Showing papers in "Financial Management in 1995"

Exchange Risk Sensitivity and Its Determinants: A Firm and Industry Analysis of U.S. Multinationals

Abstract: We develop a model of firm valuation to examine the exchange risk sensitivity of 409 U.S. multinational firms during the 1978-89 period. In contrast to previous studies, we find that exchange rate fluctuations do affect firm value. More specifically, we find that approximately sixty percent of firms with significant exchange risk exposure gain from a depreciation of the dollar. We also find that cross-sectional differences in exchange risk sensitivity are linked to key firm-specific operational variables (i.e., foreign operating profits, sales, and assets). Although we find limited support for exchange risk sensitivity when we aggregate the data into 20 SIC-based industry groups, we do observe some cross-sectional and inter-temporal variation in the exchange risk coefficients. Subperiod analysis reveals higher number of firms with significant exchange risk sensitivity during the weak-dollar period as compared to the strong-dollar period. • Exchange rate variability is a major source of macroeconomic uncertainty affecting firms in an open economy. Exchange rate fluctuations affect operating cash flows and firm value through the translation, transaction, and economic effects of exchange risk exposure. In addition, extemal shocks may create an interdependen ce between exchange rates and stock retums. Therefore, it is reasonable to expect a connection between exchange rate changes and firm value. The importance of exchange rate variability is also evidenced by the growing emphasis corporations place on exchange risk measurement and management strategies. However, compared to other macroeconomic factors, such as inflation and interest rate risk, the research on exchange risk and its impact on firm value is scant. Recent studies based on portfolio data (Bodnar and Gentry, 1993, Jorion, 1990, and Prasad and Rajan, 1995) and market-index data (Ma and Kao, 1990) have found minimal or no evidence of exchange rate fluctuations affecting stock retums. One explanation for these counterintuitive results is the research design used in these studies. We posit that, like any other

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

Abstract: 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.

A Functional Perspective of Financial Intermediation

Abstract: New financial product designs, improved computer and telecommunications technology, and advances in the theory of finance have led to dramatic and rapid changes in the structure of global financial markets and institutions. This paper offers a functional perspective as the conceptual framework for analyzing the dynamics of institutional changes in financial intermediation and uses a series of examples to illustrate the range of institutional change that is likely to occur. These examples are used to frame the managerial issues surrounding the production process for intermediaries and to discuss the regulatory process for those intermediaries.

Uses, Abuses, and Alternatives to the Net-Present-Value Rule

Abstract: financial academics think they have to offer CFOs, corporate treasurers, investment bankers, and practitioners of all stripes. In fact, it is not uncommon to spend a considerable amount of time in class making sure that the student understands all the wrong ways of thinking about investment decision making-from the IRR rule to the payback period. Wrong, of course, because they don't coincide with the NPV rule.

Does the Choice of Auditor Convey Quality in an Initial Public Offering

Abstract: To investigate the effect of reputation on auditor business decisions, we look at the relationship between auditor reputation and the characteristics of the IPOs that auditors take to the market. Consistent with our hypotheses, we find that: 1) More prestigious auditors are associated with IPOs that seem a priori less risky; 2) the market perceives as less risky the IPOs that are associated with more prestigious auditors; and 3) IPOs' long-term performance is related to the prestigious of the auditor employed.

Corporate Capital Structure Decisions: Evidence from Leveraged Buyouts

Abstract: We analyze the composition of the financing packages used in a large sample of leveraged buyout transactions in order to test a set of hypotheses developed in the prior literature about the determinants of corporate capital structure decisions. We focus in particular on the role of agency costs, bankruptcy risks, and tax considerations. We find evidence that all three have an impact, both on the degree of leverage employed in the transactions and on the attributes of the borrowings undertaken. The impacts are manifest in systematic relationships between the proportion and type of debt in the buyout financing package and the target firm's earnings rate, earnings variability, growth prospects, and its tax and liquidity position. 0 The logic and consequences of leveraged buyouts (LBOs), both for the participants involved and for the economy as a whole, have been widely debated in the academic literature and the popular business press. In a leveraged buyout, a group of investors acquires the public interest in a firm's common equity, primarily with borrowed funds, and takes the firm private. We offer here some further evidence on the nature of these transactions, with particular emphasis on the composition of the LBO financing package. Our objective is to attempt to explain why the observed financing choices were made by individual firms-by identifying the relationships between the characteristics of the target firms and the types of financings that were employed in their acquisition. We detect some clear patterns in the data, many of which we believe have broader implications for the design of corporate capital structures. In particular, we find evidence that LBO financing decisions appear systematically to be affected by the target firm's growth prospects, the level and variability of its return on assets, its pre-buyout liquidity position, and by tax considerations and post-buyout restructuring plans. We find similar evidence of systematic influences on the

Compensation Policy and the Investment Opportunity Set

Abstract: We analyze the proportions of executive pay derived from salary, bonus, long-term incentive compensation, and stock-based compensation for a sample of 321 Fortune 1,000 firms in 1992. We find that firms with abundant investment opportunities pay higher levels of total compensation to their executives. Executives of growth firms receive a larger portion of their compensation from long-term incentive compensation (such as performance awards, restricted stock grants, and stock option grants), while those of non-growth firms receive a larger portion of their pay from fixed salary. An implication is that long-term incentives contracts reduce agency costs associated with manager-shareholder information asymmetries in growth firms.

Corporate Finance over the Past 25 Years

Abstract: This paper traces developments in the theory of corporate finance over the past 25 years. These include a shift from consideration of how the value of a given cash flow stream is affected by its division among different classes of security holders to a consideration of how structure of claims affects the cash flow stream itself. A major reason for this shift of emphasis is the attention now paid to the role of individually motivated agents in the corporation. Other important developments include recognition of information asymmetries, the role of private benefits of control, and the application of the option pricing paradigm to the evaluation of real investments.

Employee Stock Ownership Plans, Firm Performance, and Monitoring by outside Blockholders

Abstract: Employee Stock Ownership Plans (ESOPs) tend to entrench incumbent managers and enhance employee incentives, so the effect of an ESOP on the sponsoring firm is important. We examine long-term performance of ESOP firms and find significant improvement in their year-end performance. This finding supports the positive effects of ESOPs on the performance of the firm overall. We hypothesize that the performance of the ESOP depends on the efficiency of the ownership structure of the firm as a monitoring mechanism. Evidence consistent with our hypothesis is found in the average long-term firm performance.

The choice of going public: spin-offs vs. carve-outs

Abstract: This study analyzes how firms choose between a spin-off and an equity carve-out as a way to divest assets. Using a sample of 91 master limited partnerships that were issued to the public, we find that riskier, more leveraged, less profitable firms choose to divest through a spin-off. The spin-off firms are smaller and less profitable than the carve-out firms. This suggests that the choice is affected by a firm's access to the capital market: Greater scrutiny and more stringent disclosure are required in carve-outs relative to spin-offs. We do not find support for the hypotheses that management attempts to leave undervalued assets in the hands of current shareholders or that parent organizations' need for cash are the driving motives behind the divestiture choice. Little, if any, support is found for operating efficiencies as a reason for these transactions. Both spin-off and the carve-out firms underperform the market by a wide margin. The spin-off parents experienced significantly poor performance, while carve-out parents' performance was commensurate with their control groups.

1995 Derivatives Practices and Instruments Survey

Abstract: 0 The significant publicity surrounding losses on derivatives transactions, beginning in the Spring of 1994, prompted the Treasury Management Association (TMA) to undertake a study of derivatives practices and instruments among its members' organizations. Many of the surveys on derivatives usage conducted in the past year were sent to known samples of derivatives users. Since TMA membership is on an individual basis for those directly or indirectly engaged in the treasury profession, its membership represents a broad spectrum of employing organizations, including educational institutions, governmental units, and privately held corporations as well as the publicly held corporations that are frequently surveyed. This broad membership base allows TMA to assess on a wider basis than previously reported the extent of derivatives practices among treasury professionals.

An Empirical Examination of Prepackaged Bankruptcy

Abstract: Analysis of 49 prepackaged bankruptcies allows identification of the economic gains from this form of restructuring. Results show that the direct costs of prepacks are comparable to those previously reported for "traditional" bankruptcies. Firms routinely pay the pre-bankruptcy expenses of creditor groups, so most direct expenses are incurred prior to filing. The gains from prepack stem from binding holdouts to a negotiated agreement and from the tax effects of future use of net operating loss carry-forwards. Significant tax savings can result from completing a prepack instead of an exchange offer, indicating the importance of tax considerations in firms' restructuring decisions.

Firm Value and External Blockholdings

Abstract: This paper examines the valuation consequences of external blockholdings. The stock market responses to announcement of block formations are positive, on average. Potential sources of gains to blockholders are identified, and the stock market responses are related cross-sectionally to firm-specific variables proxying for these sources and to blockholder-specific characteristics. The announcement period abnormal returns are explained by the potential for wealth transfer from bondholders, block size, and the identity of the blockholder. Changes in operating and performance variables following block formations provide weak evidence of hands-on monitoring by blockholders on an ongoing basis, suggesting that the observed value increases arise from expectations of future takeover gains and/or from limits on future opportunistic managerial behavior.

The Dynamics of Corporate Dividend Reductions

Abstract: The claim that divided payments serve as signals to market participants is widely accepted. However, recent evidence has increased the uncertainty regarding the information conveyed when a firm drops its dividend. In particular, DeAngelo, DeAngelo, and Skinner (1992) and Healy and Palepu (1988) find that a dividend reduction tends to be followed by a significant increase in firm earnings. Our analysis extends prior research by examining twenty-one firm characteristics three years before and three years after a dividend drop. Consistent with past results, we find that firm earnings drop prior to a dividend reduction and increase afterwards. However, following a dividend drop, firms tend to reduce asset expenditures, external financing activities, employees, and spending on R&D. In addition, firms tend to sell more assets and their sales level remains depressed in the post-dividend-drop period. These post-dividend-drop occurrences may negatively impact a firm's future competitive position and, furthermore, may explain the negative stock price reaction that accompanies the dividend-drop announcement. Overall, our results suggest that a dividend-drop marks the end of a firm's financial decline and the beginning of firm restructuring.

Insider Trading and Long-Run Return Performance

Abstract: This paper investigates the relation between security performance and the propensity for trading by "manager" insiders. The primary empirical model focuses on whether individual firms' abnormal standardized levels of insider purchases and sales are related to past, current, and future security performance. To overcome the inherent problem of identifying insider activity in proximity to material events, when insiders may face significant costs of detection on some types of transactions, our study considers firm performance over long-run (3-year) intervals. Moreover, by analyzing all NYSE and AMEX firms, we are able to characterize the propensity, probability, and profitability of insider trading in equity markets in general. Our results show a strong tendency for insider net purchases to be significantly above and below normal between one and two years in advance of long horizon returns (both market-related and firm-specific) that are above and below normal, respectively. Subsequent to abnormal returns, insiders tend to reverse their trades. Thus, insider transactions have both a long-term anticipatory and a reactive components to them. Virtually all of our results are driven by the timing of the insider sales, rather than purchases.

Monitoring versus Bonding: Shareholder Rights and Management Compensation

Abstract: Using a sample of nearly 700 firms, we documented a significant level of substitution between monitoring efforts by shareholders and bonding of Chief Executive Officers' (CEO)compensation with shareholder wealth. Direct shareholder monitoring effectiveness is measured by various dimensions of voting rights, e.g., equal voting, cumulative voting, and confidential voting. Indirect monitoring is measured by the degree of independence of the board of directors. Bonding of CEO compensation with shareholder wealth is gauged by a new pay-performance sensitivity measure that incorporates volatility in firm value. The results are consistent with prediction of agency theory that compensation contracts are designed to reduce the owner-manager conflict.

The Relationship between Corporate Compensation Policies and Investment Opportunities: Empirical Evidence for Large Bank Holding Companies

Abstract: This paper investigates whether the firm's set of investment opportunities drives the amount and type of executive compensation by conducting a detailed empirical analysis of the executive compensation plans of large bank holding companies. We examine intra-industry changes in compensation policy over a period of significant change in the investment-opportunity set, 1979 to 1985. Our empirical findings reveal that total real compensation and the ratio of incentive compensation-to-total compensation increased substantially at regional bank holding companies but remained stable at money-center bank holding companies. These results are consistent with the hypothesis that during the early 1980s financial innovation and deregulation created greater growth opportunities for regional bank holding companies than for money-center bank holding companies.

Financial Distress and Restructuring Models

Abstract: This paper provides a synthesis of the theoretical literature on financial distress. It employs a two-state framework, which more clearly captures the generalizations of the more complex models. The equation systems that are derived permit the development of a series of examples that convey the logic and intuitions behind the generalizations. The graphics help illuminate aspects of financial distress not treated in the previous literature. The role of risk is treated explicitly. Alternative assumptions generate different predictions of the effects of financial distress on investment efficiency and restructuring strategy. Central to these strategies are the recontracting arrangements between owners, creditors, and the other relevant stakeholders. The resulting framework permits an evaluation of some central provisions of the prevailing U.S. bankruptcy laws.

Corporate Debt Maturity Policy and Investor Tax-Timing Options: Theory and Evidence

Abstract: This paper argues that corporate debt maturity policy affects investor tax-timing options to tax-trade corporate securities. In a multiperiod model with interest rate uncertainty, we establish that a long-term debt maturity strategy maximizes investor tax-timing option value. The analysis predicts that the firm lengthens debt maturity as interest rate volatility increases and as the slope of the term structure increases. Empirical analysis supports the model's interest rate volatility prediction.

Deregulation, Reregulation, Equity Ownership, and S&L Risk-Taking

Abstract: This study examines the relation between equity ownership composition and insolvency risk for savings and loans (S&Ls). We hypothesize that the effect of manager/stockholder alignments on bank risk-taking is contingent on the trade-off between stockholders' incentives for risk provided by deposit insurance subsidies and their disincentives based on the regulatory price for risk imposed under alternative regulatory regimes. In support of this hypothesis, we find that S&Ls with a high concentration of managerial stock ownership exhibit greater risk-taking behavior than other S&Ls in 1988, a period of regulatory leniency and forbearance on S&L closures, but lower risk-taking behavior in 1991, a period of regulatory stringency and nonforbearance. We also find S&Ls with a greater institutional investor ownership to have lower insolvency risk than other S&Ls in 1991.

Capital Structure and Ownership Distribution of Tender Offer Targets: An Empirical Study

Abstract: This study investigates the capital and ownership structure of firms receiving tender offers. Predictions of control-driven models developed by Haris and Raviv (1988) and Stulz (1988) and value-maximizing models developed by Israel (1991, 1992) are examined. The study reports results consistent with the predictions that: 1) target firms increase leverage during control contests, 2) leverage increases are higher when the tender offer is opposed, 3) leverage increases are higher when the tender offer is unsuccessful, and 4) ownership structure is important to explaining the success of tender offers. When tested jointly with other independent variables, only capital structure is statistically significant in explaining both management's opposition and the success of a tender offer.

Who Opts out of State Antitakeover Protection?: The Case of Pennsylvania's SB 1310

Abstract: In 1990, Pennsylvania enacted Senate Bill 1310, containing five provisions designed to make takeovers prohibitively expensive but allowing firms to opt out of some or all of the law's provisions. We find that firms that opted out of SB 1310 had lower insider control of voting rights and were less likely to have a poison pill in place prior to the law's enactment, even after controlling for firm size and the monitoring activities of blockholders and outside directors. In addition, we find that opt-out firms spent less on R&D than non-opt-out firms. Our result suggest that some boards value takeover defense (whether firm or state-level) whereas others prefer to be subject to an active market for corporate control.

Determinants of the Choice of the Hostile Takeover Mechanism: An Empirical Analysis of Tender Offers and Proxy Contests

Abstract: This paper investigates the influence of target firm performance, capital structure, and ownership profile on the decision to pursue a hostile tender offer or, alternatively, a proxy contest. Empirically, firms with poorer financial performance are more likely to experience a proxy contest as opposed to a tender offer. Firms that are more highly leveraged and that tend to be management-controlled are more likely to be targets of proxy contests than of tender offers.

Derivatives Regulation and Financial Management: Lessons from Gibson Greetings

Abstract: M On April 19, 1994, Gibson Greetings, Inc. (Gibson), a manufacturer of seasonal cards, wrapping paper, and related products with headquarters in Cincinnati, Ohio, filed an 8-K with the SEC, announcing that it had taken a $16.7 million charge against first quarter income resulting from losses on two swap transactions with BT Securities Corporation, a subsidiary of Bankers Trust New York Corporation (BT). The announcement stated that this loss was in addition to a

Financial Management (1972-1994): A Retrospective

Abstract: Financial Management has published more than 800 papers from 1972 through 1994. This article documents the influence of FM on financial research, financial education, and financial practice. The evolution of subject coverage over time is discussed . The FM articles most cited in journals and text books are identified. FM ranks near the top of finance journals in every criterion examined.

An Upper Bound for the Firm's Cost of Employee Stock Options

Abstract: This paper provides an upper bound to the firm's cost of employee stock options (ESOs). The upper bound depends on the risk and return of the underlying stock and on all other investment opportunities that are available, but it does not depend on employees' risk preferences or wealth. The only assumption that is required is that employees do not hedge their ESOs. One result of the model is that the overstatement from using options-pricing models for ESOs is likely to be greatest for firms with high unsystematic risk, such as small, high-tech firms in the start-up growth stages.

An Empirical Study of Ex Ante Risk Premiums for the Electric Utility Industry

Abstract: This study examines the relationship between interest rates and utility equity risk premiums. We found that an inverse relationship exists, with an equity risk premium changing by 37 basis points for each 100 basis-point change in the 30-year Treasury bond yield. The inverse relationship is stable; however, changes in the relative risk of debt and equity securities produce shifts in the level of risk premiums, regardless of the behavior of Treasury bond yields. We also found that the equity risk premiums were consistently positive over the study period, which conforms to the basic risk/return tenet of finance.