Innovations in Investments and Corporate Finance: Volume 7

In this article, we review the recent academic research on the valuation of Internet companies. In particular, we focus on the valuation method(s) which were said to be suitable for new economy start-ups in the boom years 1998–2000, and conclude that they were neither novel nor very accurate. Since the downturn in the sector, the valuation focus has returned to advanced fundamental valuation methods such as real options valuation.

Using three subsamples of subjects that differ in their level of formal education and knowledge in economics, this experimental study of intertemporal discount rates finds that subjective discount rates decrease with the time delay and monetary sum, and are higher for postpone-a-receipt than for a postpone-a-payment scenario. The findings indicate the existence of market segmentation, implicit risk and a weak added compensation. The findings also imply that subjective discount rates are lower and closer to real market rates of interest for subjects having higher levels of formal education and economics knowledge.

We examine relations between institutional ownership and quoted bid-ask spreads in general, and the adverse-selection component of the spread in particular. For our sample of Nasdaq stocks, we find that high institutional ownership leads to narrower spreads and spreads with a smaller proportion attributable to asymmetric information. Our results are not attributable to institutions' preferences for liquid securities. The relation between spreads and institutional ownership varies significantly across institutional type and is related to the largest block size held by an institution. Our evidence suggests that increases in institutional ownership reduce the costs of liquidity services by ameliorating informational asymmetries.

There continues to be much interest in the impact of internal funds on the level of corporate investment activity. While some studies provide evidence that investment decisions of firms that are financially constrained are more sensitive to the availability of internal funds than those of less constrained firms, other studies show the opposite, i.e. investment decisions of the most credit-worthy firms are most sensitive to internal funds availability. This paper tests these opposing propositions for U.S. firms using data for a longer and more recent period than in prior studies. The results support the latter view, i.e. investments at financially constrained firms are less sensitive to internal cash flows than in financially less constrained firms. Regardless, investments levels are found to be positively related to internal cash flows for all types of firms and for all periods examined indicating a pecking order in financing (firms prefer first using internal funds and only then go to external funds).

We derive a version of the CAPM in which investor preferences depend only on the mean and variance of the ratio between the portfolio return and a reference return. The reference return is specific to each investor, and can also be interpreted as a proxy of the consumption of his neighbors. That is, investors in our economy care about how much they consume relative to their neighbors. The model provides a rational potential explanation for the home bias enigma and for other pricing anomalies.

The subject of this manuscript is marketing of a financial concept, or principle. Despite copious empirical support and scientific acceptance, the concept of capital market efficiency has not gained widespread appreciation among the general investing public. Reasons for this apparent communication failure are examined, and an integrated remedial program is outlined. If the financial academic community wants the market efficiency idea to be noticed, let alone accepted, by investors, then better marketing, primarily promotion, will be needed.

Using a sample of telecommunications mergers during the 1990–1993 period, we find that acquiring firms underperform relative to their size and industry-matched control firms. The annual cumulative abnormal returns (CARs) to these firms are significantly negative for five years following the merger. Shareholders of the acquiring firm suffer a wealth loss of nearly 20% over the five-year post-merger period. We obtain similar results from three- and five-year holding period returns (HPRs). Our findings are consistent with those of earlier studies and indicate that regulated industries also experience post-merger underperformance. We do find upon disaggregation of the sample that larger mergers exhibit positive long-run performance while the mid-size and smaller mergers underperform relative to their control firms. We further observe that conglomerate mergers demonstrate superior long-run performance while that for non-conglomerate mergers is consistent with the aggregate sample findings and suggests significant underperformance.

This study investigates the reasons for the disagreement among takeover studies on whether the return to bidders (short-term and long-term) is zero or negative. It documents that the two-day announcement-period bidder returns are inversely related to the size and age of targets, but positively related to the age of bidders. Conversely, five-year buy-hold returns (adjusted for size, market-to-book equity, and price momentum) if measured from the date of announcement are positively related to the size of targets, and if measured from the date of resolution are negatively related to the age of bidders. These and other findings are taken to suggest that if takeover studies impose different restrictions on the size and/or age of firms in the sample (and the study documents that they do), they could end up with contradictory findings about bidder returns.

This study examines the underlying factors which influence and cross-sectionally explain differences in the degree of dividend smoothing of firms. Differences in corporate dividend smoothing are documented by estimating the sensitivity of corporations' dividend payout ratios to changes in earnings. Theoretical determinants of dividend smoothing are investigated by cross-sectionally regressing the degree of dividend smoothing of firms against firm characteristics. The results show that riskier firms and smaller firms are more likely to smooth dividends. The empirical relationship between dividend smoothing and firm characteristics is much more significant for high growth firms, and varies considerably amongst sub-groups of the data that differ with respect to firm risk.

This paper examines the risk-shifting and delayed equity hypotheses concerning the use of convertible securities by Japanese firms. The popularity of equity-linked debt instruments in Japan where institutional arrangements can mitigate the transfer wealth from bondholders to stockholders appears inconsistent with the risk-shifting hypothesis. Further, we find that the probability of selecting convertible securities over common equity is not positively related to the potential for a wealth transfer from bondholders to stockholders. We obtain similar results when we examine convertible debt ratios. However, we find evidence consistent with the delayed equity hypothesis that firms use convertibles to delay equity when they have favorable information about the firm. The stock price increases preceding and following convertible issuance are positively related to offering size and growth opportunities as predicted by the delayed equity hypothesis. Overall, our findings endorse the delayed-equity hypothesis as an explanation for the use of convertible securities by Japanese firms.