. When firms face economic exposure, the negative correlation between the cashflows and exchange rates gives rise to a difference between the pricing of foreign-currency debt and the synthesized foreign debt. We show that this difference renders the use of currency swaps most appropriate for the firm facing economic exposure.

Conventional explanations for the use of currency swaps rely on international capital market segmentation which renders foreign currency denominated debt more expensive. Artificial capital market barriers lead to differential transaction costs in domestic and foreign currency debt markets. This transaction cost differential could be the result of a front-end cost differential between domestic and foreign bonds, or a search-cost differential among these bonds. For example, one argument for the existence of currency swaps is based on international capital market segmentation due to international investment restrictions. In contrast we argue that even if international capital markets get integrated (so that transaction costs are eliminated), product market imperfections cause the cashflows of the firm to be sensitive to exchange rate changes. We show that the use of currency swaps maximizes the value of such firms for the shareholders. We also demonstrate that in the absence of transaction costs, if firms do not face economic exposure, foreign-currency debt, home-currency debt, and synthesized foreign debt are equivalent financing alternatives.

We do so by discussing the conventional transaction cost based explanation as a special case of our economic exposure based analysis. We show that when there are transaction costs and when currency risk does not result in any economic exposure for the firm, currency swaps do not dominate foreign currency debt as well as home currency debt. They are however useful in providing covered interest arbitrage when there are positive deviations from UIRP. We conclude that in an integrated and frictionless capital market, synthesized foreign debt is equivalent to foreign currency debt and home currency debt and, therefore, currency swaps are redundant securities.

There are several empirically testable predictions of our analysis. Firstly, during periods of positive UIRP deviations, we should observe a greater use of currency swaps by firms in the home country. Fore example, positive UIRP deviations in the data on the US $ as the home currency and the JPY as the foreign currency and the respective riskfree interest rates would imply that U.S. firms use currency swaps involving the US$ and JPY over other financing alternatives. Secondly, comparing firms across different industries, we should find that firms sampled from industries facing imperfect competition should be using currency swaps more than the firms sampled from industries which have perfect competition.

The currency swap alternative dominates home currency borrowing only when the UIRP deviation is positive. Fore example, when the foreign country maintains the risk free interest rate at a level lower than the home country risk free interest rate or intervenes in the exchange rate market to depreciate the value of the foreign currency, the UIRP deviations are positive. Since the levels of economic exposure are not observable, firms with either type of projects will use currency swaps in a mildly segmented capital market where there are such positive UIRP deviations. Even under asymmetric information, foreign currency debt is dominated by currency swaps. We conclude that integration of capital markets will not necessarily result in more foreign currency denominated borrowing but can result in greater use of the currency swaps because of imperfect product markets and economic exposure to foreign exchange risk.

The expansion of world trade, the increasing integration of the world's money and capital markets, and improved telecommunications have dramatically changed how firms do business in the post-Bretton Woods era of floating exchange rates. To be successful in this new business environment, both domestic firms engaged in foreign trade and multinational enterprises must clearly understand certain key relationships between interest rates, exchange rates, and the forward market for foreign exchange. Failure to understand these key relationships could, ultimately, lead to the failure of the firm itself. At a minimum, not understanding the relationships between these critical variables will damage a firm's bottom line and/or subject the firm to unnecessary risks. The current instability in the Asian foreign exchange and equity markets serves to confirm the inherent challenges of doing business overseas.

This study employed daily data obtained from 1) The Wall Street Journal (i.e., spot as well as forward exchange rates based on the "best available prices" and 2) The Economist (i.e., money market and Eurocurrency interest rates) to evaluate certain key theoretical relationships and to expand the body of applied knowledge available to firms actively involved in international business. The data include observations for thirty consecutive, workable trading days for a recent period in 1997. Data for the Canadian dollar, the French franc, and the Swiss franc were evaluated. More specifically, this study performed the following tests:

1. The International Fisher Effect. Assuming that nominal interest rates include components reflecting the "real" rate of interest as well as expected inflation (commonly called the "Fisher effect" in the domestic market), the n-period interest rate differential between two countries should accurately predict the n-period appreciation/depreciation of the exchange rate between the two countries' currencies. This would be necessary to maintain purchasing power parity (i.e., the two currencies have the same value in terms of a common numeraire) as well as identical effective rates of return across countries.

To test the validity of the theory, actual percentage appreciations/depreciations (for 30-days, 90-days and 180-days) across several major currencies were computed and then compared, ex post, to the (de-annualized) interest rate differentials existing 30, 90 and 180 days prior, respectively. In effect, "expected" interest rate differentials based on currency appreciations/depreciations were compared, after the fact, to actual interest rate differentials. Because of the inevitable ambiguity as to which interest rate to use as the predictor of currency movements, this study tested differentials in both (n-period) money market and eurocurrency rates.

2. Covered Interest Arbitrage. In an efficient market, observed premiums/discounts in the forward market for foreign exchange should accurately reflect existing (n-period) interest rate differentials. If this were not true, arbitrageurs would find risk-free profit opportunities.

To test the validity of this hypothesis, 30, 90, and 180-day premiums/discounts were compared to contemporaneous, de-annualized interest rate differentials (i.e., 30, 90, and 180-day rates). In effect, "expected" interest rate differentials based on forward premiums/discounts were compared, contemporaneously, to existing interest rate differentials. This second test of interest rate parity employed data for the same time period and currencies as the first test (#1, described above). Again, because of the ambiguity surrounding the interest rate, differentials in both (n-period) money market and eurocurrency rates were evaluated.

The results reveal that neither the International Fisher Effect nor Covered Interest Arbitrage hold. While some portion of the observed discrepancies may be explained by a number of practical considerations (such as transactions costs and taxes), it appears that these factors are insufficient to fully explain the observed violations of the International Fisher Effect and Covered Interest Arbitrage theories. Hence, the data do not support these fundamental tenets of international finance. (Efforts to identify and quantify the practical considerations which can explain small deviations from the International Fisher Effect and Covered Interest Arbitrage present interesting and potentially productive topics for future research.)

3. Efficiency of the Forward Market. This study also tested if the n-period forward rates for the various currencies were accurate (unbiased) predictors of future spot rates. Data for the same thirty consecutive, workable trading days (as tests # 1 and 2, above) were employed. The results reveal an interesting point in reference to forward rates as unbiased predictors of future spot rates. While 30-day forward rates underestimated future spot rates for all three currencies, with the exception of the Canadian dollar, which was mixed, the 90-day and 180-day forward rates overestimated the future spot rates for all three currencies.

Finally, this study examined the short-term financing implications for multinationals of cases of consistent overestimation or underestimation of future spot rates by forward rates. The results indicate that multinationals, on average, can benefit in the case of overestimation (in terms of financing costs) by leaving their foreign currency position open. However, in the case of underestimation (in terms of financing costs) their foreign currency position should be covered.

The stock prices of multinational corporations (MNCs) are determined by cash flows from foreign countries, which, in turn, are greatly affected by exchange rates. Cornell (1983) and Wolff (1988) provide empirical results for a direct relationship between exchange rate and economic activity. Others find a linkage between stock price and economic activity (Chen, Roll, and Ross (1986), Mandelker and Tandon (1985), Fama (1981)). These findings support an implicit link between stock prices and exchange rates. Solnik (1987) finds a negative relation between real domestic stock returns and real exchange rate changes. Ma and Kao (1990) note that domestic currency appreciation negatively affects the domestic stock price movement for an export-dominant economy and positively affects an import-dominant economy. Jorion (1990) reports a moderate relation between the rate of return on U.S. multinational firms’ stocks and the rate of change in a trade-weighted value of the U.S. dollar over 1971-87. The relationship between exchange rates and stock prices have been frequently discussed in the financial press (e.g., Wall Street Journal (1993, 1995), Bollen (1995)).

¦ y_t = „ + - y_t-1 + 3 ( ¦ y_t-j +§ _t (1)

j=1

where y is the series being tested, and k is the number of lagged differences to capture any autocorrelation. K is chosen so that the Ljung-Box Q-statistic fails to reject the null hypothesis of no serial correlation in the residuals (§ ). The test is pseudo t-statistic for the null hypothesis that - = 0. The results show that the exchange rate and stock index series share similar temporal properties (i.e., nonstationary in the levels having one unit root), and thus two price series are tested for cointegration. If two price series are cointegrated, the OLS regression may be biased toward higher R² values, lower Durbin-Watson statistics, and lower standard errors. Then the t- and F-statistics become invalid. Cointegration test is to examine stable long-run relations between two variables. The market mechanism generating the two series may exhibit short-run drift, but in the long run the two series will approach one other. The market forces guiding these movements will correct for any discrepancy that may exist and attract them back together to ensure a long-run stationary equilibrium.

If two series are cointegrated, the intertemporal relations between the two variables are examined within the framework of an Error-Correction Model (ECM). The ECM captures both the short-run dynamics between time series and their long-run equilibrium relationship, providing a suitable framework to examine the Granger-causality. The ECM also captures the partial adjustments one variable makes to a shock caused by another variable. The causal relations between the time series suggest the short-run dynamic adjustments needed by the levels of the variables to reach positions of long-run equilibrium. Two cointegrated variables may have the joint error correction representation.

The final prediction error (FPE) criterion (Akaike (1969)) is used to determine the optimal values for the Ns. Short-run dynamics between the two price series are examined by the coefficients. If one (or more) of the, coefficients is statistically significant, movements in exchange rates will have a short-run effect on the stock market. If one of the coefficients is statistically significant, the stock market will have a short-run effect on exchange rates. But the existence of a long-run relationship between the stock market indices and exchange rates hinges crucially on the significance of and. Since S_t and F_t are cointegrated, the Z term (deviation from the long-run relation) must include both variables. Then either or will be nonzero and statistically significant. After the appropriate lag structure is identified, we estimate the system for each of the six countries using a seemingly unrelated regression approach to gain efficiency. Long-run dynamics are captured by the parameters and.

While the propensity among firms in recent years has been towards an expanded utilization of discounted cash flow methods for evaluating investment proposals, evidently practitioners still feel comfortable using less sophisticated procedures, particularly payback. Surprisingly, according to the surveys payback is being used by over 50 percent of the largest firms in the United States as either the primary or secondary method (less than 10 percent as the primary method). In the Oblak-Helm multinational survey, payback was used by 72 percent of the companies for primary and ancillary investment decision making.

The global popularity of payback undoubtedly stems from of its substantial intuitive appeal (i.e., it tells how long it takes to pay for an investment). This paper proposes a generalized time-adjusted cash flow payback approach which is theoretically consistent with the assumptions of the net present value capital budgeting technique, yet phrased in terms that practitioners may find more understandable.

The generalized time-adjusted payback decision rule develops as follows:

n

Co £ 3 (1 + k)^-t

NUS t=1

where: Co = the cost of the investment in time period o.

n

3 CF_t (1 + k)^-t

NUS = t=1

n

3 (1 + k)^-t

t=1

where: CF_t = the cash flows in time period t,

n = the life of the investment,

k = the firm’s cost of capital or risk-adjusted discount rate.

The generalized time-adjusted payback decision rule is stated in words as follows: If the investment proposal’s payback, adjusted for the timing of the net cash flows, is less than or equal to the present value annuity factor at the firm’s cost of capital or risk-adjusted discount rate for the life of the proposal, the investment should be accepted. The perceived advantage by practitioners that the simple payback technique requires no explicit estimate of the cost of capital (discount rate) is dubious. While the discount rate is not explicitly incorporated in the determination of the simple payback period, the establishment of shorter or longer payback horizons as a function of perceived differences in risk imply that practitioners are implicitly employing discount rates. These implicit discount rates are based on the decision-makers' perceived differences in project riskiness. For example, if an investment proposal's useful life is six years and the decision maker arbitrarily requires a four-year payback, he is requiring a 13% rate of return on the investment (the present value annuity factor for six years at 13% is 4.000).

The proposed generalized DCF payback decision rule allows the decision maker to make explicit his required return on an investment and then to select a definitive payback period consistent with the risk/inflation-adjusted required return. Thus the resulting proposed payback procedure suggests WHAT the time-adjusted payback should be consistent with the project's required rate of return, i.e., where there has been an explicit accounting of the project's riskiness and inflationary characteristics.

The proposed time-adjusted payback procedure always yields identical accept-reject decisions to the NPV technique. Further, it offers a sophisticated yet easily understandable discounted cash flow decision rule. This permits the practitioner to continue the use of a common and simple capital budgeting technique in a form consistent with the maximization of the shareholder wealth position objective. In other words, as with the NPV concept, the time-adjusted payback procedure only accepts those projects which increase the present value of the firm, while rejecting all others.

In this paper, the relationship between ownership structure and corporate performance is investigated for 128 Chinese firms listed in the Shenzhen Security Exchange from 1992 to 1995. The Chinese stock market provides a logical environment for examining the impacts of ownership structure for its separate categories of shares issued representing different classes of shareholder control/monitoring. The four classes of shares issued, which include state shares, legal entity shares, employee shares, and public shares, representing different degrees of management authority delegation and insiders control which might impact corporate performance in different ways. It always a question about how efficient that the state ownership monitors the corporate performance in China. The purpose of this study is to empirically verify this ownership structure and corporate performance relationship. Specifically we test for the following three hypotheses:

Under the Chinese authority delegation system, the state government delegates its authority to local state entities which in turn delegates to the management, who is responsible for daily operation. The management, who typically are the entrepreneurs who set up the company, represents some of the legal entities which are delegated with a targeted quota on performance by the state government. The management in turn has to balance each legal entity’s interest and reports to them major business decisions and profitability. It is therefore practically to say that legal entities, who are directly represented by the management, are the insiders of the company. To be in line with the corporate control literature in the view of Jensen and Meckling (1976) that the dominant the insiders, the higher the price increases, the percentage of share holding by legal entities can be used as insiders’ holding in the testing for the hypothesis that stock returns go up with insiders’ holding. State it in a more formal way:

Hypothesis 2 might be subject to some agency problems caused by the lack of incentives compensation. Key managers who represent the legal entities are the employees of one of the local legal entities, drawing on their wages and salary the same way as other employees of the company. They could be removed anytime if the government deems to be necessary. Year-end bonuses are minimal, in dis-proportion to yearly revenues. Option plans are a rare property, it might even never be heard of. The only incentives provided to the key management, and especially to the entrepreneurs who started up the company, is the perks that they can enjoy during their tenure as key manager or as the chairman of the board. It is a well-known secret that high-ranking managers of Chinese companies try to hide away corporate wealth and convert them into personal properties. The agency problem is more severe in China than in any other Western countries and the incentives-based compensation prevailing in the U.S. is less likely to mitigate agency problems in Chinese firms than those studied by Morck et al. (1988) or McConnel and Servaes (1990) The lack of incentive compensation to key managers might mitigate the importance of insiders on corporate control, weakening the relationship between insiders’ holdings and stock returns. In empirical tests, we might find that Hypothesis 2 is not significant.

Hypothesis 3 will be tested by sub-dividing the sample into two, with majority shares controlled by the state government and legal entities in one group and by the public in the other. It is expected that hypothesis 2 will be more significant for the public-dominant firms than for the state and legal entity controlled firms.

The results reported below cast doubt on the generality of models which suggest an optimal level of legal entity ownership as insiders. For a sample of up to 128 publicly-traded companies, there is not much evidence to support the relationship between the level of insider ownership and corporate performance, whether it is for the state and/or legal entity dominating firms, public dominating firms, or foreign share issuing companies. Several non-mutually exclusive explanations can be offered. One of the explanations might be due to the fact that the Chinese stock market is not efficient to reflect the corporate performance and insiders’ control relationship. This could be evidenced by the progressively improving explanatory power the regression over years as the Chinese stock market maturing.

Another reason is that the concept of insiders’ control is still unpopular in the mind of Chinese investors or the mechanism for insiders’ control is not present in the Chinese corporate sector. Both of them are fairly convincing by the way that listed companies are managed and the laws restricting corporate mergers and acquisitions

Recent debate regarding executive compensation has centered upon whether it is fair that executives receive large compensations in stagnant economic times. John Byrne (1992) argued that the pay structure of executives in this country is "out of control," and that compensation structures need to be rethought.

Williamson (1964) expands the idea that managers might focus on goals other than shareholder wealth maximization. Underlying Williamson’s work is an "expected" level of profits which satisfies shareholders. The manager in this environment maximizes his utility, subject to the shareholders’ expectations. Williamson finds evidence that compensation varies with staff size, staff compensation, and market variables such as industrial concentration. In this, Williamson shows the need for the more fully developed principle-agent theory.

Since Jensen and Meckling (1976), managerial compensation has been studied intensely. Most studies find the relationship between profits and compensation to be significant, but relatively small in magnitude (Jensen and Murphy (1990), Masson (1971), Antle and Smith (1986), Ciscel and Carroll (1980)). This led Jensen and Murphy to state that their results are inconsistent with traditional agency theory, which predicts a stronger relationship between compensation and performance.

Most of the empirical research focuses on pay for performance, i. e. explaining managerial compensation as depending on performance. We focus on the corollary -- performance for pay. If one rewards performance with an incentive structure, will performance increase? If so, then Byrne and the popular press can shut up and go home, barring abstract equity complaints.

If one rewards performance with incentives, will performance increase? Traditional principle-agent theory asserts that there is an optimal incentive mechanism to induce correct behavior in the manager. However, empirical investigation of principle-agent theory has omitted a relevant labor-leisure choice variable. Leisure is a normal good. At high compensation levels the income effect might drive the manager to take more leisure, overall, and pay less attention to the firm, lowering the performance of the firm. If such is the case, then the weak association between pay and performance is potentially caused by the lack of consideration of a possible aspect of classical "labor-leisure" choice theory, leading to a mis-specification of the empirical functional form. That is, these studies do not allow the performance-for-pay curve to "bend backward."

We treat the concept of pay-for-performance in the context of labor-leisure choice. We assume that the utility function of managers can be written as follows:

U = U(C, L), where C is the real compensation of executives and L is leisure. It is the overall utility that the managers seek to maximize.

Our empirical model included modeling compensation as "total" compensation against performance measured by ROE. The lagged compensation model included studying current year’s performance measure against past total compensation amounts. The second part of the model looks at cumulative compensation levels and performance levels.

Our results indicate presence of backward bending effect in one of the years. Though this result is not as strong as we had hoped for, it is the first of its type to report any kid of labor-leisure substitution effect. The results for the cumulative compensation, however, are much stronger and demonstrate significant backward bending effect in each of the years. Apparently, the managers tend to substitute leisure for labor after accumulating some wealth.

The results show a presence of a backward bend in the executives’ supply of performance. The implication of these results is that the owners need to realize that while increased incentives for performance are good for improving shareholder wealth, the amount of total compensation needs to take in account the concave structure of the relationship between compensation and ROE. Firms must beware of paying chief executives "too much" or the income effects of compensation will cause the firm's performance to deteriorate.

The inclusion of the income effect in research on managerial compensation is substantive. Even if the effect were not seen empirically, one omits a theoretically relevant variable by not considering the possibility that the managerial supply curve might bend backward.

In last two decades, numerous studies investigated both theoretically and empirically the relationship between asset prices and economic activities. Fama (1981, 1990), Chen, Roll and Ross (1986) and Chen (1991) tested the long-term relationship between the changes in stock prices and the macroeconomic variables with US economic data. Chen, Roll and Ross (1986) find that the changes in aggregate production, inflation, the short-term interest rates, the maturity risk premium and default risk premium are the economic factors which explain the changes in stock prices. The earliest study on Japanese stock market was carried out by Hamao (1988) which parallels the work of Chen, Roll and Ross (1986). Elton and Gruber (1988), Brown and Otuski (1990) using arbitrage pricing theory tested the relationship between the Japanese stock return and several macroeconomic variables. Most recently Mukherjee and Naka (1995) employed vector error correction model to find that the Japanese stock market is cointegrated with a group of six macroeconomic variables.

Since 1980's, emerging stock markets have grown at a rapid rate. The proportion of emerging stock market capitalization to world capital market capitalization has grown from 4 percent in 1985 to almost 14 percent in 1994 according to IFC data sources. During this time, the deregulation of goods as well as financial markets has become an world wide phenomenon. One such country in which the stock market has grown about 14 % per year and considerable deregulation has taken place in last decade is South Korea. The aim of this paper is to investigate the dynamic relationship between stock price and macroeconomic variables in Korean economy. There are several compelling reasons for undertaking this investigation. Firstly, the nature of relationship between the stock prices and the macroeconomic variables in developed economies like US and Japan may not be the same in a less developed economy like Korea. Secondly, though Korean stock market has grown considerably in last ten years, but to our knowledge there is no paper that investigates the relationship between stock prices and the macroeconomic variables. Thirdly, the Korean stock market capitalization is still only about 1.15% of world stock market value, and is considered to be a small open economy. We would like to investigate the relationship between stock market and macroeconomic variables, particularly the effect of foreign sector on stock market, in this representative small open economy

To find relationship between stock prices and economic variables and to forecast future stock prices, one may either use a ordinary least square regression (OLS) if one assumes that stock prices are only affected by other macro-economic variables or an autoregressive moving average model if one assumes the future values of stock market are forecast solely on the basis of its own past history. If neither of the assumptions is correct, one may follow vector autoregression (VAR) approach i.e., in a system of simultaneous equations, a vector of variables is explained by lagged values of that vector. If the vector has cointegrated components, i.e., there is some equilibrium relationships among variables, then this VAR approach will cause specification problems. Since the stock prices and economic state variables are endogenously related to each other in a system of equations, the causal relationship can only be determined by using a cointegration analysis. In this paper, we use Johansen's vector error correction model to find cointegrating factors or long-term relationship as well as short-term relationships between the stock market and the economic variables in South Korea. We also show how selection of time lags in macroeconomic time series data affects the number of cointegrating vectors.

Korea being a small open economy, the foreign sector may have considerable effect on domestic stock prices. Thus, we divide the Korean economy in three different sectors, namely, the financial sector, the production or real sector and the foreign sector and choose several macroeconomic variables to represent each sector of the economy. Following Chen, Roll and Ross (1986) and Mukherjee and Naka (1995) we select nine macroeconomic variables which are short-term interest rate, long-term interest rate, inflation, money supply, industrial production, oil price, balance of trade from current account, and foreign exchange rates. The first four variables represent the financial sector of the economy.

The long-term interest rate (CBY) is represented by the monthly average of yield to maturity for three year corporate bonds which is most widely believed to be the representative interest rate in Korean economy. The long-term Government bonds (ten years) are traded among only the financial institutions and the interest rates are controlled by Government. The overnight call money rate (CALL) represents the short-term interest rate which is again different from the short-term interest rate variables used by other studies using US, Canada or Japanese data. The realized inflation (CPI) is measured from consumer price index which is indexed to 100 in the year 1990 and it represents the first inflation variable. The variable (IP) represents the end of the month industrial production figure from Bank of Korea. The variable (M2) is the average balance of money supply measured in billions of Won represents the second inflation variable. Oil import in Korea constituted about one third of all imports during 1980's and is now reduced to one sixth of all imports. Still, Korean economy is highly dependent on oil imports and therefore, the stock market may be affected by changing oil prices. The Variable (OIL) represents the US composite crude oil price and collected from the monthly energy review published by Energy Information. The variable (TB) is the trade balance figure in millions of dollars collected from balance of payment accounts. Two different foreign exchange rates (WS) and (WY) represent the end of month foreign exchange rates in Korean Won per US Dollar and Korean Won per Japanese Yen. We obtain the stock market data from various issues of Securities Statistics Yearbook published by Korean Securities Exchange Commission. The macroeconomic variables are collected from various issues of Monthly Bulletin published by Bank of Korea. The sample period spans from January 1980 to June 1996, consisting of 192 monthly observations for each variable.

Before testing for the relationship between stock price and nine macroeconomic variables from Korean economy in the system of equations, we first test for the joint stationarity by employing unit root test. The level data shows that all variables are non-stationary. The Dickey-Fuller test on the first difference data truncated at four lags shows that all variables except M2 are integrated to order one. However, the phillips - Perron test for unit roots show that the first difference data for all variables at both time lag 12 and 4 are integrated to order 1. Since all the time series of macroeconomic variables are non-stationary, vector error correction model (VECM) enable us to study the equilibrium relationship within the system of equations.

Moreover, we can investigate the long-term relationship as well as the nature of short-term adjustment process between the Korean Stock Index and other macroeconomic variables. By using Johansen's multivariate cointegration test, we find that the Korean stock market is cointergrated with nine macroeconomic variables. The Korean stock prices are positively related to industrial production, inflation and short-term interest rate, and negatively related to long-term interest rates and oil prices. The foreign exchange rate changes may affect stock prices in either direction. Devaluation of Korean Won against US Dollar is positively related to stock price changes. But devaluation of Korean Won against Japanese Yen is negatively related to stock price changes. Our findings are robust to time lag selection and generally supports the long-term hypothesized relationship. We also show that the forecasting ability of VECM is generally better than VAR estimating procedure.

The Traditional Approach:

Following Littleton , a prominent traditional accounting theorist, accounting theory is simply thinking that is focused upon doing. The primary function of accounting theory is to explain why accounting action is what it is and why certain practices are better than others. Explanation, furthermore, involves justification, persuasion, and supposition. To justify is to show why a certain procedure is generally accepted. To persuade is to show why something should be accepted. To make a supposition is to show why something might be accepted. Because supposition is considered a weaker form of theory, accounting theory focuses on justification and persuasion. In order to develop a theory to fulfill these two functions, traditional accounting theorists started with an investigation of existing practices with a belief that accounting practices are developed before the related supporting theories, and that the particularly efficacious practices will survive and become generally accepted because they meet accounting needs.

It is noted that these rules reflect the inductive approach. While applying the inductive approach, however, the traditional accounting theorists added their own value judgments. They selected criteria for the evaluation of the results of their observations. One basic criterion, which has probably been used to defend the traditional cost rule more often than any other single argument, is objectivity. To give the most objective transactions increasing preference and to make the least objective transactions more objective are considered the important steps toward the improvement of accounting practice. The primary argument against the traditional approach is that to establish what should be from what is violates the pragmatic nature of accounting. Another serious objection is that to make objectivity the basic criterion in the evaluation of accounting practices is to ignore the relevancy of accounting information to the needs of users. As an alternative, the Postulative approach emerged to mark the beginning of the second stage of accounting theory formulation.

Postulative accounting theorists contend that relatively heavy reliance must be placed on deductive reasoning. We must first recognize and define the problems to be solved, then move to their solution by careful attention to what "ought" to be the case, not what "is" the case. Hopefully, the two, "ought" and "is", will not be too far apart, but we have no reason to expect them to be identical. To establish postulates by a general observation of the environment of accounting, to deduce principles from these postulates, and to prescribe what "ought" to be in accounting practice based on these principles are the typical procedures of the so-called normative deductivism. One justification of this method is the belief that in a changing society those principles derived from past experience cannot be relevant to current situations. Relevance (usefulness) is the primary claim of the postulative approach. However, the divergent concept of the relevance criterion reveals one of the weaknesses of the deductive-normative approach. It is contended that, facing an immense area of observation, different accounting theorists may stress different facts and derive from different premises. A valid accounting theory structure cannot be formulated merely by logic and reasoning.

According to this approach, accounting is conceived as a communication process in which the accountant plays a dual role: he observes economic events of a business on the one hand, and produces and transmits accounting statements on the other. This approach indicates an extension of the scope of accounting from the accountant's domain to the user's domain, and the user's action and the interaction between accounting reporting function and the user's decision function should receive great attention. Accordingly, accounting theory starts from an observation of users' decision models and ends in an evaluation of the relevance of accounting information to those models. Thus, it logically follows that relevance should be the primary criterion of accounting method evaluation. The research methodology of the communication theory approach is elective in the sense that either deductive reasoning, inductive integration, pragmatism, ethical concepts, or any combination of them can be used to construct an accounting theory, depending on the problem formulated and investigated by the researcher. To apply the communication approach, the FASB in the United States using a shared power system involving the SEC, the practicing profession, various groups of users of financial statements and researchers to obtain consensus for conceptual development rather than strict theory construction. It is found that consensus making is the watchword in the current stage of accounting theory formulation, and conceptualization, rather than theorization is more important than ever before.

Consolidation of financial statement has been regarded as one of the most significant technical problems in international accounting. In an effort to set world standards dealing with this important but complicated consolidation practice, the International Accounting Standards Committee (IASC) has issued several statements since the 1970s, including IAS 3, IAS 22 and IAS 27, on the subject. The current attempt is to introduce the highlight of these standards set by the IASC and to analyze them in the light of accounting practice in various countries, especially the generally accepted accounting principles (GAAP) pronounced by the standard-setting agencies in the United States.

1. Introduction:

Financial statement consolidation appeared first in the United States around the turn of the century. It became general practice in the United Kingdom in the 1930s, and was adopted by other European countries after WWII. In 1975, Japan pronounced financial accounting standard on consolidated financial statements, which was then followed by Taiwan ten years later, and further by the People's republic of China in 1992. Such a widespread requirement of financial reporting reflects the assertion that consolidation (along with translation and inflation accounting) is one of the three most significant technical problems in international accounting. It is no surprise that the IASC has been contributing great efforts for the normalization of international consolidation practice. The highlights of its pronouncements in this area are presented below.

IAS 27 requires the presentation of consolidated financial statements if one business entity controls another business entity. Control is deemed to exist when the parent owns, directly or indirectly through subsidiaries, more than one-half of the voting power over its subsidiary. Control may also exist even this level of ownership is lacking if the parent has more than one half of the voting power as a result of a voting trust or similar arrangement. Under certain circumstances, however, subsidiaries may be excluded from consolidation where the ability of parent control is intended to be temporary, or the subsidiary operates under restrictions as to the remittance of funds to its parent entity.

For financial statement consolidation, IAS 22 accepts both the parent company and the contemporary concepts to deal with the differences between the fair values and the book values, generally referred to as the valuation differentials, of the subsidiary's identifiable net assets. Nevertheless, the preferred treatment is the parent company concept which recognizes only valuation differentials of the subsidiary's assets that have effectively been purchased by the parent, whereas the minority interest is limited to its share in the assets at its predecessor cost basis.

Goodwill represents the excess purchase price paid in a business combination over the fair value of the identifiable net assets obtained. IAS 22 (1993) requires that any positive goodwill be amortized over a useful life not exceeding 5 years. However, a longer life up to 20 years may be permitted if it is justifiable. Negative goodwill, on the other hand, should be recognized as a liability and then amortized over a period of no longer than 5 years, or no longer than 20 years if justifiable, or, as an alternative, used to offset against the fair values of nonmonetary assets obtained in the acquisition.

IAS 22 provides a set of criteria for determining the appropriateness of a business combination to be considered as an acquisition (purchase) or a unity of interests (pooling of interests). Pooling accounting is appropriate if the combination meets all the three tests:

If a business combination is deemed to be a unity of interests, the pooling of interests method should be used, under which financial statements of the combining enterprises should include the assets, liabilities, revenues, and expenses of the combining enterprises as if they had always been combined together. No goodwill is created. If it is an acquisition, on the other hand, the acquired entity maintains a separate legal and accounting existence and all assets and liabilities remain at their premerger book values. When consolidated financial statements are prepared, however, assets and liabilities are adjusted to fair values, and goodwill, either positive or negative, is to be recognized, amortized and reported.

IASC's efforts in normalizing international consolidation practice have been highly impressive. The similarity of its statements to the GAAP in the United States is overwhelming. As such, it is criticized that the level of information aggregation inherent in the process of consolidation may raise some doubt about the usefulness of the consolidated financial statements to the users' understanding and decision making.

This paper examines the international stock market interdependence between industrial and emerging market economies. Although there are many studies on stock market interdependence, most of these studies deal with stock market movements that are propagated among developed countries only. How economies of developing countries are affected by stock market movements of developed economies and by other emerging economies is yet to be understood. This paper contributes to the existing literature on stock market interdependence by investigating the transmission patterns of stock market movements between developed and emerging market economies by estimating a four variable vector autoregression model (VAR).

A VaR model is a fine approach to uncover dynamic relationships between a set of variables. VaRs can be viewed as a flexible approximation to the reduced form of the correctly specified but unknown model of the actual economic structure. The variance decompositions (VDCs) and impulse response functions (IRFs) are constructed from the VAR model. VDCs measure the percentage contribution of each innovation to the k-step ahead forecast error variance for the dependent variable, and thus provide a means for determining the relative importance of shocks in explaining the variation of the dependent variable. The impulse response functions (IRFs) essentially show the response of the dependent variable to a one-standard-deviation shock to another variable in the system and can be thought of as a type of dynamic multiplier. Orthogonal innovations are used to capture "pure" responses to study how variables react only to a change in the value of the selected variable. Monte Carlo methods are utilized to develop confidence bands for statistical inference. In tracing the transmission patterns of shocks, the underlying economic fundamentals and trade links are considered as possible determinants of differences of stock market responses to understand whether the differences in transmission patterns are justified by economic fundamentals or not.

The weekly data is from the Emerging Markets Data Base constructed by the International Finance Corporation. The sample interval covers the period from the last week of December 1988 to the second week of September 1994. Tests of lag-length indicated that estimating the system with four lags was not statistically different from estimating it with six or twelve lags. The emerging markets considered in this study are the stock markets of Argentina, Brazil, and Mexico. The developed markets considered are the stock markets of Germany, Japan, U.K, and the U.S.

A four variable VAR model is developed first that consists of only developed markets to serve as a benchmark for the estimations involving emerging markets. The emerging market models are comprised of a developed market -such as the U.S. stock market- plus the three emerging markets mentioned earlier. The results of the impulse response functions and variance decompositions indicate that significant links exist between the stock markets of the U.S. and Mexico and weaker links between the markets of the U.S., Argentina, and Brazil. Differences in the patterns of stock market responses are consistent with the differences in trade flows. The response of emerging markets to a shock to the U.S. market lasts longer than that of a developed market such as the U.K. An emerging market responds more quickly to shocks originating in its own market than a shock coming from another market. This shows that emerging markets are faster processors of information when shocks originate domestically. This finding is also consistent with the asymmetric information hypothesis suggested in the aftermath of the Mexico's December 1994 financial crisis, implying that local investors reacted before the international investors to news about the Mexican economy. Thus, local investors were more alert and sensitive to potential warning signals, when shocks originate domestically.

Another important finding, consistent with recent developments that took place in the East Asian stock markets and their effect on developed markets is that, while no single emerging market can affect the U.S. stock market, the combined effect of emerging markets on the U.S. stock market is found to be statistically significant. The findings are also consistent with the views that differences in the speed of information processing reflect the institutional structure governing the market and that emerging market economies that have opened their markets to achieve greater financial integration now face new exogenous shocks coming from abroad. In all, the findings suggest that the transmission of stock market movements is in accord with underlying economic fundamentals rather than irrational contagion effects.

The research in corporate capital structure so far has not addressed the following questions: What are the dynamic interaction effects in a continuous time setting between non-debt tax shields, debt tax shields and the exogenous bankruptcy decision facing the equity holders and how do these effects influence the agency cost of debt, the optimal firm value and leverage. Intuitively one might expect the solution to the optimal capital structure problem to be a linear combination of the DeAngelo and Masulis (1980) and Leland (1994) models. The integrated analysis in this paper provides answers to these unresolved issues and identifies potential questions that might warrant further study.

In spirit, our model most closely resembles the benchmark model of Leland (1994). However, it differs in two different ways. First, it recognizes the importance of non-debt tax shields for determination of optimal capital structure and the resulting interaction effects which arise when they are incorporated into a continuous time stochastic model as opposed to a single period one. Those interaction effects can be considered a ‘synergy’ effect of combining non-debt tax shields with a continuos time setting in which holders of the firm are endogenously determining the optimal bankruptcy trigger (bankruptcy point) that is dependent on the utilization of the non-debt and debt tax deductions. We also show that a bankruptcy trigger is the most important determinant of agency costs of debt and the market value of debt, equity, and the firm. An increase in non-debt tax shields lowers the bankruptcy trigger, reducing the agency costs of debt. Second, we incorporate into the benchmark model a complex mechanism for the treatment of partial utilization of debt and non-debt tax deductions. Therefore, the level of utilization of tax deductions is a function of a stochastic variable (asset value), hence we refer to stochastic tax shield utilization.

For the endogenous bankruptcy case we derive qualitatively different expressions for the value of debt. There are a number of assumptions in our model that make derivations analytically tractable. We assume infinite maturity debt, a constant risk-free interest rate, constant principal amount of the debt, constant volatility for the asset value, and that the coupon payments financed by issuing additional equity. Finally, we assume that non-debt tax deductions are constant, which enables us to derive closed-form solutions.

After incorporating non-debt tax shields into the benchmark framework and deriving a complex mechanism for treatment of partial utilization of tax shields (debt and non-debt) we derive the closed-form solutions for the endogenous bankruptcy trigger, debt value, yield spreads, equity value, and levered firm value. Closed form expressions for partial derivatives of those solutions are obtained and their comparative statics are derived.

Complexity arising from incorporating non-debt tax shields and partial utilization results in three different expressions for the value of the firm. The first one is valid when the initial asset value (i.e., at the time when decision about debt issuance is made) is such that full utilization of debt and non-debt deductions is made (see Figure 1). The second one is valid in the range of asset values when either debt or non-debt or both tax deductions can only be partially utilized. The third one is valid for small asset values when neither debt nor non-debt tax shields can be utilized. All three expressions are derived so that at the stitching points those expressions and their derivatives are continuous; i.e., smooth pasting conditions are satisfied.

In our model the existence of an interior optimal capital structure, even for initial asset values such that no tax deductibility (or only partial deductibility) is feasible, is explicitly confirmed even for zero bankruptcy costs. This could not have been explicitly shown using previous models since their structure did not incorporate partial deductibility. That is, an unlevered firm will increase its value by exchanging an optimal portion of its equity for long term debt even if it is currently loosing money from operations (no signaling effects assumed). This can explain why at the maturity of current debt a firm refinances matured debt by new debt issue rather than by issuing equity even if operating profits are negative.

Our derivation of the risk spreads on the risky debt which will be issued by a firm indicates that the risk spread will decrease with an increase in non-debt tax shields of the firm. Also the value of the firm’s debt will increase with an increase of non-debt tax deductions.

Another interesting, explicitly derived result in the stochastic tax shield utilization framework is that the increase in non-debt tax deductions by units leads to an optimal coupon level decrease by much less than units. That is, non-debt tax deductions are not perfect substitutes for interest tax deductions. Even more interestingly, we find that for low volatilityof asset values, the increase in non-debt tax deductions induces an increase in the optimal coupon payment and the optimal leverage of the firm, that is, non-debt tax deductions can be complements for interest tax deductions.

We also show that the original M&M (1958) irrelevance conclusion holds for stochastic asset values when the tax rates and bankruptcy costs are set equal to zero in our expressions. A similar conclusion was previously reached by DeMarzo (1988) in a different setting. For strictly positive tax rates and arbitrary bankruptcy costs when asset volatility goes to zero, the results of the M&M (1963) correction are obtained and the existence of the tax shields increases the firm value only if some tax deduction can be utilized. However, in our general case, the firm value is increased by debt financing even if the firm cannot currently utilize any tax shields.

After we set non-debt tax deductions in our model equal to zero, we compare the net effect of incorporation of partial utilization of debt deduction with the results of Leland (1994). In this special case, the results confirm our intuition that the optimal leverage in our model is lower than the one in the benchmark which assumes full deductibility for all asset values. As a result, the value of the firm in the benchmark Leland model in comparison to our model is higher for all levels of debt deductions.

In the general case, when non-debt tax deductions are positive, for low coupon levels (low leverage) the benchmark model implies lower firm value than the firm value derived in this paper. When coupon payments are high, Leland’s model implies higher firm value unless the non-debt tax deductions become very high. Relative to Leland (1994) our model implies lower optimal leverage and in most cases lower optimal firm value. However, the benchmark implies lower optimal coupon level when the non-debt tax deductions are high asset volatility is very low, and the asset value below which no tax deductions can be utilized is high.

Several interesting empirical implications of our model that warrant further study can be summarized as follows: Optimal coupon amount of a firm with high (low) volatility of asset value decreases (increases) when non-debt tax deductions increase. Therefore, as the availability of non-debt tax deductions varies along with the tax code, the optimal interest payments should change in opposite directions for firms with low and high volatility of assets values. The yield spread is predicted to decrease for firms with high non-debt tax deductions. Cross-sectional studies that involve different types of firms as defined in the paper can be undertaken. However, the limitations of the assumptions made at the beginning of our analysis must be taken into account when conducting such empirical studies.

The univariate time-series models accuracy has been compared to analysts' earnings forecasts in various studies. Most of them have found analysts being more accurate than time series forecasts. This is true even for the most sophisticated time-series models to day. However, some recent papers argue that analysts' earnings forecasts are less accurate than forecasts by time-series models. They postulate that the analysts' forecasts are too large to be reliably used by investors, and further, that the errors are increasing over time. On the other hand, others' postulates that analysts' are more accurate than forecasts by time-series models and that the forecast errors have not been increasing over time.

The same kind of dilemma in the literature can be found in bias and under/over-reaction research. There is more evidence in favor of analysts' earnings forecasts being overly optimistic. However, others' argue that the analysts' earnings forecasts are significantly pessimistically biased.

According to some papers analysts over-react to extreme earnings changes and returns, which is in lieu with earlier evidence of the stock market overreaction to new information. Some others have found evidence that analysts under-react to earnings announcements.

At least it is evident that there exists no consensus whether, first, there is optimistic bias or not, or pessimistic, second, is there over- or under-reaction, if any, and third, are the forecasts accurate (enough) and have they been decreasing in recent years.

This paper considers possible explanations for this (seemingly) puzzling evidence, concentrating on the empirical finding that the forecasts are more accurate for the firms with increasing vs. decreasing earnings.

Thus, the purpose of the paper is to study the differences in the forecastability of decreasing vs. increasing (annual) earnings during the fiscal year in order to explain the puzzling evidence. The contribution of this paper comes from 5 sources. First, it is studied whether there are differences in bias between negative and positive earnings change firms. Second, whether there are differences in over/under-reaction between negative and positive earnings change firms. Third, how do these differences change during the fiscal year. Fourth, how do these differences change from year to year. Finally, and most importantly, are these differences adequate to explain the different results in empirical literature.

This is done by, first, studying the forecast errors per se by Theil's inequality coefficient, as well as mean and median, in years 1990-95 as well as each year solely. Firms are divided into two sub-portfolios according to the sign in earnings change from previous year. Next, a regression model is implied to investigate the bias and over/under-reaction hypothesis. Keywords: Forecast, accuracy, earnings.

Small businesses can be considered the fuel of the United States economy. Specifically, small firms employ over half of the workforce. Fifty-five percent of U.S. businesses have less than 100 employees and 71 % of businesses have less than 250 employees; only 13 % of the workforce is employed by large corporations with 1000 or more employees (Statistical Abstract of the U.S., 1996). Moreover, small firms introduce the most innovative and technological breakthroughs in comparison to larger companies. Therefore, it is not surprising that Congress, entrepreneurs, and academics continuously raise concern about the high failure rate among these firms, particularly in Chapter 11 bankruptcy. In 1996, in response to pressure from small business advocates, Congress created a committee to examine if the Chapter 11 bankruptcy process contributes toward the notoriously high failure rates experienced by small firms. The concern of Congress has been corroborated by several academic studies. White (1983), Ang et. al. (1983), and Lawless, et. al. (1994) report that over 70 % of small firms are liquidated subsequent to filing for Chapter 11. Additional research is necessary because there is a dearth of timely, reliable, and relevant information on small business failures in Chapter 11.

Prior studies concentrate exclusively on documenting the frequency of small business failure subsequent to formal bankruptcy and they provide limited financial information. None of the studies discuss the impact of managerial strategic decisions, which are critical to a firm’s turnaround strategy. Clutterbuck (1982) asserts that many of the problems experienced by distressed firms stem from inadequate strategic management plans or a lack of marketing savvy. In his article, he describes how Timex emphasized new products and developed marketing niches as a means of getting the firm out of a financial slump. He reports that the firm’s marketing strategy plays a pivotal role in distressed companies’ ability to survive. The academic literature, however, does not focus on marketing strategy as a critical determinant of survival subsequent to filing for Chapter 11.

The objective of this study is to examine whether the managers’ emphasis on marketing is related to the firms’ likelihood of emerging from Chapter 11 as an independent entity. We use the Miles and Snow (1978) theoretical framework to analyze whether management’s proposed plan of reorganization places an emphasis on marketing strategy. Miles and Snow (1978) define four strategic archetypes that are representative of most firms’ management styles. The prospector strategy archetype focuses heavily on marketing and product innovation whereas the defender strategy concentrates primarily on cost efficiency at the expense of marketing innovation. The reactor strategy has no clearly defined orientation. The analyzer strategy places a heavy emphasis on both marketing and engineering (cost-efficiency). Firms that use the analyzer strategy have a mixture of stable and entrepreneurial markets. The analyzer strategy is not considered in our study because small, closely-held mainly focus on single product markets.

Another objective is to examine whether external constituents, such as bank creditors who provide pre-petition financing and creditors who offer post-petition financing, influence managers’ strategic choices subsequent to filing for Chapter 11. Miles and Snow (1978) predict that external constituents influence managers’ strategic marketing choices. Gilson (1990) reports that bank creditors influence firms’ investment and financing policies during Chapter 11, but he does not focus on the marketing aspect of the plan of reorganization. To date, there is no empirical evidence that managers’ emphasis on marketing in the strategic management plan is related to the degree of creditor influence. In our study, distressed firms avoid marketing-oriented strategies when either bank creditors own large claims relative to total debt or general creditors provide post-petition financing, even though cost-cutting plans are rejected most often and, thus, a precursor to Chapter 7 liquidation. Closely-held firms that emerge from Chapter 11 bankruptcy have marketing-oriented plans of reorganization and nominal bank debt as a percentage of total debt.

This article summarizes our resent evidence on the ownership structure of companies listed on the New Zealand Stock Exchange (NZSE), and the ownership composition of the New Zealand shremarket. We then analyze some implications of these findings for securities regulation. In the conclusion, we suggest that market ownership has significant implications for regulatory design. To adapt a North American insight, an understanding of who owns New Zealand - as is reflected in the composition of investors in New Zealand listed companies - might improve the efficiency and fairness of regulatory choices (Cox, Hillman and Langevoort, 1991, p. 9). Regulatory choices should be assessed differently if the bulk of trading investors are small, unsophisticated investors rather than large, sophisticated and financially robust corporations choices (Cox, Hillman and Langevoort, 1991). The research summarized here shows that the latter category are now the dominant owners of the New Zealand sharemarket. For example, between 1989 and 1996 the average overseas institutional and corporate investment in the largest forty companies, by market capitalization, rose from an estimated 19 per cent to 58 per cent per company (Fox and Walker, 1996a).

We also suggest reasons for dramatic change in the ownership composition of the New Zealand sharemarket. A key precursor to ownership changes was the publication of The Treasury’s and Reserve Bank’s Briefing Papers to new Ministers following the foreign exchange crisis of July 1984 (New Zealand Treasury, 1984). The Briefing Papers published as Economic Management, listed five specific examples of poor economic management. The first, and most important, was a failure to adjust the structure of the New Zealand economy to changing external conditions (New Zealand Treasury, 1984, p.104). Rather than adjusting, the government had increased its overseas debt in an unsuccessful attempt to cushion the domestic economy from the impact of declining terms of trade in the 1970s. In retrospect, we can view this criticism as an explicit official recognition that the domestic economy must take account of change in the international economy. Such recognition was a powerful driver in the liberalization of the New Zealand economy post-1984. The ultimate expression of this logic is the concept of globalization which provides an overarching explanation for radical change in New Zealand sharemarket ownership (see Walker and Fox 1996a).

The past decades have been characterized as the era of environmental consciousness. A substantial number of environmental laws and regulations have been enacted worldwide to hold business organizations more accountable for their environmental obligations. Environmental outlays are significantly increasing and will continue to increase as the world becomes more environmentally conscious and countries issue more extensive environmental laws and regulations. The primary purposes of this presentation are to : (1) discuss recent voluntary environmental initiatives and developments including The International Standards Organization (ISO) 14000 environmental standards; (2) examine the general perception of U.S. firms toward ISO 14000; (3) discuss the current status of environmental auditing; (4) suggest continuous improvement to facilitate proper adoption and implementation of ISO 14000; and (5) make recommendation for a more proactive stance on voluntary environmental initiatives for global business. These purposes are achieved by examining the responses from a survey of a large sample of Chief Financial Officers (CFOs) of major American Manufacturing Companies. The results may provide insights to business, academia, government regulatory agencies, and accounting standard setters in addressing global environmental concerns.

Results of this study indicate that: (1) future demand and interest in environmental accounting and auditing will increase; (2) ISO 14000 environmental standards will provide adequate guidelines for global business in performing environmental audits; (3) environmental management systems, environmental auditing, and environmental performance evaluation are the most important components of ISO 14000 environmental standards; and (4) respondents consider many of the perceived benefits of ISO 14000 presented in this study as being important to their organizations.

One of the invaluable theories about human nature to the economist states that on aggregate, individuals act effectively to exogenous stimuli. In the study of finance and security markets, this inference has been adapted to suggest that since individual investors are aware of all the relevant information, the accumulation of profits or losses beyond the market average rate of return are impossible. The Efficient Markets Hypothesis (EMH) claims that security prices reflect all the available information and hence speculation, even in the short term, is a frivolous pursuit because returns beyond what the market offers cannot be achieved. However, twenty years of research and experimentation have left the merits of this hypothesis in serious doubt.

Attempts to consistently encounter the Efficient Market Hypothesis have failed. Faced with the arrival of unexpected information, agents do not adjust prices immediately in accordance with the news. The implications of new information on financial derivatives are often exaggerated and therefore, time for adjustment is required to equate the price level with the mean rate of return.

In its place, the detractors of the EMH have proposed the adoption of two possible alternatives. The first is the Overreaction Hypothesis (OH) while the second is the Uncertain Information Hypothesis (UIH). The starting premise for the former theory is that security investors are by nature inclined to overcompensate for a market disturbance. When a stimulus, such as the occurrence of a major financial announcement or incident is introduced, the financial community has the tendency to overreact. The OH argues that investors would bid prices above and beyond the average rate of return in reaction to positive stimuli and bid the price of stocks below the average rate of return following negative news. Hence, a study of stock markets should produce a pattern whereby extreme movements in prices will proceed shifts in the opposite direction. But the Uncertain Information Hypothesis approaches the question in an entirely different light. The Uncertain Information Hypothesis (UIH) models this rational behavior of agents in an uncertain environment. The theory predicts that return volatility will increase following an announcement. Specifically, post-negative disclosure volatility are greater than positive volatility. The latter is a rational consequence of risk-averse agents attempting to err on the side of caution.

The purpose of the current study is to test these theories in the context of the emerging stock markets in Europe. The present study traces the reactions of market indexes to stimuli in thirteen small European stock markets: The thirteen bourses are located in Belgium, Denmark, Finland, Greece, Ireland, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and Turkey. These countries are chosen because their diminutive size would provide them with a higher degree of dependence on the performance of the larger European countries, such as Germany, the UK, Italy and France, as well as on the world’s other major markets, the US and Japan. Furthermore, these European countries should provide safe environment for foreign capital because of additional European Union and OECD regulations and monitoring.

The paper evaluates the merits of the Efficient Market, the Overreaction and Uncertain Information Hypotheses by examining the behavior of small European stock exchanges over a 60-Day period following market disruption. Previous articles have associated inefficiencies generated by thin markets with investor overreaction, thereby refuting the Efficient Market Hypothesis. However, the arrival of new information introduces a period of increased risk and uncertainty to the rational agents. Hence, the Uncertain Information Hypothesis is a variation of the efficiency theory, accounting for investor reactions to unexpected surprises. Regardless of the nature of the shock, equity prices are undervalued. Given the increased return volatility, the reaction of the market in this case is efficient.

In this paper we examine the characteristics of thirteen small European stock markets in order to find international support for the presence of efficiency in financial markets. Although there has been strong scrutiny of American institutions, foreign markets have often been ignored. The methodology introduced by Brown, Harlow and Tinic [1988] is followed to test the validity of the three hypotheses over sixty days following an unexpected disruption in the national relative to the World Stock Index financial environment. The data are closing daily stock market indices for thirteen European security markets. The diminutive size of secondary European markets, both in terms of investors and the number of securities listed, implies a lack of efficiency and could explain the absence of interest. To negate the disadvantages of these secondary markets, two main factors will work for their benefit. First, the existence of the European Union will help monitor and reform many of these bourses, making them more efficient. Second, the trend towards globalization has fostered legislation that fosters foreign ownership and has permitted the exchanges to benefit. In the study we used market indexes as a benchmark in order to eliminate stock specific anomalies and to scrutinize the operations of the entire market. Our examination traces the effects of the passage of time on stock returns following favorable and unfavorable news. The benchmark adapted for the purpose of generating excess returns for the European exchanges is the World Stock Index. The individual market rate of return is then regressed on the global rate of return to generate events.

Market disturbances prompt the financial agents to undervalue securities following negative news and overvalue stocks after positive announcements. The Overreaction Hypothesis rejects the tenets of the Efficient Market Hypothesis. Smaller markets should be more susceptible to this sort of irrational behavior. However, with the exception of the Netherlands, Norway and Turkey, evidence is lacking to support suck a claim. Yet all three anomalies can be attributed to institutional factors.

Economic models assume that agents involved in the global financial markets perform efficiently. Yet, successive authors have contemplated situations in which this argument fails. In place of the Efficient Market Hypothesis, the Overreaction and Uncertain Information Hypotheses have been substituted with varying degrees of success. This paper attempts to provide further observations in support of the debate. Primarily, the study shows that the majority of the smaller, "globalized" equity markets behave in a manner reminiscent of the Uncertain Information Hypothesis, suggesting that the efficiency theorem is upheld.

Belgium, Luxembourg and Switzerland are the examples of across-the-board consistency. All three markets exhibit Uncertain Information behavior and provide beneficial atmospheres for foreign investors, implying the presence of efficiency. Portugal does not exhibit any significant variance between post- and non-events and between negative and positive events. In this instance, efficiency is present as well, despite the persistence of regulations meant to limit non-EU investment.

The cumulative abnormal return (CAR) data are more definitive than the variance volatility statistics. The CARs figures provide a supportive forum for the uncertain information theory since all but five of the stock markets surveyed (Netherlands, Norway, Finland, Greece and Turkey) adhere to the UIH in at least one of the two cases. The majority of the bourses polled appear to confirm the supposition that they are open to foreign investment, despite their unflattering liquidity and size.

In conclusion, given that investors in small European stock exchanges are faced with uncertainty following financial disturbances, they respond rationally by initially undervaluing the price of equities and subsequently positively adjusting the returns, in accordance with the Uncertain Information Hypothesis. Therefore, most of the European markets polled retain the characteristics of efficiency.

Over the more than fourteen years I have been a professor at the Monterey Institute of International Studies, I have had numerous conversations with international students concerning their education and living costs in the Monterey area. Students' concerns were related to the values of their home country currencies relative to the US dollar. Over the years, these currency exchange rates have fluctuated significantly. The recent monetary crisis in Eastern Asia is a case in point. The problem, however, has been ongoing for many years. Since our (MIIS) published tuition fees (and subsequent living costs in the US) are all in US dollars, these costs to our international students can and often have varied considerably, particularly for students who are studying in the US for several years. In some cases, the published MIIS tuition costs in US dollars may be almost irrelevant to numerous international students since their out-of-pocket costs are based entirely on their home country's currency value relative to the US dollar. These exchange rates may, and often do, change significantly from the time a student initially enrolls, to the time they are physically in the US undergoing their educational programs.

Currently, and in the past, exchange rates have varied significantly. For example, several Indonesian students arrived in Monterey in fall 1996 when the rupiah was valued at 2,343 per US dollar. Recently, the rupiah was quoted at more than 8,600 per US dollar (it declined briefly to 11,000 per USD), or a decline of nearly 73% relative to the US dollar. This makes the tuition of these students and their estimated living costs nearly four times the amount they had anticipated upon their acceptance of admission to the Monterey Institute.

Several Korean students also enrolled at the same time. In fall 1996, the Korean won was at 819 to the US dollar. Today it is at more than 1,600 to the US dollar, or nearly twice the 1996 rate. The Korean won has recently been floated, which will make t he exchange rate even worse.

More than 60 Japanese students enrolled in the fall of 1996 when the yen was at 97 per US Dollar. Recently, the yen was quoted at 131 per US Dollar, or a decrease of 35 percent. The Japanese yen is expected to decrease to 150 per US Dollar over the short term. The costs of education and living expenses for these students are certain to rise. The stories go on and on and MIIS is but a small part of the international community of thousands of foreign students who are studying in the US.

From the examples above, this exchange rate risk is particularly and obviously relevant to our current students from the troubled countries in East Asia. Currency values relative to the US dollar in Thailand, Indonesia, Malaysia, and Korea have plummeted in recent months. Our students from these countries have seen their tuition, fees, books, and living costs more than double in terms of their own currencies in a very short period of time. Students from other countries, such as Japan, Norway, and the Philippines have also incurred increased costs, although to a somewhat lesser degree. The US universities where international students study for a year or more are ill-equipped to bear the risks (and costs) of foreign exchange rate fluctuations. These risks (and costs) are borne by the students and their families, often at great hardship.

The objective of this study is to develop a workable mechanism whereby foreign students studying in the US would be able to hedge their home country currencies against the US dollar so that their tuition and living costs in the US would remain relatively stable during their planned period of study. Upon their acceptance to a US university (as proposed by this study), each student would be offered a standard contract for hedging their home country currency against the US Dollar for their planned period of educational preparation in the US. Major US (international) banks will (should) provide the appropriate mechanisms.

The initial phase of the study focuses on the foreign student population of MIIS and their countries of origin (nearly 50 countries). Exchange rates relative to the US dollar of these countries' currencies are collected over the past several years to determine how they have varied over time. Anonymous case studies of current MIIS students are constructed to demonstrate the magnitude of the problem. Countries with significant exchange rate variations are identified. A methodology for hedging these currencies is developed for subsequent presentation to major US banks with significant international operations for potential implementation.

At the same time, the study investigates the number and locations of all foreign students studying elsewhere in the US. In this respect, the methodology established for the MIIS community is applied on a larger scale, since it is more likely that major banks would take greater interest if large volumes of students (and foreign currencies) were involved. This study also includes a framework for forecasting new student arrivals in the US from overseas on an annual basis. This framework would assist banking institutions in planning for future currency hedging transactions.

Appropriately published results of this study and the subsequent opportunities for stabilizing the out-of-pocket costs for tuition and living expenses could result in an increase in the population of foreign students who elect to pursue undergraduate and graduate study in the US. Currently, scholarship assistance to international students who are studying in the US is minimal. This precludes a potentially large population of foreign students from studying here. The results of this study might encourage additional students from overseas to choose their location of study in the US. In addition, US financial institutions can expect to profit from these additional "standardized" student hedging contracts.

We investigate the transmission mechanism of inflation across countries under two different exchange regimes - the fixed exchange rate regime and the flexible exchange rate regime - with the dividing point of July, 1973, at which many countries began to adopt the flexible exchange regime due to the collapse of the Bretton Woods system (the fixed exchange regime).

The analysis is carried out for (i) the Group of Seven (G-7) countries; (ii) four European Monetary System countries ( France, Germany, Italy, and the U.K. ), some of which are likely to join the implementation of the single common currency - in essence, the fixed exchange regime - in European Monetary Union, effective January, 1999; (iii) two North American countries ( the U.S. and Canada ).

The empirical results indicate that there is no significant difference in inflation spillover across countries under the two exchange regimes. These empirical results are not consistent with the argument of Friedman (1953) for the flexible exchange regime in which he hypothesized an indirect linkage in the transmission of inflation across countries, assuming the inflation shock generated in a country is mostly absorbed via the change in exchange rates and thus has an indirect effect on the inflation of one or more countries.

The results also imply that governments do not always maintain autonomy to set its domestic economic policy due to the inflation spillover from other countries even under the flexible exchange regime.

During the first half of 1997, the world's currencies and economies were trading at significant premiums. Scholars, bankers, economists, business executives and political leaders from around the world reported that several of these currencies, particularly those in Asia, were significantly overvalued. As a result, several foreign exchange traders, arbitrageurs, and dealers, speculated in currency markets which led to greater volatility and ultimately, to a major financial crisis.

The purpose of this paper is to determine the relative importance of several factors that might contribute to a potential financial crisis in Brazil. The methodology that was used included structured interviews to develop a set of factors that might contribute to a potential financial crisis in Brazil. These data were compiled to develop a ten-item questionnaire which was administered via a telephone survey. Respondents were asked to rank-order nine factors on the questionnaire according to its relative importance. The tenth item on the questionnaire was an open-ended query regarding the existence of other factors that might be pertinent to potential economic disturbances in Brazil. Narrative responses were then elicited from each of the respondents to explain the rationale for their rankings.

The quantitative and qualitative data were collected during the months of November and December, 1997, from a sample of Latin American and Brazilian country analysts, economists, bankers, investors, financiers and senior executives. The respondents were from such companies as ABN Amro Bank; Alliance Capital; Banco Portugues do Atlantico, BankAmerica; Bear Stearns & Co. Inc.; Barclays (BZW); Coutts & Company; Donaldson Lufkin and Jenerete, Inc.; Goldman Sacks; ING Barings, JP Morgan & Company; Republic National Bank of California; South American Business and Development Group; and the World Bank (IBRD).

The findings from the questionnaire indicated that the six issues of greatest relative importance to avert a financial crisis in Brazil are to 1) continue Brazil's privatization process; 2) increase measures to cut government spending and balance Brazil's trade account and budget deficit; 3) avoid the potential of a regional economic and financial crisis; 4) lower the potential of a large scale sell off and capital flight from the region; 5) reduce the debt ratio and extreme capital flow deficit; and 6) not repeat history made in Mexico or the return to stages of hyper-inflation that Brazil experienced in the early 1990's. Other issues that were addressed and discussed included Brazil's Constitution and the recent reforms and austerity plan to accelerate cuts in government spending, and the perceived valuation of Brazil's assets and investments. Further consideration was given to the government's relationship with the International Monetary Fund which is demanding policy reforms and proposals aimed at bringing inflation under control, balancing trade balances and budget deficits, and restoring growth to Latin America. Additional issues that arose during interactive consultation included accelerating the privatization program, continued tightening of the fiscal program via continued legislative reforms, a more aggressive devaluation rate on the Brazilian Real, the development of a strategic plan for the future; and Brazil's preparation to move the currency to a floating exchange rate in the world market. Further concerns that were identified include shrinking reserves, the real rate of interest in Brazil, economic decline and potential political instabilities in upcoming elections.

Brazil must accomplish fiscal reforms and manage its trade balance. In order to accomplish these goals, Brazil must continue to be aggressive in their fiscal reforms, legislation, and privatization process. There are two stages and a number of steps that should help Brazil fulfill its objectives.

The first stage of Brazilian reforms should include more aggressive fiscal reforms and accelerated privatizations. 1) The Brazilian Central Bank should continue to devalue its currency at an increasingly more aggressive rate. However, this devaluation should not be so aggressive that it strangles economic growth and enacts a recession. Some level of positive growth must be maintained to keep Cardoso from losing popularity. This devaluation should fuel exports and aid the trade balance. 2) Brazil should also continue to accelerate their privatization program to realign account balances and deficits. 3) Brazil should continue to develop and pass anti-arbitrage legislation to protect the country from currency speculation. This will prepare Brazil for future reformations and currency liberalizations. 4) Brazil should also make attempts to increase domestic savings and investment to offset foreign investment flow. 5) Brazil must maintain significant reserves to fund the defense of potential future speculative attacks on the Real. 6) It is also important for Brazil not to pursue extreme measures prior to the settlement and stabilization of the Asian Financial Crisis.

The second stage would be contingent upon the October, 1998 elections. Assuming that Cardoso is reelected, reforms should continue as proposed; if the leftist government was to return to power, the future of Brazil could be very unpredictable. Given consistency in Brazil's political context, more aggressive steps would be viable. 1) Brazil should enact a very aggressive devaluation process. 2) Brazil should continue to move towards open market liberalizations and reforms. 3) Following a re-correction or re-valuation of the Real, to float Brazil should open the currency to speculation and float it for its true value. The only true way for Brazil's Real and its assets to be valued at market value would be to deregulate it.

The conclusions suggest that while Brazil is still viewed as unpredictable and problematic, vast growth potential exists. It is further indicated that given Brazil's current privatization program, natural resources, and demographics, Brazil holds the key to realizing Latin America's true economic potential. Because of Brazil's enormous economy and strength among the region, many members of the international community believe that the tangible, intangible and financial assets are actually undervalued. This is evidenced as many of Brazil's recently privatized State Owned Enterprises are attracting significant premiums in the open equity market. Thus, it is concluded that Brazil is just beginning to realize its immense potential, and in the future it will enable Brazil to perpetuate itself as Latin America's developing leader for the next century.

There has been a trend in the Asia Pacific region to have different market segments or sections on the same stock exchange to cater to specific needs of firms and investors. For example, stock exchanges in Japan, Korea, Malaysia, Singapore, Thailand, and Taiwan either currently have, or previously had, secondary market segments/sections to encourage trading in smaller, less liquid stocks. Other exchanges have also experimented with secondary sections, such as the Australian Stock Exchange which had a main and second board until 1992 and the American Stock Exchange which experimented with the Emerging Companies Market. More recently, some markets in Asia, and elsewhere, have introduced specialized segments to encourage trading in certain types of companies. Examples of these include the Infrastructure boards on the Kuala Lumpur Stock Exchange (KLSE) and the Stock Exchange of Singapore (SES"), the Foreign Section on the Tokyo Stock Exchange (TSE), the Alien Board in Thailand, and the "Red Chips" of China –traded companies listed on Hong Kong New York and Singapore stock exchanges.

One aspect of market structure is the different trading venues for different types of companies. In this context, the typical objective of having a secondary market section is to encourage trading in smaller and more earning-volatile stocks which would otherwise either not be qualified to list on the main exchange, or not to generate enough market interest to continue trading there. Once these firms become mature and start generating adequate investor interest they can be transferred to the main section on the exchange. Thus the existence of a secondary market section is often intended as a "breeding-ground" for the small, less liquid stock, cresting a two-tiered market structure for low-and high-quality companies. Adopting such a market structure can also help investors to distinguish potentially lower quality firms from higher quality ones, resulting in higher investor confidence and more liquid main market segment/section. At the same time, investor with a higher tolerance for risk always have the option of investing in the smaller, speculative firms trading on the lower quality markets.

The recent increased volatility in the stock and currency markets in the Asia –Pacific region has focused renewed attention on the market structure and especially the regulatory environment of Asian markets in general. The decision to introduce a secondary market section to complement the main market section raises the following major issues: (a) do secondary market section achieve their objectives of fostering active markets in smaller, less liquid stocks, (b) do market participants care where these small stocks trade; i.e., do market participants react positively or negatively when stocks trading on the secondary section are switched to the main section, and vice versa, and (c) does the total and/or systematic risk of stocks trading on the secondary market alter significantly after a move to the main segment/ In this paper we address these issues by analyzing the two closely related stock market of Malaysian and Singapore.

There are few studies that examine the market’s responses to firms moving from a secondary market segment to the main segment. Baker and Edelman (19900 examine the market’s response to switching form the OTC market’s NASDAQ system to its main segment, the National Market System (NMS) They find tat investors could earn significant positive abnormal returns during the period preceding the switch day. Baker and Edelman also find that firms with lower liquidity generally outperform firms with higher liquidity on the NASDAQ. Moreover, firms with relatively lower liquidity in the NASDAQ experience significant increases in liquidity after switching to the NMS. Lamba and Ariff (1997) examine the pricing and trading volume behavior of 168 firms switching within market from the secondary section of Tokyo Stock Exchange (section 2) to its main section (section 1) during 1984-92. They observe significant positive abnormal returns immediately before the switch day, and significant negative abnormal returns immediately after the switch day. Thus, a section which is generally considered "good" news by the market. The behavior of abnormal returns also implies a potential trading strategy where investors purchase shares of firms before a switch to section 1, and if possible, sell them short after the switch day. Lamba and Ariff further observe a significant and persistent increase in trading volume over the days prior to a switch to section 1. The possible effects of institutional traders at the time of switches in Japan have been reported in . Lamba and Ariff (1998) Trading activities to secure arbitrage profits appear to produce the negative abnormal returns of the high-liquidity firms being switched.

This research extends the growing body of findings on market structure effects (specifically switch effects) in the developed markets such as Tokyo to the closely related emerging stock markets of Malaysia and Singapore. More specifically, this research is about the switch effect on firms moving within the same exchange, where the moved firms is operating under the same trading procedures as those I the higher segment. The key question is whether there is a revaluation of shareholder value of switched firms. This can be addressed by examining the pricing behavior around the time of announcement and listing of the switched firms from the respective lower boards to the main boards in the two countries. Prior studies in the more developed major markets, as reviewed in the previous section, have confirmed a positive revaluation of shareholder value at least for the low-quality firms switching to the higher boards. Therefore, a prioro, we expect to confirm a positive revaluation effect, at least at the time of announcement of the switch, in these stock market.

The second issue is whether the revaluation effect is significant at the time of listing on higher boards. Where the stocks were involuntarily switched, as on the TSE, the revaluation effect was observed on the listing date. The observations covered in this study are for switches that have announcement and listing dates and are not involuntary. This study also extends the findings reported in previous studies on the US and Japanese markets because we test for the presence of listing-day effects in markets with different regulatory environments.

The third research issue is related to the question as to whether the revaluation effect of abnormal positive returns is gained by low-liquidity switching firms and not the high-liquidity firms. Existing literature suggests that the revaluation effect is limited t the low-liquidity firms. Finally, the fourth issue investigated is the change in the risk parameter of the switching firms. It may be argued that a firm switching to a higher board must be valued as being less risky than one that is not switched. Our analysis seeks to verify whether total and/or systematic risk is indeed reduced.

The data set relates to 32 switched firms in the two stock exchanges during 1990-96. Switches occurring after June 1996 are excluded as there is no data available in readily accessible forms in both markets. Price and volume data were collected from the NUS Financial Database and the KLSE Scans file. Information on announcement and listing dates were taken from the exchange publications such as the Daily Financial News (Singapore) and Investor’s Digest (Malaysia). The event study method is used to estimate abnormal returns based on both the market model and market adjusted returns method (Brown and Warner 1985) The market model parameters are estimated using daily returned over days –240 and –26. To account for possible non-synchronous trading bias the abnormal returns over days –25 and +25 around the listing date (defined as day 0 ) for each switched firm are analyzed. Since the number of observation is small, the signed rank test statistics is used in conjunction with the paramedic t-test on the average abnormal returns on each day surrounding the switch. The cumulative abnormal return (CAR) is also used to establish the trend in the price reactions around the announcement/listing date.

For measuring the effect of activity on the abnormal returned, a trading volume variable relative to outstanding shares is calculated for each firm by dividing the volume of shares transacted by the number of outstanding shares. The behavior of low-volume and high-volume switched stocks is analyzed separately.

This paper estimates the extent of risk reduction at the firm level that arises from the exposure of individual companies to foreign markets. A Company with foreign market exposure can be intuitively thought of as a portfolio of two assets, one with exposure only to domestic sources of risk and the other exposed to foreign market risk and exchange rate risk. Standard portfolio theory arguments suggest that this portfolio of two assets can have lower standard deviation than both the component assets if the correlation between the assets is sufficiently low and if the standard deviations of the two assets are sufficiently low. If, on the other hand, the two assets are highly correlated and/or the individual asset variances are high, then the standard deviation of the portfolio might exceed the standard deviation of the lower volatility asset. The volatility of the U.S. stock market is generally lower than that of many other stock markets. If foreign market volatility and/or correlation with the U.S. market are sufficiently high, then it is theoretically plausible that a company with foreign market exposure might have a higher standard deviation than an identical company with little or no foreign market exposure. An argument along similar lines applies to the systematic risk, i.e., beta, of the stock of a company with foreign market exposure when beta is measured relative to the U.S. market. Even though U.S. investors can achieve potential gains from international diversification, it is well known that U.S. portfolios contain a significant home-country bias. Hence, U.S. investors care about the sensitivity of U.S. stocks with respect to the U.S. market. Therefore, systematic risk is measured as the sensitivity of the company's stock with respect to the U.S. market. Another question that arises is the time variation in the impact of foreign market exposure on the risk of a stock. Recent research suggests that international correlation and volatility have exhibited substantial variability over time. Consistent with this finding, we would expect to see time-series patterns in the impact of foreign exposure on the systematic and total risk of U.S. stocks.

If the economic environment were relatively stable over time, one could observe the changes in the foreign exposure, beta and standard deviation of each company over time and study the effect of foreign market exposure company-by-company. This approach is not feasible for at least two reasons: a) foreign exposures change slowly over time, necessitating the use of data over very long time periods, and b) the economic environment (e.g., betas, correlation) is not stable over time. A pooled time-series cross-sectional approach to study the question of interest should be used. A market model of the usual form, i.e., r=a+brm+e, will be estimated with one exception. The beta of the stock will vary each period. The beta of stock i over time interval t is parameterized to be a function of various stock-level attributes such as sector membership, realized ordinary least-squares beta over the prior 60 months, firm size, book-to-price ratio and foreign market exposure. These attributes are known (i.e., pre-determined) at the start of period t. Two commonly used proxies in the literature for the extent of exposure to foreign markets are: a) the proportion of sales arising from foreign sources and b) the sensitivity of the company's stock to currency and foreign market movements. I use both these measures in this study. The coefficients ak, b, c, d, e along with the intercept term in the market model may be estimated via a two-pass regression technique. In the first pass, consistent estimates are obtained via a pooled time-series cross-sectional regression. This pass assumes that the regression residuals are homoscedastic and serially and cross-sectionally uncorrelated. The assumption that the residuals are serially uncorrelated is defensible on the grounds that I use monthly returns data and evidence for serial correlation at this horizon is weak.

The assumption that the residuals are cross-sectionally uncorrelated is strong and in future research I propose to relax this assumption by allowing residuals to be correlated in limited ways (e.g., intra-industry correlations). If the coefficient e on the variable frgn is negative, then a higher level of exposure to foreign markets implies, ceteris paribus, a lower level of systematic risk and vice versa. In order to study the extent of reduction or increase in systematic risk over time, the above model may be run over different time periods and the value of the coefficient e may be compared across these time periods. In order to study the effect of foreign exposure on total risk (i.e., standard deviation) I computed the realized standard deviation of the stock return over a given time period (s, t) and then ran a cross-sectional regression of the realized standard deviation against a set of attributes (such as sector membership, historical standard deviation, size, foreign exposure) known at the start of the time period, i.e., at time s. The coefficient on the foreign exposure attribute is the one of interest. The time series of coefficients estimated over different time periods can be used to infer patterns, if any, in the relationship between foreign exposure and total risk. In addition to the issues mentioned above, the following three hypotheses of special interest will be studied: a) Recent literature has pointed to the tendency of global markets to have higher correlation in down markets. One hypothesis of interest is to see if a separation of the sample into months of up moves and down moves in the market results in significantly different coefficients for the foreign exposure attribute. b) It would be interesting to estimate sector-specific coefficients for the effect of foreign exposure on systematic and total risk and see if there are any differences across sectors. c) Information on the state of the U.S. economy (e.g., growth versus recession) can be used to see if foreign operations offer diversification benefits in periods when the U.S. economy is in a recession.

The data for this study are monthly returns on companies in the S&P500 index, over the period 1973/01 through 1997/11. In addition to measured historical beta I use sector membership, firm size (measured by the log of market capitalization of equity), book-to-price ratio and foreign exposure as predictors of beta. Historical beta is measured via a market model regression of the return on the stock on the return to the S&P500 index over a 60-month period. Firm size is measured by the log of market capitalization and is updated at the start of each month. Book values are obtained from annual Compustat tapes. In the results reported below, foreign exposure is measured as follows. The residuals from the market model regression are regressed against the contemporaneous return and two lags of the monthly return on a basket of foreign currencies relative to the U.S. dollar. The currency basket chosen for this study consists of the G-7 currencies (excluding the U.S.). The lagged returns on the currency basket are used in addition to the contemporaneous return since there is some evidence of a delayed response in the stock market to movements in foreign currencies. The foreign exposure of the company is measured as the sum of the coefficients on the contemporaneous and lagged currency returns. The raw values of firm size, book-to-price and foreign exposure are normalized each month in cross-section to have a cap-weighted mean of zero and standard deviation of one. This normalization avoids problems relating to the presence of a unit root in the log of market capitalization and allows the impact of these three variables to be stated in terms that are directly comparable. Estimation of the linear combination of sector exposures, historical beta, book-to-price ratio, firm size and foreign exposure that best predicts future betas is carried out over rolling 120-month windows. My results indicate that over the period 1973-82 foreign exposure significantly increased the beta of a company while over the 120-month estimation period ending in 1990 foreign exposure decreased the beta of a company. For the most recent 120-month estimation period (ending in November 1997) foreign exposure marginally contributed to an increase in beta. Also ran were regressions of the residual standard deviation (computed from 60-month market model regressions) on the attributes at the start of the 60-month period. Results suggest that, for residual standard deviation, foreign exposure was marginally diversifying in the period 1973-78, significantly diversifying over the period 1978-83, strongly risk increasing in the period 1983-88, very marginally diversifying over the period 1988-93 and marginally risk increasing over the period 1993-97. In future work, I intend to use shorter horizon returns (e.g., daily/weekly returns). This will enable me to measure the sensitivity of betas and standard deviation to foreign exposure over shorter horizons and to study the recent surge in volatility in global markets. The net effect on total risk will also be examined in subsequent research.

The results indicate that while there have been periods over which foreign market exposure has been risk-reducing, there have also been periods over which it appears that foreign exposure has increased risk. The results have important implications not only for investment management but also for corporate finance since the beta of a company has a direct bearing on its cost of capital.

This paper analyzes volatility structures and the presence of common volatility components in the stock markets of Asian-Pacific, Europe and North America using close-to-close daily returns in local currencies. The return series are filtered before volatility modeling in order to remove first order autocorrelations. Furthermore, the consequences of nonsynchroneity in the opening hours of the markets around the globe are carefully taken into account. The results indicate that an ARCH-effect is present in all the markets. However, only a few pairs of markets seem to share common volatility. USA is present in most of these pairs. Of the European markets, only France and the small Nordic markets seem to share a common volatility process with USA. It seems that the small markets follow the volatility process generated in US. Furthermore, a common time-varying volatility process seems to be present in Canada and US. In addition, Hong Kong seems to share a common volatility with US. Analysis of weekly data suggests that common volatility is at most a regional feature.

The analysis utilizes daily close-to-close index returns from eleven markets including the stock exchanges in New York, Toronto, Tokyo, Hong Kong, London, Frankfurt, Zurich, Paris, Copenhagen, Stockholm, Oslo and Helsinki. The sample series starts on September 7, 1991 and ends November 10, 1997. The data is obtained from Global Financial Data Base. New York and Toronto floor trading hours have two hours overlap with London, one and half an hour overlap with Paris, Stockholm and Zurich, and half an hour overlap with Oslo and Helsinki. Hong Kong and Tokyo do not overlap with New York, Toronto or the European stock exchanges. The European exchanges are essentially open at the same time.

Descriptive statistics show the sample period is characterized by a small positive mean daily returns between 0.04–0.06 percentages for USA, Canada, UK, France, Denmark and Norway. Hong Kong, Switzerland, Sweden and Finland have had returns around 0.08 percentage and Japan has had a slight negative average return of –0.01 percentage. Excess kurtosis is obvious in all series. All distributions, except Finland, Norway and France seem to be skewed, too. Sweden, UK and Japan are positively skewed, and the rest (Denmark, Germany, Switzerland, USA, Canada and Hon Kong).

In North America, the common time-varying volatility hypothesis is accepted as well between Canada and US. In the Asian-Pacific, also Hong Kong seems to have a common volatility process with US. Altogether, these empirical results differ from those of Engle and Susmel (1993) and also from those of Arshanapalli et al. (1997). However, Engle and Susmel used weekly data and Arshanapalli et al. utilized daily data for only one year; 1993. Our data set consists of daily returns covering nearly seven years. Hence, with the increased number of observations smaller deviations from the null hypothesis, common ARCH-feature, is expected to emerge.

To make the results better comparable, we ran weekly analysis as well. The univariate ARCH results change to some extent from the daily case, where ARCH-effect was inferred to be present in each series. Now Sweden, Denmark, France, USA and Canada do not show univariate ARCH. Augmenting the univariate information set by other series, ARCH-effect can be inferred to be present additionally in France and possibly in Sweden, Denmark and Canada. Still there is no sign of ARCH in USA.

These preliminary results suggest that one obvious group for potential common ARCH effect might be the big European markets of Great Britain, Germany, France and Switzerland because, at least after augmenting the information set each series seems to have ARCH effect. A second European group might be the small Nordic countries of Denmark, Finland Norway and Sweden. North America and Pacific Asian areas form their own two natural groups on the basis of geographical reasons. Using these groupings as the basis, we test the existence of a common ARCH effect between the markets within the groups if either both series have a univariate ARCH or multivariate ARCH after augmenting the information set by the test pair.

Furthermore, we test the existence of an ARCH beyond geographical groups between those series that have multivariate ARCH after augmenting the information set by the test pair. The results strongly indicate that there is no common volatility process between the small Nordic markets, although the null hypothesis of common volatility between Finland and Norway would be accepted even at a ten percent level. Norway, however, does not share a common volatility process with Great Britain, but Finland does. Consequently because of the equivalence relation property Norway should share a common volatility process with Great Britain as well. Because this is not the case, we can rather infer as in the daily case that these small countries may at most follow the volatility behavior of some of the larger European markets. This partially supports the general result found in the earlier daily analysis.

The adoption of floating exchange rates and the growth in international trade of goods and services have resulted in increased volumes in foreign currency trading in the last two decades. Starting in the mid 1980s, the volume of securities traded internationally has also grown dramatically, fueled by the increased integration of world financial markets and by the development of new stock exchanges in emerging markets. During the course of these developments, the 1994 currency crisis that led to the stock market crash in Mexico and the 1997 currency crisis in Thailand that spread to other South Asian countries and to stock markets indicate the existence of a significant relationship between the world currency and stock markets. Especially the latest crisis in South Asia shows that currency values significantly affect local stock prices, and stock prices affect the currency values. Characteristics of such a relationship between exchange rates and stock prices are valuable knowledge to investors with cross-border investments, to domestic policy makers, and to finance academia. When evaluating cross border investments, investors realize the importance of the effects of exchange rate changes on expected returns. These effects, if unattractive, can be hedged like any other transaction exposure. However, if the exchange rate changes influence the stock prices, and if the stock price changes creates a feedback to exchange rates, the hedging process becomes very difficult, if not impossible. In terms of starting and maintaining a healthy stock market, the knowledge of such underlying relationships are at least as valuable to policy makers in a country as it is to foreign investors. Finally, specifics of any such relationship is valuable to academia for increasing its knowledge-base.

Despite its popularity in financial news, the literature on the relationship between stock prices and exchange rates is limited. Considered the first in the field, the multi-factor international asset pricing model (IAPM) of Solnik[1974] identifies the exchange rate, in addition to the market portfolio, as a relevant risk factor for common stocks. Empirical tests of variations of IAPM, by Bodurtha, Cho and Senbet [1989], and Ferson and Harvey [1993,1994], generally confirm the existence of exchange rate risk at the aggregate market level. However, others such as Jorion [1991], and Choi and Prasad [1995], find no evidence of foreign exchange rate risk in the stock market. Differences in the methodologies and data sets employed by these studies do not allow a direct comparison of their results.

Researchers have also employed stock prices to explain variation in exchange rates. Solnik [1987] uses stock price changes as a predictor of exchange rate changes, while Korajczyk and Viallet [1992] use international stock returns to explain the predictable component of forward exchange rates. Smith [1992] also uses stock prices to explain exchange rate changes. Overall, these results above confirm the unidirectional effects between foreign exchange and stock market.

Studies such as Bahmani-Oskoee and Sohrabian [1992], Mok [1993], Ajayi and Mougoue [1996], and Abdalla and Murinde [1997], investigate the relationship between stock prices and exchange rates using methods that enable measurement of unidirectional and bi-directional causality between the two markets. Although there is agreement on the existence of a significant relationship between stock prices and exchange rates, this second set of results are not consistent in terms of the magnitude and the direction of the effects. Those differences in results point out the need for further investigation of the topic, possibly by inclusion of other factors that are influential on those markets.

One such influential factor is interest rates, and its role in stock price-exchange rate interaction is first investigated by Solnik [1987] who includes stock price, exchange rate and interest rate series in his earlier model. However, Solnik's study is very limited in terms of the methodology, simple linear regression analysis, used. Only one study, Mok [1993], actually includes all three series in an ARIMA model and tests for Granger causality. He finds bi-directional effects between exchange rate and stock prices, but does not find any relationship between interest rates and stock prices in Hong Kong. Considering that the HK dollar is pegged to the US dollar, inclusion of US interest rates would have been interesting in his study. It is quite surprising not to see more studies that include interest rates together with the stock prices and exchange rates, as interest rates have been widely accepted as an influential factor in stock prices (such as Fama and Schwert [1977], Solnik [1983], Giovanni and Jorion [1987]) and where the role of interest rates as forward premia in exchange rate determination is widely documented (such as Lucas [1982], Fama [1984]).

In this study we use cointegration methodology to investigate the relationship between domestic stock price indices, US dollar exchange rates, and interest rates for seven industrialized countries. The cointegration methodology is the proper method to use because it is consistent with the equilibrium condition of asset pricing models and permits interactions between the factors. By including domestic and foreign interest rates, we investigate the importance of money market conditions in the exchange rate-stock price relationship, in addition to any influence between the two series.

Data used is the weekly values of domestic stock price index, the US Dollar exchange rate, and money market rate for each country, except the US. The US Federal Funds rate is employed as the foreign interest rate series, as the US Dollar is used for the exchange rate. The time period covered is from January 1986 to August 1997, however some of the series are only available for shorter time periods.

After confirming the existence of unit roots for the four series for each country, we proceed with the cointegration tests. For three countries, Canada, Germany, and Japan, the series are shown to be in a long-term equilibrium relationship, represented by the cointegration of the series. Lack of support for cointegration in Italy and France is primarily due to shorter interest rate series that are available. In the UK case, stock market crash of 1987 is the responsible for not finding cointegration among the series.

Examination of the ECM coefficients leads to interesting findings about short term influences among stock prices, exchange rates and interest rates in those three countries. The only common short term influence present in all countries is the positive influence of domestic interest rates on US dollar exchange rates. This positive influence indicates that an increase in the domestic interest rate leads to depreciation of the local currency against the US dollar. This finding suggests that the interest rate increase is not real, but due to an increase in the inflation premium.

Changes in the stock price have a negative influence on the exchange rate only in Canada, where an increase in the Canadian stock price index results in appreciation of Canadian dollar against US dollar. The US Federal funds rate appears to have significant negative short term effect only on the US dollar exchange rate for the Japanese yen, indicating that relatively higher inflation expectations for the US economy result in appreciation of yen against the US dollar.

The exchange rate, on the other hand, influences the stock prices in Canada and Germany, but not in Japan. The significant influence in Japan is from domestic interest rates, where interest rates affect stock prices adversely. This finding is not surprising, considering that Japanese financial markets have been fairly closed to foreign investors over much of the sample period. On the other hand, the influences of the exchange rate on local stock prices may reflect the international trading patterns of Canada and Germany, and in line with Abdalla and Murinde [1997]. Canada had significant current account deficits during the time period, and can be considered as an import dominated economy, and the findings show that depreciation of the Canadian dollar against US dollar leads to a decrease in Canadian stock prices. As for Germany, which had significant current account surpluses until 1991, and minor deficits thereafter, currency depreciation leads to stock price appreciation. These findings are in line with Ma and Kao [1990], who argue that the influence of exchange rates on stock prices depends on the importance of imports and exports in the economy.

The differences among countries in short term interactions and in the existence of long-term equilibrium relationships for stock prices, exchange rates and interest rates point out that the results of this study should be interpreted cautiously. When the results from G7 countries are this diverse, the influences between stock prices, interest rates and exchange rates in other markets, especially in developing nations, may have surprising patterns. Further investigation by using an extended data set, as well as inclusion of other related factors such as inflation rates and country specific factors may help improve the result, and increase our knowledge about the relationship between foreign exchange markets and stock markets.

Linda Longfellow Blodgett, Indiana University South Bend

From its peak in the mid-1970s, forced divestiture of the assets of multinational companies (MNCs) has ceased to be an important instrument of governments in less developed countries (LDCs). Whereas an average of 28 acts of expropriation per year occurred between 1960 and 1979 (Kobrin, 1980), there were only two or three acts per year during the 1980-85 period and less than one act per year during the 1986-1992 period (Minor, 1994). One of the reasons for this change is that the state owned enterprises that typically took the place of the expropriated MNCs have not performed well, leading many LDCs to pursue privatization programs. In consequence, MNCs are more likely to be viewed in a positive light, as a provider of jobs, technology, and other benefits to the local economy. Beyond that, LDC governments have become more confident about their bargaining power in relation to MNCs and are more open to finding other ways of exerting control over foreign companies operating in their country (Minor, 1994). In this changing climate for direct foreign investment, the divestment of operations in developing countries presents a diminished threat but also a more complicated question than in the recent past.

The literature on divestment is divided into two main streams: (1) the stream that deals with the domestic environment in the United States, where divestment is voluntary and is viewed primarily as a route to greater efficiency; and (2) the stream that deals with the foreign environment, where divestment either is equated with expropriation or is seen as an obsolescing bargain with the local government. In the domestic context, divestiture can be a tool by which a firm restructures its portfolio of assets (Bowman and Singh, 1993). In particular, a company that has expanded through diversification may feel pressure to downscope its operations to achieve greater strategic focus (Hoskisson, Johnson, and Moesel, 1994). Divestment also can be a way to correct a performance problem that arises because of the bounded rationality of corporate executives in a highly diversified organization (Hill and Hoskisson, 1987). In event studies of the market impact of announcements of planned divestitures, Hite, Owers, and Rogers (1987) and Montgomery, Thomas, and Kamath (1984) identified positive abnormal returns and attributed their findings to a company s desire to focus on its core competence and to achieve synergy within the company.

In the foreign context, however, especially in LDCs, divestiture is regarded primarily as a political problem that arises from factors outside the firm s control (Behrman and Grosse, 1990). While expropriation is the extreme case, other actions by the local government can result in renegotiated contracts, dilution of ownership, and premature exits. Such actions are an attempt by LDCs to cause a subsidiary to respond preeminently to host country policies rather than to the strategy of its parent company (Kobrin, 1980). According to obsolescing bargain theory, local governments modify investment agreements in their favor over time as the bargaining power of the MNC decreases (Vachani, 1995). Even when the decision is initiated by the MNC, divestment may be a company s response to political turmoil--an attempt by the MNC to cut its losses. Thus the reasons for divestment in LDCs appear different from those that occur in the domestic environment.

Differences in the perception of the domestic and the foreign environment highlight the different contexts in which divestment is undertaken. The environment of industrialized countries can be considered similar to that in the United States in the sense that markets are relatively free of barriers and MNCs are less sensitive politically. Thus the purpose of this paper is to address the question of shareholder benefit in international divestiture decisions by comparing divestiture of assets in LDCs with divestiture of assets in industrialized countries other than the U.S. Following the arguments for synergy-creation and enhanced efficiency in domestic divestments, it is hypothesized that divestiture of assets in foreign, industrialized countries will be greeted positively by the market as well. Divestment in such countries would be perceived primarily as a desire for portfolio restructuring. In contrast, divestment of assets in LDCs would be seen in light of those countries past actions as well as their current liberalization policies. Divestments would be viewed as primarily political rather than value-enhancing. Investor reaction to announcements of divestitures in LDCs therefore would be negative.

The data for this study were drawn from announcements published in F & S Predicasts International between the years 1988 and 1993. The original sample contained 146 announcements for U.S. firms in a variety of industries, but this number was reduced to 115 cases for which sufficient stock price data were retrievable from the CRSP (Chicago Research on Security Prices) database. The host country, the region, the level of economic development, and the announcement date were recorded for each act of divestment. The divestments were divided into two larger groups: industrialized countries (n = 54) and LDCs (n = 61). Then the LDC file was further subdivided by geographical region: Asia (excluding Japan) (n = 23); Africa and the Middle East (n = 17); Latin America (n = 21). Standard event study methodology was employed to measure stock market reaction in the United States to announcements of a particular divestment. The estimation period ran from 90 trading days prior to the announcement date (t = 0) to 16 days before the announcement. The observation period extended from t = - 15 to t = + 30. The event time, from t = -2 to t = 0, allowed for pre-announcement leakage of information. Cumulative abnormal returns were calculated for the event period for each of the five sub-files. The aim was to see if investor reaction to divestment decisions differed by the economic conditions or the geographical region of the host country.

The statistical results reveal support for the role of political and economic context in the valuation of divestiture plans in direct foreign investment. In these tests, the announcement of a planned divestiture produced a statistically significant positive abnormal return for decisions taken in industrialized countries (2.4894; p = .01). The announcement effect in the combined LDC sample, however, was not statistically significant. Tests for the separate geographical regions of LDCs showed negative (though not statistically significant) reaction to divestments in Asia, the Middle East and Africa. The reaction to divestment in Latin America was positive and marginally significant (1.5711; p = .10). These findings support the argument that in open economies divestment is undertaken to promote efficiency and synergy: the action promises added value to the firm and is measured accordingly by the market. This result therefore extends the event study research that has been done on divestment in the United States to similar business environments in industrialized countries. The reaction in LDCs stands in contrast to this. The hypothesized negative responses did not appear, but neither was the response positive. At the very least, investors had mixed perceptions: divestment in LDCs did not promise clear benefit. The fact that a positive reaction (significant at the .10 level) did occur in Latin America is interesting and may reflect the anticipated benefits of liberalization programs in that part of the world. Still, the fact that market reaction to divestment in LDCs was not clearly negative suggests that investors have absorbed the information that expropriation risk is on the decline and that the regulatory risks that frequently hamper foreign investors can be accommodated.

This study explores various effects of overseas delistings. First, we examine the wealth effects around the delisting announcement day. Second, we examine the trading volume effects around the removal day. Thirdly, we examine the return variance effects around the removal day. Finally, we address the issue of world capital markets integration by investigating whether firms from different economic/geographic regions experience different pricing effects around the delisting announcement day. The results for the pricing effects around the delisting announcement day lend support to our hypothesis of no significant price response to voluntary overseas delisting announcement. This contrasts sharply with previous studies which found significantly negative price responses for involuntary domestic delistings. No significant trading volume effects around the final removal day were found. This may imply that no significant inherent demand for the delisting stocks has been switched to the U.S. markets (home markets in most cases).

This paper examines the exposure of the German stock market, and of major individual German corporations, to changes in the DM/US-dollar exchange rate. Previous empirical work on economic exchange rate exposure has been inconclusive. The first major study on this topic was undertaken by Jorion (1990); looking at data for 287 U.S. non-financial multinational corporations over the period from January 1971 to 1987, he found little support for the hypothesis that the share prices of US firms are systematically influenced by exchange rate changes. Subsequent studies by Amihud (1994), Bartov & Bodnar (1994) and Choi & Prasad (1995) also failed to establish a significant contemporaneous relationship between US share price returns and movements of the dollar. Although more recent studies (Bodnar & Gentry 1993; Donnelly & Sheehy 1996; Dukas, Fatemi & Tavakkol 1996) have found somewhat stronger evidence of significant exchange rate exposures, one can conclude that the overall evidence on the issue remains weak.

Different explanations have been put forward to explain this puzzle: sample selection bias, mispricing by investors, corporate exchange risk management practices, and the use of portfolios of firms as well as trade-weighted exchange rate indices. Both the aggregation of firms and the construction of exchange rate indices lead to an "averaging-out" and, thus, to underestimation of exposure coefficients. This problem may be exacerbated by the fact that practically all tests are based on the use of monthly data. For these reasons, the present study is based on daily returns; further, we do not use exchange rate indices as our independent variable but concentrate solely on the role of the DM/US-dollar exchange rate; finally, we investigate into the exposures of both the German stock market as a whole and into the exposures of individual German firms.

The majority of empirical studies on economic exposure are concerned with US-American corporations. Both the German economy and German financial markets differ strongly from their US counterparts. Germany can be seen as an example for a small and open economy, and German firms strongly depend on their overseas activities. One can therefore expect German firms to be highly sensitive to exchange rate changes.

Consequently, we expect that German firms are significantly exposed to exchange rate changes. More precisely, our hypothesis is that, generally, German firms will benefit from depreciations, and be affected negatively by revaluations, of the DM. A second hypothesis is that their exchange rate exposures will have diminished over the time period examined (1974 to 1995). This can be expected because German firms since the 1970s have made huge foreign direct investments. By acquiring already existing, or setting up new, production facilities in their major overseas markets they have turned themselves from primarily exporting companies into globally integrated manufacturers. Thirdly, previous studies found some evidence for significant correlation between lagged US-dollar returns and share price returns. It is often conjectured that the German stock market is less efficient that its US counterpart. We therefore also test the hypothesis that the values of German firms react with time lags to changes in the DM/US-dollar exchange rate.

The work of Jorion (1990) as well as that of most other authors is based on the following regression model:

(1)

where denotes the return for a security i in period t, the contemporaneous exchange rate change, R_mt the return of the market, and is an idiosyncratic error term. The coefficient b _i in equation (1), is supposed to represent the sensitivity of company i‘s stock returns to exchange rate changes, or its economic exposure. However, equation (1) is fraught with a conceptual problem, namely the possible interaction between the market factor and the exchange rate. In order to avoid this multicollinearity, we follow a different approach in this paper and orthogonalize the control variable, i.e. the market returns. This is done by running the following side regression:

(2a) The residuals from this regression, , represent the orthogonalized market returns, or, in other words, the returns of the market that have been corrected for the influences of exchange rate changes. Including this variable (to which we refer to below as ) into equation (2) yields the following model:

(2) Using daily data and regressing the returns of the German stock market on the returns of the DM/US-dollar rate for the period from January 1974 to December 1995, we can confirm the expected relationship between the two variables for the total sample period. However, when dividing the total period into sub-periods, we obtain rather puzzling results. While the exposure coefficients are significantly positive (as our first hypothesis, and conventional belief, would predict) in the 1970s and from February 1985 onwards, they are significantly negative during the phase of the strong appreciation of the US-dollar in the first half of the 1980s. This counter-intuitive result was also displayed consistently by the coefficients of all industry sectors of the German stock market.

Looking at individual firm returns, the two-factor model using orthogonalizing market returns (equation (2)) yields results that are very similar to the results of the univariate regression of the market returns on the exchange rate changes: Exposure coefficients are significantly positive for almost all firms for the total period but unstable over time. Without any exception, all coefficients are positive from 1974 to 1979 and again from 1985 onwards; they are all negative in the first half of the 1980s; almost all estimates are highly significant.

In order to investigate further into this time variation, we run regressions for shorter time horizons (250 trading days) and move these windows step-by-step over the total period. We find that the exposure coefficients of the market, and of the individual firms, display pronounced swings over time. There are relatively little cross-sectional differences between the behaviour of the exposure coefficients of different firms. In other words, the US-dollar exchange rate appears to be a pervasive factor for the pricing in the German stock market. However, both strength and, more puzzlingly, direction of this factor change over time.

Further evidence on the time dependence of the German stock market’s exchange rate sensitivity is produced by regressing the stock market index and the industry sub-indices against lagged exchange rate returns. Using returns for days t= 0 to t = -5, we find that over the total period, in addition to the coefficient for day t = 0, the coefficients for day t = -1 and for day t = - 4 are weakly significant. Mispricing is most pronounced during the 1980s. Both during the first half of the 1980s, i.e. during the rise of the US dollar, and from 1985 to 1987, i.e. during the steep fall of the dollar, investors to some degree reversed their initial reactions to exchange rate changes over the next days.

In previous studies the question of why the values of some firms react more strongly to parity changes than that of others has received considerable attention. However, research into the determinants of German corporations’ exchange risk exposure is hampered by the fact that German financial accounting standards do not require firms to report detailed information on their geographical business segments. Thus, consistent data on the importance of foreign activities (e.g. overseas sales, assets, or profits) is currently not available.

The results obtained by the present paper suggest that future research should concentrate on finding an explanation as to why the exchange exposures of German firms change over time and, above all, why they become negative in certain periods. It is possible that the time pattern reported here are due to omitted variables that systematically influence the exposure coefficients. Future research should therefore be directed at the interaction of exchange rates, other macroeconomic variables and firm values. It would also be interesting to find out whether our results are corroborated with data from other small and open countries.

The purpose of this study is to examine the existence of herd behavior in two emerging stock markets. Several studies have suggested that investors will periodically abandon their own information in favor of the information sets of other investors. Shiller and Pound (1989) report some survey evidence that institutional investors herd on the advice of investment professionals. Mutual funds, for example, tend to trade on the same stocks at the same time (Grinblatt, Titman, and Wermers (1995), p.1089). Lakonishok and Shleifer (1992), however, note that herding behavior tends to occur among investors in small capitalization stocks.

Christie and Huang (1995) (hereafter referred to as CH) use a measure of cross-sectional dispersion to test for the presence of herding behavior in industry portfolios of U.S. securities. They postulate that herding activities by investors will have the effect of reducing the standard deviation of returns observed within a given portfolio for a given time period as investors seek out asset prices which reflect market aggregates. In addition, they argue that herding behavior is most likely to occur during periods of market stress. Such periods are characterized by extreme volatility in price levels, which result in highly positive or negative returns.

This paper employs the methodological approach of Christie and Huang (1995) to test for the presence of herding behavior in two Latin American markets: Brazil and Mexico. Brazil is the fifteenth largest stock market in the world, and is ranked fourteenth in terms of total value traded. Mexico is ranked 21st in terms of market capitalization (IFC (1995)). Moreover, Gooptu (1993) reports that more than half of the international capital flows have gone to Latin America, especially Brazil and Mexico. However, little is known about the stock price dynamics and the process in which stock prices are determined in these emerging markets. These are issues of interest to investors who seek to obtain additional diversification benefits by expanding their portfolios to include Latin American securities. Our study seeks to contribute to our understanding of the price determination in Brazil and Mexico. The existence of herding behavior in these markets means that stock prices are influenced by waves of sentiment, which could induce prolonged rises and falls in stock prices punctuated by sudden reversals.

Dispersion is measured as the standard deviation of the cross-section of returns in the sample. Accordingly, St, the dispersion measure for date t, is represented by the equation:

®INVALID_FIELD: Object¯ , (1)

where rit is the return for security i in time t, and ®INVALID_FIELD: Object¯ is the return for an equally weighted portfolio of n securities.itit Over a number of periods, this measure of dispersion captures the basic volatility relationship existing between the securities in the portfolio and can be used to observe herding behavior.

We adopt the CH methodology by estimating the following regression equation to test between the herd behavior and rational asset pricing:

®INVALID_FIELD: Object¯ (2)

where D1t and D2t represent dummy variables which equal 1 during extreme up and down markets, respectively, and 0 otherwise, and a represents the average dispersion measure for the portfolio during non-extreme time periods. The coefficients b1 and b2 can be used to test the competing hypotheses of rational market versus herding behavior. Since D1t isolates the periods of extreme positive market returns and D2t isolates the periods of extreme negative market returns, rational market behavior predicts that both b1 and b2 should be significantly positive, while herding behavior predicts that they should be significantly negative. Slow news days will be captured by a, indicating that the effects of herding must be stronger than the effects of a "slow news day" in order to validate herding behavior in the above model. The extreme up and down market dates to be used in (2) are estimated by observing the upper and lower 5% tails for the sample of market returns.

The primary data examined in this study consist of weekly returns data (calculated from weekly prices, excluding dividends) on a sample of stocks from Brazil and Mexico provided by the International Finance Corporation (IFC). The sample period begins on January 6, 1989 and ends on July 21, 1995 for a total of 342 observations.

The competing hypotheses of rational market behavior vs. herding behavior were tested using equation (2). In the case of the Mexican portfolio, both b1 and b2 are positive and statistically significant at the usual levels. This result is indicative of rational pricing of Mexican stocks. The table also shows that the estimated coefficient for b1 is greater than that for b2, however, the test for equality of coefficients fails to reject the hypothesis of equal coefficients. The regression analysis for the Brazilian investables yields several interesting results. Both b1 and b2 are positive, but only b1 is statistically significant at the usual significance levels. This suggests that investors behave rationally during up markets. No support is provided for either the rational market or herding theories during extreme down markets. Furthermore, the estimate for b1 is dramatically greater than the estimated coefficient for b2.

Similar asymmetric results were obtained by CH for the U.S. industry portfolios in their sample. They postulate that herding behavior may be more prevalent in down markets because investors tend to have natural long, rather than natural short, positions. The logic here is that investors with natural long positions will hold losing portfolios during down markets and therefore feel that their information set is inferior to that of the rest of the market. This will cause investors to seek out a consensus information set for the cross-section of securities, resulting in herding activity.

A second possibility is that some degree of herding behavior is actually present in both up and down extreme markets and counteracts the naturally occurring forces of rational markets. For example, markets that behave on a purely rational basis should have relatively large dispersions in the extreme, but it is possible that herding could also be present and merely serve to dampen the dispersion values in extreme markets. If this is the case, dispersions in extreme markets may still be larger than in non-extreme markets, but smaller than they would be in the absence of herding behavior. Such a scenario could be used to argue a bias against the theory of herding behavior in the above tests.

This paper has examined Mexican and Brazilian equity markets for the competing hypotheses of rationally behaved markets versus herding behavior. In the case of Mexico, no evidence of herding behavior was found, and the test results were generally consistent with those of rational markets. The results for the Brazilian investables were asymmetric in that evidence in favor of rational markets was found during extreme up markets, but no evidence was initially found to support either theory during extreme down markets.

This paper explores economic and historical aspects of 5 central Asian countries: Kazakhstan, Uzbekistan, Turkmenistan, Kyrgyzstan, and, Tajikistan. It also compares economic and geographical fundamentals to those of Thailand, Taiwan, Malaysia, Mexico and Switzerland, and draws conclusions about their future based on data obtained from the World Bank, the CIA and the Department of Commerce's BISNIS (Business Information Service of the Newly Independent States).

Geographically, Central Asia comprises an area extending from the Caspian Sea on the west to China on the east, Iran and Afghanistan in the south and the border between Russia and Kazakhstan to the north. After the break of the Soviet Union in 1991, the leaders of the independent republics of Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan agreed to apply the term to all five of their countries collectively. The term Central Asia is sometimes used to denote the inclusion of adjacent portions of China, Mongolia, Afghanistan, Iran, and the Himalayan lands.

Finding data for this research was particularly challenging. Most of the data sources are from government statistical abstracts (Instituto Nacional de Geografia e Informatica de Mexico), the CIA's World Factbook (www.odci.gov/cia/ publications/ nsolo/wfb-all.htm), and the Asian Studies Virtual Library (coombs.anu.edu.au/ WWWVL-AsianStudies.html).

A total of 16 primary variables were collected and for each of the countries. Transformations to those variables where also performed and they are explained later in the text. Descriptive statistics are also provided in the full paper. The bulk of the data collected was for the year 1995. Only two data points where for other years : the external debt for Taiwan (1992) and the number of telephones in Switzerland (1986).

The analysis for this data was explorative in nature. Clustering methods were employed to illustrate how the Central Asian countries compared Analysis

1. Introduction

 

Over the past decade, financial engineers have created a great variety of synthetic equity products, arguably representing the most dynamic area in the banking and finance industry, to meet the specific needs of clients. The spectrum of synthetic equity products extends from equity-linked securities, equity swaps, to virtually any other exotic option structure. These financially engineered products, embodying different instruments, are used by corporations for hedging purposes and as financing vehicles to tap new sources of capital and/or lower funding levels.

In the past few years, equity-linked convertibles have been one of the most popular synthetic equity products. For instance, PERCS (Preferred Equity Redemption Cumulative Stock), first issued in 1988, are redeemable convertible preferred stocks designed to provide the holders with an enhanced dividend rate in exchange for a limited potential for capital appreciation, usually in the 30-40% range. During the early 1990s, PERCS had been used to rescue more than a dozen of companies that attempted to restructure their balance sheets in the wake of junk bond market crash.

However, demand for PERCS has tailed off since 1993 because certain PERCS investors, notably growth and income funds, don’t like the total cap on the upside. To plug a gap in the convertibles market, Salomon Brothers designed another equity-like convertible security called DECS (Dividend Enhanced Convertible Stock) in 1993. DECS are like PERCS as both are redeemable convertible preferred stocks. But unlike PERCS that cap their upside at 30-40%, DECS offer an upside capital appreciation potential when the underlying common stock rises above the conversion price.

Since 1993, several DECS variations have been developed. But rather than use a generic name, each investment bank has invented its own acronym: ACES (Automatically Convertible Equity Securities) by Goldman Sachs, PRIDES (Preferred Redeemable Increased-Dividend Equity Securities) and STRYPES (STRuctured Yield Product Exchangeable for Stock) by Merrill Lynch, and SAILS (Stock Appreciation Income-Linked Securities) by Credit Suisse. The common characteristics of the above acronyms are as follows: (1) they are high-income exchangeable securities which convert into common stock, either in the issuing company or its subsidiary; (2) conversion is mandatory at maturity (3-5 years), with each instrument held usually converting into a minimum of around 0.8 and a maximum of one share; and (3) they pay higher yields than the underlying, normally between 6% and 9% and have a 2-3% yield advantage over comparable convertible preferred stock. Nicholls (1996) reported that there had been 35 issues since the introduction of the instruments in 1993, representing around 25% of U.S. domestic convertible issuance.

Nowadays, convertibles are no longer considered as the financing tool of last resort, and in fact, they have become far more complicated as being associated with a myriad of specially structured products labeled with an alphabet soup of acronyms. Following the remarkable success of the aforementioned equity-like convertible securities, the purpose of this paper is to examine the first DECS issued by Masco Tech Inc. in 1993, which was later cloned by ACES, PRIDES, SAILS, and STRYPES.

2. Valuation of a DECS

On July 1, 1993, Masco Tech Inc. issued 10 million shares of DECS to the public at $20 per share, which is the closing price of the Masco Tech common stock on June 30, 1993. The holders of DECS are entitled to receive enhanced preferential dividends payable quarterly at the annual rate of $1.2 per share versus the current annual rate of $0.08 per share of common stock.

Specifically, DECS are redeemable convertible preferred stocks. On July 1, 1997, the mandatory conversion date, each of the outstanding DECS will automatically convert into one share of Masco Tech common stock. However, prior to the mandatory conversion date, the holders of DECS may elect to convert into 0.806 of a share of common stock for each DECS. The equivalent conversion price is $24.81 with a 24.05% conversion premium above the initial offering price. DECS are also redeemable at the option of Masco Tech on or after July 1, 1996, the initial redemption date, for fractions of common shares having a market value equal to $20 plus all accrued and unpaid dividends.

The theoretical payoff for a DECS can be presented as follows:

V_T = S_T - Bull Call Spread = S_T - {Max[0, S_T-X₁] - F*Max[0, S_T-X₂]}.

The value of a DECS at time zero is simply the sum of the present value of eq(2) and the present value of the incremental dividend stream: V = S - {C[S,X₁=20,T]-F*C[S,X₂=24.81,T]} + I, where V = current DECS value; S = current common stock price; C(.)= call option; X = exercise price; T = time to maturity; and I = present value of the incremental dividend stream.

The sample period covers approximately twelve months after issuance, spanning from July 2, 1993 to June 30, 1994. Overall, the empirical results indicate that on average, the Masco Tech DECS issue had been slightly overpriced during the sample period. The magnitude of the overpricing reported here is very similar to the first few PERCS issues as documented by Finnerty (1993). This overpricing is in accordance with Tufano's (1989) argument that mispricing tends to be more evident in the first few issues than it is in later issues, as a seasoning process will typically take place when an innovative security enters the market. Furthermore, although the magnitudes in overpricing resulted from using the equity volatility measure are statistically significant, they are, however, quantitatively small. Recognizing transaction costs and bid-ask spreads, the mispricing reported in Table 2 is unlikely to result in any profitable arbitrage.

In addition, the overpricing can be attributed to the following four factors. First, DECS are listed on the NYSE and Salomon Brothers makes an active secondary market in DECS, thus providing liquidity for investors. Second, as in the primary market, most of the buyers were equity income funds. The high dividend rate that DECS provide attracts investors which would not be attracted by the lower yield on the underlying yet still want exposure to the common stock. Third, following Chen, Kensinger, and Pu's (1994) argument, DECS provide "one-stop shopping" for a covered bull-call-spread strategy. This could theoretically save investors transaction costs and help reduce their hedging costs. Especially for the institutional investors, it will be very difficult, if not impossible, for them to replicate the payoff for the DECS. Finally, dividends paid on the DECS will qualify for a 70 percent intercorporate dividends-received deduction subject to the minimum holding period (generally at least 46 days).

DECS also offer advantages to the issuer. First, the issuer benefits from effectively selling its common stock at the point that it issues the security. If its stock performs well, the conversion conditions insure that the company only issues a partial (0.806) share at maturity, thus benefiting from a portion of the upside. If its stock falls in value, the issuer is guaranteed a minimum price ($20) for the share. Furthermore, DECS get the best equity credit next to issuing common stock from rating agencies due to their mandatory conversion feature.

Plain vanilla interest rate swaps (hereafter swaps) are agreements between two counterparties to exchange periodic interest rate payments based on a predetermined notional amount. One counterparty makes a fixed interest payment typically called the swap rate or swap coupon, whereas the second counterparty makes its interest payment based on a floating-rate index such as the one-year London interbank offered rate (LIBOR). Since the first occurrence of swaps in the early eighties, swap markets have experienced tremendous growth both domestically and around the world. Total notional principal outstanding was $4.21 trillion denominated in U.S. dollars and the equivalent of $9.46 trillion denominated in other currencies at the end of 1996 (International Swaps and Derivatives Association).

Arbitrage arguments as for example in Duffie (1996) show that in the absence of default risk and other transactions costs the fixed payment on a swap should equal the yield of a government security with the same maturity as the swap. Observed swap rates in the U.S. typically exhibit a spread of 10 to 40 basispoints over the yields of comparable government bonds. This swap spread has been the main focus of previous empirical work on interest rate swaps. Sun, Sundaresan, and Wang (1993) find that swap dealers’ credit ratings explain variation in swap spreads. Brown, Harlow, and Smith (1994) find significant differences in the swap spread processes depending on the maturity of the swap. Much theoretical and empirical work such as Sorensen and Bollier (1994), and Cooper and Mello (1991) has focused on default risk as the explanation of the swap spread. Most of this literature is consistent with the notion that default risk will cause a positive swap spread. However, there have been only limited attempts to assess the ability of default risk to generate swap spreads of the observed magnitude. A more recent candidate explanation of swap spreads is a premium due to liquidity differences between swap contracts and the elements of the replicating portfolios used in the arbitrage arguments. Grinblatt (1995), and Duffie and Singleton (1997) are examples of this literature. The contribution of this study is three-fold: firstly, it is the first international comparison of swap spreads; secondly, it uses numerical simulation techniques to assess the ability of default risk to explain the magnitude of observed swap spreads; lastly, it proposes a new explanation of spreads based on the structure of the swap market and provides evidence consistent with it.

A panel data-set of eight currencies to compare swap spreads internationally has been used. Surprisingly, very liquid markets such as the U.S. Dollar and Japanese Yen swap market do not exhibit particularly low swap spreads while relatively illiquid markets such as the Spanish Peseta are characterized by very low spreads. In order to explain the variation in swap spreads across time and currencies I first examine an argument based on symmetric credit risk and the term structure of default rates and assess its ability to generate positive swap spreads. Since default rates for most rating classes increase with maturity, the counterparty which is a net receiver towards the end of the swap’s term faces higher expected credit losses ceteris paribus. This could generate positive swap spreads, if the pay-floating side of the swap is the net receiver towards the end. This case in turn is more likely as the slope of the yield curve, which is used to generate expectations of the floating payment, decreases. When I test for this hypothesized negative relationship between swap spreads and the slope of the yield curve, I find evidence that is at best weak.

In light of the inability of symmetric default risk to explain positive swap spreads of the observed magnitude I next assess the effects of asymmetric default risk. In doing so I extend the existing literature which typically looks at the ability of default risk measures to explain variation in swap spreads via regression tests. Instead I develop a framework which allows me to assess the direct impact of default risk on the magnitude of swap spreads. I present a recursive algorithm which models each counterparty’s decision to default on the swap contract conditional on the counterparty being bankrupt. As a result I obtain the relevant default rates at each settlement date which can then be used to calculate expected swap payments. Once expected swap payments are known I can solve numerically for the default risk-adjusted swap rate. I use this method to simulate various combinations of asymmetric default risk in my dataset and find that even extreme cases such as very high default rates and highly asymmetric swap counterparties are only able to generate swap spreads which are at most about 40% of observed spreads. This fact is due to the typical combination of upward-sloping risk-free yield curves and upward-sloping term structures of default risk. The first feature implies that pay-fix counterparties are usually net payors in the early settlements of a swap contract. The second feature implies that in the early stages of the swap contract default risk has only weak effects. This problem is made even more serious by the fact that a bankrupt pay-fix counterparty may still decide to make a net payment if this net payment is smaller than the expected present value of net receipts from future settlements.

Given the apparent inability of default risk to generate observed swap spreads under any but the very unusual circumstances of sufficiently asymmetric counterparties and a flat, humped or inverted yield curve, I present an alternative explanation of spreads which is based on the structure of the swap market. I use an argument by Titman (1992) who shows that with asymmetric information about a borrower’s credit quality and financial distress costs there is an incentive for most corporations to roll over short term debt and to swap it into a pay-fix obligation. For a firm with positive private information this strategy avoids overly high long-term interest rates from pooling with bad firms while greatly reducing expected costs of financial distress caused by interest rate risk. I extend Titman’s claim to argue that corporations typically have no incentive to take the pay-floating side of a swap. Given the over-demand for pay-floating counterparties I argue that such firms are specialized providers of swap liquidity serving a disperse corporate market wanting to take the pay-fix side. I further argue that these specialized firms typically do not hedge a large portion of their interest rate risk and that therefore swap spreads are both a compensation for interest rate risk and a price for the provision of liquidity. Three distinct pieces of evidence supporting this "market structure" explanation have been provided. Based on the pay-fix firms alternative of borrowing long-term I establish an upper bound on swap spreads and show that this upper bound holds consistently for various rating classes, industries, and maturities. Then the incentive compatibility of the pay-floating counterparty has been analyzed to show that the hypothesized unhedged positions in pay-floating swaps generate positive average returns to the liquidity provider. Finally, the evidence from panel data and pooled regressions have been used to show that observed spreads and in particular default risk-adjusted spreads obtained from my simulations are well explained by measures of pay-fix side demand, pay-floating supply, swap market competitiveness, and interest rate risk inherent in the pay-floating obligation. The remainder of the paper is organized as follows: section II describes the data and provides some preliminary diagnostics; section III compares swap spreads across currencies and tests the ability of symmetric default risk or yield curve differences to explain the variation; in section IV the framework for simulating default risk-adjusted swap rates and assess the effects of asymmetric default risk on swap spreads is introduced; section V presents the "market structure" explanation of swap spreads and give supporting empirical evidence; section VI concludes the paper.

This paper seeks to find an optimal exchange rate policy for emerging economies, especially for the Association of Southeast Asian Nations (ASEAN) countries. The Dow Jones Industrial Average lost more than 7% of its value on October 28, 1997. It was preceded by a 5.8% plunge in the Hong Kong Stock Market following months of speculation and devaluation of Southeast Asian currencies. Many people believe that the downward spiral originated in the Thai government's insistence on pegging the Thai Baht to the US dollar. The domino effect finally reached South Korea and Japan. South Korea's currency, the Won, lost the maximum daily trading limit, 10% of its value, on November 20, 1997. The demise of a powerful Japanese broker, Yamaichi Securities Co., on November 24, 1997, propelled the Asian currency and financial crises to a climax and let people wonder what will happen next. What would be the optimal exchange rate policy, if there is any, to prevent this type of financial crisis from ever happening again, or when the crisis does happen, to reduce the degree of damage and restore an economy back to a long-run equilibrium?

A general equilibrium model is set up to establish an optimal real effective exchange rate policy, coupled with optimal fiscal policy to simultaneously stabilize the balance of trade on goods and services and the price level of an economy, particularly, for a developing country. The analysis can be extended to include monetary policy and trade (tariff) policy. It is shown that a specific set of weights can be chosen for a specific policy target, which would insulate the policy target of the economy from fluctuations of real exchange rates in a third-country. In reality, policy-makers usually have more than one target at which to aim. It is further demonstrated, with the implementation of an optimal fiscal policy, that pegging a currency to a basket with a specific set of weights can attain two policy goals at the same time. It is also shown that the vector of the weights which targets simultaneously two policy goals is a weighted average of two vectors of weights that would be chosen separately to target each individual goal. The result is particularly important with respect to policy implementation and correction.

• The US market influences all other markets while other markets have little, if any influence on the US market
• The Japanese market, the second largest market in size after the US market, has no effect on other national markets.
• The UK market has some influence on market in Japan, Australia, Hong Kong and Canada and
• The linkage among Pacific-Basin markets can be attributes to the indirect influences of the US market, which are transmitted from markets that close earlier in the day to markets that close later in the day.

The studies cited above, and others, have essentially examined the long-term linkages between stock markets over periods typically ranging from 6 to 10 years. The recent currency crisis and associated stock market crashes in Asia have been seen to influence all major markets with big drops (rises) in Hong Kong’s Heng Seng Index followed by similar changes in other markets. Moreover, unlike the single market drops followed by gradual rises observed in different markets during, and after, the stock market crash of October 1987, the recent market turmoil has been characterized by a "cascading " effect where individual markets have reacted negatively and then positively, or vice versa, to information transmitted domestically as well as from other markets. In view of these differences in reactions when markets are volatile it becomes necessary to study the linkages among markets when there are significant changes in the stock market index of individual markets. This is the main focus of this paper.

Our analysis focuses on substantial increases and decreases in market indices of the major markets in the Asia-Pacific region. An increase in market index of a country may be attributed to expectations of better economic conditions leading to expectations of better earnings prospects for firm trading in that market. It is quite likely that the good performance of any national market may cause uncertainty among investors in not only that market but also among investors in other markets, and a herd instinct may force these investors to engage in selling activities, leading to decline in other stock markets. These effects are also likely to be tempered by the relative importance of the market that declined first. For example, unlike the crash in 1987 where a decline in the US market had a significant effect on all other market, in the recent turmoil, a decline in Hong Kong seemed to precipitate declines in other markets, including the US market. This indicates that the major Asian markets are beginning to exert influences over other market not previously observed.

In general, if the substantial increases and decreases in different markets are randomly distributed over time, we should not observe any swings across different markets around movement in particular market. However, the market crash in 1987 and 1997 demonstrated that substantial swings do occur with markets rising and falling around major movements in particular markets before settling down. Thus, we would expect the linkages and transmission of information across markets during substantial market movement to differ significantly from linkages during other periods.

In this paper, we analyze the following markets: Australia (AU), Hong Kong (HK), Japan (JA), Singapore (SG) and the US. For each market, data on daily market indices, measures in local currency terms, were obtained for the period 1986-87. This time period includes the market crashes of 1987 and 1997. Data on market indices are converted into continuously compounded daily rates of return as Rj,t=Ln(Ij, t-1)-Ln(Ij,t-1)

Where Ij,t is the value of the index on day t for stock market j and Ij,t-1 is the value of index on day t-1 for stock market j.

We adopt the following procedures to analyze the behavior of market around substantial market rises and falls. First we define the crash period as being the month of October 1987 and October 1997. Next, after omitting these crash periods, for each of the five markets we sort the daily returns in descending order. Daily returns of 2 % or more are classified as "good news", while daily returns of –2 % or less are classified as "bad news". This result is in a series of daily returns for all five markets corresponding to substantial rises and falls in each corresponding market. We then examine the linkages between these markets when there is "good news" in (say) US market and it rises by 2 % or more, and then when there is "bad news" in the US market and it falls by 2 % or more. In a similar manner, good and bad news periods for the other four markets are also seperated and the returns series developed for these events. This gives us ten series of returns for the five markets corresponding to good and bad news period in each of these markets.

The method used to analyzed these daily returns is a series of regression where the same day and lagged returns are examined. Based on the findings of Janakiramanan and Lamba (1998) that markets closing earlier in the day influences markets closing later in the day, we set up the following regression framework:

Where Ri,t is the return on market j on day t, ak through ek (k=0,1,…5) are the parameters to be estimated, and Ej,t are the random error terms for market j. since the US market is closed when the other markets are trading and vice versa, the system of regression includes the one day lagged US market return. Among other markets, Australia closes first, so it can be expected to reacting to the previous day’s returns on Hong Kong, Japan, Singapore. Similarly, since Japan closes after Australia it can be expected to react the same day return in Australia and the previous day’s return in Hong Kong and Singapore and so on.

The hypothesis tested is that good news in one market should not have a significant impact on other markets, implying that the coefficients for all the other market returns must not be significantly different from zero. On the other hand, in the case of bad news events, if information were transmitted quickly across markets, we would expect the coefficients for all other market returns to be significantly positive. It is also likely that the reaction of these markets will be dissimilar across different markets. Any differences in the behavior of these markets will be observable based on differences in their estimated coefficient.

To examine the systematic behavior of markets around the crash periods, for each market the crash months of October 1987 and October 1997 are included in the analysis and the above regression re-estimated. This allows us to examine whether there are significant differences in the linkages between markets in periods when markets are declining but are less volatile versus when markets are declining and are exhibiting extreme volatility. Our expectation is to find significant positive relationship between the various markets since the transmission of information during high market volatility is likely to be high. The framework also lets us examine whether markets such as Japan and Hong Kong exerted systematic influences on other markets during the crash of 1997 as opposed to the US market being dominant market in 1987.

The purpose of this paper is to analyze the relationship between financial markets and real activity in Germany at disaggregated level. Specifically, monthly, quarterly, and annual data on output and equity indexes in the four major sectors namely manufacturing, construction, mining, and agricultural are considered. Production indexes of these four sectors sum up to the industrial production (IP) index. The use of disaggregated data makes it easier to capture the idiosyncratic behavior of individual sectors and allows a richer interaction pattern between them. After documenting the properties of the individual real and financial data series, we investigate if movements in a sectoral equity index are related to the those in the corresponding sectoral IP data. As individual sectors depend on the overall economic activity, sector financial data may have a stronger relationship with the economy-wide business cycle. To examine this possibility, we test if aggregate output, as measured by IP and GDP, has a significant incremental explanatory power for variations in sector equity indexes. The effect of aggregate output on sector financial data will be explained by the interaction between the aggregate measure and sector output data.

Recent studies (e.g. Ferson and Harvey, 1994), suggest national equity markets are affected by world business cycles and the U.S. economic conditions. To study the possible spillover across national boundaries, we examine the interaction between the German sectoral data and the corresponding U.S. sector data. If the sectors are integrated, development in the U.S. sector will affect the same sector in Germany. Thus, the German sector equity index may react to movements in the corresponding U.S. sectoral output. The linkage between German sector equity index may react to movements in the corresponding U.S. sectoral output. The linkage between the German and U. S. sectoral output will be used to verify such hypothesis. Based on a similar argument, we test if aggregate U.S. output, again measured by IP and GDP, has a stronger impact on German sectoral financial data.

The basic time series properties of the sectoral data are establish using the standard Box-Jenkins and unit root test procedures. The Johansen cointegration method and the Engle –Kozicki common feature test are them employed to see if there is a common trend or a common cyclical pattern among the sector data series. The effects of aggregate output (German and U.S.) on sectoral financial data are investigated using the same tools. While the cointegration approach addresses the possible long run interaction between the sector data, the common feature test examines a more general phenomenon of the existence of a common "(long-run and short-run) cyclical pattern among the data

The German data used in this study were obtained from the Statistiches Bundesamt, Wiesbaden. The U.S. data are collected from the Citibase and Federal Reserve Board. The sample covers monthly, quarterly, annual data from 1962 to 1996. JEL Classification: E32, G15, C22

This paper investigates the integration of financial markets within the Greater China Bloc, which comprises China, Hong Kong, and Taiwan. In particular, we examine the extent of integration among the seven stock markets within these economies, and study how the relative openness of a particular market might affect its degree of integration into the larger system of markets.

The emergence of the Greater China Bloc began with the economic liberalization of China in the late 1970’s. Since then, Hong Kong has played an important role in the Chinese economy by injecting into it both investment capital and management expertise. These inputs resulted in the 29% annual compound growth rate in China-Hong Kong trade since 1980. As at 1996, Hong Kong represents the largest investment source in China, accounting for 60% of realized direct investment funds. On the other hand, China is responsible for 36% of the total trade of Hong Kong and is the territory’s largest trading partner.

The third Greater China Bloc also includes Taiwan which had started to participated in "unofficial" investment activities in mainland China since the early 1980’s. To overcome the prohibition to invest in China, Taiwanese investors typically carried out the investment projects through a Hong Kong-registered company. This investment pattern continued to dominate even after the Taiwanese Government removed the investment ban in 1987. It has been estimated that up to 1996 Taiwanese institutions had invested a total value of US$ 15 billion in China. This figure makes Taiwan the second-largest external source of capital for China. Conversely, China absorbs approximately 16% of Taiwan’s export and is an important an growing market for these exports.

This paper examines financial market integration within the Greater China Bloc. Such an effort is relevant to the understanding of economic integration in general for several reasons. First, the integration of financial markets provides a means of transferring capital from a wealthier developed economy into a less developed economy where investment opportunities are abundant. This transfer will ultimately lead to an increase in overall wealth. In other words, the existence of an integrated financial market provides an instrument that bridges the gap between the economic differences among separate economies. Second, the literature on economic integration suggests that economic integration and financial-market integration are complementary elements. Therefore, the study of financial-market integration provides an objective measure on the degree of economic integration within the Greater China Bloc. Third, financial markets form the platform that domestic investors use to evaluate the required rates of return on investments in foreign economies. The effectiveness of the investment process depends on whether the return is commensurate with the risk borne by investors. The degree of financial-market integration provides an indicator of whether investment activities across separate economies are evaluated consistently.

We employ bivariate Granger causality tests to examine lead-lag relations among the returns for the seven stock markets in the Greater China Bloc. This technique allows us to disentangle the inter-related nature of returns in different securities markets. Put differently, we address whether a particular stock market influences, or is influenced by, another stock market in our sample. This distinction is important, because we intend to evaluate the relative importance of underlying economic factors and noise in security markets. This method is superior to the cointegration tests adopted in the literature, since the economic interpretation of cointegration tests lies in the presumption that the markets under study mutually influence each another. Such a notion is more likely to be valid if the economies are at similar stages of development. In the case of the stock markets in the Greater China Bloc, it is conceivable that the mainland stock markets are in a less developed stage. Also, the general direction of capital flow is moving into China. Based on this fact, it is plausible that investors from Hong Kong and Taiwan evaluate investment values in China according to the costs of capital in these respective economies. Therefore, we can test the hypothesis that returns in the Chinese markets are influenced by returns in Hong Kong and Taiwan.

Another issue of interest is the openness of securities markets. In China there are two separate stock markets. The A-share market is restricted for Chinese nationals only, while the B-share market is for foreign investors only. Such a setting provides an experiment to verify whether a more open financial market constitutes a more efficient means for the transmission of information. Starting in August 1994, Chinese companies began to be listed on the Stock Exchange of Hong Kong in the form of H-shares. Since the Hong Kong stock market is the most open and liquid market in the Greater China region, our causality test results will provide further insight on the impact of market openness.

The data used in this study are collected from Data stream. We use stock market indices to represent the overall return and risk patterns in the stock markets under study. Each of these data series is a price index that has incorporated changes in the equity structure, such as stock splits and share dividends, but is unadjusted for cash dividends.

We find that for the whole sample period from 1992 through 1997, the Shanghai A-share market exerts a significant influence on the Shenzhen A-share market (p-value = 0.0188). Also, the Shenzhen B-share market has a strong influence on the Shanghai B-share markets (p-value = 0.0001). These two markets demonstrate one-way influence patterns that are opposite in direction. Furthermore, Hong Kong has a strong influence on Shanghai B (p-value = 0.0001) and on Taiwan (p-value = 0.0383). This result is consistent with the notion that Hong Kong acts as a financial center for the Greater China region and that changes in the Hong Kong market are transmitted to the Shanghai B and Taiwanese markets. When we re-calculate the model parameters for the period when H-share returns are available, however, we find that several of the causality results for the whole sample period disappear in the later part of the sample period. In particular, Hong Kong does not appear as a leading market in returns as opposed to the B-share markets and Taiwan. On the contrary, Hong Kong has a significant influence on the H-share market (p-value = 0.0440), but the B-share markets also impose strong influences on the H-share market. This result suggests that the H-share companies exhibit the properties of both Hong Kong and Chinese firms.

To further investigate the nature of the causality relations of stock returns, we compute the p-values for the seven markets for each of three sub-periods. Following the notion of increasing integration, we expect to see that the causality relations strengthening towards the later sub-periods. The sub-period test results reveal that for the first sub-period, Hong Kong displays significant influence on all other markets in the Greater China Bloc, except for Shenzhen B. As expected, the two A-share markets mutually influence each other, and this property is sustained for all sub-periods. For the second sub-period, both Hong Kong and H-shares exert very strong influences on Shanghai A and B shares, as well as on Shenzhen A shares. Also, the evidence suggests that Hong Kong shares leads H shares, but the converse is not true. The influence of Hong Kong on Taiwan no longer persists, and the A-share markets appear to lead the Taiwanese shares.

Today, the intense pressures of global competition, technological advances and rapid changes in consumer markets challenge companies as never before. It is not just fast-moving, high-tech industries, such as computers, or industries shaken by deregulation, such as the airlines, that are facing this brutal competition. From microchip to potato chip, from software to soft drinks, from banks to breakfast cereal, few industries have escaped this aggressive competition. As Jack Welch, CEO of GE, put it, "It's going to be brutal. When I said a while back that the 1980s were going to be a white-knuckle decade and the 1990s would be even tougher, I may have understated how hard it's going to get" (Sherman, 1992: 91).

The purpose of this paper is to investigate the following three issues. First, the paper will explore the nature, dynamics, consequences, and implications of what D'Aveni called hypercompetition (1994). Hypercompetition results from the dynamics of strategic maneuvering among global and innovative companies. In order to achieve abnormal return, firms aggressively position against one another by constantly developing new competitive advantages. The new competitive advantages are achieved through such means as new product, lower cost, speed, surprise, better customer satisfaction, establishing new rules of the game and so on. As a result of such dramatic movement, players in a given industry push the competition further into the territory of extreme competition or perfect competition where no firm will have any advantage. However, the desire to be different or better makes the equilibrium or perfect competition ever closer yet hard to reach. Thus, the battle is fought between hypercompetition and perfect competition. The winner, therefore, is the one who can disrupt the equilibrium and create disequilibrium. It is interesting to note that in hypercompetition, the winner can only enjoy temporary profits.

The examination of hypercompetition leads to the second issue of the paper. In hyper-competitive global environment, what should be the appropriate strategy? This paper investigated three approaches, the multi-domestic strategy, global strategy, and transnational strategy (Bartlett & Ghoshal, 1991). The author argues that neither global strategy, which ignores the country differences, nor multi-domestic strategy, which ignores the efficiency and integration, are valid strategies in hyper-competitive global environment. Firms that pursue these pure international strategies are extremely vulnerable to competitors' attack, thus, unable to disrupt the equilibrium and maintain even temporary competitive advantages. Consequently, the author suggests that the transnational strategy is the only solution. Unlike the previous two strategies, the transnational strategy seeks to achieve both global efficiency and individual country responsiveness. It assumes that the global market is not completely homogeneous and heterogeneous. The essence of this strategy is to simultaneously explore the homogeneous opportunities and satisfy the heterogeneous needs of consumers.

The final issue of the paper is to investigate the methods of how firms can use to achieve the difficult task of transnational strategy (Johansson & Yip, 1994; Lei, Hitt, & Goldhar, 1996). In a separate paper, Anderson and Wang developed a multidimensional competitive strategy and an implementation framework (1997). The author explains that why this multidimensional competitive strategy centering on differentiation, low cost, and speed is appropriate for firms that adopt transnational strategy to achieve effectiveness, efficiency, and rapid response and integration simultaneously. Furthermore, it articulates that why it is so important to use this competitive strategy to develop firms' specific resources and core competencies that meet the tests proposed by Collis and Montgomery (1995).

• Bartlett, C. A. & Ghoshal, S. 1991. Global strategic management: Impact on new frontiers of strategy research, Strategic Management Journal, 12: 5-16.

• Collis, D. J. & Montgomery, C. A. 1995. Competing on resources: Strategy in the 1990s, Harvard Business Review, July-August: 118-128.

• D'Aveni, R. A. 1994. Hypercompetition: Managing the dynamics of strategic maneuvering, New York: Free Press.

• Johansson, J. K. & Yip, G. S. 1994. Exploring globalization potential: U.S. and Japanese strategies, Strategic Management Journal, 15: 579-601.

• Lei, D., Hitt, M. A., Goldhar, J. D. 1996. Advanced manufacturing technology: The impact on organizational design and strategic flexibility, Organizational Studies, 17: 501-523.

• Sherman, S. 1992. How to prosper in the value decade, Fortune, Nov. 30, 91.

Two important questions involving the strategic impact of managerial compensation on firm performance continue to receive significant attention by both practitioners and researchers. The first question concerns the most efficient determinant of compensation. The second is whether managerial compensation acts as an incentive for improved future company performance or as a reward for past performance. The answers to both questions affect the way compensation plans are used and their impact on shareholder wealth. To answer these questions, this study examines the relationship between a set of market-based wealth creation measures and executive compensation.

Previous studies have examined the relationship between managerial compensation and accounting measures of firm performance. For example, Kroll, Simmons and Wright (1990) use return on equity as the performance measure, Agarwal (1981) uses profits and Pavlik and Belkaoui (1991) use return on assets. These accounting based measures of performance do not fully include all capital costs, and may thus overstate the firm’s performance. Further, earnings growth creates size, but does not always result in per-share value growth because the former may be achieved at excessive capital costs.

Wealth creation measures have several advantages over the traditional accounting measures of firm performance. First, given shareholder value maximization as the goal of the firm, market value added (MVA) directly measures the shareholder value added on the capital employed by the firm. Proponents view this measure as the best way to integrate the often-competing goals of operating efficiency and growth (Gressle, 1996). Further, economic value added (EVA) measures the firm’s return on capital employed, net of all capital costs. In this study, we examine the relation between executive compensation and these broader measures of firm performance.

The empirical tests in this study are conducted by regressing compensation measures on contemporaneous values of MVA and EVA. Total executive compensation generally consists of several components such as cash salary and bonus, stock options, and long term incentive payout. Since some components are more responsive to firm performance, we investigate the relationships separately for each broad class of compensation. Further, previous studies have demonstrated a significant positive relationship between executive compensation and firm size (see for example, Kroll, Theorathorn and Wright (1993), Rajagopalan and Prescott (1990) and Finkelstein and Hambrick (1989)). Thus, our tests control for the effect of firm size as measured by the market value of the firm. We hypothesize a positive relationship between all measures of compensation and firm performance.

We also examine the relationship between compensation and the risk of the firm. If executive compensation is related to the firm’s performance, then the higher the risk of the firm, the greater will be the risk of executive compensation. In an efficient managerial labor market, executives will demand, and receive, compensation for bearing risk, thus leading to a positive relationship between compensation and risk of the firm. To circumvent problems associated with risk measurement, the cost of capital is used as a proxy for risk. All asset pricing models predict an upward sloping relationship between the firm’s risk and its cost of capital.

The second major issue addressed in this study concerns whether compensation acts as an incentive for improved future performance or as a reward for past performance. We test this hypothesis using leading and lagged values of EVA and MVA. If compensation were a reward for past performance, then we should observe a strong positive relationship between compensation and lagged values of performance. Conversely, if compensation is used as an incentive for improved future performance, then it should be positively related to leading performance measures.

In addition to examine aggregate relationships between compensation and firm performance, we also analyze industry trends. Firms may invest capital in the current year to gain strategic advantages for future growth. In this sense, the investments made could be viewed as real options. This would result in lower EVA for the current year. However, if markets value this strategic move on the part of the firm, then this would increase the market value of the firm. Thus, by examining industries where the value of these real options is the highest, we gain additional insights about the pay-for-performance hypothesis.

The data used in this study is collected from several sources. Compensation data are obtained from Standard and Poor’s Corp. ExecuComp Database. Performance measures such as EVA and MVA, and risk measures such as the cost of capital estimates are obtained Stern Stewert & Co.’s Performance 1000 Database. Other performance measures are obtained from both the COMPUSTAT and CRSP databases. For cross-sectional analysis, we use four years of annual data (from 1992 to 1995). Since the analysis of the reward/incentive hypothesis requires us to use lagged and leading values of firm performance, we restrict our analysis to two 1992 and 1993 for reasons of data availability.

THE MVA AND RESOURCE-BASED THEORY OF COMPETITIVE ADVANTAGE: SOME EMPIRICAL FINDINGS

1. Introduction:

 

The main objective of a firm is to maximize the value of the firm. In the last two decades with corporate reengineering and restructuring catching the headlines, a number of hypotheses, theories, and schools of thoughts have been advanced. One of such theories is the Resource-Based Theory which some argue that it has capabilities of being a new paradigm that explains how sustained competitive advantage can be created. A second school of thought, popularized by Stern Steward & Company are the Economic Value added (EVA) and Market Value Added (MVA). The crux of the new theories is on the managerial and strategic decisions including resource allocations and those related to the intangible assets and their impacts on the value of the firm. This paper investigates the relationship between the RBT and MVA. We will review both theories and identify similarities and differences and their implications for the value of the firm.

2. The Major Features Of The Resource-Based Theory Of The Firm:

In late 1980s and early 1990s, the predominate developments in management strategy analysis have focused on the link between a firm’s performance and its external environment. Prominent examples are Porter's analysis of industry structure and competitive positioning and the empirical studies undertaken by Buzzell and Gale (1987) for the PIMS project. Yet, empirical investigations have failed to support a consistent link between industry structure and profitability. Schmalensee (1988), Buzzell and Gale (1987) have shown that differences in profitability within industries are much more significant than differences among industries. Only recently there has been a resurgence of interest in the role of a firm’s resources and its impact on strategy formulation. These contributions amount to what has been termed "the Resource-based Theory of the Firm" which proposes that the resources and capabilities of a firm are and should be the central considerations in formulating its strategies, and in addition they are the primary sources of a firm's sustainable competitive advantages. The major features of the Resource-Based Theory is summarized by Conner (1991) as:

To really create wealth, businesses not only have to produce profits and stock price increases, but they have to produce enough of them to exceed the cost of the capital that lenders and shareholders have invested. To pinpoint who is creating wealth and destroying it, Stern Stewart Co. has developed two related concepts: Economic Value Added (EVA) and Market Value Added (MVA). The EVA is a measure designed by Stern Stewart & Co. to estimate their true economic profit. It factors in the full cost of capital, including equity financing, which might otherwise not turn up on a company's books. It is the net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return investors could get by investing in other securities of comparable risk.

According to Thomas (1997), an EVA calculation looks at a company's after-tax net operating profit for a given period, after subtracting the total cost of capital during that time. While a company might be profitable by other measures, such as earnings per share, EVA can expose the fact that management is squandering shareholder wealth. Calculations of EVA generally do not include unusual items, such as the sale of assets. While EVA measures a company's total cost of capital during a specific period, Market Value Added expands the time frame to look at its entire corporate history. MVA calculates the difference between the current market value of a company (i.e. the amount investors can take out) and the total capital invested during the life of the company (i.e. the amount investors have put in). If the result is a positive number, the company has been a successful creator of wealth. A negative result shows the company has squandered its capital, even if it has turned a profit in terms of earnings per share. In the short term, companies looking for change must concentrate on improving EVA on a quarterly or annual basis. Success in boosting EVA will then spill over into the larger picture of MVA. Since market value looks forward to anticipate future returns, MVA can also be described as the value the market places on future streams of EVAs.

The primary purpose of this research is, using a cross-sectional approach, to empirically test the following primary hypothesis and propositions suggested by Resource-based Theory: To examine the relationship among resources and capabilities and strategic performance of the firms. To investigate the role of the firm's intangible resources and productivity of the firms. To test the primary hypothesis suggested by the Resource-based Theory of Competitive Advantage: The resources and capabilities are the primary source of superior strategic performance for a firm. In this study the conventional financial indicators of tangible resources of companies such as total assets, and capital expenditures will be considered. However, identifying intangible resources is a very challenging task. EVA, MVA, and Fortune Reputation rank will be used as proxy indicators of how well the intangible resources of corporation is used. These indices should provide some indication of importance of firm's intangible resources. These indicators will represent the distinctive competencies of an organization. Market Value was used as dependent variable, independent variables included :Revenues, Profits, Assets, Stockholders’ Equity, Earnings Per Share, Total Return to Investors, Corporate Reputation, EVA and MVA, Information Productivity Ranking as Proxy variables for Intangible Resources Management. The data was obtained from Fortune 500 (Fortune: Dec. 11, 1995 and April, 1996).

A Factor Analysis was used to reduce the twenty two independent variables to a manageable numbers of dimensions. Factor Analysis summarizes the important information in a set of variables by a new and smaller set of variables called "factor" which is simply a linear combination of other variables. The important point is that theses factors are going to be uncorrelated with each other which minimize the impact of multicollinearity in conducting multivariate regression analysis. Four factors were identified and named as: long-term profitability due to intangible assets, tangible resources, short-term profitability, and coast of capital. Almost eighty seven percent variation in the data was explained by these factors. A regression analysis with market value as dependent variables and factor scores as independent variables was performed. Approximately sixty nine percent of variation in market value was explained by four factors. The regression result was significant at alpha equal to one percent. The statistical analysis provide strong evidence that intangible assets of corporation in conjunction of MVA play a significant role in determining the market value of corporations.

In this paper, we used both the multiple variance ratio test of Chow and Denning (1993) (CHODE) and the auto-regressive fractionally integrated moving-average test of Geweke and Porter-Hudak (1983) (GPH) to test the random walk hypothesis (RWH) of equity returns in one of the important regions of the world's emerging market--i.e., Latin America. CHODE's method jointly tests the unity of variance-ratio estimates and controls the joint test size by using the Studentized Maximum Modulus distribution. This yields a lower probability of type-I error. CHODE's methodology highlights the significance of multiple statistical comparison, and suggests inferences based solely on Lo and MacKinlay's (1988) (LOMAC) variance-ratio test should be used with caution. An alternative RWH test developed by Geweke and Porter-Huddak (1983) (GPH) was also employed to check the result consistency of the more conservative CHODE test. We documented high consistencies. The GPH test both identifies long-memory as an alternative stochastic process and identifies random walk as a special case in a class of fractional integrated processes, commonly known as ARFIMA. No long-term dependency was found in any of the four Latin American equity series. They all follow a random walk.

Results of both the multiple variance-ratio and the GPH tests indicate that emerging equity market prices of Argentina, Brazil, Chile and Mexico essentially follow a random walk. Further, direct tests for market efficiency suggest that all of the examined emerging equity markets (except Chile) are weak form efficient. On balance, therefore, using updated random walk test techniques and an efficiency test, we document results that provide international investors in major Latin American emerging equity markets a clear and unifying message. The documentation of weak-form market efficiency and consistency with the random walk hypothesis suggest that investors in these major markets are unlikely to make nonzero profits by trading on the basis of equity price historical information. Therefore, international investors interested in Latin American emerging equity markets should base their trading strategy on fundamental analysis. That is, despite the general perception that these markets may seem inefficient, investors are well advised to take a long-term view and invest in companies that promise growing future net present values. Our findings are particularly important because they clarify conflicting findings of the few similar studies that have addressed emerging market equity price dynamics by using mainly the less efficient single variance-ratio test (e.g., Claessens et al. (1993) and Urrutia (1995)). In contrast to our finding, they found that most of the emerging equity markets' returns did not follow a random walk.