Showing papers in "Financial Management in 1972"

Stock Price Reaction of Multinational Firms to Exchange Realignments

Abstract: Dr. Franck is Professor of International Investment and Trade at Syracuse University. He was Dean of Robert College in Istanbul, Turkey for several years before assuming his current post. He is a contributor to World Business Systems, edited by Jean Boddewyn. Dr. Young is Associate Professor of Finance at Syracuse University. He taught at the Baruch School of Business of the City College of New York before assuming his current post. He is coauthor of The Repurchase of Common Stock.

Evidence on the importance of financial structure

Abstract: equity in lower ranges of debt to equity to lower the firm's cost of capital. Beyond an ill-defined point, however, due to excessive risk, the securities markets will not react favorably to further increases in the degree of leverage used by the firm, and its cost of capital will rise. Thus, there is an optimum financial structure that minimizes cost of capital. In basic conceptual disagreement are the proponents of the "independence" hypothesis. Modigliani and Miller [5, 6, 7], in particular, argue that, given certain conditions (i.e., no taxes on corporate income and perfect capital markets), cost of capital is not influenced by a firm's financing mix. The favorable effect upon total market value of substituting nominally low-cost debt for high-cost equity in the firm's financial structure will be offset exactly by a decrease in the price that investors are willing to pay for the firm's common stock. A higher common equity yield is imposed by the market in return for being exposed to greater financial risk. Thus the cost of capital is independent of the financial structure of the firm, and financing decisions are of minimal importance. By strict interpretation, these two theories stand at opposite poles. The principal differences between them disappear, however, in a world where interest exp nse is tax deductible and market imperfections operate to restrict the amount of fixed-income obligations a firm can issue [9, pp. 39-41]. Both schools of thought do in fact subscribe to the optimum financial structure concept under conditions approximating the actual business environment. Accordingly, it is the objective of this article to present evidence on whether the importance of the financial structure of the firm has in practice been confirmed by corporate decision makers. It is hypothesized that, if the financing decision is critical with respect to the valuation of the firm, then decision makers in various industry groups have recognized this fact and developed financial structures suited to their particular business risk. The approach will be to show that an appropriate range of leverage exis s for a particular industry and that firms seek to find this range. In addition, it will be demons rated that inter-industry financial structure differences are persistent over time and are pervasive through ut the industries studied.

Financial Policy and Market Expectations

Abstract: If financial managers do indeed seek to maximize shareholder wealth, it is incumbent on them to know something of the effects of financial decisions on investor expectations. This article seeks to provide insight into how financial policy affects shareholder expectations, and presents some evidence regarding the relative importance of decisions concerning liquidity, investment, and financing. The first section of this article contains a brief discussion of previous research and introduces the capital asset pricing model-the model that facilitates explicit study of expectations. An intuitive explanation of why the financial, marketing, and production decisions of the firm affect investor expectations follows. Then a market expectation/financial decision model is formulated and tested using multiple regression analysis. A summary of results and implications concludes the article.

Corporate Finance and Exchange Rate Variations

Abstract: In 1962 a U.S.-based automobile manufacturing company which already had extensive foreign operations began to expand and restructure its subsidiaries in the European Economic Community (EEC). The corporation decided to concentrate most of its engine production in a new plant in Strasbourg, France. This location was chosen because of shipping economies and in response to considerable inducements offered by the French government to export-oriented industries willing to settle in that part of the country. The company had no other facilities in France; however, it owned very large manufacturing operations in Germany and smaller ones in Belgium where vehicles were assembled. The entire output of the French subsidiary was sold to these two plants. The automobiles were then marketed throughout the Common Market and beyond, although the market share of the company in France was negligible.

Financing Foreign Affiliates

Abstract: In addition, we use a computer model of a simple multinational enterprise system to investigate the financial practices used by real firms. Our research was based on extensive interviews, each lasting from one day to several weeks, with financial executives in the home office, regional offices, and foreign subsidiaries of 39 multinational enterprises and with governmental, banking, accounting, and legal experts here and abroad. In addition, the unpublished records of scores of firms and the published records of almost 200 firms were studied. In the Multinational Enterprise Study of the Harvard Business School, 187 U.S. firms meet our definition of "multinational enterprise." These are firms that appeared on the Fortune 500 list of the largest U.S. firms in 1964 or 1965 and had manufacturing facilities in six or more foreign countries by 1965. We class 90 of these as "small" (having foreign operations with annual sales of less than $100 million in 1969); 75 of them as "medium" ($100 million to $500 million); and 22 of them as "large" (over $500 million).

Optimal Transfer Pricing for the Multinational Firm

Abstract: Dr. Petty is Assistant Professor of Finance at Texas Tech University. After receipt of his doctorate from the University of Texas at Austin, he taught at Virginia Polytechnic Institute and State University. His articles have appeared in The Journal of Business Research and the Proceedings of the Southwestern Finance Association. Dr. Walker is Professor of Finance at the University of Texas at Austin. He received his DBA from Indiana University. Presently he is the National Association of Credit Management's consulting economist and author of The Credit and Financial Newsletter. In addition to numerous articles, he is author of Essentials of Financial Management, coauthor of Case Problems in Financial Management, and coeditor of Monetary Issues of the 1960's.

The bond refunding decision

Abstract: with reasonable certainty. Nevertheless, it is a decision about which there has been a great deal of confusion and misleading recommendations. This article is concerned with the question of whether or not to refund. Here we assume that refunding in the future will be less desirable than refunding now. Implicitly the possibility of future refunding is not considered. There are several articles that have stressed the importance of considering whether it is more desirable to wait and refund in

The subscription price in rights offerings

Abstract: A major decision facing the financial manager planning a rights offering involves setting the subscription price. Financial managers have long understood that for a rights offering to be successful, the subscription price should be set below the market price but only at the risk that significant underpricing may affect adversely the price performance of their firm's stock following the issue. This article reviews the theoretical and practical considerations involved in setting the subscription price and presents some statistical evidence suggesting that financial managers may be overly concerned with the possible disadvantages of underpricing a rights offering.

Decision analysis for exchange risk management

Abstract: One of the factors which complicates financial decision making in a multinational enterprise is currency devaluations or revaluations in countries where subsidiaries are located. Since exchange rate changes affect the reported earnings, value of financial assets, and future earnings of the multinational corporation, it is imperative that the financial decision maker of such a firm develop a strategy to manage the foreign exchange risk assumed by the firm. It is the purpose of this article to develop relatively formal decision rules for managing the risk of exchange rate change. These rules are based on an analysis of a theoretical decision model of the exchange management process. The inherent uncertainty involved in exchange rate movements is the basic feature of the exchange risk situation. The nature of an optimal decision thus will depend on the attitudes of management toward risk and uncertainty. Four common attitudes will be assumed and examined: minimum variance, minimax, expected monetary value, and expected utility. Each yields a particular set of optimal rules for exchange risk adjustment. Three techniques are available for adjusting the exchange risk posture of the firm. These are (1) adjustment of funds flows, (2) forward contracts, and (3) exposure netting. Adjustment-of-funds-flow techniques involve an alteration in the planned funds flows of parent and/or subsidiaries, in amount and/or currency of denomination, with the view of reducing (or increasing) the local currency accounting exposure of the corporation. This exposure is defined as the difference in local currency assets translated to domestic currency at the current exchange rate and local currency liabilities translated at the same exchange rate. If the objective of management is to decrease exposure, the technique must increase local currency denominated liabilities or decrease local currency denominated assets. Techniques for increasing liabilities include local borrowing and stretching payables. Techniques for decreasing assets include reduction of cash balances and other liquid assets, reduction in investment in accounts receivable (either by tightening credit terms or factoring), and reduction in inventory investment (if inventories are translated at the current exchange rate). Each of these techniques generates local currency funds. If exposure is to be reduced, these funds must be used to acquire assets which are not exposed to the exchange risk. For example, if the parent corporation had planned to provide domestic currency funds to the subsidiary, locally generated funds can replace funds from the parent. Alternatively,

Investment Planning under Variable Price Change

Abstract: The effects of inflation on equity claims and profits have attracted the attention of numerous writers. Earlier articles such as those by Kessel and Alchian [4] and DeAlessi [1] considered the relation between monetary assets and fixed-dollar obligations. Given that product prices change at the same rate as the prices of goods and services acquired, the query posed by Nichols [8] and Motley [7] was whether the change in the real value of tax claims greatly surpassed that of the real value of fixed-income claims. Other recent studies have looked into the inflation-hedge characteristics of common stocks [2 and 9] and have pointed to a potential bias introduced into capital-budgeting decisions by price-level changes [11]. This study confirms the erratic behavior of stock prices and corporate earnings as the price level changes, describes an investment-decision model that allows for both price-change expectations and interaction between stock prices and near-term earnings, and applies the price-change model to selected company environments. Preliminary analyses of the sensitivity of common stock prices, profits, and wholesale price and wage indexes to changes in the Consumer Price Index suggest that management either has failed to incorporate price-change expectations adequately into its decision fabric or has frequently misassessed actual rates of price change. The investrient-decision model-as set forth in this article-extends previous work in this area and merits serious consideration for application by corporate planners. Specifically, it rectifies deficiencies in other capitalbudgeting models by allowing for (1) differential rates of change in prices and costs and (2) management's subjective beliefs as to the rate of inflation. Despite its emphasis on near-term earnings, the model converges on the classical net-present-value decision rule at the limit.

A Rationale for Restructuring Stock Plans

Abstract: The past few years have been trying for the financial manager concerned with executive remuneration in his corporation. First, he watched helplessly as the Congress debated a myriad of tax changes that threatened to further scramble his already complex decision environment. Next, he was forced to interpret the product of that debate, a document many believe misnamed as the Tax Reform Act of 1969. Since passage of that measure, a barrage of articles recounted the major provisions of the legislation and speculated as to its likely impact on the composition of the executive pay package. Most observers feel that the stock option, the darling of many corporate compensation programs, has lost a significant portion of its appeal and will comprise an increasingly smaller proportion of the value of future pay packages. This same conclusion, it should be noted, was advanced after the extensive tax changes in 1964; the predicted shifts at that time, however, failed to materialize. As corporate administrators have responded to the changes in the tax code, the business press has continued its assault, changing its emphasis to documentation of the accuracy of its earlier predictions. Frequently lacking in this snowstorm of advice and comment is analysis of the interests of both the executive and his employer corporation. A few exceptions [3, 4, 9, 10] provide figures to back up their conclusions; a thorough analysis of the economic justification for the observed changes has to date been unavailable. This article will provide the analysis to bridge the gap between assertion and underlying economics. The analysis utilizes a cost/benefit methodology within the framework of a simulation. The model isolates the effects of the changes in the tax structure by considering both the relative benefits and relative costs of a variety of compensation vehicles before and after tax reform. The advantage of the simulation technique is that it tests the generality of conclusions by varying parameters.

Alternative Debt Bids by State and Local Governments

Abstract: The Investment Bankers Association for many years encouraged the use of the net interest cost method of computing the cost of a bond issue [e.g., 1, pp. 128-131]. This usage did not generate much excitement in the financial or academic communities until the fall of 1972. In October 1972, a $25 million pollution control bond issue of the state of Minnesota made headlines in business periodicals and the financial sections of many newspapers. The bonds were awarded to Dillon, Read underwriting syndicate, since their bid represented the lowest "net interest cost." The reason the issue generated headlines was that it paid 50% interest per year for bonds maturing in the first four years after issue. Bonds maturing in later years paid lower interest rates, and bonds maturing after 1986 promised to pay 0.1 per year. Hopewell, Kaufman, and West [3] estimate that Minnestoa's use of the net interest cost method will cost the state an extra $1 million. In municipal issues bonds maturing early generally carry a relatively higher interest rate than those maturing in later years. The motivation for such payout arrangements lies in the use of the net interest cost method of computing the cost of the bond issue. While the Minnesota issue attracted a great deal of attention, this type of issue is not rare. For example, in November 1972, Harford County, Maryland, awarded $6 million of bonds to a syndicate headed by Chase Manhattan Bank where the interest rate was 7% for ten years and then declined to 1/10% for bonds maturing in 1997. Once or twice a week "tombstones" published in the financial newspapers announce similar types of issues. It will be argued here that the use of net interest cost introduces an undesirable bias into the decision process. If we assume that the investment banking community understands the nature of the bias, but that municipal and state financial officers do not, then this is an undesirable situation. The governmental financial officer thinks he is accepting the lowest cost offer but may actually be accepting an offer that can easily be the highest cost. Rules of thumb tend to be accepted when they give reasonable results for recurring situations. The net interest cost method used by investment bankers is such a rule of thumb and the effects of using the calculation seem to be acceptable to practitioners. The results are consistent with the actuarial yield of the bond, if the calculations are applied to one bond issue paying the same amount of interest throughout the life of the bond. If there are serial bonds paying greatly different amounts of interest, the measure is unreliable. It has been criticized in the theoretical literature [e.g., 5] but continues to be used in practice.

Coupon rate of return

Abstract: The objective of this article is to review and critique the criteria for evaluating projected cash flows that are frequently advocated as appropriate tools for managers to use in making investment decisions. Net present value and the internal rate of return are of unproven worth as criteria of investment value under the conditions normally faced by decision makers. Moreover, both lack characteristics desirable in a measure of financial worth that would be useful to most managers. A new criterion, analogous to the coupon rate on a bond, or the annual return on a non-wasting asset, is proposed as a capital-budgeting criterion which is much more useful to corporate decision makers. The article will first review the simple financial model that underlies what might be considered the conventional wisdom on capital budgeting. In the following section I will describe the circumstances under which decision makers make investment de-