1) How Stable are Corporate Capital Structures?

Harry DeAngelo
University of Southern California - Marshall School of Business - Finance and Business Economics Department

Richard Roll
University of California, Los Angeles (UCLA) - Finance Area March 14, 2011 Abstract: Capital structure stability is the exception, not the rule. The median time-series range in book leverage (Debt/Total Assets) is 0.392 among firms listed 20 years or more and, for 29.8% of these firms, Debt/TA ratios vary by more than 0.500, whereas only 2.3% (8.3%) have Debt/TA ratios that vary by less than 0.100 (less than 0.200). Leverage stability is virtually always a temporary phenomenon, and episodes of stability largely occur when firms have low leverage. Departures from stability are rarely followed by reverting to the prior stable leverage regime or by establishing a new stable regime at a different level of leverage. Leverage instability is strongly associated with asset growth and external funding to support that growth. Leverage increased broadly during the 1950s and 1960s, coincident with investment during the post-World War II boom. Overall, the evidence suggests (i) there is little benefit from adhering to a leverage target and (ii) investment policy has an important influence on the time path of leverage. Number of Pages in PDF File: 66 Keywords: capital structure stability, leverage target, leverage persistence JEL Classifications: G32, G31, G35, G33 Working Paper Series

2) Internal Corporate Governance, CEO Turnover, and Earnings Management

Sonali Hazarika
Baruch College, CUNY

Jonathan M. Karpoff
University of Washington - Michael G. Foster School of Business

Rajarishi Nahata
City University of New York, CUNY Baruch College - Zicklin School of Business - Department of Economics and Finance

March 9, 2011 Abstract: CEOs who manage earnings can impose costs on shareholders. But do boards act proactively to discipline such managers, or reactively and only when the earnings manipulations lead to external consequences? Using a sample of 402 forced turnovers and 1,493 voluntary turnovers from 19922004, we find that the likelihood and speed of forced CEO turnover are positively related to earnings management. A CEOs job tenure also is negatively related to how actively earnings are managed during his term in office. These results persist in tests that consider the possible endogeneity of CEO turnover and earnings management, and control for such external consequences as earnings restatements and SEC enforcement actions. The relation between earnings management and forced turnover occurs both in firms with good and bad performance, and when the accruals work to inflate or deflate reported earnings. These results indicate that at least some boards act proactively to discipline managers who manage earnings aggressively, before the manipulations lead to costly external consequences. This is consistent with the view that internal governance does in fact work to mitigate managerial agency problems. Number of Pages in PDF File: 60 Keywords: Management turnover, earnings management, corporate governance JEL Classifications: G38, K22, K42, M41 Working Paper Series

3) A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation

Stephen H. Penman
Columbia University - Department of Accounting

Theodore Sougiannis
University of Illinois at Urbana-Champaign - Department of Accountancy Abstract: Standard formulas for valuing the equity of going concerns require prediction of payoffs "to infinity" but practical analysis requires that they be predicted over finite horizons. This truncation inevitably involves (often troublesome) "terminal value" calculations. This paper contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when applied to a finite-horizon valuation. Valuations based on average ex-post payoffs over various horizons, with and without terminal value calculations, are compared with (ex-ante) market prices to give an indication of the error introduced by each technique in truncating the horizon. Comparisons of these errors show that accrual earnings techniques dominate free cash flow and dividend discounting approaches. Further, the relevant accounting features of techniques that make them less than ideal for finite horizon analysis are discovered. Conditions where a given technique requires particularly long forecasting horizons are identified and the performance of the alternative techniques under those conditions is examined. Number of Pages in PDF File: 68 JEL Classifications: G12, M41

Working Paper Series

4) Company Valuation Methods: The Most Common Errors in Valuations

Pablo Fernandez
University of Navarra - IESE Business School February 28, 2007 Abstract: In this paper, I describe the four main groups comprising the most widely used company valuation methods: balance sheet-based methods, income statement-based methods, mixed methods, and cash flow discounting-based methods. The methods that are conceptually correct are those based on cash flow discounting. I briefly comment on other methods since - even though they are conceptually incorrect - they continue to be used frequently. I also present a real-life example to illustrate the valuation of a company as the sum of the value of different businesses, which is usually called the break-up value. I finish the paper showing the most common errors in valuations: a list that contains the most common errors that the author has detected in the more than one thousand valuations he has had access to in his capacity as business consultant or teacher. Number of Pages in PDF File: 27 Keywords: Value, Price, Free cash flow, Equity cash flow, Capital cash flow, Book value, Market value, PER, Goodwill, Required return to equity, Working capital requirements JEL Classifications: G12, G31, M21 Working Paper Series

5) Do Dividends Matter More in Declining Markets?

Kathleen P. Fuller
University of Mississippi - School of Business Administration

Michael A. Goldstein
Babson College - Finance Division December 21, 2010 Journal of Corporate Finance, Vol. 17, No. 3, June 2011, pp. 457-473, June 2011 Abstract: We find dividends do matter to shareholders, but more in declining markets than advancing ones. Dividend-paying stocks outperform non-dividend-paying stocks by 1 to 2% more per month in declining markets than in advancing markets. These results are economically and statistically

significant and robust to many risk adjustments and across industries. In addition, we find an asymmetric response to dividend changes based on market conditions: dividend increases matter more in declining markets than advancing ones. Tests indicate that results are not due to more profitable firms and appear not to be caused either by free cash flow or signaling explanations. We also find that it is the existence of dividends, and not the dividend yield, that drives returns asymmetric behavior relative to market movements.. Number of Pages in PDF File: 44 Keywords: Dividend policy, asymmetry, market movements JEL Classifications: G35 Working Paper Series

6) Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry

John David Cummins

Temple University

Richard D. Phillips
Georgia State University

Stephen D. Smith
Deceased

Forthcoming Abstract: The use of derivatives in corporate risk management has grown rapidly in recent years. In this paper, the authors explore the factors that influence the use of financial derivatives in the U.S. insurance industry. Their objective is to investigate the motivations for corporate risk management The authors use regulatory data on individual holdings and transactions in derivative markets. According to modern finance theory, shares of widely held corporations are held by diversified investors who operate in frictionless and complete markets and eliminate non-systematic risk through their portfolio choices. But this theory has been challenged by new hypotheses that take into account market imperfections, information asymmetries and incentive conflicts as motivations for corporate managers to change the risk/return profile of their firm. The authors develop a set of hypotheses regarding the hedging behavior of insurers and perform tests on a sample of life and property-liability insurers to test them. The sample consists of all U.S. life and property-liability insurers reporting to the NAIC. The authors investigate the decision to conduct derivatives transactions and the volume of transactions undertaken. There are two primary theories about the motivations for corporate risk management maximization of shareholder value and maximization of managerial utility. The authors discuss these theories, the hypotheses they develop from them , and specify variables to test their hypotheses. They posit the following rationales for why corporations may choose to engage in risk management and also specify variables that help them study the use of these rationales by insurance firms: to avoid the costs of financial distress; to hedge part of their investment default/volatility/liquidity risks; to avoid shocks to equity that result in high leverage ratios; to minimize taxes and enhance firm value by reducing the volatility of earnings; to maximize managerial utility. The authors argue that the use of

derivatives for speculative purposes in the insurance industry is not common. The authors analyze the decision by insurers to enter the market and their volume of transactions. They use probit analysis to study the participation decision and Tobit analysis along with Cragg's generalization of the Tobit analysis to study volume. The results provide support for the authors' hypothesis that insurers hedge to maximize shareholder value. The analysis provides only weak support for the managerial utility hypothesis. Insurers are motivated to use financial derivatives to reduce the expected costs of financial distress. There is also evidence that insurers use derivatives to hedge asset volatility and exchange rate risks. There is also evidence that there are significant economies of scale in running derivatives operations - only large firms and/or those with higher than average risk exposure find it worthwhile to pay the fixed cost of setting up a derivatives operation. Overall, insurers with higher than average asset risk exposures use derivative securities. Number of Pages in PDF File: 49 Keywords: Derivatives, Risk Management, Insurance Companies JEL Classifications: G2, G3, L2 Accepted Paper Series

7) Why Do Firms Pay Dividends? International Evidence on the Determinants of Dividend Policy

Igor Osobov
University of Connecticut

David J. Denis
Purdue University - Department of Management May 2007 Abstract: In the U.S., Canada, U.K., Germany, France, and Japan, the propensity to pay dividends is higher among larger, more profitable firms, and those for which retained earnings comprise a large fraction of total equity. Although there are hints of reductions in the propensity to pay dividends in most of the sample countries over the 1994 to 2002 period, they are driven by a failure of newly listed firms to initiate dividends when expected to do so. Dividend abandonment and the failure to initiate by existing nonpayers are economically unimportant except in Japan. Moreover, in each country, aggregate dividends have not declined and are concentrated among the largest, most profitable firms. Finally, outside of the U.S. there is little evidence of a systematic positive relation between relative prices of dividend paying and non-paying firms and the propensity to pay dividends. Overall, these findings cast doubt on signaling, clientele, and catering explanations for dividends, but support agency costbased lifecycle theories. Number of Pages in PDF File: 52 Keywords: dividends, dividend policy, payout policy, disappearing dividends, earned equity, catering JEL Classifications: G35 Working Paper Series