nep-cfn New Economics Papers
on Corporate Finance
Issue of 2020‒05‒18
fourteen papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. Average rates of return, working capital, and NPV-consistency in project appraisal: A sensitivity analysis approach By Magni, Carlo Alberto; Marchioni, Andrea
  2. Nowhere Else to Go: The Determinants of Bank-Firm Relationship Discontinuations after Bank Mergers By Oliver Rehbein; Santiago Carbo-Valverde
  3. How Valuable is Financial Flexibility When Revenue Stops? Evidence from the COVID-19 Crisis By Rüdiger Fahlenbrach; Kevin Rageth; René M. Stulz
  4. Tenancy by the Entirety and the Value of Wealth Insurance for Entrepreneurs By Traczynski, Jeffrey
  5. Private Credit under Political Influence: Evidence from France By Anne-Laure Delatte; Adrien Matray; Noémie Pinardon-Touati
  6. Profits, Innovation and Financialization in the Insulin Industry By Rosie Collington
  7. Financial Distancing: How Venture Capital Follows the Economy Down and Curtails Innovation By Sabrina Howell; Josh Lerner; Ramana Nanda; Richard Townsend
  8. Cash Flow Growth and Stock Return By Benjamin A. Jansen
  9. Credit Markets, Relationship Banking, and Firm Entry By Minetti, Raoul; Cao, Qingqing; Giordani, Paolo; Murro, Pierluigi
  10. Interest Rate Uncertainty and the Predictability of Bank Revenues By Oguzhan Cepni; Riza Demirer; Rangan Gupta; Ahmet Sensoy
  11. Business or basic needs ?The impact of loan purpose on social crowdfunding platforms By Hadar Gafni; Marek Hudon; Anaïs Périlleux
  12. Credit Markets, Relationship Banking, and Firm Entry By Qingqing Cao; Paolo Giordani; Raoul Minetti; Pierluigi Murro
  13. Private Equity Buyouts in Healthcare: Who Wins, Who Loses? By Eileen Appelbaum; Rosemary Batt
  14. Operating Leverage and Stock Returns: International Evidence By Luis García-Feijóo; Benjamin A. Jansen

  1. By: Magni, Carlo Alberto; Marchioni, Andrea
    Abstract: In project appraisal under uncertainty, the economic reliability of a measure of financial efficiency depends on its strong NPV-consistency, meaning that the performance metric (i) supplies the same recommendation in accept-reject decisions as the NPV, (ii) ranks competing projects in the same way as the NPV, (iii) has the same sensitivity to perturbations in the input data as the NPV. In real-life projects, financial efficiency is greatly affected by the management of the working capital. Using a sensitivity analysis approach and taking into explicit account the role of working capital, we show that the average return on investment (ROI) is not strongly NPV-consistent in accept-reject decisions if the working capital is uncertain and changes under changes in revenues and costs. Also, it is not strongly NPV-consistent in project ranking. We also show that the internal rate of return (IRR) is not strongly NPV-consistent and economic analysis may even turn out to be impossible, owing to possible nonexistence and multiplicity caused by perturbations in the input data, as well as to possible shifts in the financial meaning of IRR under changes in the project’s value drivers. We introduce the straight-line rate of return (SLRR), based on the notion of average rate of change, which overcomes all the problems encountered by average ROI and IRR: It always exists, is unique, strongly NPV-consistent for both accept-reject decisions and project ranking, and has an unambiguous financial nature.
    Keywords: Finance, project evaluation, working capital, ROI, IRR, sensitivity analysis, net present value, straight-line, project ranking
    JEL: C4 C44 D81 D92 G12 G31 M41
    Date: 2020–04–27
  2. By: Oliver Rehbein; Santiago Carbo-Valverde
    Abstract: The decision to change or terminate a bank-firm relationship has been demonstrated to be crucial to firm performance following bank mergers. We investigate what determines this decision and find both bank competition and the available firm collateral to be important factors. We additionally provide new evidence that firms that are able to add a bank rela- tionship following a merger exhibit much stronger post-merger performance. Our findings are consistent with the interpretation that bank mergers cause a reduction in lending to most firms, leading them to search for alternative sources of finance.
    Keywords: bank mergers, relationship banking, competition
    JEL: G21 G34
    Date: 2020–05
  3. By: Rüdiger Fahlenbrach (Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute); Kevin Rageth (UEcole Polytechnique Fédérale de Lausanne; Swiss Finance Institute); René M. Stulz (Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI))
    Abstract: The COVID-19 shock creates a sudden temporary sharp shortfall in revenue for firms. We expect firms with greater financial flexibility to be better able to fund themselves in the presence of a revenue shortfall and to benefit less from the news concerning policy responses to the crisis on March 24. We show that firms with less financial flexibility experience worse stock returns until March 23 and benefit more from the news on March 24. Specifically, we find that firms with high financial flexibility experience a stock price drop lower by 26% or 9.7 percentage points than those with low financial flexibility. Similar results hold for CDS spreads. Had firms not made payouts over the last three years, the stock price drop for a firm with an average payout over assets ratio would have been lower by less than 2 percentage points. If firms in the top quartile of payouts over assets for the last three years did not have payouts over that period, they could, on average, have repaid all their long-term debt and their stock price drop would have been lower by 5.1 percentage points. Existing measures of financial constraints are not helpful in explaining the reaction of firms to the shock.
    Keywords: COVID-19, financial flexibility, cash holdings, leverage, short-term debt, stock returns, CDS premiums
    JEL: G01 G14 G32 G35
    Date: 2020–05
  4. By: Traczynski, Jeffrey (Federal Deposit Insurance Corporation)
    Abstract: This paper explores the willingness of entrepreneurs to pay for wealth insurance to protect personal assets in case of business failure and the impact of this strategy on small business operation decisions. I show that antidiscrimination laws allow married firm owners in half of U.S. states to choose between asset protection and having more collateral for business funding, allowing entrepreneurs to reveal their valuation for preserving personal assets at time of failure. I find that firm owners value asset protection offered by tenancy by the entirety laws at $900-$1000 per year. Firms receive smaller loans when entrepreneurs use this form of ownership to reduce the personal costs of firm failure, but show no differences in hiring patterns or spending on risky projects. This strategy of preparation in case of failure appears to affect small businesses through the funding channel.
    Keywords: personal bankruptcy, tenancy by the entirety, revealed preference, entrepreneurship
    JEL: K35 K36 L26 M13
    Date: 2020–04
  5. By: Anne-Laure Delatte; Adrien Matray; Noémie Pinardon-Touati
    Abstract: Formally independent private banks change their supply of credit to the corporate sector for the constituencies of contested political incumbents in order to improve their reelection prospects. In return, politicians grant such banks access to the profitable market for loans to local public entities among their constituencies. We examine French credit registry data for 2007--2017 and find that credit granted to the private sector increases by 9%--14% in the year during which a powerful incumbent faces a contested election. In line with politicians returning the favor, banks that grant more credit to private firms in election years gain market share in the local public entity debt market after the election is held. Thus we establish that, if politicians can control the allocation of rents, then formal independence does not ensure the private sector's effective independence from politically motivated distortions.
    Keywords: politics and banking;moral suasion;local government financing
    JEL: G21 G30 H74 H81
    Date: 2020–04
  6. By: Rosie Collington (University of Copenhagen)
    Abstract: The list prices of analogue insulin medicines in the United States have soared during the past decade. In the wake of high-profile cases of prescription medicine “price-gouging”, such as Mylan’s EpiPen and Turing-acquired Daraprim, actors across the insulin supply chain are today facing growing scrutiny from US lawmakers and the wider public. For the most part, however, the role of shareholders in the insulin supply chain has been overlooked. This paper considers the relationship between profits realized from higher insulin list prices, pharmaceutical innovation, and the financial structures of the three dominant insulin manufacturing companies, which set list prices. It shows that despite claims to the contrary, insulin manufacturers extracted vast profits from the sale of insulin products in the period 2009-2018, as insulin list prices rose. Distributions to the company shareholders in the form of cash dividends and share repurchases totaled $122 billion over this period. The paper also considers the role of other actors in the insulin supply chain, such as pharmacy benefits managers (PBMs), in the determination of list prices. The data and analysis presented in the paper indicates that financialization could be considered in tension with not only the development of new drugs that will be available to patients in the future, but also the affordability of products that already exist today.
    Keywords: innovation; financialization; pharmaceutical industry; insulin; corporate governance, share buybacks.
    JEL: D22 D53 G32 I11 L11 O32
    Date: 2020–03
  7. By: Sabrina Howell (New York University); Josh Lerner (Harvard Business School, Entrepreneurial Management Unit); Ramana Nanda (Harvard Business School, Entrepreneurial Management Unit); Richard Townsend (University of California, San Diego)
    Abstract: Although late-stage venture capital (VC) activity did not change dramatically in the first two months after the COVID-19 pandemic reached the U.S., early-stage VC activity declined by 38%. The particular sensitivity of early-stage VC investment to market conditions- which we show to be common across recessions spanning four decades from 1976 to 2017- raises questions about the pro-cyclicality of VC and its implications for innovation, especially in light of the common narrative that VC is relatively insulated from public markets. We find that the implications for innovation are not benign: innovation conducted by VC-backed firms in recessions is less highly cited, less original, less general, and less closely related to fundamental science. These effects are more pronounced for startups financed by early-stage venture funds. Given the important role that VC plays in financing breakthrough innovations in the economy, our findings have implications for the broader discussion on the nature of innovation across business cycles.
    Keywords: Venture Capital, Innovation, Patents, Business Cycles, Recessions
    JEL: G24 O31
    Date: 2020–05
  8. By: Benjamin A. Jansen
    Abstract: I extend financial literature by presenting a model that expresses a firm’s expected stock return as a function of its expected total cash flow growth, as opposed to simply dividend growth or profits. This is important because dividends and profits do not necessarily reflect shareholder value. Cross-sectional and time-series results support the hypothesis that realized cash flow growth and expected cash flow growth are positively related to stock returns. Evidence additionally suggests that the explanatory power in cash flow growth lies in it reflecting both operating performance and investing activities of the firm, with operating performance being relatively more economically and statistically significant.
    Keywords: Stock pricing; Stock return; Cash flow growth
    JEL: G12
    Date: 2020–03
  9. By: Minetti, Raoul (Michigan State University, Department of Economics); Cao, Qingqing (Michigan State University, Department of Economics); Giordani, Paolo (Luiss University); Murro, Pierluigi (Luiss University)
    Abstract: Credit frequently flows to the business sector through information-intensive bank-firm relationships. This paper studies the impact of relationship banking on firm entry. Exploiting Italian data, we document that relationship-oriented local credit markets feature lower firm entry, larger size at entry, and relatively more spin-offs than de novo entrepreneurs' entries. Information spillovers from credit relationships to entrants contribute to these effects. A dynamic general equilibrium model calibrated to the Italian data can match the effects when information spillovers are allowed for. Relationship banks' information on incumbents is trans-ferable to incumbents' spin-offs but crowds out information acquisition on de novo entrants. The buildup of incumbents' business wealth during credit relationships can outweigh the aggregate output effect of reduced entry.
    Keywords: Credit Relationships; Firm Entry; Information Spillovers; Spin-offs
    JEL: E44 G21 O16
    Date: 2020–05–12
  10. By: Oguzhan Cepni (Central Bank of the Republic of Turkey, Haci Bayram Mah. Istiklal Cad. No:10 06050, Ankara, Turkey); Riza Demirer (Department of Economics and Finance, Southern Illinois University Edwardsville, Edwardsville, IL 62026-1102, USA); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Ahmet Sensoy (Bilkent University, Faculty of Business Administration, Ankara 06800, Turkey)
    Abstract: This paper examines the predictive power of interest rate uncertainty over preprovision net revenues (PPNR) in a large panel of bank holding companies (BHC). Utilizing a linear dynamic panel model, we show that supplementing forecasting models with interest rate uncertainty improves the forecasting performance with the augmented model yielding lower forecast errors in comparison to a baseline model which includes unemployment rate, federal funds rate, and spread variables. Further separating PPNRs into two components that reflect net interest and noninterest income, we show that the predictive power of interest rate uncertainty is concentrated on the non-interest component of bank revenues. Finally, examining the point predictions under a severely stressed scenario, we show that the model can successfully predict the negative effect on overall bank revenues with a rise in the non-interest component of income during 2009:Q1. Overall, the findings suggest that stress testing exercises that involve bank revenue models can benefit from the inclusion of interest rate uncertainty and the cross-sectional information embedded in the panel of BHCs.
    Keywords: Bank stress tests; Empirical Bayes; Interest rate uncertainty; Out-of-sample forecasts
    JEL: C11 C14 C23 G21
    Date: 2020–05
  11. By: Hadar Gafni; Marek Hudon; Anaïs Périlleux
    Abstract: Crowdfunding has created new opportunities for poor microentrepreneurs. One crucial question is the impact that the purpose of a loan—either business investment or basic necessities—may have on the success of a campaign. Investigating a prosocial crowdfunding platform, we find that loans taken out to meet basic needs are funded faster than business-related loans, especially for small amounts, which can be explained by the prosocial motivation of microlenders. Moreover, female microborrowers are funded faster than men, especially for basic needs loans. Our results therefore suggest an ethical blind spot, since prosocially motivated crowdlenders may unintentionally end up producing adverse effects, replicating gender role by supporting women to a lesser extent when they apply for business loans. This finding expands prosocial motivational theory in ethical finance.
    Keywords: crowdfunding; business loans; basic necessities; ethical finance; microfinance; microlending; gender preference
    JEL: F35 G21 G28 L31 M14
    Date: 2020–05–08
  12. By: Qingqing Cao (Michigan State University); Paolo Giordani (LUISS University); Raoul Minetti (Michigan State University); Pierluigi Murro (LUISS University)
    Abstract: Credit frequently flows to the business sector through information-intensive bank-firm relationships. This paper studies the impact of relationship banking on firm entry. Exploiting Italian data, we document that relationship-oriented local credit markets feature lower entry, larger size at entry, and relatively more spin-offs than de novo entrepreneurs' entries. Information spillovers from credit relationships to entrants contribute to these effects. A dynamic general equilibrium model calibrated to the Italian data can match these effects when information spillovers are allowed for. Relationship banks' information on incumbents is transferable to incumbents' spin-offs but crowds out information acquisition on de novo entrants. The buildup of incumbents' business wealth during credit relationships can outweigh the aggregate output effect of reduced entry.
    Keywords: Credit Relationships, Firm Entry, Information Spillovers, Spin-offs
    JEL: E44 G21 O16
    Date: 2020–05
  13. By: Eileen Appelbaum (Center for Economic and Policy Research); Rosemary Batt (Cornell University)
    Abstract: Private equity firms have become major players in the healthcare industry. How has this happened and what are the results? What is private equity’s ‘value proposition’ to the industry and to the American people -- at a time when healthcare is under constant pressure to cut costs and prices? How can PE firms use their classic leveraged buyout model to ‘save healthcare’ while delivering ‘outsized returns’ to investors? In this paper, we bring together a wide range of sources and empirical evidence to answer these questions. Given the complexity of the sector, we focus on four segments where private equity firms have been particularly active: hospitals, outpatient care (urgent care and ambulatory surgery centers), physician staffing and emergency room services (surprise medical billing), and revenue cycle management (medical debt collecting). In each of these segments, private equity has taken the lead in consolidating small providers, loading them with debt, and rolling them up into large powerhouses with substantial market power before exiting with handsome returns.
    Keywords: European Private Equity, Leveraged Buyouts, health care industry, financial engineering, surprise medical billing revenue cycle management, urgent care, ambulatory care.
    JEL: I11 G23 G34
    Date: 2020–03
  14. By: Luis García-Feijóo; Benjamin A. Jansen
    Abstract: We empirically test theories predicting the association of operating leverage with stock returns and the value premium using an international data sample. Results suggest that operating leverage is related to stock returns and the value premium across the sampled countries. Results are robust to cross-country differences, typical controls, multiple definitions of operating and financial leverage, and while controlling for the endogeneity of operating and financial leverage. This suggests that the explanation for the presence of the value premium lies in the underlying risk exposure of fixed asset risk of operating leverage which is expressed through the value premium. Results further suggest that strengthening labor protection exogenously increases operating leverage.
    Keywords: Leverage; Value Premium; Stock Returns
    JEL: G12 G15
    Date: 2020–01

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