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Journal ArticleDOI

Optimal Capital Utilization by Financial Firms: Evidence from the Property-Liability Insurance Industry

01 Feb 2002-Journal of Financial Services Research (Kluwer Academic Publishers)-Vol. 21, Iss: 1, pp 15-53
TL;DR: This paper investigated the use of capital by insurers to provide evidence on whether the capital increase represents a legitimate response to changing market conditions or a true inefficiency that leads to performance penalties for insurers.
Abstract: Capitalization levels in the property-liability insurance industry have increased dramatically in recent years—the capital-to-assets ratio rose from 25% in 1989 to 35% by 1999. This paper investigates the use of capital by insurers to provide evidence on whether the capital increase represents a legitimate response to changing market conditions or a true inefficiency that leads to performance penalties for insurers. We estimate “best practice” technical, cost, and revenue frontiers for a sample of insurers over the period 1993–1998, using data envelopment analysis, a non-parametric technique. The results indicate that most insurers significantly over-utilized equity capital during the sample period. Regression analysis provides evidence that capital over-utilization primarily represents an inefficiency for which insurers incur significant revenue penalties.

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Citations
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Journal ArticleDOI
TL;DR: An extensive, if not nearly complete, listing of DEA research covering theoretical developments as well as "real-world" applications from inception to the year 2007 is presented.
Abstract: Since the original Data Envelopment Analysis (DEA) study by Charnes et al. [Measuring the efficiency of decision-making units. European Journal of Operational Research 1978;2(6):429–44], there has been rapid and continuous growth in the field. As a result, a considerable amount of published research has appeared, with a significant portion focused on DEA applications of efficiency and productivity in both public and private sector activities. While several bibliographic collections have been reported, a comprehensive listing and analysis of DEA research covering its first 30 years of history is not available. This paper thus presents an extensive, if not nearly complete, listing of DEA research covering theoretical developments as well as “real-world” applications from inception to the year 2007. A listing of the most utilized/relevant journals, a keyword analysis, and selected statistics are presented.

994 citations

Posted Content
TL;DR: In this paper, the authors find evidence of a positive relation between increasing levels of traditional risk management capability and firm value but no additional increase in value for firms achieving a higher ERM rating.
Abstract: Enterprise Risk Management (ERM) has emerged as a construct that ostensibly overcomes limitations of silo-based traditional risk management (TRM), yet little is known about its effectiveness. The scant research on the relationship between ERM and firm performance has offered mixed findings, and has been limited by the lack of a suitable proxy for the degree of ERM implementation. Using Standard and Poor’s (S&P) newly available risk management rating, we find evidence of a positive relation between increasing levels of TRM capability and firm value but no additional increase in value for firms achieving a higher ERM rating. Considering these results, we suggest directions for future research.

277 citations


Cites background from "Optimal Capital Utilization by Fina..."

  • ...Premiums are the main revenue source for an insurance firm, implying that a higher credit rating leads to higher returns, and supporting empirical evidence has been found (see, for example, Cummins & Nini, 2002)....

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Journal ArticleDOI
TL;DR: In this article, the effectiveness of enterprise risk management (ERM) has been investigated and little is known about its effectiveness, except that it is a construct that overcomes limitations of silo-based traditional risk management.
Abstract: Enterprise risk management (ERM) has emerged as a construct that ostensibly overcomes limitations of silo-based traditional risk management (TRM), yet little is known about its effectiveness. The s...

225 citations

Journal ArticleDOI
TL;DR: In this article, a broad efficiency comparison of 6462 insurers from 36 countries is conducted, considering life and non-life insurers, and they find a steady technical and cost efficiency growth in international insurance markets from 2002 to 2006.
Abstract: The purpose of this paper is to provide new empirical evidence on frontier efficiency measurement in the international insurance industry, a topic of great interest in the academic literature during the last several years. A broad efficiency comparison of 6462 insurers from 36 countries is conducted. Different methodologies, countries, organizational forms, and company sizes are compared, considering life and non-life insurers. We find a steady technical and cost efficiency growth in international insurance markets from 2002 to 2006, with large differences across countries. Denmark and Japan have the highest average efficiency, whereas the Philippines is the least efficient. Regarding organizational form, the results are not consistent with the expense preference hypothesis, which claims that mutuals should be less efficient than stocks due to higher agency costs. Only minor variations are found when comparing different frontier efficiency methodologies (data envelopment analysis, stochastic frontier analysis).

215 citations

Book ChapterDOI
TL;DR: A review of frontier efficiency and productivity methodologies that have been developed to analyze firm performance, emphasizing applications to the insurance industry, is presented in this article, where the focus is on the two most prominent methodologies: stochastic frontier analysis using econometrics and non-parametric frontier analyses using mathematical programming.
Abstract: This chapter reviews the modern frontier efficiency and productivity methodologies that have been developed to analyze firm performance, emphasizing applications to the insurance industry. The focus is on the two most prominent methodologies—stochastic frontier analysis using econometrics and non-parametric frontier analysis using mathematical programming. The chapter considers the underlying theory of the methodologies as well as estimation techniques and the definition of inputs, outputs, and prices. Seventy-four insurance efficiency studies are identified from 1983 to 2011, and 37 chapters published in upper tier journals from 2000 to 2011 are reviewed in detail. Of the 74 total studies, 59.5% utilize data envelopment analysis as the primary methodology. There is growing consensus among researches on the definitions of inputs, outputs, and prices.

200 citations

References
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Journal ArticleDOI
TL;DR: In this article, the authors draw on recent progress in the theory of property rights, agency, and finance to develop a theory of ownership structure for the firm, which casts new light on and has implications for a variety of issues in the professional and popular literature.

49,666 citations

Journal ArticleDOI
TL;DR: The CCR ratio form introduced by Charnes, Cooper and Rhodes, as part of their Data Envelopment Analysis approach, comprehends both technical and scale inefficiencies via the optimal value of the ratio form, as obtained directly from the data without requiring a priori specification of weights and/or explicit delineation of assumed functional forms of relations between inputs and outputs as mentioned in this paper.
Abstract: In management contexts, mathematical programming is usually used to evaluate a collection of possible alternative courses of action en route to selecting one which is best. In this capacity, mathematical programming serves as a planning aid to management. Data Envelopment Analysis reverses this role and employs mathematical programming to obtain ex post facto evaluations of the relative efficiency of management accomplishments, however they may have been planned or executed. Mathematical programming is thereby extended for use as a tool for control and evaluation of past accomplishments as well as a tool to aid in planning future activities. The CCR ratio form introduced by Charnes, Cooper and Rhodes, as part of their Data Envelopment Analysis approach, comprehends both technical and scale inefficiencies via the optimal value of the ratio form, as obtained directly from the data without requiring a priori specification of weights and/or explicit delineation of assumed functional forms of relations between inputs and outputs. A separation into technical and scale efficiencies is accomplished by the methods developed in this paper without altering the latter conditions for use of DEA directly on observational data. Technical inefficiencies are identified with failures to achieve best possible output levels and/or usage of excessive amounts of inputs. Methods for identifying and correcting the magnitudes of these inefficiencies, as supplied in prior work, are illustrated. In the present paper, a new separate variable is introduced which makes it possible to determine whether operations were conducted in regions of increasing, constant or decreasing returns to scale in multiple input and multiple output situations. The results are discussed and related not only to classical single output economics but also to more modern versions of economics which are identified with "contestable market theories."

14,941 citations


"Optimal Capital Utilization by Fina..." refers methods in this paper

  • ...Following Banker, Charnes, and Cooper (1984), the above program is modified to account for variable returns to scale (VRS) by adding the convexity constraint #N" " i !...

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Journal ArticleDOI
01 May 1957

14,922 citations


"Optimal Capital Utilization by Fina..." refers methods in this paper

  • ...Efficiency To analyze production frontiers, we utilize input-oriented distance functions as originally introduced by Farrell (1957)....

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  • ...Efficiency To analyze production frontiers, we utilize input-oriented distance functions as originally introduced by Farrell (1957). Suppose producers use input vector x ! !x1,x2, ....

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Posted Content
TL;DR: In this paper, the benefits of debt in reducing agency costs of free cash flows, how debt can substitute for dividends, why diversification programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, and why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil.
Abstract: The interests and incentives of managers and shareholders conflict over such issues as the optimal size of the firm and the payment of cash to shareholders. These conflicts are especially severe in firms with large free cash flows—more cash than profitable investment opportunities. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why “diversification” programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, 4) why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil, and 5) why bidders and some targets tend to perform abnormally well prior to takeover.

14,368 citations

Journal ArticleDOI
TL;DR: In this paper, a firm that must issue common stock to raise cash to undertake a valuable investment opportunity is considered, and an equilibrium model of the issue-invest decision is developed under these assumptions.

13,939 citations