Common Stock Valuation Research Articles

Evidenciação voluntária: fatores explicativos da extensão da informação sobre recursos intangíveis

A redução da assimetria de informação contribui para uma melhor distribuição econômica e oportunidades de investimentos. Partindo desse pressuposto, este artigo identifica fatores que influenciam a extensão da evidenciação de informação voluntária, sobre os recursos intangíveis, de empresas listadas na Bolsa Espanhola. Para a análise, utiliza-se a técnica de mínimos quadrados ordinários. Os resultados apontam que fatores como: o tamanho, o setor, o endividamento, o grau de internacionalização, os anos de existência e a diferença entre o preço da ação sobre o valor contábil da empresa explicam a maior extensão da evidenciação de informação de recursos intangíveis. Já, fatores tais como a rentabilidade, o grau de monopólio e o capital flutuante da empresa, explicam a menor extensão da evidenciação dessas informações.

How Do Practitioners Value Common Stock?

Early work in the 1970s documented a significant difference between the valuation of stock as taught by academics and as practiced by investment professionals. We revisit the issue of practitioner valuation of common stock using a survey-based investigation. We find that most practitioners use multiple techniques, that those techniques vary across the time horizon employed to estimate future variables and that the significant gap that existed between academics and practitioners continues to this day. We extend earlier work to examine differences between analysts working for different types of institutions and with different asset management styles.

The Price-Earnings Ratio

The P/E ratio is a widely used tool for valuation of common stock. One of its prime virtues is the simplicity of calculation. In this article the author suggests that in some situations a more complex calculation, but analogous to a P/E ratio, gives more useful information. The two situations reviewed are for a firm with an abnormal liability and for a firm with an abnormal amount of cash available for distribution. In these situations, adjustments to the P/E calculations of the type illustrated are desirable.

The Economic Dilution of Employee Stock Options: Diluted EPS for Valuation and Financial Reporting

In this paper, we derive a measure of diluted EPS that incorporates the economic implications of the dilutive effects of employee stock options. We show that the existing FASB treasury-stock method of accounting for the dilutive effects of outstanding options systematically understates the options' dilutive effect, and thus overstates reported EPS. Using firm-wide data on 731 employee stock option plans, our proposed measure suggests that economic dilution from options is, on average, 100 percent greater than dilution in reported diluted EPS using the FASB treasury-stock method. We examine the implications of our analysis for stock price valuation, the price-earnings relation, and the return-earnings relation. We demonstrate analytically that when firms have options outstanding, empirical applications of equity valuation models that use reported per-share earnings as an input (e.g., Ohlson 1995) yield upwardly biased estimates of the market value of common stock. We predict that when the difference between our measure of economic dilution from options and the FASB treasury-stock method dilution from options is greater, the observed return-earnings and price-earnings coefficients will be smaller, and we provide some (albeit weak) empirical support for this prediction.

An Internally Consistent Approach to Common Stock Valuation

A modern corporate finance curriculum typically extends the one-stage Gordon (1962) dividend discount model into a multi-stage environment. In such instances, each regime of constant dividend growth defines a distinct stage. The rate of sustainable dividend growth in each stage is typically determined by specifying the firm's return on asset (ROA) and plowback (PB) ratios in each stage, and then computing the implied dividend growth rate as g = ROA . PB. In a two-stage problem, current convention typically advocates that the first dividend in the second stage should equal the last dividend in the first stage, multiplied by 1 + g2, where g2 is the growth rate of dividends in the second stage. We show that the dividend stream generated with this methodology is inconsistent with the ROA and plowback assumptions used previously to compute g2. The implication is that the conventional pricing methodology results in stock valuations that are inconsistent with ROA and PB assumptions. For a common textbook problem, we demonstrate pricing errors on the order of 30%. In order to address the issue, we provide an alternative pricing methodology that results in valuations that are consistent with underlying assumptions. Pedagogically, when the proposed approach is contrasted with the traditional approach, the student is forced to develop a deeper fundamental understanding of how stock valuation relates to (i) operational efficiency, (ii) dividend policy, and (iii) the economic environment in which the firm competes.

The record on small companies: A review of the evidence

It is now exactly 20 years since the publication of the two pioneering papers — Banz, R. (1981) ‘The Relationship between Return and Market Value of Common Stock’, Journal of Financial Economics, 9, 3–18, and Reinganum, M. (1981) ‘Misspecification of Capital Asset Pricing: Empirical Anomalies Based on Earnings’ Yields and Market Values', Journal of Financial Economics, 9, 19–46 — on the performance of small capitalisation companies. The discovery of the so-called ‘small size effect’ generated a lively debate on market efficiency and asset pricing and led to a considerable amount of further research that shed light on the nature and market behaviour of this important asset class. The purpose of this paper is to review the empirical evidence on small companies with particular emphasis on the implications relevant to practising fund managers. The weight of the evidence suggests that conventional risk measures (betas) fail to reflect the inherent risks of small firms. Such firms are, however, riskier in terms of higher mortality, lower liquidity, higher short-term borrowings and higher volatility of earnings. The evidence also suggests that the outperformance of small cap stocks, even at the pinnacle of its manifestation, was driven by a relatively limited number of such stocks. Such good performers possess a number of key characteristics. They have lower than average market-to-book and price-earnings ratings, and their market value is higher than the average capitalisation of the small cap sector; they have been listed in the market for longer than a year and have not raised additional equity capital in the last year. They have reasonably stable earnings growth profile, do not belong to sectors with excessive swings in analyst forecasts and current ratings do not depend on hugely over-optimistic analyst forecasts.

Purchase, Pooling, and Equity Analysts' Valuation Judgments

We investigate whether analysts' common-stock valuation judgments are predictably affected by (1) different methods of accounting for business combinations and (2) the number of years that elapse after the business combinations occur. Numerous articles in the business press suggest that companies go to great lengths to avoid amortization of the purchase-method acquisition premium, either by structuring acquisitions to qualify for pooling treatment or aggressively allocating the acquisition premium to in-process research and development (IPRD) and immediately expensing it. Firms' reluctance to capitalize and amortize the acquisition premium often is based on their managers' belief that amortizing the acquisition premium impairs firm value, especially in years subsequent to the transaction. However, research to date neither refutes nor defends this belief. We report the results of an experiment in which 113 buy-side equity analysts participated. Consistent with our expectations, analysts' post-combination valuation judgments are lower when a parent company records and amortizes an acquisition premium in a purchase-method business combination and equivalently higher when the company either immediately expenses the entire purchase-method acquisition premium as IPRD or records the business combination using the pooling-of-interests method. In addition, in the case where the parent company records and amortizes an acquisition premium in a purchase-method business combination, analysts' stock-price judgments are significantly lower if the business combination occurred three years ago as compared to one year ago. We also test the FASB's proposal to report separate sub-totals (and related EPS figures) for pre-goodwill-amortization operating income, after-tax goodwill amortization, and net income. Our results suggest that the Board's proposed goodwill-reporting format mitigates the valuation difference between combinations that occurred one-year ago versus three-years ago. We discuss the implications of this study for users of financial accounting information and for accounting standard setters.

Accounting Standard-Setting Organizations and Earnings Relevance: Longitudinal Evidence from NYSE Common Stocks, 1927-93

We provide evidence on the relevance of earnings for valuation of NYSE common stocks from 1927-93. Based on a time series analysis of the explanatory power of yearly earnings-returns regressions, we investigate whether earnings relevance has increased following: (1) the empowerment of the Committee on Accounting Procedure (CAP) in 1939 as the first U.S. standard-setting body, and (2) subsequent reorganizations of the standard-setting process which led to the establishment of the Accounting Principles Board (APB, 1959-73) and the Financial Accounting Standards Board (FASB, 1973-Present). Income measurement and disclosure has been a central focus of accounting policymakers throughout the period covered by our study. In the early 1930's, the American Institute of Accountants (forerunner of the AICPA) emphasized the cardinal importance of income as explained by the fact that the value of a business is dependent mainly on its earning capacity (see AIA [1934]). Over 40 years later, the FASB in Statement of Financial Accounting Concepts #1 adopted a similar view when it concluded that the primary focus of financial reporting is on earnings and its components. Our analyses provide little evidence suggesting that the mean and median explanatory power (i.e., adjusted R2) of yearly returns-earnings regressions are significantly higher following empowerment of the CAP in 1939 and subsequent reorganizations leading to creation of the APB and FASB. We find weak evidence of a higher median during the CAP?s tenure (1939-59) compared to the Pre-CAP era (1927-38), but this result is not robust under alternate specifications of our primary tests where either yearly rank regressions are used, losses are excluded from the sample, or operating income is used in lieu of net income in the yearly regressions. We also estimate yearly models where stock price is regressed against earnings and book value similar to other recent longitudinal studies (e.g., Collins, Maydew, and Weiss [1997] and Francis and Schipper [1997]). Results of tests examining incremental earnings relevance in price regressions are consistent with results based on earnings-returns regressions: we find no evidence indicating that the valuation relevance of earnings has significantly increased since the initiation of U.S. standard-setting in 1939. Consistent with evidence in these other studies, we document a highly significant increase in the combined relevance of earnings and book value during the FASB?s tenure compared to the APB era. However, this result is largely the artifact of abnormally low relevance in the APB era. For instance, the combined relevance of earnings and book value is lowest during the APB?s tenure (1960-73), but the combined relevance of earnings and book value in the FASB era is similar to that observed during the Pre-CAP and CAP periods.

Accounting Standard-Setting Organizations and Earnings Relevance: Longitudinal Evidence from NYSE Common Stocks, 1927-93

We provide evidence on the relevance of earnings for valuation of NYSE common stocks from 1927-93. Based on a time series analysis of the explanatory power of yearly earnings-returns regressions, we investigate whether earnings relevance has increased following: (1) the empowerment of the Committee on Accounting Procedure (CAP) in 1939 as the first U.S. standard-setting body, and (2) subsequent reorganizations of the standard-setting process which led to the establishment of the Accounting Principles Board (APB, 1959-73) and the Financial Accounting Standards Board (FASB, 1973-Present). Income measurement and disclosure has been a central focus of accounting policymakers throughout the period covered by our study. In the early 1930's, the American Institute of Accountants (forerunner of the AICPA) emphasized the cardinal importance of income as explained by the fact that the value of a business is dependent mainly on its earning capacity (see AIA [1934]). Over 40 years later, the FASB in Statement of Financial Accounting Concepts #1 adopted a similar view when it concluded that the primary focus of financial reporting is on earnings and its components. Our analyses provide little evidence suggesting that the mean and median explanatory power (i.e., adjusted R2) of yearly returns-earnings regressions are significantly higher following empowerment of the CAP in 1939 and subsequent reorganizations leading to creation of the APB and FASB. We find weak evidence of a higher median during the CAP?s tenure (1939-59) compared to the Pre-CAP era (1927-38), but this result is not robust under alternate specifications of our primary tests where either yearly rank regressions are used, losses are excluded from the sample, or operating income is used in lieu of net income in the yearly regressions. We also estimate yearly models where stock price is regressed against earnings and book value similar to other recent longitudinal studies (e.g., Collins, Maydew, and Weiss [1997] and Francis and Schipper [1997]). Results of tests examining incremental earnings relevance in price regressions are consistent with results based on earnings-returns regressions: we find no evidence indicating that the valuation relevance of earnings has significantly increased since the initiation of U.S. standard-setting in 1939. Consistent with evidence in these other studies, we document a highly significant increase in the combined relevance of earnings and book value during the FASB?s tenure compared to the APB era. However, this result is largely the artifact of abnormally low relevance in the APB era. For instance, the combined relevance of earnings and book value is lowest during the APB?s tenure (1960-73), but the combined relevance of earnings and book value in the FASB era is similar to that observed during the Pre-CAP and CAP periods.

The Economic Dilution of Employee Stock Options: Diluted EPS for Valuation and Financial Reporting

We derive a measure of diluted EPS that incorporates economic implications of the dilutive effects of employee stock options. We show that the existing FASB treasury-stock method of accounting for the dilutive effects of outstanding options systematically understates the dilutive effect of stock options, and thereby overstates reported EPS. Using firm-wide data on 731 employee stock option plans, we find that economic dilution from options in our proposed measure of options-diluted EPS is, on average, 100% greater than dilution in reported diluted EPS using the FASB treasury-stock method. We examine the implications of our analysis for stock price valuation, the price-earnings relation, and the return-earnings relation. We demonstrate analytically that when firms have options outstanding, empirical applications of equity valuation models that use reported per share earnings as an input (e.g., Ohlson, 1995), yield upwardly biased estimates of the market value of common stock. We predict that observed return-earnings and price-earnings coefficients are expected to be smaller the greater the difference between our measure of economic dilution from options and FASB treasury-stock method dilution from options, and provide weak empirical support for this prediction.

TRANSITION-COST ISSUES FOR US ELECTRICITY UTILITIES

▪ Abstract The US electric-utility industry is in the midst of major changes. These changes include deintegration of the industry and substantial increases in competition. A major consequence of these changes is the exposure of transition costs. These costs, which amount to $100–$200 billion nationwide, reflect the differences between regulated prices for electricity generation and the prices that might occur in fully competitive power markets. The large financial stakes, equivalent to nearly the total value of US electric-utility common stock, guarantee controversy. Debates occur over transition-cost amounts; analytical and market methods to estimate these costs; the assets and liabilities to include in such calculations; the assumptions used in developing these estimates; approaches that can be used to offset some of these costs; the allocation of the remaining costs among utility shareholders, different classes of retail customers, independent power producers and other wholesale suppliers, and taxpayers; and appropriate cost-recovery mechanisms.

The Value of the Voting Right: A Study of the Milan Stock Exchange Experience

I study the large premium (82 percent) attributed to voting shares on the Milan Stock Exchange. The premium varies according to the ownership structare and the concentration of the voting rights, and it can be rationalized in the presence of enormous private benefits of control. A case study seems to indicate that in Italy private benefits of control can easily be worth more than 60 percent of the value of nonvoting equity. A tentative explanation for these findings is provided. Traditional finance theory disregards the value of voting rights in pricing common stock. In most cases this omission does not seem harmful. Many studies of differential voting stocks in different countries have indicated that voting rights are generally worth between 10 percent and 20 percent of the value of common stock.’ The Italian evidence I present differs sharply from this view. In Italy voting shares that have inferior dividend rights trade at an average premium

An Empirical Examination of White Knight Corporate Takeovers: Synergy and Overbidding

This study investigates corporate takeovers by knights, a friendly bidding firm actively sought by a target firm in order to avoid being taken over by a hostile bidding firm. White knights are particularly vulnerable to for their targets, i.e., bidding more than the aggregate market value of the target's common stock, since they are, by definition, involved in a competitive bidding contest. Since previous studies have shown: (i) that acquisitions do not, on average, confer substantial benefits on bidding firm shareholders, and (ii) that shareholders of bidding firms entering a merger competition subsequent to the first bidder suffer significant losses in stock value, the white knight's motivation for attempting to outbid its hostile rival is not well-understood. One of the hypotheses investigated in this study, that white knights systematically overbid for their targets, presumes that becoming a white knight does not serve the interests of the bidder's shareholders. Rather, the beneficiaries of a white knight acquisition would be target shareholders, who receive a higher price for their shares, and target managers, who would risk losing their jobs if the firm was taken over by a hostile bidder. Overbidding leads to a wealth transfer from shareholders of the white knight to target shareholders. Under the overbidding hypothesis, white knight acquisitions are expected to generate greater share price losses to bidding firm shareholders and greater share price gains to target shareholders than non-white-knight acquisitions.

The Tylenol Incident, Ensuing Regulation, and Stock Prices

The much publicized Tylenol incident in 1982 led to stringent packaging regulations for over-the-counter pharmaceutical drugs. The sudden incident and the swift progression of associated events offer a unique opportunity to assess the wealth effects of the resultant regulations. The market value of common stock of Johnson & Johnson, makers of Tylenol, declined by approximately 29 percent, amounting to $2.31 billion. Although other firms in the industry also suffered significantly, their share price decline did not occur around the Tylenol incident but occurred around the subsequent packaging reg? ulation proceedings. On average, 28 other pharmaceutical firms analyzed in this study experienced a decline of $310 million per firm, or a total of about $8.68 billion. The results suggest that the regulation had a significant negative effect on the common stock prices of firms in the pharmaceutical industry.

Discounts on Restricted Stock: The Impact of Illiquidity on Stock Prices

A simple statistical model explains price differences between securities that differ in resale provisions-in particular, restricted securities, which can be sold only after a two-year holding period, are compared with publicly traded securities of the same company. The discount on restricted stock varies directly with the amount of restricted stock relative to publicly traded stock and inversely with the credit-worthiness of the issuing company. That credit-worthy companies must offer price discounts of more than 30 per cent to sell a significant block of restricted stock illustrates the importance of liquidity to the valuation of common stock.

A Bibliography of Finance.

Finance - general decisions under uncertainty economics of information the principal-agent relationship social responsiblity capital markets and securities markets market microstructure intermediation efficiency of securities markets rates of return on securities risk portfolio selection equilibrium prices of risky assets measurement of investment performance valuation of common stocks accounting information and valuation interest rates debt and preferred stock options convertible securities and warrants hedging instruments - futures and forwards capital expenditures cost of capital new securities issues splits and stock dividends cash dividends company financing and capital structure leasing and project finance financial planning working capital mergers and corporate restructuring regulated industries foreign exchange real estate commodity markets and exhaustible resources other speculative markets human capital tax inflation econometrics and statistics.

Insurance Firm Market Response to California Proposition 103 and the Effects of Firm Size

Insurance Firm Market Response to California Proposition 103 and the Effects of Firm Size Introduction California voters, dissatisfied with high insurance rates, approved Proposition 103 on November 8, 1988. The key provision was an immediate 20 percent reduction of automobile, homeowner, commercial, and municipal liability insurance rates. Rates also were to be frozen for one year, unless the insurance commissioner of all rate increases, repeal of the insurance industry's state antitrust exemption, allowing banks to sell insurance, and limiting the determinants of automobile liability rates to the insured's accident record. A major result of Proposition 103 was the movement of the insurance regulatory system in California from one of open competition to prior approval of rates. Brostoff (1988) and Aschkenasy (1989), among others, recognize that consumer dissatisfaction with the insurance industry is spreading, and legislation similar to Proposition 103 is being considred in at least 14 other states. Some consumers believe insurance rates, especailly those for auto insurance, are unfairly high. The public interest theory of regulation (Needham, (1983)) assumes that regulation is a government response to public demands for the rectificatin of inequitable practices (primarly in price setting) by business organizations. Regulation in the insurance industry is an example of public interest regulation because its purpose is to enforce the requirement that rates remain adequate, reasonable, and fair. Various researchers have examined the methods used for property-liability insurance rate regulation. Biger and Kahane (1978), Fairley (1979), and Hill (1979) proposed CAPM type models to determine fair rates of return for the property-liability insurance industry. Joskow (1973), Samprone (1979), Harrington (1984, 1987), and Grabowski, Viscusi and Evans (1989) analyze accounting data to determine the impact of open competition versus regulated ratemaking on insurer profitability. The findings of these studies are inconsistent with regard to whether open competition or regulated ratemaking serve to maximize insurer profitability. Peltzman (1976) developed a general model dealing with the influence of regulation based on the premise that regulation creates a wealth transfer. Industry and special interest groups compete for the benefits of regulatory change. Under Peltzman's model, regulatory change often transfers wealth to insurers since their financial interests are greater than that of individual consumers. Consumers' financial interests or costs are directly related to their involvement in the regulatory policy change. Higher levels of consumer involvement are generally associated with fewer industry benefits from the regulatory change. Proposition 103 provided short-term benefits for consumers. The most immediate attraction was the 20 percent reductionand freezing of automobile and other insurance rates for one year. Since consumers had such a large financial advantage from the enactment of Proposition 103, it is likely that the insurance industry suffered. The purpose of this research is to examine the impact of the passage of California Proposition 103 on insurance stock values. It is hypothesized that the passage had a significant negative impact on property-liability insurers, especially those doing large volumes of business in California. Fields, Ghosh, Kidwell, and Klein (1990) have examined California's Proposition 103. They found that for several days surrounding the election, insurance firms' stock values reacted negatively. The decrease in value is directly related to the proportion of the firm's revenues that are affected by the referendum. Profitable companies were found to have less negative effect. Szewczyk and Varma (1990) also analyze Proposition 103. Their study examines the effect of Proposition 103 on the common stock values of property-liability insurers around both the passage of the measure and the court decision upholding the rate rollback and overturning the insolvency provision. …

Restructuring the black-scholes isomorphism

where N(') is the cumulative probability distribution of the unit normal. There are two types of strategies which the stockholders of a firm can adopt to expropriate wealth from the firm's bondholders-the game of refusing to contribute equity capital and the risk-shifting game. The rationale for the former derives from the fact that the derivative of equation (1) with respect to (V) is less than t. If the stockholders were to invest $1 in the firm and the firm were to invest in a zero net present value (NPV) project, less than $1 would accrue to the stockholders. Thus, if an investment project's NPV is not sufficiently positive, the stockholders would refuse to contribute equity capital. The rationale for the latter strategy derives from the fact that the derivative of equation (1) with respect to a is greater than 0. Thus, if the stockholders were to shift the firm's investments from tow to high volatility assets, holding constant the firm's value, the value of the firm's common stock would rise. A troublesome feature is that the values of the two derivatives of equation (1) always satisfy the requirements for these two strategies. What is proposed here is an adjustment to equation (1) which would allow the values of the derivatives to violate the conditions required for the adoption of the two strategies. Assume the presence of post-T investment opportunities available to the firm's stockholders, if and only if the firm does not declare bankruptcy. The NPV of these opportunities valued at time Tequals G. The payoff to stockholders equals 0 if V B. Thus, the value of the common stock equals equation (1) plus the present value of G, weighed by the appropriate probability. As N ( & ) is the probability that V > B, equation (1) may be reformulated, with derivatives given by equations (3) and (4): C = VN(d~) Be-rrN(d2) + Ge-rrN(d2) (2)

Abandonment decisions and the market value of the firm: The case of nuclear power project abandonment

This article investigates empirically the behavior of stock prices around announcements of nuclear power project abandonment decisions by public utility firms. Tests were performed for both the whole sample period 1974–1982, and a sample period partitioned into before the Three Mile Island (TMI) accident 1974–1978 and after the TMI accident July, 1979–1982 periods. The empirical results for the whole sample period indicates no significant changes in the value of these firms as a result of nuclear power project abandonments. This is consistent with the argument that decreases in planned capital expenditures for public utility firms are associated with insignificant excess stock returns (McConnell and Muscarella 1985, p. 416). However, the results for the split sample periods are different. Our results for the pre-TMI period suggest that utility companies are firms which face investment projects with positive net present values. For the post-TMI accident period we find significant positive abnormal returns associated with nuclear project abandonments, i.e., decreases in capital expenditures are associated with increases in the market value of common stock.

Some Observations on Capital Structure and the Impact of Recent Recapitalizations on Share Prices

This paper discusses two fundamental issues in capital structure theory and analyzes the recent recapitalizations of Phillips and Unocal. It is shown that a value-maximizing capital structure may be inconsistent with shareholder utility maximization and that the Miller debt and taxes equilibrium may be inconsistent with a complete capital market. In spite of these and other unresolved issues, the markets's reactions to the recent recapitalizations of Phillips and Unocal are consistent with the predictions of capital structure theory. Except for small redistribution effects against bondholders, the recapitalizations per se had no positive impact on common stock values.