Pushing Back the Boundaries

1. Introduction
§ Debt markets → the most important developments have been continued deregulation and regulatory harmonization
§ Eurobond, Euro-medium ten note (EMTN) and Euro-commercial paper (ECP) markets
§ Access to the Eurobond market → be made less cumbersome by the rapidly growing acceptance of EMTNs by investors who traditionally purchased Eurobonds
§ Access to the Euromarkets → has always been determined less by overt regulation than by unofficial or investor-driven market practice
§ Current economic climate → regulatory developments which have facilitated access to the securities markets have been partially offset by investors' concerns over credit risk
§ Ratings have become increasingly important → unrated entities will find it more difficult than before to borrow via a Eurobond offering
§ Financial covenants for corporate issuers → more restrictive → as investors try to protect themselves against downgrading and defaults
§ Domestic markets have also continued to benefit from deregulation and regulatory harmonization:
i. Standards of prospectus and listing requirements converge → issuers find it less expensive and time consuming to issue outside their home market
ii. Deregulation often permits the issuance of a more sophisticated range of instruments than was previously allowed
iii. The distinction between international and domestic securities markets has become increasingly blurred → it has become correspondingly easier for issuers to find an appropriate investor base for their securities
§ The international equity markets → have traditionally been far smaller in issuance volume terms than their debt counterpart → because of regulatory differences and equities tend to be denominated in the currency of the issuer and settled in its home market

2. Europe
§ The international bond market has traditionally had its headquarters in London
§ Eurobond market → can be accessed by institutions ranging from small, unrated corporations to large supranational institutions
§ The liberalization → has increased the pressure on other regulatory authorities to bring their regulations into line
i. The strongest candidates for change are the French, Dutch and Swiss markets
§ Banking industry is pressing for the securities industry to be forced to comply with bank-style capital adequacy requirements
i. Large corporations and state and sovereign entities might find it more difficult to access the markets
§ Continental European equity markets still differ considerably in structure, liquidity and regulation
§ Supply of equity is increasing → as family-run businesses are sold off by a generation that does not wish to continue running these businesses
§ The European investor base is becoming more institutionalized
§ Admission Directive → coordinates the conditions for the admission of securities to official stock exchange listing → by setting minimum requirements which have to be met by any company seeking a listing
§ European Commission (EC) Directives → should mean greater efficiency and transparency in the markets for public securities → both debt and equity

3. United States
§ The US authorities still operate a separate environment
§ All public offerings of securities in the US → must be registered under the Securities Act of 1933
§ The appeal of the US public markets for foreign issuers → has traditionally been limited to larger borrowers with the time
§ By limiting the extraterritorial impact of the existing regulations and extending the exemption for private placements → the Securities and Exchange Commission (SEC) has made it easier and cheaper for foreign borrowers to access the US debt and equity markets

4. Emerging Markets
§ One of the most significant trends → has been the increase in companies and financial institutions from emerging markets seeking to raise capital outside their home markets
§ The size of predicted capital flows from these countries → has serious implications for the international securities markets
§ The economic and political background of the companies whose shares are being offered → involve particular challenges when the shares are being offered internationally

5. New Products
§ Most encouraging for potential issuers of securities → is the increased range of instruments and currencies available
§ Development in derivatives as well as a proliferation of hybrid debt / equity instruments → have allowed issuers far greater flexibility in choosing securities
§ These new instruments → require a far greater understanding of the legal and accounting environments of:
i. the jurisdiction from which the securities are issued
ii. Of those into which they may be sold
§ Some of the most powerful instruments and structures → have developed simply as a response to the increased internationalization of world securities markets
§ Global offerings → allow issuers to gain access to a more diverse investor base than was available to them previously → enabling them to lower their cost of funds and to increase name recognition
§ Debt markets → global bond issues are becoming an increasingly popular tool for certain of the larger borrowers
§ Development of the Global Depository Receipt (GDR) → another indication of the increasing internationalization of the international securities markets
§ GDR → a capital raising structure that provides issuers with a means to tap international capital markets through the simultaneous issuance of a single, fungible security in the US and other markets
§ The GDR → is offered simultaneously in several jurisdictions
§ GDRs → have facilitated offerings of securities from Korea, Malaysia, the Philippines, India, China, Taiwan, Thailand and Singapore → without obliging investors to operate within the confines of the local trading and settlement systems
§ The general trend is clear and it is a positive one for issuers of debt and equity securities
§ By giving issuers access to a greater diversity of markets and so a greater number of potential investors → these trends should also lower borrowers' costs of borrowing

Foreign Ownership and Investment: Evidence from Korea

1. Introduction
§ Korean equity market → opened to foreign investors in January 1992
§ Maximum foreign investment limits → eliminated in May 1998
§ Effects of increase in foreign ownership → attract many attentions
§ Researches found → firm’s investment depends on the availability of internal funds
§ The importance of financial factors → is attributed to higher costs of external finance arising from information asymmetry and agency costs in an imperfect capital market
§ This study → focuses on the level of foreign ownership as a segmenting criterion
§ If financial intermediaries consider that foreigners favour firms with low information asymmetry → firms with high foreign ownership are able to raise external funds at low cost
§ If foreign investors have better monitoring skills than domestic investors in developing countries → foreign firms have less managerial agency problems
§ Test whether firms owned by foreigners face less credit constraint than domestically owned firms → main empirical findings:
i. Cash flow sensitivity of investment ↓ as foreign ownership ↑
ii. After 1998 → effect on foreign ownership on financial constraints became stronger

2. Relevant Literature and Hypothesis Formulation
§ Modigliani and Miller → Firms investment depend on the profit opportunity
§ Empirical literature → found that firms’ investment decision depend on financial factors → availability of internal funds
§ Why investment is sensitive to internal funds in imperfect financial markets → two streams:
i. Focus on lemon premium → firms must pay on external finance → firms tend to rely internal funds to carry out performance
ii. Studies attribute the importance of internal funds to managerial agency problems
§ Managers → not the owners → may pursue their own interest → not the stakeholders’ interest
§ Managers tend to spend all available funds on investment projects at their own discretion
§ Both stream of literature predict → the availability of internal funds does affect investment
§ Investment of more financially constrained firms respond more sensitively to changes in cash flow
§ Concentrated ownership → leads to less liquidity-constraint
§ Managers’ ownership stakes in their firms increase → investment-cash flow sensitivity increase
§ Cash flow sensitivity decrease → after a certain level of insider holding
§ Most developing countries →have recently experienced an increase in the equity share of foreigners
§ FDI → eases credit constraints by bringing in capital
§ Ivory Coast → foreign firms were less credit-constrained than domestic firms
i. FDI → reduces firm-level financing constraints
§ Present study → examine whether financial constraints are mitigated as a result of a favorable financing position in market
§ Foreign investors prefer → equity shares in firms with low information asymmetry to those with higher information asymmetry
§ Japanese market → Foreigners prefer large firms, firms with good performance, low risk, and low leverage
§ Swedish firms → foreigners prefer large firms, firms paying low dividends, and firms with large cash position
§ Czech firms → foreign investors seek safe and profitable firms where they can exert influence on corporate governance
§ Financial constraints model and managerial discretion model → one expect cash floe sensitivity of investment to be lower in foreign owned firms than in domestically owned firms

3. Model and Method
§ Model
i. q is the only determinant of investment and no other financial variable should matter
ii. A test for existence of financing constraints amounts to a test for null hypothesis
iii. Test → whether cash flow sensitivity of investment differs across foreign ownership structure
iv. Test → whether the complete opening of the Korean equity market has effected the degree of financial constraints
v. q model has many limitation → difficult to measure q → because average q is equal to marginal q under strict condition
vi. Forbes → derived an Euler equation
a. From the model of maximization of the firm value → under the assumption that dividend must be non-negative
b. Implying that external financing is costly due to information asymmetry
§ Method
i. OLS for dynamic investment models → result in biased estimates → because of endogeneity and heterogeneity problems
ii. Sales and cash flow depends on technological shock
iii. The presence of lagged investment-to-capital ratio as an explanatory variable → bias the coefficient estimates from the OLS
iv. The generalized method of moments (GMM) estimation → widely used for dynamic panel model → depends:
a. On the adoption of appropriate instruments
b. On the efficient elimination of unobserved firm effect
v. Arellano and Bond → two specification tests:
a. A Sargan test for over identifying restriction → used to test for the validity of instruments
b. A test of serial correlation of errors terms → used to detect the presence of unobserved individual effect
§ Data and definition of variables
i. A firm-level panel data set → constructed from the Korea Investors Service-Financial Analysis System
ii. Data set → consist of 5084 observations of 371 firms used → period 1992-2002
iii. High foreign ownership → based on two criteria:
a. More than 5.88% foreign ownership
b. More than upper quartile foreign ownership
iv. The dummy variable High → has a value of one for firms with high foreign ownership and zero

4. Empirical Result
§ Sargan test result for over-identifying restrictions → indicate that the instruments used are valid
§ q-model and Euler equation → suggest that:
i. The availability of internal funds does effect investment levels
ii. Persistence is found in a firm’s investment from significant estimates in the lagged investment-to-capital ratio
§ q-model and Euler equation → the cash flow sensitivity for firms with high foreign ownership is statistically insignificant
i. It suggest → financial constraints faced by firm decrease as foreign ownership increases
§ Managers of a firm with high foreign ownership → less likely to use cash flow at their discretion due to improving corporate governance system
§ In the Korean Stock Market → found that estimates in cash flow are lower after 1998
§ It is conjectured → the opening of the stock market is surely one of the factors in the mitigation of financial constraints
§ Found → liquidity constraints are reduced in firms with low foreign ownership
§ Cash-flow sensitivity in firms with high foreign ownership → statistically insignificant regardless of time period
§ Liquidity constraints → not statistically significant in firms with high foreign ownership
§ With non-linear relationship between foreign ownership structure and the value of the firm → foreign ownership seems to have a linear relationship to financial constraints

How Corrupt is Wall Street?

§ Kanjinal → a Queens pediatrician → claimed he lost $500,000 investing in INSP
§ The Securities and Exchange Commission → launched a probe into practices at 10 firms → while the Justice Dept. is pondering an enquiry or its own
§ The widening scandal → plunged Wall Street into crisis
o Because many more individuals lost money in the recent market collapse
§ Relationship between analyst and their investment banking colleagues → grow
o Because it comes on the heels of several other scandals → raise big questions about how Wall Street operates
§ Enron Corp.’s collapse
o Many firms may have made a bundle investing in the partnership
o Those same firms advised clients to hold Enron stock virtually → until it went bankrupt
o Makes Wall Street seem rigged for the benefit of insiders as never before
§ Entire economy depends on the financial system → to raise and allocate capital
o Financial system → is built on the integrity on its information
§ Investors hesitate to put money into stocks
o It could easily put a damper on the economy → if companies are less willing or less able to raise capital on Wall Street
§ Wall Street → was always struggled with conflict of interest
§ An investment bank → is a business built on the conflict of interest → the same institution serve two masters:
o The companies → sells stocks, issued bonds, or executes mergers → want high price and low interest rates on their bonds
o The investors → it advised → low price and high interest rates
§ The bank gets fee from both → trades stocks and bonds on its own behalf
§ Mega banks → are allowed to do everything from trading stocks to lending money and managing pension funds
§ Chinese walls → were supposed to keep the bankers honest and free from corruption
§ The final blow → was the tide of money that flooded over Wall Street during the great tech bubble
§ The bubble burst in the spring 2000 → wiping out more than $4 trillion in investor wealth
§ The fact → bubble market allowed the creation of bubble companies, entities designed more with an eye to making money off investors
§ A feeding frenzy set in as rivals fought to grab a big share of the market to bring companies public
§ Investors took everything at face value → understandable
§ Analyst disparage stocks as “crap” and “junk”
o They threaten to thrust Wall Street into the sort of public relations nightmare
o All the ingredients are present:
· Publicity-hungry attorneys general, packs of plaintiffs’ lawyers, and potential congressional hearings
§ More explosive documents may be on the way
§ Spitzer and the SEC → seek the analyst’ recommendation and their potential conflicts of interest
§ Analyst were being paid to help the firms’ banking clients
§ If the analyst covering other industries at the firm harbored similar doubts about the companies they hawked → the number of claimants will expand exponentially
§ If the prosecutors conclude that firms are guilty of systemic fraud → research directors and other high-ranking execs could be vulnerable
§ New rules forcing analyst to limit and disclose contracts with investment banker colleagues
§ Analyst who work at investment banks often work against investors
§ Analysts are under pressure from the companies they cover → as well as from big institutional clients who may own the stock → to give positive ratings
§ Analysts also need to shine in surveys → in which money managers vote for their favorite stock pickers → they spend too much time lobbying clients rather that crunching numbers
§ The biggest factor contaminating the system is COMPENSATION
§ Analyst’ pay → tied to how much investment banking business they bring in
§ Experts say → a lot of the corruption oozing from Wall Street has to do with an erosion in investment banking ethics and practices
§ Slashed commission → meant the firms were forced to derive more revenues from investment banking business
§ Investment bankers generated mega profits from secretly investing in Enron’s hidden partnership
§ Wall Street itself → used to have much more of an interest initial public offerings is way of its 200 high
§ It’s unlikely that Wall Street → can sustain its profitability
§ Firms has already taken some steps → such as eliminating direct reporting by analyst to investment bankers
§ Focusing on increased disclosure will do little to end the abuse
§ The Street should take great pains to monitor itself in an effort to restore investors’ confidence

Dividend policy and firm performance: Hotel REITs vs. Non-REIT hotel companies

1. Introduction
§ Mid-1990s → Real Estate Investment Trusts (REITs) à experienced rapid growth fueled by readily available external equity and debt financing
§ The authors → Economies of scale are the driving force behind recent mergers and acquisitions in the industry
§ REITs → over invest → must distribute 95% of their taxable income to shareholders in order to maintain their preferential tax status
i. Reits → less likely to suffer from agency problems associated with free cash flow
§ REITs have less internally generated equity financing and are more likely to seek external financing for acquisitions
§ Nobel and Tarhan (1998) → demonstrate improved operating performance for over-investing firms making larger distribution of cash to stockholders

2. Data and Methodology
§ Sample:
i. Sixteen hotel REITs and fifty-one non-REIT corporations from 1993 to 1999
ii. Examine whether differences in internally generated equity financing can explain differences in performance
§ The control group → consists of firms identified from COMPUSTAT as non-REIT corporations → whose primary business involves investment in hotels and motels
§ More than thirty variables of both types of companies have been collected
§ Examine the free cash flow hypothesis → create two sets of variables to capture the free cash flow for a company:
i. FCF1 → measures the total amount of post-tax free cash flow that is discretionary for mangers before they determine the amount of either interest or dividend payments
ii. FCF2 = EBITDA - TAX - INTEXP – TOTDIV
a. TOTDIV is the total dollar of dividends declared on common and preferred stock
iii. This definition → based on the assumption → depreciation and amortization expenses are at managers' discretions in both types of companies

3. Empirical Results
§ Structural differences
i. T-tests → conducted on collected variables → to examine the differences between the two types of firms
ii. Non-REIT hotel firms are about the same size as the hotel REITs
iii. Non-REIT companies produce higher income adjusted by firm size than REITs
iv. On annual returns of common stock (Stock Return) → non-REIT companies:
a. Perform marginally better than REITs
b. Riskier investments measured by Beta although the t-Statistic is insignificant
v. Return on assets (ROA) → REITs have significantly higher means than the non-REIT companies
vi. Mean of the market-to-book ratio → statistically higher for non-REITs than for REITs
vii. Non-REIT companies are more highly leveraged
a. Non-REIT companies have higher means than REITs on total liability, total debt and total interest expenses
viii. Non-REIT companies → higher means than REITs in total capital expenditure and total acquisition
ix. Non-REIT companies → higher depreciation and amortization expenses → which is typically considered an additional source of free cash flow
x. The means of dividend per share, common dividends and total dividends → higher for REITs than for non-REITs → maintaining high dividend payouts

§ The impact of free cash flow
i. Examine:
a. The relationship between a firm's market-to-book ratio and free cash flow controlling for whether the firm is a REIT
b. A firm's assets (size), leverage, debt coverage ratio, change in assets (growth) and profitability
ii. The asset growth variable → RASSET → proxies for opportunities for profitable reinvestment of cash flow
iii. Free cash flow has a negative impact on firm performance
iv. Market-to-book ratio is significantly greater for:
a. Larger firms (where size is measured by assets)
b. More heavily leveraged firms and more profitable firms
v. Market-to-book ratio → negatively related to free cash flow net of common dividends
vi. Market-to-book ratio decreases with the free cash flow measured at both before and after common dividend distribution levels
vii. Examine further → the relationship of the excess market value of the company and free cash flow
viii. Market-to-book ratio → positively dependent on the leverage level, the asset growth rate, the asset-adjusted operating income and the debt coverage ratio

4. Conclusion
§ Two types of companies statistically significant differences → in means across asset-adjusted earnings, leverage level, dividend policy, and most importantly, free cash flow levels
§ Non-REIT companies → more heavily leveraged and pay lower dividends than the REIT
§ Larger amount of free cash flow is retained by non-REIT firms than their REIT
§ Market-to-book ratio is negatively related to free cash flow

Share Repurchase:To Buy or Not to Buy

1. Introduction
§ Stock buybacks have leap-frogged corporate stock issues by ever-increasing amounts
§ Total number of shares repurchased in the last six years → far outstripped the total number of new shares issued
§ FEI members → Key findings:
i. 39% of the respondents instituted a share repurchase program → to improve their earnings per share numbers
ii. 28% → to distribute excess cash to shareholders
iii. 27% → their companies were trying to reduce the cost of employee stock option plans
iv. 12% → main reason → adjusting capital structure
§ Financial Executives Research Foundation → mission:
i. Determine the long-term effects of stock buyback programs on a company’s stock price
ii. Assess which companies benefit most from this programs
§ Data → 200 firms that announced, conducted and completed share purchase programs from 1991 to 1996
§ Completed Repurchase Plans → The firm announced and later purchase at least 50% of the shares authorized for the program
§ Firms that announced buyback program → usually just buy very little stock

2. Why Repurchase Shares?
§ Five commonly reasons:
i. To increase share price
ii. To rationalized the company capital structure
iii. To substitute share repurchases for cash dividend payouts → tax advantages
iv. To prevent dilution of earnings
v. To deploy excess cash flow → become alternative investment
§ Firm repurchases shares has different options:
i. Open market repurchases
ii. Tender offers
iii. Privately negotiated repurchases
§ Sample → Firms were consent in a range of industry and market capitalization:
i. 48% → have market caps below %200 million
ii. 10% → have market caps in excess of $10 billions
iii. 42% → along the continuum

3. Four Key Findings
§ Shares Outstanding
i. Proportion of share repurchases →5%
ii. This proportion → repurchases were measured in terms of numbers of shares or in terms of dollar value
§ No substitute for dividend payouts
i. Dividend payouts ratio → increase once the stock buyback program is over
ii. Large-cap and small-cap companies → reported the same increase in dividend payout ratios
§ Effect on earnings per share
i. The repurchasing firms → effectively closing gap → between their EPS growth rates and those of industry peers that aren’t buying back stock
§ Effect on debt
i. 27% of the fund used to finance the stock repurchases → stem from excess operational cash flow

4. Guidelines for Getting Going
§ A stock buyback program signaling:
i. Management won’t be funneling anymore money into markets or product lines that are dead ends
ii. The company isn’t hunting around for an acquisition
§ Companies repurchase equity only under these circumstances:
i. When they have excess debt capacity, and the supply of funds exceed the demand
ii. When they’re under-performing → profitability and sales growth rates→ relative to their industry’s averages
§ Companies should avoid stock buybacks under these circumstances:
i. When they’re over-leveraged and sales growth rates exceed industry averages
ii. When both their profitability and sales growth rates exceed industry average
§ A share repurchase program → must be conducted in strict accordance with federal securities laws to avoid liability for market manipulation or insider trading
§ Company’s board of directors → must determine that any purposed buyback program is a sound course of action and that it’s in the best interests of shareholders

5. The Value Connection
§ Shareholder Value Based Management → demonstrates that long-term shareholder value is created buy the firm’s growth and profitability prospects from its product market positions
§ The company’s decision to conduct a repurchase program could be misinterpreted by investors as a negative signal
§ But also can be a positive sign → because investors interpret the repurchases as the welcome return of capital and an indication that management is turning the business around
§ Conducting a successful stock buybacks → he or she must figure out how to bring the two major aspect – strategy and finance – together in the most effective way possible