nep-cfn New Economics Papers
on Corporate Finance
Issue of 2014‒05‒04
five papers chosen by
Zelia Serrasqueiro
University of the Beira Interior

  1. Why has the literature on corporate governance and firm performance yielded mixed results? By Jimmy A. Saravia
  2. The lifecycle of the firm, corporate governance and investment performance By Jimmy A. Saravia
  3. European energy industry shocks, corporate control and firms' value By John J. García; Francesc Trillas
  4. Generalized Makeham's Formula and Economic Profitability By Carlo Alberto Magni
  5. Model Risk in Backtesting Risk Measures By Evers, Corinna; Rohde, Johannes

  1. By: Jimmy A. Saravia
    Abstract: This paper reviews the empirical literature on corporate governance and firm performance and finds that it has yielded mixed results. The paper argues that a primary reason for this situation is that the relevant theories have not been applied to the class of phenomena they were designed to explain. In particular, the literature that focuses on ownership structure and firm performance employs entrepreneurial agency theories of the firm but applies them to managerial firms where ownership is separated from control. This is evidenced by the fact that firms in which managerial ownership is close to zero percent are included in the samples. Conversely, empirical work centered on the relationship between board composition and firm performance (which relies on managerial agency theories of the firm) not only does not make sure that the firms in their samples are characterized by the separation of ownership and control, but it also ignores the alternative managerial agency theory concerning the agency costs of free cash flows. Additionally, the paper maintains that other approaches, such as that which studies the relationship between indices of anti-takeover provisions and firm performance, do not rely on any particular theory and for this reason are beset by problems of interpretation. The paper concludes with recommendations for avoiding the drawbacks and achieving future progress.
    Keywords: Corporate Governance, Firm Performance, Agency Theory, Firm lifecycle
    JEL: G31 G34
    Date: 2014–01–01
  2. By: Jimmy A. Saravia
    Abstract: According to firm lifecycle theory the agency costs of free cash flows are not transitory problems, but are a recurrent issue once firms reach a certain stage in their lifecycle. In particular, as firms mature their cash flows increase substantially while their investment opportunities decline and, to prevent retrenchment, managements need to invest in negative net present value projects. However, too much overinvestment leads to low firm valuation and potentially a hostile takeover. This paper extends firm lifecycle theory by arguing that to neutralize the threat of takeover, managements of maturing firms and their boards of directors progressively deploy antitakeover provisions which allow them to overinvest safely and prevent a decline in the size of their corporations. Firm lifecycle theory is also tested empirically. In this respect, a contribution of this paper is to develop a new empirical index that permits the identification of mature corporations with governance problems due to agency costs of free cash flows. The empirical results show that as firms mature agency costs of free cash flows increase, more antitakeover provisions are put into place and firms invest in projects with returns below their cost of capital.
    Keywords: Firm Life Cycle; Free Cash flows; Corporate Governance; Overinvestment
    JEL: G31 G34
    Date: 2013–11–11
  3. By: John J. García; Francesc Trillas
    Abstract: The deregulation process in the EU electricity sector triggered strategic decisions that led to industry restructuring. This paper presents preliminary evidence of the impact of this process on investors, using event studies and estimation techniques such as least squares and GARCH. Our findings suggest three stylized facts: 1) regulatory reform in Europe was certainly accompanied by a takeover wave, as predicted by Mitchell and Mulherin (1996); 2) mergers and acquisitions had a positive impact on the stock price of target firms, and a much lower and sometimes even a negative impact for the bidding firms; 3) the effect of takeover announcements on the returns of competitors of the merging firms depends on the degree of market power. In countries with high market power (like Spain) competitors significantly increase share returns upon takeover announcements, whereas in countries with lower market power (like England and Wales) returns do not change significantly.
    Keywords: Deregulation; mergers and acquisitions; event study; energy
    JEL: L94 G14 G34 G38
    Date: 2013–11–12
  4. By: Carlo Alberto Magni
    Abstract: This paper generalizes Makeham’s formula, allowing for varying interest rates and for a non-flat structure of valuation rates. An average interest rate (AIR) is introduced, as well as an average valuation rate (AVR), which exist and are unique for any asset. They can be computed either as principal-weighted arithmetic means or as interest-weighted harmonic means of period rates. Economic profitability of an asset or a portfolio of assets is captured by the spread between AIR and AVR, which has the same sign as the Net Present Value. This makes (i) AIR a more reliable tool for valuation and decision than the venerable Internal Rate of Return, and (ii) AVR a natural generalization of the cost-of-capital notion.
    Keywords: Makeham’s formula, net present value, average interest rate, internal rate of return
    JEL: G11 G12 G31
    Date: 2013–09–26
  5. By: Evers, Corinna; Rohde, Johannes
    Abstract: Under the Basel II regulatory framework non-negligible statistical problems arise when backtesting risk measures. In this setting backtests often become infeasible due to a low number of violations leading to heavy size distortions. According to Escanciano and Olmo (2010, 2011) these problems persist when incorporating estimation and model risk by adjusting the asymptotic variance of the test statistics. In this paper, we analyze backtests based on hit and duration sequences in a univariate framework by running a simulation study in order to identify the problems of backtests that examine the adequacy of Value at Risk measures. One main finding indicates that backtests of all classes show heavy size distortions. These problems for the relevant Basel II set-up, however, cannot be alleviated by modifying backtests in a way that accounts for estimation risk or misspecification risk.
    Keywords: Model risk, backtesting, Value at risk
    JEL: C12 C52 G32
    Date: 2014–04

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