nep-cfn New Economics Papers
on Corporate Finance
Issue of 2015‒12‒08
twelve papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. The weighted average cost of capital over the lifecycle of the firm: is the overinvestment problem of mature firms intensified by a higher WACC? By Carlos S. García; Jimmy A. Saravia; David A. Yepes
  2. Reducing Asymmetric Information in Venture Capital Backed IPOs By Escobari, Diego; Serrano, Alejandro
  3. The Determinants of Effective Tax Rates: Firms’ Characteristics and Corporate Governance By Ana Isabel Martins Ribeiro; António Cerqueira; Elísio Brandão
  4. Option-Based Estimation of the Price of Co-Skewness and Co-Kurtosis Risk By Peter Christoffersen; Mathieu Fournier; Kris Jacobs; Mehdi Karoui
  5. The Effect of Bank Shocks on Firm-Level and Aggregate Investment By João Amador; Arne J. Nagengast
  6. Determinants of Corporate Capital Structure: Evidence from Non-financial Listed French Firms By Ana Margarida Fernandes Afonso Correia; António Melo Cerqueira; Elísio Brandão
  7. Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels By Kadir G. Babaglou; Peter Christoffersen; Steven L. Heston; Kris Jacobs
  8. Endogenous Market Making and Network Formation By Briana Chang; Shengxing Zhang
  9. Access to finance for innovative SMEs since the financial crisis By Neil Lee; Hiba Sameen; Marc Cowling
  10. Interlocked Executives and Insider Board Members: An Empirical Analysis By Gayle, George-Levi; Golan, Limor; Miller, Robert A.
  11. Securitization and Credit Quality By Alper Kara; David Marques-Ibanez; Steven Ongena
  12. Hedging with Derivatives and Firm Value By Mariana Vila Nova; António Melo Cerqueira; Elísio Brandão

  1. By: Carlos S. García; Jimmy A. Saravia; David A. Yepes
    Abstract: Abstract: Firm lifecycle theory predicts that the Weighted Average Cost of Capital (WACC) will tend to fall over the lifecycle of the firm (Mueller, 2003, p. 80-81). However, given that previous research finds that corporate governance deteriorates as firms get older (Mueller and Yun, 1998; Saravia, 2014) there is good reason to suspect that the opposite could be the case, that is, that the WACC is higher for older firms. Since our literature review indicates that no direct tests to clarify this question have been carried out up till now, this paper aims to fill the gap by testing this prediction empirically. Our findings support the proposition that the WACC of younger firms is higher than that of mature firms. Thus, we find that the mature firm overinvestment problem is not intensified by a higher cost of capital, on the contrary, our results suggest that mature firms manage to invest in negative net present value projects even though they have access to cheaper capital. This finding sheds new light on the magnitude of the corporate governance problems found in mature firms.
    Keywords: WACC, firm lifecycle, corporate governance, overinvestment.
    JEL: D23 G12 G30 G31 G34
    Date: 2015–11–20
  2. By: Escobari, Diego; Serrano, Alejandro
    Abstract: Purpose – The purpose of this paper is to model asymmetric information and study the profitability of venture capital (VC) backed initial public offerings (IPOs). Our mixtures approach endogenously separates IPOs into differentiated groups based on their returns’ determinants. We also analyze the factors that affect the probability that IPOs belong to a specific group. Design/methodology/approach – We propose a new method to model asymmetric information between investors and firms in VC backed IPOs. Our approach allows us to identify differentiated companies under incomplete information. We use a sample of 2,404 U.S. firms from 1980 through 2012 to estimate our mixture model via maximum likelihood. Findings – We find strong evidence that companies can be separated into two groups based on how IPO returns are determined. For companies in the first group the results are similar to previous studies. For companies in the second group we find that profitability is mainly affected by the reputation of the seed VC and capital expenditures. Tangible assets and age help explain group affiliation. We also motivate our findings for a continuum of heterogeneous IPO groups. Practical implications – The proposed mixture approach helps decrease asymmetric information for investors, regulators, and companies. Originality/value – Our mixture methods help decrease asymmetric information between investors and firms improving the probability of making profitable investments. Separating between groups of IPOs is crucial because different determinants of an IPO operating performance can potentially have opposite effects for different groups.
    Keywords: Venture Capital, Mixture Model, Initial Public Offerings
    JEL: C31 D82 G24 G32
    Date: 2015–11–20
  3. By: Ana Isabel Martins Ribeiro (University of Porto, School of Economics and Management); António Cerqueira (University of Porto, School of Economics and Management); Elísio Brandão (University of Porto, School of Economics and Management)
    Abstract: Investors, managers and shareholders benefit from the study of what influences and determines corporate effective tax rates (ETRs) as this analysis may contribute to potential tax savings. Moreover, standard setters, regulators and policy makers have a crucial interest in identifying the main factors driving corporate taxes. Therefore, the purpose of our investigation and contribution is twofold. Firstly, we provide evidence of how ETRs are determined by firms’ financial and operational characteristics. Secondly, our objective is to show the role of Corporate Governance attributes in explaining ETRs. As the literature about this topic using non-US firms is not abundant, to address these questions we select a sample of 704 non-financial firms listed on the London Stock Exchange between 2010 and 2013. We estimate our econometric model by using GLS cross-section weights. Our results show that larger and more profitable firms have higher ETRs. On the contrary, capital intensity, leverage and R&D expenses have a negative impact on ETRs. Regarding ownership structure and board composition, our findings reveal that managerial ownership contributes to lower ETRs. On the other hand, more independent firms from controlling shareholders exhibit higher ETRs. Moreover, a larger number of board members and non-executive directors results in higher ETRs
    Keywords: Effective tax rate; Corporate Finance; Corporate Governance
    JEL: G30 H20
    Date: 2015–12
  4. By: Peter Christoffersen (University of Toronto - Rotman School of Management and CREATES); Mathieu Fournier (HEC Montreal); Kris Jacobs (University of Houston - C.T. Bauer College of Business); Mehdi Karoui (McGill University)
    Abstract: We show that the prices of risk for factors that are nonlinear in the market return are readily obtained using index option prices. We apply this insight to the price of co-skewness and co-kurtosis risk. The price of co-skewness risk corresponds to the spread between the physical and the risk-neutral second moments, and the price of co-kurtosis risk corresponds to the spread between the physical and the risk-neutral third moments. The option-based estimates of the prices of risk lead to reasonable values of the associated risk premia. An out-of-sample analysis of factor models with co-skewness and co-kurtosis risk indicates that the new estimates of the price of risk improve the models performance. Models with higher-order market moments also robustly outperform standard competitors such as the CAPM and the Fama-French model.
    Keywords: Co-skewness, co-kurtosis, risk premia, options, cross-section, out-of-sample
    JEL: G12 G13 G17
    Date: 2015–01–09
  5. By: João Amador; Arne J. Nagengast
    Abstract: We show that credit supply shocks have a strong impact on firm-level as well as aggregate investment by applying the methodology developed by Amiti and Weinstein (2013) to a rich dataset of matched bank-firm loans in the Portuguese economy for the period 2005 to 2013. We argue that their decomposition framework can also be used in the presence of small firms with only one banking relationship as long as they account for a small share of the total loan volume of their banks. The growth rate of individual loans in our dataset is decomposed into bank, firm, industry and common shocks. Adverse bank shocks are found to strongly impair firm-level investment, particularly in small firms and in those with no access to alternative financing sources. For the economy as a whole, granular shocks in the banking system account for around 20-40% of aggregate investment dynamics.
    JEL: E32 E44 G21 G32
    Date: 2015
  6. By: Ana Margarida Fernandes Afonso Correia (FEP-UP, School of Economics and Management, University of Porto); António Melo Cerqueira (FEP-UP, School of Economics and Management, University of Porto); Elísio Brandão (FEP-UP, School of Economics and Management, University of Porto)
    Abstract: This paper analyses firms’ characteristics that influence managers’ decisions about how to finance their companies. It also aims to study which financial theory better explains those decisions that affect the capital structure of the firms. Our empirical study uses panel data and OLS estimations with cross-section fixed effects and year dummy variables. The sample includes 436 non-financial listed French firms, over the period from 2007 to 2013 (3052 firm-year observations). In the empirical study to test the results’ sensitivity to the use of debt with different maturities we use two regressions and hence two dependent variables: the total debt and the long term debt. The independent variables that we use are the tangibility of assets, the profitability, the firm size, the growth opportunities and the non-debt tax shields. All independent variables exhibit explanatory power and the results are robust to the use of debt with different maturities. The empirical results show that there is no leading theory in explaining managers’ decisions about how to finance firms. Additionally, the sample was divided into pre-crisis (2007-2008) and crisis (2009-2013) periods, the results show a substantial change of the influence of the tangibility of assets, as a result of the financial crisis.
    Keywords: capital structure, trade-off theory, pecking order theory, market timing theory, Euronext Paris
    JEL: C33 G32
    Date: 2015–12
  7. By: Kadir G. Babaglou (University of Toronto - Rotman School of Management); Peter Christoffersen (University of Toronto - Rotman School of Management and CREATES); Steven L. Heston (University of Maryland - Department of Finance); Kris Jacobs (University of Houston - C.T. Bauer College of Business)
    Abstract: We nest multiple volatility components, fat tails and a U-shaped pricing kernel in a single option model and compare their contribution to describing returns and option data. All three features lead to statistically significant model improvements. A second volatility factor is economically most important and improves option fit by 18% on average. A U-shaped pricing kernel improves the option fit by 17% on average, and more so for two-factor models. Fat tails improve option fit by just over 3% on average, and more so when a U-shaped pricing kernel is applied. Our results suggest that the three features we investigate are complements rather than substitutes.
    Keywords: volatility components, fat tails, jumps, pricing kernel
    JEL: G12
    Date: 2014–11–18
  8. By: Briana Chang (School of Business, University of Wisconsin–Madison;); Shengxing Zhang (Department of Economics, London School of Economics (LSE); Centre for Macroeconomics (CFM))
    Abstract: This paper proposes a theory of intermediation in which intermediaries emerge endogenously as the choice of agents. In contrast to the previous trading models based on random matching or exogenous networks, we allow traders to explicitly choose their trading partners as well as the number of trading links in a dynamic framework. We show that traders with higher trading needs optimally choose to match with traders with lower needs for trade and they build fewer links in equilibrium. As a result, traders with the least trading need turn out to be the most connected and have the highest gross trade volume. The model therefore endogenously generates a core-periphery trading network that we often observe: a financial architecture that involves a small number of large, interconnected institutions. We use this framework to study bid-ask spreads, trading volume, asset allocation and implications on systemic risk.
    Keywords: Over-the-Counter Market, Trading Network, Matching, Intermediation
    JEL: C70 G1 G20
    Date: 2015–11
  9. By: Neil Lee; Hiba Sameen; Marc Cowling
    Abstract: In the wake of the 2008 financial crisis, there has been increased focus on access to finance for small and medium sized firms. Some evidence from before the crisis suggested that it was harder for innovative firms to access finance. Yet no research has considered the differential effect of the crisis on innovative firms. This paper addresses this gap using a dataset of over 10,000 UK SME employers. We find that innovative firms are more likely to be turned down for finance than other firms, and this worsened significantly in the crisis. However, regressions controlling for a host of firm characteristics show that the worsening in general credit conditions has been more pronounced for non-innovative firms with the exception of absolute credit rationing which still remains more severe for innovative firms. The results suggest that there are two issues in the financial system. First, we find evidence of a structural problem which restricts access to finance for innovative firms. Second, we show a cyclical problem has been caused by the financial crisis and impacted relatively more severely on non-innovative firms.
    Keywords: Finance; SME; Entrepreneurship; Recession; Innovation
    JEL: G21 G32 L2 O31
    Date: 2015–03
  10. By: Gayle, George-Levi (Federal Reserve Bank of St. Louis); Golan, Limor (Federal Reserve Bank of St. Louis); Miller, Robert A. (Carnegie Mellon University)
    Abstract: This paper asked the question of whether the behavior and compensation of interlocked executives and non-independent board of directors are consistent with the hypothesis of governance problem or whether this problem is mitigated by implicit and market incentives. It then analyzes the role of independent board of directors. Empirically, we cannot reject the hypothesis that executives in companies with a large number of non-independent directors on the board receive the same expected compensation as other executives. In our model, every executive has an incentive to work. Placing more of non-independent directors on the board mitigates gross losses to the firm should any one of them shirk because they monitor each other. It also reduces the net benefits from shirking and increases the gross value of the firm from greater coordination (reflected in the firm’s equity value and thus impounded into its financial returns). Therefore having a greater non-independent director representation on the board create a more challenging signaling problem to solve thereby raising the risk premium. However, giving more votes on the board to non-independent executives fosters better executive working conditions, which in turn offsets the higher risk premium in pay by a lower certainty-equivalent wage in equilibrium. Thus, our estimates undergird a plausible explanation of how large shareholders determine the number of insiders on the board to maximize the expected value of their equity. We then conduct counterfactual policy experiment imposing 50% upper bound on the fraction of insiders on the board and another counterfactual imposing 40% quotas for women on the boards.
    JEL: G34 J24 J33 J41 J44 J63 L22 M12
    Date: 2015–11–27
  11. By: Alper Kara (Loughborough University); David Marques-Ibanez (Board of Governors of the Federal Reserve System; Bangor University); Steven Ongena (University of Zrich)
    Abstract: Banks are usually better informed on the loans they originate than other financial intermediaries. As a result, securitized loans might be of lower credit quality than otherwise similar non- securitized loans. We assess the effect of securitization activity on credit quality employing a uniquely detailed dataset from the euro-denominated syndicated loan market. We find that, at issuance, banks do not select and securitize loans of lower credit quality. Following securitization, however, the credit quality of borrowers whose loans are securitized deteriorates by more than those in the control group. We find tentative evidence suggesting that poorer performance by securitized loans might be linked to banks reduced monitoring incentives.
    Keywords: Securitization; syndicated loans; credit risk
    JEL: G21 G28
    Date: 2015–11
  12. By: Mariana Vila Nova (FEP-UP - School os Economics and Management); António Melo Cerqueira (FEP-UP - School os Economics and Management); Elísio Brandão (FEP-UP - School os Economics and Management)
    Abstract: This study examines the impacts of risk management strategies with derivatives on firm’s market value using a sample of non-financial firms listed in the FTSE-350 share index at the London Stock Exchange between 2005 and 2013. We focus on the derivatives use to hedge both the foreign exchange risk and the interest rate risk. To avoid, as far as possible, the endogeneity among variables and consequently strengthen the tests, it is employed an instrumental variables approach in addition to the OLS with time and industry fixed effects. The results reveal a positive effect of foreign currency derivatives and interest rate derivatives on firm’s market value, which indicates that investors, at least under the conditions described in the study, appreciate these risk management practices and reward them with higher market values. However, if we attempt to the derivative contract employed – forward, option, swap - their impacts on firm value differ. For instance, while swaps use to hedge the interest rate risk or the forward contracts to hedge the foreign exchange rate risk have positive and significant effects on value, this effect is not clear when we employ an option contract.
    Keywords: Hedging, Derivatives, Firm Value, Risk Management
    JEL: G32 F31
    Date: 2015–12

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