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378 SHORT SELLING AND MARKET EFFICIENCY Closed-End Funds and Spin-Offs To test value additivity, it is necessary to find cases where prices of assets are available as a package and for the components separately. One case is closed-end funds and another is where divisions of firms are spun-off. A closed-end fund is an investment company that holds stock in other companies, but does not offer continuously to redeem its shares at net-asset prices (unlike a mutual fund). The prices of closed-end funds are set in the competitive markets in which they trade, as are the prices of the stocks of the companies they hold. Usually, closed-end funds sell at a sub- stantial discount to their net asset values, 48 a fact Brickley and Schallheim call “an interesting anomaly.” 49 A graph of the discounts from 1933 to 1982 shows only two periods with negative discounts. 50 Similar puzzling discounts were found for dual-purpose funds. 51 Richards et al. found closed-end bond fund discounts of 12.3% (December 1979). 52 Malkiel proposed several possible explanations for these discounts but decides that none are adequate, and eventually concluded the mar- ket was inefficient here. 53 Thompson showed that profitable trading strategies existed. 54 The closed-end fund discount is contrary to the value additivity the- ory but is predicted by the divergence of opinion theory. An investor 48 See Thomas J. Herzfield, The Investor’s Guide to Closed-End Funds (New York, NY: McGraw-Hill, 1980); and Rex Thompson, “The Information Content of Dis- counts and Premiums on Closed-End Fund Shares,” Journal of Financial Economics (June 1978), pp. 151–187. 49 James A. Brickley and James S. Schallheim, “Lifting the Lid on Closed-End Invest- ment Companies: A Case of Abnormal Returns,” Journal of Financial and Quanti- tative Analysis (March 1985), p. 107. 50 William F. Sharpe, Investments (Englewood Cliffs, N. J.: Prentice Hall, 1981). p. 592. 51 See Robert H. Litzenberger and Howard B. Sosin, “The Theory of Recapitaliza- tions and the Evidence of Dual Purpose Funds,” Journal of Finance (December 1977), pp. 1433–55, and Robert H. Litzenberger and Howard B. Sosin, “The Per- formance and Potential of Dual Purpose Funds,” Journal of Portfolio Management (Spring 1978), pp. 49–56. 52 R. Malcolm Richards, Donald R. Fraser, John C. Groth, “The Attractions of Closed- end Bond Funds,” Journal of Portfolio Management (Winter 1982), pp. 56–61. 53 Burton G. Malkiel, “The Valuation of Closed-End Investment-Company Shares,” Journal of Finance (June 1977), pp. 847–859. For other attempts, see Kenneth J. Boudreaux, “Discounts and Premiums on Closed-End Mutual Funds: A Study in Valuation,” Journal of Finance (May 1973), pp. 515–522; and Rodney L. Roenfeldt and Donald L. Tuttle, “An Examination of the Discounts and Premiums of Closed- End Investment Companies,” Journal of Business Research (Fall 1973), pp. 129– 140. 54 Rex Thompson, “The Information Content of Discounts and Premiums on Closed- End Fund Shares,” Journal of Financial Economics (June 1978), pp. 151–187. 14-Miller-Puzzles Page 378 Thursday, August 5, 2004 11:19 AM Short Selling and Financial Puzzles 379 will find that a portfolio of stocks selected by someone other than the investor himself will contain some stocks he would not have chosen himself, either because they did not meet his own unique needs, or because he was less optimistic about them than the portfolio managers for the closed-end fund were. The closed-end fund discount has long been recognized as an anomaly. No alternative explanation able to explain the magnitude of the discount has been offered, although some are plausible and could explain part of the discounts. Another opportunity for testing the implications of value additivity is to observe what happens when a firm spins-off a subsidiary. Pure value additivity predicts that if the cash flows are not changed by the spin-off then the market value of the separate units will equal the prebreakup value. However, studies have shown that spin-offs create wealth, with the stockholders being wealthier after the spin-off than before. 55 At first glance the wealth increases do not appear to be large since the total increase in wealth is small in percentage terms (7% according to Hite and Owers). However, as Hite and Owers put it (the size factor referred to is the percentage of the value of the firm spun-off): The reevaluations seem quite large in relation to the fraction spun- off. For the overall sample, the median size factor is 0.066 of the combined firm value, and the revaluation of 0.070 during the event period is of the same order of magnitude. Similarly, the point esti- mate for the small group is roughly the same as the size factor. Even for the large group, the revaluation is about a half the frac- tion spun-off. That spin-offs per se could generate gains roughly equal to the value of the divested unit is to suggest that the market 55 Kenneth J. Boudreaux, “Divestiture and Share Price,” Journal of Financial and Quan- titative Analysis (November 1975), pp. 619–626; Gailen L. Hite and James E. Owers, “Security Price Reactions Around Corporate Spin-Off Announcements,” Journal of Fi- nancial Economics (December 1983), pp. 409–436; Oppenheimer (quoted in Ronald J. Kudla and Thomas H. McInish, Corporate Spin-offs: Strategy for the 1980’s (Westport, CT, 1984), pp. 46–50; Ronald J. Kudla and Thomas H. McInish, “Valuation Conse- quences of Corporate Spin-Offs,” Review of Business and Economic Research (Winter 1983), pp. 71–77; Ronald J. Kudla and Thomas H. McInish, “Divergence of Opinion and Corporate Spin-Offs,” Quarterly Review of Economics and Business (Summer 1988), pp. 20–29; Katherine Schipper and Abbie Smith, “Effects of Recontracting on Shareholder Wealth: The Case of Voluntary Spin-Offs,” Journal of Financial Econom- ics (December 1983), pp. 437–469; James A. Miles and James D. Rosenfeld, “The Effect of Voluntary Spin-offs Announcements on Shareholder Wealth,” Journal of Finance (December 1983), pp. 1597–1606; and James D. Rosenfeld, “Additional Evidence on the Relation Between Divestiture Announcements and Shareholder Wealth,” Journal of Finance (December 1984), pp. 1437–48, to name a few. 14-Miller-Puzzles Page 379 Thursday, August 5, 2004 11:19 AM 380 SHORT SELLING AND MARKET EFFICIENCY value of the parent’s equity is hardly diminished even though assets are distributed to the subsidiary. The gains seem quite large, to be explained by the savings from using separate specialized contracts in which the parent and subsidiary have comparative advantages. 56 Schipper and Smith report similar values for the overall gains. 57 The literature discusses several possible explanations for the gains from spin-offs. Both Hite and Owers and Schipper and Smith consider the possi- bility that the spin-off reduces the assets backing the firms’ bonds and transfers wealth from bondholders to equity holders, but find no evidence of bondholders being made worse off. 58 Some spin-offs are done to facili- tate mergers but most are not, and those for other reasons report compara- ble gains. Regulatory factors explain some spin-offs, but Hite and Owers report that the legal/regulatory inspired spin-offs actually had negative excess returns over the whole preevent period, but positive returns around the announcement date that were similar to those for all spin-offs. 59 Schip- per and Smith report higher returns for regulatory related spin-offs. Separating operations in different industries might permit better and more specialized management or incentive compensation plans for man- agers related to stock prices. Ravenscraft and Scherer, drawing on both interviews and statistical studies, present evidence that profitability gains in the spun-off units frequently do occur with spin-offs. 60 Both Hite and Owers and Schipper and Smith discuss this possibility at length, with Schipper and Smith concluding that it explains the wealth gains with spin-offs. Hite and Owers (in the quote above) question whether it can explain the magnitude of the effect. While there clearly can be disadvantages to a single management try- ing to manage several different businesses, most of these managerial spe- cialization economies could be obtained by a separate management team for each unit. If anything, if the operation remained a subsidiary, the concentration of ownership in the parent would appear to permit more efficient monitoring than could be done by numerous uninformed stock- holders. Evidence suggests that stock in small firms is valued at less than 56 Hite and Owers, “Security Price Reactions Around Corporate Spin-Off Announce- ments,” p. 430. 57 Schipper and Smith, “Effects of Recontracting on Shareholder Wealth: The Case of Voluntary Spin-Offs.” 58 As discussed by Dan Galai and Ronald W. Masulis, “The Option Pricing Model and the Risk Factor of Stock,” Journal of Financial Economics (January/March 1976), pp. 53–82. 59 Hite and Owers, “Security Price Reactions Around Corporate Spin-Off Announce- ments,” p. 432. 60 Ravenscraft and Scherer, Mergers, Sell-Offs, and Economic Efficiency. 14-Miller-Puzzles Page 380 Thursday, August 5, 2004 11:19 AM Short Selling and Financial Puzzles 381 that of large firms. 61 A spin-off typically creates a much smaller firm, one that is usually traded over the counter where transactions costs and liquidity are less. Thus, the gains from improved contracting and man- agement (as Hite and Owers noted) appear unable to fully explain how assets can be spun-off without perceptible effects on the parent’s stock price (the result Hite and Owers report for small spin-offs). Very closely related to complete spin-offs are equity carve-outs in which only part of a subsidiary’s stock is sold to the public. Schipper and Smith have shown that announcement of carve-outs are accompanied by an average increase in the parent’s stock price of just under 2%, a strong contrast with the typical price lowering effect of announcing a stock sale. 62 Although at first glance a 2% stock price gain appears small, it is large rel- ative to the value of the subsidiary interest being sold, which was reported to have a median value of 8% of the parent’s value. This wealth increase represents either a belief that the carve-out was actually going to raise the value of the parent’s interest in the subsidiary by an appreciable amount or a belief that the equity interest sold would be sold for about 25% (2% gain divided by 8%) more than its value as part of the parent firm. The lat- ter interpretation implies an appreciable violation of value additivity. Predicting Firms for Which Spin-Offs and Divestitures Are Likely Given there are often stock price increases (as shown above) when spin-offs or carve-outs are announced, it would be useful for investors to be able to predict the types of firms for which these are most likely. Spin-offs are pre- sumably most likely when the parts will be worth more than the whole, as discussed above. One distinguishing characteristic of firms that do spin-offs is a firm with operations in widely differing industries. There are not likely to be any appreciable synergies from combining operations in different industries, and thus there are no lost economies of scale from breaking the firm up or diseconomies from dissolving integrated operations. Schipper and Smith examine the industries of spun-off operations and document that in only 21 out of 93 spin-offs is the parent in the same broadly defined industry. 63 They interpret this as supporting their 61 For instance, Donald B. Keim, “Size Related Anomalies and Stock Return Season- ality: Further Empirical Evidence,” Journal of Financial Economics (June 1983), pp. 13–32. 62 Katherine Schipper and Abbie Smith, “A Comparison of Equity Carve-Outs and Seasoned Equity Offerings,” Journal of Financial Economics (January/February 1986), pp. 153–186. 63 Schipper and Smith, “Effects of Recontracting on Shareholder Wealth: The Case of Voluntary Spin-Offs,” p. 462. 14-Miller-Puzzles Page 381 Thursday, August 5, 2004 11:19 AM 382 SHORT SELLING AND MARKET EFFICIENCY hypothesis that spin-offs raise productivity by alleviating “diminishing returns to management, which arise with expansion in the number and diversity of transactions under one management.” 64 Ravenscraft and Scherer report that operations sold are often in different industries, and frequently in ones with quite different characteristics than the parent. 65 While the difference in industries between the parent and the operation sold or spun-off is certainly consistent with managerial specialization con- siderations, it is also consistent with the clientele group for the separated assets differing from the group owning the parent company. Earnings fore- casts are frequently made by projecting sales for a particular industry and then applying these (with adjustments) to a particular firm. Ownership will come to be concentrated in those investors who are relatively optimistic about that industry (relative to other industries). It follows that the current stock owners are likely to have on average somewhat lower expectations for other industries. Thus, situations where spin-offs of operations in other industries would increase stockholder wealth should be common. However, in identifying candidates for break up, another thing to look for is a case where the assets appeal to different types of investors. In some cases there may be a specific type of investor to whom assets of a particular type appeal. A particularly interesting example is the “gold bugs.” There seems to be a distinct group of investors who highly value gold related assets. This arises from some combination of optimism about gold prices, and a belief that gold is very useful for diversification. Gold has historically done well in times of inflation and during periods of political instability. Thus, gold and gold-mining stocks are often bought by individuals who want a hedge against these risks. In one short period, no less than six firms spun off all or part of their gold mines. 66 Such a concentration of spin-offs in this industry is hard to explain in models where spin-offs are motivated by a desire to motivate managers, or to otherwise increase cash flows. However, it can be explained with the clientele paradigm that emerges from the diver- gence of opinion model. At the time of the spin-offs, gold mining stocks appealed to a particular group of investors (“gold-bugs”) who would pay high prices for them (the price-to-earnings ratios for the five profit- able operations were reported as 31, 37, 113, 59, and 36, which were higher than other mining firms in 1986). These gold bugs appear to be different investors than those holding the parent companies (which were 64 Schipper and Smith, “Effects of Recontracting on Shareholder Wealth: The Case of Voluntary Spin-Offs,” p. 464. 65 Ravenscraft and Scherer, Mergers, Sell-Offs, and Economic Efficiency. 66 Sandra D. Atchinson, “Gold Mines: Pay Dirt on Wall Street,” Business Week (Au- gust 4, 1986). 14-Miller-Puzzles Page 382 Thursday, August 5, 2004 11:19 AM Short Selling and Financial Puzzles 383 conglomerates and general mining companies). When these mining assets were part of a much larger firm, the valuation was that of inves- tors who lacked unusually optimistic expectations for gold prices, or who did not desire gold’s diversification benefits. The contribution of earnings from gold mining to the parent firm’s value was less than these assets value when sold to gold bugs. In many cases a firm will have operations both in mature, stable industries (appealing to investors who seek high and stable dividends with a low level of risk), and in high-growth risky industries that are currently “sexy.” One of the earliest financiers to exploit this technique was James Ling. In his Project Redeployment, he exchanged stock in three subsidiar- ies of Ling-Temco-Vought (LTV Aerospace Corporation, LTV Electrosys- tems and LTV Ling Altec) for stock in the parent corporation (which retained control of the subsidiaries). The subsidiaries’ publicly traded stock sold for good prices, and this led other investors to conclude LTV must be worth at least the market value of the stock in the subsidiaries it owned. (Banks also proved willing to lend on these market values.) As one author asked, “Could it be that 1 + 1 + 1 could equal more than 3?” 67 Ling suggested that this was so that the shares in three companies, each of which was in a single industry, would be worth more than that of a single corporation involved in three different enterprises, and then went on to say, “Thus, in a way, 1 + 1 + 1 worked out to around 4.” The clientele theory explains what happened; stock in each com- pany appealed to those most optimistic about the subsidiaries’ indus- tries. Those believing military aviation had a bright future would pay well for the aerospace company, those believing in military electronics would pay well for LTV Electrosystems, and those optimistic about civilian sound and testing equipment bought Ling Altec. The sum of the amounts certain investors would pay exceeded the original willingness to pay for the parent. Another early example is provided by the LTV takeover of Wilson, followed by its division into three parts: Wilson & Company, Wilson Sporting Goods, and Wilson Pharmaceutical & Chemical. Sales of minority interests in the three companies brought in enough cash to pay much of the acquisition costs. What had happened? Wilson Sporting Goods was a “pure play” in the then fashionable leisure industry; Wil- son Pharmaceutical & Chemical was in the growing drug business. Both appealed to investors convinced that these industries had bright futures, and hence deserved high price-to-earnings ratios. As Sobel put it, “Almost immediately Sporting Goods and Pharmaceutical & Chemical 67 Robert Sobel, The Rise and Fall of the Conglomerate Kings (New York: Stein and Day, 1984), p. 91. 14-Miller-Puzzles Page 383 Thursday, August 5, 2004 11:19 AM 384 SHORT SELLING AND MARKET EFFICIENCY became semiglamour issues, and their stocks took off.” 68 Wilson & Company, the heart of the original firm, remained an old line meatpack- ing firm which appealed to its traditional clientele, those who thought a major meatpacking firm was a desirable investment (presumably value investors since it was clearly not a growth firm). Why had Wilson & Company not been valued at the sum of its parts? In pure financial theory, rational investors would compute the value of each part separately and offer this amount for the whole. If they use a dividend discount model, the sum of the potential dividends form the parts would equal the dividends from the whole (leaving out any pos- sible tax related effects), and the discount rate would be a suitably weighted average of those applicable to the different parts. The dividend discount model of the textbooks implies value additivity. The observed valuation behavior supports a model where investors are using a variety of methods to evaluate potential investments, and hence disagree. Another example of spinning off a subsidiary in a glamour industry is provided by the Imperial Industries spin-off of “Solar Systems by Sun Dance.” Imperial Industries was a Florida building material company spe- cializing in wallboard and gypsum products. As an extension of this, it had gotten into rooftop solar hot-water heaters. At the time, the press was filled with stories about the bright future expected for solar energy. Stock in any new solar energy company was in immediate demand. Thus, it could be predicted that those optimistic about solar energy would value highly stock in the solar subsidiary. However, solar energy was a small part of the oper- ations of the parent company. Investors who hold stock in a building mate- rial company are not the type who will attach much value to a not yet profitable solar energy subsidiary. The solar operation was too small a part of the parent for those interested in solar energy to be attracted to the par- ent. The solution was to spin-off the subsidiary, keeping control with the parent, and hoping that this would cause the remaining interest to be val- ued at the price solar energy enthusiasts were willing to pay. An example in the carve-out area is provided by the creation of Inter- feron Sciences from National Patent Development. Schipper and Smith use this as an example of a carve-out to try to explain why it was easier for the firm to raise capital by selling stock in the subsidiary rather than by any other technique. 69 The theory presented in this chapter provides an alterna- tive explanation. By selling only 25% of the equity in the new subsidiary, the firm was able to raise all of the capital needed to finance the develop- ment of the interferon technology transferred from the parent to the new 68 Sobel, The Rise and Fall of the Conglomerate Kings, p. 95. 69 Schipper and Smith, “A Comparison of Equity Carve-Outs and Seasoned Equity Offerings.” 14-Miller-Puzzles Page 384 Thursday, August 5, 2004 11:19 AM Short Selling and Financial Puzzles 385 subsidiary. At the time there was much discussion in the popular press about the wonders of interferon and its potential for curing cancer and other diseases. A very simple explanation for the decision to sell stock in Interferon Sciences exists. Most likely, the stock sold was valued at less by the stockholders in the parent company than by those members of the pub- lic who were enthusiastic about the future of the wonder drug, interferon. The same explanation probably extends to other carve-outs. Schip- per and Smith state that growth opportunities financed include Atlantic City casinos, Hawaiian condominiums, oil drilling, and bioengineering products, and note that, “There is a tendency for sample subsidiaries to belong to industries that, at the time of equity carve out, were expanding relatively rapidly (e.g., gambling, health care, sporting goods and games, home video and biotechnology.)” 70 This sounds like a typical list of fads. It seems very plausible that stock was carved out simply because the most optimistic members of the public would pay more for the stock than the management thought the stock was worth, a simple divergence of opinion explanation which Schipper and Smith ignore. Another way to classify investors, not exclusive to classifying them by the type of industry they are optimistic about, is by the type of ana- lytic methods they use in valuing stocks or in deciding whether or not to purchase them. In what Nobel laureate Herbert Simon calls “substantive rationality,” all relevant facts are known and incorporated into valuation decisions. 71 However, in practice investors cannot realistically collect that much information, nor can the human brain process it. Observers of the investment scene believe that no one individual or firm can master all the available methods, and that investors or investment managers who try, end up doing worse than those who pick a consistent strategy and diligently employ it. 72 Thus, investors use what Simon calls “procedural rationality:” They find valuation methods that give reasonable results and help them to build what they regard as acceptable portfolios. (Notice that if a method undervalues a stock that could have been included in the portfolio; but this stock is comparable to those included in the portfolio, so there is no great loss.) Observers report that the two most popular approaches currently are growth stock investing and “value” oriented procedures. 70 Schipper and Smith, “A Comparison of Equity Carve-Outs and Seasoned Equity Offerings,” Note 17. 71 Herbert Simon, Models of Bounded Rationality: Behavioral Economics and Busi- ness Organization (Cambridge, MA: MIT Press, 1982). 72 Charles D. Ellis, Investment Policy: How to Win at the Loser’s Game (Home- wood, IL: Dow Jones Irwin, 1985), Chapter 3; Train, Dance of the Money Bees, A Professional Speaks Frankly on Investing, and Train, The Money Masters, Nine Great Investors: Their Winning Strategies and How You Can Apply Them. 14-Miller-Puzzles Page 385 Thursday, August 5, 2004 11:19 AM 386 SHORT SELLING AND MARKET EFFICIENCY Probably the most common of the procedurally rational methods is basing valuations on price-earnings ratios depending on industry or on historical or estimated growth rates. A perusal of the practitioner ori- ented publications (Business Week, Wall Street Journal, etc.) shows price-earnings ratios to be commonly used. Before such methods are summarily put down as too primitive, it should be noted that the simple procedure of ranking securities by price-earnings ratio and then choos- ing the stocks with the lowest ratio has been repeatedly shown to out- perform the stock averages (which in turn usually outperform most actively managed portfolios). 73 For instance, a Zacks study using the 3,300 companies (excluding companies forecast to lose money), which had forward price-earnings ratios, found that from October 1987 to September 2002 the portfolio with the top fifth of the stocks by forward price-to-earnings ratio had an average annualized return of 2.5%, versus 19.4% for the fifth of stocks with the lowest price-to-earning ratios with the other quintiles spread out in between. 74 Incidentally, forward price-earnings ratios are the ana- lysts’ projected earnings divided by the current price. When the absolute standard was used of stocks that had forward price-to-earnings ratios that exceed 65, the annualized rate of return was negative, –0.1%. Interpreted in terms of the theory of this chapter, optimistic investors can bid stocks up to values well above what they should be. Obviously, selecting securities by current price-to-earnings ratios may fail to select some securities, which would be logical candidates for inclu- sion in a portfolio. For instance, some firms may have no earnings or earn- ings that are below those their assets should produce. However, it should not be assumed that these stocks, which are obviously undervalued by price-earnings ratio based rules, are true investment bargains. They are not, simply because investors using other procedures, perhaps asset-based, provide clientele groups for these securities. These groups often purchase stocks that are not currently profitable, but which have a potential for being profitable in the future, perhaps under new management. Some growth-oriented investors specialize in identifying stocks with low earnings, or even with no earnings, but which have prospects for high growth and for being much larger in the future. Other investors 73 By studies starting with S. Basu, “Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios: A Test of the Efficient Markets Hypothesis,” Journal of Finance (June 1977), pp. 663–682; and continuing through Jeffrey Jaffre, Donald B. Keim, and Randolph Westerfield, “Earnings Yields, Market Values, and Stock Returns,” Journal of Finance (March 1989), pp.135–148; to Zacks, Ahead of the Market. 74 Zacks, Ahead of the Market, p. 231. 14-Miller-Puzzles Page 386 Thursday, August 5, 2004 11:19 AM Short Selling and Financial Puzzles 387 specialize in selecting stocks on the basis of their assets or their breakup values. These and many other investment procedures are in use, with the price of each security set by the investment procedure that attaches the highest valuation to it. If any of these procedures consistently gives much better investment results than another, money will flow to those managers using it, and other managers will adopt the technique. The final result could easily be that most securities (maybe even virtually all) are priced at close to efficient market levels, although other parts of this chapter and my other chapters in this book, argue this is not so. How- ever, security prices for firms that are close to efficient market levels may still leave profitable opportunities for restructuring. However, even if all securities are priced at approximately appropri- ate levels, it should not be assumed that a business unit makes an equal contribution to firm value regardless of the firm it is part of (even if cash flows remain the same). Some business units have a higher value when evaluated by one method than by another. They may add more to the value of a firm whose dominant investors use the valuation method which gives them the highest valuation than they add when part of a firm whose investors use another method. For instance, if a firm trades on the basis of the value of its assets, a unit with a high book value, but low earnings will probably add more to the total value than it would as part of a firm valued by applying a price-earnings ratio to the latest earnings. In practice, investors do differ in their optimism about industries or about new technologies and very often the shareholders in the parent firm (only a small part of whose value is related to exposure to a partic- ular technology) are not among those who are most optimistic about a subsidiary’s industry or technology. When spun-off as a separate firm or sold to a new owner already in the subsidiary’s business, the value may be based on a more optimistic evaluation of the prospects. Those investors who have high growth projections for a particular industry or technology are likely to have bought stock in that industry and to have hired managers who make high growth projections. Thus, they will use a similar growth factor when evaluating a new project in their home industry, while there is no reason for the managers to choose unusually optimistic growth factors for other industries. When this is done, a firm in an acquiring industry (or a spin-off) will value the divi- sion at a higher multiple than it had as a small part of a larger firm in a slowly growing industry. Big investment banking profits have been earned (and will continue to be earned) by identifying companies whose divisions and other assets appeal to different types of investors and selling the pieces off to them. 14-Miller-Puzzles Page 387 Thursday, August 5, 2004 11:19 AM [...]... net investment See Aggregate ETF net investment report, advisors, 43 short interest, 53, 56 short sales, purpose, 38 short sellers, safety protection features, 38–39 short selling, 37 trading costs, 51 risk management activity, effect, 49–51 short selling, effect, 49–51 trading volume risk management activity, effect, 49–51 short selling, effect, 49–51 usage, 200 Exchange-traded funds (ETFs) shares... 208 Shefrin, Hersh, 100 Shiller, Robert J., 100 Shleifer, Andrei, 84, 100 , 251 Short futures, 18 Short holdings See Active investors; Passive investors Short interest, 187, 234 See also Yearend short interest data (1994), 251, 254 determinants, 247–249 figures, reporting, 233 information content, impact, 247–249 profitability, impact, 247–249 significance See Exchange-traded funds strategies, 247–249... 90 Long weights, short weights (combination), 223 Long-horizon process, 253–254 Long-only index, 216 See also Market portfolio Long-only investors, 311 Long-only portfolio, 218, 303, 310, 316 market neutrality, 310 Long-only strategy, 300 Long-plus -short investors, 311 Long-plus -short portfolios, 218–227, 231, 310 Long-plus -short strategy, 218–219, 227 Long-run growth rates, 148 Long -short construction,... Long -short construction, concerns, 316–318 Long -short equity portfolios, 303 Long -short hedge funds, 212 Long -short investment companies, 78 Long -short management, 312 Long -short portfolios See Dollar-neutral long -short portfolios; Riskneutral long -short portfolios attack process, 290–291 cases, discovery process, 266–269 clues, 259 construction, benefits, 310 311 diagnoses, 270 evaluation, 318–319 examples,... Starks Yan model, 166–174, 346 Qualifying dividends, 48 Quinn, James, 42 410 Ramesh, K., 136, 137, 245 Random selection risks, usage, 109 Random walk, 170 Rate of return See Competitive rate of return Ravenscraft, David J., 376, 380, 382 Raviv, Artur, 165 Rayner, A.C., 101 Ready, Mark J., 99, 102 Rebate interest, 2 Rebate rates, 10, 79 data, 188 determinants, 15–16 representation, 249 Recall notice,... usage, 109 – 110 Securities baskets, depositing, 38 benchmark weights, 309 class, 111 expected returns, 110 lending facilities, 331 number, impact, 106 pairs, 132 prices, deduction, 118 returns, 108 risk properties, 131 value, 304 Securities and Exchange Commission (SEC) filings, 43 regulations, 182 imposition, 147 reports See Total holdings requirements, 235 Rule 10a-1, 316 rules, consideration, 236 short. .. 1968), pp 1–20 80 Galai and Masulis, “The Option Pricing Model and the Risk Factor of Stock.” 81 Lawrence D Schall, “Asset Valuation, Firm Investment, and Firm Diversification,” Journal of Business (January 1972), pp 11–28 Short Selling and Financial Puzzles 393 tutions experience a gap between market rates and the rates they receive Notice the arbitrage argument requires holding the short position open... listing Index Short selling (Cont.) restrictions, 61, 118 absence, 166 interaction See Opinion usage See Efficient portfolios; Enhanced indexing Short spikes, 248 Short squeeze, 2, 234, 268 See also Exchange-traded funds occurrences, 84, 238 Short weights, combination See Long weights Shorting costs, 188–191 futures, usage, 17 mechanical impediments, 180–182 options, usage, 17 Short- only index, 218 Short- stock... SPDRs See Standard & Poor’s 500 Special See Trading special Special purpose entity, 268 Speculative premium, 199 SPX See Standard & Poor’s 500 SSF See Single stock futures Stafford, Erik, 15 Standard & Poor’s (S&P) 100 Index (OEX), 32 Standard & Poor’s (S&P) 500, 29 futures, 40 Index (SPX), 32 shorting, 93 SPDRs, 38, 40, 41, 50–51 stocks, 360 data, 136 Standard & Poor’s (S&P) Midcap 400, 29 Standard &... Zero-beta portfolio construction, 105 –114 See also Market-neutral portfolio diversification, 111–112, 132 decrease, 122 efficiency, 206, 230 improvement, short selling (impact), 205 holding See Passive portfolio integration See Long -short portfolios management, 107 108 measurement error, 231 optimization, 221, 232 models, 205 replication positions, 39 risk, 353 control, 309 short holdings See Active investor . Investing, and Train, The Money Masters, Nine Great Investors: Their Winning Strategies and How You Can Apply Them. 14-Miller-Puzzles Page 385 Thursday, August 5, 2004 11:19 AM 386 SHORT SELLING AND. to short selling. Since divergence of opinion, uncertainty, and risk are correlated, this shortfall can be expected to 14-Miller-Puzzles Page 393 Thursday, August 5, 2004 11:19 AM 394 SHORT SELLING. Kings (New York: Stein and Day, 1984), p. 91. 14-Miller-Puzzles Page 383 Thursday, August 5, 2004 11:19 AM 384 SHORT SELLING AND MARKET EFFICIENCY became semiglamour issues, and their stocks took