TAX PROGRESSIVITY AND CORPORATE INCENTIVES TO HEDGE

If a company faces some form of tax progressivity—that is, its marginal tax rate increases over the firm's expected range of reported taxable income—corporate hedging can reduce the firm's expected tax liability by reducing the volatility of pre-tax income. In a study described in this article, the authors used simulation methods to investigate the extent to which tax progressivity arises from various provisions of the tax code, such as the AMT and tax carryforwards and carrybacks. Based on their analysis of over 80,000 COMPUSTAT firm-year observations, the authors find that, in about 50% of the cases, corporations face effective tax functions that exhibit progressivity. The other 50% of cases are about evenly divided between firms that are tax neutral and those facing tax schedules that are regressive (again, over the relevant range of expected reported income).
For those companies facing progressive tax functions, the authors estimate that the projected average tax savings from a 5% reduction in the volatility of taxable income is about 5.4% of the expected tax liabilities. However, the distribution of expected reductions is highly skewed, in extreme cases exceeding 40% of the total tax liability. Most of these extreme cases are small to medium-sized companies, since such firms are much more likely to meet the two conditions for achieving large tax benefits: (1) expected pretax income that is close to zero; and (2) sufficiently volatile income that the firm (in the absence of hedging) expects to report losses in some years. In sum, small to medium-sized companies experience the greatest tax benefits from hedging.     

TAX INCENTIVES AND HIGH RISK INVESTMENT

The objectives of this paper are to examine reasons for the Australian Government's decision to create a tax incentive for high risk (hi-tech) industries. Comparisons are made with similar policies in other countries, and policy issues related to the administration of the Australian scheme are discussed. The paper does not attempt to examine the broader issue of whether or not there is a requirement for such a scheme to encourage hi-tech industries.     

MANAGERIAL INCENTIVES AND CORPORATE DIVERSIFICATION STRATEGIES

Because the break-up of conglomerates typically produces substantial increases in shareholder wealth, many commentators have argued that the conglomerate form of organization is inefficient. This article reports the findings of a number of recent academic studies, including the authors' own, that examine the causes and consequences of corporate diversification. Although theoretical arguments suggest that corporate diversification can have benefits as well as costs, several studies have documented that diversified firms trade at a significant discount from their single-segment peers. Estimates of this discount range from 10–15% of firm value, and are larger for “unrelated” diversification than for “related” diversification. If corporate diversification has generally been a value-reducing managerial strategy, why do firms remain diversified? One possibility, which the authors label the “agency cost” hypothesis, is that top executives without substantial equity stakes may have incentives to maintain a diversification strategy even if doing so reduces shareholder wealth. But, as top managers' ownership stakes increase, they bear a greater fraction of the costs associated with value-reducing policies and are therefore less likely to take actions that reduce shareholder wealth. Also, to the extent that outside blockholders monitor managerial behavior, the agency cost hypothesis predicts that diversification will be less prevalent in firms with large outside blockholders. Consistent with this argument, the authors find that companies in which managers own a significant fraction of the firm's shares, and in which blockholders own a large fraction of shares, are significantly less likely to be diversified. If agency problems lead managers to maintain value-reducing diversification strategies, what is it that leads some of these same firms to refocus? The agency cost hypothesis predicts that managers will reduce diversification only if pressured to do so by internal or external mechanisms that reduce agency problems. Consistent with this argument, the authors find that decreases in diversification appear to be precipitated by market disciplinary forces such as block purchases, acquisition attempts, and management turnover.     

EX-DIVIDEND DAY PRICE CHANGES AND IMPLIED TAX RATES: AN EVALUATION

The ratio of price changes to dividends is sometimes used to assess personal tax rates and detect tax clientele for dividends. It is suggested here that the model is unable to detect possible tax effects, given the sample sizes available to most researchers.     

OPTIMUM CORPORATE LEVERAGE WITH RISKY DEBT: A DEMAND APPROACH

Traditional models of corporate interior optimum leverage rely on institutional schemes such as taxes, bankruptcy, and agency costs. Theories of leverage indifference in the presence of risky debt depend on various features of perfect and complete markets and on the assumption that all investors hold a uniform portfolio. In the model developed here, corporate interior optimum leverage is obtained as a result of a fundamental risk-return trade-off for investors who hold nonuniform portfolios of risky equity and debt claims in the absence of market mechanisms, forcing leverage indifference. The dynamic optimization solution accommodates bankruptcy costs and specialized institutional factors but does not rely on their presence.     

MODELLING AUSTRALIAN BANK BILL RATES: A KALMAN FILTER APPROACH

This paper examines the applicability of the Kalman Filter technique to forecast future spot interest rates, based upon the expectation hypothesis of the term structure of interest rates, in the Australian bank bill market. In this approach, regression estimates are based on the last period's estimate together with data from the current period. In contrast to constant parameter models, this allows effective use of information underlying the process driving the evolution of the parameters. For the period tested, forecasting accuracy of such a time-varying parameter model shows marked improvement over a constant parameter model.     

UNDERWRITING SPREADS AND REPUTATIONAL CAPITAL: AN ANALYSIS OF NEW CORPORATE SECURITIES

When entering a new security market, investment banks must establish their reputation. This is done through direct experience in the security market or through reputational capital established in existing security markets. I examine the effects of underwriters' market reputation in publicly underwritten offerings in forty-three financial innovations and find more significant entry barriers for less prestigious underwriters. An analysis of underwriting spreads reveals first-issue pricing advantages due to reputational capital. Unlike the more prestigious underwriters, the less prestigious underwriters reduce spreads upon first entry into each new security market to overcome their lack of market reputation.     

MEASURING THE MEANING OF FINANCIAL STATEMENT TERMINOLOGY: A PSYCHOLINGUISTICS APPROACH

Measuring the meaning of communication between and among producers (certified public accountants, academic accountants, and private accountants) and users (chartered financial analysts, commercial bank loan officers, and shareholders) of financial statements is the purpose of this study. Two psycholinguistic techniques, classification analysis and association analysis, were used in a field experiment to measure the intergroup and intragroup transference of denotative (objective) and connotative (subjective) meaning, respectively. The study concluded that we are somewhere in between the “worst” and the “best” on a communication continuum. The evidence indicated only one communication problem — a problem involving the transfer of connotative (subjective) meaning on an intergroup basis, that is, between producers and users.