THE MARGINAL-EFFICIENCY-OF-CAPITAL FUNCTION OF THE FIRM

In this paper, the author points out that over a decade ago E. Norman Bailey identified the marginal-efficiency-of-capital (MEC) function as erroneous and argued that revisions in capital budgeting theory and teaching were necessary. The author develops more fully the arguments against the function and offers the theoretically correct MEC function. The development of the correct MEC function is a straightforward application of basic price theory; however, this application requires that the capital of the firm be viewed as a collection of complementary resources, in addition to its role as an income-producing investment.     

AN INVESTIGATION INTO THE ROLE OF THE MARKET PORTFOLIO IN THE ARBITRAGE PRICING THEORY

This paper investigates the role of the market portfolio in the arbitrage pricing theory (APT). We show that if the multifactor return-generating process put forth in the APT is valid, then unexpected deviations in the return on the market portfolio must be completely explained by unexpected deviations in the underlying return-generating factors. As well, market betas are developed as a combination of return-generating factor sensitivity coefficients. These results lead us to conclude that an empirically significant “market factor’ is evidence of omitted return-generating factors, rather than evidence that the market is a factor. Finally, results obtained when market betas are regressed against factor sensitivity coefficients are consistent with these insights. The results suggest that there are at least three return-generating factors. This evidence does not rely on ex post pricing of estimated factors.     

THE NPM AGENDA: BACK TO THE FUTURE

The New Public Management agenda for change has been extremely influential. This paper considers future developments in NPM. In this evaluation of the future of NPM it is argued that the complexity of NPM – in concept and in practice – requires a multi‐dimensional consideration of what NPM is and what it will become. In this paper, NPM is explained around three key dimensions: (1) management processes; (2) mechanisms of change, and (3) constraints. Within these three dimensions, nine key elements of NPM implementation are discussed. This paper concludes that the pressures for NPM will not abate. However, its evolution will continue to be severely contested.     

THE REASONABLE EXPECTATIONS DOCTRINE: UNDERSTANDING THE LAW AND THE LORE BEHIND UPHOLDING THE REASONABLE EXPECTATIONS OF INSURANCE POLICYHOLDERS

Abstract: The authors examine the increasing recognition by the courts that an insurance policy is a consumer product, not merely a contract. This evolution has been the result of an increasing focus on the reasonable expectations doctrine. A review of the legal environment involving reasonable expectations and insurance coverage is presented.     

ON IMPROVING THE PERFORMANCE OF THE MARKET MODEL

Data on 4,087 securities from 1988 to 1990 are used to test the relation between market model R² and trading volume. Eliminating high-volume observations increases R² by about 10 percent, confirming results previously reported. This study indicates that this improvement is possible by eliminating a small number of observations. It also indicates that this relation between R² and volume is unrelated to firm size.     

THE EVOLUTION OF THE DISTRICT AUDIT

This paper examines the origins and development of the local authority audit from medieval times to 1933, and briefly reviews later developments. It gives particular attention to the role of the district audit which, as an independent mechanism operating within a centrally established administrative framework, gradually accumulated responsibility for monitoring most aspects of local authority expenditure, which grew from relatively modest amounts to about £5m by the beginning of the nineteenth century and £535m in 1933, which is roughly equivalent to £19.5b in 1990 prices. The paper shows that the government's present objective of greater central control has been a consistent theme over time.     

THE EFFICIENCY OF THE INTERNATIONAL MONEY MARKETS: A REPLY

In their original article, McInish and Puglisi (1982) examine the weak form efficiency of nineteen international money market instruments using a runs test. Taylor asserts that on theoretical grounds other tests would have been better. McInish and Puglisi argue that their tests were satisfactory and that until empirical evidence is offered the economic significance of Taylor's claims is uncertain (at best).     

EVALUATING THE FINANCE JOURNALS: THE DEPARTMENT CHAIRPERSON'S PERSPECTIVE

Finance department chairpersons report that the role of published research is more important than ever in influencing appointment and promotion decisions of finance professors. This study and one conducted 15 years ago focus on the pivotal role of finance chairpersons in the evaluation of their faculties' journal publications. These studies show that the major factor influencing the finance chairpersons' evaluations of publications is the journal in which an article is published. Journals of high merit are perceived to have low acceptance rates and vice versa. These estimates of perceived acceptance rates are not correlated with actual acceptance rates. Because perceived acceptance rates play a key role in evaluating faculty publications, there is a need for finance chairpersons to know the relative difficulties of publishing in leading finance and related journals.     

THE CAPITAL STRUCTURE PUZZLE: ANOTHER LOOK AT THE EVIDENCE

Since the formulation of the M & M irrelevance propositions 40 years ago, financial economists have been debating whether there is such a thing as optimal capital structure—a proportion of debt to equity that maximizes current firm value. Some finance scholars have followed M & M by arguing that both capital structure and dividend policy are largely “irrelevant” in the sense that they have no significant, predictable effects on corporate market values. Another school of thought holds that corporate financing choices reflect an attempt by corporate managers to balance the tax shields and disciplinary benefits of greater debt against the increased probability and costs of financial distress. Yet another theory says that companies do not have capital structure targets, but instead follow a financial pecking order in which retained earnings are preferred to outside financing, and debt is preferred to equity when outside funding is required. In reviewing the evidence that has accumulated since M & M, the authors argue that taxes, bankruptcy (and other “contracting”) costs, and information costs (the main factor in the pecking order theory) all appear to play an important role in corporate financing decisions. While much if not most of the evidence is consistent with the argument that companies set target leverage ratios, there is also considerable support for the pecking order theory's contention that firms are willing to deviate widely from their targets for long periods of time. According to the authors, the key to reconciling the different theories—and thus to solving the capital structure puzzle—lies in achieving a better understanding of the relation between corporate financing stocks (leverage ratios) and flows (specific choices between debt and equity). Even if companies have target leverage ratios, there will be an optimal deviation from those targets—one that will depend on the transactions and information costs associated with adjusting back to the target relative to the costs of deviating from the target. As the authors argue in closing, a complete theory of capital structure must take account of these adjustment costs and how they affect expected deviations from the target.     

THE EFFECTS OF THE ANNOUNCEMENTS OF DIVIDEND INCREASES ON STOCK RETURN VOLATILITY: THE EVIDENCE FROM THE OPTIONS MARKET

This paper examines the impact of the announcements of dividend increases on the volatility of underlying stock returns implied by option prices, and analyses whether the impact is related to the label associated with the dividend increase. The results suggest that the announcements of labelled dividend increases are accompanied by a decrease in implied volatility, while the announcements of unlabelled increases in dividends are associated with no change in implied volatility. These results are consistent with the hypothesis that signal implicit in the announcements of dividend increases provides noisy information about the firm's volatility.     

THE EXPECTATIONS HYPOTHESIS OF THE TERM STRUCTURE IN EUROCURRENCY MARKETS

This paper uses daily eurocurrency deposit rates for six currencies to extend previous research on the expectations hypothesis of the term structure. The reported results confirm earlier findings that the behavior of long term interest rates is perverse. For example, it is shown that in the case of five-year eurocurrency deposits denominated in US dollars, German marks and Swiss francs, the coefficient relating the excess holding period return to the yield spread between long and short term securities exceeds one, implying that long term rates tend to move in a direction opposite to the prediction of the expectations hypothesis. This study also employs a variety of techniques to examine the temporal stability of the coefficient in both the long and short maturity regressions used in testing the expectations hypothesis. While we do find instability, the nature of the parameter variation is markedly different from that found in foreign exchange markets when similar tests are employed.     

THE PRICING OF FUTURES CONTRACTS AND THE ARBITRAGE PRICING THEORY

When interest rates are stochastic, the cash flows of futures and forward contracts differ because of the marking-to-market requirement of futures contracts. The price effect of this difference is examined here by applying the risk and return model of the arbitrage pricing theory. The resulting futures pricing equation is preference free, and is obtainable using other no-arbitrage approaches. The pricing equation suggests that the price difference is due to the covariance of spot asset returns and interest rates. An empirical study is conducted on the Major Market Index futures from October 1, 1984 to September 27, 1985. Results indicate that the covariance, extracted by the Kalman filter according to the pricing equation, is significant in the pricing of futures contracts.     

THE IMPACT OF SSAP 25 AND THE 10% MATERIALITY RULE ON SEGMENT DISCLOSURE IN THE UK

The identification of reportable segments has long been recognised as a fundamental obstacle to meaningful disclosure of disaggregated data. SSAP 25 introduced the 10% rule to help directors identify those classes of business and geographic segments which are significant to the enterprise as a whole. Its application is non-mandatory. In this paper we address the inter-related issues of the initial impact of SSAP 25 on segment disclosure, the ways in which managers have interpreted the standard and its materiality guideline, and whether these have changed as company directors have become more familiar with the disclosure requirements. A sample of UK companies» disclosure practices for the years 1989, 1992 and 1995 is reported to detect underlying trends. Disquietingly, whilst the introduction of the standard has increased the volume of disclosure, notably net asset data, our results suggest that growing familiarity with the standard has led to a subsequent decline in the detail of disclosure, namely the number of reported segments, particularly for geographic operations. When companies are classified as inadequate disclosers, compliers or voluntary disclosers, based on their reporting practice in 1989, we find that this trend is most pronounced amongst the complying disclosers. Thus, contrary to the intention of the standard, the evidence indicates that the 10% rule is used to identify fewer and larger segments and that a convergence of disclosure practice across the three groups has resulted. Whilst the requirements now appear to be generally followed by the 1989 inadequate disclosers, the complying and voluntary disclosers seem to be reducing the detail of disclosure. It therefore appears that the 10% rule has induced a disclosure pattern which confounds the original intention of the standard.     

THE EFFICIENCY OF THE INTERNATIONAL MONEY MARKETS: A COMMENT

McInish and Puglisi reccntly claimed that weak form efficiency should be tested by runs tests and not autocorrelation tests, when returns are not Normal. It is the opinion of this author however, that autocorrelation tests are not invalidated by a non-Normal distribution. Furthermore, it can be shown that the runs test has lower power than autocorrelation tests and ihat the runs test is not preferable.     

THE EVA REVOLUTION

Stern Stewart's EVA framework for financial management and incentive compensation is the practical application of both modern financial theory and classical economics to the problems of running a business. It is a fundamental way of measuring and motivating corporate performance that encourages managers to make decisions that make economic sense, even when conventional accounting-based measures of performance tell them to do otherwise. Moreover, EVA provides a consistent basis for a comprehensive system of corporate financial management—one that is capable of guiding all corporate decisions, from annual operating budgets to capital budgeting, strategic planning, and acquisitions and divestitures. It also provides companies with a "language" for communicating their goals and achievements to investors—a language that the market is increasingly coming to interpret as a sign of superior future performance.
The authors report that more than 300 companies have implemented Stern Stewart's EVA framework, including a growing number of converts in Europe, Asia, and Latin America. After describing significant behavioral changes at a number of EVA companies, the article focuses in detail on a single case history—that of auto parts manufacturer Federal-Mogul. Besides bringing about a dramatic change in the company's strategy and significant operating efficiencies, the adoption of EVA also led to an interesting change in Federal—Mogul's organizational structure—a combination of two large business units into a single profit center designed to achieve greater cooperation and synergies between the units.     

THE TIME‐VARYING EQUITY PREMIUM AND THE S&P 500 IN THE TWENTIETH CENTURY

I present a new hindcast stock market index for the United States over the twentieth century. This is constructed by calibrating a rational asset pricing model that allows for a time‐varying equity premium driven by heteroskedasticity in consumption growth. By incorporating this variation in risk, the mean square error of the generated index series, when compared to the observed levels of the S&P 500, is significantly reduced. The model also explains the broad magnitudes and timings of the major bull and bear markets of the twentieth century, particularly before 1973, and the excess volatility puzzle is largely resolved.     

AUDITOR LIABILITY: THE OTHER SIDE OF THE DEBATE

The auditing industry claims to be an unfair victim of lawsuits and has deployed its considerable economic and political muscle in a campaign to secure further liability concessions. Amongst other things, it seeks to replace “joint and several liability” of partnerships with “full proportional liability”, a “cap” on auditor liability and a statutory right to negotiate liability limits with company directors. This paper challenges the evidence and the arguments advanced by the UK auditing industry. It argues that there is little convincing argument to support that industry's claims. On the contrary, ordinary stakeholders are relatively powerless to take action against negligent auditors. It is noted that most of the major lawsuits are by one accountancy firm against another. The UK auditing industry already enjoys considerable privileges, such as incorporation and “contributory negligence”, a form of modified proportional liability. Despite these privileges, the industry has shunned public accountability. It is holding the UK public to ransom by threats of locating its operations in offshore islands. Scholars are urged to develop alternative public policy options and analysis.     

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.     

THE RELATION BETWEEN THE FEDERAL FUNDS CASH AND FUTURES MARKETS

The introduction of futures contracts did not alter the regularity in the cash market that results from the Federal Reserve regulation of the bank-settlement process. Although we find a positive preholiday effect in the Fed funds futures returns, we do not find evidence that Federal Reserve regulations cause that effect. Contrary to previous observations for other futures contracts, we find Fridays and preholidays have the largest net volume. We suggest this finding of high volume is consistent with hedging activity by financial institutions before market closings.     

THE SUBJECTIVITY OF THE FASB'S CONCEPTUAL FRAMEWORK: A COMMENTARY ON BRYER

Bryer argues that the FASB's conceptual framework is inherently subjective because it is based on the concept of “economic value”, or the anticipated net cash inflows attributable to presently owned assets. By contrast, Marxist economics is based on objective facts that can be measured to a “socially required level of accuracy”. The objective facts of a Marxist conceptual framework rest on the theory that capital circulates in three forms: money, commodities to be sold, and commodities to be used in production. Capital, and, therefore assets, are essentially physical (or technical) in nature rather than monetary in nature. Measurement of assets is objective because Marxist theory emphasizes management stewardship and requires historical cost and a strict realization criterion for recognition of revenue. Bryer's argument that the FASB's conceptual framework is “unacceptably subjective” because it is based on “economic value” is misplaced. A careful reading of the FASB's concepts statements suggests that assets represent service-potential, or “use-value” in Marxist terms, and that economic-value is never advocated as a conceptual basis for the measurement of assets. The reason the FASB's conceptual framework is “subjective and vague” is that the FASB lacked the political will to advocate a conceptual preference for any particular measurement method.