A commentary on “Why DCF capital budgeting is bad for business and why business schools should stop teaching it”

‘Towards a conceptual framework for auditing’ suggest a conceptual framework, which it is hoped may help in the teaching and understanding of external attest auditing. Briloff's (1986) view that ‘as concern for ecology and the wellbeing of consumers in posterity intensifies, this responsibility (accountability) will extend to the total society and environment’ is taken as the philosophical departure point for the conceptual framework.

The paucity of attempts to develop a unifying theory of auditing is noted and a brief history of developments is traced commencing with Mautz and Sharaf in 1961. Flint's 1988 work (The Philosophy and Principles of Auditing) is adopted and developed. Each of Flint's concepts is examined in some detail to consider its significance in the conceptual framework and its implications for audit practice. Reasons for changes from earlier frameworks are offered.

In order to illustrate the effectiveness of the framework as an holistic tool of analysis, the concepts identified are then related to the Auditing Standards and Guidelines of our national professional accounting association, the New Zealand Society of Accountants (NZSA). Whilst considerable correlation is noted, some inconsistencies are also identified. It is suggested that the standards and guidelines may not have derived from any philosophical analysis and that the inconsistencies between the concepts and the standards appear to have resulted from a lack of a clear theory as to what constitutes a standard and what constitutes a guideline; higher and lower order ideas would appear to fall somewhat indiscriminately in both. It is noted that this analysis may be repeated in respect of the auditing standards of any professional organization.

It is concluded that the application of these concepts can lead to more informed discussion of some of the controversial issues that face the auditing profession at this time, and to an holistic understanding of the discipline of auditing as well as of professional audit promulgations. It is recommended that standard setters should give thought to the adoption of a more holistic approach to standard setting, grounded in a conceptual framework, and that auditing educators should adopt such a framework in order to assist students towards an understanding of the role and process of auditing and away from the memorizing of techniques.     

A rejoinder to commentaries on “Why DCF capital budgeting is bad for business and why business schools should stop teaching it”

This paper examines the effects of exposing accounting graduate students to professional ethics. First, a method of instruction that encourages students to consider the ethical implications of business decisions was developed. This instruction included exposure to Kohlberg's theory of moral development, study of professional codes of ethics, and extensive use of written and video ethics cases. Next, instructional effectiveness was assessed through a pre-post-test with control group design. An accounting-specific test instrument was developed and validated. This instrument contains decision scenarios designed to elicit and identify students' stages of ethical reasoning, Test results revealed that students receiving ethics instruction demonstrated gains in ethical reasoning within the decision context. Appropriately designed ethics modules can thus foster consisitent consideration of ethical issues in decision making.     

Did the U.S. Treasury’s capital purchase program (CPP) help bank lending and business activity?

The 2008 financial crisis led the U.S. Treasury to implement the capital purchase program (CPP) to revive commercial bank lending and hence stimulate business activity. Employing dynamic panel techniques and methodologies from the bank lending channel literature we find that after controlling for asset size, bank capital, and macroeconomic variables (real GDP growth rate and interest rate spreads), the impact of the CPP program is statistically significant only for money center banks. However, over our sample period from 2008Q3 to 2009Q4 we find a very modest impact on lending by only the largest banks. Overall, our results suggest that CPP’s business objective to boost loan growth and hence business activity during the crisis remained unfulfilled.     

What's a business for?

In the wake of the recent corporate scandals, it's time to reconsider the assumptions underlying American-style stock-market capitalism. That heady doctrine--in which the market is king, success is measured in terms of shareholder value, and profits are an end in themselves--enraptured America for a generation, spread to Britain during the 1980s, and recently began to gain acceptance in Continental Europe. But now, many wonder if the American model is corrupt. The American scandals are not just a matter of dubious personal ethics or of rogue companies fudging the odd billion. And the cure for the problems will not come solely from tougher regulations. We must also ask more fundamental questions: Whom and what is a business for? And are traditional ownership and governance structures suited to the knowledge economy? According to corporate law, a company's financiers are its owners, and employees are treated as property and recorded as costs. But while that may have been true in the early days of industry, it does not reflect today's reality. Now a company's assets are increasingly found in the employees who contribute their time and talents rather than in the stockholders who temporarily contribute their money. The language and measures of business must be reversed. In a knowledge economy, a good business is a community with a purpose, not a piece of property. If, like many European companies, a business considers itself a wealth-creating community consisting of members who have certain rights, those members will be more likely to treat one another as valued partners and take responsibility for telling the truth. Such a community can also help repair the image of business by insisting that its purpose is not just to make a profit but to make a profit in order to do something better.     

What lures cross-border venture capital inflows?

We investigate if economic factors drive gross and net cross-border venture capital inflows differently. Using a dataset of venture capital investments in European and North American countries from 2000 to 2008, we find that higher expected economic growth goes hand in hand with higher gross as well as net inflows, while higher market capitalization and a more favorable environment for venture capital intermediation entail higher gross inflows, but lower net inflows. The latter two findings may suggest that cross-border venture capital inflows partly compensate for potential limits in domestic venture capital supply. However, the findings may also reflect that venture capitalists’ locational decisions depend on the viability of capital markets.     

What's your real cost of capital?

In valuing any investment project or corporate acquisition, executives must decide what discount rate to use in their estimates of future cash flows. The traditional approach is to apply the capital asset pricing model (CAPM), which has remained fundamentally unchanged for 40 years. But the formula--in particular, its beta element--has long been a source of frustration. In fact, corporate executives and investment bankers routinely fudge their CAPM estimates, say the authors, because experience and intuition tell them the model produces inappropriate discount rates. CAPM has three main problems: First, beta is a measure of both a stock's correlation and its volatility; second, beta is based on historical data; and third, CAPM rates don't take into account the term of the investment. These factors together result in discount rates that defy common sense. As an alternative to CAPM and its beta element, the authors developed a forward-looking approach to calculating a company's cost of capital, the market-derived capital pricing model (MCPM). It does not incorporate any measure of historical stock-to-market correlation, relying instead on estimates of future volatility derived from the options market. This is helpful since investor expectations from the options market are built into a company's current stock price. Using GE as an example, the authors give step-by-step instructions for how to calculate discount rates with MCPM. They also offer evidence from a range of industries to show that MCPM's discount rates are more realistic--especially from the corporate investor's perspective--than are CAPM's.     

Does bank capital reduce liquidity creation?

This paper investigates the relationship between bank capital and liquidity creation against the backdrop of the 2007–2008 financial crisis. Analyzing an unbalanced panel of 11,617 U.S. commercial banks from 1996 to 2016, we find a negative association between regulatory capital and on-balance-sheet liquidity creation, but positive associations for small banks and after the financial crisis. Further, we observe lower liquidity creation among banks that participated in the Troubled Asset Relief Program (TARP). The results are largely robust to several alternate variable proxies and model specifications. Our findings suggest that “one-size-fits-all” policy may have some unintended consequences for banks.     

What's the matter with business ethics?

The more business ethics secures its status in campuses across the country, the more bewildering it appears to actual managers. It's not that managers dislike the idea of doing the right thing. As University of Toronto Assistant Professor Andrew Stark argues, far too many business ethicists just haven't offered them the practical advice they need. Before business ethics became a formal discipline, advocates of corporate social responsibility claimed that the market would ultimately reward ethical behavior. But ethics and interests did not always intersect so fruitfully in the real world. And when they did not, managers were left in the dark to grope for the right ethical course. In the 1970s, the brand-new field of business ethics came onto the scene to address this issue. Critical of the "ethics pays" approach, academics held that ethics and interests can and do conflict. Still, scholars took an equally unrealistic line. To them, a manager's motivation could be either altruistic or self-interested, but never both. In short, ethicists still weren't addressing the difficult moral dilemmas that managers face on a day-to-day basis, and only recently have they begun to do so. After some initial stumbles, ethicists are getting their hands dirty and seriously considering the costs of doing the right thing. Finally, a new business ethics is emerging that acknowledges and accepts the messy world of mixed motives. As a result, novel concepts are springing up: moderation, pragmatism, minimalism, among others.(ABSTRACT TRUNCATED AT 250 WORDS)     

‘Wait-and-See’ business cycles?

Are shocks to firms' profitability risk, propagated by physical capital adjustment costs, a major source of business cycle fluctuations? This paper studies this question using a heterogeneous-firm dynamic stochastic general equilibrium model, where firms face fixed capital adjustment costs. Surprise increases in idiosyncratic risk lead firms to adopt a ‘wait-and-see’ policy for investment. The model is calibrated using a German firm-level data set with broader coverage than comparable U.S. data sets. The main result is that time-varying firm-level risk through ‘wait-and-see’ dynamics is unlikely a major source of business cycle fluctuations.     

Does CEO reputation matter for capital investments?

This paper examines the association between CEO reputation and corporate capital investments. The efficient contracting hypothesis predicts a positive association between CEO reputation and wealth effects of corporate capital investments. In contrast, the rent extraction hypothesis predicts that the wealth effects of capital investments are negatively associated with CEO reputation. We find that the stock market's responses to announcements of capital investments are more favorable for firms with more reputable CEOs. Moreover, CEO reputation mitigates the negative stock price reaction associated with announcements of capital investments by firms with high free cash flow and low growth opportunities. Additional analysis indicates that firms with more reputable CEOs exhibit significantly better post-investment operating performance improvements than those with less reputable CEOs, especially in firms with high free cash flow and low growth opportunities. Collectively, our results suggest that the efficient contracting hypothesis dominates the rent extraction hypothesis in terms of net economic impact of capital investments on the investing firm.     

Is American business working for the poor?

At first glance, poverty seems to have little to do with business. When most people--managers included--think about poverty, they assume that people are poor because they are isolated from the mainstream economy, not productive participants in it. But according to Harvard University professors Mary Jo Bane and David Ellwood, this is a misleading image of the true face of poverty in the United States today. Most poor adults--and a full 90% of poor children--live in families where work is the norm, not the exception. Poor people often work or want to work. But at the low-wage end of the American economy, having a job is no guarantee of avoiding poverty. Poverty is a business issue, then, because the American poor are part of the American work force. And this poses a problem for managers. In a more competitive and fast-changing economic environment, the performance of companies increasingly depends on the capabilities of their employees. In response to this human-resource challenge, more and more managers are embracing the language of "empowerment". And yet how can low-wage employees believe empowerment when their experience of work is, quite literally, impoverishment? It is unlikely that American companies can create the work force of the future with the poverty policies of the past. Fortunately, there are some simple policy mechanisms that can assist the working poor without putting an undue burden on business. Enacting them, however, requires managers to see poverty policy as one part of a national human-resource strategy that links the strategic concerns of companies to a broad social agenda.     

London‘best for global business’Urges

London must not be complacent1about its continuing pre-eminence as a financial centerbutt hea vailabilityo f skilleds taff,f lexiblelabour markets and comparatively lightregulation now make the city the bestplace for global institutions to do business,acc…     

Did gold-standard adherence reduce sovereign capital costs?

A commonly cited benefit of the classical gold standard is that it reduced borrowing costs by signaling a country's commitment to financial probity. Using a new dataset, this paper tests whether gold-standard adherence was negatively correlated with the cost of capital. Conditional on UK risk factors, there is no evidence that the bonds issued by countries off gold earned systematically higher excess returns than the bonds issued by countries on gold. This conclusion is robust to allowing betas to differ across exchange-rate regimes; to including other determinants of the country risk premium; and to controlling for the British Empire effect.     

Does the budget process matter for infrastructure spending? Capital budgeting in local government

Investment in long-term capital projects plays an increasingly important role in improving the quality of many public services, as well as promoting economic development. Using data on capital spending and capital budget structures in county governments in Georgia, USA, this paper explains how a separate capital budget protects infrastructure spending in times of fiscal distress. The author found little evidence that county governments with a separate capital budget spent more than those without a capital budget.     

Do capital adequacy requirements reduce risks in banking?

In a dynamic framework it is shown that capital adequacy rules may increase a bank's riskiness. In addition to the standard negative effect of rents on risk attitudes of banks a further intertemporal effect has to be considered. The intuition behind the result is that under binding capital requirements an additional unit of equity tomorrow is more valuable to a bank. If raising equity is excessively costly, the only possibility to increase equity tomorrow is to increase risk today.     

Linking dividends and capital injections – a probabilistic approach

In the context of collective risk theory, we give a sample path identity relating capital injections in the original model and dividend payments in the time-reversed counterpart. We exploit this duality to provide an alternative view on some of the known results on the expected discounted capital injections and dividend payments for risk models driven by spectrally negative Lévy processes. Furthermore, we present a probabilistic analysis and simple resulting expressions for a model with two dividend barriers, which was recently shown by Schmidli to be optimal in various Lévy risk models when maximizing the difference of dividend payments and injections in the presence of tax exemptions.     

Audit committees’ social capital and financial reporting quality

We draw on social capital theory to examine the relationship between audit committee (AC) members’ social capital and financial reporting quality. Using US data for the period 2001–2010, our results suggest that non-AC directors’ social capital does not appear to be relevant to financial reporting quality. As far as AC members are concerned, our findings show a negative relationship between their social capital and financial reporting quality, suggesting a ‘dark side’ to social capital. Specifically, we find that sitting in multiple ACs (centrality) has a negative impact on reporting quality only for those AC members designated as financial experts. When other proxies for social capital are considered (connectedness, brokerage position and strong ties), our results show that the quality of financial reporting significantly decreases with the social capital of non-financial experts sitting in the AC. We contribute to prior research by: (i) relying on social capital theory, which is widely neglected in accounting research, (ii) using multiple metrics to capture the complex dimensions of social capital, and (iii) discriminating between the effects of financial and non-financial experts’ social capital on reporting quality. Our results suggest policy-makers might wish to limit financial experts’ multiple directorships as well as assess the actual contribution of non-financial experts to AC effectiveness.     

Can science be a business? Lessons from biotech

In 1976, Genentech, the first biotechnology company, was founded by a young venture capitalist and a university professor to exploit recombinant DNA technology. Thirty years and more than 300 billion dollars in investments later, only a handful of biotech firms have matched Genentech's success or even shown a profit. No avalanche of new drugs has hit the market, and the long-awaited breakthrough in R&D productivity has yet to materialize. This disappointing performance raises a question: Can organizations motivated by the need to make profits and please shareholders successfully conduct basic scientific research as a core activity? The question has largely been ignored, despite intense debate over whether business's invasion of basic science-long the domain of universities and nonprofit research institutions- is limiting access to discoveries, thereby slowing advances in science. Biotech has not lived up to its promise, says the author, because its anatomy, which has worked well in other high-tech sectors, can't handle the fundamental challenges facing drug R&D: profound, persistent uncertainty and high risks rooted in the limited knowledge of human biology; the need for the diverse disciplines involved in drug discovery to work together in an integrated fashion; and barriers to learning, including tacit knowledge and murky intellectual property rights, which can slow the pace of scientific advance. A more suitable anatomy would include increased vertical integration; a smaller number of closer, longer collaborations; an emphasis by universities on sharing rather than patenting scientific discoveries; more cross-disciplinary academic research; and more federal and private funding for translational research, which bridges basic and applied science. With such modifications, science can be a business.     

Analysts’ estimates of the cost of equity capital

We explore a large sample of analysts' estimates of the cost of equity capital (CoE) to evaluate their usefulness as expected return proxies (ERP). We find that the CoE estimates are significantly related to a firm's beta, size, book-to-market ratio, leverage, and idiosyncratic volatility but not other risk proxies. Even after controlling for the popular return predictors, the CoE estimates incrementally predict future stock returns. This predictive ability is better explained as the CoE estimates containing ERP information rather than reflecting stock mispricing. When evaluated against traditional ERPs, including the implied costs of capital, the CoE estimates are found to be the least noisy. Finally, we document CoE responses around earnings announcements, demonstrating their usefulness to study discount-rate reactions of market participants. We conclude that analysts' CoE estimates are meaningful ERPs that can be fruitfully employed in a variety of asset pricing contexts.