Financial Risk Management, Firm Structure & Valuation, an Empirical Analysis.

Rapport de recherche

Corporate cash-pool valuation in a multi-firm context: a closed formula

Following our earlier paper on the subject, we present a general closed formula to value the interest savings due to a multi-firm cash-pool system. Assuming normal distribution of the accounts the total savings can be expressed as the product of three independent factors representing the interest spread, the number and the correlation of the firms, and the time-dependent distribution of the cash accounts. We derive analytic results for two special processes one characterizing the initial build-up period and the other describing the mature period. The value gained in the stationary system can be thought of as the interest, paid at the net interest spread rate on the standard deviation of the account. We show that pooling has substantial value already in the transient period. In order to increase the practical relevance of our analysis we discuss possible extensions of our model and we show how real option pricing technics can be applied here.

Multiple founders and firm value

In this paper, we highlight the existence of multi-founder firms, which were founded by multiple individuals (with no family connections) who are still actively involved in the firm as directors and/or managers. These firms provide a unique setting to shed further light on the net valuation effects of founder involvement. In particular, multi-founder firms provide us with the opportunity to examine the benefits and costs to shareholders of multiple founders involved as directors, CEOs and managers in the same firm. Our analysis indicates that multi-founder firms are more valuable than all other types of firms, including single-founder firms and family firms, with the valuation premium positively related to the number of founders involved in the firm. Further analysis confirms that this valuation premium is linked to the direct involvement of the multiple founders as directors and CEOs. However, further founder involvement in vice president positions has a negative relationship with firm value.

Outsider board activity, ownership structure and firm value : evidence from Korea

Using a sample of publicly listed firm in Korea from 2002 to 2006, this article examines the impact of board monitoring on firm value and productivity. We use outsider's attendance of board meetings as a proxy for board monitoring. Consistent with the commitment hypothesis, we find that outsider's attendance rate increases firm value, suggesting that attending board meeting itself is a strong signal that reflects outsider's intention to monitor insiders. While ownership of controlling shareholders negatively affects firm value, this relationship is not moderated by increased monitoring by outsiders. Our findings provide further evidence that the outside director system is less effective in chaebol-affiliated firms. Results also indicate that the effect of outsider's board monitoring activity on investor's valuation of the firm is greater than on productivity improvement of the firm. Our conclusions are robust for possible endogeneity in the relationship between firm value and board attendance by outside directors.

The Valuation Implications of Enterprise Risk Management Maturity

Enterprise Risk Management (ERM) is the discipline by which enterprises monitor, analyze, and control risks from across the enterprise, with the goal of identifying underlying correlations and thus optimizing the risk-taking behavior in a portfolio context. This study analyzes the valuation implications of ERM Maturity. We use data from the industry leading Risk and Insurance Management Society Risk Maturity Model over the period from 2006 to 2011, which scores firms on a five-point maturity scale. Our results suggest that firms that have reached mature levels of ERM are exhibiting a higher firm value, as measured by Tobin's Q. We find a statistically significant positive relation to the magnitude of 25 percent. Upon decomposition of the maturity score, we find that the most important aspects of ERM from a valuation perspective relate to the level of top–down executive engagement and the resultant cascade of ERM culture throughout the firm. Firms that have successfully integrated the ERM process into both their strategic activities and everyday practices display superior ability in uncovering risk dependencies and correlations across the entire enterprise and as a consequence enhanced value when undertaking the ERM maturity journey ceteris paribus.

Knowledge and information evaluation practice: an exploratory study in a construction firm

There are a number of challenges associated with managing knowledge and information in construction organizations delivering major capital assets. These include the ever-increasing volumes of information, losing people because of retirement or competitors, the continuously changing nature of information, lack of methods on eliciting useful knowledge, development of new information technologies and changes in management and innovation practices. Existing tools and methodologies for valuing intangible assets in fields such as engineering, project management and financial, accounting, do not address fully the issues associated with the valuation of information and knowledge. Information is rarely recorded in a way that a document can be valued, when either produced or subsequently retrieved and re-used. In addition there is a wealth of tacit personal knowledge which, if codified into documentary information, may prove to be very valuable to operators of the finished asset or future designers. This paper addresses the problem of information overload and identifies the differences between data, information and knowledge. An exploratory study was conducted with a leading construction consultant examining three perspectives (business, project management and document management) by structured interviews and specifically how to value information in practical terms. Major challenges in information management are identified. An through-life Information Evaluation methodology (IEM) is presented to reduce information overload and to make the information more valuable in the future.

Valuation and performance of firms in complex ownership structures : an application to Korean chaebols

We propose several new metrics to describe the complex ownership structure of business groups, and provide simple formulas and algorithms to compute these metrics. We use these measures to describe in detail the ownership structure of Korean chaebols in the period of 2003 to 2004. In addition, we validate the usefulness of our new metrics by showing empirically that they are important for understanding the valuation and performance of group firms. In particular, we show evidence that firms that are central to the control structure of the chaebol (central firms), firms in cross-shareholdings, and firms that are placed at the bottom of the group (i.e., with lower ultimate ownership) have lower profitability than other group firms. The valuation results suggest that central firms and firms in cross-shareholding loops have lower valuations than other public Chaebol firms. The lower valuation of these firms is not explained by variation in measures of ownership concentration and separation between ownership and control.

Investment Valuation with Tax-optimized Financing Decisions and a Tax-optimized Default Alternative

In this paper we evaluate an indivisible investment project that is carried out in a corporation under very simple premises. In particular, we discuss a one-period model with certainty, the pure domestic case and proportional tax rates. Surprisingly, the decision problem turns out to be rather complex if one has to make allowance for different taxation of the corporation and its owner. Altogether there are more than 10 cases that have to be distinguished if the firm's managers want to make a correct decision, depending on the relation of personal and corporate tax rates.

A Simple Accounting-based Valuation Model for the Debt Tax Shield

This paper describes a simple way to integrate the debt tax shield into an accounting-based valuation model. The market value of equity is determined by forecasting residual operating income, which is calculated by charging operating income for the operating assets at a required return that accounts for the tax benefit that comes from borrowing to raise cash for the operations. The model assumes that the firm maintains a deterministic financial leverage ratio, which tends to converge quickly to typical steady-state levels over time. From a practical point of view, this characteristic is of particular help, because it allows a continuing value calculation at the end of a short forecast period.

Decision-usefulness of ideal cost- and ideal value accounting for valuation and stewardship

This paper contrasts the decision-usefulness of prototype accounting regimes based on perfect accounting for value, i.e. ideal value accounting (IVA), and perfect matching of cost, i.e. ideal cost accounting (ICA). The regimes are analyzed in the context of a firm with overlapping capacity investments where projects earn excess returns and residual income is utilized as performance indicator. Provided that IVA and ICA systematically differ based on the criterion of unconditional conservatism, we assess their respective decision-usefulness for different valuation- and stewardship-scenarios. Assuming that addressees solely observe current accounting data of the firm, ICA provides information which is useful for valuation and stewardship without reservation whereas IVA entails problems under specific assumptions.

Valuation of a new entrant in an oligopolistic market, including its option to abandon: A real-life case

The purpose of this paper is to increase current empirical evidence on the relevance of real options for explaining firm investment decisions in oligopolistic markets. We study an actual investment case in the Spanish mobile telephony industry, the entrant in the market of a new operator, Yoigo. We analyze the option to abandon in order to show the relevance of the possibility of selling the company in an oligopolistic market where competitors are not allowed free entrance. The NPV (net present value) of the new entrant is calculated as a starting point. Then, based on the general approach proposed by Copeland and Antikarov (2001), a binomial tree is used to model managerial flexibility in discrete time periods, and value the option to abandon. The strike price of the option is calculated based on incremental EBITDA margins due to selling customers or merging with a competitor.

Relative accuracy and predictive ability of direct valuation methods, price to aggregate earnings method and a hybrid approach

In this paper, we assess the relative performance of the direct valuation method and industry multiplier models using 41 435 firm-quarter Value Line observations over an 11 year (1990–2000) period. Results from both pricingerror and return-prediction analyses indicate that direct valuation yields lower percentage pricing errors and greater return prediction ability than the forward price to aggregated forecasted earnings multiplier model. However, a simple hybrid combination of these two methods leads to more accurate intrinsic value estimates, compared to either method used in isolation. It would appear that fundamental analysis could benefit from using one approach as a check on the other.

Firm performance and investment in R&D and intellectual property

This paper analyses the relationship between innovation - proxied by Research and Development (R&D), patent and trade mark activity – and profitability in a panel of Australian firms (1995 to 1998). Special attention is given to assessing the nature of competitive conditions faced by different firms, as the nature of competition is likely to affect the returns to innovation. The hypothesis is that lower levels of competition will imply higher returns to innovation. To allow for a time lag time before any return to innovation, the market value of the firms is used as a proxy for expected future profits. The results give some support for the main hypothesis: the market’s valuation of R&D activity is higher in industries where competition is lower. However, the paper highlights the difficulty in assessing competitive conditions and finds a number of results that challenge the simple hypothesis.

Market valuation of environmental performance

This research investigated the general association between corporate environmental performance and the firms’ annual returns independent of any particular environmental event. The association analysis was based on the most recent environmental data for the years 2006, 2007, and 2008. The results indicated that while some environmental variables were significantly associated with firms’ returns, the majority were not. The results also indicated that environmental concerns were more likely to be associated with increase in the firm value than were environmental strengths; however, there were no mean differences between firms whose environmental performance increased as compared with those whose performance deteriorated. Overall, the results provided support for the perspective that environmental strengths require firm expenditures that place additional financial burdens on firms, resulting in lower stock returns.^