Matching Organizational Structure with Firm Attributes: A Study of Master Limited Partnerships

To create value and reduce agency costs, firms adopt availableorganizational structures that match their attributes. Thispaper studies the characteristics of firms that choose to becomemaster limited partnerships (MLPs). The MLP sample is dominatedby firms in low-growth industries that have highly focused operationsand superior profitability compared to their industry peers.After becoming an MLP, sample firms reduce capital expendituresand increase cash distributions, taking advantage of their focus,profitability, and status as non-taxable entities. A subsampleof MLPs subsequently change back to corporate form. After becomingcorporations, these firms reverse course by cutting cash distributionsand increasing capital spending. This cycle demonstrates howfirms restructure to adopt organizational forms that best fittheir needs.     

Why Financial Institutions Matter: The Case of Energy Infrastructure MLPs

Institutional investors entered the Master Limited Partnership (MLP) space in 2001 with the Kinder Morgan offering of I‐share units. In the ten years that have passed since then, the number of MLPs has quadrupled, and their total market capitalization has increased tenfold. When compared to the MLPs of the 1980s, today's MLP are more focused both in terms of operations and distribution policy. After its birth in 1981, the MLP spread to over 30 different industries. But thanks in large part to tax law changes in 1987 that have helped limit MLPs to natural resource sectors, companies adopting the MLP structure since then have been concentrated in energy, and especially in energy infrastructure. And whereas distribution policy varied considerably among the early MLPs, today's MLPs uniformly pay out a large majority of their distributable cash flow. But to maintain or expand existing energy infrastructure while paying out most of their cash from operations, many MLPs require significant amounts of new capital. To help meet this ongoing funding requirement, new kinds of institutional intermediaries such as closed‐end C‐Corporation investment companies have emerged to provide capital to MLPs in the form of direct placements that offer flexibility with regard to offer sizing and timing. Since 2004, the total value of such direct placements of MLP units has exceeded $15 billion. What's more, the rise of this MLP operating/C‐corporation investment company structure has resulted in a novel realignment of incentives and functions. In this innovative arrangement, the pass‐through operating vehicle (i.e., the MLP) avoids double taxation of dividends while effectively committing managers to distribute cash. At the same time, for those MLPs with large maintenance and other requirements for capital, the commitment to pay out cash effectively forces the operating companies to raise capital continuously and stay “close to the capital marketplace.” This unusual combination of operating and investment vehicles also means that C‐Corporation investment companies, unlike their pass‐through counterparts, must manage tax on their own books and disclose to their investors the after‐tax results of their portfolio trading as well as their capital gains “overhang.”     

THE ENERGY MLP GOES INSTITUTIONAL: IMPLICATIONS FOR STRATEGY AND GOVERNANCE

Master limited partnerships (MLPs) were popular in the 1980s because of the favorable tax treatment of their cash distributions. But since the Revenue Act of 1987, which imited the lines of business and income sources for which this tax treatment was available, virtually all remaining public MLPs have been in natural resource businesses.
Institutional investors have traditionally avoided investing in master limited partnerships because any cash distributions must be treated as unrelated business income, creating an immediate tax liability. But in an innovative underwriting in May 001, Goldman Sachs offered shares in a limited liability company that would pay stock dividends equivalent to the cash distributions on its proportional ownership interest in Kinder Morgan Energy Partners, a pipeline operator. In effect, this structure allows tax-exempt investors (institutions) to own an interest in Kinder Morgan Energy Partners without triggering unrelated business taxable income.
An interesting aspect of this recent development is that while the MLP was originally viewed as a vehicle for slow-growth firms to distribute cash and wind down operations, the "institutional" MLP could be used to facilitate growth by attracting needed investment to businesses currently housed in MLP form—typically energy transportation and storage infrastructure businesses (so-called "mid-stream" energy assets). The new structure raises some potential corporate governance challenges in that it is highly complex and offers investors only limited control rights. But the authors' conclusion is that the institutional MLP is likely to be a successful financing innovation whose tax-favored status and extensive public disclosure will outweigh any governance concerns.     

Operating Hedge and Gross Profitability Premium

We show theoretically that variable production costs reduce systematic risk of firms' cash flows if capital and variable inputs are complementary in firms' production and input prices are procyclical. In our dynamic model, this operating hedge effect is weaker for more profitable firms, giving rise to a gross profitability premium. Moreover, gross profitability and value factors are distinct and negatively correlated, and their premia are not captured by the capital asset pricing model (CAPM). We estimate the model by simulated method of moments, and find that its main implications for stock returns and cash flow dynamics are quantitatively consistent with the data.     

THE CAPITAL BUDGETING BEHAVIOUR AND CORPORATE CHARACTERISTICS OF CAPITAL-CONSTRAINED FIRMS

This paper addresses (1) the nature and pervasiveness of organisational constraints, frnancial and otherwise, on investment, and (2) the corporate characteristics and capital budgeting behaviour of capital-constrained firms for a sample of 126 UK companies. The results indicate that corporate size, risk and profitability are important corporate characteristics in this regard, and that financially-constrained firms tend to adopt naive capital budgeting methods in resolving the capital rationing problem.     

Corporate Diversification and the Cost of Capital

We examine whether organizational form matters for a firm's cost of capital. Contrary to the conventional view, we argue that coinsurance among a firm's business units can reduce systematic risk through the avoidance of countercyclical deadweight costs. We find that diversified firms have, on average, a lower cost of capital than comparable portfolios of stand‐alone firms. In addition, diversified firms with less correlated segment cash flows have a lower cost of capital, consistent with a coinsurance effect. Holding cash flows constant, our estimates imply an average value gain of approximately 5% when moving from the highest to the lowest cash flow correlation quintile.     

Corporate governance and firm cash holdings in the US

Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures actually have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions. Firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is only limited evidence that the presence of excess cash alters the overall relation between governance and profitability. In the US, weakly controlled managers choose to spend cash quickly on acquisitions and capital expenditures, rather than hoard it.     

Payout policy in Brazil: Dividends versus interest on equity

We examine the impact of tax burden on cash distribution using a sample of Brazilian firms, which are allowed by law to distribute cash to shareholders in two forms: dividends and tax-advantaged interest on equity. The Brazilian institutional setting is superior to those used in prior studies that examine the choice between dividends and capital gains because, in some cases, dividends provide advantages that outweigh their negative tax consequences, leading firms to rationally choose payout policies that are not optimal when viewed only from the perspective of taxes. We find that taxes are a primary determinant of Brazilian firms’ payout policy decisions, as profitability and payout ratios (nonequity tax shields) are positively (negatively) related to the likelihood that a firm pays interest on equity. However, many firms continue to pay dividends despite the tax advantages of interest on equity payments. Abnormal returns around payout policy announcements suggest that these firms are, at least in part, catering to investor demand.     

The Effects of Liquidity Shocks on Corporate Investments and Cash Holdings: Evidence from Actuarial Pension Gains/Losses

This paper investigates how anticipated liquidity shocks affect corporate investment and cash holdings by examining the impacts of actuarial pension gains/losses that do not reduce current internal resources but will reduce those available in the future. Using a sample from Japanese manufacturing firms in which pension deficits had a huge impact on the internal resources of sponsoring firms, I show that pension losses significantly decrease the capital expenditures of sponsoring firms. Pension losses also increase corporate cash holdings, suggesting precautionary demands for cash prepared for future pension contributions. Overall, the results indicate that managers consider anticipated liquidity shocks in determining current investment and cash‐saving policies.     

Determinants of corporate cash holdings: Evidence from spin-offs

We study the factors that influence the cash allocation decision around a spin-off, using variables suggested by the trade-off theory, and controlling for the possible endogeneity of leverage and cash ratios. Spin-offs provide an opportunity to examine the determinants of cash allocation at the margin at the time of creation of a new entity. Our results indicate that managers allocate higher cash ratios to smaller firms, and firms with high research and development expense ratio, low net working capital ratio, and low leverage. Thus, higher cash ratios are correlated with difficulty of raising external capital and reduced availability of cash from internal sources. In addition, managers also base the cash allocation on observable immediate growth opportunities instead of on long-term possible growth. An analysis of excess cash ratios, defined as the difference between the actual and predicted cash ratios, indicate that firms are, on average, allocated less cash than suggested by trade-off models, and this deviation in allocated cash from predicted levels is explained only by concurrent profitability of the firms (a pecking order theory implication).     

The effects of anticipated future investments on firm value: evidence from mergers and acquisitions

I examine the long-term valuation consequence of investment in mergers and acquisitions on acquiring firms through the “anticipation effect,” in which forward-looking prices embed investors’ expectations about the profitability of firms’ future acquisitions. Using a sample of firms with past acquisitions, I find that their market valuations depend on both the profitability of their past acquisitions and their current free cash flow. Among firms with positive free cash flow (when future acquisitions are likely), those with a worse history of value-destroying acquisitions experience lower market valuations. Among firms with negative free cash flow (when future acquisitions are less likely), firm value is not systematically related to acquisition history. These findings are consistent with investors forming expectations about the profitability of future acquisitions based on realized acquisition outcomes and valuing these firms based on their likelihood of making future acquisitions. They also provide support for using observed market prices as a proxy for investors’ expectations about future investment opportunities.     

自由现金流量创造力与违约风险——来自A股公司的经验证据

本文基于我国A股上市公司数据,研究了企业自由现金流量创造力与违约风险之间的关系。研究发现：(1)企业自由现金流量创造力越强,其违约风险越低。经过一系列稳健性检验后,该结论依旧成立。(2)自由现金流量创造力越强的企业往往有更低的债务规模、更高的资产收益率和更低的股票波动,因而其违约风险更低。(3)自由现金流量创造力与违约风险的负相关关系,主要存在于货币政策紧缩时期以及外部信息环境较差的企业。本文发现意味着,监管部门和投资者应重视上市公司自由现金流量创造力不足所带来的潜在债务违约风险,通过不断提高公司自由现金流量创造力,助力我国宏观经济与微观企业高质量发展。     

What Happens During the Private Period?: Evidence from Public‐to‐Private Reverse LBOs

This study provides new evidence on the restructuring activities undertaken by public‐to‐private reverse leveraged buyouts (RLBOs) while owned by private equity firms. The authors' comprehensive sample of public‐to‐private LBOs that return to public ownership through IPOs enables them to observe changes in profitability, valuation, financial structure, operating structure, and cost structure from the time the firms go private through (and after) their emergence through (re‐) IPOs. With their exclusive focus on reverse LBOs involving public‐to‐private deals, the authors reach findings that contradict previous conclusions about RLBOs. At the time of the LBO, the target firms in reverse LBOs are more levered than their peers, pay higher dividends, and are more profitable than their peers. At the same time, however, they appear to have lower market valuations before the buyouts. During the private period, the target firms of reverse LBOs achieve significant increases in employee productivity, asset restructuring, and improved gross margins, while operating with substantially higher levels of debt financing, lower levels of cash and working capital, and greater concentration of equity ownership. After the companies return to public ownership through IPOs, such companies continue to operate with higher leverage and ownership concentration than their publicly traded peers while producing further increases in profitability, resulting in substantial increases in both enterprise and equity valuation. The authors' analysis also shows that higher debt levels from the buyout play an important role in increased enterprise values. The evidence suggests that possible undervaluation as well as expected efficiency gains from restructuring actions are the primary motives for such reverse LBOs.     

Sources of Corporate Financing and Operating Performance: The effects of strategic ownership and financial restatements

Using a sample from European markets this study documents that changes in external financing, both in the form of equity and debt, can predict future operating performance (profitability and cash flows). In terms of future profitability, increases in equity (debt) financing particularly benefit large-size growth firms (large-size value firms). It is notable that a firm environment of low information quality, indicated by the presence of accounting restatements, intensifies the association between external financing and operating performance, due to the heightened scrutiny investors/lenders apply to firms that have recently restated their financials. In addition, strategic ownership in the firm has no significant effect on the financing – operating profitability association but may amplify the positive effects of equity financing on future operating cash flows. Moreover, financial analysts' forecasts of operating profitability and operating cash flows reflect the impact of external financing changes on future operating performance but exhibit a financing-related systematic inefficiency particularly for firms that have recently announced a material restatement of their prior financial results. Finally, controlling for information contained in analyst forecast surprises, the market is efficient overall and incorporates the effects of equity and debt financing changes into stock prices.     

Dividend policy and the earned/contributed capital mix: a test of the life-cycle theory

Consistent with a life-cycle theory of dividends, the fraction of publicly traded industrial firms that pay dividends is high when retained earnings are a large portion of total equity (and of total assets) and falls to near zero when most equity is contributed rather than earned. We observe a highly significant relation between the decision to pay dividends and the earned/contributed capital mix, controlling for profitability, growth, firm size, total equity, cash balances, and dividend history, a relation that also holds for dividend initiations and omissions. In our regressions, the mix of earned/contributed capital has a quantitatively greater impact than measures of profitability and growth opportunities. We document a massive increase in firms with negative retained earnings (from 11.8% of industrials in 1978 to 50.2% in 2002). Controlling for the earned/contributed capital mix, firms with negative retained earnings show virtually no change in their propensity to pay dividends from the mid-1970s to 2002, while those whose earned equity makes them reasonable candidates to pay dividends have a propensity reduction that is twice the overall reduction in Fama and French [2000, Journal of Financial Economics 76, 549–582]. Finally, our simulations show that, if well-established firms had not paid dividends, their cash balances would be enormous and their long-term debt trivial, thus granting extreme discretion to managers of these mature firms.     

The significance of working capital management in determining firm profitability: Evidence from developing economies in Africa

PurposeThe purpose of this study is to examine the relationship between working capital efficiency and corporate profitability and in particular, to determine their significance across countries with differential industrial levels.DesignThe paper adopts a quantitative approach using balanced panel data of manufacturing firms in Egypt, Kenya, Nigeria and South Africa. We accessed financial statements of manufacturing firms from the Orbis database for the period 2005–2009. The database is known to be reliable and has universal acceptability.FindingsThe study reveals that there is a strong negative relationship between profitability, measured through net operating profit, and cash conversion cycles across different industrialisation typologies. The negative association implies that, when the cash conversion cycle increases, the profitability of the firm declines.Practical implicationsManagers can create positive value for shareholders by reducing the days customers settle their accounts, ensuring that they sell off their inventories as quickly as possible and delaying the payments to their suppliers, as long as this does not affect their credit rating.OriginalityTo the best of our knowledge, this is the first paper to provide a fresh perspective on how working capital management influences profitability across Africa within different typologies.     

Tax‐efficient irregular payout methods: The case of B share schemes and capital repayments via a court‐approved scheme of arrangement

Advance corporation tax (ACT) increased the tax cost to UK firms of distributing cash to shareholders. We demonstrate how the tax cost arising from ACT payments affected the channels through which UK firms returned capital to shareholders. In particular, we document and describe two unconventional irregular payout methods that enabled firms to avoid paying ACT. Firms choosing these methods are associated with significantly greater ACT problems than a control sample of firms that opted for conventional self‐tender offers and special dividends. Event study tests indicate that the decision to adopt tax‐efficient payout methods created significant additional value for shareholders beyond the basic cash distribution decision.     

Why companies do not pay cash dividends: The Turkish experience

This study uses a survey approach to examine the views of corporate managers of non-dividend-paying firms listed on the Borsa Istanbul (BIST) in order to identify the factors leading to the decision not to pay cash dividends in Turkey. Our survey results show that cash constraints, growth opportunities, low profitability and earnings, and the cost of raising external funds (debt) are the major reasons inducing BIST firms not to pay dividends. Additionally, non-dividend-paying firms consider their shareholder preferences when setting a policy of paying no cash dividends. Yet, they neither view taxes as an important factor for paying no dividends nor perceive that stock repurchases are substitutes for cash dividends. Statistical analysis using secondary data of publicly-traded BIST firms reveals whether the actual corporate actions are consistent with the managerial views revealed by our survey research. These tests show that growth opportunities and debt level have a negative effect on the dividend payment decisions of BIST firms. Also, large blockholders and the existence of multiple large shareholders reduce the likelihood and intensity of paying a cash dividend in the Turkish market. Overall, the evidence suggests that non-dividend-paying companies are likely to be smaller in size, relatively younger (in the earlier stage of their life cycle) with high-growth opportunities or with a low level of profitability (or even loss) and small (negative) earnings. By contrast, highly-profitable, mature and large-size corporations are more likely to pay cash dividends.     

Motives for and Effects of Asset Revaluation: An Examination of South Korean Data

Examining a sample of South Korean firms, of which 201 revalued assets and 899 did not during the period 2008–2009, we find that the average debt cost, equity cost, and weighted average cost of capital (WACC) are higher among the firms that revalued. Firms with higher equity costs and leverage are more likely to revalue and the propensity has a negative relationship with profitability, cash flow, and Tobin’s q. Firms that engage in revaluation experience reductions in all capital costs from year ?1 to +1, comparable to those among firms that did not revalue. Our results support both the information hypothesis and the debt-cost hypothesis.     

Firm structure and corporate cash holdings

We analyze whether the organizational structure of firms (i.e., whether a firm is diversified or focused) affects their cash holdings. Using Compustat firm level and segment-level data, we find that diversified firms hold significantly less cash than their focused counterparts. Our results are robust to industry adjustments at the segment level and to different factors previously found to be important determinants of cash holdings. Using time-series, cross-sectional, and additional robustness tests we are able to attribute the lower cash holdings among diversified firms to complementary growth opportunities across the different segments of these firms and the availability of active internal capital markets. We find that the other theories that rely on the potentially effective use of asset sales of non-core segments of diversified firms to generate cash, and the increased agency/influence costs in diversified firms do not offer an economically significant explanation for the lower cash holdings among diversified firms.