Victor von Wachter, Johannes Rude Jensen, Ferdinand Regner, Omri Ross
The smart contract-based markets for non-fungible tokens (NFTs) on the Ethereum blockchain have seen tremendous growth in 2021, with trading volumes peaking at 3.5b in September 2021. This dramatic surge has led to industry observers questioning the authenticity of on-chain volumes, given the absence of identity requirements and the ease with which agents can control multiple addresses. We examine potentially illicit trading patterns in the NFT markets from January 2018 to mid-November 2021, gathering data from the 52 largest collections by volume. Our findings indicate that within our sample 3.93% of addresses, processing a total of 2.04% of sale transactions, trigger suspicions of market abuse. Flagged transactions contaminate nearly all collections and may have inflated the authentic trading volumes by as much as 149,5m for the period. Most flagged transaction patterns alternate between a few addresses, indicating a predisposition for manual trading. We submit that the results presented here may serve as a viable lower bound estimate for NFT wash trading on Ethereum. Even so, we argue that wash trading may be less common than what industry observers have previously estimated. We contribute to the emerging discourse on the identification and deterrence of market abuse in the cryptocurrency markets.
Purpose This paper aims to examine the applicability of real options methodology with respect to developing internal transfer pricing mechanisms. A pervasive theme in existing models is their inability to handle the dynamic and volatile nature of todayâs business environment, as well as their lack of objective managerial flexibility. The authors address these and other issues and develop a transfer pricing mechanism based on BlackâScholes and the binomial options pricing methodology, which is better suited in todayâs dynamic business environment. Design/methodology/approach The authors use a conceptual approach in developing theoretical justifications and show, practically, how a transfer price can be developed using two different real options pricing models. Findings The authors find that real options transfer price mechanism (real options framework [ROF]) can effectively deal with many of the issues that permeate a modern organization with complex multi-dimensional operations. The authors argue that uncertainty and behavioral issues commonly associated with setting transfer prices are better handled using a transfer pricing mechanism that preserves flexibility at the business unit level, the managerial level and the firm level. The approach allows for different managerial styles in both centralized and decentralized sub-units within the same organization. The authors argue that an open multi-dimensional framework using real options is suitable under conditions of uncertainty and managerial opportunism. Practical implications ROF-based transfer pricing may be significant in that firms can use it as a tool to manage an organization by setting the prices centrally and at the same time allowing managers to select the transfer price that best suits their specific situation and operating conditions. This may result in a more efficient and more profitable organization. Originality/value The contribution of the paper is the melding of the ROF from the finance literature with the accounting problem of setting a transfer price for items lacking a competitive market price. The authors also contribute to existing research by explicitly developing a framework that values managerial flexibility, takes into account uncertainty and considers the behavioral aspects of the transfer pricing process. The authors establish the conditions under which a generic real options model is a feasible alternative in determining a transfer price.
Cryptocurrency and blockchain has conjointly become trending buzzwords in the business\nworld today. As the blockchain technology has become older and more researched, its areas\nof usage have broadened far beyond payment solutions like Bitcoin. In venture financing,\nblockchain has been used to establish a prominent fundraising tool, called initial coin offerings\n(ICO). An ICO is a crowdfunding method resembling initial public offerings, where ventures\nissue a blockchain based token, subject to public sale. ICO has become a lucrative financing\nmethod for blockchain affiliated ventures.\nThe hype around cryptocurrency has led to increased ICO attention. Everyone can invest in an\nICO, and thus, it has become a popular investment opportunity. This thesis looks at ICOs as\ninvestment objects, with the aim to find out what an investor should consider before investing.\nAdditionally, we assess whether ICOs are profitable financial instruments relative to its close\nsubstitutes, and evaluate measures to avoid scams.\nThe study is based on 104 companies that have had ICOs, and analyzes what factors influence\nboth ICO success rate, and post-ICO capital gains. Our results indicate that hype and pricing\nis influential on the outcome of an ICO, which in turn is important for subsequent price\nmovements. We have also observed that venture capital seed funded companies performed\nbetter in the ICO aftermath. By further using the results, we have also found that investors\nmay use these parameters when investing in an ICO to outperform both our benchmark\ncryptocurrency Ethereum, and other ICOs.
Trading securities is a process that requires multiple trusted intermediaries to ensure that the trade is done correctly. The securities industry is therefore very slow and expensive; the central securities depository (CSD) being one of the main contributors to the disruption. In an effort to fix this, financial institutions has recently started looking into the blockchain technology; the innovation behind the cryptocurrency Bitcoin. Bitcoin is a digital currency that can be traded peer-to-peer without the need for a trusted intermediary. If this concept could be used when trading securities it would simplify the process, making the settlement-time near instant. In addition to the speedup, it would also save the industry a lot of money since many processes could be automated. The purpose of this paper is to provide an overview of the blockchain technology and its applications in the finance industry. The focus is on how a blockchain could be used to reduce the responsibility of the central securities depository as much as possible, and especially on how corporate actions could be automated. The goal is to answer these questions: Is blockchain a suitable platform for a decentralized corporate actions solution? Whatare the benefits and drawbacks of using a blockchain versus a traditional centralized solution? The aim is to provide an evaluation of the usage of blockchains in finance, with extra focus on the CSD and corporate actions
Joanna BĹach, Monika WieczorekâKosmala, Maria GorczyĹska, Anna DoĹ
IntroductionLiquidity management is a crucial managerial area of corporate finance. There is a common knowledge that even the most profitable company may go bankrupt if it does not manage its liquidity in a proper way. The importance of liquidity maintenance arises in times of crisis characterized by the high volatility of financial markets and clear symptoms of economic downturn.In this paper we focus on the problem of liquidity management by discussing the objectives and functions of corporate treasury. Corporate treasury is relatively new phenomenon, representing a profession dedicated for a defined, complex set of financial management-related tasks in a company. Corporate treasury function may be performed solely or by a dedicated department under the CFO supervision.In particular, the purpose of this paper is to support a thesis that corporate treasury has potential to enhance innovative actions within liquidity management. This potential arises primarily from the holistic managerial approach of the corporate treasury, which is supported by the broad understanding of the entire company and the extensive knowledge of all financial management areas that influence liquidity (through cash inflows and outflows) accompanied by the deep knowledge of financial market and instruments.This is a conceptual paper, based on the analysis of the current literature and practical documents. The paper is organized as follows. In the first Section we present the contemporary views on corporate treasury objectives and functions. The second Section discusses the understanding of liquidity management of a company, with cash management as the core issue regarding actions within, in the context of the core function of corporate treasury. In the third Section we address the potential areas of innovative actions of corporate treasury. The last Section concludes the paper.1. The identity of corporate treasury objectives and functionsCorporate treasury management involves financial activities within maximizing company's liquidity and mitigating various types of financial risk. However, the understanding of tasks and functions of corporate treasury is not homogenous. Possibly, it is partially connected with the clearly visible several stages of the development of corporate treasury functions. The role of the corporate treasury evolved over time, as the financial market was developing and becoming more volatile, with the growing importance of large international corporations (Figure 1).The evolution of the treasury role can be divided into three phases. During Phase I (Immature Treasury, TS 1.0) before the 1970s, treasury functions were decentralized and informal, characterized by manual processes, concerned with operational activities. Phase II (Mature Treasury, TS 2.0) started with the introduction of floating currencies systems and the end of gold standard for US dollar. This led to the increased volatility in financial markets and greater importance of treasury that become focused on financial risk management, using more and more sophisticated tools and instruments. Changing role of the treasury in Phase III (Strategic Treasury, TS 3.0) is a result of globalization process and increased complexity of financial system. Corporate treasury has to coordinate its activity with business partners and support business units in their strategies in order to create value (Polak, Robertson, Lind, 2011, p. 50). It is said that treasury involvement should be increased in all areas that require cash management, asset and liabilities management and financial risk management. It also involves enhanced reporting and communication with internal and external stakeholders as a response to their demand for better information. The strategic role of treasury in Phase III is to deliver value and efficiency for the company and act as a strategic unit to achieve the company's goals. It is stressed that the efficient treasury management is determined by four important factors: (1) centralization, (2) standardization, (3) simplification and (4) automation (Ala, 2011). âŚ
Since the foundation of New China,the reform and development of financial management system of state-owned enterprises falls into three periods.The first period,from 1949 to1978,China implemented planned economy system,in which the finance of enterprises actually was the extension of national finance,while the state controlled over the income and expenditure,and was responsible for the losses and and enterprises barely had autonomy in management.The second period can be devided into two parts.From the end of 1978 to 1984,China was dominated by planned economy and supplemented by market adjustment,the financial management system of enterprises began the initial reform of decentralizing power and allowing profits retained within enterprises;from 1984 to 1993,China began to carry out planned market-oriented economy system and separate government functions from enterprise management,the financial management system entered into the period that the state expanded enterprises' power and allowed more profits retained within enterprises,and took partial responsibility for the losses and profits.The third period,from the 3th plenary session of the 14th CPC Central Committee in 1993 till now,China has established the socialist market economy system,basically set up the modern enterprise system and modern financial management system that state-owned enterprises self-management in finance and full responsibility for their own losses and profits.
The parent-subsidiary enterprise finance control pattern appears to be the continual dynamical equilibrium between the centralization and the decentralization,but in essence it is.the financial control intrinsic mechanism match in the dynamic process.The modern parent-subsidiary enterprise finance control featuring the department hierarchy is characterized by the mechanism in which the non-authority control mechanism replace the authority control mechanism,a basic form of control.Moreover,such a phenomenon should be looked as the remedying mechanism to replace the authority control with the non-authority control when the former is insufficient due to the failure of the department hierarchy and therefore is an improvement on the authority control.,which can determine the effectiveness of the financial control.
In this paper, we study the relationship between institutional ownership and capital structure. Based on the principle of minimizing financing cost, this paper firstly constructs a dynamic optimizing model of capital structure from the angle of institutional ownership. Then, it uses panel data of 539 China listed companies of manufacturing industry from 2005 to 2007 to make regression of fixed effects model. The results indicate that the percentage of institutional stock holdings has positive relation with capital structure, and the decentralized degree of institutional ownership is negatively related to capital structure. The robustness check agrees with these results. Finally, this paper points that developing institutional investors is one way to solve the current low debt ratio of China listed companies.
Financial-right and property right are closely related but they two should belong to two different levels. Financial governance right is the right-balancing relationship between financing agents in the process of financial right segmentation from the level of corporate governance.And financial control is established on the basis of the incomplete contract theory,but financial control has several different meanings because of the importance of ,the distinction between narrow and broad senses of decision-making power,and the power implementation process etc. Financial-right configuration follows the basic principles of contribution and risk-taking and is the centralized and decentralized symmetrical arrangement of residual claim and residual control under the co-restriction of knowledge cost and agency cost.
It has become an important subject of the financial management to explore how to strike a balance between cen- tralization and decentralization in collectivized financial management,and to maximize the scale advantages of collectivized enterprises.The article explains and analyzes many aspects,such as financial management,budget management system,key decisive control system,CFO dispatch system,and finance supervision system.
With the recent years' development, institutional investors have played a more important role in corporate governance and operational decisions of China listed companies. However, the empirical research on the influence of institutional ownership on capital structure is rare. Based on the principle of minimizing financing cost, this paper constructs a dynamic optimizing model of capital structure from the angle of institutional ownership. We also use panel data of 568 China listed companies of manufacturing industry from 2002 to 2004 to make regression of fixed effects model. The evidences indicate that the percentage of institutional stockholdings has positive relation with capital structure, which means the debt ratio increases when the percentage of institutional stockholdings increases. We also find that the decentralized degree of institutional ownership is negatively related to capital structure, that is, a more decentralized degree of institutional ownership causes a lower debt ratio.
The weakness of traditional financial management is obvious increasingly in network economy,such as management means backward comparatively,budget control system imperfect,capital control ineffective,which will restrict the optimization of resource allocation.Correspondingly,network technique provides guarantee for business groups to establish centralized management model in finance.i.e.business groups can adapt to the requirement of network economic development and realize the reform,innovation and maximum of total profit via transferring the model of financial management from decentralized to centralized,strengthening the functions of supervising agency,centralized management of capital and limitation of right to financial personnel.
The paper analyzes the capital financing behavior of Hongdu Aviation Industrial Shareholding Co.,Ltd and finds out that the company has made much headway in the reform of its capital financing structure. Meanwhile, the author diagnoses Hongdu Aviationâs strong partiality for equity capital financing and lack of debt capital financing, low capital profitability and efficiency of capital utilization. Hence, the author suggests that the company decentralize its equity to big proportions, promotes the circulation of its property right and increases debt capital for its sustainable, fast and healthy development.
Examines six issues to decide whether total quality management (TQM) concepts can improve the effectiveness of companyâwide financial activities, i.e. the finance function. These issues address the basic role of a central finance department; TQM concepts in specific financial processes including capital budgeting and working capital management; competitive benchmarking; and personnel skills needed for the future. The finance function in most organizations has been pulled in many directions recently by downsizing, technology, ethical issues and, of course, TQM. The central finance office (CFO) needs to understand how TQM issues may not be a negative constraint on the finance process but actually assist in reâengineering the finance process for the future. Defines the service role of the finance function and how it can be decentralized throughout the organization. Presents many issues in a question format which allows the finance manager to organize the implications of TQM in the total finance operation. Also investigates various financial processes such as capital budgeting and workingâcapital management.
0 Until more than a decade ago, financial economists typically explored problems of capital structure and dividend policy under the assumption that operating cash flows or investment decisions were exogenously determined, either with certainty or with an endowed, known distribution. Micro and macro-economic theorists, on the other hand, discussed what might be called operating income maximization, and treated as irrelevant the origin of the funds they allocated between labor and capital. It is now the consensus, I believe, that although these approaches constitute important simplifications, they may obscure some of the more important activities that take place in the firm. Interactions of production and financial decisions have thus been the focus of many recent studies. This research is extremely important for financial decision makers. If indeed it turns out that there are economically significant interactions between production and financing, then proper financial management may be vastly more difficult than typically portrayed in modern textbooks. Most of what is taught in capital budgeting, for example, is based on separation of investment and financing. If in reality this is not the case, then decentralization of the firm's operations can not be maintained, and all decisions will have to be made at the same time. Indeed, the many papers described here show how investment decisions, product pricing, labor negotiations, and market power may all be significantly related to the choice of capital structure. While this survey represents an attempt to assess the economic significance of each interaction, it must be emphasized that, as a casual glance at the references should reveal, we are dealing with on-going research that is not, as yet, supported by sufficient empirical evidence to yield definitive answers.
Stewart C. Myers President of American Finance Association 1983 This paper's title is intended to remind you of Fischer Black's well-known note on âThe Dividend Puzzle,â which he closed by saying, âWhat should the corporation do about dividend policy? We don't know.â 6 I will start by asking, âHow do firms choose their capital structures?â Again, the answer is, âWe don't know.â The capital structure puzzle is tougher than the dividend one. We know quite a bit about dividend policy. John Lintner's model of how firms set dividends 20 dates back to 1956, and it still seems to work. We know stock prices respond to unanticipated dividend changes, so it is clear that dividends have information contentâthis observation dates back at least to Miller and Modigliani (MM) in 1961 28. We do not know whether high dividend yield increases the expected rate of return demanded by investors, as adding taxes to the MM proof of dividend irrelevance suggests, but financial economists are at least hammering away at this issue. By contrast, we know very little about capital structure. We do not know how firms choose the debt, equity or hybrid securities they issue. We have only recently discovered that capital structure changes convey information to investors. There has been little if any research testing whether the relationship between financial leverage and investors' required return is as the pure MM theory predicts. In general, we have inadequate understanding of corporate financing behavior, and of how that behavior affects security returns. I do not want to sound too pessimistic or discouraged. We have accumulated many helpful insights into capital structure choice, starting with the most important one, MM's No Magic in Leverage Theorem (Proposition I) 31. We have thought long and hard about what these insights imply for optimal capital structure. Many of us have translated these theories, or stories, of optimal capital structure into more or less definite advice to managers. But our theories don't seem to explain actual financing behavior, and it seems presumptuous to advise firms on optimal capital structure when we are so far from explaining actual decisions. I have done more than my share of writing on optimal capital structure, so I take this opportunity to make amends, and to try to push research in some new directions. A static tradeoff framework, in which the firm is viewed as setting a target debt-to-value ratio and gradually moving towards it, in much the same way that a firm adjusts dividends to move towards a target payout ratio. An old-fashioned pecking order framework, in which the firm prefers internal to external financing, and debt to equity if it issues securities. In the pure pecking order theory, the firm has no well-defined target debt-to-value ratio. Recent theoretical work has breathed new life into the pecking order framework. I will argue that this theory performs at least as well as the static tradeoff theory in explaining what we know about actual financing choices and their average impacts on stock prices. I have arbitrarily, and probably unfairly, excluded âmanagerialâ theories which might explain firms' capital structure choices.1 I have chosen not to consider models which cut the umbilical cord that ties managers' acts to stockholders' interests. I am also sidestepping Miller's idea of âneutral mutation.â2 He suggests that firms fall into some financing patterns or habits which have no material effect on firm value. The habits may make managers feel better, and since they do no harm, no one cares to stop or change them. Thus someone who identifies these habits and uses them to predict financing behavior would not be explaining anything important. The neutral mutations idea is important as a warning. Given time and imagination, economists can usually invent some model that assigns apparent economic rationality to any random event. But taking neutral mutation as a strict null hypothesis makes the game of research too tough to play. If an economist identifies costs of various financing strategies, obtains independent evidence that the costs are really there, and then builds a model based on these costs which explains firms' financing behavior, then some progress has been made, even if it proves difficult to demonstrate that, say, a type A financing strategy gives higher firm value than a type B. (In fact, we would never see type B if all firms follow value-maximizing strategies.) There is another reason for not immediately embracing neutral mutations: we know investors are interested in the firm's financing choices, because stock prices change when the choices are announced. The change might be explained as an âinformation effectâ having nothing to do with financing per seâbut again, it is a bit too easy to wait until the results of an event study are in, and then to think of an information story to explain them. On the other hand, if one starts by assuming that managers have special information, builds a model of how that information changes financing choices, and predicts which choices will be interpreted by investors as good or bad news, then some progress has been made. So this paper is designed as a one-on-one competition of the static tradeoff and pecking-order stories. If neither story explains actual behavior, the neutral mutations story will be there faithfully waiting. A firm's optimal debt ratio is usually viewed as determined by a tradeoff of the costs and benefits of borrowing, holding the firm's assets and investment plans constant. The firm is portrayed as balancing the value of interest tax shields against various costs of bankruptcy or financial embarassment. Of course, there is controversy about how valuable the tax shields are, and which, if any, of the costs of financial embarassment are material, but these disagreements give only variations on a theme. The firm is supposed to substitute debt for equity, or equity for debt, until the value of the firm is maximized. Thus the debt-equity tradeoff is as illustrated in Fig. 1. Costs of adjustment. If there were no costs of adjustment, and the static tradeoff theory is correct, then each firm's observed debt-to-value ratio should be its optimal ratio. However, there must be costs, and therefore lags, in adjusting to the optimum. Firms can not immediately offset the random events that bump them away from the optimum, so there should be some cross-sectional dispersion of actual debt ratios across a sample of firms having the same target ratio. The static-tradeoff theory of capital structure. Large adjustment costs could possibly explain the observed wide variation in actual debt ratios, since firms would be forced into long excursions away from their optimal ratios. But there is nothing in the usual static tradeoff stories suggesting that adjustment costs are a first-order concernâin fact, they are rarely mentioned. Invoking them without modelling them is a cop-out. Any cross-sectional test of financing behavior should specify whether firms' debt ratios differ because they have different optimal ratios or because their actual ratios diverge from optimal ones. It is easy to get the two cases mixed up. For example, think of the early cross-sectional studies which attempted to test MM's Proposition I. These studies tried to find out whether differences in leverage affected the market value of the firm (or the market capitalization rate for its operating income). With hindsight, we can quickly see the problem: if adjustment costs are small, and each firm in the sample is at, or close to its optimum, then the in-sample dispersion of debt ratios must reflect differences in risk or in other variables affecting optimal capital structure. But then MM's Proposition I cannot be tested unless the effects of risk and other variables on firm value can be adjusted for. By now we have learned from experience how hard it is to hold âother things constantâ in cross-sectional regressions. Of course, one way to make sense of these tests is to assume that adjustment costs are small, but managers don't know, or don't care, what the optimal debt ratio is, and thus do not stay close to it. The researcher then assumes some (usually unspecified) âmanagerialâ theory of capital structure choice. This may be a convenient assumption for a cross-sectional test of MM's Proposition I, but not very helpful if the object is to understand financing behavior.3 But suppose we don't take this âmanagerialâ fork. Then if adjustment costs are small, and firms stay near their target debt ratios, I find it hard to understand the observed diversity of capital structures across firms that seem similar in a static tradeoff framework. If adjustment costs are large, so that some firms take extended excursions away from their targets, then we ought to give less attention to refining our static tradeoff stories and relatively more to understanding what the adjustment costs are, why they are so important, and how rational managers would respond to them. But I am getting ahead of my story. On to debt and taxes. Debt and taxes. Miller's famous âDebt and Taxesâ paper 27 cut us loose from the extreme implications of the original MM theory, which made interest tax shields so valuable that we could not explain why all firms were not awash in debt. Miller described an equilibrium of aggregate supply and demand for corporate debt, in which personal income taxes paid by the marginal investor in corporate debt just offset the corporate tax saving. However, since the equilibrium only determines aggregates, debt policy should not matter for any single taxpaying firm. Thus Miller's model allows us to explain the dispersion of actual debt policies without having to introduce non-value-maximizing managers.4 Trouble is, this explanation works only if we assume that all firms face approximately the same marginal tax rate, and that is an assumption we can immediately reject. The extensive trading of depreciation tax shields and investment tax credits, through financial leases and other devices, proves that plenty of firms face low marginal rates.5 Given significant differences in effective marginal tax rates, and given that the static tradeoff theory works, we would expect to find a strong tax effect in any cross-sectional test, regardless of whose theory of debt and taxes you believe. Figure 2 plots the net tax gain from corporate borrowing against the expected realizable tax shield from a future deduction of one dollar of interest paid. For some firms this number is 46 cents, or close to it. At the other extreme, there are firms with large unused loss carryforwards which pay no immediate taxes. An extra dollar of interest paid by these firms would create only a potential future deduction, usable when and if the firm earns enough to work off prior carryforwards. The expected realizable tax shield is positive but small. Also, there are firms paying taxes today which cannot be sure they will do so in the future. Such a firm values expected future interest tax shields at somewhere between zero and the full statutory rate. In the âcorrectedâ MM theory 28 any tax-paying corporation gains by borrowing; the greater the marginal tax rate, the greater the gain. This gives the top line in the figure. In Miller's theory, the personal income taxes on interest payments would exactly offset the corporate interest tax shield, provided that the firm pays the full statutory tax rate. However, any firm paying a lower rate would see a net loss to corporate borrowing and a net gain to lending. This gives the bottom line. There are also compromise theories, advanced by D'Angelo and Masulis 12, Modigliani 30 and others, indicated by the middle dashed line in the figure. The compromise theories are appealing because they seem less extreme than either the MM or Miller theories. But regardless of which theory holds, the slope of the line is always positive. The difference between (1) the tax advantage of borrowing to firms facing the full statutory rate, and (2) the tax advantage of lending (or at least not borrowing) to firms with large tax loss carryforwards, is exactly the same as in the âextremeâ theories. Thus, although the theories tell different stories about aggregate supply and demand of corporate debt, they make essentially the same predictions about which firms borrow more or less than average. The net tax gain to corporate borrowing. So the tax side of the static tradeoff theory predicts that IBM should borrow more than Bethlehem Steel, other things equal, and that General Motors' debt-to-value ratio should be more than Chrysler's. Costs of financial distress. Costs of financial distress include the legal and administrative costs of bankruptcy, as well as the subtler agency, moral hazard, monitoring and contracting costs which can erode firm value even if formal default is avoided. We know these costs exist, although we may debate their magnitude. For example, there is no satisfactory explanation of debt covenants unless agency costs and moral hazard problems are recognized. The literature on costs of financial distress supports two qualitative statements about financing behavior.6 Risky firms ought to borrow less, other things equal. Here âriskâ would be defined as the variance rate of the market value of the firm's assets. The higher the variance rate, the greater the probability of default on any given package of debt claims. Since costs of financial distress are caused by threatened or actual default, safe firms ought to be able to borrow more before expected costs of financial distress offset the tax advantages of borrowing. Firms holding tangible assets-in-place having active second-hand markets will borrow less than firms holding specialized, intangible assets or valuable growth opportunities. The expected cost of financial distress depends not just on the probability of trouble, but the value lost if trouble comes. Specialized, intangible assets or growth opportunities are more likely to lose value in financial distress. Firms prefer internal finance. They adapt their target dividend payout ratios to their investment opportunities, although dividends are sticky and target payout ratios are only gradually adjusted to shifts in the extent of valuable investment opportunities. Sticky dividend policies, plus unpredictable fluctuations in profitability and investment opportunities, mean that internally-generated cash flow may be more or less than investment outlays. If it is less, the firm first draws down its cash balance or marketable securities portfolio.7 If external finance is required, firms issue the safest security first. That is, they start with debt, then possibly hybrid securities such as convertible bonds, then perhaps equity as a last resort. In this story, there is no well-defined target debt-equity mix, because there are two kinds of equity, internal and external, one at the top of the pecking order and one at the bottom. Each firm's observed debt ratio reflects its cumulative requirements for external finance. The pecking order literature. The pecking order hypothesis is hardly new.8 For example, it comes through loud and clear in Donaldson's 1961 study of the financing practices of a sample of large corporations. He observed 13 that âManagement strongly favored internal generation as a source of new funds even to the exclusion of external funds except for occasional unavoidable âbulgesâ in the need for funds.â These bulges were not generally met by cutting dividends: Reducing the âcustomary cash dividend payment⌠was unthinkable to most managements except as a defensive measure in a period of extreme financial distressâ (p. 70). Given that external finance was needed, managers rarely thought of issuing stock: Though few companies would go so far as to rule out a sale of common under any circumstances, the large majority had not had such a sale in the past 20 years and did not anticipate one in the foreseeable future. This was particularly remarkable in view of the very high Price-Earnings ratios of recent years. Several financial officers showed that they were well aware that this had been a good time to sell common, but the reluctance still persisted. (pp. 57â58). Of course, the pecking order hypothesis can be quickly rejected if we require it to explain everything. There are plenty of examples of firms issuing stock when they could issue investment-grade debt. But when one looks at aggregates, the heavy reliance on internal finance and debt is clear. For all non-financial corporations over the decade 1973â1982, internally generated cash covered, on average, 62 percent of capital expenditures, including investment in inventory and other current assets. The bulk of required external financing came from borrowing. Net new stock issues were never more than 6 percent of external financing.9 Anyone innocent of modern finance who looked at these statistics would find the pecking order idea entirely plausible, at least as a description of typical behavior. Writers on âmanagerial capitalismâ have interpreted firms' reliance on internal finance as a byproduct of the separation of ownership and control: professional managers avoid relying on external finance because it would subject them to the discipline of the capital market.10 Donaldson's 1969 book was not primarily about managerial capitalism, but he nevertheless observed that the financing decisions of the firms he studied were not directed towards and that to explain decisions would have to start by the âmanagerial of corporate finance. This is given the of finance theory in the it is not so that financing by a pecking order against interests. financing with I to the pecking order story because I could think of no theoretical for it that would in with the theory of modern finance. An could be made for internal financing to avoid issue costs, and if external finance is needed, for debt to avoid the still higher costs of But issue costs in do not seem large enough to the costs and benefits of leverage in the static tradeoff story. However, recent work based on information gives predictions in line with the pecking order The is based on a paper by and although I will down that paper's to the firm has to in order to some valuable investment be this net value and be what the firm will be if the opportunity is The firm's what and are, but investors in capital markets do they see only a of values The information is as from the information capital markets are and MM's Proposition I in the sense that the stock of debt to assets is if information to investors is constant. The to by a security issue is the of the firm's investment There is also a the firm may have to sell the securities for less than they are really the firm issues stock with an aggregate market when of will consider debt issues in a However, the the are really That is, is what the new will be other things equal, when investors the special and I managers might in this The one we think makes the most sense is the or value of the firm's That is, the about the value of the in the firm. investors know the will do In the investors who any stock issue will assume that the is not on their and will the they are to If the information is is and the firm will always even if the only good for the funds is to them in the If the information is the firm may a investment opportunity than issue Thus, given and and given that stock is the greater the per the less value is given to new and the less The cost of relying on external We usually think of the cost of external finance as administrative and costs, and in some cases of the new securities. information the of a different of the that the firm will choose not to and will therefore a This cost is if the firm can enough internally-generated cash to its opportunities. The advantages of debt over equity If the firm external it is off issuing debt than equity securities. The rule is, safe securities before This is explaining that the firm issues and if the of its investment is greater than or to the by which the new are if or if For example, suppose the investment but in order to that the firm must issue that are really It will go ahead only if is at least If it is only the firm to the for the value of the firm is by but the are The could have this by the firm's cash that is The only he can do now is to the security issue to For example, if could be cut to the investment could be without the value of The way to is to issue the safest securities whose future value changes least when the information is to the Of course, is so it is loose to of the it. However, there are cases in which the value of is always less for debt than for For example, if the firm can issue debt, is and the firm never a valuable investment Thus, the to issue debt is as good as cash in the if default risk is the value of will be less for debt than for equity if we make the of Thus, if the has information it is to issue debt than This assumes that new or debt would be if the managers' information is so that any security issue would be In this the firm want to make as large as to take advantage of new If stock would seem than debt The rule seems to debt when investors the and equity, or some other when they The trouble with this strategy is you in investors' If you know the firm will issue equity only when it is and debt you will to equity unless the firm has its is, unless the firm has so much debt that it would face costs in issuing Thus investors would the firm to follow a pecking this is too The model just would need of out before it could actual behavior. I have it just to how models based on information can predict the two of the pecking order the for internal the for debt over equity if external financing is I will now what we know about financing behavior and try to make sense of this in of the two I with about financing behavior, and then a few from evidence or personal Of even based on good statistics have been to away under so with external investment are by debt issues and internally-generated stock issues a relatively as has this is what many managers they are to This is what the pecking order hypothesis in the first However, it might also be explained in a static tradeoff theory by adding significant costs of equity issues and the tax of capital gains to This would make external equity relatively It would explain why companies target dividend low enough to avoid having to make stock It would also explain why a firm whose debt ratio target not immediately issue back debt, and a more debt-to-value ratio. Thus firms might take extended excursions their debt that the static tradeoff hypothesis as usually rarely this of adjustment But the costs of seems small. It is thus hard to explain extended excursions a firm's debt target by an static tradeoff firm could quickly issue debt and back if personal income taxes are important in explaining firms' apparent for internal equity, then difficult to explain why external equity is not strongly is, why most firms gradually to lower target payout ratios and the cash to of security Firms try to stock issues when security prices are Given that they external they are more likely to issue stock than stock prices have than they have For example, past stock were one of the variables in study of firms' choices between new debt and new equity and have similar behavior in the This is to static tradeoff If firm value the debt-to-value ratio and firms ought to issue debt, not equity, to their capital The is to the pecking order There is no reason to that the information is more when stock prices are if there were such a investors would have learned it by and would the firm's issue There is no way firms can take advantage of of new equity in a rational against and growth opportunities. Firms holding valuable intangible assets or growth opportunities to borrow less than firms holding tangible assets. For example, and a significant relationship between of investment in and research and and the of borrowing. They also a significant positive relationship between the rate of capital and and the of borrowing. the same by a different for a firm's and growth opportunities was the difference between the market value of its debt and equity securities and the cost of its tangible assets. The higher this he the less the firm's debt-to-value ratio. There is plenty of evidence that the of borrowing is determined not just by the value and risk of the firm's but also by the type of assets it For example, without this the static tradeoff theory would specify all target debt ratios in of not book Since many firms have market values far in of book values if book values are in current we ought to see at least a few such firms operating at very high book debt of we do This to make as as we that book values reflect assets-in-place assets and values reflect and growth opportunities as well as Thus, firms do not set target book debt ratios because the values are for the values of assets in Masulis has that stock prices on average, when a firm
Traditionally, financial management theory has emphasized the separation of the capital investment and financing decisions [2, pp. 81 and 176]. This separation assumes that the firm's financing decision is taken as given when the investment decision is made or that the two decisions are independent of each other. In reality, these decisionis are seldom independent. Mergers and acquisitions are typical examples of capital investments that make the investment/financing separation inappropriate. The tone of research on the interaction between investment and financing decisions was set by Myers [16]. Myers advanced the concept of Adjusted Present Value (APV), which permits an examination and evaluation of the consequences of interactions between the firm's financing and investment decisions. A new project's APV is defined as the sum of the present value of its net operating income assuming all-equity financing plus the value of any additional debt capacity to the firm contributed by the project. The definition of the new project's APV presented above represents a fairly simplified version. However, a closer look at the concept of APV brings up other potential issues relating to stock purchase decisions, dividend policy, and transaction costs associated with new sources of funding, etc. These are important financial management variables that have been considered in other research efforts [1, 3, 7, 17]. The second phase of the investment/financing interaction process was developed by Bower and Jenks (BJ) [1]. They used the simplified concept of APV in their effort to estima e divisional screening rates for decentralized investm nt decisions. After assuming that each investment project had its implicit optimal debt ratio, BJ used this implicit ratio to estimate the project's cut-off rate in the fr m work of the capital asset pricing model. While BJ's study does provide an important application of the APV concept, it does not go far enough: (a) It does not provide any theoretical basis for assessment of the implicit debt ratio of each project. Their analysis instead relies on average debt ratios of different industries observed on an ex post basis. (b) It assumes that the firm's debt capacity is increased by an amount equivalent to the project's debt capacity. Although the additivity of the firm's debt ca-
Abstract The accounting fraternity has employed regression analysis rather infrequently. This article presents an application of multiple regression analysis to cost control. The context of the application is the consumer finance industry where extensive decentralization makes effective cost control extremely important. The consumer finance industry is made up of companies whose principal activity is making personal installment cash loans under state small loan laws. The cost behavior model employed in this article is developed from the results of multiple regression analysis of cost and other operating data of branch offices of a major consumer finance chain. While the consumer finance industry is used as the basis, it should be emphasized that the procedure outlined would be applicable to other types of businesses as well. The article shows that an important requirement for the applicability of the procedure is the existence of a relatively large number of homogeneous operating units. Consumer finance companies meet this requirement particularly well. However, other types of business also operate with large numbers of homogeneous units-food including service chains and lodging chains. The procedure outlined would, therefore, be applicable to them as well.