A Multidimensional Framework for Financial-Economic Decisions

Most financial-economic decisions are made consciously, with a clear and constant drive to ???good???, ???better??? or even ???optimal??? decisions. Nevertheless, many decisions in practice do not earn these qualifications, despite the availability of financial economic theory, decision sciences and ample resources. We plea for the development of a multidimensional framework to support financial economic decision processes. Our aim is to achieve a better integration of available theory and decision technologies. We sketch (a) what the framework should look like, (b) what elements of the framework already exist and which not, and (c) how the MCDA community can co-operate in its development.decision making;finance;decision analysis;financial decisions;multiple criteria

Optimal Capital Structure: Reflections on Economic and Other Values

Despite a vast literature on the capital structure of the firm there still is a big gap between theory and practice. Starting with the seminal work by Modigliani & Miller, much attention has been paid to the optimality of capital structure from the shareholders’ point of view. Over the last few decades studies have been produced on the effect of other stakeholders’ interests on capital structure. Well-known examples are the interests of customers who receive product or service guarantees from the company. Another area that has received considerable attention is the relation between managerial incentives and capital structure. Furthermore, the issue of corporate control and, related, the issue of corporate governance, receive a lion’s part of the more recent academic attention for capital structure decisions. From all these studies, one thing is clear: The capital structure decision (or rather, the management of the capital structure over time) has to deal with more issues than the maximization of the firm’s market value alone. In this paper, we give an overview of the different objectives and considerations that have been proposed in the literature. We show that capital structure decisions can be framed as multiple criteria decision problems which can then benefit from multiple criteria decision support tools that are widely available.Capital structure;MCDA;Multi criteria decision analysis

A Conceptual Model of Investor Behavior

Based on a survey of behavioral finance literature, this paper presents a descriptive model of individual investor behavior in which investment decisions are seen as an iterative process of interactions between the investor and the investment environment. This investment process is influenced by a number of interdependent variables and driven by dual mental systems, the interplay of which contributes to boundedly rational behavior where investors use various heuristics and may exhibit behavioral biases. In the modeling tradition of cognitive science and intelligent systems, the investor is seen as a learning, adapting, and evolving entity that perceives the environment, processes information, acts upon it, and updates his or her internal states. This conceptual model can be used to build stylized representations of (classes of) individual investors, and further studied using the paradigm of agent-based artificial financial markets. By allowing us to implement individual investor behavior, to choose various market mechanisms, and to analyze the obtained asset prices, agent-based models can bridge the gap between the micro level of individual investor behavior and the macro level of aggregate market phenomena. It has been recognized, yet not fully explored, that these models could be used as a tool to generate or test various behavioral hypothesis.behavioral finance;financial decision making;agent-based artificial financial markets;cognitive modeling;investor behavior

The effects of decision flexibility in the hierarchical investment decision process

Large institutional investors allocate their funds over a number of classes (e.g. equity, fixed income and real estate), various geographical regions and different industries. In practice, these allocation decisions are usually made in a hierarchical (top-down), consecutive way. At the higher decision level, the allocation is made on basis of benchmark portfolios (indexes). Such indexes are then set as targets for the lower levels. For example, at the top level the allocation decision is made on the basis of asset class benchmark indexes, on the second level the decisions are made on the basis of sector benchmark indexes, etc. Obviously, the lower levels have considerable flexibility to deviate from these targets. That is the reason why targets often come with limits on the maximally allowed deviation (or "tracking error") from these targets. The potential consequences of deviations from the benchmark portfolios have received very little attention in the literature. In this paper, we discuss and illustrate this influence. The lower level tracking errors with respect to the benchmark indexes propagate to the top level. As a result the risk-return characteristics of the actual aggregate portfolio will be different from those of the initial benchmark-based portfolio. We illustrate this effect for a two level process to allocate funds over individual US stocks and sectors. We show that the benchmark allocation approaches used in practice yield inferior solutions when compared to a non-hierarchical approach where full information about individual lower level investment opportunities is available. Our results reveal that even small deviations from the benchmark portfolios can cause large shifts in the top-level risk-return space. This implies that the incorporation of lower level information in the initial top-level decision process will lead to a different (possibly better) allocation.decision flexibility;multi-level decision process;porfolio management;tracking error analysis

Portfolio Return Characteristics of Different Industries

Over the last decade we have witnessed the rise and fall of theso-called new economy stocks. One central question is to what extentthese new firms differ from traditional firms. Empirical evidencesuggests that stock returns are not normally distributed. In thisarticle we investigate whether this also holds for portfolios ofstocks from a growth industry. Furthermore, we will compare this typeof portfolios with portfolios of stocks from a more traditionalindustry. Usually, only value weighted and equally weighted portfoliosare used to describe and compare portfolio return characteristics.Instead, in our analysis, we use a novel approach in which we use aninfinite number of portfolios that together represent the set of allfeasible portfolio opportunities.performance evaluation;portfolio management;investments;stock markets;sector index

Impact of Japanese Mergers on Shareholder Wealth: An Analysis of Bidder and Target Companies

The market for corporate control in the second largest economy in the world behaves very different from that in the U.S. Using a sample of 91 mergers in the period 1982-2003 we document several distinctive features of this market in Japan. First, we show that in stark contrast to the pro-cyclical U.S. merger waves, mergers in Japan tend to be counter-cyclical, both with respect to the general economy as well as with respect to stock market valuations. Second, and again in contrast to the U.S. experience, we find that a significant fraction of Japanese mergers are orchestrated by the main banks; in such cases, mergers are not between two weak companies, but at least one of the merging companies is financially strong. Other distinctive features of Japanese mergers are the positive pre-announcement returns accruing to both bidders and targets, with bidders capturing approximately half the gains that accrue to target firms. We also find differential shareholder wealth effects in the bubble period (1982-1989), the early 1990s, and the post-financial regulation regime (1997-2003). Overall our results point to a market for corporate control that is distinctly less shareholder-centered than that in the U.S. and one where creditors play an important, perhaps dominant, role.mergers;Japanse mergers;corporate control;take-over