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Abstract:
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.

Capital Structure, Cost of Capital, Cost of Equity, Capital Budgeting, Discount Rates, Project Valuation, Survey

Abstract:
We survey 384 financial executives and conduct in depth interviews with an additional 23 to determine the factors that drive dividend and share repurchase decisions. Our findings indicate that maintaining the dividend level is on par with investment decisions, while repurchases are made out of the residual cash flow after investment spending. Perceived stability of future earnings still affects dividend policy as in Lintner (1956). However, fifty years later, we find that the link between dividends and earnings has weakened. Many managers now favor repurchases because they are viewed as being more flexible than dividends and can be used in an attempt to time the equity market or to increase EPS. Executives believe that institutions are indifferent between dividends and repurchases and that payout policies have little impact on their investor clientele. In general, management views provide little support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play a secondary role. This is the final working paper version of our 2005 publication in the Journal of Financial Economics.

Payout, Dividend policy, Share repurchases, Lintner model

Abstract:
We survey 384 CFOs and Treasurers, and conduct in-depth interviews with an additional two dozen, to determine the key factors that drive dividend and share repurchase policies. We find that managers are very reluctant to cut dividends, that dividends are smoothed through time, and that dividend increases are tied to long-run sustainable earnings but much less so than in the past. Rather than increasing dividends, many firms now use repurchases as an alternative. Paying out with repurchases is viewed by managers as being more flexible than using dividends, permitting a better opportunity to optimize investment. Managers like to repurchase shares when they feel their stock is undervalued and in an effort to affect EPS. Dividend increases and the level of share repurchases are generally paid out of residual cash flow, after investment and liquidity needs are met. Financial executives believe that retail investors have a strong preference for dividends, in spite of the tax disadvantage relative to repurchases. In contrast, executives believe that institutional investors as a class have no strong preference between dividends and repurchases. In general, management views provide at most moderate support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play only a secondary role. By highlighting where the theory and practice of corporate payout policy are consistent and where they are not, we attempt to shed new light on important unresolved issues related to payout policy in the 21st century.

Abstract:
We survey 401 financial executives, and conduct in-depth interviews with an additional 20, to determine the key factors that drive decisions related to performance measurement and voluntary disclosure. The majority of firms view earnings, especially EPS, as the key metric for an external audience, more so than cash flows. We find that the majority of managers would avoid initiating a positive NPV project if it meant falling short of the current quarter's consensus earnings. Similarly, more than three-fourths of the surveyed executives would give up economic value in exchange for smooth earnings. Managers believe that missing an earnings target or reporting volatile earnings reduces the predictability of earnings, which in turn reduces stock price because investors and analysts dislike uncertainty. We also find that managers make voluntary disclosures to reduce information risk associated with their stock but at the same time, try to avoid setting a disclosure precedent that will be difficult to maintain. In general, management's views support stock price motivations for earnings management and voluntary disclosure, but provide only modest evidence consistent with other theories of these phenomena (such as debt, political cost and bonus plan based hypotheses).

Financial statement, earnings management, earnings benchmark, voluntary disclosure, information risk

Abstract:
We survey 401 financial executives, and conduct in-depth interviews with an additional 20, to determine the key factors that drive decisions related to performance measurements and voluntary disclosure. The majority of firms view earnings, especially EPS, as the key metric for an external audience, more so than cash flows. We find that the majority of managers would avoid initiating a positive NPV project if it meant falling short of the current quarter's consensus earnings. Similarly, more than three-fourths of the surveyed executives would give up economic value in exchange for smooth earnings. Managers believe that missing an earnings target or reporting volatile earnings reduces the predictability of earnings, which in turn reduces stock price because investors and analysts dislike uncertainty. We also find that managers make voluntary disclosures to reduce information risk associated with their stock but try to avoid setting a disclosure precedent that will be difficult to maintain. In general, management's views support stock price motivations for earnings management and voluntary disclosure, but provide only modest evidence consistent with other theories of these phenomena (such as debt, political cost and bonus plan based hypotheses).

financial statement, earnings management, earnings benchmark, voluntary disclosure, information risk,

Abstract:
We survey 401 financial executives, and conduct in-depth interviews with an additional 20, to determine the key factors that drive decisions related to reported earnings and voluntary disclosure. The majority of firms view earnings, especially EPS, as the key metric for outsiders, even more so than cash flows. Because of the severe market reaction to missing an earnings target, we find that firms are willing to sacrifice economic value in order to meet a short-run earnings target. The preference for smooth earnings is so strong that 78% of the surveyed executives would give up economic value in exchange for smooth earnings. We find that 55% of managers would avoid initiating a very positive NPV project if it meant falling short of the current quarter's consensus earnings. Missing an earnings target or reporting volatile earnings is thought to reduce the predictability of earnings, which in turn reduces stock price because investors and analysts hate uncertainty. We also find that managers make voluntary disclosures to reduce information risk associated with their stock but try to avoid setting a disclosure precedent that will be difficult to maintain. In general, management's views provide support for stock price motivations for earnings management and voluntary disclosure, but provide only modest evidence in support of other theories of these phenomena (such as debt, political cost and bonus plan based hypotheses).

Abstract:
We survey 401 financial executives, and conduct in-depth interviews with an additional 20, to determine the key factors that drive decisions related to performance measurement and voluntary disclosure. The majority of firms view earnings, especially EPS, as the key metric for an external audience, more so than cash flows. We find that the majority of managers would avoid initiating a positive NPV project if it meant falling short of the current quarter's consensus earnings. Similarly, more than three-fourths of the surveyed executives would give up economic value in exchange for smooth earnings. Managers believe that missing an earnings target or reporting volatile earnings reduces the predictability of earnings, which in turn reduces stock price because investors and analysts dislike uncertainty. We also find that managers make voluntary disclosures to reduce information risk associated with their stock but at the same time, try to avoid setting a disclosure precedent that will be difficult to maintain. In general, management's views support stock price motivations for earnings management and voluntary disclosure, but provide only modest evidence consistent with other theories of these phenomena (such as debt, political cost and bonus plan based hypotheses).

financial statement, earnings management, earnings benchmark, voluntary disclosure, information risk

Abstract:
This paper reviews tax research related to domestic and multinational capital structure, payout policy, compensation policy, risk management, and organizational form. For each topic, the theoretical arguments explaining how taxes can affect corporate decision-making and firm value are reviewed, followed by a summary of the related empirical evidence and a discussion of unresolved issues. Tax research generally supports the hypothesis that high-tax rate firms pursue policies that provide tax benefits. Many issues remain unresolved, however, including understanding whether tax effects are of first-order importance, why firms do not pursue tax benefits more aggressively, and whether corporate actions are affected by investor-level taxes.

Capital Structure, Corporate Finance, Compensation, Dividends, Payout Policy, Taxes

Abstract:
This paper reviews tax research related to domestic and multinational capital structure, payout policy, compensation policy, risk management, and organizational form. For each topic, the theoretical arguments explaining how taxes can affect corporate decision-making and firm value are reviewed, followed by a summary of the related empirical evidence and a discussion of unresolved issues. Tax research generally supports the hypothesis that high-tax rate firms pursue policies that provide tax benefits. Many issues remain unresolved, however, including understanding whether tax effects are of first-order importance, why firms do not pursue tax benefits more aggressively, and whether corporate actions are affected by investor-level taxes.

Capital Structure, Corporate Finance, Compensation, Dividends, Payout Policy, Taxes

Abstract:
In February and March of 1999, we surveyed 392 CFOs about the cost of capital, capital budgeting, and capital structure. The survey consisted of 14 main questions, most with subparts - over 100 questions in total. Although the survey was anonymous, we also collected information on 12 characteristics of the firms and management. We asked questions about firm size, foreign sales, industry, CEO education, age of the CEO, CEO tenure, ownership, whether the firm paid dividends, whether the firm was regulated, and the proportion of common stock that the top three executives owned if all their options were exercised. We also collected information on debt-equity ratios and debt ratings. The analysis, published in the 2001 Journal of Financial Economics (http://ssrn.com/abstract=220251), showed that many survey responses differed by the firm and management characteristics.

Our research left much of the data unexplored. In particular, in only one instance in the paper did we perform question-conditional analysis. That is, given a particular response to one question, how does that impact the response on another question. For example, is it the case that those CFOs that use real options analysis in project evaluation decisions also value financial flexibility in capital structure? Given the large number of inquiries we have received for the survey data, we now publicly release the raw data files so that other researchers can conduct question-conditional analysis. Using these data, researchers should be able to obtain CFO survey evidence related to specific aspects of their own research agendas, as well as perform more detailed analysis of the survey responses.

Abstract:
We present new evidence on the distribution of the ex ante risk premium based on a multi-year survey of Chief Financial Officers (CFOs) of U.S. corporations. Currently, we have responses from surveys conducted from the second quarter of 2000 through the third quarter of 2001. The results in this paper will be augmented as future surveys become available. We find direct evidence that the one-year risk premium is highly variable through time and 10-year expected risk premium is stable. In particular, after periods of negative returns, CFOs significantly reduce their one-year market forecasts, disagreement (volatility) increases and returns distributions are more skewed to the left. We also examine the relation between ex ante returns and ex ante volatility. The relation between the one-year expected risk premium and expected risk is negative. However, our research points to the importance of horizon. We find a significantly positive relation between expected return and expected risk at the 10-year horizon.

Abstract:
We present new evidence on the distribution of the ex ante risk premium based on a multi-year survey of Chief Financial Officers (CFOs) of U.S. corporations. Currently, we have responses from surveys conducted from the second quarter of 2000 through the third quarter of 2001. The results in this paper will be augmented as future surveys become available.

We find direct evidence that the 10-year expected risk premium is stable and equal to about 4%. In contrast, the one-year risk premium is highly variable through time. In particular, after periods of negative returns, CFOs significantly reduce their one-year market forecasts, disagreement (volatility) increases and returns distributions are more skewed to the left.

We also examine the relation between ex ante returns and ex ante volatility. The relation between the one-year expected risk premium and expected risk is negative. However, our research points to the importance of horizon. We find a significantly positive relation between expected return and expected risk at the 10-year horizon. Finally, our last survey was delivered September 10, 2001. We are able to measure the increase in perceived risk following the September 11, 2001 crisis.

Risk premium, cost of capital, asymmetric volatility, skewness, leverage effect, expectations, risk to reward, momentum, September 11 crisis

Abstract:
We use a novel sample of 44 tax shelter cases involving public corporations to investigate which types of firms shelter, the magnitude of the tax shelters they use, and whether participating in a shelter affects corporate debt policy. The propensity to shelter increases with firm size, profitability, R&D expenditures, foreign operations, and the market to book ratio. The average deduction produced by the shelters in our sample is very large, equaling approximately nine percent of asset value. This is about three times as large as interest deductions for comparable firms.

Our results suggest that corporations substitute away from debt when using tax shelters. Seven years before they engage in sheltering activity, shelter firms have mean debt ratios of about 25 percent, roughly equivalent to matched firm debt ratios. By the year of the sheltering activity, shelter firm debt ratios have fallen to approximately 18 percent while matched firm debt ratios have not fallen. These results help explain why some firms appear to be under-levered when tax-sheltering activity is ignored, and also why corporate tax payments have fallen so precipitously in recent years.

Taxes, tax shelters, debt, capital structure

Abstract:
We study the derivative holdings of firms facing interest rate and/or currency risk. We net long and short positions to measure the extent of hedging with net notional values. We find that hedging increases with expected financial distress costs, firm size, and investment opportunities. Our evidence is also consistent with firms hedging to increase debt capacity and therefore firm value. We explicitly estimate the convexity in each firm's tax function but do not find evidence that convexity affects corporate hedging. We estimate that the potential increase in value related to tax convexity is much smaller than the tax gain associated with increased debt capacity.

Abstract:
Miscalibration is a standard measure of overconfidence in both psychology and economics. Although it is often used in lab experiments, there is scarcity of evidence about its effects in practice. We test whether top corporate executives are miscalibrated, and whether their miscalibration impacts investment behavior. Over six years, we collect a unique panel of nearly 7,000 observations of probability distributions provided by top financial executives regarding the stock market. Financial executives are miscalibrated: realized market returns are within the executives' 80% confidence intervals only 38% of the time. We show that companies with overconfident CFOs use lower discount rates to value cash flows, and that they invest more, use more debt, are less likely to pay dividends, are more likely to repurchase shares, and they use proportionally more long-term, as opposed to short-term, debt. The pervasive effect of this miscalibration suggests that the effect of overconfidence should be explicitly modeled when analyzing corporate decision-making.

Overconfidence,Behavioral Biases,Behavioral Corporate Finance,Investment Policy,Payout Policy,Managerial Forecast,Survey Methodology,Stock Returns,Capital Structure,Executive Compensation,Risk,Volatility,Stock Market Forecasts,Debt Policy,Dividends,Behavioral Finance,Risk Premium,Managers,Forecasts

Abstract:
A large body of academic research describes the optimal decisions that corporations should make, given certain assumptions and conditions. Anecdotal evidence, however, suggests that the way that corporations actually make decisions is not always consistent with the academic decision rules. In this paper, we analyze a comprehensive survey that describes the current practice of corporate finance. This allows us to identify areas where the theory and practice of corporate finance are consistent and areas where they are not.

Capital structure, Cost of capital, Cost of equity, Capital budgeting, Discount Rates, Project valuation, Survey, Debt policy, Trade-off theory

Abstract:
We analyze several hundred firms that expand via acquisition and/or increase their reported number of business segments. The average combined market reaction to acquisition announcements is positive but, according to the Berger and Ofek (1995) method for valuing conglomerates, the excess values of the acquiring firms decline after the diversifying event. For our sample, half or more of the reduction in excess value occurs because the firms acquire already-discounted business units, and not because combining firms destroys value. We also show that firms that increase their number of business segments due to pure reporting changes do not exhibit reductions in excess value. Our results suggest that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone firms should be carefully reconsidered.

Corporate diversification; Diversification discount; Excess value

Abstract:
We analyze several hundred firms that expand via acquisition and/or increase their reported number of business segments. The average combined market reaction to acquisition announcements is positive but, according to the Berger and Ofek (1995) method for valuing conglomerates, the excess values of the acquiring firms decline after the diversifying event. For our sample, half or more of the reduction in excess value occurs because the firms acquire already-discounted business units, and not because combining firms destroys value. We also show that firms that increase their number of business segments due to pure reporting changes do not exhibit reductions in excess value. Our results suggest that the standard assumption that conglomerate divisions can be benchmarked to typical stand-alone firms should be carefully reconsidered.

Corporate Diversification, diversification discount, excess value

Abstract:
The comprehensive survey reported here allowed analysis of how senior U.S. financial executives make decisions related to performance measurement and voluntary disclosure. Chief financial officers were asked what earnings benchmarks they cared about and which factors motivated executives to exercise discretion—even sacrifice economic value—to deliver earnings. These issues are crucially linked to stock market performance. The results show that the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business. Indeed, the amount of value destroyed by companies striving to hit earnings targets exceeds the value lost in recent high-profile fraud cases.

Financial Statement Analysis, Accounting and Financial Reporting Issues; Equity Investments, Fundamental Analysis and Valuation Models; Corporate Governance

Abstract:
We recently conducted a comprehensive survey that analyzes how senior financial executives make decisions related to performance measurement and voluntary disclosure. In particular, we ask CFOs what earnings benchmarks they care about and which factors motivate executives to exercise discretion, and even sacrifice economic value, to deliver earnings. These issues are crucially linked to stock market performance. Much of the media attention is focused on a small number of high profile firms that have engaged in earnings fraud. Our results show that the destruction of shareholder value through legal means is pervasive, if not a routine way of doing business. Indeed, we assert that the amount of value destroyed by firms striving to hit earnings targets exceeds the value lost in these high profile fraud cases.

Earnings management, earnings smoothing, consensus earnings, meeting benchmarks, value destruction, agency problems, real earnings management, unexpected earnings, earnings surprise, net present value

Abstract:
We analyze the results of the most recent survey of U.S. Chief Financial Officers (CFOs) which looks ahead to the first quarter of 2007 and beyond. We present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond. This multi-year survey has been conducted every quarter from June 2000 to November 2006. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests there is a positive correlation between the ex ante risk premium and real interest rates as reflected in Treasury Inflation Indexed Notes. The level of the risk premium also appears to track market volatility as reflected in the VIX index.

Cost of capital, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX

Abstract:
We present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond based on a survey of U.S. Chief Financial Officers (CFOs). This multi-year survey has been conducted each quarter from June 2000. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests that there is a positive correlation between the ex ante risk premium and real interest rates as reflected in Treasury Inflation Indexed Notes.

Cost of capital, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward

Abstract:
The global credit crisis of 2008 provides a unique opportunity to study the effects of financing constraints on corporate behavior. Based on standard economic priors, we investigate whether this credit supply shock has a differential impact on the real and financial policies of credit constrained firms. In contrast to previous research, which has used proxies such as firm size and credit ratings to measure constraints, we survey 1,050 CFOs in the U.S., Europe, and Asia and directly assess whether their firms are credit constrained. Our evidence shows that the impact of the financial crisis is severe on credit constrained firms, leading to deeper cuts in planned R&D, employment, and capital spending. These firms also burn through more cash, draw more heavily on lines of credit for fear banks will restrict access in the future, and sell more assets to fund their operations. Using our direct measure of constraints, we also find that the inability to borrow externally causes many firms to bypass attractive investment projects, with 86% of constrained U.S. CFOs saying their investment in attractive projects has been restricted during the credit crisis of 2008 and more than half outright cancelling or postponing their investment plans. Our results also hold in Europe and Asia, and in many cases are stronger in those economies.

Financial crisis, financing constraints, investment spending, liquidity management, matching estimators

Abstract:
We survey 1,050 CFOs in the U.S., Europe, and Asia to assess whether their firms are credit constrained during the global credit crisis of 2008. We study whether corporate spending plans differ conditional on this measure of financial constraint. Our evidence indicates that constrained firms planned deeper cuts in tech spending, employment, and capital spending. Constrained firms also burned through more cash, drew more heavily on lines of credit for fear banks would restrict access in the future, and sold more assets to fund their operations. We also find that the inability to borrow externally causes many firms to bypass attractive investment opportunities, with 86% of constrained U.S. CFOs saying their investment in attractive projects was restricted during the credit crisis of 2008. More than half of the respondents say they will cancel or postpone their planned investment. Our results also hold in Europe and Asia, and in many cases are stronger in those economies. Although survey-based analyses have limitations, our evidence adds to the portfolio of approaches and knowledge about the impact of credit constraints on corporate behavior.

Financial crisis, financing constraints, investment spending, liquidity management, matching estimators

Abstract:
This paper estimates how much "interest deductibility" contributes to firm value. By integrating under firm-specific benefit functions, the present value tax benefit of interest deductions is estimated to equal approximately 10% of firm value. The economy-wide benefit peaked at about $118 billion in 1990 (or about $60 billion, net of the personal tax penalty).

The implicit cost of debt is inferred by observing where firms locate on their interest-deduction benefit curves. Paradoxically, profitable firms with low apparent costs are very conservative in their pursuit of interest deductions. Conservative debt policy is persistent and firms do not use their financial slack to fund future capital expenditures or acquisitions.

Abstract:
People are more willing to bet on their own judgments when they feel skillful or knowledgeable (Heath and Tversky (1991)). We investigate whether this "competence effect" influences trading frequency and home bias. We find that investors who feel competent trade more often and have a more internationally diversified portfolio. We also find that male investors, and investors with higher income or more education, are more likely to perceive themselves as competent investors than are female investors, and investors with lower income or less education. Our results are unlikely to be explained by other hypotheses, such as overconfidence or information advantage. Finally, we separately establish a link between optimism towards the home market and international portfolio diversification.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
People are more willing to bet on their own judgments when they feel skillful or knowledgeable (Heath and Tversky, 1991). We investigate whether this 'competence effect' influences trading frequency and home bias. We find that investors who feel competent trade more often and have more internationally diversified portfolios. We also find that male investors, and investors with larger portfolios or more education, are more likely to perceive themselves as competent than are female investors, and investors with smaller portfolios or less education. Our paper also contributes to understanding the theoretical link between overconfidence and trading frequency. Existing theories on trading frequency have focused on one aspect of overconfidence, i.e., miscalibration. Our paper offers a potential mechanism for the 'better-than-average' aspect of overconfidence to influence trading frequency. In the context of our paper, overconfident investors tend to perceive themselves to be more competent, and thus are more willing to act on their beliefs, leading to higher trading frequency.

Behavioral Finance, Investment, Competence, Ambiguity, Stock Trading Frequency, Home Bias

Abstract:
We study stock holdings and trading behavior of more than 60,000 households and find evidence consistent with dividend clienteles. Retail investor stock holdings indicate a preference for dividend yield that increases with age and decreases with income, consistent with age and tax clienteles, respectively. Trading patterns reinforce this evidence: Older, low-income investors disproportionally purchase stocks before the ex-dividend day. Furthermore, among small stocks, the ex-day price drop decreases with age and increases with income, consistent with clientele effects. Finally, consistent with the behavioral attention hypothesis, we document that older and low-income investors purchase stocks following dividend announcements.

Retail investors, Dividend clienteles, Dividend events, Dividend taxation, Attention hypothesis

Abstract:
We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, the median marginal tax rate is 31 percent when option deductions are ignored but falls to 5 percent when one accounts for the deductions. For S&P firms, however, option deductions do not affect marginal tax rates to a large degree. In the spirit of DeAngelo and Masulis (1980), option deductions are important nondebt tax shields that can affect corporate policies. We find evidence consistent with option deductions substituting for interest deductions in corporate capital structure decisions. This evidence explains in part why some firms appear to be underlevered.

Abstract:
We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, including the effect of options reduces the estimated median marginal tax rate from 31 percent to 5 percent. For S&P firms, in contrast, option deductions do not affect marginal tax rates to a large degree. Our evidence suggests that option deductions are important nondebt tax shields and that option deductions substitute for interest deductions in corporate capital structure decisions, explaining in part why some firms use so little debt.

capital structure, corporate taxes, debt policy, employee stock options, option deductions

Abstract:
We estimate firm-specific marginal cost of debt functions for a large panel of companies between 1980 and 2007. The marginal cost curves are identified by exogenous variation in the marginal tax benefits of debt. The location of a given company's cost of debt function varies with characteristics such as asset collateral, size, book-to-market, intangibility, cash flows, and whether the firm pays dividends. By integrating the area between the benefit and cost functions we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit of debt of 10.4% of asset value and an estimated cost of debt of 6.9%. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that the cost of default makes up approximately half of the total ex ante cost of debt.

capital structure, cost of debt

Abstract:
In early 2002, we surveyed 384 financial executives, to determine the factors that drive dividend and share repurchase decisions. Our survey was supplemented by in-depth interviews with an additional 23 executives. The survey consisted of 11 main questions, most with subparts - over 100 questions in total. Although the survey was anonymous, we also collected information on 20 characteristics of the firms and management. We asked questions about firm size, number of employees, industry, CEO education, age of the CEO, CEO tenure, ownership, the proportion of common stock owned by insiders, credit ratings, debt/equity ratios, dividend payout, earnings per share, average price to earnings ratio over the past few years, and the current price of the stock. The analysis was recently published in the September 2005 Journal of Financial Economics (http://ssrn.com/abstract=571046).

Our findings indicate that maintaining the dividend level is on par with investment decisions, while repurchases are made out of the residual cash flow after investment spending. Perceived stability of future earnings still affects dividend policy as in Lintner (1956). However, 50 years later, we find that the link between dividends and earnings has weakened. Many managers now favor repurchases because they are viewed as being more flexible than dividends and can be used in an attempt to time the equity market or to increase earnings per share. Executives believe that institutions are indifferent between dividends and repurchases and that payout policies have little impact on their investor clientele. In general, management views provide little support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play a secondary role.

We provide new analysis of the survey responses which are conditional on the firm and CEO characteristics. In addition, we provide the codebook and original survey data. This allows researchers to conduct question-conditional analysis. It is now possible to address questions like: given the set of respondents that answered one set of questions in a particular way, what are their responses to other questions? We hope that these data spur future research on payout policy.

Payout, Dividend policy, Share repurchases, Survey, Survey data

Abstract:
We provide evidence that corporate tax status is endogenous to the financing decision, which induces a spurious relation between measures of financial policy and many commonly used tax variables. Specifically, both interest expense and lease payments are tax deductible. Thus, a firm that finances its operations with debt or leases reduces its taxable income, potentially lowering its tax rate. This endogeneity of the tax rate can bias an experiment in favor of finding a negative relation between leasing and taxes and against finding a positive relation between debt and taxes. We document that the endogeneity of the marginal tax rate is a very real problem that may confound the interpretation of tax-related effects in previous studies.

We develop a direct measure of the corporate marginal tax rate that is based on taxable income before financing and therefore is not endogenously affected by financing decisions. Using this tax rate, and focusing on operating leases (which are likely to be true leases for tax purposes), we document a negative relation between operating leases and tax rates and a positive relation between debt levels and tax rates. Our leasing result is the first unambiguous evidence that low tax rate firms lease more than high tax rate firms, while the debt result helps resolve the "capital structure puzzle." Previous research has shown that incremental debt financing decisions are positively related to tax rates; our result provides the first evidence linking debt levels to tax rates in a manner that is consistent with the theory.

Abstract:
We provide evidence that corporate tax status is endogenous to the financing decision, which induces a spurious relation between measures of financial policy and many commonly used tax proxies. Specifically, both interest expense and lease payments are tax deductible. Thus, a firm that finances its operations with debt or leases reduces its taxable income, potentially lowering its tax rate. This endogeneity of the tax rate can bias an experiment in favor of finding a negative relation between leasing and taxes and against finding a positive relation between debt and taxes. We document that the endogeneity of the marginal tax rate is a very real problem that may confound the interpretation of tax-related effects in previous studies.We develop a direct measure of the corporate marginal tax rate that is based on taxable income before financing and therefore is not endogenously affected by financing decisions. Using this tax rate, and focusing on operating leases (which are likely to be true leases for tax purposes), we document a negative relation between operating leases and tax rates, and a positive relation between debt levels and tax rates. Our leasing result is the first unambiguous evidence that low tax rate firms lease more than high tax rate firms, while the debt result helps resolve the "capital structure puzzle." Previous research has shown that incremental debt financing decisions are positively related to tax rates. Our result provides the first evidence linking debt levels to tax rates in a manner that is consistent with the theory.

Abstract:
We analyze the history of the equity risk premium from surveys of U.S. Chief Financial Officers (CFOs) conducted every quarter from June 2000 to March 2009. The risk premium is the expected 10-year S&P 500 return relative to a 10-year U.S. Treasury bond yield. The last two surveys were conducted during the darkest parts of a global financial crisis and our results show that the equity premium sharply increased during the crisis. The survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The level of disagreement in late 2008 and early 2009 is 64% higher than 2007 levels. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests the level of the risk premium closely tracks both market volatility (reflected in the VIX index) as well as credit spreads.

Cost of capital, financial crisis, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX, Credit spreads

Abstract:
This paper provides a comprehensive review of Accounting for Income Taxes (AFIT). The first half of the paper provides background and a primer on AFIT. The second half reviews existing studies in detail and makes suggestions for future research. We emphasize the research questions that have been addressed (most of it related to whether the tax accounts are used to manage earnings, and whether the tax accounts are priced in capital markets) and also highlight the areas that to date have not received much research attention. We draw six broad conclusions regarding AFIT research: (1) a comprehensive theoretical framework for interpreting and guiding empirical AFIT studies does not exist; (2) an apparent inconsistency exists between empirical findings that suggest the tax information in the financial statements is useful and the practitioner view that the data are of poor quality; (3) future research should study the disaggregated components of book-tax differences to better explain the underlying causes; (4) we need to better understand whether some empirical findings imply market inefficiency or whether they are driven by market imperfections; (5) the extant empirical research does not take full advantage of panel data econometric techniques and hence it is likely that some of the existing results are overstated; and (6) research opportunities may present themselves as the U.S. moves toward IFRS.

accounting for income taxes, accounting, taxes, earnings management, asset pricing

Abstract:
We study dividend announcements, conditioning on whether the timing of the announcement is anticipated. We find that liquidity deteriorates before (after) anticipated (unanticipated) announcements. We identify both timing and content effects, and also contrast trading volume, price volatility, adverse selection, and price impact separately for anticipated and unanticipated events. Our results generally imply that news announcements reduce information asymmetry. An implication of our analysis is that market reactions around information events differ depending on whether an event's timing is known in advance. Therefore, researchers should consider whether event timing is known ex ante when studying news announcements.

Dividends, news releases, announcements, stock price reactions, stock returns, information flow, scheduled, unscheduled, anticipated, unanticipated

Abstract:
We compare changes in information flow and liquidity around anticipated and unanticipated dividend announcements. When the timing of the news announcement can be anticipated in advance, traditional market microstructure models predict that liquidity will deteriorate before the announcement and return to normal after the announcement. Our empirical results generally confirm these predictions and show that the return to normal happens fairly rapidly. The time required to return to normal increases in the information content of the news announcement.

In a separate sample of surprise dividend announcements (i.e., initiations, the timing of which is not publicly known in advance), our empirical analysis detects abnormal volume, but no change in liquidity prior to the news release. If informed trading occurs before these unanticipated events, it is apparently not detected by market-makers. After the unanticipated dividend announcements, we find that liquidity is low and volume and volatility are high for a short period - but this uncertainty appears to be resolved relatively quickly. We also find that informational asymmetry and price impact decline following dividend initiations.

By contrasting market microstructure for anticipated and unanticipated events, we find results that are generally consistent with microstructure theory that models news announcements as uncertainty-reducing events. We find less evidence that news announcements increase uncertainty by introducing new information that informed traders have an advantage interpreting. The main take-away from our analysis is that market reactions before and after information events differ depending on whether the timing of the event known in advance, implying that researchers should consider whether event timing is ex ante known when studying news announcements.

dividends, news releases, announcements, stock price reactions, stock returns, information flow, scheduled, unscheduled, anticipated, unanticipated

Abstract:
There are two tax incentives for corporations to hedge: To increase debt capacity and interest tax deductions, and to reduce expected tax liability if the tax function is convex. We test whether these incentives affect the extent of corporate hedging with derivatives. Using an explicit measure of tax function convexity, we find no evidence that firms hedge in response to tax convexity. Our analysis does, however, indicate that firms hedge to increase debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Our results also indicate that firms hedge because of expected financial distress costs and firm size.

Corporate hedging; Derivatives; Capital structure; Taxes

Abstract:
There are two tax incentives for corporations to hedge: To increase debt capacity and interest tax deductions, and to reduce expected tax liability if the tax function is convex. We test whether these incentives affect the extent of corporate hedging with derivatives. Using an explicit measure of tax function convexity, we find no evidence that firms hedge in response to tax convexity. Our analysis does, however, indicate that firms hedge to increase debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Our results also indicate that firms hedge because of expected financial distress costs and firm size.

Corporate hedging; Derivatives; Capital structure; Taxes

Abstract:
We analyze the results of a recent survey of U.S. Chief Financial Officers (CFOs) conducted in 2008. We present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond. This multi-year survey has been conducted every quarter from June 2000 to March 2008. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. Using our time series of risk premia, we explore the link between these premia and real interest rates implied in Treasury Inflation Indexed Notes, stock market volatility represented by the VIX index, past stock market returns and equity valuation reflected in price to earnings ratios.

cost of capital, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX

Abstract:
This paper investigates the degree to which personal taxes affect corporate financing decisions. The traditional view is that interest deductibility encourages firms to use debt financing; however, some argue that the personal tax disadvantage to interest negates the corporate tax advantage at the margin (e.g., Miller, 1977). The Miller argument implies that firms should not have tax-driven optimal capital structures.

Cross-sectional regressions that control for personal taxes are performed. The results indicate that debt usage is positively correlated with tax rates in each year 1980-1994, with significant coefficients in almost every year. A specification that adjusts tax benefits for the personal tax penalty statistically dominates a specification that does not. The positive (negative) effect of corporate (personal) taxes on debt usage is distinctly identified.

Overall, the results indicate that personal taxes offset but do not negate the corporate tax advantage to debt. The evidence is consistent with firms having tax-driven optimal capital structures.

Abstract:
The traditional view is that interest deductibility encourages firms to use debt financing; however, some argue that the personal tax disadvantage to interest offsets the corporate tax advantage. This paper investigates the degree to which personal taxes affect corporate financing decisions. In cross-sectional regressions that control for personal taxes, debt usage is positively correlated with tax rates in each year 1980-1994, with significant coefficients in almost every year. A specification that adjusts tax benefits for the personal tax penalty statistically dominates a specification that does not. The positive (negative) effect of corporate (personal) taxes on debt usage is distinctly identified.

Abstract:
A model is developed that implies that if an analyst has high
reputation or low ability, or if there is strong public information that is inconsistent with the analyst's private information, she is likely to herd. Herding is also common when informative private signals are positively correlated across analysts. The model is tested using data from analysts who publish investment newsletters. Consistent with the model's implications, the empirical results indicate that a newsletter analyst is likely to herd on Value Line's recommendation if her reputation is high, if her ability is low, or if signal correlation is high. Recommendations are made about how to test herding models.

Hard Copy Paper requests: Carol Bass at ceb4@mail.duke.edu, ask for working paper 9714.

Abstract:
A model is developed that implies that if an analyst has high reputation or low ability, or if there is strong public information that is inconsistent with the analyst's private information, she is likely to herd. Herding is also common when informative private signals are positively correlated across analysts. The model is tested using data from analysts who publish investment newsletters. Consistent with the model's implications, the empirical results indicate that a newsletter analyst is likely to herd on Value Line's recommendation if her reputation is high, if her ability is low, or if signal correlation is high. Recommendations are made about how to test herding models.

Abstract:
This paper is the first to study the effect of financial restatement on bank loan contracting. Compared with loans initiated before restatement, loans initiated after restatement have significantly higher spreads, shorter maturities, higher likelihood of being secured, and more covenant restrictions. The increase in loan spread is significantly larger for fraudulent restating firms than other restating firms. We also find that after restatement, the number of lenders per loan declines and firms pay higher upfront and annual fees. These results are consistent with the view that banks use tighter loan contract terms to overcome risk and information problems arising from financial restatements.

Abstract:
This paper is the first to study the effect of financial restatement on bank loan contracting. Compared with loans initiated before restatement, loans initiated after restatement have significantly higher spreads, shorter maturities, higher likelihood of being secured, and more covenant restrictions. The increase in loan spread is significantly larger for fraudulent restating firms than other restating firms. We also find that after restatement, the number of lenders per loan declines and firms pay higher upfront and annual fees. These results are consistent with the view that banks use tighter loan contract terms to overcome risk and information problems arising from financial restatements.

Corporate misreporting, financial restatement, corporate fraud, bank loans, financial contracting, cost of debt

Abstract:
We study corporate performance during and after the Great Depression for all industrial firms on the NYSE. Our first goal is to identify the factors that contribute to business insolvency and valuation during the period 1928 to 1938. To this end, we examine factors such as debt policy, credit-worthiness, corporate governance, and investment. Our second goal is to determine whether experiences during the Depression had a lasting effect on corporate decisions in the 1940s.

We find that firms with more debt and lower bond ratings in 1928 had a greater probability of becoming financially distressed during the Great Depression. The value loss associated with high leverage for 'value' firms is very significant, while the effect for 'growth' firms is small. The probability of encountering distress during the Depression is also related to operating profits and firm size in the year prior to the occurrence of distress. We also find that companies with large boards, and boards dominated by insiders, are less likely to survive the Depression. Finally, we find that the Depression experience appears to have affected the preference to use debt, even after the economic environment improved: Firms that were highly levered during the Depression use relatively little debt in the 1940s. Moreover, this behavior appears to be individual - specific because the use of debt increases in the 1940s at companies for which the Depression-era company president retires or otherwise leaves the firm.

Abstract:
By the end of January 2001, all NYSE stocks had converted their price quotations from 1/8ths and 1/16ths to decimals. This study examines the effect of this change in price quotations on ex-dividend day activity. We find that abnormal ex-dividend day returns increase in the 1/16th and decimal pricing eras, relative to the 1/8th era, which is inconsistent with microstructure explanations of the ex-day price movements. We also find that abnormal returns increase in conjunction with a May 1997 reduction in the capital gains tax rate, as they should if relative taxation of dividends and capital gains affects ex-day pricing.

Ex-dividend, transaction costs, taxes, decimalization

Abstract:
By the end of January 2001, all NYSE stocks had converted their price quotations from 1/8ths and 1/16ths to decimals. This study examines the effect of this change in price quotations on ex-dividend day activity. We find that abnormal ex-dividend day returns increase in the 1/16th and decimal pricing eras, relative to the 1/8thera, which is inconsistent with microstructure explanations of the ex-day price movements. We also find that abnormal returns increase in conjunction with a May 1997 reduction in the capital gains tax rate, as they should if relative taxation of dividends and capital gains affects ex-day pricing.

Ex-dividend, transaction costs, taxes, decimalization

Abstract:
Based on a multi-year survey of U.S. Chief Financial Officers (CFOs), we present expectations of the risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond. Our survey also provides measures of the disagreement over the risk premium. We also provide a measure of individual uncertainty in that we ask for each respondent's 80% confidence interval for their risk premium assessment. We combine the June 2005 survey data with 20 historical quarterly surveys that date back to June 2000. We also collect demographic information about our survey participants. Finally, we present the results of other questions on the survey in June 2005 which include assessments of both economy-wide and firm optimism.

Cost of capital, equity premium, hurdle rate, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward

Abstract:
Campbell, Lettau, Malkiel, and Xu (2001) document a positive trend in idiosyncratic volatility during the 1962 to 1997 period. We show that this trend completely reverses itself by 2007, falling below pre-1990s levels. Furthermore, we show that the reversal is concentrated among firms with low stock prices and high retail ownership. This evidence suggests that the increase in idiosyncratic volatility through the 1990s was not a time trend but, rather, an episodic phenomenon, at least partially associated with retail investors. Results from cross-sectional regressions, conditional trend estimation, stock-split events, and attention-grabbing events are consistent with a retail trading effect.

Idiosyncratic volatility, stock market bubbles, retail investors, speculation, stock splits

Abstract:
We analyze the results of the most recent survey of U.S. Chief Financial Officers (CFOs) which looks ahead to the first quarter of 2006 and beyond. We present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond. This multi-year survey has been conducted every quarter from June 2000 to November 2005. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests there is a positive correlation between the ex ante risk premium and real interest rates as reflected in Treasury Inflation Indexed Notes. The level of the risk premium also appears to track market volatility as reflected in the VIX index.

Cost of capital, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX

Abstract:
We document that simulated corporate marginal tax rates based on financial statement data (Shevlin 1990 and Graham 1996a) are highly correlated with simulated rates based on corporate tax return data. We provide algorithms that can be used to estimate the book or tax simulated rates when they are not available. We find that the simulated book marginal tax rate does a better job of explaining financial statement debt ratios than does the analogous tax return variable and discuss how the book simulated rate is likely to be an appropriate measure in settings with global, long-term considerations.

Abstract:
We document that simulated corporate marginal tax rates based on financial statement data (Shevlin 1990 and Graham 1996a) are highly correlated with simulated rates based on corporate tax return data. We provide algorithms that can be used to estimate the book or tax simulated rates when they are not available. We find that the simulated book marginal tax rate does a better job of explaining financial statement debt ratios than does the analogous tax return variable and discuss how the book simulated rate is likely to be an appropriate measure in settings with global, long-term considerations.

marginal tax rate, simulated tax rates, tax return data, financial statements, book tax difference, capital structure

Abstract:
We study the role of firm- and manager-specific heterogeneities in executive compensation. We decompose the variation in executive compensation into time variant and invariant firm and manager components and find that time invariant firm and especially manager fixed effects explain a majority of the variation in executive pay. In addition, we show that including fixed effects alters coefficients and interpretations of other variables. We also find that firm performance improves after CEOs with larger compensation fixed effects are hired, which is consistent with the fixed effect being associated with innate managerial ability or social capital, which in turn leads to better performance. We further explore managerial excess compensation by purging time variant effects and firm, manager, and year fixed effects, and show that firms with over-paid managers adopt financial structures that increase job security.

Executive compensation, CEO pay, latent managerial ability, human capital, fixed effects, manager fixed effects, capital structure

Abstract:
We survey 328 financial executives to determine the effects of the May 2003 dividend tax cut on corporate payout policy. We find that the tax cut led to initiations and dividend increases at some firms, weakly more so at firms for which retail investors are particularly important. However, financial executives say that the tax rate reduction ranks behind stability of future cash flows and cash holdings (and for firms already paying dividends, taxes also rank behind the historic level of dividends) in a list of factors that affect dividend policy. Tax effects are of roughly the same importance as attracting institutional investors and the availability of profitable investments. We also search press releases and find that the dividend tax cut is only occasionally mentioned as the reason for an initiation, especially from 2004 onward. Overall, the evidence indicates that dividend tax rates are a second-order concern in setting payout policy.

Payout, Dividend policy, Share repurchases, Tax cut, Press Release

Abstract:
The focus of the current credit crisis is on the immediate implications, such as reduced profits and increased unemployment. In contrast, we show that there are worrisome long-term economic consequences of the crisis through its effect on financially constrained firms. Using a survey of over 1,000 CFOs in the United States, Europe and Asia, we show that firms are cutting back or canceling projects that they know add to firm value. The elimination of profitable projects is especially acute for firms that face financial constraints. One of the basic tenets of finance is that projects that enhance firm value should be pursued. Financial constraints potentially prevent the funding of these projects. The current credit crisis is an ideal setting to measure the impact of constraints on value creation. Turning down or canceling profitable projects is a lesser known cost of the current financial crisis. Our evidence suggests that in the scramble for short-term cash flow, firms are sacrificing long-term value. This implies lower future growth opportunities and lower future employment growth.

Financial crisis, financing constraints, investment spending, liquidity management, matching estimators

Abstract:
In this paper, we investigate the effect of stock options on the tax position of the firm. We argue that option tax deductions can significantly affect a firm's marginal tax rate and that the effect is masked by current financial reporting rules. We present an approach for factoring in option deductions in assessing a firm's tax position and document that the effect can be substantial. In particular, many firms that appear to be profitable and face high income tax burdens (based on public financial statement data) actually pay relatively little in taxes. We provide evidence that the effect of options on taxes may help to explain managerial decisions such as why apparently profitable firms carry so little debt, lease rather than purchase, and out-source tax-advantaged activities, such as research and development, to syndicated partnerships.

Employee stock options, corporate tax rate, capital structure, debt ratio, cash flows

Abstract:
We analyze the results of the September 2005 survey of U.S. Chief Financial Officers (CFOs). We present expectations of the equity risk premium measured over a 10-year horizon relative to a 10-year U.S. Treasury bond. This multi-year survey has been conducted every quarter from June 2000 to September 2005. Each quarter the survey also provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk premium assessment. We also present evidence on the determinants of the long-run risk premium. Our analysis suggests there is a positive correlation between the ex ante risk premium and real interest rates as reflected in Treasury Inflation Indexed Notes. The level of the risk premium also appears to track market volatility as reflected in the VIX index.

Cost of capital, equity premium, long-term market returns, long-term equity returns, expected excess returns, disagreement, individual uncertainty, skewness, asymmetry, survey methods, risk and reward, TIPs, VIX

Abstract:
We analyze the advice contained in a sample of 237 investment strategies over the 1980-1992 period. Each newsletter strategy recommends a mix of equity and cash. We construct portfolios based on these recommendations and find that only a small number of the newsletters appear to have higher average returns than passive portfolios constructed to have the same returns variance. We test the timing abilities of newsletters by examining how often newsletters correctly change their equity weights. Our evidnece shows that the newsletters offer unimpressive asset allocation advice. Knowledge of the asset allocation weights also implies knowledge of the exact conditional betas. As a result, we present direct tests of market timing ability that bypass beta estimation problems. Assuming that different letters cater to investors with different risk aversions, we are able to infer each newsletter's forecasted market returns. The standard deviation of newsletters' forecasts provides a natural measure of disagreement in the market. We find that the degree of disagreement contains information about both market volatility and trading activity.

Newsletter performance, market timing

Abstract:
As liquidity became scarce and internal profits plunged, many firms were forced to rely on bank lines of credit during the 2008-9 financial crisis. Surprisingly, little is known about these credit facilities in general, let alone about their importance during a crisis. This paper investigates a unique dataset that describes how public and private firms in the U.S. and abroad use lines of credit during early 2009. Our analysis emphasizes the interaction between internal funds, external funds, and real decisions such as corporate investment and employment. Among other things, we find that firms that are "credit constrained" (small, private, non-investment grade, and unprofitable) have larger credit lines (as a proportion of assets) than their large, public, investment-grade, profitable counterparts both before and during the crisis. Constrained firms draw more funds from their credit lines and are more likely to face difficulties in renewing or initiating new lines during the crisis. The terms of credit line facilities changed significantly with the crisis: maturities declined; and commitment fees and interest spreads went up for all firms, but particularly for constrained firms. Our evidence suggests that while being profitable helps firms establish credit lines, it does not monotonically lead to increased use. Instead, lines of credit are used when internal funds (cash stocks and cash flows) decline. Looking at real-side decisions, our estimates suggest that lines of credit provide the liquidity "edge" firms need to invest during the crisis.

Financial crisis, investment, liquidity management, lines of credit

Abstract:
We study a period of severe disequilibrium to investigate whether board characteristics are related to corporate debt, investment policy, and firm value. Before 1930 and after 1938, when many firms plausibly operated with optimal or near optimal governance structures, we find no relation between firm performance and board attributes. During the 1930-1938 Depression era, when the corporate sector was severely shocked by an unprecedented downturn, we document a relation between board characteristics and firm performance that varies in economically sensible ways: Complex firms (that would benefit from board advice) exhibit a positive relation between board size and firm value, and simple firms exhibit a negative relation between board size and firm value (consistent with any benefits of larger boards for simple firms being more than offset by increased costs). Simple firms with large boards also invest more (or shrink less) and use more debt (or reduce debt less) during the 1930s depression. We document similar effects for the number of outside directors on the board. The results are consistent with agency problems existing in simple firms with large boards during the Depression, and these firms not downsizing adequately in response to a severe economic contraction.

Corporate Governance, Capital Structure, Investment Policy, Great Depression, Firm Stock Market Value

Abstract:
Tax code IRS Section 162(m) effective prohibits corporate tax deductibility of non-performance based compensation expenses over $1 million for any one of its top 5 employees. This $1 million cap also applies to all forms of compensation if a firm has an insider on its compensation committee, thus imposing differing cost of compensation on firms with differing compensation committee structures. Using the introduction as a natural experiment, we provide evidence of agency problems and private benefit seeking behaviors that increases with managerial entrenchment and interlocked compensation committee. We find a significant salary reduction for executives dropping their interlock statuses as a result of 162(m). More broadly, we examine 162(m)'s effect on compensation and describe where it is ineffective or has unintended consequences.

Corporate Governance, Executive Compensation, Insiders, Interlock, Corporate Taxes

Abstract:
Traditional economic theory suggests no role for managerial attitudes in forming corporate policies. In contrast, our paper provides striking evidence based on psychometric tests administered to CEOs that personal (or behavioral) traits such as managerial risk aversion, time preference, and optimism are related to corporate financial policies. We also provide evidence consistent with a matching between the behavioral traits of executives and the kinds of companies they join; that is, certain types of firms attract executives with particular psychological profiles. Further, we provide new evidence that behavioral traits help explain compensation structure. Finally, we offer evidence that U.S. CEOs differ from non-U.S. CEOs in terms of their underlying attitudes. CEOs are also significantly more optimistic and risk-tolerant than the lay population.

Managers, attitudes, risk aversion, capital structure, debt, acquisitions, corporate policies, behavioral corporate finance

Abstract:
Using data from a survey of tax executives, we examine the corporate response to the one-time dividends received deduction in the American Jobs Creation Act of 2004 (AJCA). We describe the firms' reported sources and uses of the cash repatriated under the Act. In addition, we examine non-tax costs companies incurred rather than bringing the cash home prior to the AJCA. We also contribute to current policy debates by examining whether firms would repatriate reinvested earnings again if a similar Act were to occur in the future and the likelihood that firms assess on there being another such Act. Overall, the evidence is consistent with a substantial lockout effect resulting from the current U.S. tax policy of taxing the worldwide profits of U.S. multinationals.

repatriation, tax, American Jobs Creation Act, Homeland Investment Act, dividends received deduction, trapped equity, international tax, trapped cash, Section 965, stimulus, tax amnesty

Abstract:
Do firms issue stock when prices seem irrationally high? Do they invest or save the proceeds from the sale of overvalued stocks? Is value created or destroyed in the process? This paper uses a novel identification strategy to tackle these questions. We examine the capital investment, stock issuance, and cash savings behavior of financially constrained and unconstrained non-tech manufacturers (old economy firms) around the 1990's technology bubble. Our results suggest that, because they relax financing constraints, high stock prices affect corporate policies. In particular, during the bubble, constrained non-tech firms issued equity in response to mispricing and used the proceeds to invest. They also saved part of those funds in their cash accounts. We do not find similar patterns for unconstrained non-tech firms, neither for tech firms. Our findings do not support the notion that managers systematically issue overvalued stocks and invest in ways that transfer wealth from new to old shareholders, destroying economic value. Rather, our evidence implies that what appears to be overvaluation in one sector of the economy may have welfare-increasing effects across other sectors.

Abstract:
Do firms issue stock when prices seem irrationally high? Do they invest or save the proceeds from the sale of overvalued stocks? Is value created or destroyed in the process? This paper uses a novel identification strategy to tackle these questions. We examine the capital investment, stock issuance, and cash savings behavior of financially constrained and unconstrained non-tech manufacturers ("old economy firms") around the 1990's technology bubble. Our results suggest that, because they relax financing constraints, high stock prices affect corporate policies. In particular, during the bubble, constrained non-tech firms issued equity in response to mispricing and used the proceeds to invest. They also saved part of those funds in their cash accounts. We do not find similar patterns for unconstrained non-tech firms, nor for tech firms. Our findings do not support the notion that managers systematically issue overvalued stocks and invest in ways that transfer wealth from new to old shareholders, destroying economic value. Rather, our evidence implies that what appears to be overvaluation in one sector of the economy may have welfare-increasing effects across other sectors.

Stock markets, real investment, bubbles, financial constraints, endogeneity

Abstract:
We investigate how the length of the net operating loss carryback period affects corporate liquidity and marginal tax rates. We estimate that extending the carryback period from two to five years, as recently proposed in President Obama’s budget blueprint, would provide $19 ($34) billion of additional liquidity to the corporate sector for 2008 (2009). Our calculations imply that the benefits of the extended carryback period would be concentrated in the homebuilding, automobile, and financial industries. Extending the carryback period would increase the marginal tax rate of loss firms by more than 200 basis points on average, which all else equal would lead corporations to use an additional $8 ($10) billion of debt and reduce tax payments by another $1.2 ($1.5) billion in 2008 (2009). Overall, the tax break proposed by the Obama administration would have a significant liquidity effect on corporations suffering large losses in recent years. If the tax proposal were extended to include TARP firms, the liquidity effect would triple in size.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
We investigate how the length of the net operating loss carryback period affects corporate liquidity and marginal tax rates. We estimate that extending the carryback period from two to five years, as recently proposed in President Obama’s budget blueprint, would provide $19 ($34) billion of additional liquidity to the corporate sector for 2008 (2009). Our calculations imply that the benefits of the extended carryback period would be concentrated in the homebuilding, automobile, and financial industries. Extending the carryback period would increase the marginal tax rate of loss firms by more than 200 basis points on average, which all else equal would lead corporations to use an additional $8 ($10) billion of debt and reduce tax payments by another $1.2 ($1.5) billion in 2008 (2009). Overall, the tax break proposed by the Obama administration would have a significant liquidity effect on corporations suffering large losses in recent years. If the tax proposal were extended to include TARP firms, the liquidity effect would triple in size.

Loss Carryback, Tax Cut, Tax Stimulus, Corporate Tax Payment, Obama Tax Proposal, Tax Relief, Corporate Liquidity, Marginal Tax Rate, Federal Tax Revenue

Abstract:
We analyze survey responses of nearly 600 tax executives to better understand decisions related to location of operations, reinvestment, and profit repatriation. Prior literature does not examine how these decisions are affected by the ability to avoid recording for financial reporting purposes the U.S. income tax expense on foreign earnings. Our evidence indicates that avoiding financial accounting expense is an important influence on decisions about where firms locate operations, as well as whether to reinvest or repatriate foreign earnings. Indeed, the importance of avoiding expense recognition is statistically indistinguishable from the importance of avoiding real, cash taxes. This result is important in light of the decades of research on location and repatriation decisions that examines cash tax implications but has heretofore not investigated the importance of financial reporting effects. Our analysis suggests that financial reporting considerations could be one cause of "trapped" equity and high foreign cash holdings.

investment, reinvestment, repatriation, tax expense, multinational, tax policy, tax stimulus, tax reform

Abstract:
Miscalibration is a standard measure of overconfidence in both psychology and economics. Although it is often used in lab experiments, there is scarcity of evidence about its effects in practice. We test whether top corporate executives are miscalibrated, and whether their miscalibration impacts investment behavior. Over six years, we collect a unique panel of nearly 7,000 observations of probability distributions provided by top financial executives regarding the stock market. Financial executives are miscalibrated: realized market returns are within the executives' 80% confidence intervals only 38% of the time. We show that companies with overconfident CFOs use lower discount rates to value cash flows, and that they invest more, use more debt, are less likely to pay dividends, are more likely to repurchase shares, and they use proportionally more long-term, as opposed to short-term, debt. The pervasive effect of this miscalibration suggests that the effect of overconfidence should be explicitly modeled when analyzing corporate decision-making.

Abstract:
We analyze the advice contained in a sample of 237 investment letters over the 1980-1992 period. Each newsletter recommends a mix of equity and cash. We construct portfolios based on these recommendations and find that only a small number of the newsletters appear to have higher average returns than a buy-and-hold portfolio constructed to have the same variance. Knowledge of the asset allocation weights also implies knowledge of the exact conditional betas. As a result, we present direct tests of market timing ability that bypass beta estimation problems. Assuming that different letters cater to investors with different risk aversions, we are able to imply the newsletters' forecasted market returns. The dispersion of the newsletters' forecasts provides a natural measure of disagreement in the market. We find that the degree of disagreement contains information about both market volatility and trading activity.

Abstract:
In this paper, the authors analyze the results of the most recent survey of US Chief Financial Officers (CFOs), which looks ahead to the first quarter of 2007 and beyond. They present the expectations of the equity risk premium measured over a ten-year horizon relative to a ten-year US Treasury bond. This multi-year survey has been conducted every quarter from June 2000 to November 2006. Each quarterly survey provides measures of cross-sectional disagreement about the risk premium, skewness, and a measure of individual uncertainty. The individual uncertainty is deduced from the 80% confidence interval that each respondent provides for his or her risk Premium assessment. The authors also present evidence on the determinants of the long run risk premium. The analysis suggests that there is a positive correlation between the ex ante risk premium and real interest rates as reflected in the Treasury Inflation Indexed Notes. The level of risk premium also appears to track market volatility as reflected in the VIX index.

Abstract:
We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, including the effect of options reduces the estimated median marginal tax rate from 31% to 5%. For S&P firms, in contrast, option deductions do not affect marginal tax rates to a large degree. Our evidence suggests that option deductions are important nondebt tax shields and that option deductions substitute for interest deductions in corporate capital structure decisions, explaining in part why some firms use so little debt.

Capital structure, corporate taxes, debt policy, employee stock options, option deductions

Abstract:
Do taxes affect corporate debt policy? This paper answers this question by testing whether the incremental use of debt is positively related to firm-specific, tax-code-consistent marginal tax rates. Using annual data for almost 10,000 firms for the years 1980-1992, evidence is provided which indicates that high-tax-rate firms issue more debt than their low-tax-rate counterparts. The estimated marginal tax rates exhibit substantial cross-sectional and time-series variation.

Abstract:
This paper focuses on how to best measure the corporate marginal tax rate, which is an important input into analysis of the cost of capital, financing policy, corporate hedging, corporate reorganizations, and the relative pricing between taxable and tax-advantaged securities. The results indicate that the simulated tax rate used by Shevlin (1990) and Graham (1996) is the best available proxy for the "true" marginal tax rate; however, the simulated variable is difficult to calculate. If the simulated rate is unavailable, a very easy-to-calculate trichotomous variable and the statutory marginal tax rate are reasonable alternatives, better than most commonly used tax variables. The difficult task of forecasting taxable income is also discussed.

Abstract:
Can economists forecast the direction of economic growth? Casual observation indicates that individual economists make poor predictions of economic growth and that their forecasts are highly correlated. This paper examines the loss of information resulting from correlation and develops a method of combining forecasts which are cross-sectionally correlated. This approach greatly increases the accuracy of near-term forecasts of the direction of economic growth, although the individual with the best historical performance is better over longer horizons. Overall, when the data are properly aggregated, economists predict the direction of near-term economic growth and call turning points reasonably well.

Abstract:
This paper focuses on how best to measure the corporate marginal tax rate, which is an important input into financial analysis of the cost of capital, financing policy, corporate hedging, and corporate reorganizations. The results indicate that the simulated tax rate used by Shevlin (1990) and Graham (1996), although difficult to calculate, is the best available proxy for the "true" marginal tax rate. If the simulated rate is unavailable, an easy-to-calculate trichotomous variable or the statutory marginal tax rate (which captures the progressivity in the tax rate schedule) are reasonable alternatives, better than most commonly used tax variables. The difficult task of forecasting taxable income is also discussed.

Abstract:
We quantify the tax savings from hedging by modeling major provisions of the tax code. Using data from COMPUSTAT, we simulate likely tax savings from reducing the volatility of taxable income. The average tax savings from a 5 percent volatility reduction is $142,360 or about 3 percent of taxable income. In identifiable cases, the savings approach 8 percent. To judge the importance of these magnitudes: (1) This tax-related benefit of hedging must be compared with the cost of hedging; (2) it should be considered that tax savings from hedging are not mutually exclusive from other hedging benefits.