Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 THE RESCUE OF TROUBLED BANKS: CONSEQUENCES FOR CORPORATE STRATEGIES TO DEAL WITH FINANCIAL AND OPERATING STRESS Peter S. Rose Texas A&M University Abstract A rapidly growing literature on the financing of distressed companies finds that troubled firms often secure relief from stress through asset restructuring, capital restructuring, or both. However, none of the earlier corporate distress restructuring studies have focused on the centrally important commercial banking industry which has been one of the most financially distressed industries of the past decade. In this study financial and operating changes experienced by nearly 730 U.S. insured banks that experienced at least two years of negative earnings and then returned to positive profitability were examined using both univariate and joint tests. The study finds that troubled banking corporations displayed evidence of both financial and operating problems simultaneously, so that financial distress appears to be linked to operating stress in the majority of instances observed. However, operating problems (as reflected, for example, in production inefficiencies and expense-control problems) tended to be of longer duration than corporate financial problems, suggesting that either financial stress tends to be easier to address or is subject to more rapid resolution than are corporate operating problems. Relief from corporate stress in the banking sector appears to be accompanied by accelerated growth in total assets, reduced debt financing costs, a strengthening of liquid asset positions, strengthening of customer loan performance, greater employment of junior-priority and shorter-term debt, and reduced dividends on common stock.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 SINGLE VERSUS MULTIPLE DISCOUNT RATES IN INVESTMENT THEORY Kashi Nath Tiwari Kennesaw State College Abstract The conventional procedure to estimate the rate of return on an investment project appears to contain significant errors on three counts. First, it uses a single discount rate as an estimator for all the periodic changes in the market rates that take place during the life of a project which may either overestimate or underestimate the net rate of return. The use of a single discount rate to present value the future cash flows will result in two types of errors: (a) errors committed during the estimation of individual one-period rates, and (b) errors committed during the estimation of a single discount rate as an estimator of the individual one-period rates. Second, it overestimates (under estimates) the rate of return by excluding the increase (decrease) in the opportunity cost of the various segments of the price paid from the time the cash inflows accrue until the termination or the sale of the project. If the opportunity costs increase (decrease) during the investment period, then the actual rate of return will be lower (higher). It is inconsistent in including only the time value of the cash inflows while excluding the time value of their corresponding prices. Third, it overemphasizes the geometric-mean-based procedure to calculate the rate of return, while ignoring other equally excellent procedures such as harmonic-mean-based and arithmetic-mean-based. Recognizing that conventional methods of calculating the rate of return on various investment projects often yield significant errors, this paper introduces a new procedure to correct the inconsistency in the estimation of the rate of return by explicitly recognizing the time value of the various segments of the project's price (cost). The choice of a particular mean-based (harmonic, geometric, or arithmetic) technique to calculate the rate of return can be linked to the risk preference of the investors. The results of this paper indicate that under variable rate conditions a harmonic-mean-based rate of return will always be lower than a geometric-mean-based rate of return which, in turn, will always be lower than an arithmetic-mean-based rate of return. The differences in the values of these three mean-based rates of return are very small. With regard to the adoption of an investment project (or to the purchase of an asset), therefore, the cautious risk-averse investor is more likely to make a decision based upon the harmonic-mean based rate of return; the flamboyant risk preferrer investor is more likely to make a decision based upon the arithmetic-mean-based rate of return; and a risk-neutral investor is more likely to make a decision based upon the geometric-mean-based rate of return. All of the three measures to calculate the rate of return are equally effective in appropriate contexts. This paper uses multiple single-period rates as opposed to a single discount rate to evaluate a project's net worth.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 INTEREST RATE PARITY IN TIMES OF TURBULENCE: THE ISSUE REVISITED Nada Boulos University Of Texas At Arlington Peggy E. Swanson University Of Texas At Arlington Abstract Empirical studies on covered interest arbitrage suggest that the interest rate parity condition does not always hold during times of turbulence in the foreign exchange markets, implying market inefficiency. This paper considers two different approaches [Taylor (1989) and Clinton (1988)] to measuring deviations from interest rate parity for a period of turbulence in the foreign exchange markets and for a control period. The different procedures yield results which conflict with earlier studies.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 UNDERWRITER CHOICE AND ANNOUNCEMENT EFFECTS FOR SEASONED EQUITY OFFERINGS Fredrick P. Schadler East Carolina University Timothy L. Manuel University Of Montana-Missoula Abstract This study examines differences in company and issue characteristics of firms which choose different types of underwriters to market their seasoned equity offerings. Larger, slower growth firms with a lower percentage of inside ownership contract with prestigious investment bankers while smaller, higher growth firms utilize non-prestigious underwriters. After controlling for different firm and issue characteristics, the abnormal returns upon announcement of an equity offering are more negative for issues marketed by prestigious investment bankers. Finally, the announcement of a seasoned equity issue by more rapidly growing firms results in less negative abnormal returns.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 THE CAPITALIZATION OF THE STATE TAX EXEMPTION BENEFIT IN MUNICIPAL BOND YIELDS C. Steven Cole University of North Texas Pu Liu University of Arkansas Stanley D. Smith University of Arkansas We are grateful for the helpful comments and suggestions by Paul Hsueh and Duane Stock. We are also thankful to Standard & Poor's for providing the data for the study. The remaining errors, if any, are solely ours. This study was supported by a grant from the Worthen Banking Corporation Research Fund. Abstract Thirty-three states treat in-state municipal bond interest income differently from out-of-state municipal bond interest income. While they tax the interest income of out-of-state bonds, they exempt interest income of in-state bonds from state taxes. This differential treatment in taxes creates a demand for in-state bonds and provides a disincentive for holding out-of-state bonds. A priori, this preferential treatment of in-state bonds would lower the interest yields on in-state bonds. This paper examines the degree to which the personal state tax exemption benefit is reflected in bond prices or yields in the secondary market for municipal bonds. The evidence suggests that the tax exemption benefit is fully capitalized in the bond's yield.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 THE EFFECT OF COMMON STOCK BETA VARIABILITY ON THE VARIABILITY OF THE PORTFOLIO BETA Herbert J. Weinraub University of Toledo Bruce R. Kuhlman University of Toledo Abstract The relationship between the variability of individual stock betas and the variability of small portfolio betas is tested. Stocks are combined into small portfolios using two measures of beta variability, the standard deviation of beta and the coefficient of variation of beta. The following results are of particular interest to managers of small portfolios: (1) minimization of portfolio beta variability cannot be achieved by combining stocks which, individually, have low beta variability, and (2) stocks with low betas have greater relative beta variability.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 TAX REFORM AND THE EFFECTS ON BANK INVESTMENT PORTFOLIOS AND BOND SPREADS Amy Dickinson Florida Atlantic University Gordon Karels University of Nebraska Arun J. Prakash Florida International University The authors would like to thank Robert Avery of Cornell University for helpful comments. Abstract Commercial banks have traditionally been a primary force in the tax exempt bond market. The Tax Reform Act of 1986 provided major incentive changes. The purpose of this study is to investigate the motivation for bank participation in the municipal bond market in order to determine which theory, market segmentation versus excess funds, is the most predominant. Empirical results from yield and portfolio analyses most strongly support the excess funds motivation for commercial bank investment in municipal securities.

Journal of Financial and Strategic Decisions Volume 7, Number 2   Summer 1994 INSURANCE CONTRACT VALUATION, EXPERIENCE RATING, AND ASYMMETRIC INFORMATION Helen I. Doerpinghaus University of South Carolina William T. Moore University of South Carolina Abstract The study follows previous work on the role of experience rating in resolving information asymmetry problems in insurance contracting. Results of the study provide additional evidence that contracts which are experience-rated are less susceptible to pricing inefficiency due to moral hazard and adverse selection than are contracts which are not experience-rated. This study extends previous work by showing that experience-rated contracts are most effective among lower risk insureds.

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