A Unified Valuation Framework for Dividends, Free Cash Flows, Residual Income, and Earnings Growth Based Models

Valuation techniques are important to practitioners and academics. Although theoretically equity value equals the present value of expected dividends, in practice, higher-level metrics such as free cash flows, earnings, and book values are used for valuation. This paper helps us understand these metrics by: (1) providing a common and simple theoretical framework that shows how these alternative valuation metrics can be used instead of dividends; (2) using the common framework to provide the theoretical underpinnings of earnings-based valuation

Debt vs. Equity: Accounting for Claims Contingent on Firms' Common Stock Performance with Particular Attention to Employee Compensation Options

This paper lays out a comprehensive solution to the problem of accounting for claims based the performance of a firm's stock price. The accounting covers employee stock options, stock appreciation rights, put and call options, convertible debt and preferred stock, warrants, and other hybrid securities. This issue has vexed the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) who have approached the problem on a piecemeal basis, leading to inconsistent treatments of claims that in substance are very similar

On the Analysis of Firms' Cash Flows

This paper revisits the whys and hows of cash flows analysis. The analysis maintains a strict common shareholders' perspective with an equity valuation focus. The paper argues that analysts turn to cash flows to evaluate the potential ambiguity inherent in accruals. The GAAP statement of cash flows, however, (i) relies on a too narrow concept of cash and (ii) lacks a clear bottom-line directly comparable to net income per GAAP. To circumvent (i) and (ii), the paper proposes a framework of Modified Cash Accounting (MCA). A MCA statement of cash earnings satisfies a crucial property: It works like a regular income statement yet eschews all accruals. The paper discusses not only how one motivates and develops a MCA statement of cash earnings, but also how it should be put to use. A crucial issue deals with how one compares the two bottom-lines -- GAAP income vs. that of MCA cash earnings -- given alternative growth scenarios. The paper shows how one can estimate a "normal accrual," which can be added to MCA cash earnings, given assumptions about the firm's growth

A Unified Valuation Framework for Dividends, Free Cash Flows, Residual Income, and Earnings Growth Based Models

Valuation techniques are important to practitioners and academics. Although theoretically equity value equals the present value of expected dividends, in practice, higher-level metrics such as free cash flows, earnings, and book values are used for valuation. This paper helps us understand these metrics by: (1) providing a common and simple theoretical framework that shows how these alternative valuation metrics can be used instead of dividends; (2) using the common framework to provide the theoretical underpinnings of earnings-based valuation

Default Risk and Equity Returns: A Comparison of the Bank-Based German and the U.S. Financial System

In this paper, we address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. Using an implementation of Merton's option-pricing model for the value of equity to estimate firms' default risk, we construct a factor that measures the excess return of firms with low default risk over firms with high default risk. We then compare results from asset pricing tests for the German and the U.S. stock markets. Since Germany is the prime example of a bank-based financial system, where debt is supposedly a major instrument of corporate governance, we expect that a systematic default risk effect on equity returns should be more pronounced for German rather than U.S. firms. Our evidence suggests that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts some previous results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio. It further turns out that the composition of corporate debt affects equity returns in Germany. Firms' default risk sensitivities are attenuated the more a firm depends on bank debt financing

The Fate of Firms: Explaining Mergers and Bankruptcies

Using a uniquely complete data set of more than 50,000 observations of approximately 16,000 corporations, we test theories that seek to explain which firms become merger targets and which firms go bankrupt. We find that merger activity is much greater during prosperous periods than during recessions. In bad economic times, firms in industries with high bankruptcy rates are less likely to file for bankruptcy than they are in better years, supporting the market illiquidity arguments made by Shleifer and Vishny (1992). At the firm level, we find that, among poorly performing firms, the likelihood of merger increases with poorer performance, but among better performing firms, the relation is reversed and chances of merger increase with better performance. Such a changing relation has not been detected in prior merger studies. We also find that low-growth, resource-rich firms are prime acquisition targets and that firms’ debt capacity relates negatively to the likelihood of a merger. Debt-related variables, leverage and secured debt, play an especially prominent role in distinguishing between which firms merge and which firms go bankrupt

Not So Lucky Any More: CEO Compensation in Financially Distressed Firms

There is a debate on whether executive pay reflects rent extraction due to managerial power or is the result of arms-length bargaining in a principal-agent framework. In this paper we offer a test of the managerial power hypothesis by empirically examining the CEO compensation of U.S. public companies that were ever in financial distress between 1992 and 2005. Using a bias-corrected matching estimator that estimates the causal effects of financial distress, we find that, for the distressed firms, CEO turnover rates increase markedly and their CEOs, both incumbents and successors, experience significant reductions in total compensation. The bulk of the reduction in total compensation derives from the decline in value of stock option grants, which we argue is due to a change in the opportunistic timing of option grants. We define lucky grants as those with grant prices below or at the lowest stock price of the grant month, and we find that the proportion of lucky grants for financially distressed firms is higher before insolvency and lower upon and after insolvency, while the proportion for similar but solvent firms remains stable throughout the period. We interpret this evidence as consistent with a decrease in managerial power induced by a tightening in the outrage constraint due to the episode of financial distress

NRXN3 Is a Novel Locus for Waist Circumference: A Genome-Wide Association Study from the CHARGE Consortium

Central abdominal fat is a strong risk factor for diabetes and cardiovascular disease. To identify common variants influencing central abdominal fat, we conducted a two-stage genome-wide association analysis for waist circumference (WC). In total, three loci reached genome-wide significance. In stage 1, 31,373 individuals of Caucasian descent from eight cohort studies confirmed the role of FTO and MC4R and identified one novel locus associated with WC in the neurexin 3 gene [NRXN3 (rs10146997, p = 6.4×10−7)]. The association with NRXN3 was confirmed in stage 2 by combining stage 1 results with those from 38,641 participants in the GIANT consortium (p = 0.009 in GIANT only, p = 5.3×10−8 for combined analysis, n = 70,014). Mean WC increase per copy of the G allele was 0.0498 z-score units (0.65 cm). This SNP was also associated with body mass index (BMI) [p = 7.4×10−6, 0.024 z-score units (0.10 kg/m2) per copy of the G allele] and the risk of obesity (odds ratio 1.13, 95% CI 1.07–1.19; p = 3.2×10−5 per copy of the G allele). The NRXN3 gene has been previously implicated in addiction and reward behavior, lending further evidence that common forms of obesity may be a central nervous system-mediated disorder. Our findings establish that common variants in NRXN3 are associated with WC, BMI, and obesity

Systematic review of the evidence relating FEV1 decline to giving up smoking

<p>Abstract</p> <p>Background</p> <p>The rate of forced expiratory volume in 1 second (FEV₁) decline ("beta") is a marker of chronic obstructive pulmonary disease risk. The reduction in beta after quitting smoking is an upper limit for the reduction achievable from switching to novel nicotine delivery products. We review available evidence to estimate this reduction and quantify the relationship of smoking to beta.</p> <p>Methods</p> <p>Studies were identified, in healthy individuals or patients with respiratory disease, that provided data on beta over at least 2 years of follow-up, separately for those who gave up smoking and other smoking groups. Publications to June 2010 were considered. Independent beta estimates were derived for four main smoking groups: never smokers, ex-smokers (before baseline), quitters (during follow-up) and continuing smokers. Unweighted and inverse variance-weighted regression analyses compared betas in the smoking groups, and in continuing smokers by amount smoked, and estimated whether beta or beta differences between smoking groups varied by age, sex and other factors.</p> <p>Results</p> <p>Forty-seven studies had relevant data, 28 for both sexes and 19 for males. Sixteen studies started before 1970. Mean follow-up was 11 years. On the basis of weighted analysis of 303 betas for the four smoking groups, never smokers had a beta 10.8 mL/yr (95% confidence interval (CI), 8.9 to 12.8) less than continuing smokers. Betas for ex-smokers were 12.4 mL/yr (95% CI, 10.1 to 14.7) less than for continuing smokers, and for quitters, 8.5 mL/yr (95% CI, 5.6 to 11.4) less. These betas were similar to that for never smokers. In continuing smokers, beta increased 0.33 mL/yr per cigarette/day. Beta differences between continuing smokers and those who gave up were greater in patients with respiratory disease or with reduced baseline lung function, but were not clearly related to age or sex.</p> <p>Conclusion</p> <p>The available data have numerous limitations, but clearly show that continuing smokers have a beta that is dose-related and over 10 mL/yr greater than in never smokers, ex-smokers or quitters. The greater decline in those with respiratory disease or reduced lung function is consistent with some smokers having a more rapid rate of FEV₁decline. These results help in designing studies comparing continuing smokers of conventional cigarettes and switchers to novel products.</p