Equity Transactions Research Articles

Cash equity transaction cost analysis: State of the art … and beyond

The Markets in Financial Instruments Directive (MiFID) is the second step in the harmonisation of the European capital markets industry and intends to adapt the first Investment Services Directive (ISD 1 issued in 1993) to the realities of the current market structures. After clarifying the nature of the new regulation, this paper first describes the role of transaction cost analysis in the fulfilment of the best execution obligation as well as the limits of existing frameworks. Then, the paper presents a new methodology that allows one to measure the quality of execution as part of peer group review and identify whether the broker, trader or algorithm has implemented the execution too aggressively or too slowly. This approach relies on two indicators allowing an easy comparison of a large universe of trades and providing insightful information not only about the final performance (absolute EBEX indicator), but also about the possible justification of the performance (directional EBEX indicator). In order to illustrate both the framework and the level of interpretation made possible, the results of a preliminary study conducted on 2,737 orders on Euronext blue chips over a four-month sample period are reported.

Private equity investments beyond Earth orbits: Can space exploration be the new frontier for private investments?

The year 2004 can be considered an important milestone for space activities. First, on January 14, 2004 President Bush announced a new vision for human and robotic space exploration named “A Renewed Spirit of Discovery”. This new space exploration policy called for “a sustained and affordable human and robotic program to explore the solar system and beyond” and seeks also to “promote international and commercial participation in space exploration to further US scientific, security, and economic interests”. Secondly, the satellite industry has experienced a trend of private investment fund acquisitions. Five of six major fixed and mobile satellite service providers in the world have been partly or entirely sold to conventional financial investors. These transactions have taken place despite the background noise of overcapacity, stagnant growth and declining operating margins satellite services sector. Over the last 18 months, we have seen a total of approximately US $ 12 B dollars in private equity transactions in the satellite sector. Finally, the Ansari X prize has been won opening the possibility of the personal spaceflight revolution. This paper seeks to provide some insights into the nature, timing and a rationale for these investments in the space sector. Then, an attempt is made to analyze the potential that space exploration might present for traditional financial investors.

Are Observed Capital Structures Determined by Equity Market Timing?

AbstractContrary to Baker and Wurgler (2002), I find that the importance of historical average market-to-book ratios in leverage regressions is not due to past equity market timing. Although equity transactions may be timed to equity market conditions, they do not have significant long lasting effects on capital structure. Debt transactions exhibit timing patterns that are unlikely to induce a negative relation between market-to-book ratios and leverage. I also find that historical average market-to-book ratios have significant effects on current financing and investment decisions, implying that they contain information about growth opportunities not captured by current market-to-book ratios.

Putting Integrity into Finance: A Positive Approach (PDF of Keynote Slides)

Finance theory and practice are incomplete without an integrated theory of integrity. Following Erhard, Jensen and Zaffron (2007) I define integrity without reference to morals, values, religion, or ethics. Something is in integrity if it is whole, complete and sound. Integrity is closely related to workability because an entity or system that is out of integrity will not be whole, complete and sound. Workability is the bridge to value. The farther out of integrity the less well any given entity will work. The positive proposition that increasing the integrity of a firm will contribute to increasing its value is no different in kind from the positive proposition that the net present value investment rule will lead to value creation. The theory thus implies that integrity is a necessary, but not sufficient condition for the maximization of long-term value. The theory is testable and refutable. I illustrate the application of this concept in finance by considering several examples:1. The implicitly held proposition that firm's managers owe fiduciary responsibility to current shareholders only (excluding current and future bondholders and future shareholders). This leads to the widely held recommendation/belief that the appropriate action for a firm whose equity is substantially overvalued is to sell new equity and pay out the proceeds to current shareholders or to acquire a less overvalued firm through an equity transaction. Both of these policies will create a system in which future shareholders find that they have been taken in the transaction. Policies that expropriate wealth from future shareholders or bondholders cannot contribute to the creation of long-term value. Interestingly, U.S. disclosure laws provide some obligations for managers to take into account the interests of future bond and stockholders. 2. I discuss the extensive empirical evidence on the puzzling low-integrity value-destroying equilibrium between managers and capital markets and argue that understanding how this equilibrium continues to exist is a major challenge for our profession.-------PDF file of Keynote slides for speech first presented on the occasion of the presentation of the LECG Lifetime Achievement Award in Recognition of his Contributions to the Field of Financial Economics to Michael C. Jensen at the meetings of the American Finance Association, Boston, MA, Jan. 6, 2006; also presented to the Centre for Corporate Governance, London Business School, London, UK, Jan. 19, 2006; the Center for Corporate Governance, LeBow College of Business, Drexel University, Philadelphia, PA, March 1, 2006; Journal of Corporate Finance Conference on Private Equity, LBOs, and Corporate Governance, Rensselaer Polytechnic Institute, Troy, NY, April 21, 2006; CFO Forum, U. of Washington Business School, Seattle, WA, May 17, 2006, JOIMs Fall 2006 Conference, Boston, MA, Sept. 2006, Zicklin Center for Corporate Integrity, Baruch College, NYC, Oct. 2006; State Street Global Markets 7th Annual Research retreat, Boston, MA March 1, 2007: Society of Quantitative Analysts (SQA) Society, Fuzzy Day Conference, NY, NY, June 18, 2007; Smith Breeden Associates? Investment Research Seminar, Pinehurst, NC, Oct. 4, 2007; Tuck School of Business, Corporate Governance Workshop for Large Institutional Investors, Oct. 8, 2007; Deutsche Asset Management, Global Quantitative Investor Strategies: The Art of Alpha and Beta, NY, NY, Oct. 17, 2007; Financial Management Association, Orlando, FL, Oct. 18, 2007; DeAM European Investor Conference -- Alternative Sources of Alpha: The Art of Alpha and Beta, Berlin, Germany, Nov. 7, 2007; U. of South Florida and Society of Financial Analysts Conference on The Relationship of Value to Governance, Tampa, FL, Feb. 1; London Business School Private Equity Institute Seminar, April 14, 2008; Mays Business School, Texas AM Keynote Address, Financial Intermediation Research Society (FIRS), Prague, Czech Republic, May 29, 2009; and Keynote Address, European J. of Finance and J. of Business Ethics Joint Conference: Law, Ethics and Finance, Schulich Business School, York U., Sept. 17, 2010; Financial Accounting and Reporting Section (FARS) of the American Accounting Association (AAA), Plenary Session, Tampa, FL,January 28, 2011.

THE NEW LOSS RECOUPMENT RULES—GOOD NEWS, BAD NEWS

The Federal Government has proposed to change the tests to enable companies to recoup losses for tax purposes. There is some good news and some bad news. This paper will discuss the changes and comment on how the changes may impact oil and gas companies.The good news is that the continuity of ownership rules will be changed for widely-held companies from 1 July 2002, to simplify compliance. In essence, stakeholders of less than 10% will be attributable to a single notional entity, making it easier to test whether there has been a sufficient continuity of ownership to pass this test.The bad news is that the government also proposes to remove the same business test for companies whose total income is more than A$100 million. This is proposed to apply to losses incurred in income years commencing on or after 1 July 2005.With oil at US$60 per barrel it is likely there will be a number of oil producers whose income will exceed the A$100 million test, particularly where there has been an accelerated development of the fields. It is also possible given the high costs of exploration and move into production that companies may have undeducted losses for income tax purposes. The problem is that for junior/ medium level producers particularly, equity transactions are not uncommon and the opportunities for breaching the continuity of ownership test are increased. Without access to the same business test these losses may be at risk of being lost permanently.It may be possible to structure an instrument that enables the oil producer to issue paper resembling equity in certain ways, without causing a breach of the continuity of ownership. The paper discusses this and other issues in relation to the proposal.

Rivals or Partners? Evidence from Europe's International Private Equity Deals

Cross-border private equity deals have increased substantially in recent years. This study looks at the issue of how European investors view their local counterparts in the portfolio companies’ home countries. If they regard them as rivals, they will target countries that lack a private equity industry. If they view them as (potential) partners, however, they will prefer investing in countries with a mature private equity industry. We test these two contradictory hypotheses by using a unique cross-border country dataset on international investments of European private equity investors. We find that European investors redominantly invest in countries with more mature private equity industries. The presence of local private equity investors also determines how European investors exploit differences in growth rates between the target country and their home country: European private equity investors respond more strongly to given growth differentials if investments can be syndicated with an experienced local investor. In our reading, these findings are in line with the partnership hypothesis.

Methods of Payment in Asset Sales: Contracting with Equity versus Cash

ABSTRACTWe analyze intercorporate asset sales where equity is the means of payment, and compare the results to cash asset sales. Equity deals are value‐enhancing for both buyers, 10%, and sellers, 3%, while cash sales generate seller returns of 1.9% and buyer returns that are not significant. Combined wealth gains are large for equity deals, but modest for cash deals. Equity‐based asset sales are not a precursor to consolidations between buyers and sellers, and do not affect buyer openness to the takeover market. We conclude that the use of buyer equity conveys favorable information about the value of assets and buyers.

On Accounting-Based Valuation Formulae*

This paper considers accounting-based valuation formulae. Its initial focus is on two problems related to residual income valuation (RIV). First, insofar valuation depends on theresent value of expected dividends per share, applying RIV requires clean surplus accounting on a per share basis. Awkwardly, equity transactions that change the number of shares outstanding generally imply eps ≠ Δ bvps − dps. A clean surplus equality holds only if one “re-conceptualizes” either end-of-period bvps or eps as a forced “plug”. Second, one cannot circumvent the per share issue by evaluating RIV on a total dollar value basis unless one introduces relatively subtle MM-type restrictions. In light of RIV’s unsatisfactory aspects, the paper proposes an alternative to RIV. This new approach maintains a strict eps-focus. It derives by replacing bvps t in RIV with eps t +1 capitalized (i.e. divided by r). One obtains a formula such that the current market price equals next-period expected earnings capitalized plus the present value of expected abnormal earnings growth, referred to as AEG. A number of propositions then demonstrate the advantages of the AEG approach as compared to RIV. These results follow because eps t+1 capitalized generally approximates market price better than bvps t .

Will Multiple Acquirers Ever Learn? The US Evidence from Single versus Multiple Acquirers

The literature on multiple acquirers is confined to a few studies, none of which compares the performance of single and multiple acquirers in the US market. This study considers shareholder returns for a large sample of 16,221 US takeovers between 1985 and 2004. It finds that single acquirers outperform multiple acquirers by 1.66%, and that the gap widens to nearly 5% in equity exchange offers. In contrast to multiple acquirers, single acquirers generate higher returns in equity deals than in cash and mixed offers, which is due to the high returns earned through the acquisition of non-public targets. Returns for multiple acquirers remain positive through the fourth merger deal. Unsuccessful first time acquirers learn but successful first time bidders suffer from hubris behaviour in subsequent acquisitions. The study finds that size, relative size, and valuation differences could explain the higher returns for single acquirers, and that the positive relationship between toehold presence and acquiring firm returns results in less information asymmetry about the true value of the target firm, which leads to paying lower premiums.

Private Equity in a Low-Return World

In light of modest equity return expectations for the public markets, many institutional investors are turning to private equity to try to boost portfolio returns. But investors must realize that although private equity returns come from a variety of sources that are not market driven, the potential for diversification in this asset class is not as high as they may think. Additionally, other factors, such as choice of manager, can have a drastic impact on performance. Consequently, investors should choose a manager carefully by evaluating several factors, including firm stability as well as the discipline and strategy for buying, managing, and exiting private equity deals.

What is the Magic in Equity Deals? Theory and Evidence on the Means of Payment in Asset Sales

We develop a general asymmetric information model that explains the value-enhancing role of equity in asset sales, without having to specify a particular negotiation or sales procedure. We demonstrate that the identity of the informed party is crucial to explaining the positive effects of equity as a means of payment. When sellers (and not buyers) have the private information, equity-based transactions generate greater increases in aggregate wealth than cash sales. Buyers obtain a significant portion of combined gains because sellers need to send a credible signal. Empirical tests support that model's predictions and indicate that sellers have an informational advantage and are in a stronger bargaining position than buyers.

The determinants of cross-border equity flows

We explore a new panel data set on bilateral gross cross-border equity flows between 14 countries, 1989–1996. We show that a “gravity” model explains international transactions in financial assets at least as well as goods trade transactions. Gross transaction flows depend on market size in source and destination country as well as trading costs, in which both information and the transaction technology play a role. Distance proxies some information costs, and other variables explicitly represent information transmission, an information asymmetry between domestic and foreign investors, and the efficiency of transactions. The geography of information is the main determinant of the pattern of international transactions, while there is weak support in our data for the diversification motive, once we control for the informational friction. We broaden the scope of our results by presenting some evidence linking the results on equity transactions to equity holdings.

Transaction Structures in the Developing World: Evidence from Private Equity

While variations in public securities markets across nations have attracted increasing scrutiny, private financings have received little attention. But in developing nations, the bulk of financings are private ones. This paper analyzes 210 private equity transactions in developing countries. We find that unlike in the U.S., where convertible preferred securities are ubiquitous, in developing nations a much broader array of securities are employed and private equity investors often have fewer contractual protections. The choice of security appears to be driven by the legal and economic circumstances of the nation and the private equity group. Investments in common law nations are structured similar to those in the U.S., being less likely to employ common stock or straight debt, and more likely to use preferred stock with a variety of covenants. By way of contrast, in nations where the rule of law is less established, private equity groups are likely to use common stock and own the majority of the firm's equity if the investment encounters difficulties. Private equity groups based in the U.S. and U.K. rely more on preferred securities but also adapt transactions to local conditions. These contractual differences appear to have real consequences: larger transactions with higher valuations are seen in common law countries. These findings suggest that the structure of a country's legal system affects private contracts and cannot easily be undone by (bi-lateral) private solutions.

Discount for Lack of Marketability: Do IPO Studies Tell Us Anything?

This article analyzes some of the criticisms made by analysts in connection with the use of IPO studies for the purpose of estimating discounts for lack of marketability applicable to equity transactions in private companies. A simple model is presented that shows that the discounts observed in such studies may underestimate the true marketability discount, as the price discount required by investors will fall with the likelihood of a successful IPO. The model suggests a bias in the opposite direction of that commonly mentioned, where the observed discount is likely to be an overestimate of the true marketability discount. The conclusion reached is that the overall direction of bias is unclear, and that information that is not easily observed would be required to adjust the observed discounts to reflect the true marketability discount.

Home Equity Lending in Texas: Are Loan Origination Fees Interest?

The constitutional amendment did not define what constituted a fee for purposes of a home equity loan, and this ambiguity has created much concern among lenders. This Comment argues that a loan origination fee charged by a lender in a home equity transaction should be considered interest and not a fee for purposes of the three percent fee limitation. Part II of this Comment will discuss homestead protection in Texas and the 1997 constitutional amendment authorizing home equity lending. Specifically, Part II will discuss the three percent fee limitation, the forfeiture and cure provisions contained in the constitutional amendment, and the problems inherent in interpreting what constitutes a fee for purposes of the cap on fees. Part III will discuss the potential charges to a borrower in a hypothetical home equity transaction by defining and describing the varying lender and non-lender charges. Part IV will discuss how interest and fees have historically been defined under Texas law. Part V will discuss whether the legislature intended a different definition of interest and fees for purposes of the three percent cap on fees. Part V will also examine the language of the pertinent section of the constitutional amendment, applying the rules of statutory construction in Texas, and will discuss how Texas regulatory agencies interpret the amendment. Part VI will discuss four recent judicial interpretations of the constitutional amendment relative to the classification of points and/or origination fees in Texas home equity transactions. Part VI will also discuss a recent decision by the Texas Supreme Court interpreting the cure provision contained in the constitutional amendment and its application to a violation of section 50(a)(6)(E). In addition, Part VI will provide a summary of recent home equity cases. Part VII will discuss the relevant policy considerations in classifying interest and fees for purposes of home equity lending in Texas and lender options for dealing with the problem created by the uncertainty of whether a loan origination fee constitutes interest or a fee. Part VII will also discuss the 2003 amendment to the Texas Constitution on home equity lending, to the extent that the amendment addresses the problem of interpretation and the process by which a lender or note holder may cure a violation of the home equity law. Finally, Part VIII will summarize why loan origination fees should be considered interest and not fees for purposes of home equity lending in Texas.

Measuring and modeling systematic risk in factor pricing models using high-frequency data

This paper demonstrates how high-frequency data may be used in more effectively measuring and modeling the systematic risk(s) in factor pricing models. Based on a 7-year sample of continuously recorded US equity transactions, we find that simple and easy-to-implement time series forecast for the high-frequency-based factor loadings in the three-factor Fama–French model gives rise to more accurate factor representations and improved asset pricing predictions when compared to the conventional monthly rolling regression-based estimates traditionally employed in the literature, in turn resulting in more efficient ex post mean-variance portfolios. As such, the methodology proposed in the paper holds the promise for important new insights concerning actual real-world investment decisions and practical situations involving risk management.

Does ownership matter in the presence of strict antiactivism legislation? Evidence from equity transactions in Denmark

This study analyzes the effects of institutional and strategic investor equity transactions on the behavior of stock prices on the Copenhagen Stock Exchange (XCSE). Unlike the positive relationship between managerial ownership and security performance, we find that the relationship between ownership and performance is a bell-shaped curve. There is an optimal threshold level of ownership at which security performance, measured by abnormal returns, is maximized. At the threshold level, the management can take advantage of the shared benefit of control. Beyond the threshold level of ownership, the security performance decreases. We attribute this threshold level to an increasing entrenchment benefit.

The Decline in Lawyer Independence: Lawyer Equity Investments in Clients

In the modern legal profession, lawyers have entered into business transactions with their clients. These dealings, however, have been highly regulated through the ethics codes and common law. The ethics codes have imposed procedural and substantive requirements for such transactions. The state courts have similarly applied rules of agency law and fiduciary principles to ensure that lawyers are properly dealing with clients in such transactions. In the last decade, law firms have increasingly taken equity interests in client ventures. This practice has been commonplace in the Silicon Valley and has spread to law firms in other regions of the country. Various state and local bar associations as well as the ABA have recently liberalized the application of the traditional business transaction rules in the client equity context. The authors offer a detailed examination of the law firm practices of taking equity in client ventures based upon two years of research and interviews with lawyers and clients throughout the country. They examine these practices in light of the ethics rules, ethics opinions, and common law and offer a critique of the current positions advocated by the organized bar. They further detail the ethics and securities concerns that arise when a law firm accepts equity interests in a client and continues to represent that client in general legal affairs. This article argues that the Bar's current position dramatically underestimates the actual and potential conflicts that arise when lawyers invest in client ventures. Such practices expose law firms to significant ethical, malpractice, and securities liability. Lawyer-client equity transactions have the potential to undermine the independence of the lawyers' advice to clients and thereby harm the attorney-client relationship.

Growth Expectations, Capital Flows and International Risk Sharing

Over the past decades, cross-border financial flows have increased in importance and have in many occasions exceeded the underlying current account positions. This phenomenon has been accompanied by an increase in the volume of international equity transactions that accentuate the role of international risk sharing as a factor for the macroeconomic response to shocks. We use a stylised two-bloc, two-period model of the global economy, with a simple stochastic productivity shock affecting only one country. Efficient global risk-sharing imply that expected productivity gains in one country will attract equity inflows in excess of those needed to finance the current account. Upward-biased expectations about prospects for the productivity gains can further increase the risk exposure of foreign shareholders. The model is calibrated to show how ex post market losses - whether due to normal stock market downturn or ex ante over-optimism - are distributed and how they affect global consumption and current account positions. The results suggest that international spill over effects of stock market bubbles can contribute to business cycle synchronisation across economic areas.

Private Equity Disciplines for the Corporation

The private equity world has delivered astounding investment returns over the past decade. While this trend will unquestionably be affected by the hang over of the big tech and internet fallout, there is still a long-term trend for superior performance when comparing private companies with public ones. After studying over 2,000 private equity transactions, the authors propose that five management disciplines outline the essential difference between public and private companies: defining a limited investment thesis; getting managers to act like owners; focusing on a few measures; making capital work hard; making the center an active shareholder.