Interfirm Stock Price Effects of Asset-Quality Problems at First Executive Corporation

[Arnold R. Cowan]

Interfirm Stock Price Effects of Asset-Quality Problems
at First Executive Corporation

Arnold R. Cowan (Iowa State University)
Mark L. Power (Iowa State University)

URL: http://www.bus.iastate.edu/arnie/FirstExecutiveRetail.pdf

JEL Classification: G22, G14, G28, G33, G38, L14

Keywords: Contagion, Writedown, Disintermediation, Insurance, Life
insurance, Politics of finance, Bank runs, Junk bonds, Financial distress,
First Executive, Institutional investors, Event study

Abstract: We use stock return data to investigate the effects of the First Executive
(FE) failure on other life insurance firms. In contrast to previous studies,
we explicitly test for the separate effects of individual (retail) and
institutional customer responses. The announcement of an accounting charge
for junk-bond losses by First Executive Corporation triggers negative
stock-price reactions for unrelated life insurers. Insurers with larger
portfolio holdings of junk bonds, and greater dependence on retail business,
experience stronger negative reactions to the announcement. However, an
earlier announcement that regulators were investigating possible junk-bond
concealment at FE is positively related to dependence on retail
policyholders. The reversal between the two events is consistent with retail
customer perceptions responding to disproportionate media coverage,
documented by others, of junk-bond problems. Tests of interactions indicate
that retail policyholder responses are conditioned on the degree of
junk-bond holdings, not indiscriminate. Therefore, our work implies that in
the event of a future financial crisis at a large life insurer, realistic,
balanced information about the condition of the industry targeted toward
individual customers will be useful in preventing a surge in policy
surrenders and attendant deadweight losses.