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on Corporate Finance |
| By: | Anderson, Ronald W; Carverhill, Andrew |
| Abstract: | We study a continuous time model of a levered firm with fixed assets generating a cash flow that fluctuates with business conditions. Since external finance is costly, the firm holds a liquid (cash) reserve to help survive periods of poor business conditions. Holding liquid assets inside the firm is costly as some of the return on such assets is dissipated due to agency problems. We solve for the firms optimal dividend, share issuance, and liquid asset holding policies. The firm optimally targets a level of liquid assets which is a non-monotonic function of business conditions. In good times, the firm does not need a high liquidity reserve, but as conditions deteriorate, it will target higher reserve. In very poor conditions, the firm will declare bankruptcy, usually after it has depleted its liquidity reserve. Our model can predict liquidity holdings, leverage ratios, yield spreads, expected default probabilities, expected loss given default and equity volatilities all in line with market experience. We apply the model to examine agency conflicts associated with the liquidity reserve, and some associated debt covenants. We see that a restrictive covenant applied to the liquidity reserve will often enhance the debt value as well as the equity value. |
| Keywords: | contingent claims; corporate finance; dividend policy; liquidity |
| JEL: | G13 G30 G32 G35 |
| Date: | 2005–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4994&r=cfn |
| By: | Bodnaruk, Andrij; Kandel, Eugene; Massa, Massimo; Simonov, Andrei |
| Abstract: | We study IPOs by focusing on the degree of portfolio diversification of the shareholders taking the company public. We argue that a less diversified shareholder has more to gain from taking the company public and would be more willing to accept a lower price for the sale of its shares, i.e. tolerate higher underpricing. We test these hypotheses by considering all the IPOs that took place in Sweden in the period 1995-2001. We have obtained detailed information on the portfolio composition of all the investors in the companies being taken public, both before and after the IPO, as well as the portfolio composition of investors in similar (in terms of size, book-to-market and industry) companies not taken public. The information is detailed at the stock level, for both private and public companies. We construct several proxies for portfolio diversification of the shareholders and relate them to both the probability of the IPO and the underpricing. We show that companies held by less diversified shareholders are more likely to go public and suffer a higher underpricing. We show that, as predicted, the degree of diversification explains a significant (economically and statistically) part of the probability of going public, and may account for between one third and one half of the reported underpricing. This suggests that the degree of diversification of controlling shareholders should play a prominent role in the discussion of the process of going public. |
| Keywords: | diversification; IPO; underpricing |
| JEL: | G12 G14 G24 G32 |
| Date: | 2004–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4820&r=cfn |
| By: | Eckbo, B Espen; Norli, Øyvind |
| Abstract: | We examine the risk-return characteristics of a rolling portfolio investment strategy where more than six thousand Nasdaq initial public offering (IPO) stocks are bought and held for up to five years. The average long-run portfolio return is low, but IPO stocks appear as ‘longshots’, as five-year buy-and-hold returns of 1000% or more are somewhat more frequent than for non-issuing Nasdaq firms matched on size and book-to-market ratio. The typical IPO firm is of average Nasdaq market capitalization but has relatively low book-to-market ratio. We also show that IPO firms exhibit relatively high stock turnover and low leverage, which may lower systematic risk exposures. To examine this possibility, we launch an easily constructed ‘low minus high’ (LMH) stock turnover portfolio as a liquidity risk factor. The LMH factor produces significant betas for broad-based stock portfolios, as well as for our IPO portfolio and a comparison portfolio of seasoned equity offerings. The factor-model estimation also includes standard characteristics-based risk factors, and we explore mimicking portfolios for leverage-related macroeconomic risks. Because they track macroeconomic aggregates, these mimicking portfolios are relatively immune to market sentiment effects. Overall, we cannot reject the hypothesis that the realized return on the IPO portfolio is commensurable with the portfolio’s risk exposures, as defined here. |
| Keywords: | asset pricing; capital structure; Initial Public Offering (IPO); liquidity; market efficiency; risk and return |
| JEL: | G10 G11 G12 G20 G24 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4832&r=cfn |
| By: | Campbell, John Y; Viceira, Luis M |
| Abstract: | Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist over long periods of time. In this paper we propose an empirical model that is able to capture these complex dynamics, yet is simple to apply in practice, and we explore its implications for asset allocation. Changes in investment opportunities can alter the risk-return tradeoff of bonds, stocks, and cash across investment horizons, thus creating a ‘term structure of the risk-return tradeoff’. We show how to extract this term structure from our parsimonious model of return dynamics, and illustrate our approach using data from the US stock and bond markets. We find that asset return predictability has important effects on the variance and correlation structure of returns on stocks, bonds and T-bills across investment horizons. |
| Keywords: | long-horizon investing; mean-variance analysis; risk-return tradeoff; vector autoregression |
| JEL: | G12 |
| Date: | 2005–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4914&r=cfn |
| By: | Burkart, Mike; Ellingsen, Tore; Giannetti, Mariassunta |
| Abstract: | We use a broad range of contractual information to assess the empirical relevance of different financial theories of trade credit. The common feature of all financial theories is that suppliers have an advantage over other lenders in financing credit-constrained firms. While the reasons for the financing advantage differ across theories, they are usually related either to product characteristics or to market structure. We propose a novel identifying strategy that exploits this insight to analyse the trade credit volume and the contract terms. Our analysis suggests that the most important product characteristic for explaining trade credit volume and contract terms is the ease with which the seller’s product can be diverted. Market power in input and output markets also contributes to explain trade credit patterns. |
| Keywords: | collateral; contract theory; moral hazard; trade credits |
| JEL: | G32 |
| Date: | 2004–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4823&r=cfn |
| By: | Goetzmann, William; Massa, Massimo |
| Abstract: | We use a panel of more than 100,000 investor accounts in US stocks over the period 1991-95 to construct an investor-based measure of dispersion of opinion, unlike the analyst based measure used in the literature. We use this measure to test two competing hypotheses: the sidelined investors hypothesis and the uncertainty/asymmetric information hypothesis. We find evidence that supports the sidelined-investors hypothesis. We show that the dispersion of opinion of the investors in a stock is positively related to the contemporaneous returns and trading volume of the stock and negatively related to its future returns. Moreover, dispersion of opinion aggregates across many stocks and generates factors that have a market-wide effect, affecting the stock equilibrium rate of return and providing additional explanatory power in a standard asset-pricing model. This supports the interpretation of dispersion of opinion as a risk factor. We also show that dispersion of opinion among retail investors Granger causes dispersion of opinion among analysts. |
| Keywords: | asset prices; dispersion of opinion; volatility |
| JEL: | D10 G10 |
| Date: | 2004–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4819&r=cfn |
| By: | Acharya, Viral V; Almeida, Heitor; Campello, Murillo |
| Abstract: | We model the interplay between cash and debt policies in the presence of financial constraints. While saving cash allows constrained firms to hedge against future cash flow shortfalls, reducing current debt – ‘saving borrowing capacity’ – is a more effective way of securing investment in high cash flow states. This trade-off implies that constrained firms will allocate cash flows into cash holdings if their hedging needs are high (i.e., if the correlation between operating cash flows and investment opportunities is low). Those same firms, however, will use free cash flows to reduce current debt if their hedging needs are low. The empirical examination of debt and cash policies of a large sample of firms reveals evidence that is consistent with our theory. In particular, our evidence shows that financially constrained firms with high hedging needs have a strong propensity to save cash out of cash flows while leaving their debt positions unchanged. In contrast, constrained firms with low hedging needs direct most of their free cash flows towards debt reduction, as opposed to cash savings. Our analysis points to an important hedging motive behind standard financial policies such as cash and debt management. It suggests that cash should not be viewed as negative debt. |
| Keywords: | cash holdings; debt policies; financing constraints; hedging; risk management |
| JEL: | G31 |
| Date: | 2005–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4886&r=cfn |
| By: | Clarida, Richard; Sarno, Lucio; Taylor, Mark P; Valente, Giorgio |
| Abstract: | We examine the relationship between interest rates of different maturities for the US, Germany and Japan over the period 1982-2000, using a general, multivariate vector equilibrium correction modelling framework capable of simultaneously allowing for asymmetric adjustment and regime shifts. This approach has a very general underlying theoretical rationale that allows for time-varying term premia and other short-run deviations from the expectations model of the term structure. The resulting non-linear models provide good in-sample fits, display regime switches closely related to key state variables driving monetary policy decisions and have satisfactory out-of-sample forecasting properties. |
| Keywords: | forecasting; markov switching; term structure of interest rates |
| JEL: | E43 E47 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4835&r=cfn |
| By: | Audretsch, David B; Keilbach, Max |
| Abstract: | Since the early 1980s, the role and general perception of entrepreneurship and start-up activities has changed drastically. In this paper, we investigate what determines regions’ entrepreneurial behaviour and the impact of it on regional economic performance. We argue that economic knowledge not only differs from traditional factors of production due to its public goods characteristic but it is also uncertain. With that perspective, the role of entrepreneurship is to take on the corresponding risk by starting up a new firm and thus to ‘test’ uncertain economic knowledge. This implies that knowledge spills over to the start-up firm and therefore entrepreneurship can be expected to have a positive impact on economic performance in a knowledge-based economy. We test this hypothesis using a production function approach. Using data on German regions, we estimate a two-equation system that regresses on both variables, entrepreneurship and economic performance, simultaneously, thus correcting for an endogeneity bias. We find a significant impact of entrepreneurship capital on economic output. On the other hand, spatially-specific entrepreneurship capital is shaped by regional-specific factors. However, the extent of this is different for knowledge based and non-knowledge based measures of entrepreneurship. We derive policy conclusions from our findings. |
| Keywords: | economic output; endogeneity bias; entrepreneurship; production function; three stage least squares |
| JEL: | M13 O32 O47 |
| Date: | 2005–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:4905&r=cfn |