Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 A PEDAGOGICAL EXAMINATION OF THE RELATIONSHIP BETWEEN OPERATING AND FINANCIAL LEVERAGE AND SYSTEMATIC RISK Edwin H. Duett Mississippi State University Andreas Merikas University of Pireaus Manolis D. Tsiritakis Mississippi State University INTRODUCTION The study and understanding of risk is of paramount importance to any discussion of the value of a particular firm or enterprise. Most of basic financial management addresses risk from the perspective of a portfolio or the financial and operating characteristics of the firm. The two are often loosely connected and interrelationships ignored. This paper offers a pedagogical approach to the relationship between balance sheet decisions, product markets, and the systematic risk of a firm. This is accomplished by decomposition of the firm’s beta. This decomposition extends earlier works and allows the reader to see the interrelationships mentioned above. Financial theory is predicated on the notion that the goal of the firm is to maximize value and thus firms configure their balance sheets to achieve this goal. The selected configuration of assets and liabilities determines the total risk of the firm. Portfolio theory shows us that the relevant risk is the systematic risk as investors are able to diversify away the unsystematic portion of total risk. Several authors, in their study of systematic risk, have derived decompositions of beta providing insight into the financial and economic factors affecting beta. Hamada (1972) and Rubenstein (1973) have partitioned beta into operating risk and financial risk. Mandelker and Rhee (1984) provided an alternative decomposition.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 THE JANUARY SIZE EFFECT REVISITED: IS IT A CASE OF RISK MISMEASUREMENT? R.S. Rathinasamy Ball State University Krishna G. Mantripragada Ball State University The authors thank Terry Zivney, Maxon Distinguished Professor of Finance, Ball State University, for his useful comments. Remaining errors are those of the authors only. Abstract Using risk-adjusted Treynor and Sharpe portfolio performance measures, this paper re-examines the well-documented January effect, small firm effect, and the small firm January effect. While the return increases along with risk for small firms in January, the extra return is more than what is warranted by the extra risk. There is an abnormal return component to the January small firm return even after adjusting for the added risk in January.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 AN ANALYSIS OF SHAREHOLDER REACTION TO DIVIDEND ANNOUNCEMENTS IN BULL AND BEAR MARKETS Scott D. Below East Carolina University Keith H. Johnson University of Kentucky The authors acknowledge the helpful comments of seminar participants at the Southern Finance Association meetings, the Midwest Finance Association meetings and workshop participants at the University of Kentucky. Abstract This paper examines the differential share price reaction to dividend increase and decrease announcements with respect to market phase. We find that market phase has a significant impact on abnormal returns around the announcement, and it appears that more information is conveyed by dividend change announcements which run counter to market phase. The results are robust in that the conclusions are the same for both an analysis of the raw abnormal returns data, and for the FGLS regressions which control for possible confounding factors. These results are consistent with the information content of dividends hypothesis, and have important implications for event studies where clustering is problematic.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 STOCK PRICES AND THE BARRON'S 'RESEARCH REPORTS' COLUMN Ki C. Han Suffolk University David Y. Suk Rider University Abstract We examine stock price reactions to securities recommendations by investment firms. We focus on the market reaction on the date an investment firm issues a research report and the date the report is subsequently covered in the Barron’s ‘Research Reports’ column. The results show significant stock price effects on both the issuance date and the Barron’s publication date, although investors can obtain all necessary information about recommendations on the issuance date, which is the first public announcement. Thus, the results suggest the market reaction to the coverage in Barron’s is separate from that to the investment firms’ recommendations. The media coverage is responsible for the wider dissemination of information to the investing public, partly because the cost of acquiring information from research reports before the Barron’s publication may not be trivial. The empirical results also show that the initial market reaction to stocks with positive recommendations is reversed within 5 trading days, supporting the price pressure hypothesis.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 DOES 12B-1 PLAN OFFER ECONOMIC VALUE TO SHAREHOLDERS OF MUTUAL FUNDS? Spuma M. Rao University of Southwestern Louisiana Abstract A total of 964 mutual funds were analyzed for the period 1994. An examination of the differential effect that fund size, age, objective, load versus no-load status and the existence of 12b-1 plan have on cross-sectional differences in mutual fund expense ratios extends prior research. Results suggest that the existence of 12b-1 plan increased expenses by about 0.516 to 0.531 percent of net assets and that the plan did not offer ecenomic value to shareholders.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 AGENCY CONFLICTS, MANAGERIAL COMPENSATION, AND FIRM VARIANCE Robert L. Lippert Rutgers University Abstract This paper presents a theoretical model of the agency conflict between managers and shareholders. The problem is examined in an expected-utility-maximization scenario in which the explicit cost of the agency conflict that arises between the manager and shareholders is derived. The model determines the effect of changes in firm variance on various compensation components. Development of this model depends upon the recognition that an individual firm’s propensity for variance is firm specific and that the manager has limited control over the risk of the firm’s future cash flows. The ability of the manager to affect the variance of the firm’s future cash flows is shown to be an important characteristic in the development of an effective incentive compensation package.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 NEW PRODUCT INTRODUCTIONS, SHAREHOLDERS' WEALTH, AND FIRST-MOVER ADVANTAGES Zaher Zantout Rider University Radha Chaganti Rider University The authors thank the participants of session # 1.1.c at the 1994 International Conference of the Strategic Management Society, Jouy-en-Josas, France, for their helpful comments. The summer grant from Rider University is acknowledged. The usual disclaimer applies. Abstract This paper examines the impact of announcements of new product introductions on the stock price of pioneering firms and their rivals to determine whether first-movers gain long-term competitive advantages. An analysis of 108 radically new products indicates that pioneering firms earn statistically positive abnormal returns at announcement while their rivals suffer statistically significant negative abnormal returns. These wealth effects indicate that pioneering firms attain sustainable first-mover advantages, in general. The cross-sectional regression analysis of the abnormal returns reveals that the magnitude and/or durability of first-mover advantages are greater in fragmented but high-technology industries.

Journal of Financial and Strategic Decisions Volume 9, Number 3   Fall 1996 THE OPTIMAL DEGREE OF OUTSOURCING Swapan Sen Michigan Technological University Guangxi Zhu Michigan Technological University Abstract This paper develops an economic model to determine the optimal degree of outsourcing by a firm and explain conditions for complete, partial, or no outsourcing decisions. It is found that for outsourcing to be profitable, it is not necessary, although sufficient, that a vendor be more efficient than the original producer. Moreover, corporate downsizing and outsourcing appear to be complementary strategies.

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