Profitable Investment Opportunities Research Articles

Intended use of proceeds and the long-run performance of seasoned equity issuers

We investigate the relation between seasoned equity issuers' stated intended use of proceeds and their subsequent long-run stock and operating performance. Stated intended uses of proceeds are: investment, recapitalization, and general corporate purposes. We find that issuers stating recapitalization or general corporate purposes experience abnormally poor performance in the subsequent three years, but issuers stating investment display little or no subsequent underperformance. These results suggest that issuers with specific plans to use the proceeds for investment purposes are credibly signaling profitable investment opportunities, whereas issuers without specific investment plans are more likely to be opportunistic market timers. Consistent with a timing motive, the secondary component of the offering is significantly larger when the issuer is not specific about investment plans.

The Explosion of Debt and Speculation

In a series of articles in Monthly Review and in Monthly Review Press books during the 1970s and 1980s, Harry Magdoff and Paul Sweezy proposed that the general economic tendency of mature capitalism is toward stagnation. A shortage of profitable investment opportunities is the primary cause of this tendency. Less investment in the productive economy (the "real economy") means lower future growth. Marx wrote about the possibility of this very phenomenonThis article can also be found at the Monthly Review website, where most recent articles are published in full.Click here to purchase a PDF version of this article at the Monthly Review website.

The role of cash holdings in reducing investment–cash flow sensitivity: Evidence from a financial crisis period in an emerging market

This paper investigates the relationship between financing constraints and investment–cash flow sensitivities by focusing on cash holdings of firms as the main classification variable to separate firms into financially constrained and unconstrained categories. The idea is that high cash reserves increase the ability of firms to undertake profitable investment opportunities. Our classification is based on an optimal cash model, which helps us identify the firms that deviate significantly from their target cash ratio. We conduct the analysis for an emerging market, before and during a financial crisis to test the hypothesis that the hedging role of cash is more critical in states of the world characterized by high asymmetric information and excessive costs of external finance. The results are in line with our expectations and show that constrained firms exhibit greater investment–cash flow sensitivities than unconstrained firms. Also, there is strong evidence that cash stands as an effective device for firms, mainly during the crisis period.

COMMENT: WHAT CAUSED FIXED INVESTMENT TO STAGNATE DURING THE 1990S IN JAPAN? EVIDENCE FROM PANEL DATA OF LISTED COMPANIES

The investment-saving balance of the Japanese non-financial corporate sector persistently declined over the 1990s. In 1990, on the eve of the collapse in land prices, investment exceeded savings by 53 trillion, 226 billion yen reflecting lively investment activities, but in 1998 savings exceeded investment by 20 trillion, 248 billion yen. A financial surplus in the corporate sector casts doubt on the importance of the availability of internal funds in a fixed investment decision. This paper is a serious look at this issue and is based on a panel data set of Japanese listed firms and sheds new light on the role of cash flows in investment decision. This paper shows that the role of cash flow, or more broadly liquidity, changed in the course of the 1990s from mitigation of current liquidity constraints to preparation for future liquidity constraints. The paper finds that positive cash flow sensitivity can be seen as evidence of liquidity constraints for the first half of the 1990s, but it is an indicator for poor preparation for future liquidity constraints in the latter half of the 1990s. This hints at the importance of precautionary savings in the corporate sector in this period. Increasing uncertainty caused by the banking crisis in the late 1990s prompted firms to accumulate liquidity assets that served as a buffer against future liquidity shocks. The paper further shows that lack of profitable investment opportunities, represented by low Tobin’s q, can explain the stagnancy of fixed investment in the 1990s. This paper is an important contribution to understanding the mechanism of the stagnancy of Japanese corporate fixed investment in the 1990s. My comments are concerned with three points. One is the usefulness of information on firm attributes when the whole sample is divided into subgroups in estimating investment functions. Another is on the interpretation of estimation results. If the firms are not liquidity constrained in the latter half of 1990s, they are then unconstrained in investment decisions? The last point is on the importance of bank health in the latter half of the 1990s. A fresh interpretation of the results found in the paper by Hori, Saito and Ando (2006) is possible when issues related to bank health are considered.

Disparities in Geographic Performance: Some Effects on the Cost of Capital and the Payout Policy

We analyze the association of operating country profitability with stock returns on a large sample of Australasian, European and North American multinationals. Our evidence suggests that it heavily depends on investors' expectations of operating regions, which are not totally met. Investors in non-dividend paying stocks comparatively seem to be sensitive to both profitability levels and changes. By contrast, dividend-paying stock returns seem rather associated with profitability changes, connected with existing projects and permanent profitability, because the dividend policy measures may already contain information about the profitability of numerous foreign projects. A firm with a low dividend yield and dividend payout ratio may be valued more in terms of its future investment opportunities and dividend future growth. We find that the dividend yield and the payout ratio will generally be pushed down by regions of operations with many sustainable growth opportunities and pushed up by regions with relatively few profitable investment opportunities. However, excess transitory profitability from regions with many growth opportunities tends to be paid out through sporadic stock repurchases, while excess transitory profitability from regions with few profitable investment opportunities tends to be paid out through dividends.

Capital Allocation in Financial Firms

This paper develops a theory of capital allocation in financial intermediaries where the cost of “risk capital” is a critical consideration. The implication for capital budgeting is that financial firms should use a modified NPV rule in which projects are valued by calculating the NPV of cash flows using marketdetermined discount rates and then subtracting a deadweight cost of capital that reflects the project's marginal contribution to firm-wide risk. By taking account of deadweight costs—mainly monitoring and moral hazard costs associated with having too little equity capital as well as “free cash flow” agency costs and higher taxes associated with having too much—the capital allocation model predicts that financial firms will diversify across businesses with similar deadweight costs. Such diversification reduces the cost of risk capital for the individual businesses, thereby creating more profitable investment opportunities at the margin and enabling the businesses to operate on a larger scale. The authors note that their model has similarities to but also important differences from the standard applications of RAROC models.

Coordination Failures, Clusters, and Microeconomic Interventions

Econom�a 6.1 (2005) 1-42 [Access article in PDF] Coordination Failures, Clusters, and Microeconomic Interventions Andrés Rodríguez-Clare [Comments] The failure of market-oriented reforms to generate high and sustained growth in Latin America has led to the widespread agreement that such reforms should be complemented by other policies.1 The strategies to complement market-oriented reforms fall into three categories: macroeconomic policies to reduce the region's high vulnerability to crises; institutional and microeconomic reforms to improve the business climate and provide better foundations for growth; and microeconomic or competitiveness policies that include a broad range of government interventions to allow markets, sectors, and companies to take advantage of the opportunities afforded by market-oriented reforms. This paper focuses on the third strategy, which I henceforth refer to as one of microeconomic interventions. Countries have engaged microeconomic interventions for decades. Since the switch to outward-oriented development strategies in the mid-1980s, the main such interventions have been aimed at promoting exports, attracting foreign direct investment (FDI), and supporting small and medium-sized enterprises (SMEs). Another strategy that is receiving renewed interest is promoting inno-vation.2 These types of microeconomic intervention enjoy wide support and are encouraged by international institutions such as the World Bank and the Inter-American Development Bank. But the conceptual and empirical foundation for some of these interventions is not as solid as many people believe.3 For instance, it is hard to find a convincing [End Page 1] theoretical argument in favor of policies to support SMEs. On the contrary, recent research suggests that such policies may have significant negative effects on aggregate productivity under some circumstances.4 Empirical research also fails to find evidence for the positive externalities from exports and FDI that form the basis for policies to promote these activities. A more effective set of microeconomic interventions should specifically address the market failures that are important in the development process. Recent research suggests two kinds of market failures that may seriously hamper development. The first is related to externalities in the entrepreneurial process of discovering new profitable investment opportunities.5 The second is associated with coordination failures in taking the necessary actions to increase sectorwide productivity. This paper explores the latter market failures, their relation to clusters and agglomeration economies, and the set of microeconomic interventions that could be followed to deal with them. The paper is organized as follows. The next section introduces the notion of coordination failures, their relevance to developing countries, and the circumstances under which they occur. The following section then argues that clusters can be seen as agglomerations of firms and organizations in related economic activities among which coordination failures are likely to arise. In other words, clusters provide opportunities for microeconomic interventions that promote coordination and collective action to improve productivity. The paper goes on to explain that although one may alternatively think of clusters as resulting from agglomeration economies, the notion of coordination failures is more useful for deriving appropriate policies to encourage clustering. I explore this issue formally in a subsequent section, which presents a model of a small economy that is plagued by sector- or cluster-specific coordination failures. This section shows that, rather than trying to reallocate resources toward sectors that are seen as offering high clustering possibilities (as is the case with import substitution), policy should aim at fostering cooperation in sectors in which the economy is already showing comparative advantage. Next, I discuss a particular application of these ideas to innovation policy. I argue that general policies to increase innovation across the board are likely to be inferior to policies that take the more selective approach of trying to induce the development of innovation clusters in areas of comparative advantage. Finally, I offer some suggestions on how these ideas about coordination failures [End Page 2] and clusters can form the basis for a set of effective microeconomic interventions for middle-income countries. Coordination Failures A firm's productivity depends not only on its own efforts and abilities and on general economic conditions (such as the macroeconomic environment and the legal system...

Is Universal Banking Justified? Evidence from Bank Underwriting of Corporate Bonds in Japan

As the Glass-Steagall restrictions on bank underwriting were relaxed in the U.S. during the 1990s, the Financial System Reform Act (FSRA) of 1993 in Japan allowed commercial banks to underwrite securities. Using a large sample of unsecured corporate bond issues in Japan after the passage of the FSRA, we examine the debate on the role of commercial banks when they underwrite securities of firms with which they have prior lending relationships. We find that the issues underwritten by banks derive significantly lower prices (i.e., higher yields) than do those underwritten by houses. However, after the offerings, bank-underwritten issues do not experience as high a probability of credit rating downgrades as do house-underwritten issues. Taken together, these results strongly reject the certification view and suggest that the differences in ex ante yields are attributable to conflicts of interest. Our results contrast sharply with much of the evidence in the U.S., which documents a certification role for banks. Further analysis shows that the yield spreads of bonds are positively related to the market share of bank underwriters. Since banks that are more rapidly expanding their underwriting business face a greater need to provide investors with high-reward investment opportunities, our result suggests that banks excessively discount the prices of bonds in order to attract potential investors. Furthermore, we find that the lending relationships between bank underwriters and issuers weaken significantly more for issues with a better post-issuance rating performance. This result contradicts the information-misrepresentation view that banks underwrite poor-quality securities in order to use the proceeds from the issues to pay off loans. Rather, it is consistent with the price-discount view since bank underwriters who want to increase their market share in bond underwritings need to provide investors with profitable investment opportunities and thus have an incentive to extend credit to poor-quality issuers so that these issuers can maintain sufficient liquidity for future financial needs. We also find that competition from investment houses limits but does not eliminate these conflicts. Finally, we find that the magnitude of conflicts of interests the banks create is different for main-bank underwriters and other-bank underwriters. Although the main-bank- and other-bank-underwritten issues are on average priced similarly, the former exhibit a significantly lower probability of ex post rating downgrades than do the latter. Overall, our findings from the Japanese data suggest that it is premature to generalize the U.S. experience with universal banking to economies that have different traditions in their bank relationships.

Protectionist Lobbying and Strategic Investment

Why are some uncompetitive industry sectors so effective in lobbying for greater protection and support? This paper attempts to explain the lobbying success of these industries in terms of the strategic role of investment in technology as a credible commitment device. By eschewing potentially profitable investment opportunities firms credibly signal to the government that the cost of a tariff reduction will be substantial. This enables the firms to lobby more effectively for policy concessions. Political considerations may therefore provide a significant incentive for firms to reject investment in newer technologies, even when these lower production costs.

Project Selection, Income Smoothing and Bayesian Learning

The use of fixed capital budgets is an empirically well-documented phenomenon in business practice. Whensoever some profitable investment opportunities cannot be realized, managers have to make investment decisions between mutually exclusive investment opportunities. In a multiperiod agency setting this paper analyses accounting rules that provide managerial incentives for efficient project selection when a short-sighted manager is rewarded based on residual income. Before having access to profitable investment opportunities the agent has to expend unobservable effort. At each date the less informed principal observes a noisy cash flow signal which is informative about the agent's investment decision. By updating prior beliefs the principal faces a trade-off between agency costs resulting from differences in discount rates and the benefits resulting from the information content of the noisy cash flow signals.

Takeover risk and the market for corporate control: the experience of British firms in the 1970s and 1980s

This paper investigates the determinants of takeovers in a large sample of UK quoted companies. We focus on the channels through which the market for corporate control monitors company performance and discretionary managerial behaviour. Our results are consistent with the view that the market for corporate control disciplines poorly performing companies, and suggest that this effect is quantitatively important: a one standard deviation increase in profitability is associated with a fall in the conditional probability of takeover of 25%. However, we find no evidence that firms without apparent profitable investment opportunities are more likely to be taken over if managers increase investment or reduce dividends, contrary to the predictions of the free-cash-flow theory of takeovers.

Technological Change, Entry, and Stock-Market Dynamics: An Analysis of Transition in a Monopolistic Industry

We consider the share-price dynamics induced by changes in technological progress (perhaps due to the introduction of a new technology or institutional reforms) and the resultant entry of firms. The focus is not so much in comparing the steady states before or after the change, but rather on the transitional dynamics of the industry or economy as it adjusts. The model is one with efficient markets and perfect foresight where fundamentals drive the stockmarket value. Should we expect technological progress to lead only to increases in the level of the stockmarket (monotonic dynamics), or should we expect nonmonotonic behavior of boom followed by partial bust (a U-shaped or overshooting dynamic)? Is it possible to have share values falling even when the underlying technology is improving? We model a stylized monopolistic industry or economy in a continuous-time generalequilibrium setting with no uncertainty and perfect foresight. We adopt a model of entry found in Sanghamitra Das and Satya P. Das (1997), Datta and Dixon (2000), and Marta Aloi and Dixon (2001), in which the cost of entry is increasing in the flow of entry (due to some congestion effect or other externality). The flow of entry is determined by an intertemporal arbitrage condition that equates the cost of entry with the present value of incumbency. This gives rise to a dynamic zero-profit condition: the present value of incumbents in each instant is equal to the cost of entry. We first consider the case of a step increase in the level of technology with no other underlying growth. When an unanticipated technological improvement occurs, it causes a stock-market boom: there is a jump in the share value, the current profitability of incumbents, and an increase in the flow of entry. However, eventually entry drives the profit level back to zero, and shares decline back to the initial value. The initial boom is followed by a bust. We next consider the case of an economy with constant exponential technology growth. What happens when the pace of technological change unexpectedly increases? There is an upward jump in the stock-market value of firms. This can overshoot the new balancedgrowth path, with the possibility that there will be a U-shaped dynamic: the initial boom is followed by a slump before tracking back to the higher growth rate. If the initial jump overshoots the new balanced-growth path, there is a downward pull of share prices toward the new balanced-growth path, which may dominate. This stock-market behavior reflects the behavior of entry: after an initial rush, there is a temporary slowdown before eventually getting back on track. A similar pattern can occur if the change is anticipated. We believe that this might be some part of the explanation of the behavior of the stock market in the late 1990’s(although real life is much more complicated [see Jeremy Greenwood and Boyan Jovanovic, 1999]). The initial technological change causes a bonanza of profitable investment opportunities, resulting in high profits for incumbents and many new firms being set up. The increase in entry reduces profitability, and this may cause the flow of entry to reduce, if only in the short run. Finally, however, the long-run growth opportunities begin to come through, and the economy gets onto the new higher growth path.

The 1990s in Japan: A Lost Decade

This paper examines the Japanese economy in the 1990s, a decade of economic stagnation. We find that the problem is not a breakdown of the financial system, as corporations large and small were able to find financing for investments. There is no evidence of profitable investment opportunities not being exploited due to lack of access to capital markets. The problem then and today is a low productivity growth rate. Growth theory, treating TFP as exogenous, accounts well for the Japanese lost decade of growth. We think that research effort should be focused on what policy changes will allow productivity to again grow rapidly. Journal of Economic Literature Classification Numbers: E2, E13, O4, O5.

Urban Agriculture in Mwanza, Tanzania

AbstractMany people living in Mwanza, Tanzania, provision themselves through urban agriculture—the planting of crops and raising of animals in urban and peri-urban areas, as well as in the countryside. This article compares Mwanza's urban farmers with those in Kenya, Zambia, Zimbabwe and Ghana. Like Zimbabwe's urban agriculturalists, more and more of Mwanza's are not among the poorest of the poor. Much like Ghana's urban farmers, those in Mwanza are often middle and upper-class males with access to scarce land and inputs. Urban cultivators in Mwanza differ from those in Kenya and Zambia with regard to gender, socio-economic class and the factors motivating their farming activities. These findings suggest that even though socio-economic differentiation is on the increase in Tanzania it has not reached the levels of divergence found in Kenya and Zambia. Many of Mwanza's wealthier males continue to face enough job/income insecurity to choose to plant crops to support themselves and their household in lean times. They may also engage in urban agriculture because they are unable or unwilling to take advantage of more profitable investment opportunities outside the food market, or because they desire to spread risk across a number of different investments.

Energy services for an electricity industry based on renewable energy

This article investigates the potential for an entirely new structure for the electricity industry. This aims to provide energy services, such as light and heat, in the most economical way, by combining on-site generation with comprehensive energy efficiency measures. As well as leading to improved energy efficiency, it is shown how such an approach is more compatible with renewable sources of energy. It is also argued that such a structure would open up many profitable new investment opportunities to the electricity industry. The article explains why the traditional model for electricity systems fails to deliver both energy efficiency and renewable energy, and examines the effects that an energy services approach might have on the electricity industry if adopted on a wide scale. Factors that may cause the transition are also discussed. The article concludes that such a radically new approach may be the best way to deliver the large reductions in emissions required to mitigate climate change.

Incentives in Internal Capital Markets: Capital Constraints, Competition, and Investment Opportunities

This paper considers the effect of competition for scarce financial resources on managers' incentives to generate profitable investment opportunities. Competition is only unambiguously beneficial if projects are symmetric. If divisions differ in their cash endowments or their growth potential, integration may reduce incentives for some managers, which may lower total firm value. Moreover, relaxing capital constraints, e.g., by integrating a cash cow project, may reduce incentives. We treat two different scenarios where contracts can either only specify monetary incentives or additionally the allocation of funds. While distorted capital allocations increase managers' incentives, they only survive renegotiations in integrated firms.

Urban Agriculture in Mwanza, Tanzania

Many people living in Mwanza, Tanzania, provision themselves through urban agriculture—the planting of crops and raising of animals in urban and peri-urban areas, as well as in the countryside. This article compares Mwanza's urban farmers with those in Kenya, Zambia, Zimbabwe and Ghana. Like Zimbabwe's urban agriculturalists, more and more of Mwanza's are not among the poorest of the poor. Much like Ghana's urban farmers, those in Mwanza are often middle and upper-class males with access to scarce land and inputs. Urban cultivators in Mwanza differ from those in Kenya and Zambia with regard to gender, socio-economic class and the factors motivating their farming activities. These findings suggest that even though socio-economic differentiation is on the increase in Tanzania it has not reached the levels of divergence found in Kenya and Zambia. Many of Mwanza's wealthier males continue to face enough job/income insecurity to choose to plant crops to support themselves and their household in lean times. They may also engage in urban agriculture because they are unable or unwilling to take advantage of more profitable investment opportunities outside the food market, or because they desire to spread risk across a number of different investments.

Publicly sponsored regional venture capital: what can the UK learn from the US experience?

National venture capital activity in both the US and UK is concentrated in just a handful of regions. As a consequence, there are perceived to be local gaps in the availability of venture capital. Governments in both countries have sought to fill these gaps using taxpayer funds, although in recent years the policy emphasis has shifted in favour of measures to stimulate local activity by private sector venture capitalists. This paper addresses three questions. First, can locally targeted funds be an additional profitable investment opportunity for institutional investors including public sector pension funds? Second, to what extent is there a conflict for those sponsoring, or providing funding to, locally targeted funds betweenfinancial investment returns and economic development objectives? Third, what are the best mechanisms to balance the interests of the three parties-those with responsibility for regional development, investment managers within funding institutions and venture capitalists-while attempting to build a sustainable local venture capital industry? The paper concludes that given a clear-sighted approach to the goals of both parties, locally targeted private equity funds can indeed be an additional profitable investment opportunity for public sector funds. Good practice in sponsorship principles, as distilled from the American experience, should be largely applicable in Britain. However, the mechanisms will not easily translate from the US to the UK.

Peer Group Formation in an Adverse Selection Model

This paper develops an adverse selection model where peer group systems are shown to trigger lower interest rates and remove credit rationing in the case where borrowers are uninformed about their potential partners and ex post state verification (or auditing) by banks is costly. Peer group formation reduces interest rates due to a 'collateral effect', namely, cross subsidisation amongst borrowers acts as collateral behind a loan. By uncovering such a collateral effect, this paper shows that peer group systems can be viewed as an effective risk pooling mechanism, and thus enhance efficiency, notjust in the full information set up. A well-known family of adverse selection models in the Stiglitz and Weiss (1981) tradition demonstrates that when banks are imperfectly informed about the riskiness of borrowers' projects and therefore cannot discriminate against risky borrowers, interest rates become inefficiently high, and worthy borrowers are driven out of the credit market. The extent of this problem is substantially magnified when borrowers do not have adequate collateral to secure a loan. Typically, adverse selection combined with lack of collateral leads to prohibitively high interest rates. Poorly endowed individuals (e.g. students, immigrants, the unemployed, and a vast majority of poor individuals in developing countries) often face such high rates, and therefore cannot take advantage of profitable investment opportunities. A peer group formation system represents a possible solution to the above problem. Under this system a bank lends to borrowers without collateral on condition that the borrowers organise themselves into groups, and that participant borrowers within each group accept to take 'joint responsibility' for a loan. Thus, in addition to repaying their own share of the loan, each group member must accept to repay the obligations of their defaulting peers, otherwise the entire group is denied access to future refinancing. Systems of this kind have been very successful in practice: they have generated lower interest rates for the rural poor in, for example, Bangladesh, the Philippines, Bolivia, and the State of Arkansas in the United States. Moreover, group lending has also been successfully implemented in large urban areas such in the cities of Dhaka and Chicago.1

Corporate Leverage And Currency Crises

This paper provides an explanation of currency crises based on an argument that bailing out financially distressed exporting firms through a currency depreciation is ex-post optimal. Exporting firms have profitable investment opportunities, but they will not invest because high leverage causes debt overhang problems. The government can make investments feasible by not defending a fixed exchange rate and letting the currency depreciate. Currency depreciation always increases the profitability of new investments when revenues are in a foreign currency and costs are at least partially in domestic. Interestingly, foreign borrowing by exporting firms doesn't change the qualitative results: if firms' debt is denominated in foreign currency, a larger depreciation is needed to restore incentives to invest. An important feature in our model is that in general exporting firms choose to finance investments with debt instead of equity. Currency depreciation is socially optimal if risky projects have a higher expected return than safe projects and if firms are forced to rely on debt financing because of underdeveloped equity markets. Although currency depreciation is always ex-post optimal, it can be harmful ex-ante. Exporting firms know that the government will let the currency depreciate, if their risky investments have failed. This leads to excessive investment in risky projects even if more valuable safe projects are available.