nep-cfn New Economics Papers
on Corporate Finance
Issue of 2007‒11‒17
twelve papers chosen by
Zelia Serrasqueiro
University of the Beira Interior

  1. Banking competition and financial fragility: Evidence from panel-data By Ruiz-Porras, Antonio
  2. Rating and ranking firms with fuzzy expert systems: the case of Camuzzi By Magni, Carlo Alberto
  3. The Structure of Multiple Credit Relationships: Evidence from US Firms By Luigi Guiso; Raoul Minetti
  4. Did Firms Substitute Dividends for Share Repurchases after the 2003 Reductions in Shareholder Tax Rates? By Jennifer L. Blouin; Jana Smith Raedy; Douglas A. Shackelford
  5. Financial Risk in the Biotechnology Industry By Joseph H. Golec; John A. Vernon
  6. Bargaining power and efficiency in insurance contracts By John Quiggin; Robert G. Chambers
  7. To each according to her luck and power: Optimal corporate governance and compensation policy in a dynamic world By Thomas H. Noe; Michael J. Rebello
  8. Duality in Mean-Variance Frontiers with Conditioning Information By Francisco Peñaranda; Enrique Sentana
  9. Zelig and the Art of Measuring Excess Profit By magni, Carlo Alberto
  10. Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM? By Magni, Carlo Alberto
  11. Measuring performance and valuing firms: In search of the lost capital By Magni, Carlo Alberto
  12. Corporate Governance as a Commitmente and Signalling Device By Angelo Baglioni

  1. By: Ruiz-Porras, Antonio
    Abstract: We study how banking competition may affect the stability of banking systems. We develop our study by expanding the failure-determinant methodology to include panel-data techniques and by controlling the effects of financial structure and development. We use indicators for 47 countries between 1990 and 1997. The main findings show that banking concentration and foreign ownership are associated to bank-based financial systems and financial underdevelopment. They also show that banking credit and bank-based financial systems enhance banking fragility. Banking concentration is not a significant determinant. Furthermore our findings suggest that financial structure and, maybe, the property regime matter to assess fragility.
    Keywords: Banks; competition; fragility; financial systems
    JEL: L16 D40 G10 G21
    Date: 2007–10–29
  2. By: Magni, Carlo Alberto
    Abstract: In this paper we present a real-life application of a fuzzy expert system aimed at rating and ranking firms. Unlike standard DCF models, it integrates financial, strategic and business determinants and processes both quantitative and qualitative variables. Twenty-one value drivers are defined, concerning the target firm (strategic assets in place and expected financial performance), the acquisition (synergies, quality of management) and the sector (intensity of competition, entry barriers). Their combination via “if-then” rules leads to the definition of an output represented by a real number in the interval [0,1]. Such a number expresses the value-generating power of the target firm inclusive of synergies with the bidder (Strategic Enterprise Value). The system may be used for rating and ranking firms operating in the same sector. A regression analysis using hostile takeovers multiples may be employed to translate the score into price. The real-life case refers to Camuzzi (a natural gas distributor), acquired by Enel, the Italian ex monopolist of electric energy.
    Keywords: Corporate finance; firm; rating; ranking; expert system; fuzzy; evaluation.
    JEL: C6 G31 C02 G34 G30 M21
    Date: 2007–06
  3. By: Luigi Guiso; Raoul Minetti
    Abstract: When firms borrow from multiple concentrated creditors such as banks they appear to differentiate their allocation of borrowing. In this paper, we put forward hypotheses for this borrowing pattern based on incomplete contract theories and test them using a sample of small U.S. firms. We find that firms with more valuable, more redeployable, and more homogeneous assets differentiate borrowing more sharply across their concentrated creditors. We also find that borrowing differentiation is inversely related to restructuring costs and positively related to firms’ informational transparency. This evidence supports the predictions of incomplete contract theories: the structure of credit relationships appears to be used as a device to discipline creditors and entrepreneurs, especially during corporate reorganizations.
    Keywords: Credit Relationships, Multiple Creditors, Borrowing Allocation
    JEL: G21 G33 G34
    Date: 2007
  4. By: Jennifer L. Blouin; Jana Smith Raedy; Douglas A. Shackelford
    Abstract: This paper tests whether firms altered their dividend and share repurchase policies in response to the 2003 reductions in shareholder tax rates. We predict that firms substituted dividends for repurchases, because the reduction in dividend tax rates exceeded the reduction in the capital gains tax rates. As expected, we find substitution and find that it is increasing in the percentage of the company owned by individual investors, the only shareholders affected by the legislation. These findings are consistent with boards of directors considering the tax preferences of individual stockholders (particularly officers and managers) when setting dividend and share repurchase policies.
    JEL: G3 G35 H24 H25
    Date: 2007–11
  5. By: Joseph H. Golec; John A. Vernon
    Abstract: The biotechnology industry has been an engine of innovation for the U.S. healthcare system and, more generally, the U.S. economy. It is by far the most research intensive industry in the U.S. In our analyses in the current paper, for example, we find that, over the past 25 years, average R&D intensity (R&D spending to total firm assets) for this industry was 38 percent. Consider that over this same period average R&D intensity for all industries was only about 3 percent. In the current paper we examine this industry along a number of dimensions and estimate its average financial risk. Specifically, we use Compustat and Center for Research in Securities Prices (CRSP) data from 1982 to 2005 for firms defined by the North American Industry Classification System (NAICS) as biotechnology firms to estimate several Fama-French three factor return models. The finance literature has established this model as the gold standard. Single factor models like the Capital Asset Pricing Model (CAPM) do not capture all of the types of systematic risk that influence firm cost of capital. In particular, the CAPM does not reflect the empirical evidence that supports both a size-related and a book-to-market related systematic risk factor . Both of these factors, based on biotech industry characteristics, will exert a greater influence on biotech firms, on average. Another implication is, of course, that cost of capital estimates for the industry will be underestimated when a single factor model, like the CAPM, is used. This also implies that the cost estimates of bringing a new drug and/or biologic to market will be understated if financial risk and cost of capital are measured using a single-factor model. In the current study we find that biotechnology firms are exposed to greater financial risk than other industries and are also more sensitive to policy shocks that affect, or could affect, industry profitability. Average nominal costs of capital over the 1982-2005 time period were 16.25 percent for biotechnology firms. Of course, these average estimates obscure significant variation in financial risk at the firm level, but nonetheless shed light on some interesting aggregate differences in risk. In the current paper we discuss the theoretical links between financial risk, stock prices and returns, and R&D spending. Several caveats are also discussed.
    JEL: G18 G32 I0 I18 K23 L0 L2 L21 L5 L65
    Date: 2007–11
  6. By: John Quiggin (Risk & Sustainable Management Group, School of Economics, University of Queensland); Robert G. Chambers (Dept of Agricultural and Resource Economics, University of Maryland, College Park)
    Abstract: Insurance contracts are frequently modelled as principal--agent relationships. Although it is commonly assumed that the principal, in this case the insurer, has complete freedom to design the contract, the problem formulation in much of the principal--agent literature presumes that the contract is constrained-Pareto-efficient. In the present paper, we consider the implications of a richer specification of the choices available to clients. In particular, we consider the entire spectrum of possible power differentials in the contracting relationship between insurers and clients. Our central result is that the agent can exploit information asymmetries to offset the bargaining power of the insurer, but that this process is socially costly.
    JEL: D82 G22
    Date: 2007–03
  7. By: Thomas H. Noe; Michael J. Rebello
    Abstract: We model long-run firm performance, management compensation, and corporate governance in a dynamic, nonstationary world. We show that managerial compensation and governance policies, which, in a single-period context, can best be rationalized by self-serving managerial influence over board policy, are shareholder-wealth maximizing in a dynamic setting. For example, shareholder wealth is maximized by governance policies that tie board deference to generous compensation and link the level of current compensation more to luck than performance. Further, under shareholder-wealth maximizing polices, managerial diversion of firm resources for private consumption is likely to accompany stock price declines which immediately follow sustained price increases and lax board oversight. Unless the the likelihood of a control transfer is large, stock-based managerial compensation may not produce as much shareholder value as simple salary contracts.
    Keywords: governance, institutional design
    JEL: G20 G34
    Date: 2007
  8. By: Francisco Peñaranda; Enrique Sentana
    Abstract: Portfolio and stochastic discount factor (SDF) frontiers are usually regarded as dual objects, and researchers sometimes use one to answer questions about the other. However, the introduction of conditioning information and active portfolio strategies alters this relationship. For instance, the unconditional portfolio frontier in Hansen and Richard (1987) is not dual to the unconditional SDF frontier in Gallant, Hansen and Tauchen (1990). We characterise the dual objects to those frontiers, and relate them to the frontiers generated with managed portfolios, which are commonly used in empirical work. We also study the implications of a safe asset and other special cases.
    Keywords: Asset Pricing, Dynamic Portfolio Strategies, Representing portfolios, Stochastic Discount Factors
    JEL: G11 G12
    Date: 2007–10
  9. By: magni, Carlo Alberto
    Abstract: This paper tells the story of a student of economics and finance who meets a couple of alleged psychopaths, suffering from the ‘syndrome of Zelig’, so that they think of themselves to be experts of economic and financial issues. While speaking, they come across the concept of excess profit. The student tells them that the formal way to translate excess profit is to apply Stewart’s (1991) EVA model and shows that this model is equivalent to Peccati’s (1987, 1991, 1992) decomposition model of a project’s Net Present (Final) Value. The ‘Zeligs’ listen to him carefully, then try to apply themselves the EVA model: Unfortunately, both She-Zelig and He-Zelig seem to feel uneasy with basic mathematics, so they make some mistakes. Consequently, each of them miscalculates the excess profit. Strangely enough, they make different mistakes but both get to the (correct) Net Final Value of the project and, in addition, their excess profits do coincide. Further, the (biased) models presented by the Zeligs, though different from the EVA model, seem to bear strong relations to the latter. The student is rather surprised. I give my version of this event, arguing that the Zeligs are offering us a rational way of measuring excess profit, alternative to the standard one (EVA) but equally valuable. As I see it, they are only adopting a different cognitive interpretation of the concept of excess profit, which is based on a counterfactual conditional that differs from Stewart’s and Peccati’s.
    Keywords: Excess profit; residual income; economic value dded; net final value; systemic value added; counterfactual
    JEL: G11 G31 C0 M4 G00 G30 D46 B40 M41 G12 A12 M2
    Date: 2006–06
  10. By: Magni, Carlo Alberto
    Abstract: This paper focuses on inconsistencies arising from the use of NPV and CAPM for capital budgeting. It shows that (i) CAPM capital budgeting decision-making based on disequilibrium NPV is deductively inferred by the Capital Asset Pricing Model, (ii) the use of the disequilibrium NPV is widespread in finance both as a decision rule and as a valuation tool, (iii) the disequilibrium NPV does not guarantee additivity nor consistency with arbitrage pricing, so that it is unreliable for valuation, (iv) Magni’s (2002, 2007a, forthcoming) criticism of the NPV criterion refers to the disequilibrium NPV, and De Reyck’s (2005) project valuation method, on the basis of which Magni’s criticism to NPV is objected, leaves decision makers open to arbitrage losses and incorrect decisions.
    Keywords: Corporate finance; investment analysis; Net Present Value; Capital Asset Pricing Model; disequilibrium; decision; valuation; nonadditivity; arbitrage.
    JEL: G12 G11 G31
    Date: 2007
  11. By: Magni, Carlo Alberto
    Abstract: Residual income as commonly described in academic papers and in real-life applications may be formally described as a function of three variables: (i) the capital invested, (ii) the rate of return, (iii) the opportunity cost of capital. This paper shows that a different paradigm of residual income is generated if a fourth element is added: (iv) the capital that investors lose if they infuse their funds into the firm (or project). The lost-capital paradigm has various interesting economic, nancial, accounting interpretations and bears intriguing formal and conceptual relations to the standard paradigm. It may be soundly employed in real-life applications as a tool for rewarding managers as well as for appraising firms. Firm value is shown to be a function of total abnormal earnings and independent of time, if the new paradigm is used: what matters is only the book value and the sum of total expected residual incomes, not the periods in which they are generated. This aggregation property is particular important for highlighting the link between accounting values and market values. A numerical example illustrates the practical implementation of the new paradigm to the Economic Value Added and the Edwards-Bell-Ohlson model; also, a model is presented which has the nice property of being aligned in sign with the Net Present Value: this makes it a good candidate for use in value-based management.
    Keywords: Corporate finance; management accounting; residual income; performance measurement; lost capital; value-based management; firm valuation; abnormal earnings aggregation.
    JEL: G11 G12 M41 G31 M52 G30 M40
    Date: 2007–09
  12. By: Angelo Baglioni (DISCE, Università Cattolica)
    Abstract: A model is presented, where firms issuing equity differ in the ability of their controlling shareholders to extract private benefits: this creates a lemon problem, leading to cross-subsidization across issuers. A governance institution is introduced, enabling large shareholders to (imperfectly) commit to the general interest of shareholders. The following main results are obtained. I) Controlling shareholders willing to apply such an institution are those with a level of private benefits either very low or very high: the former employ the institutional constraint as a signalling device, the latter as a commitment device. Those with an intermediate level of private benefits are not interested. II) A higher ownership concentration reduces the large shareholder’s incentive to commit. III) Self-regulation dominates regulation.
    Keywords: large shareholders, private benefits, (self-)regulation
    JEL: G34 G38
    Date: 2007–06

This nep-cfn issue is ©2007 by Zelia Serrasqueiro. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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