https://faculty.fuqua.duke.edu/~jgraham/website/SurveyPaper.PDF

The theory and practice of corporate finance: Evidence from the field

/pdf/the-theory-of-industrial-organization-19bejph0ej.pdf

The Theory of Industrial Organization

FIRST ARTICULATED by scholars of the ISalamanca school in sixteenth century Spain,1 purchasing power parity (PPP) is the disarmingly simple empirical proposition that, once converted to a common currency, national price levels should be equal. The basic idea is that if goods market arbitrage enforces broad parity in prices across a sufficient range of individual goods (the law of one price), then there should also be a high correlation in aggregate price levels. While few empirically literate economists take PPP seriously as a short-term proposition, most instinctively believe in some variant of purchasing power parity as an anchor for long-run real exchange rates. Warm, fuzzy feelings about PPP are not, of course, a substitute for hard evidence. There is today an enormous and evergrowing empirical literature on PPP, one that has arrived at a surprising degree of consensus on a couple of basic facts. First, at long last, a number of recent studies have weighed in with fairly persuasive evidence that real exchange rates (nominal exchange rates adjusted for differences in national price levels) tend toward purchasing power parity in the very long run. Consensus estimates suggest, however, that the speed of convergence to PPP is extremely slow; deviations appear to damp out at a rate of roughly 15 percent per year. Second, short-run deviations from PPP are large and volatile. Indeed, the one-month conditional volatility of real exchange rates (the volatility of deviations from PPP) is of the same order of magnitude as the conditional volatility of nominal exchange rates. Price differential volatility is surprisingly large even when one confines attention to relatively homogenous classes of highly traded goods. The purchasing power parity puzzle then is this: How can one reconcile the enormous short-term volatility of real exchange rates with the extremely slow rate at which shocks appear to damp out? Most explanations of short-term exchange rate volatility point to financial factors such as changes in portfolio preferences, short-term asset price bubbles, and monetary shocks (see, for example, Maurice Obstfeld and Rogoff forthcoming). Such shocks can have substantial effects on the real economy in the presence of sticky nominal wages and prices. I See Lawrence H. Officer (1982, ch. 3) for an extensive discussion of the origins of PPP theory; see also Dornbusch (1987).

/pdf/the-purchasing-power-parity-puzzle-2mj15yxf16.pdf

The Purchasing Power Parity Puzzle

The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs, but more broadly, tariffs, nontariff barriers, and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home-bias-in-trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity-home-bias puzzle, and the Backus-Kehoe-Kydland consumption-correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad range of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing-power-parity puzzle emphasized by Rogoff, and what we term the exchange-rate disconnect puzzle. The latter cat...

/pdf/the-six-major-puzzles-in-international-macroeconomics-is-a9ipbn2dgn.pdf

The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?

We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large firms rely heavily on net present value techniques and the capital asset pricing model, while small firms are relatively likely to use the payback criterion. Older executives without an MBA are more likely to rely on payback than are younger executives with an MBA. Surprisingly, most companies use a single company-wide discount rate to evaluate a project in a new industry and country. In addition to market risk, firms also frequently adjust cash flows or discount rates for interest rate risk, exchange rate risk, business cycle risk, and inflation risk. Few firms adjust discount rates or cash flows for book-to-market, distress, or momentum risks. A majority of large firms have a tight or somewhat tight target debt ratio, in contrast to only one-third of small firms. Executives rely heavily on informal rules when choosing capital structure. The most important factors affecting debt policy are maintaining financial flexibility and having a good credit rating. When issuing equity, respondents are concerned about earnings per share dilution and recent stock price appreciation. We find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes. If CFOs behave according to these deeper hypotheses, they apparently do so unknowingly.

The Theory and Practice of Corporate Finance: Evidence from the Field

This paper investigates pricing by Japanese manufacturing firms in export and domestic markets. The paper reports equations explaining the margin between export prices in yen and domestic prices for a wide range of final goods including many of the electronic and transport products which have figured so prominently in recent trade discussions. Evidence is presented showing that Japanese firms respond to changes in real exchange rates by "pricing to market", varying their export prices in yen relative to their domestic prices. The empirical specification makes it possible to disentangle planned changes in the margin between export and domestic prices from inadvertent changes in this margin due to unanticipated changes in exchange rates. The degree of pricing to market varies widely across products, but there is strong evidence that pricing to market occurs. The paper also investigates whether pricing to market has increased in scale in the period since 1985 when the yen began a sustained appreciation, but finds that only five of seventeen products experienced a shift in price behavior over that period.

Pricing to Market in Japanese Manufacturing

This is the third in a series of surveys on financial risk management practice and derivatives use by non-financial corporations in the United States undertaken by the Wharton School. This 1998 survey, written in partnership again with CIBC World Markets, extends the previous two surveys by asking new questions about certain aspects of derivative use and risk management practice. This report compares responses across the various surveys and notes changes in responses over time. A tabulation of the responses to all questions is included in the appendix.

1998 Wharton survey of financial risk management by US non-financial firms

https://www.nber.org/system/files/working_papers/w2905/w2905.pdf

In November, 1994, the Weiss Center for International Financial Research of the Wharton School undertook its first survey of derivatives and risk management practice by non-financial corporations in the United States. This 1995 survey, sponsored by CIBC Wood Gundy, is more detailed than the 1994 survey, with a broader range of questions about valuation and risk management and with more specific questions about the use of derivatives. One of the primary objectives of the survey is the development of a database on risk management practices suitable for academic research.

1995 Wharton Survey of Derivatives Usage by US Non-Financial Firms

Firms differ in the extent to which they “pass through” changes in exchange rates into foreign currency prices and in their “exposure” to exchange rates—the responsiveness of their profits to changes in exchange rates. Because pricing affects profitability, a firm’s pass-through and exposure should be related. This paper develops models of exporting firms under imperfect competition to study these related phenomena. From these models we derive the optimal pass-through decisions and the resulting exchange rate exposure. The models are estimated on eight Japanese export industries using both the price data pass-through and financial data for exposure. EXCHANGE RATES CAN HAVE A MAJOR inf luence on the pricing behavior and profitability of exporting and importing firms. Firms differ in the extent to which they “pass through” the change in exchange rates into the prices they charge in foreign markets. They also differ in their “exposure” to exchange rates— the responsiveness of their profits to changes in exchange rates. Previous papers have studied either pass-through or exposure, but none has studied these two phenomena together. Yet, because pricing directly affects profitability, the exposure of a firm’s profits to exchange rates should be governed by many of the same firm and industry characteristics that determine pricing behavior. This paper develops models of firm and industry behavior that are used to study these closely related phenomena together. It also provides estimates of pass-through and exposure behavior using data from Japanese export industries. To examine pass-through behavior and exchange rate exposure, we model a firm with sales to a foreign export market. This exporting firm competes with a foreign firm in that export market. The costs of the exporting firm are based primarily in the local ~domestic! currency, while the foreign firm

/pdf/pass-through-and-exposure-520rwwtyv6.pdf

Richard C. Marston

Papers

Pricing to Market in Japanese Manufacturing

1998 Wharton survey of financial risk management by US non-financial firms

Pricing to Market in Japanese Manufacturing

1995 Wharton Survey of Derivatives Usage by US Non-Financial Firms

Pass-through and Exposure