Uncertainty and stepwise investment

We analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points. The presence of economies of scale gives rise to the following trade-off: lumpy investment has a lower total cost, but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage. Our main question is how uncertainty in market development affects this trade-off. The answer is unambiguous and in contrast with a conventional real-options intuition: higher uncertainty makes the single-stage investment more attractive relative to the more flexible stepwise investment strategy

Leaders and followers in hot IPO markets

We model the dynamics of going public within an IPO wave. The model predicts that firms with better growth opportunities can find it optimal to go public early and accept underpricing of their issues to signal quality. Data supports this prediction as, on average, early movers underprice their issues significantly more and we show that leaders (early movers with high underpricing) obtain much higher valuations when going public than other IPO firms. Furthermore, after going public, leaders invest significantly more, their sales grow faster, and their profitability remains higher compared to other IPO firms

Effectiveness of monitoring, managerial entrenchment, and corporate cash holdings

We develop a dynamic model of a firm in which cash management is partially delegated to a self-interested manager. Shareholders trade off the cost of dismissing the manager with the cost of managerial discretion over the use of liquid funds. An improvement in corporate governance quality may have a positive or a negative effect on levels and values of cash balances, depending on the source of the improvement. While a reduction of managerial entrenchment results in lower cash balances and mostly higher marginal cash values, we demonstrate that the opposite is true when the monitoring of managerial actions becomes more effective. A managerial asset substitution problem produces a novel hump-shaped relation between the firm's liquidity levels and the collective propensity of shareholders and managers to reduce cash flow risk. We also discuss the firm's risk management strategies as well as derive implications of the presence of an investment opportunity, debt financing, and shareholder activism.info:eu-repo/semantics/publishedVersio

Essays on the role of narrative disclosures in financial reporting

This thesis contains two essays on the role of narrative disclosures in financial reporting. The first essay, “Tightening rating standards: The effect of narrative risk-related disclosures” (co-authored with Argyro Panaretou and Grzegorz Pawlina), examines how narrative disclosures affect rating stringency, a phenomenon where credit rating agencies assign ratings worse than what firm fundamentals justify. Results suggest that narrative disclosures about risk and uncertainty in Form 10-K reports moderate rating stringency. Moreover, this moderating effect is more pronounced when Form 10-K reports have textual attributes that can affect how users contextualize firm risk. The second essay, “Context matters: The role of fair value footnote narratives” (co-authored with Argyro Panaretou and Catherine Shakespeare), investigates how narrative disclosures in Form 10-K report footnotes that discuss the measurement of fair values affect investor uncertainty. The findings of this essay show that longer fair value footnote narratives reduce investor uncertainty for opaque fair values, and are particularly informative to sophisticated investors. Further test results suggest that standardized and non-specific fair value narratives increase investor uncertainty for Level 3 fair values, and that fair value narratives offer incremental information to investors relative to tabulated fair value footnote disclosures. Finally, the thesis includes a technical appendix, “A guide on extracting, processing, and operationalizing Form 10-K report narratives,” on the advantages and challenges in identifying, collecting, and integrating narrative disclosure data from Form 10-K reports into archival accounting studies

Optimal exercise of jointly held real options:A Nash bargaining approach with value diversion

This paper provides a two-stage decision framework in which two or more parties exercise a jointly held real option. We show that a single party’s timing decision is always socially efficient if it precedes bargaining on the terms of sharing. However, if the sharing rule is agreed before the exercise timing decision is made, then socially optimal timing is attained only if there is a cash payment element in the division of surplus. If the party that chooses the exercise timing can divert value from the project, then the first-best outcome may not be possible at all and the second-best outcome may be implemented using a contract that is generally not optimal in the former cases. Our framework contributes to the understanding of a range of empirical regularities in corporate and entrepreneurial finance

Taxation of Risky Investment and Paradoxical Investor Behavior

Under uncertainty and irreversibility, real option-based models are widely accepted for assessing investment projects. So far the existing post-tax analyses do not provide a general analytical description of investor reactions towards profit tax rate changes. This paper sets out to fill part of the void. We implement a simple tax system and focus on risky capital market investment and an option to wait. Taxes affect risk-free and risky capital market investment asymmetrically and hence cause distortions. We analytically identify a set of neutral tax rates (tax regimes) that preserve the critical post-tax investment threshold in case of tax rate changes as well as general normal and paradoxical settings. Unlike for other tax paradoxa neither depreciation rules nor loss offset restrictions are responsible for the observed paradoxical reaction. Identifying normal and paradoxical tax regimes can be regarded as a first step to a generalized description of tax effects under uncertainty, both for individual project evaluation as well as for understanding tax effects on an aggregate level

A theory of net debt and transferable human capital

Traditional theories of capital structure do not explain the puzzling phenomena of zero-leverage firms and negative net debt ratios. We develop a theory where firms adopt a net debt target that acts as a balancing variable between equityholders and managers. Negative (positive) net debt occurs in human (physical) capital intensive industries. Negative net debt arises because tradeable claims cannot be issued against transferable human capital. Heterogeneity in capital structure occurs when firms have debt that is not fully collateralized. Physical capital intensive firms take on high leverage but may underlever to avoid bankruptcy costs. This creates excess rents for managers (even if the supply of human capital is competitive) because wealth constraints prevent managers from co-investing