Market Equilibrium and Corporation Finance: Some Issues

Kumar, Prem

doi:10.1111/j.1540-6261.1974.tb03095.x

Cited by 5 publications

(2 citation statements)

References 19 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…Under the assumption that the default risk associated with debt financing is insignificant (Hamada, 1972), the systematic risk of a levered firm (e.g., equity beta) can be obtained by the product of the unlevered beta (e.g., asset beta) and the sum of one plus the debt-to-equity ratio. Further, BKS (1970), Kumar (1974), and Bowman (1979) found that variables such as earning variability, financial and operating leverage, accounting beta, growth rate, and asset size were among those most highly correlated with market beta for non-banking firms. Finally, it is well known that exposure to interest rate risk can be an important determinant of market risk for financial institutions (see for example Stone, 1974).…”

Section: Cross-sectional Regression Resultsmentioning

confidence: 99%

The Relationship Between Market and Accounting Betas for Commercial Banks

Karels¹,

Sackley²

1993

Rev Financ Econ

View full text Add to dashboard Cite

This study examines the correlation between market equity betas and accounting asset and equity betas in the commercial banking sector. A sample of banks was taken from the COMPUSTAT tapes and annual equity and asset accounting betas (calculated with various indices) were estimated over varying time periods. Cross-sectional correlations were then determined for individual banks and five-bank portfolios. The results indicate that the correlations are comparable to those found in other non-banking studies ofaccounting and market betas. A noticeable difference in our study was the sensitivity ofthe correlations to the length of the estimation interval for the betas. The longest estimation intervals (16-18 years) produce few significant correlations in our sample. These correlations were Significantly lower than those obtained using fifteen or fewer years ofdata. Construction ofportfolios generally increases all the correlations but the longer time period correlations are still significantly lower. The correlations are largely invariant, however, to the choice of index used in the estimation of the betas. . The authors wish to thank Arun J. Prakash for his helpful comments as well as two anonymous referees for their valuable suggestions.

show abstract

Section: Cross-sectional Regression Resultsmentioning

confidence: 99%

The Relationship Between Market and Accounting Betas for Commercial Banks

Karels¹,

Sackley²

1993

Rev Financ Econ

View full text Add to dashboard Cite

show abstract

“…Therefore, there is no necessary relationship between size and systematic risk. '8 17 Bogue [71 pp. 37-38, has reached a comparable result using a different analytical approach.…”

Section: +8s2 Si+8s2mentioning

confidence: 99%

The Theoretical Relationship Between Systematic Risk and Financial (Accounting) Variables

Bowman

1979

The Journal of Finance

215

View full text Add to dashboard Cite

CONSIDERABLE EMPIRICAL RESEARCH HAS been directed to the relationship between financial and accounting variables and market based measures of risk.1 The results of this research indicate that some financial (accounting) variables are highly correlated with a market based measure of risk (beta) and are useful in the prediction of future risk. However, there has been relatively little research into the theoretical relationship between financial variables and market determined risk.Hamada [13,14] has researched the relationship between portfolio analysis and corporate finance. More specifically, he has shown that the systematic risk of a firm's common stock should be positively correlated with the firm's leverage. The analytical approach used by Hamada will be discussed more thoroughly below. The approach used in this paper to develop a relationship between systematic risk and leverage draws on the earlier work of Hamada. In the later paper, he adopted a different approach to arrive at a similar conclusion. Lev [19] has shown, using the approach adopted by Hamada [14], that a firm's operating leverage (the ratio of fixed to variable operating costs) is a variable affecting systematic risk.Pettit and Westerfield [30] assumed a discounted cash flow valuation model and separated the individual security return into cash flow and capitalization rate components. They proceeded to analytically develop a two factor model of beta.2 Although the approach which they used is promising, the model which they developed was not readily testable.The purpose of this paper is to provide a theoretical basis for empirical research into the relationship between systematic risk and financial (accounting) variables. Section II develops the assumptions and relationships of the capital asset pricing model. Systematic risk is defined as the /B parameter from this model. In the following sections we will show that, given the assumptions, there is a theoretical relationship between a firm's systematic risk and the firm's leverage and accounting beta. Also, we show that systematic risk is not theoretically related (directly) to the earnings variability, dividends, size or growth of a firm. * Assistant Professor, University of Oregon. The author wishes to acknowledge the helpful comments of William Beaver. 'Beaver, Kettler and Scholes [4], Pettit and Westerfield [30] and Rosenberg and McKibben [31] conducted tests involving many financial and accounting variables. Ball and Brown [2], Gonedes [11, 12] and Beaver and Manegold [5] were primarily concerned with the relationship between systematic risk and "accodnting beta." 2 See Sharpe [33] for a general theoretical model for this approach. 617 618 The Journal of Finance

show abstract

Stochastic Demand and the Equity Capitalization Rate

Long¹,

Racette

1979

Business Fin & Account

View full text Add to dashboard Cite

While the relationship between capital cost and financing mix has long been of interest to those interested in exploring firm decisions, detailed study of the relationship between capital cost and the firm's output and investment decisions has awaited development of a theory of the firm which formally incorporates uncertainty. Though only partially developed, such a theory is now available.Sandmo (23), Leland (1 l), Lintner (16), and others in their pioneering works developed the implications of stochastic demand for enterprise optimization. They focused on the effects of uncertainty on a risk averse firm maximizing its utility. Their development implicitly ruled out the firm's participation in external capital markets as Hite (7) points out. These works lead to the models of Long and Racette (17) and Hite (6) which incorporate both capital markets and stochastic demand into the firms operating and investment decisions. The Sharpe (24), Lintner (1 S), Mossin (21) Capital Asset Pricing Model (CAPM) is used to model the capital markets. Though the CAPM imposes rather restrictive assumptions on the capital market structure, this framework allows detailed investigation into the impact of output and investment decisions on risk, equilibrium rates of return, and firm value. This paper focuses on the behaviour of equilibrium rates of return. Since, in the context of the model, it is generally accepted that an optimizing firm should maximize value, this focus requires some justification.That is, one can relate firm decisions directly to the value maximization criterion without stopping to discuss equilibrium rates of return. We feel that our focus serves two important purposes. On a theoretical level, relating the required rate of investment and output allows direct assessment of the impact of managerial decisions on the risk of the firm as specified by the CAPM. On a more pragmatic level, we recognize that required rates of return are of more than passing interest to finance practitioners. The value of an asset is most often assessed by computing the present value of expected future cash flows using some risk-adjusted discount rate as an essential element of the calculation. Our analysis shows that it is not only financing policy which should be considered when establishing the appropriate discount rate. The level of output and the size of investment may be equally important.

show abstract

Market Equilibrium and Corporation Finance: Some Issues

Cited by 5 publications

References 19 publications

The Relationship Between Market and Accounting Betas for Commercial Banks

The Relationship Between Market and Accounting Betas for Commercial Banks

The Theoretical Relationship Between Systematic Risk and Financial (Accounting) Variables

Stochastic Demand and the Equity Capitalization Rate

Contact Info

Product

Resources

About