Book Equity Research Articles

Financing a Loss

When companies have a net loss accompanied by negative operating cash flows, they must decide how to handle the financing deficit, or, stated differently, they must decide how to finance the loss. By examining a large sample of firms with net losses, we document how companies respond to the financing shock that occurs with negative cash flow. For companies with a one-year loss, current assets decrease and current liabilities increase. While we observe that leverage ratios increase during a loss year, this increase has more to do with decreasing book equity than an increase in long-term debt. However, when the loss persists into a second year, companies make more fundamental changes, often downsizing by decreasing fixed assets and by issuing longer term debt.

Book-to-Market and the Cross-Section of Expected Returns in International Stock Markets

Fama and French (2008) provide evidence that past changes in book equity and price contain independent information about expected cash flows that can be used to improve estimates of expected returns. This paper focuses on international stock markets and re-examines whether the origins of the book-to-market ratio (BM) in terms of past changes in book equity and price enhance the estimates of expected returns provided by BM alone. Results are presented for All stocks as well as Microcap, Small, Big, and All but Microcap stocks trading in the UK, Germany, France, Italy, Canada, and Japan. The firm-level crosssectional regressions indicate that recent changes in book equity and price are more relevant than more distant changes to disentangle the information in BM about expected cash flows and expected returns, thus enhancing estimates of expected future returns. The tests also show that a change in book equity is much more informative about expected stock returns than a change in price.

Capital Structure Shifts And Recession: An Empirical Investigation

<span style="font-family: Times New Roman; font-size: small;"> </span><p style="margin: 0in 0.5in 0pt; text-align: justify; mso-pagination: none;" class="MsoNormal"><span style="color: black; font-size: 10pt; mso-themecolor: text1;"><span style="font-family: Times New Roman;">This study investigates whether the 2007-2009 recession impacted the capital structures of U.S. corporations.<span style="mso-spacerun: yes;"> </span>Investigating all non-financial firms in the S&P 500 Index, the study finds that by boosting their book equity via dividend cuts and some debt reductions, firms kept book leverage unchanged.</span></span></p><span style="font-family: Times New Roman; font-size: small;"> </span>

Ownership concentration and dividend policy in Japan

Purpose – The purpose of this paper is to test two agency‐based hypotheses regarding the effect of ownership concentration on dividend policy using a large sample of Japanese firms.Design/methodology/approach – Level regressions associating payout rates to ownership concentration are run. Different measures of payout are used to ensure the robustness of our findings. Endogeneity of ownership is taken into account. The choice of instruments is carefuly motivated and their statistical power and exogeneity are checked. How ownership concentration affects the propensity to increase dividends following changes in variables correlated with free cash flows is also examined.Findings – The results are consistent with rent extraction by large shareholders. Ownership concentration is associated with significantly lower dividends in proportion to earnings as well as relative to book equity. An endogenous relation between ownership concentration and dividend payout is established, but the results are not statistically...

Returns and Risks to Private Equity

We assess returns and risks to private equity investors from 35 countries for the time interval of 1996-2008. We find that returns to private equity (measured as return on book equity (ROE)) are significantly higher than ROEs to publicly traded equity. Using customary measures to adjust for risk, the spread between private and public equity returns is sufficiently high to justify the idiosyncratic risk borne by undiversified private equity investors. Despite their apparently high undiversified portfolio risk, investors in non-publicly traded firms appear to allocate their capital efficiently.

Equity valuation under Bull and Bear market regimes in South East Asia firms: a switching regression approach

A switching regression approach is used to analyse the market equity value of firms in the three South East Asia countries with a comparison to Japan. Two regimes are used to optimally sort the firms in a given country based on a switching function using profit rate (net income to book equity) as its variable. The regimes are identified as a Bear security market or a Bull security market depending on the value of the profit rate. Two financial ratios are used in the regime regressions. It was found that the optimum scaled switch point separating the Bulls from the Bears for the countries was a positive profit rate ranging between 6 and 24%. The notion that a zero or negative profit rate identifies a Bear market is not supported. In general, the results across countries and for the long-term debt ratio were quite consistent. The post-Asian financial crisis of 1997 had a depressing effect on firm market equity values, regardless of the market type and the country. The Bulls and the Bears are not cousins when it comes to their different reactions to the long-term debt ratio and their different, relative, adverse responses to the financial crisis.

Residual income valuation and management remuneration under uncertainty: a note

The so-called Residual Income Valuation theorem states that the value of a project or a firm can be determined either on the basis of cash flows between the firm and its owners or by using residual incomes, provided that cash flows and residual incomes are derived from a set of accounting data that fulfills certain regularity conditions. Residual income is defined as accounting earnings reduced by a capital charge on book equity capital. In this paper it is shown that this theorem also applies when residual incomes and in particular the discount factors are uncertain. Risk-aversion of principals and agents is taken into account on the basis of properly defined risk-adjusted discount rates. This approach is preferred as it facilitates practical application. Implications are drawn with regards to valuation but also to the design of management remuneration systems. It is shown that the capital charge rate used to determine the performance-related compensation component should be reduced below the risk-adjusted rate, if the fixed component falls below a certain threshold. Absent agency cost or other externalities, the reduction of the capital charge rate is required to avoid underinvestment.

Size or Book-to-Market Ratio and Default Risk from Negative Book Equity Perspective

Size or Book-to-Market Ratio and Default Risk from Negative Book Equity Perspective

Adapting to succeed? Leveraging the brand equity of best sellers to succeed at the box office

Many movies are based on best-selling novels. While book adaptation is an often used strategy in the motion picture industry, it has received little academic attention. Using a multi-method approach, this research investigates the drivers behind the success of book-based movies. In Study 1, we analyze over 700 movies and find that book-based movies perform better at the box office on the opening weekend than non-book movies. However, this superior performance dissipates after the opening weekend. Further, the opening weekend performance of book-based movies is positively driven by book equity, book-movie similarity, and recency between the book’s peak equity and movie release. After the opening weekend, many of these book-related variables cease to have an impact, and the effect of movie-related variables (e.g., reviews) increases. Because Study 1 documents that book-movie similarity positively impacts the movie’s performance, contrary to prior findings that content similarity has negative or null impact on performance of a movie sequel, we undertake a second study to reconcile the discrepancy. Study 2 finds that content similarity results in satiation and therefore hampers the movie success for sequels; however, when a movie is adapted from a book, due to experiential modality change (i.e., from book format to film format rather than film to film), content similarity increases the movie’s chance of success.

Asset-pricing anomalies and spanning: Multivariate and multifactor tests with heavy-tailed distributions

Abstract In this paper we propose a multivariate regression based assessment of the multifactor model first developed by Fama and French (1993). We study mean-variance efficiency and spanning, as well as factor relevance. In particular, we assess the relative contribution of the factors in accounting for asset pricing anomalies. Our tests are motivated by a finite-sample distributional theory, invariant to portfolio repackaging, and achieve size control exactly conditioning on observed factors, in normal and non-normal contexts. We focus on the multivariate normal and Student-t distributions, in which case we rely on the simulation procedure proposed and applied in Beaulieu et al. (2007). We also assess, from a finite-sample and multivariate test perspective, the specification and fit of the model and error distributions considered. In its most general form, the model considered includes six factors: the market portfolio, size, the ratio of book equity to market equity as well as term structure variables (a term premium and a default premium) and momentum. Portfolio returns (coming from assets traded at NYSE, AMEX and NASDAQ) from Fama and French's data base are analyzed on monthly frequencies from 1961–2000. Our results show the following. (1) Normality in model residuals becomes more dependable as a working hypothesis, over short time spans, when the book to market equity and size factors or when the momentum factor are accounted for. (2) Allowing for heavy tailed distributions empirically accommodates some stylized asset pricing anomalies. (3) Loadings on the term structure variables and the momentum factor seem (jointly, across portfolios) statistically insignificant at usual levels in many sub-periods. (4) Mean-variance efficiency is rejected in fewer subperiods allowing for non-normal errors in multi-factor settings; the book to market equity and size factors contribute importantly in reinforcing efficiency. (5) Enlarging the set of assets [from a one factor to a six factor model] does not reinforce the mean-variance spanning hypothesis, which is globally rejected at usual levels.

A New Value-Weighted Total Return Index for the Finnish Stock Market

This paper presents a new monthly value-weighted, all-share total return index for the Finnish stock market. The index covers the period from the establishment of the Helsinki Stock Exchange in October 1912 to the beginning of 1970, after which the WI index by Berglund et al (1983) and later in December 1990, the Exchange’s own HEX index are available. When combined, these can be used to study the development of the Finnish equity market without a break from the beginning of the stock market until the present day. We also provide a detailed description of the construction methodology and a comparison between our index and those available earlier. The new index replaces the Unitas price index, which has been the only index available for long-term studies from 1928 onwards. The new index also provides an alternative to the book equity weighted Poutvaara (1996) price index for the period 1912–1929.

A new value-weighted total return index for the Finnish stock market

This paper presents a new monthly value-weighted, all-share total return index for the Finnish stock market. The index covers the period from the establishment of the Helsinki Stock Exchange in October 1912 to the beginning of 1970, after which another index becomes available. When combined, they can be used to study continuously the development of the Finnish equity market from the beginning of the stock exchange until the present day. We also provide a detailed description of the construction methodology and a comparison between our index and those available earlier. The index replaces the Unitas price index which has been the only index available for long-term studies from 1928 onwards. The new index also provides an alternative to the book equity weighted Poutvaara (1996) price index for the period 1912–1929.

Estimando o Retorno das Ações com Decomposição do Índice Book-to-Market: Evidências na Bovespa

A relação book-to-market (BM) difere entre empresas devido a diferentes expectativas em termos de fluxos de caixa e retornos esperados das ações. A hipótese central é que a evolução do BM, em termos de mudanças passadas no preço e valor patrimonial, contém informação sobre os fluxos de caixa futuros que pode ser utilizada para melhorar as estimativas de retornos esperados. Este artigo utilizou a base de dados da Economática para extrair uma amostra de ações de empresas não financeiras de capital aberto listadas na BOVESPA e testar essa hipótese. As regressões realizadas foram estimadas mensalmente durante o período de julho de 1996 a junho de 2008. Tanto para as large and mid caps quanto para as small caps, os resultados encontrados não favorecem essa hipótese e mostram que somente o BM mais recente é relevante para se prever os retornos dos ativos. Além disso, emissões e recompras de ações também estão relacionadas a fluxos de caixa futuros e se espera que possam melhorar as estimativas de retornos esperados. No entanto, os resultados encontrados não trazem evidências que favorecem essa afirmação.

Are Firms with Negative Book Equity in Financial Distress?

Are Firms with Negative Book Equity in Financial Distress?

The Value Relevance of Earnings and Book Value Using an Option-Style Equity Valuation Model: Evidence from Korea

The purpose of this paper is to investigate the value relevance of earnings and book value in security prices from 1982 to 2001 in Korean stock market. The study examines whether the accounting earnings and book value have a nonlinear relationship to equity value by using an option-style model of equity. The study uses an option-style model of equity value to test the hypothesis that earnings and book value have a nonlinear relationship to equity value by examining firms listed in the Korean stock market (7,928 firm-year observations). To this end, the paper performs analyses for all samples and across subsamples divided into loss firms and profit firms, and observes changes in relationships over the past twenty years. This paper reports three sets of findings. First, the value-relevance of accounting earnings differs between loss firms and profit firms. Second, Korean firms differently acknowledge accounting earnings and book value for equity valuation. Third, an option-style valuation model can explain the nonlinear relationship between equity value and accounting earnings/book value. The important contribution of the study is to show the nonlinear relationship between equity value and book value in the Korean stock market. And the empirical results of the paper reinforces the adoption of a new equity valuation model that explicitly recognized the option that firms have to adapt their resources to the alternative uses available to them.

Earnings management and initial public offerings: The case of the depository industry

In a typical IPO, insiders are “net sellers” of IPO shares; however, in a demutualizing thrift, insiders are “net buyers” of IPO shares. Using a sample of mutual depository IPOs, we find evidence consistent with earnings management prior to the conversion of mutual thrifts. We find on average that mutuals report lower ROA and increased loan loss provisions and loan loss reserves in the period prior to the demutualization. Using a two-stage approach, we also find that the level of discretionary loan loss provisions and discretionary reserves are positively related to both the level of insider participation in the IPO and the first-day returns to investors. Our results are consistent with management of mutual thrifts benefiting at the conversion from reduced pre-IPO earnings and book equity resulting from earnings management.

Going Negative: What to Do with Negative Book Equity Stocks

Going Negative: What to Do with Negative Book Equity Stocks

Earnings Management and Initial Public Offerings: The Case of the Depository Industry

In a typical IPO, insiders are “net sellers” of IPO shares; however, in a demutualizing thrift, insiders are “net buyers” of IPO shares. Using a sample of mutual depository IPOs, we find evidence consistent with earnings management prior to the conversion of mutual thrifts. We find on average that mutuals report lower ROA and increased loan loss provisions and loan loss reserves in the period prior to the demutualization. Using a two-stage approach, we also find that the level of discretionary loan loss provisions and discretionary reserves are positively related to both the level of insider participation in the IPO and the first-day returns to investors. Our results are consistent with management of mutual thrifts benefiting at the conversion from reduced pre-IPO earnings and book equity resulting from earnings management.

A Review of the Value Relevance Literature

Value relevance research empirically investigates the usefulness of accounting information to stock investors. Accounting information is denoted as value relevant if there is a statistical association between the accounting numbers and market values of equity. This review provides a comprehensive study of the value relevance literature. The review fo- cuses mainly on high-quality value relevance research from the last two decades, but it also covers seminal studies from the late 1960s. The primary focus is on research on U.S. financial data, but some international evidence is also presented. The articles are generally selected from top accounting journals. The review offers an introduction to the methodology employed within this research tradition and presents the main results from studies regarding the value relevance of the two summary measures used in financial reports, namely, earnings and book equity. Furthermore, the review describes studies on the development in value relevance over time and shows how value relevance from different accounting methods can be compared. Overall, the review provides in-depth information on the value relevance literature to readers who wish to familiarise themselves with this line of empirical accounting research.

The cross section of cashflow volatility and expected stock returns

Abstract I show that historical cashflow volatility is negatively related to future returns cross-sectionally. The negative association is large; economically meaningful; long-lasting up to five years; robust to known return-informative effects of size, value, price and earnings momentums and illiquidity; and extends to both systematic and idiosyncratic cashflow volatilities. Using the standard deviations of cashflow to sales and of cashflow to book equity as proxies for cashflow volatility, the least volatile decile portfolio outperforms the most volatile decile portfolio by 13% a year relative to the Fama–French four factors. The cashflow volatility effect is closely related to the idiosyncratic return volatility effect documented in Ang et al. [Ang, A., Hodrick, R.J., Xing, Y. and Zhang, X. “The cross-section of volatility and expected returns.” Journal of Finance, 51 (2006), 259–299.]. However, in portfolios simultaneously sorted on both cashflow and return volatilities, and in cross sectional regressions of returns at the firm level, these two effects neither drive out nor dominate each other. While the pricing of idiosyncratic cashflow volatility represents an anomaly against the traditional asset pricing theories, the pricing of historical cashflow uncertainty sheds light on potential fundamental risks embodied in the Fama–French HML and SMB factors.