Property Lending Survey 1996

Financial Conservatism: Evidence on Capital Structure from Low Leverage Firms

Abstract

A persistent and puzzling empirical regularity is the fact that many firms adopt conservative
financial policies. These “under-leveraged” firms carry substantially less debt than predicted by
dominant theories of capital structure (Graham (2000) and Myers (1984)). This paper examines the
phenomenon of financial conservatism by studying firms that adopt a persistent policy of low
leverage. Our major findings are as follows. 1) Conservative firms follow a pecking order style
financial policy. A high flow of funds and substantial cash balances allow them to fund the bulk of discretionary expenditures internally. 2) Financial conservatism is largely transitory. Seventy
percent of low leverage firms drop their conservative financial policy; almost 50% do so within five years. 3) Conservative firms stockpile financial slack or debt capacity. Their “stockpiles” are
utilized later to finance discretionary expenditures, particularly acquisitions and capital expenditures. 4) Financial conservatism is not an industry-based phenomenon. Conservative firms do, however, have relatively high market-to-book and operate relatively frequently in industries thought to be sensitive to financial distress. 5) Conservative firms do not have low tax rates, high non-debt tax shields or face severe information asymmetries.

A Non-linear Approach to Public Finance Sustainability in Latin America

Abstract

Public finance sustainability plays a central role in the stabilization efforts in Latin America. The emphasis on fiscal policy in these countries goes back to the debt crisis of the 1980s, which was associated with large fiscal imbalances.We analyze the sustainability of government debt for a sample of Latin American countries, employing unit root tests that incorporate nonlinear alternative hypotheses. These tests capture the potential thresholds or corridor behavior that international agreements or markets impose on emerging economies’ public finances. We show that support for sustainability substantially improves when the possibility of nonlinear mean-reversion is taken into account.

The Near-Term Financial Performance of Capital Expenditures: A managerial perspective

Abstract

Despite recent findings that capital expenditures are value-relevant, papers have not shown direct evidence that a positive linear association exists between capital expenditure and future earnings. I initially show that there is no linear association between capital expenditures and future earnings for the overall sample (after controlling for current earnings and opening price). I then examine whether “successful”(“unsuccessful”) firms systematically choose profitable (unprofitable)projects. I consider three measures of success, two that are ex-ante—(1)no prior loss years in the five previous years; (2)firms that have higher than median beginning market-value to book-value ratios — and one ex-post measure—absence of future loss over the next five years. Neither of the two exante success measures identifies firms that are better able to find profitable capital expenditures. I find, however, that firms without (with)at least one year of losses in the next five years exhibit a strong positive (negative)linear association between capital expenditures and future earnings. I then consider whether losses are uninformative (i.e., because they are not expected to perpetuate)by excluding them from the performance of the firms with future losses. Capital expenditures are found to increase (rather than decrease)future earnings for the majority of firms with future losses (i.e., those with no more than two years of losses).

A Survey of Behavioral Finance

Financial statement analysis: A data envelopment analysis approach

Abstract

Ratio analysis is a commonly used analytical tool for verifying the performance of a firm. While ratios are easy to compute, which in part explains their wide appeal, their interpretation is problematic, especially when two or more ratios provide conflicting signals. Indeed, ratio analysis is often criticized on the grounds of subjectivity, that is the analyst must pick and choose ratios in order to assess the overall performance of a firm. In this paper we demonstrate that Data Envelopment Analysis (DEA) can augment the traditional ratio analysis. DEA can provide a consistent and reliable measure of managerial or operational efficiency of a firm. We test the null hypothesis that there is no relationship between DEA and traditional accounting ratios as measures of performance of a firm. Our results reject the null hypothesis indicating that DEA can provide information to analysts that is additional to that provided by traditional ratio analysis. We also apply DEA to the oil and gas industry to demonstrate how financial analysts can employ DEA as a complement to ratio analysis.

A Framework for Valuing Derivative Securities

Abstract

This paper develops a general framework for valuing a wide range of derivative securities. Rather than focusing on the stochastic process of the underlying security and developing an instantaneously-riskless hedge portfolio, we focus on the terminal distribution of the underlying security. This enables the derivative security to be valued as the weighted sum of a number of component pieces. The component pieces are simply the different payoffs that the security generates in different states of the world, and they are weighted by the probability of the particular state of the world occurring. A full set of derivations is provided. To illustrate its use, the valuation framework is applied to plain-vanilla call and put options, as well as a range of derivatives including caps, ?oors, collars, supershares, and digital options.