Interfirm stock price effects of asset-quality problems at first executive corporation

The authors use stock return data to investigate the effects of the First Executive (FE) failure on other life insurance firms. In contrast to previous studies, they 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 stockprice 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, the authors' 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.