Financial Management Decisions Research Articles

Knowledge level modeling for systemic risk management in financial institutions

The current subprime mortgage crisis is a typical case for systemic risk in financial institutions. In order to further our understanding and communication about systemic risk management (SRM) in financial institutions, this paper proposes a knowledge level model (KLM) for systemic risk management in financial institutions. There are two parts considered in the proposed KLM: ontologies and problem solving method (PSM). Ontologies are adopted to represent a knowledge base of KLM, which integrates top level ontology and domain level ontologies. And then the problem solving method is given to show the reasoning process of this knowledge. The symbol level of KLM is also discussed which integrates OWL, SWRL and JESS. Further, the discussion about Lehman Brother’s Minibonds case in 2008 is provided to illustrate how proposed KLM is used in practice. With these, first, they will enhance the interchange of information and knowledge sharing for SRM within a financial institution. Second, they will assist knowledge base development for SRM design, for which a prototype of financial systemic risk management decision support system is given in this study. Third, they will support coordination among different institutions by using standardized vocabularies. And finally, from the design science perspective, the whole proposed framework could be meaningful to models in other domains.

Foreign Investments in Electric Utilities: A Comparative Analysis of Belgian and American Companies in Argentina, 1890–1960

This article analyzes the performance of foreign electric-utility companies and the evolution of the electric-power industry in Argentina from 1890 until the end of the 1950s, when the electric utilities were nationalized. It focuses on the decisions and strategies of the subsidiaries controlled by two holding companies: the Société Financière de Transports et d'Entreprises Industrielles (SOFINA) and the American & Foreign Power Company. The study suggests that the divergence in the performance of these two companies was determined both by their investment patterns and by their financial styles and management decisions. The impact of private decisions and public regulation on the Argentinean electric-power system is also explored.

Sovereign financial disaster risk management: The case of Mexico

In 2006, Mexico became the first transition country to transfer part of its public-sector natural catastrophe risk to the international reinsurance and capital markets. The Mexican case is of considerable interest to highly exposed transition and developing countries, many of which are considering similar transactions. Risk financing instruments can assure governments of sufficient post-disaster capital to provide emergency response, disaster relief to the affected population and repair public infrastructure. The costs of financial instruments, however, can greatly exceed expected losses, and for this reason it is important to closely examine their benefits and alternatives. This paper analyzes the Mexican case from the perspective of the risk cedent (the Ministry of Finance and Public Credit), which was informed by analyses provided by the International Institute for Applied Systems Analysis (IIASA). The rationale for a government to insure its contingent liabilities is presented along with the fiscal, legal and institutional context of the Mexican transaction. Using publicly available data, the paper scrutinizes the choice the authorities faced between two different risk-transfer instruments: reinsurance and a catastrophe bond. Making use of IIASA's catastrophe simulation model (CATSIM), this financial risk management decision is analyzed within the context of a public investment decision.

An Economic Evaluation of Livestock Odor Regulation Distances

Setback regulations-legislated distances that livestock production facilities must be removed from surrounding properties-are meant to mitigate odor impacts. If the setback length is too short, then there is evidence that surrounding properties and people suffer uncompensated damages. If, on the other hand, setback lengths are too long, then livestock producers may be paying more than that required to compensate for odor-related environmental damages. The purpose of this study is to assess the impact of Kentucky's livestock production facility setbacks on the value of surrounding properties and farm financial management decisions. This paper develops a model of the benefits of livestock odor reduction and the livestock odor abatement cost associated with setback lengths paid by producers. The results of this investigation indicate that the mandated setback lengths for Kentucky are too short. Livestock production firms are worse off under longer setback lengths, but the losses to surrounding home owners far exceed the firm gains at the mandated setbacks. A finding of this study is that the firm has no incentive to completely protect the legislated setback length. Livestock producers in compliance with the relevant setback length may feel protected from odor lawsuits despite damage being done to surrounding property. This suggests that the perceived threat of lawsuit is currently low in the state of Kentucky. Both industry and public goals could be met from further research including location and economic impact of livestock production.

Evolution, financial management and learning in the small firm

There is an assumption that inadequate financial management practices are contributors to turbulence in the small firm sector; yet there have been few investigations into the factors that influence an owner‐manager’s approach and the processes involved in the evolution of strategy and associated learning in this area. Previous studies have adopted a comparative static approach that is survey‐based; we argue that these studies can only give limited insights. We adopt a comparative case study methodology to develop an evolutionary process view of financial management in small firms. Despite the increased attention paid to owner‐managers in the small firms sector, we know comparatively little about the process of financial management and how small firms learn and adjust strategy and decision‐making in this area. In this paper, we attempt to shed some light on the process issues within small firms from qualitative evidence collected as part of a programme of case study research with entrepreneurs and owner‐managers. We discuss case evidence and focus on how owner‐managers reach financial management decisions, how they learn and adjust behaviour within the entrepreneurship process.

Financial Risk Management (corrected)

This article presents an integrated theoretical framework to guide financial risk management decisions. The framework is based on two key principles: the use of a “Sharpe rule” to assess prospective changes in a firm's or portfolio's risk–expected return profile and the maintenance of a constant probability of default, which determines the firm's or portfolio's leverage. The rules are not restricted to normal return distributions; they can also accommodate a variety of nonnormal distributions. The approach can be applied with either portfolio standard deviation or value at risk as the measure of risk.

State Government Credit Quality: Down, but Not Out!

Municipal (state and local) governments issue debt to finance capital projects and meet their cash flow needs. Most state governments issue large amounts of long-term debt on a regular basis. The state government share of outstanding municipal debt grew significantly from 1961 to 1992, from 26 percent to 38 percent (U.S. Department of Commerce, 1975-1996), with the rate of growth accelerating in the 1980's (Regens and Lauth, 1992). Accordingly, state government debt is taking up an increasingly larger share of municipal financial resources and will continue to do so in the future. Yet, the ability of state governments to repay their debt may have been adversely affected by the fiscal stress they underwent in the 1980's and early 1990's (Poterba, 1994; Gold, 1995). Since the state government sector surplus peaked at historical highs in the mid-1980's, the fiscal position of the states has deteriorated to the point where in 1992 the state sector suffered its largest deficit in U.S. history (Fleenor, 1995). Inevitably, such fiscal problems adversely affect the ability of state governments to finance their citizens' capital needs at lowest cost. In this article state government credit ratings are used to analyze aggregate state government credit quality from 1970 to 1995. Our analysis focuses on changes in the overall credit quality of state governments, and changes in the comparative credit ratings of Moody's Investors Service and Standard and Poor's. This article adds to the public administration and financial certification literatures by providing a new means of understanding and analyzing the aggregate structure of state government credit quality over time. In addition, it appears that the only prior time series study of state government credit quality in the academic literature was published in 1978 and examined the period 1950-1972 (Osteryoung and Blevins). The study used Moody's ratings, but did not compare credit quality judgements across rating agencies. The other state government credit quality study in the literature measures the impact of ratings on yields at a single point in time (Liu and Thakor, 1984). An analysis of credit rating changes over time provides a useful framework for analyzing the relationship between government financial management decisions and the actions of rating agencies. Specifically, a finding of deteriorating credit quality over time would suggest that public officials have been ineffective at managing the factors--economic, financial, debt, and administrative--that credit rating agencies consider important. Such a finding would demand a major reassessment of state government financial management. On the other hand, an improving credit condition would imply just the opposite, that state government officials have been increasingly successful at managing their fiscal affairs. This article also adds to the financial certification literature by examining dual certification on a market structure basis by comparing Moody's and Standard and Poor's credit ratings for the same issuer over time. Prior certification studies (Hsueh and Kidwell, 1988; Thompson and Vaz, 1990) have analyzed dual certification for individual debt issuers at one point in time by estimating the value of a second rating on the cost of a new bond issue. Historically, state governments obtained a single credit rating from Moody's or Standard and Poor's when bringing a new bond issue to market. Now, state governments routinely purchase two ratings from Moody's and Standard and Poor's. This study addresses the question of whether more than one rating on a state government bond issue is necessary. Also, virtually all of the credit certification literature looks at local governments and corporations. This article extends the literature by analyzing state governments exclusively. Our analysis shows that the distribution of state credit ratings have changed markedly since 1970. In the aggregate, state governments in the United Stares are less creditworthy (rated lower) in 1995 than they were in 1970. …

Book Review Section

Book reviewed in this article:Philip Brown Capital Markets ‐ Based Research in Accounting: An IntroductionJonathan Anderson and Milicent Poole Thesis and Assignment WritingJohn Wiley & Sons, Queensland, Second EditionK Keasey and R Watson Small Firm Management: Ownership, Finance and PerformanceJohn J Glynn Public Sector Financial Control and AccountingStephen A Zeff and Bala G Dharan Readings and Notes on Financial Accounting: Issues and ControversiesJohn G Burch Cost of Management Accounting ‐ A Modern ApproachK David and I Harper Privatisation: The Financial ImplicationsP Hutchinson, S Alison, W Gregory and S Lumby Financial Management Decisions, Principles and Applications

Foreign exchange exposure and the pricing of currency risk in equity returns: Some Australian evidence

Having regard to the importance of knowing whether equity returns are sensitive to exchange rate changes and if currency risk is priced when making international financial management decisions, the following evidence is provided in this paper. Although equity returns of Australian industries display differential ex post sensitivity to exchange rate movements, evidence from a two factor asset pricing model suggests that equity returns do not include any premium for currency risk borne. One implication of these findings is that corporate hedging of currency exposure may not add value.

Economic theory and exchange rate forecasts

Businesses use forecasts of exchange rates to make decisions about production, employment, investment, financial management, and pricing decisions. The proper statistical criteria for making and evaluating these exchange rate forecasts are implied by the underlying decision problem. That decision problem is in turn affected by the economic environment facing the firm and its industry, the overall macroeconomic situation, and the main types of disturbances affecting exchange rates. In general, the proper loss function for the forecasting problem will be asymmetric.

A FINANCIAL MANAGEMENT THEORY OF THE NONPROFIT ORGANIZATION

AbstractCertain unique operational and financial characteristics of nonprofit organizations prevent the transfer and successful application of orthodox economic and financial management theories to financial management decisions in the nonprofit context. These characteristics include a dual management structure composed of professional and financial managers, multiple objectives, legal restrictions on the disposition of earnings and assets, and the constant threat of illiquidity as the result of the uncoupling of organizational goals and cash flows.The financial management theory presented here separates the financial management goals from the professional goals and allows the finance practitioner to concentrate on keeping the nonprofit organization operating as a going concern. The theory is designed as a “partial” theory of the firm and is completely consonant with accepted economic orthodoxy. Hence, by employing financial decision rules based on the new theory, a nonprofit organization can survive financially through time while its professional manager pursues utility‐denominated goals delineated by the organization's tax‐exempt status.

The Book Shelf

Abstract Abstract Basic Accounting Procedures, by William Niven and Anka Ohman. Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 369 pp., 1964. $4.95. Financial Management Decisions: Case Problems, by Paul E. Fenlon, Boston: Allyn and Bacon, Inc., 202 pp. (paperbound), 1964. $3.95. College Typewriting, Seventh Edition, Complete Course, by D. D. Lessenberry, S. J. Wanous, and C. H. Duncan; Cincinnati: South-Western Publishing Company, $5.00 list, 1965. College Secretarial Procedures, Third Edition, by Irene Place and Charles B. Hicks. New York: Gregg Division, McGraw-Hill Book Company, Inc., 1964. $5.75. Records Management, by Mary Claire Griffin, Boston: Allyn and Bacon, Inc., 300 pp., 1964. $6.95. College English and Communication, by Marie M. Stewart, Frank W. Lanham, Kenneth Zimmer: New York: Gregg Division, McGraw-Hill Book Company, Inc., 1964. $5.75. How to use the Business Library, Third Edition, by H. Webster Johnson, Cincinnati: South-Western Publishing Company, 1964. $1.75.