Capsules and Comments:Briloff and the Capital MarketsElizabeth EdwardHassan RazaRony SuthermarajGeoffrey Smith

Intro•Abraham Briloff is a well-known

accountant that is noted for being critical of the accounting methods of companies

•Economist, George Foster , analyzed the effects that Abraham Briloff’s articles had on the capital market

Intro•An average drop of 8% was noted in the

stocks of the companies he researched when his info was released to the public

•George Foster examines 5 reasons for why this occurs

Capital Market Model•Two criteria used for George Foster’s

examination of Briloff’s work:• -The day the article became “Publicly

Available” is obtainable• -The accounting practices of specific

companies must be criticized•Fifteen articles selected that included

security returns on 28 companies

Capital Market Model•The article mentions that announcements

appear to have an effect on the capital market.

•This effect is concentrated within two day period around the announcements.

•Because of this Foster uses daily security returns in his analysis

•He examines the security returns thirty days prior to and after the publication of Briloff’s articles

Capital Market Model•The capital market equilibrium model used to

describe the pricing of capital assets in the study is:

•(1) E(Rit) = E (Rat) + β i[E(Rmt) – E(Rat)] where

•Rit = return on asset i in period t•Rat = return on an asset whose returns are

uncorrelated with Rmt in period t•Rmt = return on the market portfolio in period t•β i = relative risk of asset i

Capital Market Model•Using the previous model the effect of any

new information on asset i becoming available in period t can be determined as:

•(2) Uit = Rit – E(Rit│Rat, Rmt, βi) where•Uit = abnormal return•Abnormal Return calculated based on the

“companion portfolio” of Black and Scholes•Stocks are ranked on an estimate of beta in

period t-1 and placed into twenty portfolios

Capital Market Model•The abnormal return on stock i in period t

is estimated using:

•(3) Uit = Rit - Rpt where

•Rpt = return on “companion portfolio” p in period t

Cumulative Abnormal Return (C.A.R)What is it?-Sum of all the differences between the expected returns and the actual returns up to a given point in time

Cumulative Abnormal Return (C.A.R)

Figure 1, shows the average cumulative abnormal return (CAR) of the 28 stocks

Cumulative Abnormal Return (C.A.R)

Figure 2, shows The average cumulative abnormal return (CAR) of the 15 articles.

Cumulative Abnormal Return (C.A.R)

Figure 3, is an overlap off the first two graphs to better display the affect Briloff’s articles had on the market. The blue line represents the CAR of Briloff's articles, and the red line depicts the CAR of the 28 stocks.

Kolmogorov–Smirnov Test

5 Explanations1. The Capital Market is Inefficient2. Briloff Brings New Ideas to the Market3. Briloff’s Use of Non-public Info Sources4. Increased Government Regulation5. Uncontrollable Factors

The Capital Market is Inefficient•If we assume that Briloff used information

that was “costless” and available to the public, then by definition of market efficiency there should be no price reaction to Briloff’s article

•Because the market was inefficient there was a price reaction to the article

Briloff Brings New Ideas to the Market•Individuals can create their own analysis•This affects the ability to test the capital

market efficiently •When articles such as Briloff’s are released

one should predict the “appropriate” price reaction to such info releases

•Compare the predicted and actual results•Timing and magnitude of the info release

can play a large part in the “appropriate” price reaction

Briloff’s Use of Non-public Info Sources•The data sources used by Briloff extend

beyond the information set “publicly available”

•Unfortunately there is no clear-cut distinction between “publicly available” and “non-publicly available” information sets

Increased Government Regulation•Due to the effective way Briloff writes, he

acts as a catalyst to parties who can affect the future cash flows of firms

•Information on how the criticisms of a single individual influence the decisions of congressmen and bureaucrats are not easily available

Uncontrollable Factors•There is always the possibility in any

experiment that uncontrolled factors may cause the results observed

•If the publication of each Briloff article coincides with the release of other information about the cited companies then ambiguity would exist over the cause of the results

Questions•What were some of the financial analyses

that George Foster used to understand Briloff’s results?

Questions•Explain market inefficiency?

Questions•Which of the 5 explanations do you think

was the most influential to the changes in stock prices?

5 Explanations1. The Capital Market is Inefficient2. Briloff Brings New Ideas to the Market3. Briloff’s Use of Non-public Info Sources4. Increased Government Regulation5. Uncontrollable Factors

Conclusion•Timing of the price reaction is consistent

with an efficient market•When research goes beyond publically

available information it affects the tests of market efficiency

•Results are subject to varying interpretations