Towards the formalization of ‘small is beautiful’: Societal effectiveness versus economic efficiency

Economic efficiency criteria are often based on considerations of concentration, standardization and centralization of activities which may undertake or omit entirely various internal and external diseconomies of by-products associated with any growth process. This paper re-examines the context in which the efficiency criterion is usually applied. The notion of effectiveness is analysed theoretically from two perspectives. Social costs are introduced initially in a static framework and then the inertia of large organizations is discussed in a dynamic perspective. The flexibility of the system in adjusting to rapid changes in technology is analysed from a structural approach based on smaller and more decentralized organizations.     

On relief value (deprival value) versus fair value measurement for contract liabilities: a comment and a response

Horton, Macve and Serafeim (2011) (HMS) argue for the use of relief value for the measurement of certain types of liabilities, and that the replacement liability (an entry price) is normally the appropriate measure of relief. I had previously argued elsewhere for an exit price (normally, the performance value, PV). In this paper, I first try to clarify the terminology used, and then I show why PV rather than RL is usually appropriate for the industries in HMS' example and for some others. My scope is more modest than that of HMS because I do not address revenue/profit issues, which I think should be dealt with separately.     

What Do FAS 157 “Fair Values” Really Measure: Value Or Risk?

FAS 157, the U.S. accounting standard that prescribes how fair values of assets and liabilities are to be measured when other U.S. GAAP standards require fair valuation, stipulates that fair values be measured as the exit values of assets and liabilities—the proceeds for assets hypothetically sold on the date of the financial report, and, correspondingly, the amount required to settle liabilities on the date of the financial report. This conceptual article argues that exit values do not reflect the value of the net assets of the firm to shareholders, which is best reflected by discounted cash flows to maturity. Moreover, exit values—biasing fair values downward when markets are illiquid—have a pernicious, systemic risk effect; specifically, they give rise to write‐downs that in turn cause contagion: prices of equities and other financial instruments of peers react negatively, leading to further write‐downs by those peers. This may have aggravated the recent financial crisis. However, while exit values are not proper measures of value to shareholders, they are useful measures of downside risk when prospects turn sour for a firm. Thus, both exit values and discounted cash flows should be presented in financial statements.     

Canonical Valuation of Mortality‐Linked Securities

A fundamental question in the study of mortality‐linked securities is how to place a value on them. This is still an open question, partly because there is a lack of liquidly traded longevity indexes or securities from which we can infer the market price of risk. This article develops a framework for pricing mortality‐linked securities on the basis of canonical valuation. This framework is largely nonparametric, helping us avoid parameter and model risk, which may be significant in other pricing methods. The framework is then applied to a mortality‐linked security, and the results are compared against those derived from other methods.     

What determines the exit decision for leveraged buyouts?

How and when to exit portfolio company investments are critical choices facing private equity funds. In this paper we analyze 1022 European private equity exits, using information on fund and portfolio company characteristics, and on conditions in capital markets. For over 43% of the exits, private equity funds sold to each other and we analyze why such secondary buyouts have gained in popularity relative to IPOs and sales to corporate acquirers. We find that the exit route depends on various portfolio company characteristics, and that conditions in the debt and equity markets have a strong influence on exit choice. The existing literature has tended to portray the IPO is the “preferred” exit route. However, our analysis suggests this is mistaken: private equity funds take advantage of ‘windows of opportunity’, and the exit route that maximizes value varies with market conditions.     

Financial density selection

We propose and study simple but flexible methods for density selection of skewed versions of the two most popular density classes in finance, the exponential power distribution and the t distribution. For the first type of method, which simply consists of selecting a density by means of an information criterion, the Schwarz criterion stands out since it performs well across density categories, and in particular when the DGP is normal. For the second type of method, general-to-specific density selection, the simulations suggest that it can improve the recovery rate in predictable ways by changing the significance level. This is useful because it enables us to increase (reduce) the recovery rate of non-normal densities by increasing (reducing) the significance level, if one wishes to do so. The third type of method is a generalisation of the second type, such that it can be applied across an arbitrary number of density classes, nested or non-nested. Finally, the methods are illustrated in an empirical application.     

Fiscal Multipliers under an Interest Rate Peg of Deterministic versus Stochastic Duration

This paper revisits the size of the fiscal multiplier. The experiment is a fiscal expansion under the assumption of a pegged nominal rate of interest. We demonstrate that a quantitatively important issue is the articulation of the exit from the policy experiment. If the monetary‐fiscal expansion is stochastic with a mean duration of T periods, the fiscal multiplier can be unboundedly large. However, if the monetary‐fiscal expansion is for a fixed T periods, the multiplier is much smaller. Our explanation rests on a Jensen's inequality type argument: the deterministic multiplier is convex in duration, and the stochastic multiplier is a weighted average of the deterministic multipliers. The quantitative difference in the two multipliers also arises in a model with capital, and in the baseline nonlinear model. However, the differences between the two are less pronounced in the nonlinear models. The errors from a linear approximation are much larger for the stochastic exit model then for the deterministic exit model.     

Restructuring and Firm Value: The Effects of Profitability and Restructuring Purpose

This study extends prior research on the information content of restructuring charges. We find that the relationship between restructuring activities and returns during the restructuring charge year is different for loss firms than for profit firms. Restructurings that are primarily intended to either eliminate personnel or exit a line of business are positively associated with returns of the loss firms, suggesting that investors view these activities as value-increasing. In contrast, common stock returns of profit firms exhibit a nonpositive association with restructuring charges. Overall, our results point to the role of the context and the content of the restructuring announcement in the market's assessment of the value relevance of restructuring charges reported in the financial statements.     

XVA analysis from the balance sheet

XVAs denote various counterparty risk related valuation adjustments that are applied to financial derivatives since the 2007–2009 crisis. We root a cost-of-capital XVA strategy in a balance sheet perspective which is key to identifying the economic meaning of the XVA terms. Our approach is first detailed in a static setup that is solved explicitly. It is then plugged into the dynamic and trade incremental context of a real derivative banking portfolio. The corresponding cost-of-capital XVA strategy ensures for bank shareholders a submartingale equity process corresponding to a target hurdle rate on their capital at risk, consistently between and throughout deals. Set on a forward/backward SDE formulation, this strategy can be solved efficiently using GPU computing combined with deep learning regression methods in a whole bank balance sheet context. A numerical case study emphasizes the workability and added value of the ensuing pathwise XVA computations.     

What drives the valuation premium in IPOs versus acquisitions? An empirical analysis

Using a hand-collected data set of private firm acquisitions and IPOs, this paper develops the first empirical analysis in the literature of the “IPO valuation premium puzzle,” which refers to a situation where many private firms choose to be acquired rather than to go public at higher valuations. We also test several new hypotheses regarding a private firm's choice between IPOs and acquisitions. Our analysis of private firm valuations in IPOs and acquisitions indicates that IPO valuation premia disappear for larger VC backed firms after controlling for various observable factors affecting a firm's propensity to choose IPOs over acquisitions. Further, after controlling for the long-run component of the expected payoff to firm insiders from an IPO exit, we find that the IPO valuation premium vanishes even for larger non-VC backed firms and shrinks substantially for smaller firms as well. Our Heckman-style treatment effects regression analysis demonstrates that the above results are robust to controlling for the selection of exit mechanism by firm insiders based on unobservables. Our findings on private firms' choice between IPOs and acquisitions can be summarized as follows. First, firms operating in industries characterized by the absence of a dominant market player (and therefore more viable against product market competition) are more likely to go public rather than to be acquired. Second, more capital intensive firms, those operating in industries characterized by greater private benefits of control, and those which are harder to value by IPO market investors are more likely to go public rather than to be acquired. Third, the likelihood of an IPO over an acquisition is greater for venture backed firms and those characterized by higher pre-exit sales growth.     

Exit as Governance: An Empirical Analysis

Recent theory posits a new governance channel available to blockholders: threat of exit. Threat of exit, as opposed to actual exit, is difficult to measure directly. However, a crucial property is that it is weaker when stock liquidity is lower and vice versa. We use natural experiments of financial crises and decimalization as exogenous shocks to stock liquidity. Firms with larger blockholdings experience greater declines (increases) in firm value during the crises (decimalization), particularly if the manager's wealth is sensitive to the stock price and thus to exit threats. Additional tests suggest exit threats are distinct from blockholder intervention.     

Modeling hedge fund lifetimes: A dependent competing risks framework with latent exit types

Due to the voluntary nature of hedge funds reporting to databases, hedge funds may stop reporting and exit a database not only because of failure, but also as a result of success and reaching the optimal size of assets under management. The existing hedge fund databases do not seem to provide reliable and unambiguous information on the reasons of hedge fund exits. In this paper, we consider that the causes of hedge fund exits are latent, and develop a competing risks model with two exit specific hazard functions, one for each cause of exit. We further allow both exit specific hazard functions to depend on unobserved heterogeneity terms that can be mutually dependent. In this way, we investigate the interdependence between the exit specific hazard functions, and explore their determinants. We show that even without observability on causes of exit, the two sets of coefficients, one for each cause of exit, can be estimated. We find an evidence of strong dependence between the unobserved heterogeneities. We also find that the estimated coefficients of the observed covariates are generally similar whether unobserved heterogeneities or the dependence between them is taken into account or not. However, the estimated exit specific hazard functions are significantly different, due to the standard negative duration dependence in the case of omitted heterogeneity.     

Revaluation of Fixed Assets in Accruals Accounting

The paper explores the topic of revaluation in accruals accounting under the assumption that an important purpose of financial statements is to report 011 management's financial performance. Having differentiated valuation and matching based approaches, the paper proceeds to indicate some reasons for revaluation in the latter by reference to the literature of management accounting and logical argument. It identifies exit value (net realisable value) as the most appropriate basis for valuation for the postulated purpose, but argues that revaluation should not occur annually but by reference to the expiration of ‘planning periods’ or to other specified events which may occur earlier. Therefore its arguments and proposals differ from those previously associated with advocates of exit value. The article concludes by discussing some of the practical issues arising from its suggestions.     

International comparison of industrial development in the European context — the problems

Conclusion The index of production enables us to analyse current developments in the countries considered in the cyclical context, the information on real value added that is available for these branches of industry not being sufficiently up to date. In 1999, the division of labour within industry and between industry and the services sector changed, both nationally and in the international context. There was a rise in the nominal and the real ratios of intermediate input. Our conclusion is that, at least in some branches, the structural changes between 1995 and 1999 were of greater importance in Germany than in the other countries. In view of such structural changes the index of production cannot adequately reflect the dynamic of these branches in an international comparison. Different developments in the real ratios of intermediate input and divergent real developments in value added that are evident in the statistics are partly the result of the different methods of price deflation used in the countries and branches considered. The real value added gives a distorted picture of the development in output in these branches in the individual countries. The development in the index of production probably overstates the dynamic of German industry compared with industry in the other countries considered for the period on which this article is based, while understating the trend in value added. It follows from this that the indicators designed to measure output in economic sectors are not enough to give a realistic picture of the trend in output in branches of industry for international comparison. More information, e.g. the trends in employment and investment, also needs to be taken into account.     

Utilitarianism and fairness in portfolio positioning

The paper introduces the theory of optimal positioning of financial products. It is illustrated in the context of long-term intertemporal portfolio allocation and can be applied for example to asset allocation funds. We embed this problem in location theory: the portfolio is optimized within the investors’risk aversion dimension. For the CRRA utility functions, we compute explicitly the distance functions. For the first (utilitarian criterion), the average utility of the investors is maximized. For the second one (fairness criterion), the choice of portfolio is optimized so that the average monetary loss due to the lack of customization is minimized. Given the distribution of investors’ risk aversion, we provide a solution method and an algorithm to optimally position standardized portfolio along one of these two criteria.     

Fair Value Accounting and Stewardship*

Current standards define fair value as the market price at which an asset could be sold or a liability could be settled in the normal course of business. Setting aside measurement issues, assessing the relevance of exit values has intensified in recent years as fair value becomes a pervasive component of accounting regulation. The current debate about accounting measurement is framed in terms of making a choice between fair value and historical cost. In this article I argue that this is not a correct framing of the issues; knowledge of fair value alone cannot help investors to evaluate stewardship, because they would not know how much resources the management had sacrificed to obtain that fair value. To properly evaluate stewardship, investors need both types of information, historical cost and fair value.Using this information, a rate‐of‐return‐like index of stewardship quality is proposed. This commentary concludes with a statement about three significant drawbacks of relying solely on fair value accounting.     

会计计量属性的探讨——市场价格、历史成本、现行成本与公允价值

资产和负债必须有相关的计量属性。本文讨论三项资产(包括负债)的三项属性,即市场价格、历史成本、现行成本和公允价值。市场价格是所有计量属性的基本概念,其他计量属性如历史成本、现行成本、现行销售(脱手)价格都来自市场价格。本文详细解释并说明历史成本和现行成本,重点是公允价值。在本文中,我们介绍并陈述了九个不同的公允价值定义,讨论了公允价值的层次,并反复说明公允价值是在现行交易中的估计价格,而不是在过去交易中形成的实际价格。     

Regime switching based portfolio selection for pension funds

This paper shows how a mean variance criterion can be applied to a multi period setting in order to obtain efficient portfolios in an asset and liability context. The optimization model allows for rebalancing activities, transaction costs, stochastic volatilities for both assets and liabilities. Furthermore, a general framework for the projection of pension fund liabilities as well as for the generation of asset returns is given. In a further step the dynamics of the liability maturity structure is modeled as customized index, whose volatility and correlation with asset returns become integral components of the applied regime switching approach. The numerical results illustrate the diversification of the assets and its risk return pattern in dependency of the liability dynamics.     

Poverty,Preference or Pensioners? Measuring Material Deprivation in the UK*

Indicators of material deprivation are typically based on a two-part question, asking, first, whether respondents possess a series of deprivation items and, second – if they do not – whether this is because of a lack of resources or is by choice. This second subquestion, or ‘enforced lack’ criterion, is ubiquitous but its efficacy has been questioned by a number of authors. In an important critique published in Fiscal Studies, McKay (2004) claimed that older people were more likely than younger respondents to report that they did not want the items they lacked, despite their lower incomes, and also that the enforced lack criterion introduced a subjectivity which, in effect, required respondents to feel poor in order to be classified as such. This critique has potentially profound implications for poverty measurement. In this paper, we seek to address the question of whether, if we are to employ indicators of material deprivation for poverty measurement, we should include the enforced lack criterion or not. In seeking to answer this question, we draw on data from the British Household Panel Survey (BHPS) and present tests of reliability and validity on indices of material deprivation, with and without the enforced lack criterion. Using odds ratio and analysis of variance methods, we find that the inclusion of the enforced lack criterion provides a measure of material deprivation which is both more reliable, and more valid based on a subjective measure of deprivation as well as on a majority of more objective forms of deprivation. Amongst the remaining minority (ill health for both methods and income quintile for the analysis of variance method), the divergent results can be explained, at least in part, by the older age profile of respondents in poor health and on low incomes. Thus, while there are legitimate concerns about the performance of such deprivation indicators amongst certain subgroups – in particular, amongst older people – on aggregate the enforced lack criterion helps to distinguish between poverty and preference.     

Board Members and Company Value

This essay surveys research about the value of individual members of boards of directors. When directors join or exit corporate boards, company stock prices respond, often in magnitudes of 1% of firm value or more. Related research shows that when a significant event impacts the stock price of one company, the effects are transmitted to other companies that share board members in common with the primary company. Share price reactions are sensitive to variables such as a director’s occupation, independence, and professional qualifications. Together, this evidence suggests that a well-functioning market for directors might already exist, making direct regulation unnecessary and possibly counter-productive.