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Abstract:
While most efforts in corporate finance focus on how firm characteristics influence financing decisions, recent studies indicate that interest rates can influence tax shields and bankruptcy costs, affecting the optimal capital structure. Using a yield curve factor model, I examine how interest rates affect the debt-equity choice. While the T-bill yield affects the likelihood of debt financing positively, the T-bond yield and the yield curve volatility affect the likelihood of debt financing negatively. These effects are partially due to the changes of tax shields and bankruptcy costs caused by the interest rate movements.

interest rates, corporate financing decisions, debt-equity choice, tax shields, bankruptcy costs, trade-off theory

Abstract:
To understand the performance implications of corporate strategies as conditioned by business group affiliations, we analyze the relationship between corporate diversification and performance for 889 Indian firms. We find that diversified firms perform significantly worse than focused firms and that there exists a significant negative relationship between the degree of diversification and firm performance. A comparative analysis of firms affiliated with Indian business groups and those affiliated with MNCs indicates that sources of negative impact of diversification on performance are conditioned by the nature of a firm's affiliation. For multinational affiliates, diversification appears to be associated with poor asset quality and asset management, which is an indicator of possible agency conflict. For domestic business group affiliates, diversification appears to generate cost inefficiencies leading to poor performance.

Diversification discount, Operating performance, Agency cost, Business groups, Emerging markets

Abstract:
This study develops a model of dynamic capital structure in the presence of stochastic interest rates. Having separated the impact of firm characteristics, the paper shows that the optimal leverage and maturity are positively related to the short-term interest rates and negatively associated with the long-term interest rates. The volatility of interest rates affects the optimal leverage negatively. The optimal maturity is related to the volatility positively (negatively) when the yield curve is normal (inverted). The aforementioned are due to the changes in the firm's tax shields, bankruptcy costs and recapitalization costs caused by interest rate movements.

dynamic capital structure, stochastic interest rates, contingent claim pricing, corporate tax, bankruptcy, static trade-off

Abstract:
Macroeconomic conditions are known to affect risks factors and thereby influence asset returns within a given economy. We explore this link in a global setting. Given the dominant role the U.S. economy plays in the global economic environment, U.S. Macro economic shocks are expected to affect asset returns in other countries. The impact should be more pronounced in the developed economies where the U.S. is a large trading and capital-flows partner. Our results shows that residual returns and conditional volatilities in major developed economies are significantly impacted by US macroeconomic surprises. We identify U.S. macro economic shocks that have spillover impact on global asset returns over and above those transmitted through equity market returns. While return levels are significantly influenced by productivity and retail sales surprises, return conditional volatilities are mainly influenced by inflation, personal income, industrial production, leading indicators, and gross domestic product surprises.

Macroeconomic Announcements, forecasts, surprises, USA, Europe

Abstract:
Ferguson and Shockley (2003) demonstrate that by utilizing an equity-only proxy for the market index, an empirical single factor capital asset pricing model can lead to anomalies. As most extant studies, they show that information from firms' liabilities-equity structures, per se, leverage and distress, can improve factor pricing models. We show that information about asset structure, per se, firm's asset liquidity (i.e. cash holdings) and business risk, can be as important. We complement Ferguson and Shockley's (2003) leverage based-theory with a liquidity based-theory. We show that since by adding cash to the asset mix, a firm can substantially change the investment opportunity set, asset liquidity and business risk should affect asset prices.

We first explore the pertinence of cash holdings theoretically. In our economy, the capital asset pricing model holds in theory. True betas are calculated with respect to aggregate wealth, and proxy betas might not take into account the cash holdings of the firms. We show that the true beta of the firm's assets is higher than a proxy beta of the firm's assets that 'forgets' the riskless assets of the economy. The true stock beta of a firm is also higher than the proxy stock beta that does not take into account the riskless assets held by the firms. By other words, systematic risk is underestimated when the economy's aggregate cash holdings are not recognized as a valuable asset.

Our empirical analysis shows that asset liquidity and business risk are priced factors in an extended asset pricing framework of Fama and French. In the cross-section of firms, we regress the observed returns on the erroneous proxy betas and then show that the alpha and beta coefficient estimates from a one-factor model would be different from the CAPM pricing error and market price of risk, respectively. Furthermore, we also show that well-known pricing factors such as size, book-to-market, leverage, and distress could serve as instruments that capture asset liquidity (i.e. cash holdings) and business risk. We show that the asset liquidity or cash holdings and business risk have significant risk premiums. We also show that while our asset liquidity and business risk factors partly correlate with the Fama-French size and book-to-market factors, and the Ferguson-Shockley leverage and distress factors, they still represent uncaptured risk that significantly affects equity betas.

Multifactor Asset Pricing, Asset Liquidity, Business Risk, Cash holdings, Fama-French Factors

Abstract:
In this paper, we evaluate external capital issuance from the perspective of an optimizing agent in a static choice framework. Thus, the issue choice affords a glimpse into the decision-making process of public companies. In the context of this decision, we examine the extent to which we are able to quantify the heterogeneity across firms. To this end, we estimate a hierarchical choice model where the utility derived from each alternative depends only on characteristics (e.g., costs) of that alternative. In the model, firm's responses to these characteristics are functions of that firm's attributes. We find that the higher the cost of an alternative, the lower is the indirect utility derived from that alternative (in a manner that is fully consistent with choice theory). Furthermore, this budget constraint effect is significantly influenced by firm attributes. For instance, more profitable firms are less cost-sensitive in their issuance choices.

External financing choice

Abstract:
Motivated by failures of iconic corporate hallmarks like Enron and WorldCom, in July of 2002 the Sarbanes-Oxley Act was passed to prevent managerial misconduct and deceptive accounting in an effort to ensure incentives alignment between managers and shareholders. Whether the Act has been effective in mitigating the problems that it set out to resolve is the subject of a lively debate, discussion and research. Most current analyses of the Act focus on stock market evidence because it assumes that underpinning agency conflicts that gave rise to high-profile corporate failures of 2001 - 2002 were exclusively limited to incentive misalignments between managers and investors. If the managerial misconducts and accounting deceptions were a reflection of a different agency conflict, per se that of managers and bondholders, then the evidence from corporate bond markets would be much more telling simply because the brunt of such an agency cost would be borne by creditors (Myers, 1977). These iconic debacles trace back to managerial engagement in extremely risky projects and overexpansion in an attempt to meet unreasonable expectations. Equipped with complex accounting practices which made disclosure effectively a voluntary managerial decision, as Shin (2003) predicts, managers 'rolled the dice' with shareholders' fortunes, hoped for unlikely favorable results that could meet unreasonably high expectations, and hide their failures. This of course is the classical Myers' (1977) asset substitution. Since bondholders bear the cost of wealth transfer due to asset substitution, a priori, they will charge a premium. In fact Leland (1998) shows that while agency cost as a percentage of firm value increases moderately with firm's riskiness, the bonds' credit spreads exponentially rise. Examining the impact of the Sarbanes-Oxley on credit spreads then provides us with an excellent setting to determine to what extent manger/bondholder agency problems affects corporate bonds and the firm value. Using a panel regression analysis of credit spreads and controlling for a host of determining variables, we investigate how the Sarbanes-Oxley Act has changed the credit spreads. We show that the Act indeed has caused one third of the 150 basis points increase in credit spreads preceding the passage of the Act to dissipate, implying that the Act succeeded in partially resolving underlying problems.

Sarbanes-Oxley, Credit Spreads, Asset Substitution, Overinvestment

Abstract:
Using a stylized construct where analysts wish to minimize their forecasting error, we model forecasted earnings when firm characteristics and prior forecasts are public information but analysts can gain private information by appeasing management via deviating from the consensus. Combining endogenously acquired private information with consensus beliefs, analysts determine the optimal forecast deviation. We analytically show and empirically verify that the degree of rational deviation is influenced by analysts' experience and the degree of information asymmetry about the firm's prospects. An analyst's rational deviation increases with information asymmetry, but is concavely related with experience, i.e., deviation increases with analyst experience but actually decreases when an analyst is a novice or highly seasoned.

Financial analysts, forecast accuracy, information asymmetry, forecast deviation

Abstract:
Evidence from hedging practices suggests that firms will only hedge if they expect unfavorable events to arise. Stulz (1990) argues that selective hedging will only enhance value when the firm has an information advantage over the market, which enables the firm to foresee price movements. In markets with a significant degree of information asymmetry where hedgers are oligopolists with superior knowledge concerning supply and demand, like oil and gas futures, we contend that these companies will selectively hedge oil and gas price movements, causing sharp price adjustments upon resolution of information asymmetry. Using aggregate analysts' surprise as a proxy for the degree of information asymmetry, we show that positive aggregate surprises lead to a price decline for futures, which indicates that these firms unload their futures when the outlook is favorable.

Futures, hedging, analysts

Abstract:
This study examines the market for delinquent property tax certificates, a commonly used enforcement mechanism in property tax systems around the United States. We model the value of such certificates using a continuous-time framework and propose a statistical model that allows testing for factors that affect interest rates charged by investors who purchase the certificates as investment instruments. Using sample data from tax certificate sales in Florida from 1982 to 2000, we find that interest rates charged by investors who purchase the certificates as investment instruments. Using sample data from tax certificate sales in Florida from 1982 to 2000, we find that interest rates on certificates are negatively and signiciantly related to assessed property value and homestead status, and positively related to local ownership. We find an inverse relationship between interest rates and the number of certificates purchased by the certificate investor, indicating a significant clientele effect in this market. We also find that the implied effective tax rate is positively related to the interest rates charged by investors. Overall, the findings provide insight into the function of this unique market niche.