Total Firm Value Research Articles

Leverage Strategies of Real Estate Investment Trusts and Real Estate Operating Companies

This paper employs empirical data in three major Asian real estate markets - Hong Kong, Japan, and Singapore, from 2001 to 2021, to study the leverage strategies of two related types of real estate companies – real estate investment trusts (REITs) and real estate operating companies (REOCs). The business model of the former must adhere to a real-estate-focused investment strategy while the latter undertakes a whole range of real estate development activities including land acquisition, financial feasibility analysis, construction, investment and asset management to redevelopment and disposal, and are not subject to the REIT rules with respect to tax transparency, earning distribution, real estate holding and leverage limit. We find that REOCs use 18.96% more debt than REITs after controlling for the agency and market risks, dividend yields, and property sector, country, and year fixed effects of firms; dividend payout has no effect on the leverage strategies; and high tax ratio increases the debt usage of REOCs relative to REITs. We also analyze the liquidation costs and business uniqueness effects. We find real estate value to total firm value ratio, as a proxy of liquidation cost, has negative effects on debt ratios for both real estate firms. Due to their uniqueness, REOCs with a high concentration of rental revenue stream are more vulnerable to liquidation risks, and thus more likely to have lower debt ratio. REITs however tend to have higher debt usage as rental incomes enhance cash-flow liquidity.

Policy analysis to maximize the firm value: performing firm valuation using system dynamics

PurposeThe purpose of this study is firm value management through corporate finance policy design and scenario analysis to maximize the firm value.Design/methodology/approachThe study develops a system dynamics model for an oil firm and incorporates the financial and physical processes to perform the firm valuation. The model is simulated under the current and alternative investment, capital structure and dividend policies of the case firm, assuming different oil and gas price and tax rate scenarios to identify which combination of policies maximizes the firm value.FindingsThe simulation results suggest that lowering the volume of investments, increasing the debt ratio and reducing the dividend payments from the current level increases the share price, given increased oil and gas price expectations and lower tax rates. However, the total firm value outperforms with increased investments toward the end of the simulation period. In case of decreased oil and gas price expectations, lower volume of investments, lower debt ratio and lower dividend payments increase the share prices, given lower taxes.Originality/valueThis study entails significance as it provides a comprehensive financial planning model for an oil firm, which incorporates the complex interactions of key financial and physical processes of the firm. The study contributes to debates on corporate finance policies by integrating multiple theories, accounting for accumulation processes and feedback loops and their non-linear interactions. The study proposes the consideration of combined impact of policies for firm value management.

Influence of Liquidity, Leverage, Profitability And Company Size to Company Value (Empire Study on Food Sub-Sector Companies And Beverages Listed on The Indonesia Stock Exchange Period 2014-2017)

The research aims to analyze the influence of liquidity, leverage, profitability and firm size on the firm value of food and beverage sub-sector company listed on the Indonesia Stock Exchange period 2014-2017. Variables that used tomeasure variable liquidity are current ratio (CR), variable leverage measured by debt to equity ratio (DER), variable profitability measured by return on equity (ROE), and firm size according to the total assets and firm value measure by (the ratio PBV). Sample of this research are food and beverage manufacturing company listed on the Indonesia Stock Exchange period 2014-2017 with the total 18 companies. By using the purposive sampling, it took 13 companies as the sample of research. Analysis technique used are descriptive analysis, test the assumption classical which includes normality test, multi-co linearity test, heteroscedasticity test and autocorrelation test, with a significance alpha 5 percent and 1 percent. Panel analysis data which multiple regression linear analysis and the hypothesis test includes f statistic test, t test statistic and determination test. The research result shows that the liquidity variable (CR) does not influence the firm value. Leverage variable (DER) has the positive influence and significantly to firm value (PBV). Profitability has the positive infuence and significantly to firm value (PBV) meanwhile the firm size variable (Ln Total Asset) has the negative influence and significantly to firm value (PBV).

Investment and financing for SMEs with bank-tax interaction and public-private partnerships

In this paper, we consider a small- and micro-sized enterprise (SME) with assets-in-place invests a project. Especially, we assume that the fund needed by the investment are shared by the government’s direct investment through public-private partnerships (PPPs) and the bank-tax interaction (BTI), which is a financial innovation instrument to solve the financing problem encountered by the SMEs. We address the pricing of corporate securities and optimal investment strategies. By providing a comparison with the pure private lending, we discover that the BTI makes the investment much cheaper and more attractive, and therefore mitigates the problem of under-investment in unstable markets. In addition, the BTI can increase the total firm value, reduce the leverage ratio and bankruptcy probability. The credit line of the BTI contract increases with the factors that influence the loan structure of the SME, such as the volatility, the tax rate, the investment cost sharing and the credit multiple. Most importantly, there exists an optimal investment cost sharing, such that the agency cost between SMEs and the government reaches zero due to the direct investment through PPPs.

Dual Holders: Valuation, Default Policy, and Capital Structure

Dual holders own debt and equity in the same firm. By maximizing the total value of the dual holders' assets, we derive optimal default policies and show that dual holdership reduces default risk. We analyze the two most common priority structures: 1) Dual holders' private debt rank junior to external debt, typically found in small and medium sized companies. 2) Private debt ranks pari-passu to external debt, typically the case for publicly traded debt. The reduction in default probability is larger for the junior-senior case. We calculate the value of debt and other claims, and by the standard approach of trading off tax benefits from debt with bankruptcy costs, we analyze firms' optimal capital structure. Total firm value in the pari-passu case is lower or equal to total firm value in the junior-senior case. Private debt displaces equity financing and equity values can be negative. Any negative equity values are more than offset by positive values of private debt. Without exogenous restrictions, dual holders always prefer to increase private debt. For fixed, sufficiently high levels of private debt, the optimal use of external debt is proportional to the use of private debt. This case illustrates an odd, non-sustainable economic situation for high levels of private debt. Tax benefits from debt decrease the total cost of financing and removes default risk. In this case, the bankruptcy cost is zero, so there is no cost of including debt in the capital structure. All debt is therefore risk-free and credit spreads vanish. In addition, any differences between the two priority structures disappear in this case.

Corporate governance roles of information quality and corporate takeovers

We examine the corporate governance roles of information quality and the takeover market with asymmetric information regarding the value of the target firm. Increasing information quality improves the takeover efficiency however, a highly efficient takeover market also discourages the manager from exerting effort. We find that perfect information quality is not optimal for either current shareholders’ expected payoff maximization or expected firm value maximization. Furthermore, current shareholders prefer a lower level of information quality than the level that maximizes expected firm value, because of a misalignment between current shareholders’ value and total firm value. We also analyze the impact of antitakeover laws, and find that the passage of antitakeover laws may induce current shareholders to choose a higher level of information quality and thus increase expected firm value.

What matters most in CEO compensation?

Components of compensation have been analysed in previous studies of corporate financial variables of interest but never together to get a sense of the complete picture of what truly matters. This paper includes variable interactions using the difference-in-differences methodology for panel regressions. Data is collected from Capital IQ, Compustat, CRSP, and ExecuComp for S&P 1500 firms from 2006 to 2013. Inside debt is negatively related to a firm’s total risk, idiosyncratic risk, and CEO turnover. Inside debt is positively related to diversification, liquidity, firm value, and return. Overconfidence is negatively related to total risk, liquidity, investment, and firm value. The CEO pay slice is positively related to total risk but negatively related to diversification, liquidity, and firm value. Interactions among these variables lead to an increase in total risk but a decrease in investment, diversification, liquidity, and firm value. Inside debt mitigates CEO risky decision making, whereas CEOs who are overconfident by their option exercise behaviour or their relative compensation to other directors creates a situation where they are encouraged to take on more risk, which, on average, is shown to harm the firm.

Value Creation Thinking: Life-Cycle Reviews (Presentation Slides)

Life-Cycle Reviews would improve management/board capital expenditure decisions and fundamentally upgrade investor communications. The key is a reality-based analysis of the firm's major business units grounded in the life-cycle framework. The focus is on why business-unit reinvestment should create value in the future. This PowerPoint presentation expands upon the ideas presented in my book, Value Creation Thinking. The book website, Value Creation Thinking dot com, contains a % Future scorecard for 1,000 U.S. industrial firms, updated quarterly. The % Future metric uses an estimate of the wind-down value of the firm's existing assets in order to derive the implied value of the firm's future investments, expressed as a percent of the total firm value. As part of a Life-Cycle Review, the % Future metric helps pinpoint, based on current stock prices, the market's assessment of the firm's position on the life cycle.

The micro patterns of export diversification under financial constraints

Combining detailed data on export transactions and an informative firm-level measure of financing constraints, this article provides new evidence on the extent and dynamics of product and geographical diversification of constrained exporters. Financial constraints associate with: (i) narrower product/destination margins, (ii) higher probability to drop products and destinations, (iii) larger loss of export value associated to dropping product or destination markets, (iv) higher probability to discard products with relatively large share in firm total export values, and (v) larger likelihood to drop country markets that are bigger, richer, geographically closer and with a relatively larger share in total firm export value.

Approximate Default Probabilities of a Holding Company, with Complete and Partial Information

This paper studies the valuation of credit risk for firms that own several subsidiaries or business lines. We provide simple analytical approximating expressions for probabilities of default, and for equity-debt market values, both in the case when the information is available in continuous time as well as in the case that it is not instantaneously available. The total firm's asset value being modeled as a sum of lognormal random variables, we use convex upper and lower approximations to infer these analytical approximating expressions. We extend the model to firms financed by multiple stochastic liabilities and conclude by numerical illustrations.

Tax policy and macro-finance in a competitive global economy where government is considered as firms' third financial stakeholder

Domestic tax policies must provide needed revenues for public infrastructure and social programs and must be structured to promote sustainable, growing, vibrant economies where individual rights and living standards are preserved or improved. We propose a macro-financial model be included with traditional financial macroeconomic theory postulating that, among other things, economic activity results from net international trade, inter-country capital flows, aggregate effects of all domestic private and public saving and investment and consumption decisions. We modify Modigliani and Miller’s capital structure propositions (Modigliani and Miller, 1958, 1963) by adding government as the third major financial stakeholder where government possesses a stake in the firm because of the potential, just as stockholders, to receive future cash flows. We posit a ‘conservation of value’ where capital structure and the domestic tax structure have no effect on total firm value; however, affect relative stakeholder values, discount rates, capital investment and flow of capital into and out of a country.

Value of Debt Tax Shields in Colombia: An Empirical Study

The Spanish version of this paper can be found http://ssrn.com/abstract=1899685This paper estimates the value of tax shields, using the discounted cash flow method for 23 major non financial firms listed in the Bolsa de Valores de Colombia (Colombian Stock Exchange) between 2001 and 2010 It shows that this value represents on average between 5.40% and 56.73% out of total firm value depending on discount rate for tax shields and calculation method. It also finds that firms’ average leverage is low relative to other countries. Using Data Panel regressions, it explores the behavior of total value of firms and found no evidence that debt creates value.

Valor de los Ahorros en Impuestos por Deuda en Colombia: Un Estudio Empírico (Value of Debt Tax Shields in Colombia: An Empirical Study)

The English version of this paper can be found at http://ssrn.com/abstract=1919305This paper estimates the value of tax savings, using the method of discounted cash flows for 23 major industrial firms in the Bolsa de Valores de Colombia (Colombian Stock Market) between 2001 and 2010, showing that this value represents on average between 5.74% and 56.73% out of total firm value depending on discount rate for tax savings. Using Data Panel regressions, it also finds that the average leverage of firms is low relative to other countries. Given this fact, we explored the behavior of the total value of the firm, VT and found no evidence that debt creates value.

A Case Study on Pomace Olive Oil Investment-Option Valuation, Optimal Leverage and Expected Agency Costs

Based on a case study firm whose asset is an investment option, this paper focuses on the debt financing impact and the existence of agency conflicts regarding the option exercise on optimal investment decisions, optimal capital structure and option value. The investment opportunity which is a starting project consists on extracting and refining pomace olive oil. Two sequences are considered: a crude pomace oil extraction and pomace oil refining as a second sequence. The duration of each sequence is 20 semesters of which two semesters correspond to development phase and the commercialization spreads on 18 semesters from 1997 to 2006 for the initial sequence and 1998 to 2007 for the second sequence. Conflicts of interest between equityholders-bondholders are managed through the optimal choice of the investment thresholds and optimal leverage. We show that debt financing may significantly distort investment decisions. Levered equityholders choose to speed up exercising the investment option when they maximize equity value instead of total firm value. This incentive reduces option value and optimal leverage and increases credit spread of risky debt. We find that expected agency costs constitute an important driver both of the optimal investment decisions and optimal capital structure. Numerical simulations illustrate how agency costs vary with the investment opportunity parameters.

Managerial Discretion, Agency Costs, and Capital Structure

In a dynamic continuous-time model, we examine the impact of a manager-shareholder conflict over the choice of investment risk on firm value and optimal capital structure. The manager's optimal investment risk policy is substantially different from the policy that maximizes equity or total firm value. The resulting agency costs of equity are many times larger than the agency costs of debt. Among a number of important implications, we find that managerial risk-aversion decreases the agency costs of equity. We also find that when equityholders have control rights over financing decisions, optimal leverage may increase relative to optimal leverage when investment risk is chosen to maximize total firm value. Additionally, greater managerial equity compensation may exacerbate the manager-stockholder conflict over investment policy, and in spite of higher agency costs of equity, may increase optimal leverage. Finally, we find that an increase in risk encourages the manager to pursue a more conservative investment strategy, which increases the agency costs of equity. Managerial risk-aversion, however, acts to mitigate this effect of risk on the agency costs of equity.

Uncertain Private Benefits and the Decision to Go Public

This paper focuses on the decision to go public when both seller and potential buyers have private benefits of control. The basic model by Zingales (1995) is extended to account for uncertainty of private benefits. This leads to new implications for the sales process, ownership structure, measurement of private benefits and the efficiency of takeover regimes. The optimal way to sell the company differs from the model with perfect information in that the incumbent always choses to go public instead of selling directly to a potential rival whenever the rival is expected to increase cash flow but not necessarily total firm value. IPO price and volume are lower than under perfect information which induces a socially non-optimal solution in takeover transactions. Imperfect information also explains post-IPO underperformance of firms which are not subject to control transfers. To compensate shareholders for potential losses during the sales process, the offering price has to be lower than under perfect information. This provides the basis for a differential stock price performance depending on the buyer taking over or not. Furthermore, an overestimation bias exists in prior estimates of control premiums, because some firms going public are never sold but nevertheless provide private benefits. Finally, mandatory tender offers in the form of a fair price rule and an equal opportunity rule are discussed, which indicate that the social superiority of either rule is strongly dependent on the empirical distribution characteristics of private benefits.

Expropriation, Unification, and Corporate Governance in Italy

Extant literature has usually argued that firms that unify dual class shares are likely to increase shareholder value. We examine the universe of Italian dual class unifications over the 1974-2005 period and show that the unification process is considerably more complex than described in prior literature. In over half the universe, Italian voting shareholders are not compensated for allowing their voting rights to be diluted, and, not surprisingly, experience a price decline at the announcement of unifications. While non-voting shares appreciate in value at the announcement there is little evidence that the unification increases total firm value. We argue that share unifications are designed to benefit the controlling shareholders and, in several cases, controlling voting shareholders use the unification to expropriate wealth from minority shareholders.

Freedom and Corporate Responsibility: The Niger Delta Case

This article briefly introduces a new argument concerning corporate social responsibility, based in an analysis of values expressed by the recent and contemporary liberal economists Milton Friedman and Michael Jensen. I will provide the gist of the argument by considering implications of Friedman’s very familiar view, that “…there is one and only one social responsibility of business - to use its resources and engage in activities to increase its profits so long as it stays within the rules of the game.” Harvard professor Michael Jensen has argued from slightly different premises to a similar conclusion, that “social welfare is maximized when all firms in an economy attempt to maximize their own total firm value.” Vestiges of such influential argument are also easily spotted in American corporate culture (See Palmer, 2007). I suggest that these authors’ positions allow for possibilities that undermine their broader fundamental values, however. I will concentate especially on Friedman’s classic treatment of liberal politics and capitalist economics, Capitalism and Freedom, in which he alludes to the importance of accepting and promoting individual freedom. Such values demand governmental and social stability, and so, in some cases, particularly where business activity may destabilize society, it would appear that freedom may be seriously threatened by corporate activity that follows Friedman’s narrow prescription. Nowhere is this more evident, at present, than in the Niger River Delta, where the promise and profits of oil have produced a society in great disarray. A case study of the delta situation indicates the problems of the narrow view of business goals and business responsibility, and this article will go on to consider possible solutions to those problems that delineate general sorts of responsibilities. The solutions require corporations to take a much broader view of their activity: I suggest that Friedman’s flaw reflects a general weakness of liberal individualism, nicely exposed in Amartya Sen’s arguments that lead to the conclusion that, “we have to see individual freedom as a social commitment.” That social commitment includes the goal of promoting individual freedom, but reaching for the goal may proceed along lines that are not so narrowly economic as Friedman would have, indicating new roles for business and government cooperation even in less extreme cases than that of the Niger Delta.

Expansion Financing and Capital Structure

We analyze the financing of an expansion project, as well as the pre-expansion capital structure decision. Using too much equity (debt) in the expansion financing results in under (over)-investment relative to the first-best (total firm value maximizing) policy. We identify the expansion financing packages that ensure first-best as well as second-best (optimal, or equity value maximizing) policies, and show that they are in general quite different. The optimal expansion financing package generally implies a significantly larger debt component than the first-best. With optimal expansion financing, the model's implications are consistent with empirical regularities such as (i) existing debt has a negative effect, while the debt component of expansion financing has a positive effect, on investment; (ii) the debt component of expansion financing is generally a decreasing function of the existing debt level, except for highly-levered firms; and (iii) the debt component of expansion financing is decreasing in growth opportunities. The ex-ante (pre-expansion) leverage ratio is also identified for both cases - first-best and second-best expansion financing. In the latter case, the model's implications are again consistent with empirical regularities: (i) growth opportunities have a negative effect on both book and market optimal leverage ratios; and (ii) optimal leverage ratio is negatively related to earnings or profitability. Overall, the available empirical evidence suggests that expansion decisions are usually second-best, i.e., made to maximize equity value rather than total firm value.

Integration among Major Capital Markets in the World: An Investigation Focusing on Firm Value

This study examines the degree of capital market integration among major stock markets in the world. Unlike prior studies that focus on stock returns, this study focus on firm values in investigating the degree of capital market integration. Specifically, I use firm value measures-such as price/cash flow, price/earnings and price/book-for a sample of large-cap firms from seven major industrial countries over the 1998~2002 period in order to examine the relative importance of country, industry, year and firm effects in explaining the variance of firm value. Our variance components analysis reveals that the extent to which firm values tend to differ across countries is not small. Specifically, in some model specification, the extent to which firm values vary across countries explains as much as over 15 percent of the total firm value variation. However this observation does not necessarily imply that the degree of integration of world capital markets is low, because business fundamentals tend to differ across countries to a similar or greater extent. Our results suggest that world capital markets are integrated in the sense that the firm-value difference across countries is not greater than the business fundamentals difference across countries.