THE MARKET REACTION TO STRAIGHT DEBT ISSUES: THE EFFECTS OF FREE CASH FLOW

In this paper we measure the market reaction to 937 straight debt issues between 1983 and 1993. We find a negative and significant market reaction to a straight debt announcement. In addition, we find that the market reaction to a straight debt issue is directly related to the issuing firm's level of existing cash and inversely related to the issuing firm's investment opportunities.     

LEVERAGING THE UNDERINVESTMENT PROBLEM: HOW HIGH DEBT AND MANAGEMENT SHAREHOLDINGS SOLVE THE AGENCY COSTS OF FREE CASH FLOW

It is argued that leveraged buyouts (LBOs) provide managers with a powerful incentive to release excess cash rather than invest in negative net present value projects. This incentive is attributed to the large debt obligations associated with “junk” bond financing and to an increase in the shareholdings of top management. In this paper I explore the conditions under which leverage and management shareholdings complement one another in resolving the agency costs of free cash flow and would therefore optimally be used “together” as in an LBO. Complementarity is shown to obtain under plausible conditions, essentially because increased leverage reduces equityholders' share of investment returns. Increased management shareholdings then leverage this underinvestment effect. My analysis also helps explain why top managers who participate in an LBO receive a highly leveraged equity claim rather than a share of the “strip” that is generally provided to outside investors.     

CASH FLOW ACCOUNTING AND THE ALLOCATION PROBLEM

Cash flow accounting (CFA) proposals typically have included firm statements that CFA data are allocation-free. This is not entirely true if the term allocation is interpreted in a wide sense. However, it can be argued that most allocations can be avoided in CFA systems, and this paper is an attempt to present this argument. In particular, it aims to strengthen the case for CFA in practice.     

THE ACCURACY OF CASH FLOW ESTIMATION PROCEDURES

Prior research uses mechanical procedures to estimate cash flow data. This study examines the accuracy of these procedures by measuring errors between estimated cash flows and reported cash flows. The results indicate that mechanical rules provide poor estimates for reported cash flows. We also show that the errors between cash flow estimates and reported cash flows can be reduced by adjustments made from footnote disclosures. However, large errors remain, even after adjustments are made from footnote disclosures. These remaining errors are correlated with firm specific characteristics such as sales (firm size), extraordinary items, foreign currency gains and losses, and changes in inventory.     

THE RELATIONSHIP BETWEEN DIVIDEND CHANGES AND CASH FLOW: AN EMPIRICAL ANALYSIS

It is often assumed that cash flow affects dividend payout. This study provides evidence on the incremental information content of cash flow numbers over Profits and Previous Year's Dividends (Lintner's model) in explaining changes in cash dividends. It further examines whether different measures of cash flow differ in information content for dividend-increasing and dividend-decreasing firms. Lintner's model of dividend changes is robust across firms with either dividend increases or decreases. The null hypotheses, that no definition of cash flow adds to the model, could not be rejected for any of the definitions.     

CORPORATE GOVERNANCE IN AN EMERGING MARKET: THE CASE OF ISRAEL

Despite significant capital-market reforms in the mid-1980s, the Israeli government and banks continue to play an unusually dominant role in Israeli financial markets. Israeli banks operate as merchant banks and, through pyramid structures of ownership, control large segments of manufacturing, construction, insurance, and services. In addition, the banks dominate all facets of the capital market, including underwriting, brokerage, investment advice, and the management of mutual and provident funds.
Because of this dominance by the banks, several important mechanisms of corporate governance are missing. There is no effective market for corporate control; institutional investors have little incentive to monitor corporate managers; and those managers in turn have little incentive to improve firm performance and increase shareholder value.
To be sure, there has been an impressive wave of IPOs on the Tel Aviv Stock Exchange (TASE) in the 1990s. But those firms' stocks have substantially underperformed the market since going public, and many higher-quality Israeli firms have chosen in recent years to list their securities on the NASDAQ and not at home. The main reason the most promising Israeli firms go public in the U.S. is because that is where U.S. and other foreign investors want to buy them; such investors want the assurances that come with the U.S. corporate governance system.     

A TEST OF THE TWO-TIER CORPORATE GOVERNANCE STRUCTURE: THE CASE OF JAPANESE KEIRETSU

We examine the effect of corporate governance structure on the relation between ownership structure and financial leverage among Japanese firms. Under normal conditions, we find no significant relation between ownership variables and financial leverage. When firms signal financial difficulties, however, keiretsu financial institution equity owners intervene to moderate the use of debt. This evidence reveals the existence of a keiretsu two-tier corporate governance system. In the first stage, the unique corporate cross-shareholding allows mutual monitoring under normal circumstances. In the second stage, when firms get into financial trouble, keiretsu financial institutions assume control by reducing debt levels. The results highlight differences between keiretsu and independent corporate governance structures.     

THE IMPACT OF THE QUALITY OF EARNINGS ON THE VALUATION RELEVANCE OF CASH FLOW DISCLOSURES

This study investigates whether the ‘quality of earnings’, defined as the relationship between profitability and cash generating ability, is a conditioning factor with regard to the valuation relevance of cash flow disclosures. The study is performed on a sample of 197 British firms employing data over a 23-year period. The results of the study support the contention that the valuation relevance of cash flow disclosures is conditional upon the ‘quality of earnings’, as previously defined. Specifically, the decomposition of unexpected earnings into its cash flow and accruals components provides incremental information content to earnings when the firm-specific time-series correlation between earnings and cash flows is low. Furthermore, the cash flow ‘surprise’ is valued more than the accruals ‘surprise’ when the firm-specific time-series correlation between earnings and cash flows is low.     

CASH FLOW REPORTING AND DISTRIBUTIONAL ALLOCATIONS: A NOTE

This Note clarifies certain problems associated with the construction and interpretation of cash flow statements.     

RETURN OF CAPITAL: CASH FLOW,WEALTH TRANSFER AND INFORMATION SIGNALLING EFFECTS

This paper examines the price effects of an announcement to distribute cash to shareholders via the return of capital procedure currently applying under Australian company law. The impact of such announcements on the market value of ordinary shares is analysed in terms of three hypothesised effects: the cash flow effect, the wealth transfer effect and the information signalling effect. Using data from 17 companies which announced a return of capital between 1970–1978, and applying the “comparison period” methodology, significant positive returns were observed at the time of the announcement of a return of capital. Possible explanations for this result are considered.