Market-based Information Research Articles

Industry Peer Information and the Equity Valuation Accuracy of Firms Emerging from Chapter 11

Valuation plays a central role in determining Chapter 11 reorganization outcomes. However, obtaining accurate valuation estimates of reorganized firms is challenging because of limited firm-specific market-based information and the oft-conflicting incentives of claimholders. We examine the role of industry peer information in reducing misvaluations and its implications for unintended interclaimant wealth transfers and postreorganization performance. First, we find that the availability of relevant industry peer information is negatively associated with equity valuation errors for firms emerging from Chapter 11. Cross-sectional results suggest that the relation between industry peer information and valuation errors varies substantially with debtors’ information environment and case characteristics. Second, we find that industry peer information quality is associated with better ex post financial performance of emerged firms because of lower overvaluation. Finally, we document the role of industry peer information in substantially reducing the frequency and magnitude of unintended wealth transfers between claimants arising from equity valuation errors. This paper was accepted by Suraj Srinivasan, accounting. Funding: The authors appreciate financial support from the Social Sciences and Humanities Research Council of Canada [Grant 435-2020-0583] and the Canadian Academic Accounting Association. B. Fang acknowledges financial support from the Della Suantio Fellowship. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01233 .

Analyzing the Models of Financial Distress in Credit Risk

This paper presents a study comparing the effectiveness of accounting-based and market-based models predicting financial distress. We examine various periods, including events from the 1970s to the 1990s, the impact of COVID-19, and the effect of APRA. Our findings demonstrate that an accounting-based distress model performs similarly to the market-based model of defaults. Furthermore, when we combine both sources of information, the resulting model outperforms either individual model. These results suggest that accounting and market-based information are mutually reinforcing when assessing distress levels in pricing.

Implied volatility smoothing at COVID-19 times

This work aims at studying the impact of the SARS-CoV-2 pandemic on the global financial markets. In particular, such impact is analysed through the changes of the shape of the implied volatility smile of the options written on several equity indexes and on several stocks. The implied volatility function is estimated using the market-based information of liquid options and applying a semi-parametric smoothing technique that exploits a kernel function and no-arbitrage conditions. Such approach is applied to an extensive set of data to study the evolution of the implied volatility functions through the months of the pandemic. We show, in several cases, a sudden and massive change in the shape of the implied volatility functions.

Multi-Agent Learning-Based Nearly Non-Iterative Stochastic Dynamic Transactive Energy Control of Networked Microgrids

Coordination of networked microgrids (MGs) offers a promising solution to utilize distributed resources flexibilities and accommodate renewable energy. This paper studies real-time coordination of distribution system operation (DSO) and MGs considering multivariate uncertainty. Current researches suffer from inadaptability to dynamic system uncertainty, extensive iterations, and dependence on prediction. To fill these gaps, A novel multi-agent learning based stochastic dynamic programming (MASDP) is proposed to obtain the optimal policy for entities. Specifically, transactive energy control (TEC) mechanism, which requires only market-based information interactions, is employed to facilitate coordination between MG and DSO. A data-driven offline self-learning is proposed for entities to learn how to manage resources in response to system uncertainty. After sufficient offline learning, online operation of MASDP can be run in both non-iterative and iterative manners, by which near-optimal/optimal real-time solutions of DSO and MGs can be given sequentially and distributedly. Numerical comparisons with state-of-art policies and TEC algorithms verify the optimality, efficiency, adaptability, and scalability of MASDP.

COVID-19 government support reinforces zombification

We investigate the effect of government support on firm zombification during the COVID-19 crisis for Belgium, Germany, Spain, France, United Kingdom, the Netherlands and the United States. For this purpose, we use a simple model that links insolvency developments at the macro level to GDP developments. We first observe from the data that insolvencies have declined during the crisis despite economic contraction. We then use the model to calculate the total firms saved from insolvency by government intervention and the fraction of which are not healthy, the zombies. It appears that government intervention has been effective in saving firms during the height of the crisis in Q2 of 2020. The impact is smaller in Q3 when the recovery set in. But it comes at a cost of efficiency as it causes significantly higher zombification in the economy. The effect can be seen in both quarters, most notably in Belgium. In Germany and the Netherlands, zombification was low in Q2 but soared in Q3. The reverse effect was visible in Spain as the number of insolvencies picked up in Q3. Therefore, government intervention during the crisis has reinforced the existing trend of zombification there. With government support only gradually withdrawing in the recovery phase of the crisis and probably further pushing up the number of zombie firms, risk management faces the challenging task of detecting them. We offer a few suggestions. These are based on the classification of zombies, including ICR and Tobin’s q, as well as research on underlying drivers. Compared to the sector median, zombies appear smaller, less productive, slower growing, with lower investments and higher leverage despite higher equity issues and implied interest rate subsidies. Complementary to this market-based information, more proprietary, higher frequency data such as payment behaviours, revenue growth pace change, credit sourcing, bank covenant compliance and management competencies can be monitored using scorecards. Finally, we recommend a high level of vigilance and an additional provisioning to anticipate any delayed effects of the crisis.

Identification of systemically important banks in India using SRISK

Purpose Systemic risk has been a cause of concern for the bank regulatory authorities worldwide since the global financial crisis. This study aims to identify systemically important banks (SIBs) in India by using SRISK to measure the expected capital shortfall of banks in a systemic event. The sample size comprises a balanced data set of 31 listed Indian commercial banks from 2006 to 2019. Design/methodology/approach In this study, the authors have used SRISK to identify banks that have a maximum contribution to the systemic risk of the Indian banking sector. Leverage, size and long-run marginal expected shortfall (LRMES) are used to compute SRISK. Forward-looking LRMES is computed using the GJR-GARCH-dynamic conditional correlation methodology for early prediction of a bank’s contribution to systemic risk. Findings This study finds that public sector banks are more vulnerable to macroeconomic shocks owing to their capital inadequacy vis-à-vis the private sector banks. This study also emphasizes that size should not be used as a standalone factor to assess the systemic importance of a bank. Originality/value Systemic risk has attracted a lot of research interest; however, it is largely limited to the developed nations. This paper fills an important research gap in banking literature about the identification of SIBs in an emerging economy, India. As SRISK uses both balance sheet and market-based information, it can be used to complement the existing methodology used by the Reserve Bank of India to identify SIBs.

Discount Rate Uncertainty and Capital Investment

Firms obtain noisy estimates of investors' required rates of return (discount rates) using market-based information. Discounted-cash-flow (DCF) methods, as commonly taught in MBA courses, lead to upward-biased estimates of project values in the presence of such noise, even when cash flow and discount rate estimates are unbiased, due to Jensen's inequality. We show that this bias affects corporate investment decisions and firm financial performance, and we test additional predictions derived from the DCF model in the presence of noisy discount rates. Our evidence implies that a one-standard-deviation increase in discount rate uncertainty is associated with increased firm investment of 6.8%, while profitability decreases by 4.1%.

Intersectoral linkages, diverse information, and aggregate dynamics

What are the aggregate consequences of information frictions? We address this question in a multi-sector real business cycle model in which firms learn from market-based information. Theoretically, we present two distinct cases in which the aggregate effects of incomplete information completely disappear: either (i) market-based information reveals sector-level optimal actions, or (ii) market-based information reveals aggregate conditions in the economy. When the model is calibrated to United States' sectoral data, both conditions hold almost exactly and incomplete information has a negligible effect on aggregate dynamics.

Predicting corporate bankruptcy: What matters?

Whether accountingor market-based information should be employed to predict corporate default is a long-standing debate in finance research. Incorporating a regime-switching mechanism, we establish a hybrid bankruptcy prediction model with non-uniform loadings in both accounting- and market-based approaches to reexamine the issue. We find the following. Creditors should increase the loading on market-based information when large and liquid corporations are considered. Conversely, for companies with incremental information involved in accounting reporting proxied by discretionary accruals, banks could emphasize accounting ratio-based variables more than they are already emphasized. Since managerial discretion in accounting numbers could serve as a tool to bring undisclosed information about the firm to the public, the weight on accounting-based information could be increased for firms with high information asymmetry. In addition, the loading on market-based (accounting-based) information should be increased (decreased) during periods of financial crisis, defined by negative gross domestic product growth.

Market evidence against widespread point shaving in college basketball

This paper proposes using market-based information to investigate the likelihood of widespread point shaving in college basketball games with strong favorites. Information embodied in pre-game money lines facilitates the calculation of the market's expectation that the game will end with a strong favorite winning but not covering the point spread, a result deemed suspicious in previous studies. Additional market-based information embodied in second-half lines reveal how the market's expectation about second-half play differs from pre-game expectations. Applying our methodology to college basketball reduces previous estimates of the percentage of games thought to be consistent with potential point shaving to insignificant levels. Our approach can apply to other sports in which strong favorites are common.

Mark-to-Market Accounting and Systemic Risk in the Financial Sector

One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the U.S. insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across U.S. states. Rather than promoting a shift away from market-based information, our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk.

Corporate Social Responsibility and Social Media Corporations: Incorporating Human Rights Through Rankings, Self-Regulation and Shareholder Resolutions

This article examines the emergence and evolution of selected ranking and reporting frameworks in the expanding realm of business and human rights advocacy. It explores how indicators in the form of rankings and reports evaluating the conduct of transnational corporate actors can serve as regulatory tools with potential to bridge a global governance gap that often places human rights at risk. This article examines the relationship of transnational corporations in the Internet communications technology sector (ICT sector) to human rights and the risks presented to the right to freedom of expression and the right to privacy when ICT sector companies comply with government demands to disclose user data or to conceal information users seek. Specifically, it explores the controversial role of transnational ICT corporations in state censorship and surveillance practices. The article explains how conflicts over corporate complicity in alleged abuses served to catalyze change and lead to the creation of the Global Network Initiative, a private multi-stakeholder project, and the Ranking Digital Rights Initiative, an industry independent market-based information effort. Both aim to promote more responsible business practices in the social media industry sector. In conclusion, the article argues that regulating corporate reporting of information relevant to assessing the potential for adverse human rights impacts is necessary.

Collaborative culture and relationship strength roles in collaborative relationships: a supply chain perspective

PurposeThe purpose of this paper is to model and investigate collaborative culture and relationship strength roles in supply chain collaboration. This research highlights critical role played by culture and relationship strength in collaboration.Design/methodology/approachDrawing from relational view, a conceptual model is developed with the help of literature, and the model is validated with data collected in India using partial least squares method.FindingsResults and analyses revealed that culture and relationship strength significantly and strongly influence each collaborative activity. The relationship strength fully mediates between collaborative culture and supply chain performance. The research also finds that the relationship strength partially mediates between collaborative culture and market-based information sharing, operational resource planning and sharing. In the long-term, collaborative culture drives relationship strength and the element enhances collaborative activities.Originality/valueThis research attempted to explore collaborative culture and relationship strength which are crucial for collaborative relationship. Many mediation effects are studied which increase the understanding and give insights for its implementation. Its theoretical and practical implications are highlighted. This knowledge has enough potential to lead collaborative relationships towards success.

Divergent Behavior in Markets with Idiosyncratic Private Information

Perpetually evolving divergent trading strategies is the natural consequence of a market with idiosyncratic private information. In the face of intrinsic uncertainty about other traders' strategies, participants resort to learning and adaptation to identify and exploit profitable trading opportunities. Model-consistent use of market-based information generally improves price performance but can inadvertently produce episodes of sudden mispricing. The paper examines the impact of trader's use of information and bounded rationality on price efficiency.

Bank Capital Regulation: Theory, Empirics, and Policy

Minimum equity ratio requirements promote bank stability, but compliance must be measured credibly and requirements must be commensurate with risk. A mix of higher book equity requirements, a carefully designed contingent capital requirement, cash reserve requirements, and other measures, would address prudential objectives better than book equity requirements alone. Basel III’s ill-defined liquidity ratios, book capital ratios, and internal models of risk must be replaced by a system of credible, incentive-robust rules that combine valid concepts with objective, market-based information into a simplified and credible regulatory process. Raising minimum capital requirements will not be socially costless; bank profitability, share prices, and loan supply are likely to suffer. But avoiding the dramatic consequences of banking crises would more than repay those costs.

Value-based assessment of sovereign risk

Purpose– The purpose of this paper is to introduce a methodology to evaluate sovereign risk. Hereby, a value-based approach using different market measures is introduced.Design/methodology/approach– This study’s approach aims to provide a value-based assessment of sovereign risk, combining market measures from government bond, credit derivatives and other markets as well as economic indicators.Findings– The study finds that the assessment of sovereign risk is only possible when using information from different markets and adjusting according to the information included in these measures. Combining both market-based and economic information leads to a value-based evaluation of sovereign risk.Practical implications– The practical implications are given for any institution with sovereign risk on their asset side. In fact, part of this research was done for the German Actuarial Foundation which uses the recommendations of this paper for the insurance industry.Originality/value– The study’s approach is novel because it is the first to include several market-based and economic measures of a sovereign and combines it into a value-based assessment.

Mark-to-market accounting and systemic risk: evidence from the insurance industry

One of the most contentious issues raised during the recent crisis has been the potentially exacerbating role played by mark-to-market accounting. Many have proposed the use of historical cost accounting, promoting its ability to avoid the amplification of systemic risk. We caution against focusing on the accounting rule in isolation, and instead emphasize the interaction between accounting and the regulatory framework. First, historical cost accounting, through incentives that arise via interactions with complex capital adequacy regulation, does generate market distortions of its own. Second, while mark-to-market accounting may indeed generate fire sales during a crisis, forward-looking institutions that rationally internalize the probability of fire sales are incentivized to adopt a more prudent investment strategy during normal times which leads to a safer portfolio entering the crisis. Using detailed, position- and transaction-level data from the U.S. insurance industry, we show that (a) market prices do serve as ‘early warning signals’, (b) insurers that employed historical cost accounting engaged in greater degrees of regulatory arbitrage before the crisis and limited loss recognition during the crisis, and (c) insurers facing mark-to-market accounting tend to be more prudent in their portfolio allocations. Our identification relies on the sharp difference in statutory accounting rules between life and P&C companies as well as the heterogeneity in implementation of these rules within each insurance type across U.S. states. Rather than promoting a shift away from market-based information, our results indicate that regulatory simplicity may be preferred to the complexity of risk-weighted capital ratios that gives rise, through interactions with accounting rules, to distorted risk-taking incentives and potential build-up of systemic risk.

Learning and Adaptation as a Source of Market Failure

In the developed model, without knowing the trading strategies of the other traders in a financial market, traders cannot derive a rational expectations equilibrium. In a dynamic setting, market participants employ learning and adaptation to develop trading strategies to accommodate for this information deficiency. Model-consistent use of market-based information generally improves price performance. It can also produce episodes of extreme sudden mispricing despite model generated historical support for its use. Simulations examine the impact of information constraints and bounded rationality on general price efficiency and sudden market mispricing.

The uses of product costs in decision-making

This paper assess the use of product costs in decision-making. Using questionnaire responses and interviews with British management accountants, product costs are used all the time in decision making to support the profit motive in profit/investment centres and to control costs in cost centres. They are used only sometimes in decision making when there are limitations in the product costing system and/or the market has a greater role in decision-making. Operating units use product costs as attention directing information in decision making: to highlight loss making products for special studies to identify any further information required, because market-based information has an important role in decision making and when product costs are not accurate enough to use directly in decision-making. Operating units use product costs directly in decision making because they have confidence in the accuracy of costs or because of ignorance of using the information as attention directing information.

Value investing in credit markets

We outline a parsimonious empirical model to assess the relative usefulness of accounting- and equity market-based information to explain corporate credit spreads. The primary determinant of corporate credit spreads is the physical default probability. We compare existing accounting-based and market-based models to forecast default. We then assess whether the credit market completely incorporates this default information into credit spreads. We find that credit spreads reflect information about forecasted default rates with a significant lag. This unique evidence suggests a role for value investing in credit markets.