The weighted average cost of capital is not quite right

A firm's cost of capital used in discounted cash flow analysis is commonly calculated as a weighted average of the after tax costs of the firm's various sources of financing (equity, debt, preferred stock). Its use implies that for investment projects earning precisely the WACC the cash (in)flow is exactly sufficient to reward all the suppliers of finance with their respective costs of capital. However, the necessary cash flow (normal profit) implied by the WACC is inadequate to provide the cash flows to the individual sources of financing when they are considered separately. This note discusses the problem (WACC is a linear approximation of a nonlinear relationship) and presents a modification of the WACC which is conceptually superior to the WACC as commonly calculated.     

Corporate debt,corporate taxes and leasing

This paper utilizes recent developments in capital lease modeling to develop a new specification of the relationship between the expected returns to debt, levered equity and unlevered equity for firms that lease a portion of their assets. Accounting explicitly for leases is shown to be important when the difference between equity and debt risk is large, when the risk of leased assets differs from the firm's other assets and when salvage value is a significant portion of the capitalized value of the firm's lease obligations. This new specification yields improved estimates of firms' unlevered cost of capital, thereby facilitating improved capital budgeting decisions in those that lease a significant portion of their assets.     

Investment and capital structure decisions with strategic debt service under asymmetric information

This paper examines the agency problem due to manager-shareholder conflicts in a real option framework by incorporating strategic debt service. We show that when the equityholders’ bargaining power is weak, the optimal coupon is larger and the manager overinvests the project relative to the case without renegotiation, while the results are totally opposite when the bargaining power is strong. An increase in equityholders’ bargaining power reduces the manager’s value and the total social value. Especially, the social value can be improved by debt renegotiation when the systematic risk is high, which provides an explanation why Chinese government encourage the market-oriented debt restructuring.     

公司发行可转换债券融资的动机分析

公司使用可转换债券筹集外部资金既是作为普通债券的替代,增加转换特性来降低利息率从而保持现金流量,也是转换条款建立“延迟股权”,通过转换,以高于现行股票的价格出售。本文研究发现,公司发行可转换债券是为了减少由于股东和管理者以及股东和债权人之间冲突所引起的代理成本;为了降低由发行普通债券带来的高额预期财务危机成本和普通股发行中经常出现的严重负面公告效应;以及在投资者和管理者对公司面临的风险认识不同时,使其价值不易受公司风险变化的影响。     

Equity‐based incentive contracts and behavior: Experimental evidence

Equity ‐ based incentive contracts provide managers with dual incentives, motivating both effort and fraud. We report the results from an experiment in which manager subjects make effort and fraud decisions that affect a firm's value. The main treatment variable is the incentive contract, which can be of either the simple equity or stock option type. We find that both effort and fraud are increasing in a manager's share of equity and decreasing in the strike price of an option. Interestingly, the stock option contract induces relatively more fraud than the simple equity contract, even though the two induce the same effort.     

The dividend policies of all-equity firms: A direct test of the free cash flow theory

This paper finds support for Jensen's (1986) hypothesis that dividends and debt are substitute mechanisms for controlling the agency costs of free cash flow. We find that dividend payout ratios of a sample of all-equity firms are significantly higher than those of a control group of levered firms. Further, within the group of all-equity firms, firms with lower managerial holdings have higher payout ratios. These results hold after controlling for free cash flow and growth rates. Overall, our evidence suggests that dividends and managerial ownership are substitute mechanisms for reducing agency costs in all-equity firms.     

Project financing,entrepreneurial activity,and investment in the presence of asymmetric information

We analyze a two-period signaling model in which a representative entrepreneur in a regional economy has a project that generates a random cash flow and that requires investment that the entrepreneur raises from a competitive market. The project's type is known to the entrepreneur but not to the investors. Further, the entrepreneur is restricted to issuing debt only or equity only. We first show that there is no separating perfect Bayesian equilibrium (PBE) contract involving the issuance of equity only, that there exists a pooling PBE contract involving the issuance of equity only, and that a debt contract is preferred to an equity contract by our entrepreneur. Next, we suppose that the entrepreneur incurs a non-pecuniary cost of financial distress F > 0 whenever he is unable to make a repayment at time t = 1. We provide conditions on F under which a pooling PBE contract with debt exists and a separating PBE contract with debt and equity exists. Finally, we examine whether a high type entrepreneur will prefer a setting with a cost of financial distress (F > 0) or a setting in which there is no such cost (F = 0).     

Agency and Anxiety

In this paper, we introduce the psychological concept of anxiety into agency theory. An important benchmark in the anxiety literature is the inverted-U hypothesis, which states that an increase in anxiety improves performance when anxiety is low, but reduces it when anxiety is high. We show that the inverted-U hypothesis is consistent with evidence that high-powered incentives can reduce the agent's optimal effort and expected performance. In equilibrium, however, a profit-maximizing principal never offers such counterproductive incentives. We also show that the inverted-U hypothesis can explain empirical anomalies related to monitoring, the informativeness principle, and the risk–reward tradeoff.     

Contract design in dynamic agency: An experimental analysis

This paper reports results from an experiment studying contract design in a dynamic 2‐period agency relationship with unobservable effort. A deferred compensation contract is theoretically optimal—it places all incentives on the outcomes in the second period. Observed contract choices offer a substantial part of the incentives for the high outcome in the first period suggesting a strong preference for timely rewards. Information about theoretically optimal bonuses and effort decisions shifts contract choices towards a deferred compensation contract. This contract structure is more profitable for principal participants.     

Moral hazard,debt overhang and capital structure

This paper investigates the impact of managerial moral hazard on the debt overhang of a firm by constructing a contingent claims model in which the manager faces costly effort. Using a calibrated capital structure model, we show that the costs of debt overhang become more serious in the presence of managerial moral hazard. Such costs even account for more than half of the total agency costs at a high level of cash flow. Moreover, in contrast to the results of Hackbarth and Mauer (2012), our model predicts a U-shaped relationship between the leverage ratio and investment opportunities of a firm, which is caused by managers’ moral hazard. Finally, by considering this moral hazard, we also show the coexistence of low leverage ratios and high credit spreads, which explains the phenomenon of “low debt levels and high credit spreads” observed in practice.     

Incorporating a “no claim bonus” in insurance agency contract

A bonus received by an agent from an insurer when the insured does not make a claim is called a “no claim bonus” (NCB). An NCB rewards the agent's risk‐management (RM) effort that reduces the probability that the insured suffers a loss. This paper designs an incentive compatible contract that induces the agent to choose an RM effort. If the agent's RM effort cost is lower than a threshold, feasible ranges of NCB and premium values exist such that the insurer can offer an incentive compatible agency contract with an NCB that is acceptable to the agent.     

The Route to Take‐up: Evidence from the UK Pension Credit Reform

Viable routes to increase the take‐up of cash transfer programs include raising the financial incentive to claim and reducing claiming barriers. Older people's response to both is evaluated exploiting the introduction of Pension Credit in the UK. The reform involved improved application assistance, simplified claiming procedure, extended recertification interval, less intrusive reporting requirements and outreach campaigning; also, the cash entitlement was increased for a subgroup of pensioners. The behavioral response is identified using Family Resources Survey data. Results support the effectiveness of financial incentives, while no effect is found in the case of reducing barriers policies when unaccompanied by financial incentives.     

The effects of corporate antitakeover provisions on long-term investment: empirical evidence

This paper's empirical results indicate that the average effect of antitakeover provisions on subsequent long‒term investment is negative. The interpretation of these results depends on whether one thinks that there was too much, too little, or just the right amount of long‒term investment prior to the antitakeover provision adoption. We use agency theory to devise more refined empirical tests of the effects of antitakeover provision adoption by managers in firms with different incentive and monitoring structures. Governance variables (e.g. percentage of outsiders on corporate boards, and separate CEO/chairperson positions) have an insignificant impact on subsequent long‒term investment behavior. However, consistent with agency theory predictions, managers in firms with better economic incentives (higher insider ownership) tend to cut subsequent long‒term investment less than managers in firms with less incentive alignment. Furthermore, managers in firms with greater external monitoring (due to higher institutional ownership) also tend to cut subsequent long‒term investment less than managers in firms with less external monitoring. Thus, the decrease in subsequent long‒term investment is significantly less for firms where the managers have greater incentives to act in shareholders' interests. Finally, there are interesting effects of the control variables. First, high book equity/market equity firms cut total long‒term investment more. Second, firms that were takeover targets or rumored to be takeover targets cut long‒term investment more. These results suggest that inefficient firms cut long‒term investment more when an antitakeover provision is adopted. © 1997 John Wiley & Sons, Ltd.     

Contingent capital,capital structure and investment

We examine the interaction between investment and financing policies in a dynamic model for a firm with existing assets-in-place and a growth option, of which investment cost is financed with equity and contingent convertible bonds (CoCos). We attempt to clarify how CoCos impact on investment timing, capital structure and inefficiencies arising from debt overhang and asset substitution. We show that there is a conversion ratio (the fraction of equity allocated to CoCo holders upon conversion) to eliminate the inefficiencies. Our conclusions predict that debt leverage decreases with investment option payoff factor and the average appreciation rate of the cash flow. In contrast to traditional corporate finance theory saying that a firm's value decreases globally with business risk, our model indicates that it might first decrease and then increase with asset volatility.     

董事会计师事务所工作背景与企业现金持有水平——来自中国资本市场的经验证据

基于2004—2012年我国上市公司数据,考察了董事会计师事务所工作背景对企业现金持有水平的影响。研究发现,董事会会计师事务所工作背景（董事会中是否有成员具有会计师事务所工作背景、董事会中拥有会计师事务所工作背景的董事人数、董事会中拥有会计师事务所工作背景的董事比例等）显著降低了企业的现金持有水平。进一步的分组检验结果还发现董事会计师事务所工作背景带来的现金方面的治理效应仅仅体现在高成长企业和管理层权力较大的企业之中,因为这两类企业面临的潜在代理冲突或信息不对称问题更为严重。     

Private Debt and Timely Loss Recognition

Abstract

In this study, we investigate whether private debt contracting provides incentives for borrowers to recognize economic losses earlier in accounting earnings. Focusing on the window around firms' issuances of private loans, we document that timely loss recognition significantly increases following an issuance. This effect is significantly stronger for debt contracts that include performance covenants acting as trip-wires when firm performance deteriorates. We also find that timely loss recognition is particularly used when writing debt contracts is hampered by uncertainty about a firm's future development. These findings are consistent with timely loss recognition being used to increase contract efficiency by facilitating state-contingent control allocation based on a borrower's performance over the loan term.     

基于债务约束的自由现金流过度投资问题研究

自由现金流理论认为,当企业存在大量自由现金流时,管理者倾向于过度投资。债务控制是降低因自由现金流引起的代理成本的有效方法之一。模型检验发现,我国制造业上市公司并不显著存在自由现金流量的过度投资行为;债务约束效应在我国没有发挥应有的作用。     

Agency costs,corporate governance mechanisms and ownership structure in large UK publicly quoted companies: A panel data analysis

This paper examines the impact of governance and ownership variables on agency costs for a panel of large UK quoted companies. We use three measures of agency costs: the ratio of sales-to-total assets, the interaction of free cash flows and growth prospects and the number of acquisitions. We employ a range of techniques to analyse the data: fixed-effects, instrumental variables, and Tobit regressions. We find that the changes in board structures that have occurred in the post-Cadbury period have not, generally, affected agency costs. This suggests a range of mechanisms is consistent with firm value maximisation. We also find that having a nomination committee increases agency costs, which indicates that there are costs associated with certain governance mechanisms. Increasing board ownership also helps to reduce agency costs. We also find that debt reduces agency costs. Our results raise questions about the usefulness of the information sent to shareholders when firms adopt a recommended governance framework.     

Do institutional investors monitor management? Evidence from the relationship between institutional ownership and capital structure

We examine the dynamic relations between institutional ownership and a firm's capital structure. We find that a firm's leverage decreases when institutional ownership increases. This result implies that a firm reduces its debt level as institutional investors substitute for the monitoring role of debt. More importantly, we find that a firm's suboptimal leverage decreases when the institutional ownership increases, and institutional ownership decreases when a firm's suboptimal leverage increases. This finding shows that institutions not only effectively monitor a firm's capital structure but they also passively sell their shares when dissatisfied with it. In addition, we find that the monitoring evidence on a firm's leverage and suboptimal leverage are more pronounced when the institutional investors are less likely to have business relationships with a firm or the information asymmetry is high in the market.     

Executive compensation and firm risk after successful mergers and acquisitions in Africa

This paper examines the impact of various executive compensation types on the postmerger risk taking by firm's executives. We find that executive pay influences firm risk differently depending on compensation type and risk measure. Specifically, we find that rewarding executives with cash compensation reduces the total postmerger risk of acquirers. However, managers are motivated to increase systematic risk when they are rewarded with stock‐based incentives. Besides, based on the argument that managerial compensation portfolio might impact systematic and unsystematic risks differently, our findings show no evidence of the impact of executive pay on unsystematic risk.