nep-cfn New Economics Papers
on Corporate Finance
Issue of 2008‒03‒25
eleven papers chosen by
Zelia Serrasqueiro
University of the Beira Interior

  1. Stock Market Volatility and Learning By Albert Marcet; Klaus Adam; Juan Pablo Nicolini
  2. Guidelines for forecasting historical financial statements for valuation purposes By Ignacio Velez-Pareja
  3. A new approach to WACC, value of tax savings and value for non growing perpetuities: a clarification By Ignacio Velez-Pareja
  4. Valuation of cash flows with constant leverage: further insights By Ignacio Velez-Pareja; Joseph Tham
  5. Conditions for consistent valuation of a growing perpetuity By Ignacio Velez-Pareja
  6. What is the Role of Legal Systems in Financial Intermediation? Theory and Evidence By Bottazzi, L.; Da Rin, M.; Hellmann, T.
  7. Collateral Pricing By Efraim Benmelech; Nittai K. Bergman
  8. Taxes and Mutual Fund Inflows Around Distribution Dates By Woodrow T. Johnson; James M. Poterba
  9. Increasing Derivatives Market Activity in Emerging Markets and Exchange Rate Exposure By Uluc Aysun; Melanie Guldi
  10. The Hedge Fund Game: Incentives, Excess Returns, and Piggy-Backing By Dean P. Foster; H. Peyton Young
  11. The Exit Decision in the European Venture Capital Market By Elisabete Gomes Santana Félix; Cesaltina Pires; Mohamed Azzim Gulamhussenb

  1. By: Albert Marcet; Klaus Adam; Juan Pablo Nicolini
    Abstract: Introducing bounded rationality in a standard consumption-based asset pricing model with time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though our learning scheme introduces just one free parameter and we only consider learning schemes that imply small deviations from full rationality. The findings are robust to the learning rule used and other model features. What is key is that agents forecast future stock prices using past information on prices.
    JEL: G12 D84
    Date: 2008–01–25
  2. By: Ignacio Velez-Pareja
    Abstract: In this teaching note I list some suggestions that might be useful to take into account when forecasting financial statements departing from historical data. The ideas presented in this note are the result of advising undergraduate and graduate students in the course Econ 195.96/295.96 (Crosslisted: PubPol 264.96): Cash Flow Valuation (CFV): A Basic Introduction to an Integrated Market-based Approach at Duke University during the Fall 2005 and my previous experience of teaching the subject at Politécnico Grancolombiano in Bogotá, and other universities in Colombia. The note is divided in four sections: In Section One, Analyzing the Historical Financial Statements, is related to the analysis and use of historical information from the financial statements. In Section Two I mention some tips related to the construction of forecasted financial statements. In Section Three I present a list of tips related to the proper way to valuate the cash flows. In Section Four a brief summary is presented. There are three appendixes that can be applied to cases of ongoing concerns and to cases of new firms or projects. The first appendix has a list of possible variables to be taken into account in the forecast, the second one is a summary on how to proceed to forecast nominal price increases and nominal interest rates and the third one illustrates the use of the implicit deflator of the Gross Domestic Product, GDP and the Produces Price Index for the same task.
    Date: 2008–03–10
  3. By: Ignacio Velez-Pareja
    Abstract: In this note we correct the findings reported by Vélez-Pareja and Tham (2005). Although perpetuities are somewhat artificial in the sense that in practice they do not exist, they are relevant because no matter how detailed and complex a forecasted financial plan for a firm or project could be, terminal value usually is calculated as a perpetuity. This terminal value might be a growing or a non growing perpetuity. On the other hand, usually terminal value is a substantial part of the firm value. We examine in detail the proper discount rate for cash flows in perpetuity, the present value of tax savings and the calculation of terminal value, which is the value of the perpetuity. We compare the typical textbook proposals for calculating the value of a perpetuity and we found that there are significant deviations. We compare with the Miller and Modigliani (1961) plowback proposal adopted by Copeland et al. (2000). The findings contradict what is generally accepted in the literature.
    Date: 2008–03–11
  4. By: Ignacio Velez-Pareja; Joseph Tham
    Abstract: It is widely known that if the leverage is constant over time, then the cost of equity and the Weighted Average Cost of Capital (WACC) for the free cash flow, FCF, is constant over time. In other words, it is inappropriate to use a constant WACCFCF to discount the free cash flow (FCF) if the leverage changes over time and some conditions are not satisfied. However, it is common to find analysts who inconsistently use a constant WACCFCF even if the leverage is not constant and the proper conditions are not satisfied. In this teaching note, we use a simple numerical example to illustrate how to model cash flows that are consistent with constant leverage. We verify the consistency of the example with two basic principles: conservation of cash flows and conservation of values. The note is based on a previous one and includes the procedure to value with constant leverage when some restrictive conditions are not satisfied.
    Date: 2008–03–12
  5. By: Ignacio Velez-Pareja
    Abstract: Using the model proposed by Velez-Pareja (2006) and assuming straight line depreciation we examine the conditions to assure a constant growth rate in a growing perpetuity. Our findings are that in practical terms for a growing perpetuity there are two options: either depreciation life is one year or there is no depreciation at all. The practical implication of this is that we have to find approximations when calculating terminal values in valuing cash flows. We examine some models and compare them with the theoretical model proposed in this note. The results based on an example are that the model with a nominal plowback ratio is the one that approximates more to the “theoretical” value when depreciation life is one year. The nearest value for typical depreciation lives is more than 95% higher than the theoretical value. In the last part of this note we pose questions rather than solutions. We invite the reader to answer those questions and even to pose additional ones.
    Date: 2008–03–13
  6. By: Bottazzi, L.; Da Rin, M.; Hellmann, T. (Tilburg University, Center for Economic Research)
    Abstract: We develop a theory and empirical test of how the legal system affects the relationship between venture capitalists and entrepreneurs. The theory uses a double moral hazard framework to show how optimal contracts and investor actions depend on the quality of the legal system. The empirical evidence is based on a sample of European venture capital deals. The main results are that with better legal protection, investors give more non-contractible support and demand more downside protection. These predictions are supported by the empirical analysis. Using a new empirical approach of comparing two sets of fixed-effect regressions, we also find that the investor?s legal system is more important than that of the company in determining investor behavior.
    Keywords: Financial Intermediation;Law and Finance;Corporate Governance;Venture Capital
    JEL: G20 G30 G24 K22
    Date: 2008
  7. By: Efraim Benmelech; Nittai K. Bergman
    Abstract: We examine how collateral affects the cost of debt capital. Theories based on borrower moral hazard and limited pledgeable income predict that collateral increases the availability of credit and reduces its price. Testing these theories is complicated by the very selection problem which they imply: creditors will demand collateral precisely from those borrowers who are riskier. This selection problem leads to a positive relation in the data between the presence of collateral and the loan yield. Analyzing the extensive margin of collateral use, therefore, masks the hypothesized negative impact that collateral exhibits on debt yields. In this paper, we alleviate this problem by focusing on a particular industry and examining its intensive, rather than extensive, margin of collateral use. Using a novel data set of secured debt issued by U.S. airlines, we construct industry-specific measures of collateral redeployability. We show that debt tranches that are secured by more redeployable collateral exhibit lower credit spreads, higher credit ratings, and higher loan-to-value ratios -- an effect which our estimates show to be economically sizeable. Our results suggest that the ability to pledge collateral, and in particular redeployable collateral, lowers the cost of external financing and increases debt capacity.
    JEL: G12 G24 G32 G33 L93
    Date: 2008–03
  8. By: Woodrow T. Johnson; James M. Poterba
    Abstract: Capital gain distributions by mutual funds generate tax liability for taxable shareholders, thereby reducing their after-tax returns. Taxable investors who are considering purchasing fund shares around distribution dates have an incentive to delay their purchase until after the distribution, since this will reduce the present value of their tax liability. Non-taxable shareholders, such as those who invest through IRAs and other tax-deferred accounts, face no such incentive for delaying purchase. This paper compares daily shareholder transactions by taxable and non-taxable investors in the mutual funds of a single no-load fund complex around distribution dates. Gross inflows to taxable accounts are significantly lower in the weeks preceding distribution dates than in the weeks following them, but gross inflows to tax-deferred accounts do not change around these dates. This finding suggests that some taxable shareholders time their purchase of mutual fund shares to avoid the tax acceleration associated with distributions. Taxable shareholders who purchase shares just before distribution dates also have shorter holding periods, on average, than those who buy after a distribution. The cost of the distribution-related tax acceleration for pre-distribution buyers is therefore somewhat less than that for those who buy after the distribution.
    JEL: G11 G23 H24
    Date: 2008–03
  9. By: Uluc Aysun (University of Connecticut); Melanie Guldi (Mount Holyoke College)
    Abstract: Understanding the effects of off-balance sheet transactions on interest and exchange rate exposures has become more important for emerging market countries that are experiencing remarkable growth in derivatives markets. Using firm level data, we report a significant fall in exposure over the past 10 years and relate this to higher derivatives market participation. Our methodology is composed of a three stage approach: First, we measure foreign exchange exposures using the Adler-Dumas (1984) model. Next, we follow an indirect approach to infer derivatives market participation at the firm level. Finally, we study the relationship between exchange rate exposure and derivatives market participation. Our results show that foreign exchange exposure is negatively related to derivatives market participation, and support the hedging explanation of the exchange rate exposure puzzle. This decline is especially salient in the financial sector, for bigger firms, and over longer time periods. Results are robust to using different exchange rates, a GARCH-SVAR approach to measure exchange rate exposure, and different return horizons.
    Keywords: Exchange rate exposure; derivatives; emerging markets
    JEL: G15 G32 F31
    Date: 2008–03
  10. By: Dean P. Foster; H. Peyton Young
    Abstract: We show that it is very difficult to structure incentive schemes that distinguish between unskilled hedge fund managers, who cannot generate excess returns, and highly skilled managers who can consistently deliver such returns. Under any incentive scheme that does not levy penalties for underperformance, managers with no investment skill can "game" the system to earn expected fees that are at least as high, relative to expected gross returns, as they are for the most skilled managers. Various ways of eliminating this "piggy-back problem" are examined, but the nature of the derivatives market means that it cannot be eliminated entirely.
    Keywords: Incentive Contract, Excess Return, Tail Event
    JEL: G32 D86
    Date: 2008
  11. By: Elisabete Gomes Santana Félix (Universidade de Évora,Departamento de Gestão); Cesaltina Pires (Universidade de Évora,Departamento de Gestão); Mohamed Azzim Gulamhussenb (Instituto Superior de Ciências do Trabalho e da Empresa,Departamento de Finanças e Contabilidade)
    Abstract: This article analyzes the exit decision in the European venture capital market, studying when to exit and how it interacts with the exit form. The paper emphasizes the impact of asymmetric information on the divestment decision. Our model considers the impact of haracteristics of the venture capital investor, characteristics of the investment and contracting variables on the exit decision. Our results show that venture capitalists associated with .nancial institutions have quicker exits, a result which is stronger for trade-sales exits. In addition, our results highlight the importance of the contracting variables on the exit decision. An unexpected but interesting result is that the presence in the board of directors leads to longer investment duration.
    Keywords: Asymmetric information, venture capital, trade sales, IPO, write-offs, exit decision, competing risks model
    JEL: C24 G24 G32 G38 K22
    Date: 2008

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