Cash Flow Uncertainty Research Articles

Carbon emissions and credit ratings

We examine the impact of firm-level carbon emissions on credit ratings, drawing on a sample of 3116 firm-year observations over the period 2004–2018 in the context of U.S. We find a negative, economically meaningful impact of carbon emissions on credit ratings. This finding remains robust when we employ the instrumental variable approach, difference-in-differences approach, and propensity score matching estimates to address potential endogeneity concerns. Our channel analysis reveals that firms that emit high carbon face higher cash flow uncertainty, which in turn, results in lower credit ratings.

Cash flow uncertainty, financial constraints and R&D investment

Based on the data from Chinese listed companies of Shanghai and Shenzhen stock markets between 2005 and 2016, we systematically examine the relationship between cash flow uncertainty and R&D investment, and further research the moderating effect of financial constraints on the association between the two. Our empirical results find that R&D investment decisions tend to be more conservative and cautious due to cash flow uncertainty, which is not conducive to innovation efficiency. Firms with higher cash flow uncertainty invest more cautiously in R&D innovation, whereas firms with lower cash flow invest more boldly in R&D innovation. Financial friction may exacerbate the negative impact of cash flow uncertainty on innovation activities. Strategic cash holding can help firms better deal with the risks caused by cash flow uncertainty. In provinces with high marketization, the market competition intensifies, resulting in more significant cash flow uncertainty.

A combined analysis of hedge effectiveness and capital efficiency in longevity hedging

By hedging longevity exposures, annuity providers can reduce both the uncertainty in future cash flows and capital charges in a cost efficient manner. We argue that a separate analysis of these two aspects cannot provide a full picture of the implications of longevity hedging, in particular when using index-based instruments.Hence, we propose a stochastic modeling framework for a joint analysis of the risk-reducing effect and the economic impact of longevity hedges in terms of hedge effectiveness and capital efficiency, respectively. In an economic capital model under Solvency II, a wide selection of customized and index-based instruments is analyzed. We show that different hedging objectives require different instruments on different index populations and discuss the accompanying trade-off between hedge effectiveness and capital efficiency. While customized hedges naturally outperform their index-based counterparts in terms of hedge effectiveness, we show that cost efficient index-based designs may be more capital efficient.

Product market competition, disclosure framing, and casting in earnings conference calls

An extensive stream of literature investigates how product market competition, by increasing the proprietary costs of disclosure, influences corporate disclosure policy. We hypothesize that the proprietary costs incurred by firms are associated with how a disclosure is framed and structured. We predict and find that the intensity of competition in the product market is associated with more negative and uncertain earnings conference calls. We also find evidence of firms “casting calls” by emphasizing more pessimistic analysts’ questions. Our results are robust to matched analyses on cash flow uncertainty and to examining the casting of analysts, as opposed to their questions, on the earnings call. Finally, we find consistent results using alternative measures of linguistic structure and in an alternative channel of disclosure with an alternative measure of linguistic framing. Our results demonstrate that firms attempt to mitigate proprietary costs by managing discretionary disclosure structure and framing their conference calls.

Extrapolation Bias and Robust Dynamic Liquidity Management

We consider the optimal dynamic liquidity management of a financially constrained firm when its existing shareholders are risk neutral but ambiguity averse with respect to the firm’s future cash flows. The shareholders’ ambiguity aversion generates endogenous time-varying worst-case beliefs that overweight recent cash flow realizations, thereby providing a microeconomic foundation for extrapolation bias. Moreover, shareholders’ ambiguity aversion has different implications on firms’ liquidity management and recapitalization policies than risk. Models with risk alone imply that higher cash flow volatility increases firms’ payout and refinancing thresholds. By contrast, our model predicts that, when ambiguity-averse shareholders face a higher long-term cash flow uncertainty, they optimally reduce firms’ payout and refinancing thresholds. The implications for investment are also studied. This paper was accepted by Agostino Capponi, finance.

Cash flow uncertainty and IPO underpricing: evidence from income guarantee in Thai REITs

PurposeThe purpose of this article is to investigate the relationship between cash flow uncertainty and the underpricing of real estate investment trust (REIT) initial public offerings (IPOs) using hand-collected data on income guarantee in Thailand from January 2005 to December 2019.Design/methodology/approachThis article uses linear regression to determine the relationship between underpricing (initial return) and proxy for cash flow uncertainty (income guarantee), controlling for other factors. Because issuers can use several actions to signal their quality under asymmetric information, the joint decisions are analyzed as simultaneous equations and estimated using three-stage least square (3SLS) to address potential endogeneity concern.FindingsThis article finds that underpricing, on average, is negatively related to income guarantee, which is a proxy for ex ante cash flow uncertainty. The relationship is economically and statistically significant and robust to simultaneous equations estimation. Further investigation shows that REITs with income guarantee tend to have lower systematic risk (measured by CAPM beta) and returns, making the nature of some REITs more debt-like than equity-like.Practical implicationsFor issuers, the result suggests that offering income guarantee (which is more costly for assets with lower quality) can be a useful signal of asset quality to investors and reduce IPO discount. For institutional and retail investors, the results are informative about the risk-return tradeoffs in REIT IPO investment opportunities. Income guarantees makes REIT exposure more fix income-like, so there is a need to consider the credibility of the guarantor as well.Originality/valueThis article is the first to use income guarantee as an ex ante measure of cash flow uncertainty and explicitly investigates its linkage to IPO underpricing. This aspect of uncertainty and IPO underpricing remains little-studied in the academic literature. It also contributes to the growing literature of REIT IPOs in Asia.

Optimal Interest Rates for Supply Chain Payables Finance

Problem definition: Payables finance, also known as reverse factoring or supply chain finance, is a form of trade finance arrangement that provides a supplier with the option to receive a buyer's payables early while allowing the buyer to extend its payment due date. Its recent adoption of the blockchain technology has made the process more efficient and secure. In this paper, we study the supplier's optimal cash management policy under such a payables finance arrangement, based on which we quantify the value of payables finance to the supplier and also determine the equilibrium payment term extension for the buyer. Academic/Practical Relevance: Our work presents one of the first rigorous analyses of the optimal cash management policy with payables finance by extending the classic cash management models to allow all interest gains and costs to accrue together with the cash balance. Methodology: We develop a finite-horizon random cash management model and transform it into a cash flow cost minimization problem with a dynamic program formulation. Results: Our analysis reveals that the optimal cash policy has a cash balance-dependent (L, M, U) structure, which differs from the threshold policies found in the classic cash management models. We show that it is the cash liquidity enabled by payables finance to hedge cash flow uncertainty that generates value to the supplier. Such value increases with a lower payables finance interest rate and/or a higher payables finance amount. We further show that the equilibrium payment term extension for the buyer increases with a lower payables finance interest rate, but not necessarily with a higher payables finance amount. To tackle the computational challenge of the problem, we show that the myopic policy for this problem has a simple threshold policy structure. For performance evaluation purposes, we also derive an easy-to-compute cost lower bound based on a system with slightly modified cash balances. Our numerical study shows that both the myopic policy and the optimal policy of the modified system achieve near-optimal performance in the original problem. Managerial Implications: Our study provides theoretical support for the wide adoption of payables finance for small suppliers with poor credit ratings and tight cash constraints. Our model analysis also suggests that the adoption of the blockchain technology can offer greater value to such suppliers. The computational methods developed in the paper can be used as a means to evaluate the value of payables finance and the payment term extension, especially in a frictionless blockchain setting.

Downside Variance Premium, Firm Fundamentals, and Expected Corporate Bond Returns

We find a positive relationship between individual downside variance premia, the difference between risk-neutral and physical expected downside variances, and future corporate bond returns. The hedge portfolio earns the economically substantial and statistically significant excess return of 0.35% (0.39%) per month in value (equal)-weighted returns. The predictive power of downside variance premium is stronger in non-investment-grade (long-maturity) corporate bonds than in investment-grade (short-maturity) ones. We show that downside variance premium positively relates to the likelihood of future default and cash flow uncertainty and negatively relates to future cash flow. When rational investors anticipate a high likelihood of future default, high cash flow uncertainty, or low future cash flow, the current bond price has to decline, resulting in higher future bond returns.

Product Market Competition and Disclosure Framing: Evidence from Earnings Conference Calls

An extensive stream of literature investigates how product market competition, by increasing the proprietary costs of disclosure, influences corporate disclosure policy. We hypothesize that the proprietary costs incurred by firms are associated with how a disclosure is framed and structured. We predict and find that the intensity of competition in the product market is associated with more negative and uncertain earnings conference calls. We also find evidence of firms “casting calls” by emphasizing more pessimistic analysts’ questions. Our results are robust to matched analyses on cash flow uncertainty and to examining the casting of analysts, as opposed to their questions, on the earnings call. Finally, we find consistent results using alternative measures of linguistic structure and in an alternative channel of disclosure with an alternative measure of linguistic framing. Our results demonstrate that firms attempt to mitigate proprietary costs by managing discretionary disclosure structure and framing their conference calls.

Fair Value Accounting and Corporate Reporting in Nigeria: A Logistics Regression Approach

This study examined the impact of fair value accounting on corporate reporting in Nigeria. The primary data used were gathered through a well-structured questionnaire, designed and administered to 120 respondents, who are made up of accountants, auditors, bankers, financial experts and practitioners in Lagos State, Nigeria. We adopted the logistic regression approach in analyzing the research questions. We found that fair value accounting has impact on corporate reporting. The Cox and Snell’s R-Square revealed that 67.1% of the variation in the corporate reporting was explained by the logistic model. We further found a moderate strong relationship between the fair value accounting and corporate reporting. Based on this finding, the study concluded that the used of fair value helped in predicting the earnings and assessment of the amounts, timing and uncertainty of future cash flows in corporate reporting which dependent on its reliability. However, institutional factors played an essential role in enhancing the reliability of discretionary fair value estimates which in return increased the informativeness of accounting information in corporate reporting.

Moving the Conceptual Framework Forward: Accounting for Uncertainty

ABSTRACTTo meet the objectives of financial reporting in the IASB's Conceptual Framework, the “balance‐sheet approach” embraced by the Framework is necessary but not sufficient. Critical, but largely overlooked, is the role of uncertainty, which we argue defines the role of accrual accounting as a distinctive source of information for investors when investment outcomes are uncertain. This role is in some sense paradoxical: on the one hand, uncertainty undermines both the balance sheet (because uncertain assets are unrecognized) and the income statement (because mismatching is unavoidable). However, these inevitable accounting effects can be exploited to provide information about uncertainty, though not by a balance‐sheet approach alone. Rather, balance sheet recognition and measurement criteria are established by consideration of the impact of uncertainty on matching and mismatching in the income statement. This combination of balance‐sheet and income‐statement approaches enhances the communication of information to investors under conditions of uncertainty, thereby giving greater clarity and purpose in satisfying the objective of the Framework to provide information about “the amount, timing, and uncertainty of future cash flows.”

Uncertainty of Cash Flow and Corporate Innovation

Facing the uncertainty of internal and external environment, how to reasonably manage the cash flow and improve the competitiveness has become a hot research topic. Based on the theory of financing priority, liquidity preference and financing constraint, this paper analyzes the relationship between cash flow uncertainty and enterprise innovation, and verifies the effect of cash flow uncertainty on enterprise innovation. In addition, government subsidies and senior management shareholding are added into the original model as moderating variables to explore whether external factors of enterprises such as government subsidies and internal factors of enterprises such as governance structure will have an impact on the relationship between cash flow uncertainty and enterprise innovation.

Оценка эффективности инновационного проекта по созданию производства биотоплива с использованием опционного и нечетко-множественного анализа

Implementation of innovative projects at first stages is associated with risks determined by high uncertainty of cash flows. As such, the application of standard methods to analyze the project’s economic efficiency does not allow us to give reliable estimates of the forecast dynamics of economic indicators. All this requires the development of special techniques for the analysis of the effectiveness of innovation spending. The use of real options as well as fuzzy sets approach seems to be a basic conceptual focus for the further improvement of these methods. The paper contains the results of the effectiveness estimation for an innovative project aimed at establishing motor fuel production from high energy biomass with the use of option and fuzzy sets analysis. The use of the proposed fuzzy sets methods makes it possible to complement the traditional financial analysis and quantitatively estimates sustainability of different indicators of the innovative project efficiency to a change in exogenous parameters. Besides, it could be rather useful to identify the project’s bottlenecks. Moreover, the application of this method allows to quantitatively estimate reliability of the calculated project effectiveness indicators. Hardly can such estimations be made by means of traditional methods of financial analysis; either low or high reliability of the obtained effectiveness indicators could serve as an additional argument in favor of negative or positive decision on the project finance, allowing a venture capital fund to allocate the resources among the analyzed innovative projects more efficiently. On the whole, the use of the real options combined with the fuzzy sets method is sure to expand venture capital tools used for financial justification of submitted projects.

Crowdfunding via Revenue-Sharing Contracts

Problem definition: We analyze a new model of crowdfunding recently introduced by Bolstr, Localstake, and Startwise. A platform acts as a matchmaker between a firm needing funds and a crowd of investors willing to provide capital. After the firm is funded, it pays back the investors using revenue-sharing contracts, with a prespecified investment multiple (investors will receive [Formula: see text] dollars for every dollar invested) and a revenue-sharing proportion, over an investment horizon of uncertain duration. Academic/practical relevance: We analyze the revenue-sharing contract approach to crowdfunding, and we assist the firm to determine its optimal contract parameters to maximize its expected net present value (NPV) subject to investor participation constraints and platform fees. Methodology: A natural multiperiod formulation for the firm’s problem results in an intractable stochastic optimization model, which we approximate using a deterministic model. In the approximation model, we use a cash buffer for dealing with cash flow uncertainties; we are able to solve the approximation model analytically. Results: Parametrized on real data from Bolstr campaigns, our approximation solutions give an NPV in the stochastic problem that is within 0.2% of the simulation-based optimal NPV for all levels of cash flow uncertainty. We compare revenue-sharing contracts with equity crowdfunding and observe that the former result in higher NPVs and comparable bankruptcy probabilities. We also compare revenue-sharing contracts with fixed rate loans and find that, for most cases considered, revenue-sharing contracts provide a higher NPV and a lower probability of bankruptcy than a fixed rate loan. We also show that these benefits are more significant for firms with higher levels of cash flow uncertainty. Managerial implications: Revenue-sharing contracts are a novel approach to crowdfunding, and we show that are superior to other financing models.

A method to evaluate credit risk for banks under PPP project finance

PurposeThe purpose of this paper is to provide a method that can better evaluate the credit risk (CR) under PPP project finance.Design/methodology/approachThe principle to evaluate the CR of PPP projects is to calculate three critical indicators: the default probability (DP), the recovery rate (RR) and the exposure at default (EAD). The RR is determined by qualitative analysis according to Standard & Poor’s Recovery Scale, and the EAD is estimated by NPV analysis. The estimation of the DP is the focus of CR assessment because the future cash flow is not certain, and there are no trading records and market data that can be used to evaluate the credit condition of PPP projects before financial close. The modified CreditMetrics model and Monte Carlo simulation are applied to evaluate the DP, and the application is illustrated by a PPP project finance case.FindingsFirst, the proposed method can evaluate the influence of the project’s cash flow uncertainty on the potential loss of the bank. Second, instead of outputting a certain default loss value, the method can derive an interval of the potential loss for the bank. Third, the method can effectively analyze how different repayment schedules and risk preference of banks influence the evaluating result.Originality/valueThe proposed method offers an approach for the bank to value the CR under PPP project finance. The method took into consideration of the uncertainty and other characteristics of PPP project finance, adopted and improved the CreditMetrics model, and provided a possible loss range under different project cash flow volatilities through interval estimation under certain confident level. In addition, the bank’s risk preference is considered in the CR evaluating method proposed in this study where the bank’s risk preference is first investigated in the CR evaluating process of PPP project finance.

A Matter of Principle: Accounting Reports Convey Both Cash-Flow News and Discount-Rate News

This paper modifies the standard returns-earnings regression in accounting research to show that financial reports convey both cash-flow news and discount-rate (expected-return) news. The paper points to the realization principle, associated as it is with the resolution of risk, as the accounting feature that conveys expected-return news. The modified returns-earnings regressions indicate that the information so conveyed pertains to priced risk. In corroboration, the paper also shows that the identified expected-return news forecasts changes in both stock return betas and earnings betas, and expected-return news predicts future returns, whereas cash-flow news does not. The analysis yields a number of additional insights: financial statements distinguish expected-return news associated with operations from that associated with financing activities; given accounting information, there is not much news in dividends; and, in comparing the information content of earnings versus cash flows, cash flows largely convey expected-return news rather than cash-flow news. In sum, the paper shows that the objective of the Financial Accounting Standards Board and International Accounting Standards Board to provide information about the amount and uncertainty of future cash flows is (as least, partially) satisfied by accounting principles underlying current financial reporting. This paper was accepted by Suraj Srinivasan, accounting.

Employment, Corporate Investment, and Cash-Flow Risk

We highlight the role of cash-flow uncertainty on corporate employment and investment. We find that a 1% increase in cash-flow uncertainty leads to a 0.62% decrease in tangible investment, a 1.39% decrease in intangible investment, and a 3.67% decrease in corporate employment growth. Our results are statistically and economically significant. We further find that these relationships are stronger during economic recessions. Our findings have significant policy implications. To wit, if policy makers would like corporations to increase their employment and investment, they should focus on policies that decrease corporate cash-flow uncertainty.

Dividend and Investment Decisions of Indian Corporate Firms Under Cash Flow Uncertainty

The Miller–Modigliani theory proposed that in perfect capital market, dividend and investment decisions are mutually separable, which is commonly known as the “separation principle.” On the basis of this theory, this article tries to investigate the dividend–investment relationship from a new perspective by introducing the cash flow uncertainty. This cash flow uncertainty is measured by cash flow shortfall and cash flow volatility. Using firm-specific data on relevant variables of the BSE-listed firms from 2001 to 2015, this article tries to explore the instruments which help to resolve cash flow uncertainty of the firm. Classifying firms into quintiles and dividing them into positive and negative shortfalls on the basis of both the measures of cash flow uncertainty, our main results show that firms mainly use external financing to resolve cash flow uncertainty. However, cash drawdown plays a trivial role in mitigating shortfalls. Moreover, applying the linear panel data estimation, the relationship between dividend and investment is explored for firms having a positive cash flow shortfall, using both measures of cash flow uncertainty. Our results reported that firm’s investment decision has no impact on dividend decision and vice versa. Hence, dividend and investment choices are made independently under cash flow uncertainty. Thus, our results support the “separation principle” under cash flow uncertainty.

Modeling Price Volatility Based on a Genetic Programming Approach

AbstractBusiness profitability is highly dependent on risk management strategies to hedge future cash flow uncertainty. Commodity price shocks and fluctuations are key risks for companies with global supply chains. The purpose of this paper is to show how artificial intelligence (AI) techniques can be used to model the volatility of commodity prices. More specifically, the authors introduce a new model – LIQ‐GARCH – that uses genetic programming to forecast volatility. The newly generated model is then used to forecast the volatility of the following three indexes: the Commodity Research Bureau (CRB) index, the West Texas Intermediate (WTI) oil futures prices and the Baltic Dry Index (BDI). The empirical model performance tests show that the newly generated model in this paper is considerably more accurate than the traditional GARCH model. As a result, this model can help businesses to design optimal risk management strategies and to hedge themselves against price uncertainty.

INNOVATION COMPONENT OF POLYSTRUCTURAL PROCESS OF FORMATION AND DIAGNOSTICS OF ECONOMIC SECURITY OF ENTERPRISE

For the first time, the use of the V&V concept for the diagnosis of economic security of agricultural enterprises was proposed. This study creates regulatory models for enterprises to make the best decisions in the network of values, when the goal is an efficient and structurally reliable cooperation. The models use theoretical game concepts for multilateral decision making, which involves both cooperation and competition. The purpose of the article was to identify the innovative component of the polystructural process of forming and diagnosing economic security of the enterprise. From a conceptual point of view, it is useful to distinguish between the analysis and diagnostics of the system of economic security of an individual enterprise, from the analysis of economic security of a set of enterprises with clear group characteristics or models. Each individual enterprise or set of enterprises has its own peculiarities that arise as a result of changes in resources and circumstances in the context of local institutions and policies. They turn into productive activities, as well as enterprise consumption and decision-making activities. In this analysis, the system of economic security of a set of enterprises is defined as a combination of small and large enterprises, which, like a group, have similar patterns of life and consumption, as well as constraints and opportunities, and for which such development strategies and interventions would be appropriate. Often such systems have similar agroecological and market conditions. Enterprises usually make their decisions to maximize profits. Profit is the result of incoming and outgoing cash flows, which, on the one hand, depend on the success of the market, and, for example, on operating costs and capital costs, on the other. Consequently, future cash flows determine the level of success, as long as the cost of time is recorded. However, an accurate estimate of future cash flows at the time of the decision is usually unrealistic. Uncertainty, for example, the development of the market, the decisions of competitors, as well as future costs, give rise to high uncertainty in future cash flows.