The Business Cycle,Investor Sentiment,and Costly External Finance

The recent financial crisis shows that financial markets can impact the real economy. We investigate whether access to finance typically time‐varies and, if so, what are the real effects. Consistent with time‐varying external finance costs, both investment and employment are less sensitive to Tobin's q and more sensitive to cash flow during recessions and low investor sentiment periods. Share issuance plays a bigger role than debt issuance in causing these effects. Alternative tests that do not rely on q and cash flow sensitivities suggest that recessions and low sentiment increase external finance costs, thereby limiting investment and employment.     

Determinants of individual investment decisions in investment‐based crowdfunding

We investigate determinants of investment decisions in investment‐based (equity and bond) crowdfunding campaigns, using a novel investment‐, investor‐ and campaign‐level database, where equity refers to investments in entrepreneurial start‐ups and bonds to large real estate projects. We find that investors who have higher social interactions invest more. Social interactions are important in an equity crowdfunding context but do not affect participation in bond investments. This is consistent with the view that investors' social networks help reduce information asymmetry. Women invest less in the riskiest (equity) investments but more in safer ones (bonds). These findings are better explained by differences in risk aversion than differences in overconfidence between men and women. Overall, the findings contribute to the understanding of how investment‐based crowdfunding can be a viable source of entrepreneurial finance and how entrepreneurs' campaign decisions affect investor participation in this new form of entrepreneurial finance.     

The Corporate Propensity to Save

Why do corporations accumulate liquid assets? We show theoretically that intertemporal trade‐offs between interest income taxation and the cost of external finance determine optimal savings. Intriguingly, we find that, controlling for Tobin's q, saving and cash flow are negatively related because firms lower cash reserves to invest after receiving positive cash‐flow shocks, and vice versa. Consistent with theory, we estimate negative propensities to save out of cash flow. We also find that income uncertainty affects saving more than do external finance constraints. Therefore, contrary to previous evidence, saving propensities reflect too many forces to be used to measure external finance constraints.     

Estimating the Cost of Capital Using Stock Prices and Near‐term Earnings Forecasts

Earnings‐based valuation models, although long used by finance practitioners, have become increasingly popular among finance academics as well. Among the most important reasons for academics' increased acceptance of earnings‐based valuation is the well‐documented claim that earnings over a short (three‐ to four‐year) forecast horizon tend to capture a large fraction—as much as 80%—of today's value, much more than is captured by near‐term forecasts of free cash flow, the measure long advocated by finance theorists as the basis for DCF valuation. But most important for the purposes of this article, the recognition that such a large percentage of the current values of many public companies is captured within a short forecast horizon has led to a large academic literature that uses earnings‐based valuation models together with current stock prices to “back out” estimates of the companies' implied expected rates of return and costs of equity capital. The effectiveness and precision of such reverse engineering depend on the reliability of the forecasts both within a finite forecast horizon and beyond. And although the models tested in academic work, which are based on large samples of forecasts and hard‐to‐verify assumptions about earnings beyond the forecast horizon, often do not appear to provide useful estimates, the author argues that such reverse engineering of the valuation models should become straightforward and workable once reliable forecasts of earnings are obtained—say, from the corporate (or investment) analysts who are familiar with the operations of the companies they work for (or cover).     

Infrastructure Finance and Industrial Takeoff in England

That financial matters did not constrain industrial takeoff in the UK is generally accepted in the historical literature; in contrast, contemporary empirical analyses have found evidence that financial development can be a causal determinant of economic growth. We look to reconcile these findings by concentrating on a particular aspect of industrializing UK where inefficiencies in finance could have had bite: the finance of physical infrastructures. We document the historical record and develop the importance of spatial disaggregation and spillovers in both technological and financial development. We develop a simple model that captures the nature of infrastructure finance within a theory of endogenous growth where financial costs are endogenous. We argue that the conception of the finance‐growth nexus as a largely static, aggregative phenomenon misses out a good deal of complexity and we relate that complexity to a number of implications for regulation of both financial systems and the emergence of infrastructures.     

Quote Competitiveness, 100‐share Quotes,and Decimalization

The finance literature documents a significant post‐decimalization decline in intermarket quote competitiveness. We show that this result is due primarily to the decline in 100‐share NBBO‐matching quotes posted by NASDAQ. After decimalization, such quotes decline by more than 90%. At that time, the intermarket trading system (ITS) regards 100‐share quotes as meaningless; these quotes are exempt from the trade‐through rule and are generally ignored by ITS participants. We therefore argue that the major decline in quote competitiveness observed by previous research is largely nominal, and that decimalization had a much lesser impact on quote competitiveness than previously believed.     

Big Data Opportunities for Accounting and Finance Practice and Research

We examine the research opportunities for the use of ‘big data’ in accounting and finance. The purpose of the study is to present a snapshot of big data academic research in information systems, accounting and finance, and to highlight areas for further research in accounting and finance. The research question addressed in this work is: What are the major themes in existing research in big data and where are the resulting gaps in the accounting and finance literature? An analysis is presented of 47 accounting, finance and information systems journals from 2007–2016. We identify and sample the relevant literature to derive a taxonomy of themes. These themes are presented as a conceptual matrix in which the themes from the taxonomy are used as concepts, and the matrix identifies where they appear, and where there are potential areas for further research. Prior research in big data in accounting, finance and information systems falls into six themes. The six under‐researched areas of big data in accounting and finance are risk and security, data visualisation and predictive analytics, data management and data quality. Increased research in these areas will lead to improvements in industry practices, and opportunities for cross‐disciplinary research.     

THE HISTORY OF FINANCE: AN EYEWITNESS ACCOUNT

In this account of the evolution of finance theory, the “father of modern finance” uses the series of Nobel Prizes awarded finance scholars in the 1990s as the organizing principle for a discus‐sion of the major developments of the past 50 years. Starting with Harry Markowitz's 1952 Journal of Finance paper on “Portfolio Selection,” which provided the mean‐variance frame‐work that underlies modern portfolio theory (and for which Markowitz re‐ceived the Nobel Prize in 1990), the paper moves on to consider the Capi‐tal Asset Pricing Model, efficient mar‐ket theory, and the M & M irrelevance propositions. In describing these ad‐vances, Miller's major emphasis falls on the “tension” between the two main streams in finance scholarship: (1) the Business School (or “micro normative”) approach, which focuses on investors ‘attempts to maximize returns and cor‐porate managers’ efforts to maximize shareholder value, while taking the prices of securities in the market as given; and (2) the Economics Depart‐ment (or “macro normative”) approach, which assumes a “world of micro optimizers” and deduces from that assumption how the market prices actually evolve. The tension between the two ap‐proaches is resolved, and the two streams converge, in the final episode of Miller's history–the breakthrough in option pricing accomplished by Fischer Black, Myron Scholes, and Rob‐ert Merton in the early 1970s (for which Merton and Scholes were awarded the Nobel Prize in 1998, “with the late Fischer Black everywhere ac‐knowledged as the third pivotal fig‐ure”). As Miller says, the Black‐Scholes option pricing model and its many successors “mean that, for the first time in its close to 50‐year history, the field of finance can be built, or…rebuilt, on the basis of ‘observable’ magnitudes.” That option values can be calculated (almost entirely) with observable vari‐ables has made possible the spectacu‐lar growth in financial engineering, a highly lucrative activity where the prac‐tice of finance has come closest to attaining the precision of a hard sci‐ence. Option pricing has also helped give rise to a relatively new field called “real options” that promises to revolu‐tionize corporate strategy and capital budgeting. But if the practical applications of option pricing are impressive, the op‐portunities for further extensions of the theory by the “macro normative” wing of the profession are “vast,” in‐cluding the prospect of viewing all securities as options. Thus, it comes as no surprise that when Miller asks in closing, “What would I specialize in if I were starting over and entering the field today?,” the answer is: “At the risk of sounding like the character in ‘The Graduate,’ I reduce my advice to a single word: options.”     

Pledgeability,Industry Liquidity,and Financing Cycles

Why do firms choose high debt when they anticipate high valuations, and underperform subsequently? We propose a theory of financing cycles where the importance of creditors’ control rights over cash flows (“pledgeability”) varies with industry liquidity. The market allows firms take on more debt when they anticipate higher future liquidity. However, both high anticipated liquidity and the resulting high debt limit their incentives to enhance pledgeability. This has prolonged adverse effects in a downturn. Because these effects are hard to contract upon, higher anticipated liquidity can also reduce a firm's current access to finance.     

Analyst Coverage and Financing Decisions

We provide evidence that analyst coverage affects security issuance. First, firms covered by fewer analysts are less likely to issue equity as opposed to debt. They issue equity less frequently, but when they do so, it is in larger amounts. Moreover, these firms depend more on favorable market conditions for their equity issuance decisions. Finally, debt ratios of less covered firms are more affected by Baker and Wurgler's (2002) “external finance‐weighted” average market‐to‐book ratio. These results are consistent with market timing behavior associated with information asymmetry, as well as behavior implied by dynamic adverse selection models of equity issuance.     

Land and Credit: A Study of the Political Economy of Banking in the United States in the Early 20th Century

We find that, in the early 20th century, counties in the United States where the agricultural elite had disproportionately large land holdings had significantly fewer banks per capita, even correcting for state‐level effects. Moreover, credit appears to have been costlier, and access to it more limited, in these counties. The evidence suggests that elites may restrict financial development in order to limit access to finance, and they may be able to do so even in countries with well‐developed political institutions.     

An Investigation of the Relationship between Use of International Accounting Standards and Source of Company Finance in Germany

This study examines the relationship between use of international accounting standards and companies’ source of finance. We investigate the proposition contained in Nobes’ (1998) model that postulates outsider companies (those with a higher level of public finance) in weak equity–outsider markets (capital markets where public equity finance is not the dominant source of finance) are more likely to change their type of accounting system from one focused on information for creditors and tax authorities to one that meets the needs of external financiers. We found strong support for Nobes’ model. Using 408 German listed companies at 1999, we observed that companies with more outsider finance (the proportion of shares held by outsiders and the presence of public debt) were more likely to use international standards (U.S. GAAP or IAS). The results indicate the importance of controlling for source of finance at the company rather than country level in cross‐country studies investigating the benefits of adoption of international standards.     

Australian evidence on student expectations and perceptions of introductory business finance

This study examines the differences in perceptions and expectations between students at the Caulfield and Peninsula campuses of Monash University with different entrance criteria and degree availability to determine whether two different introductory finance subjects should be offered rather than one. Results reported in this study suggest that students at the Caulfield campus are interested in studying a challenging introductory finance subject, whereas students at the Peninsula campus perceived that introductory finance is ‘difficult’. Capital structure and cost of capital topics are statistically significantly ranked higher by Caulfield students than Peninsula students. The results reported in this study revealed that two different introductory finance subjects would be more effective. The core subject at the finance major campus (Caulfield) follows a traditional structure with more emphasis on finance theory, whereas the new subject at the non‐finance campus (Peninsula) places greater emphasis on applications.     

Robust inference in single firm/single event analyses

Single firm/single event (SFSE) studies are relevant in corporate finance. Since inference on abnormal returns in this context necessarily relies on the time series variance of these abnormal returns, the implied problem of heteroscedasticity is obvious, although hard to solve. We analyze robust inference in an SFSE setting using Monte Carlo and resampling experiments. Estimation is biased when the calibration and event period occur in different volatility regimes. We develop a unique specification test for these structural breaks. The most robust inference is obtained by using intraday data and a multiplicative component GARCH estimator.     

Narratives in managers’ corporate finance decisions

This article uses the extended case method to explore senior executives’ corporate finance decisions. We quantified firm’s finance practices using a mail survey, and then – to resolve puzzles in managers’ decision processes – conducted face‐to‐face interviews with chief finance officers of large listed firms. The interviews identified six themes as consistent influences on finance decisions: pressures imposed by clienteles; constraints on resources; risk management; heuristics; real options; and sustainability. We conclude that managers are logical and rational in their decisions, but employ a wider range of criteria than assumed in conventional finance theories.     

Political risk,project finance,and the participation of development banks in syndicated lending

How should loan contracts for financing projects in countries with high political risk be designed? We argue that non-recourse project finance loans and the participation of development banks in the loan syndicate help mitigate political risk. We test these arguments by conducting a study with a sample of 4978 loans made to borrowers in 64 countries. Our results show that if political risk is higher, then project finance loans are more likely to be used, and development banks are more likely to participate in the syndicate. We also show that the terms of the loan contract depend not only on the political risk but also on the legal and institutional environment as well.     

The Credit Ratings Game

The collapse of AAA‐rated structured finance products in 2007 to 2008 has brought renewed attention to conflicts of interest in credit rating agencies (CRAs). We model competition among CRAs with three sources of conflicts: (1) CRAs conflict of understating risk to attract business, (2) issuers' ability to purchase only the most favorable ratings, and (3) the trusting nature of some investor clienteles. These conflicts create two distortions. First, competition can reduce efficiency, as it facilitates ratings shopping. Second, ratings are more likely to be inflated during booms and when investors are more trusting. We also discuss efficiency‐enhancing regulatory interventions.     

Should Derivatives Be Privileged in Bankruptcy?

Derivatives enjoy special status in bankruptcy: they are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and incentives to engage in derivative transactions. While derivatives are value‐enhancing risk management tools, seniority for derivatives can lead to inefficiencies: it transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross‐netting benefits to derivative counterparties that provide hedging services.     

The impact of credit scoring on consumer lending

We study the adoption of automated credit scoring at a large auto finance company and the changes it enabled in lending practices. Credit scoring appears to have increased profits by roughly a thousand dollars per loan. We identify two distinct benefits of risk classification: the ability to screen high‐risk borrowers and the ability to target more generous loans to lower‐risk borrowers. We show that these had effects of similar magnitude. We also document that credit scoring compressed profitability across dealerships, and provide evidence consistent with the view that credit scoring may have substituted for varying qualities of local information.     

Building a Bridge between Marketing and Finance

Corporate finance executives are often frustrated by spending proposals from their marketing colleagues but cannot seem to be able to quantify the putative benefits. Similarly, the marketing staff is frustrated by the finance team's inability to convert soft marketing metrics, such as “awareness” and “customer satisfaction” into financial forecasts. The challenge is that neither marketers nor finance executives have been able to articulate a single analytical framework which both explains how and why brands come to flourish or flounder and how brand growth contributes to the business's short and long term bottom line. Lacking an effective way to do this now, most managers default to using the hard data they do have, namely how marketing investment is likely to impact sales this quarter and next. This reinforces the widespread focus on quarterly EPS and reduces the perceived value of the marketing department to their ability to hit three month sales targets. This degraded view of marketing's contribution and the inability to link “soft” marketing metrics to longer term financial returns impedes building long‐term brand value. This article focuses on how advances in behavioral science and financial analytics offer an effective way to bridge this gap between marketing and finance. Building that bridge requires better measures of brand health and financial performance to allocate capital and marketing resources. Undoubtedly, brand building is both an art and a science. But, the finance people can develop an evidence‐based framework explaining how some of the “softer” investments such as brand building, contribute to the value of the firm.