Volume 10, 2021


pdf Does Investors’ Divergence of Opinion Affect Stock Mispricing?

Diogo Silva*, António Cerqueira, Elísio Brandão

School of Economics and Management, University of Porto

The main purpose of this study is to address the association between investors’ divergence of opinion (DIVOP) and stock mispricing for UK firms listed in the London Stock Exchange Market. Previous research on this topic has provided mixed results. Some studies provide evidence consistent with the overpricing hypothesis, which indicates that DIVOP leads to overpricing because the market overweighs the most optimistic valuations, since optimistic investors can always buy a stock but pessimistic investors can only sell a stock if they already own it or need rely on short-selling, which has costs. Other studies support the underpricing hypothesis, which proposes that DIVOP works as a price risk factor that generates underpricing. We develop an empirical analysis that do not depend on the interpretation of abnormal future stock returns to assess contemporaneous mispricing. We use five explicit measures of mispricing. Also, to safeguard the development of a comprehensive study, we use three kinds of proxies of DIVOP, based on idiosyncratic volatility, dispersion in analysts’ forecasts and unexpected trading volume. The results show a positive significant association between DIVOP and stock mispricing on a yearly basis. This association is stronger for underpriced stocks, which is consistent with the underpricing hypothesis, and indicates that DIVOP signals risk. An implication of this study is that firms have incentives to provide high-quality and explicit information to limit DIVOP and avoid being underpriced.

Keywords: Divergence of opinion, Stock mispricing

pdf Mandatory IFRS Adoption and Real/Accruals Bases Earnings Management in the UK

Mohammad I. Almaharmeh 1, Adel Almasarwah* 2, Ali Shehadeh 1

1 The University of Jordan/Aqaba, 2 The Hashemite University

Here, the link between the mandatory adoption of International Financial Reporting Standards (IFRS) and Real Earnings Management (REM), as well as Accrual Earnings Management (AEM), will be examined for non-financial listed firms in the London Stock Exchange. Robust regression analysis of the mandatory IFRS adoption will be conducted on the panel data, as well as earnings management using three AEM models and three REM models. Mixed results with respect to the qualities of AEM and REM were notably garnered, with mandatory IFRS adoption positively relating to the Roychowdhury of abnormal cash flow and the Roychowdhury of abnormal production. Meanwhile, the Roychowdhury of abnormal discretionary expenses, standard Jones, and Kothari negatively related to mandatory IFRS adoption, whilst modified Jones showed an insignificant relation to mandatory IFRS adoption. Changes in IFRS adoption and guidelines for UK firms may have an impact on AEM and REM, and, as predicted, mandatory IFRS adoption mostly affects the Kothari model followed by the standard Jones model as proxies for accounting earnings quality.

Keywords: Mandatory IFRS, Accruals earnings management (AEM), Real earnings management (REM), Robust Regression

pdf The Role of Political Connections and Family Ownership in Increasing Firm Value

Momon, Lela Nurlaela Wati, Sutar

1 Universitas Padjadjaran, Bandung, Indonesia
2 Sekolah Tinggi Ilmu Ekonomi Muhammadiyah Jakarta, Indonesia

In the face of business competition, a company strategy is needed by seeking and exploiting opportunities in the business environment, one of which is through political connections. Ownership structure plays an essential role in the company to determine the firm performance. The high concentration of family ownership has the power to reduce agency conflicts between management and stakeholders in a company. Concentrated ownership can serve as corporate governance mechanism for better and effective monitoring of management. This study was conducted to determine empirical evidence of the effect of political connections and family ownership structure on firm value. The sample in this study was 390 data of the manufacturing company. The data analysis used is moderating regression analysis. The results of this study are a positive influence of political connections and family ownership structure on firm value. The results showed that the more the company had a strong political connection and was controlled by the family, the more the firm value would increase. The interaction of political connections can strengthen the influence of family ownership on firm value. It proves that the family ownership structure plays a role in determining political connections in Indonesia, especially in manufacturing companies. The existence of empirical evidence that shows that the firm value controlled by a politically connected family is higher than companies that are not connected politically, which implies investors to invest in companies that are politically connected and companies controlled by families with majority ownership because it is proven to increase firm value.

Keywords: Firm value, Political connection, Family ownership, Controlling shareholder

pdf Behavioral Finance Research in 2020: Cui Bono et Quo Vadis?

Katharina Fischer 1, Othmar M Lehner 2

1 University of Applied Sciences Upper Austria
2 Hanken Schools of Economics, Helsinki, Finland

Emanating from the influential survey of Barberis and Thaler (2003), this systematic literature review examines the significant volume of studies on behavioral finance from 36 reputable finance journals published be-tween 2009 and 2019. The findings are clustered into eight prominent research streams, which indicate the current developments in behavioral finance. Findings show that research intensively focuses on behavioral biases and their influence on economic phenomena. Driven by the impetus to understand the human mind, significant findings originated in the relatively new field of Neurofinance. Additionally, the analysis addresses the influence of market sentiment and its correlation with some of the other findings. Furthermore, implications on the limits to arbitrage in connection with some financial anomalies complete the holistic picture.

Keywords: Behavioral Finance, Neurofinance, Limits to Arbitrage, Market Anomalies, Behavioral Biases

pdf Corporate Social Responsibility as a managerial learning process

Ahmed Marhfor *1, Kais Bouslah 2, Bouchra M’Zali 3

1 Université du Québec en Abitibi-Témiscamingue. Member of CAIMD, Mohammed VI Polytechnic University
2 University of St. Andrews. Member of CAIMD, Mohammed VI Polytechnic University
3 Université du Québec à Montréal. Member of CAIMD, Mohammed VI Polytechnic University

The purpose of this paper is twofold. 1) We propose for the first time in the literature a theory (managerial learning hypothesis) that may explain why managers engage in corporate social responsibility (CSR). 2) We use an intuitive empirical methodology (Edmans et al. 2017) to test the relevance/irrelevance of our new theory. The idea behind our main contribution is that managers engage in CSR to learn new relevant information from other informed stakeholders. In return, managers will use both the new information and other information they already have to choose the optimal level of firm’s investment (Jayaraman and Wu, 2019). Therefore, we propose to examine whether a strong CSR engagement improves revelatory efficiency (Edmans et al. 2012, 2017). The latter accounts for the extent to which stock prices reveal new information to managers that will help them make value-maximizing choices. Our findings suggest that CSR activities do not allow firm’s managers to extract new information from their stock prices and ultimately improve the efficiency of their investment choices.

Keywords: Corporate social responsibility, Managerial learning theory, Revelatory efficiency, Investment-price sensitivity

JEL Classification: G14, G34, M14

pdf Beyond the three lines of defense: The five lines of defense model for financial institutions

Georgios L. Vousinas*

National Technical University of Athens, School of Mechanical Engineering, Sector of Industrial Management & Operational Research, Greece

The purpose of this study is to provide an updated version of the widely accepted three lines of defense model (3LoD) to better apply for regulated financial institutions. The author proposes the five lines of defense model (5LoD) which consists of the existing three lines along with external audit and regulators (comprising the fourth and fifth line of defense respectively). In spite of the fact that the bodies forming the two additional lines of defense constitute the external lines of defense, there should be active in supervising and monitoring control issues within the organization, in strong cooperation with the internal lines. This calls for closer interaction among the internal auditors, external auditors and regulators in the design and implementation of an efficient and effective internal control system, aiming to strengthen the existing framework regarding the governance of modern financial institutions, which operate in a highly demanding regulated environment.

Keywords: Three lines of defense, Five lines of defense, Internal audit, External audit Regulator

pdf The Impact of Financial Sector Sustainability Guidelines and Regulations on the Financial Stability of South American Banks

Pedro Ildemaro Alguindigue Ruiz, Olaf Weber*

University of Waterloo

Sustainability risks represent a significant concern for the banking industry. Consequently, financial regulators created financial sector sustainability guidelines and regulations. However, the effect of these policies on banks’ financial stability is unclear. Hence, this study analyzes 149 banks in 17 countries in Latin America to explore the impact of financial sector sustainability guidelines and regulations on the banking industry. We use the Z-Score to measure the financial stability of banks in countries with and without financial sector sustainability guidelines and regulations. Based on panel regression, our results suggest significant differences between banks in countries with and without financial sector sustainability guidelines and regulations. We conclude that sustainable finance regulations promote financial stability as well as sustainable banking practices.

Keywords: Sustainability, Regulation, Supervision, Financial stability, South-America

JEL Classification: G14, G34, M14

pdf The value of political independent supervisory boards: Evidence from Indonesian dual board setting

Joni Joni*, Jahja Hamdani Widjaja, Maria Natalia, Ivan Junius Salim

Maranatha Christian University, Indonesia

We investigate whether political independent supervisory boards (political I-SBs) help companies to reduce their corporate risks in the setting of Indonesian two-tier board system. This study is different from other studies in several ways. First, while most prior studies examine the effectiveness of independent boards in one-tier board setting, we use dual board system. This system promotes the strategic role of political I-SBs. Second, we use two measures of corporate risks: operating and market risks. Based on 1,176 firm-year observations for operating risk analysis and 1,254 firm-year observations for market risk analysis, we find that firms with political I-SBs have lower operating and market risks than firms with non- politically connected independent SBs. We also control for endogeneity problem using GMM (Generalized Method of Moments) method, and the results are still consistent.

Keywords: Political I-SBs, Corporate risks, Two-tier board system

pdf Price, Volatility and the Second-Order Economic Theory

Victor Olkhov*

TVEL, Moscow, Russia

We introduce the new price probability measure, which entirely depends on the probability measures of the value and the volume of the market trades. We define the nth statistical moment of the price as the ratio of the nth statistical moment of the value to the nth statistical moment of the volume of all trades performed during an averaging time interval Δ. The set of the price statistical moments determines the price characteristic function and its Fourier transform defines the price probability measure. The price volatility depends on the 1st and the 2nd statistical moments of the value and the volume of the trades. The prediction of the price volatility requires a description of the sums of squares of the value and the volume of the market trades during the interval Δ and we call it the second-order economic theory. To develop that theory, we introduce numerical continuous risk ratings and distribute the agents by the risk ratings as coordinates. Based on distributions of the agents by the risk coordinates, we introduce a continuous economic media approximation that describes the collective trades. The agents perform the trades under the action of their expectations. We model the mutual impact of the expectations and the trades and derive equations that describe their evolution. To illustrate the benefits of our approach, in a linear approximation we describe perturbations of the mean price, the mean square price and the price volatility as functions of the first and the second-degree trades’ disturbances.

Keywords: Price probability, Volatility, Economic theory, Market trades, Expectations

pdf Analysis of Option Trading Strategies Based on the Relation of Implied and Realized S&P500 Volatilities

Alexander Brunhuemer, Gerhard Larcher*, Lukas Larcher

Johannes Kepler University Linz

In this paper, we examine the performance of certain short option trading strategies on the S&P500 with backtesting based on historical option price data. Some of these strategies show significant outperformance in relation to the S&P500 index. We seek to explain this outperformance by modeling the negative correlation between the S&P500 and its implied volatility (given by the VIX) and through Monte Carlo simulation. We also provide free testing software and give an introduction to its use for readers interested in running further backtests on their own.

Keywords: Option-trading, S&P500-index, Implied volatility, Realized volatility

pdf Are Strategies for International Diversification by Country, Industry and Region Equivalent?

Rachid Ghilal 1, Ahmed Marhfor 2,*, M’Zali Bouchra 3, Jean Jacques Lilti 4

1 University of Quebec in Rimouski (UQAR)
2 University of Quebec in Abitibi- Témiscamingue (UQAT)
3 ESG/UQÀM Montréal
4 University of RENNES1

In this study, we examine whether international portfolio diversification still matters despite an increase in the cross-country correlations of assets returns. More specifically, we explain why an increase in global return correlations does not necessarily imply a reduction in the benefits of international portfolio diversification. We also propose to compare empirically two traditional strategies of international diversification (by country and industry) in addition to a new strategy (by region) using two different methodological approaches, namely the mean variance spanning and multivariate cointegration analysis. Over the full sample period (1994- 2008), our results suggest that the three strategies of international diversification remain effective despite the secular increase in the cross-country return correlations. When we divide the sample into two different sub-periods (1994-2000 and 2000-2008), the findings indicate that the strategy based on regional diversification proved to be a new competing strategy during the second period in comparison to the other two traditional strategies.

Keywords: International diversification, Countries Industries/sectors Regions, Market indexes, Mean variance spanning, Cointegration

pdf Nordic green bond issuers’ views on the upcoming EU Green Bond Standard

Linn Björkholm, Othmar M. Lehner

Hanken School of Economics

The green bond market is growing and becoming increasingly important in green finance and for the transition to a low-carbon economy. Still, the green bond market is to a large extent unstandardised. There is no commonly agreed definition of the term ‘green’. This has been seen as one of the biggest challenges when it comes to the development of the green bond market. The need of a unified EU standard has been raised and as an effect the establishment of the EU Green Bond Standard is now in development. However, new standards might not only bring advantages, but also challenges. Striking the right balance of strictness might be hard. The research has been conducted through qualitative method with semi-structured interviews. Nine interviews were held during November and December 2020. The data was then analysed through thematic coding in order to find patterns of meaning. The results show that Nordic green bond issuers overall are positive towards the EU Green Bond Standard. The EU GBS has a good aim, to harmonise and enlarge the green bond market. However, the standard brings challenges that are to a large extent known challenges which the EU GBS aims to address, such as labour intensive reporting processes, lack of initiative and reputational risk. Also, it is argued that the standard is not fair and applicable for all the countries and companies. Countries national laws may not always go hand in hand with the standard. For example, the requirements for green buildings are seen as challenging in the Nordics. If these challenges are not taken into consideration, Nordic green bond issuers fear that the market will not grow, but instead decrease. Additionally, Nordic green bond issuers argue the adoption of the EU GBS is not a guarantee for issuers. Bigger institutes are seen to be early adopters. For other issuers investor requirement and positive impact on their company reputation is seen as the key drivers for adoption of the standard.

Keywords: Green bond, Nordics, Green bond issuer, EU Green Bond Standard, EU GBS

pdf Discriminating between Islamic and Conventional banks in term of cost efficiency with combination of credit risk and interest rate margin in the GCC countries: Does Arab Spring revolution matter?

Mohamed Sadok Gassouma* and Mohamed Ghroubi

Higher Institute of Theology, Ez-zitouna University, Tunisia

This study aims to test the contagion effect of the Arab Spring revolution in the GCC countries on discrimination between Islamic and conventional banks in terms of cost efficiency, and to test how prudential factors can influence this comparison. We used the stochastic frontier of Battese and Coelli (1995) to measure the cost efficiency of both Islamic and conventional banks in the GCC countries during 2006_ 2015 (before the Arab revolution 2006-2010 and after the Arab revolution 2011-2015). Second, we used a logit model to discriminate between Islamic and conventional banks in terms of cost efficiency combined with credit risk, regulatory capital and interest margin. Third, we finally test the convergence and divergence between Islamic and Conventional banks by measuring the probability of having Islamic/conventional activities for both banks. We have shown that there is no absolute difference in terms of cost efficiency between Islamic and conventional banks. This difference can be observed through the credit risk taking but not through the interest rate margin. In addition, Islamic banks have taken advantage from the event of the Arab Spring revolution, compared to conventional ones, by being more efficient through risk mitigating due to their participatory financial product. Unlike previous research, we have used a cost efficiency measurement following Battese and Coelli’s (1995) model and we have incorporated it in a logit model, in the context of crisis. Cost efficiency is combined with a set of prudential factors to determine their effect on the convergence/divergence between Islamic and conventional bank.

Keywords: Islamic banks, Conventional banks, Cost efficiency, Efficiency stochastic frontier, Credit risk, Regulatory capital, Logistic regression

pdf Basel capital requirements, portfolio shift and bank lending in Africa

Damilola Oyetade, Adefemi A. Obalade, Paul-Francois Muzindutsi*

University of KwaZulu-Natal, South Africa

Bank lending is a major source of income for a bank. Compliance with higher Basel capital requirements (CAR) portends serious implication for distribution of loan portfolio across different sectors. The objective of the study is to examine African banks’ responses to higher CAR in terms of portfolio shift. The study used descriptive statistics and ANOVA for panel data of African commercial banks that have implemented Basel II or III CAR for the period 2000 and 2018. Based on the results of our analysis, implementation of higher Basel CAR by African banks revealed four key findings. Firstly, our results suggest that higher Basel CAR particularly Basel III reduced total loans for South African banks. Secondly, African banks engage in portfolio shift with higher Basel levels. Thirdly, higher Basel capital increased banks' capital ratios in Africa, but some banks are still characterized by low equity. Fourthly, African banks reduce lending to high risk-weighted loans such as real estate and commercial loans except for South African banks which increased lending to commercial loans with higher Basel CAR. Lastly, this study proffers key insight into the lending behaviour of African banks with the implementation of higher Basel CAR.

Keywords: Bank lending, Portfolio shift, Basel capital requirements, Africa