Net Present Value-Consistent Investment Criteria Based on Accruals: A Generalisation of the Residual Income‐Identity

Abstract:   In recent years, many firms have favoured residual income for value based management. One main argument for this measure is its identity with the net present value rule and that this compatibility with the net present value rule holds true for all possible depreciation schedules selected. In this article, we analyse whether there are other, undiscussed, accrual accounting numbers that enable net present value‐consistent investment decisions for all possible depreciation schedules. Our analysis provides an if‐and‐only‐if characterisation of the entire class of net present value‐consistent investment criteria, based on accounting information. This provides new insights into the residual income concept, hurdle rates, opening and closing error conditions achieved by applying more common performance measure structures, and allocation rules. Moreover, our analysis shows the limits of constructing such investment criteria.     

Investment and Abandonment Decisions with Uncertain Price and Cost

We analyze firms' investment and abandonment decisions when both output price and investment cost change stochastically. The model allows for and makes endogenous the abandonment decision, thereby incorporating irreversibility. We show that the investment trigger may be much higher than the standard net present value rule suggests even when a substantial portion of the investment cost may be recovered. Further, we argue that the correlation between output price and investment costs significantly affects the effect of irreversibility on investment behavior. Empirical implications are discussed with extensive numerical illustrations, along with an application to the banking industry.     

Optimal Sequential Investment When Capital is Not Readily Reversible

When investment opportunities arrive one at a time and are reviewed sequentially, a corporation's optimal policy differs from a standard net present value rule if the corporation exercises control over an industry state variable and control is costly. The first condition presupposes a degree of market power for the firm; the second occurs if corporate investment decisions are imperfectly reversible. To address the problem of optimal investment in this context, a firm's investment decisions are modeled as a Markov reward process. The causes of economic irreversibility are discussed and general propositions concerning the optimal investment policy are derived. These propositions are then applied to the optimization of an exploration program by an oligopolistic firm (a price leader). Under particular demand and distributional assumptions, solutions for the optimal decision rule and the value of the exploration program are obtained and their properties examined.     

The non-neutrality of debt in investment timing: a new NPV rule

Summary Limited liability debt financing of irreversible investments can affect investment timing through an entrepreneur’s option value, even after compensating a lender for expected default losses. This non-neutrality of debt arises from an entrepreneur’s unique investment opportunity, and it is shown in a standard model of irreversible investment that includes the equilibrium effect of a competitive lending sector. The analysis is partial, in that it takes as exogenously given an entrepreneur’s use of debt. Intuitively, limited liability lowers downside risk for the entrepreneur by truncating the lower tail of risks, and lowers the investment threshold. Compensating the lender for expected default losses reduces project profitability to the entrepreneur, and increases the investment threshold. The net effect is negative, because lower downside risk has an additional impact on the option value of delaying investment. The standard NPV rule in real options theory implicitly assumes debt to be neutral. With non-neutrality of debt, an investment threshold is higher than investment cost, but lower than the standard NPV rule. Comparisons with other standard investment thresholds show similar relationships.     

Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms

Under the standard real options approach to investment underuncertainty, agents formulate optimal exercise strategies inisolation and ignore competitive interactions. However, in manyreal-world asset markets, exercise strategies cannot be determinedseparately, but must be formed as part of a strategic equilibrium.This article provides a tractable approach for deriving equilibriuminvestment strategies in a continuous-time Cournot–Nashframework. The impact of competition on exercise strategiesis dramatic. For example, while standard real options modelsemphasize that a valuable "option to wait" leads firms to investonly at large positive net present values, the impact of competitiondrastically erodes the value of the option to wait and leadsto investment at very near the zero net present value threshold.     

The odd notion of “reversible investment”

Irreversible investment and the attendant concept of real-option value have been well discussed. Complete reversibility has been frequently invoked but less studied, especially for the case of lumpy investment typically considered in capital budgeting. We examine a simple lumpy investment problem for the full range, from complete irreversibility to completely reversibility, with a focus on the latter. The optimal stopping rules under complete reversibility are to invest when the project generates enough net cash flow to cover Jorgenson’s opportunity cost of investment and to disinvest when it does not. Given the static nature of these rules, net present value as a timing criterion under reversibility is not pertinent. Investments that are partially reversible have much in common with completely irreversible investments but nothing in common with completely reversible investments. The case of reversible investment provides a foil for understanding that the distinguishing feature of investment as treated in corporate finance is that it entails at least some irreversibility.     

Innovation killers: how financial tools destroy your capacity to do new things

Most companies aren't half as innovative as their senior executives want them to be (or as their marketing claims suggest they are). What's stifling innovation? There are plenty of usual suspects, but the authors finger three financial tools as key accomplices. Discounted cash flow and net present value, as commonly used, underestimate the real returns and benefits of proceeding with an investment. Most executives compare the cash flows from innovation against the default scenario of doing nothing, assuming--incorrectly--that the present health of the company will persist indefinitely if the investment is not made. In most situations, however, competitors' sustaining and disruptive investments over time result in deterioration of financial performance. Fixed- and sunk-cost conventional wisdom confers an unfair advantage on challengers and shackles incumbent firms that attempt to respond to an attack. Executives in established companies, bemoaning the expense of building new brands and developing new sales and distribution channels, seek instead to leverage their existing brands and structures. Entrants, in contrast, simply create new ones. The problem for the incumbent isn't that the challenger can spend more; it's that the challenger is spared the dilemma of having to choose between full-cost and marginal-cost options. The emphasis on short-term earnings per share as the primary driver of share price, and hence shareholder value creation, acts to restrict investments in innovative long-term growth opportunities. These are not bad tools and concepts in and of themselves, but the way they are used to evaluate investments creates a systematic bias against successful innovation. The authors recommend alternative methods that can help managers innovate with a much more astute eye for future value.     

Cash Flow Immediacy and the Value of Investment Timing

In a model with stochastic interest rates, irreversible investment, and two investment dates, the value of investment delay has two components: the expected gain from committing now to investment at a future date and the potential gain from the ability to reverse this commitment. Holding net present value constant, we show that the values of both these components are increasing in the proportion of project cash flows that accrue in the more distant future. Our results emphasize the importance of the interaction between cash flow immediacy and interest rate uncertainty for the optimal investment policy.     

Recognition versus Disclosure of Stock Option Compensation: An Analysis of Judgements and Decisions of Nonprofessional Investors*/CONSTATER OU PRÉSENTER PAR VOIE DE NOTE LA RÉMUNÉRATION SOUS FORME D'OPTIONS D'ACHAT D'ACTIONS: UNE ANALYSE DES JUGEMENTS ET DES DÉCISIONS DES INVESTISSEURS NON PROFESSIONNELS

Given the importance of stock options in the aggregate compensation of chief executive officers and other firm employees in the 1990s and early 2000s, the International Accounting Standards Board issued an International Financial Reporting Standard on stock‐based payments on February 19, 2004, requiring that all share‐based payment transactions be recognized at fair value in entities' financial statements. The Canadian Institute of Chartered Accountants' Accounting Standards Board had already agreed to this principle and amended section 3870 of the CICA Handbook (stock‐based compensation) for financial periods beginning on or after January 1, 2004, making Canada the first major jurisdiction to require all public companies to expense employee stock‐based compensation awards. The revised section eliminated the possibility of disclosing pro forma net income and earnings per share only by way of a note. This research, conducted as a between‐subjects experiment with executive MBA students as nonprofessional investors, examines whether changes in the way stock option compensation is reported (recognition as an expense in the income statement or note disclosure of pro forma net income and earnings per share) affect financial statement users' judgements and investment decisions. Our results indicate that, consistent with the functional fixation hypothesis, the reporting method does indeed significantly influence subjects' judgement of the expected stock price direction, but has no material influence on their investment decisions.     

The irrelevance of the MM dividend irrelevance theorem

Contrary to Miller and Modigliani [1961. Dividend policy, growth, and the valuation of shares. Journal of Business 34, 411–433], payout policy is not irrelevant and investment policy is not the sole determinant of value, even in frictionless markets. MM ask “Do companies with generous distribution policies consistently sell at a premium above those with niggardly payouts?” But MM's analysis does not address this question because the joint effect of their assumptions is to mandate 100% free cash flow payout in every period, thereby rendering “niggardly payouts” infeasible and forcing distributions to a global optimum. Irrelevance obtains, but in an economically vacuous sense because the firm's opportunity set is artificially constrained to payout policies that fully distribute free cash flow. When MM's assumptions are relaxed to allow retention, payout policy matters in exactly the same sense that investment policy does. Moreover (i) the standard Fisherian model is empirically refutable, predicting that firms will make large payouts in present value terms, (ii) only when payout policy is optimized will the present value of distributions equal the PV of project cash flows, (iii) the NPV rule for investments is not sufficient to ensure value maximization, rather an analogous rule for payout policy is also necessary, and (iv) Black's [1976. The dividend puzzle. Journal of Portfolio Management 2, 5–8] “dividend puzzle” is a non-puzzle because it is rooted in the mistaken idea that MM's irrelevance theorem applies to payout/retention decisions, which it does not.     

Information content and the contractual nature of hedging derivative incomes

In a sample of 87 banks representing 631 bank-years for the period 1996–2003, we examine whether information content of hedging derivative incomes is predicated on the contractual nature of the derivative. Of particular interest are the different abnormal trading volume reactions to incomes arising from executory contracts (i.e., cash flow and net investment hedges) and incomes arising from nonexecutory contracts (i.e., fair value hedges). We find a positive and significant relationship between two alternative measures of abnormal trading volume and incomes arising from cash flow and net investment hedges. The results are robust in an equity valuation framework. Our findings suggest that derivative incomes are informative, notably those incomes that are related to executory contracts. An implication for standard setters is that the complex rules for disaggregating incomes on hedging derivatives provide valuable information to the market.     

BALANCE SHEET ITEMS AS THE PRESENT VALUE OF FUTURE CASH FLOWS

This paper develops balance sheets assuming that assets are future service potentials, or future cash flows. All balance sheet items are the present (discounted) values of future cash flows. All future flows, whether receipts or payments, including transactions with shareholders, are accounted for on the balance sheet. Balance sheets are constructed on the basis of (1) full knowledge of the future, and (2) knowledge only of past flows, assuming that investment projects have zero net present value. Capital gains (losses) are recorded when events demonstrate that projects have positive (negative) net present value.     

英美资产管理业谨慎人原则及其发展

谨慎人原则是英美资产管理业的一项重要法律规则,该原则在不同发展阶段具有不同要求。谨慎人原则的最新变化是其不再对投资范围做过多的限制,而且还允许投资管理人将投资管理的权利再委托给他人;这些变化适应了现代投资市场和投资理论的发展,另一方面,为对投资管理人进行合理制约,谨慎人原则开始越来越强调投资管理的程序要符合谨慎的要求。我国资产管理业也需要加强对引入谨慎人原则的相关研究。     

Payback without apology

When interest rates are uncertain, the net‐present‐value threshold required to justify an irreversible investment is increasing in the length of a project's payback period. Therefore, slow‐payback projects should face a higher hurdle than fast‐payback projects, just as investment folklore suggests. This result suggests that the widely disparaged use of payback for capital budgeting purposes can be an intuitive response to correctly perceived costs and benefits.     

Comment on: “When does a central bank’s balance sheet require fiscal support?” by Marco Del Negro and Christopher A. Sims

A central bank is insolvent if its plans imply a Ponzi scheme on reserves so the price level becomes infinity. If the central bank enjoys fiscal support, in the form of a dividend rule that pays out net income every period, including when it is negative, it can never become insolvent independently of the fiscal authority. Otherwise, this note distinguishes between intertemporal insolvency, rule insolvency, and period insolvency. While period and rule solvency depend on analyzing dividend rules and sources of risk to net income, evaluating intertemporal solvency requires overcoming the difficult challenge of measuring the present value of seignorage.     

Pricing of national index funds

This article investigates the pricing behavior of national index funds (NIFs). Under barriers to capital flows in an otherwise perfect capital market, the familiar result of zero premium/discount obtains. The more realistic assumption of imperfect cross-border arbitrage suggests that in a two country setting the NIFs will sell at a premium. In a multicountry framework, the investment barriers will result in NIFs generally trading at a premium, although theoretically one cannot rule out a discount from net asset value (NAV). A simple test supports the proposition that under investment barriers, NIFs should trade at a premium to NAV after controlling for the average domestic closed-end fund discount.     

农村义务教育财政支出结构实证分析

本文从农村义务教育财政体制投资支出结构现状出发,采取定性与定量的方法对农村义务教育财政体制投资支出结构变化趋势进行了实证分析,对我国农村义务教育投资支出结构特征进行了研究,以达到合理分配投资支出结构,促进农村义务教育的快速协调发展.     

Pension Regulation,Firm Borrowing,and Investment Risk

This article builds a new model of capital structure and nonpension investment decisions to show that regulatory and investment incentives created by accrued pension obligations exacerbate traditional agency problems between stockholders and bondholders. The article identifies conditions under which firms with accrued pension liabilities have an incentive to choose an overly risky capital structure, invest in risky projects with negative net present value, and/or under-fund their pension accounts.     

上市公司投资价值分析

本文通过对中国证券市场发展过程中,投资理念逐步转变为价值投资,随着中国证券市场的逐步成熟和法律监管体系的进一步完善,越来越关注企业的内在价值以赚取分红送股。本文分析了国内外上市公司投资价值的背景和重要性,从宏观背景、产业、市场和区域因素和公司情况等方面对上市公司投资价值分析的方法进行了阐述。并重点对公司情况的基本面、财务、投资收益水平、偿债能力和获利及发展水平进行了具体的投资价值的分析,以及各指标公式的使用方法。旨在帮助投资者理性分析选择,挖掘上市公司的内在价值,并能获得较理想的收益。     

Value‐Added Per Share (VAPS): A Value‐Relevant Corporate Performance Metric

The authors introduce Value Added Per Share (VAPS) as a value‐relevant metric that is intended to complement earnings per share (EPS) in helping corporate managers and analysts understand and overcome the limitations of GAAP‐based reporting. VAPS discounts a firm's past and projected cash flows at its “cost of capital,” allowing companies to avoid the subjective accounting accrual process and other practices that often make EPS misleading. A company's VAPS is calculated in three main steps: (1) estimate the change in the capitalized value of after‐tax operating cash flow by taking the net change (plus or minus) of the firm's operating cash flow after taxes and dividing that number by the firm's cost of capital; (2) subtract total investment expenditures; and (3) divide by the number of shares outstanding. By capitalizing the change in after‐tax operating cash flow, one finds the net change in a firm's current operations value. By subtracting investment expenditures from that change in current operations value, the analyst gets a clearer picture of the benefit to shareholders net of the funds used to create that benefit. Consistent with basic theory, VAPS is positive when a company earns a return at least equal to its cost of capital and negative otherwise. Because of their fundamental differences, EPS and VAPS are likely to send different signals, and VAPS is expected to provide greater insight into stock price changes. The authors provide the findings of statistical tests showing the superior explanatory power of VAPS and recommend that companies publish statements of VAPS along with standard GAAP results, especially since the former can be readily calculated using the available income statement, balance sheet, and cash flow statement data.