Research summaries, 1984-1996

Karpoff's earlier research groups into several areas. Scroll down for an outline of these areas and descriptions of published papers.

A. Corporate finance – Capital and dividends

B. Corporate governance

C. Trading volume in financial markets

D. Corporate crime and punishment

E. Fishery economics and regulation

F. Miscellaneous


A. Corporate finance -- Capital and dividends

1. "Short Term Trading Around Ex-Dividend Days: Additional Evidence" (with Ralph A. Walkling). Journal of Financial Economics 21:2 (September 1988): 291-298.

A dividend tax penalty (i.e., a higher tax rate on dividend than capital gains income) creates profitable trading opportunities for short-term traders with sufficiently low transaction costs. In stocks with ex-dividend day returns affected by short-term trading, ex-day returns are positively correlated with transaction costs. Data from 1964-1985 indicate that short-term traders are the marginal investors in high-yield stocks, primarily since the introduction of negotiated commissions on the NYSE. Short-term trading is not evident in low-yield stocks, nor does it appear prevalent before negotiated commissions.

2. "Dividend Capture in NASDAQ Stocks" (with Ralph A. Walkling). Journal of Financial Economics 28:1-2 (November/December 1990): 39-65.

This paper shows analytically that, when dividend capture occurs, ex-day returns will be positively related to transaction costs. The theory provides a concise and comprehensive characterization of dividend capture tradinge. Empirical tests then demonstrate that ex-day returns are positively related to transaction costs among high-yield stocks -- precisely those stocks most likely to attract dividend capture trading.

3. "Insider Trading Before New Issue Announcements" (with Daniel Lee). Financial Management 20:1 (Spring 1991): 18-26.

Unable to find support for other explanations of the stock price reactions to new issue announcements, finance researchers frequently conclude that such announcements convey information to investors. There is little direct evidence of such information effects, however, so information hypotheses are theories of last resort. This paper provides direct evidence that is consistent with information signaling by new issue announcements. We find that an unusual number of insiders sell stock before common stock and convertible debt issues. There is no abnormal insider trading before new issues of straight debt. These findings are consistent with prior evidence that the stock price reaction to announcements of common stock and convertible debt is negative and significant, but is small and statistically insignificant for issues of straight debt. The evidence suggests that managers have and act on privileged information before announcing it through new issue announcements.


B. Corporate governance

1. "Organizational Form, Share, Transferability, and Firm Performance: Evidence from the ANCSA Corporations" (with Edward M. Rice). Journal of Financial Economics 24:1 (September 1989): 69-105.

Theories of firm organization are difficult to test because, for most firms, organizational characteristics and performance are determined endogenously. This paper provides a rare test of theory of the firm predictions. It does so by exploiting data from an unusual set of thirteen firms established by the Alaska Native Claims Settlement Act of 1971 (ANCSA). The ANCSA firms are saddled with unusual organizational restrictions, the most important of which is that stock cannot be traded. Drawing from theory of the firm literature, we derive predictions that the ANCSA firms have poor financial performance, a high incidence of costly disputes over firm policy, and high turnover among directors and managers. All predictions are supported by the data. The data provide weaker evidence that is also consistent with predictions derived in the paper: the ANCSA firms use unusual monitoring and incentive mechanisms, incur high general and administrative expenses, diversify a great deal, invest heavily in financial assets, and pay their managers low monetary wages.

2. "The Wealth Effects of Second Generation State Takeover Legislation" (with Paul H. Malatesta). Journal of Financial Economics 25:2 (December 1989): 291-322.

Since 1982, 35 states have passed nearly 100 laws regulating corporate takeovers. Advocates of the laws claim that they protect shareholders, local communities, and employees from abusive takeover tactics. Opponents argue that the laws help entrench inefficient managers and harm the long-term economic health of many firms. This paper provides a large-scale examination of the state antitakeover laws, by examining the stock-price effects of all such laws introduced from 1982 through 1987. On average, the announcements are associated with a small but statistically significant decrease in the stock prices of firms incorporated in the state and of large firms headquartered in the state. The stock-price effects are concentrated in firms without preexisting firm-level takeover defenses. Firms with prior defenses have no significant stock-price reactions. The results indicate that state antitakeover laws introduced between 1982 and 1987 resulted in a $6 billion loss to shareholders of the affected companies.

3. "Share Values and Antitakeover Legislation: The Case of Pennsylvania's Act 36" (with Paul Malatesta). Journal of Corporate Finance 1:3/4 (1995): 367-382.

This paper resolves a dispute over the valuation effects of the country's most notorious state takeover law. Opponents claimed the law lowered firm values. Proponents argued that the opponents' numbers were unreliable because they ignored firm size and other effects. We show that the law's proponents were correct in this narrow dispute. However, both sides had mis-identified the dates information about the law entered the market. Taking into account the correct information dates and various other influences, the law lowered firm values.

4. "Corporate Governance and Shareholder Initiatives: Empirical Evidence" (with Paul Malatesta and Ralph Walkling), Journal of Financial Economics 1996.

Shareholder-initiated proxy proposals on corporate governance issues became popular in the late 1980s as corporate takeover activity declined. We find firms attracting governance proposals have poor prior performance, as measured by the market-to-book ratio, operating return, and sales growth. There is little evidence that operating returns improve after proposals. The proposals also have negligible effects on company share values and top management turnover. Even proposals that receive a majority of shareholder votes typically do not engender share price increases or discernible changes in firm policies.


C. Trading volume in financial markets

1. "A Theory of Trading Volume." Journal of Finance 41:5 (December 1986): 1069-1088.

Most finance students learn that exchange occurs when market agents assign different values to an asset. But things quickly get complicated when one looks at the number of assets exchanged in a market with diverse traders. Many models of financial markets implicitly assume away trading volume by assuming away heterogeneity. Yet there is active trading in most financial markets, indicating that agents are heterogeneous and operate in a changing environment.

This paper develops a theory of trading volume based on heterogeneous investors who periodically and idiosyncratically revise their demand prices. A better understanding of trading volume is important for at least three reasons. First is the inconsistency between the widespread use of the homogeneous investor assumption and observations of positive trading volume. This model presumes that investors have a demand to trade even in the absence of new information because of unique liquidity or speculative desires. Second, volume data are regularly reported in the financial media along with price data. Yet it is not clear what, if any, information is reflected by volume data. Some empirical researchers attempt to draw inferences from volume data, but others argue that the link between information and volume is ambiguous. This paper establishes two distinct ways information affects trading volume, and thus it provides a rationale for deriving the inference that an event contains information from empirical volume data. However, the ambiguity is not eliminated, as a volume increase can indicate that investors interpret the information differently or that they interpret the information identically but begin with diverse prior expectations. And third, the effects of the institutional design of the market on trading volume are not well understood. These effects are explored through simulations of a continuous market with significant frictions (information and transaction costs) and a costless Walrasian call market. Trading volume is lower in the imperfect market, and information has a persistence effect on volume in the imperfect market. This is consistent with empirical evidence, and suggests that markets do not immediately clear all demands motivated by the information or that investors make trading mistakes and have demands to recontract in subsequent periods.

2. "The Relation Between Price Changes and Trading Volume: A Survey." Journal of Financial and Quantitative Analysis 22:1 (March 1987): 109-126.

There are at least four reasons the price-volume relation is important. First, it provides insight into the information structure of financial markets. Second, it is important for event studies that use a combination of price and volume data from which to draw inferences. Third, it is critical to the debate over the empirical distribution of speculative prices. And fourth, it has several significant implications for research into futures prices.

This paper reviews previous and current research on the relation between price changes and trading volume in financial markets, and makes four contributions. First, two empirical relations are established: volume is positively related to the magnitude of the price change and, in equity markets, to the price change per se. Second, previous theoretical research on the price-volume relation is summarized and critiqued, and major insights are emphasized. Third, a simple model of the price-volume relation is proposed that is consistent with several seemingly unrelated or contradictory observations. And fourth, several directions for future research are identified.

3. "Costly Short Sales and the Correlation of Returns with Volume." Journal of Financial Research 11:3 (Fall 1988): 173-188.

One of the stylized facts established in item #2 above is that contemporaneous returns and volume are positively correlated in some markets. Previous explanations rely on unusual assumptions about investors' behavior, sometimes requiring irrational behavior. This paper proposes an alternate explanation based on the notion that short positions are more costly than long positions in these markets. This costly short sales hypothesis is consistent with previous findings and with futures markets data, in which the costs of assuming short and long positions are symmetric and in which the correlation between returns and volume is not significant.


D. Corporate crime and punishment

1. "The Reputational Penalty Firms Bear for Committing Criminal Fraud" (with John R. Lott, Jr.). Journal of Law and Economics, 36:2 (October 1993): 757-802.

This paper shows theoretically that the optimal criminal penalty for frauds of private parties is small because the external effects of such frauds is small. It then reports empirical tests that show that, in practice, criminal penalties for private frauds are very small compared to market-imposed penalties.

2. "Why the Sentencing Commission's Rules May Create Greater Disparity" (with John R. Lott, Jr.). Federal Sentencing Reporter 3:3 (November/December 1990): 140-141.

This paper observes that one of the United States Sentencing Commission's primary purposes is to eliminate disparities in sentencing practice for similar crimes. In establishing sentencing guidelines for corporate crimes, however, the Commission has ignored the role market forces play in disciplining corporate criminal behavior. The guidelines overturn decades of common law and court decisions, which frequently do take into account such market forces. As a result, the Commission's guidelines increase sentencing disparity for some classes of crime.


E. Fishery economics and regulation

1. "Low Interest Loans and the Markets for Limited Entry Permits in the Alaska Salmon Fisheries." Land Economics 60:1 (February 1984): 69-80.

This paper evaluates the impact of loans at subsidized rates on the markets for the affected assets. The model's predictions are supported by data from the Alaska salmon fisheries. Under the entry limitation program, transferable permits convey fishing rights. A loan subsidy available to Alaska residents increased permit prices by 23% and trading volume during an adjustment period by 22%. Observed changes in prices and trading volumes are decomposed into permanent and temporary effects, where temporary effects reflect two-way trades by Alaska residents engineered to take advantage of the loan subsidy. Overall, the loan subsidy is estimated to have caused a $0.3 million deadweight loss and a $48.9 million transfer to existing permit holders.

2. "Insights from the Markets for Limited Entry Permits in Alaska." Canadian Journal of Fisheries and Aquatic Sciences 41:8 (August 1984): 1160-1166.

Information from the permit markets is used to examine several key issues regarding the behavior of fishermen and the effects of fishery management policy. The results indicate that (1) expectations of future fishing incomes are the primary determinants of permit prices, (2) Alaska Department of Fish and Game forecasts of fish recruitment (the number of fish returning to spawn) are capitalized in permit values, and (3) such forecasts are discounted when recent error rates are high. Using an adaptive expectations model of fishing profits, it is further concluded that the "average memory" of fishermen in projecting future fishing incomes is 2.56 years (which is nearly identical to Friedman's estimates of consumers' "average memory" in consumption decisions), and that the average risk premium on fishing income is 5.05%.

3. "Alaska's Limited Entry Permit Markets: A Summary of Empirical Results." 1984 Western Proceedings (Proceedings of the 64th Annual Conference of the Western Association of Fish and Wildlife Agencies and Western Division of the American Fisheries Society): 326-335.

The ability to preserve some of the value of an open-access resource such as a fishery by limiting entry is examined using data from the Alaska salmon fisheries. The capitalized value of all permits in early 1981 was $432.0 million, which is a rough estimate of the fishery rent preserved by entry limitations. In the absence of limitations, theory and previous evidence indicate that most (under some circumstances, all) of this value would be dissipated in the form of higher harvesting costs and/or a smaller gross harvest. Entry limitations do not maximize the value of the fishery, however, because they do not address the fundamental problem of the common pool, which is that property rights are unassigned until fish are caught.

4. "Non-Pecuniary Benefits in Commercial Fishing: Empirical Findings from the Alaska Salmon Fisheries," Economic Inquiry 23:1 (January 1985): 159-174.

It is widely argued that non-pecuniary benefits are unusually high for producers in fisheries, and that such benefits distort the intended effects of fishery regulations. This paper measures the importance of non-pecuniary benefits in commercial fishing using data from the Alaska salmon fisheries, which are subject to entry limitations. Although limited entry permit prices reflect primarily pecuniary factors, the continued presence of many low-revenue fishermen in the fisheries suggests that they, at least, derive non-money benefits. The existence of non-pecuniary benefits, however, does not appear to depend substantially on the gear type or geography of the fishery.

5. "Time, Capital Intensity, and the Cost of Fishing Effort." Western Journal of Agricultural Economics 10:2 (December 1985): 254-258.

The notion that a fishing vessel's costs are a function of its effort is a useful paradigm in fishery analysis. This paper elaborates on this micro-theoretic approach, and proposes a way to view the cost of effort as the interaction of capital intensity and the length of the fishing season. The model indicates that capital intensity decisions are affected by season closures, and that season closures can be used to redistribute wealth among different classes of fishermen.

6. "Suboptimal Controls in Common Resource Management: The Case of the Fishery." Journal of Political Economy 95:1 (February 1987): 179-194.

This paper represents a departure from traditional fishery analysis, which has ignored the economic theory of regulation and evidence that producers are heterogeneous. Actual fishery regulations are not "irrational," as is commonly argued, but instead are the outcomes of a political process used to redistribute wealth among fishery producers.

The self-interest hypothesis of regulation and fisherman heterogeneity can explain two historically popular types of fishery regulations, season closures and capital constraints. These regulations affect fishermen differently, and typically redistribute the fishery's harvest from more efficient toward less efficient producers. In many fisheries, less efficient fishermen tend to be indigenous to the regulators' jurisdiction. In these fisheries, I predict that current regulations will persist, despite economists' hue and cry about them.

7. "Characteristics of Limited Entry Fisheries and the Option Component of Entry Licenses." Land Economics 65:4 (November 1989): 386-393.

Entry limitations are frequently proposed as a partial solution to the common pool problem that characterizes most fisheries. Entry limitations have actually been imposed, however, in relatively few fisheries. At first glance, this contradicts the self-interest hypothesis of regulation, because most proposals to limit entry would convey licenses to many existing fishermen at a nominal price. Item #6 above argues that traditional regulations such as capital constraints and season closures are popular because they redistribute the catch toward the politically dominant groups. This paper directly examines conditions under which political support for entry restrictions is likely to be sufficient among fishermen, i.e., when the expected net benefits are positive for a sufficient number of fishermen. Such support is likely when minority groups are targeted for exclusion, expected fishing incomes are low, and the variance of fishing returns is high.

Limited entry licenses limit competition when the fishery is profitable but do not force participation when the fishery is unprofitable. They are therefore similar to option contracts. I use the option analogy to derive an exact license valuation model.

8. Regulatory Techniques in the Fishery: A Model for Pacific Salmon. Juneau: Alaska Commercial Fisheries Entry Commission, 1982, 50 p.

One of the most valuable fisheries in the world, the Alaska salmon fisheries have attracted attention from policy makers because they were among the first subjected to entry limitations. The agencies responsible for entry limitations have tried unsuccessfully to fulfill a legislated mandate to determine the optimum number of entry licenses. This paper addresses the optimum numbers issue by constructing a model of renewable resource exploitation in a common pool, using assumptions that approximate the biological and regulatory characteristics of the Alaska salmon fisheries. The optimum number of licenses, i.e., that which maximizes the fishery's value, is at the point of unitary elasticity of the demand curve for licenses. Hence, the optimum numbers dilemma can be solved using data from the markets for entry licenses.

The model is combined with evidence from the Bristol Bay fisheries to yield the following additional implications: (1) The open access fishery involves redundant effort in the form of too many optimally sized vessels, not in the form of overcapitalized vessels. (2) Gear or vessel restrictions limit effective effort, but any resulting preserved rent is dissipated in the higher costs that are necessarily implied by the restrictions. (3) Very weak evidence suggests that these higher costs take the form of a greater number of participants, not higher costs per vessel, which (4) implies that gear and vessel restrictions permit higher-cost producers to compete by limiting the efficiency of lower-cost producers. (5) Further evidence indicates that fishermen respond to time restrictions by employing smaller amounts of capital and not operating marginal vessels, which implies that (6) time restrictions decrease vessels' revenues more than their money costs. (7) Restrictions on the number of competing vessels encourages competition along other input dimensions, and the amount of preserved rent from the fishery is inversely related to the ease with which effort-per-vessel can be substituted for numbers of vessels. (8) Because of the propensity to dissipate rent along other input dimensions, the optimum number of vessels in a fishery regulated by entry limitation is most probably less than what a sole owner of the fishery would employ, because the sole owner could control effort-per-vessel.


F. Miscellaneous

1. "In Search of a Signaling Effect: The Case of Corporate Name Changes" (with Graeme W. Rankine). Journal of Banking and Finance 18:6 (1994).

Researchers who cannot explain a positive stock price reaction to an event frequently claim the event "signals" some type of information. This sometimes seems to me to be a flaky argument. It is at least an argument of last resort. In this paper we put the argument to test using one type of event -- name changes -- that is widely regarded as signalling information to investors. We show that the signalling story does not hold up to empirical scrutiny.

2. "Barter Trading as a Microeconomics Teaching Device." Journal of Economic Education 15:3 (Summer 1984): 226-236.

This paper describes how a barter trading game can be used as a supplementary teaching device in microeconomics classes. The actual results of this game in four sections of an introductory course are described and critiqued. The game can be used to allow students to participate actively in a market process, in addition to studying one. Students experience the effects on markets of price controls, taxes, wealth redistributions, and government grants of monopoly power.

3. "The ANCSA Corporations: Still Troubled After All These Years" (with Edward M. Rice), Contemporary Policy Issues, July 1992.

The Alaska Native Claims Settlement Act of 1971 (ANCSA) resolved disputes over aboriginal lands by giving Alaska Natives 44 million acres of land and $962.5 million largely through Native-owned corporations. While the corporations initially performed poorly, their performance appeared to improved in later years. This paper documents that the apparent improvement in ANCSA firm performance is illusory. The causes of the poor performance are inherent in restrictions ANCSA placed on the corporate form, which have not changed substantially since the Act's passage. Some suggestions for alleviating the costs of the restrictions are provided, but the most important lesson derived for future Native settlements is to avoid creation of entities with ANCSA-type organizational restrictions.

Once considered a hallmark of aboriginal land claims settlements, the ANCSA corporate structure has fallen out of favor among Native land claims experts who now generally favor the creation of semi-autonomous aboriginal political units (such as the recently announced Inuit homeland in northern Canada). This paper argues that the fundamental problem with the ANCSA settlement has not been understood by policy-makers, and may be repeated in future Native settlements.