The Parent Company Puzzle (three studies)

Remember the Seagate Technology case...Also, as a side note, I am one of the founders (with Ken Lehn of the University of Pittsburgh) of the Journal that this article appears. There is no paper to download, only the abstract below...from SSRN.

The Parent Company Puzzle: When is the Whole Worth Less Than One of the Parts?

Qiao Liu
University of Hong Kong - School of Economics and Finance

Bradford Cornell
California Institute of Technology

Journal of Corporate Finance, Vol. 7, pp. 341-366, December 2001

-----Also see the abstract below [No paper download option]

Abstract:
This paper examines seven instances in which the market value of a parent company was less than the market value of its publicly traded subsidiary. Efforts are made to explain this "parent company puzzle" in terms of taxes, agency costs, liquidity effects and noise trader risk. None of them work. The only explanation consistent with the evidence is a mispricing of the subsidiary shares associated with noise trader demand and impediments to arbitrage. As further evidence in support of this view, five corporate control transactions, all designed to exploit the apparent mispricing, were initiated while this research was in progress.

The Parent Company Puzzle on the German Stock Market

Frank Schuhmacher
University of Applied Sciences and Technology Aachen (RWTH Aachen)

Martin Eling
University of Muenster - Faculty of Economics

FInancial Markets and Portfolio Management, Vol. 19, No. 1, 2005

Abstract:
In this paper, we investigate the German stock market with regard to "negative stub values" or "parent company puzzles." These are situations where a firm's market value is less than the value of its ownership stake in a publicly traded subsidiary. According to MITCHELL/PULVINO/STAFFORD (2002), negative stub values indicate clear arbitrage opportunities, which sometimes exist and persist. First, we have collected five years of German stock market data from 1999 to 2003 in order to construct a sample of eleven negative stub values. Second, we analysed the performance of investment strategies based on the parent company puzzle. Finally, we applied different traditional closed-end fund discount and other theories to our sample of negative stub values. This study supports the view of MITCHELL/PULVINO/STAFFORD (2002), that mispricings exist and persist, because of costs associated with imperfect information. Due to imperfect information the ex ante expected profits of finding and exploiting negative stub values may be so small, that arbitrageurs do not enter the business of eliminating mispricings.

Also, see the study below. You can download a copy from the SSRN page.

Limited Arbitrage in Equity Markets

Mark L. Mitchell
CNH Partners

Todd C. Pulvino
Northwestern University - Kellogg School of Management

Erik Stafford
Harvard Business School

October 2000

Harvard Business School Working Paper No. 01-069


Abstract:
This paper examines the impediments to arbitrage in 82 situations between 1985 and 2000, where the market value of a company is less than the sum of its publicly traded parts. These situations suggest clear arbitrage opportunities and provide an ideal setting in which to study the risks and market frictions that prevent arbitrageurs from immediately forcing prices to fundamental values. We find that 30% of the situations terminate without converging. Furthermore, because of forced liquidation to satisfy capital requirements, we estimate that the returns to a specialized arbitrageur would be 50% larger if the path to convergence was smooth rather than as observed. Uncertainty about the distribution of returns and characteristics of the risks appear to be an important obstacle.

How many jobs have been saved?

“One can search economic textbooks forever without finding a concept called ‘jobs saved’,” said Allan Meltzer, a professor at Carnegie Mellon University, in a memo to House of Representatives Republican leader John Boehner today. “How can anyone know that his or her job has been saved?”

For the complete article see here.

Portfolio Theory and Asset Pricing - Blatant Marketing

Please consider enrolling in Portfolio Theory and Asset Pricing [BA620 7:00-10 pm]; the class is offered Monday/Wednesday beginning 01/21/09. I have a preliminary syllabus which I can e-mail to you. The materials are already ready from Harvard. The course is now listed on course finder http://www.uaf.edu/coursefinder/

Finance Links

IMCA - Investment Management Consultants Association

CFA - Charter Financial Analyst Institute

JNPE - Journal of Neuroscience, Psychology and Economics

Joint Hypothesis Problem in Finance

We cannot test for market efficiency. Why you ask?

1) One needs a measuring stick against which abnormal returns can be compared;

2) We do not know if the market is efficient IF we do NOT know that a model such as the CAPM, APT or the Black-Scholes model correctly stipulates the required rate of return. (Again, we have no measuring stick.)

Therefore, we must conclude either the asset pricing model is incorrect or the market is inefficient, but we have no way of knowing which is true.

Average Marginal Tax Rates

h/t Greg Mankiw; from Robert Barro & Charles Ridlick.

Michael Gibbs on 'the invisible hand' and Hayek

The post below is from Michael Gibbs at the University of Chicago.


"....Smith's Invisible Hand notes the paradox that selfish individuals acting in their own interest create great overall social value (economic growth, low DWL, etc.) in market economies. One very important insight into how markets do this is to view a market as an *information system* that provides collective intelligence. Friedrich von Hayek won a Nobel for first making this argument (yes, he spent part of his career at Chicago). You can easily find the article on the web; here is a brief summary.

Hayek argued that markets are a powerful way to make use of "specific knowledge of time and place" dispersed throughout the economy. A farmer uses his experience & talent at farming, knowledge of local soil conditions & weather, etc. to maximize the value of his land. He also has good incentives to do so - or to sell it to someone who can use it better - b/c he owns the land & the profits from it. Hayek argued that markets, because they are decentralized, use this dispersed knowledge that central planners would not be able to use, and thus allocate resources more effectively than more centralized economies - yielding the Invisible Hand.

Hayek's argument is hugely insightful and important. He teaches us to view markets as a giant information system, and highlights that one of if not the most important problems that an economic system must solve is to create and use knowledge effectively."