2013 - Reprints: Finance, Accounting and Insurance
Non-marketability and the value of employee stock options, Journal of Banking and Finance, 37(12), 5500-5510, 2013.
M. Abudy and S. Benninga
(Reprint No. 257)
We adapt the Benninga et al. (2005) framework to value employee stock options (ESOs). The model quantifies non-diversification effects, is computationally simple, and provides an endogenous explanation of ESO early-exercise. Using a proprietary dataset of ESO exercise events we measure the non-marketability ESO discount. We find that the ESO value on the grant date is approximately 45% of a similar plain vanilla Black-Scholes value. The model is aligned with empirical findings of ESOs, gives an exercise boundary of ESOs and can serve as an approximation to the fair value estimation of share-based employee and executive compensation. Using the model we give a numerical measure of non-diversification in an imperfect market.
Production and hedging implications of executive compensation schemes, Journal of Corporate Finance, 19, 119-139, February 2013.
S. Akron and S. Benninga
(Reprint No. 256)
This paper connects executive compensation with hedging and analyzes a crucial shareholders and managers agency source that evolves from the pricing of the hedging device. The shareholders are risk-neutral, while the risk-averse manager hedges the price risk of the manufactured quantity, and his compensation package includes equity-linked compensation-stock grants. Only when the hedging instrument's pricing includes a risk premium, is hedging costly to the shareholders, while it is costless to the manager. Then from the owners' point of view, we observe managerial over-hedging, increasing in the equity-linked compensation level. This result leads to a violation of the classical production and hedging separation theorem. We conclude that, in the case where the hedging device's pricing bears a risk premium, shareholders can regulate the corporate value diversion to managers through diminishing the managerial equity-linked compensation scheme or by putting restrictions on the extent of hedging activities of executives.
Extracting sustainable earnings from profit margins, European Accounting Review, 22(4), 685-718, 2013. DOI:10.1080/09638180.2012.749067
E. Amir, E. Einhorn and I. Kama
(Reprint No. 245)
Revenues and expenses are fundamentally proportional to one another, but are likely to be disproportionally affected by transitory items or economic shocks. We build on this observation and propose a new measure of sustainable earnings based on deviations from normal profit margins. While some other sustainable earnings metrics attempt to identify transitory components on a line-by-line basis, our measure, referred to as the intensity of core earnings (ICE), uses ratio analysis to extract the transitory portion of earnings from all line items. We find that the ICE, as measured here, is positively associated with earnings persistence, better earnings predictability, and stronger market reaction to unexpected earnings. We also find that our measure is positively associated with post-earnings announcement excess stock returns. Comparing our measure with an accrual-based measure of earnings quality, we find that, in general, the two metrics provide distinct incremental information relative to one another and in some instances our measure is better than an accrual-based measure in assessing earnings quality.
The world business cycle and expected returns, Review of Finance, 17(3), 1029-1064, 2013.
I. Cooper and R. Priestley
(Reprint No. 234)
Research No. 00500100
We study the predictability of stock returns using a pure macroeconomic measure of the world business cycle, namely the world’s capital to output ratio. This variable tracks variation in expected stock returns in a group of the major industrial economies in the presence of world financial market–based predictor variables. The world’s capital to output ratio exhibits strong out-of-sample predictive power in almost all countries studied. This is in contrast to financial market–based variables that almost never have out-of-sample forecasting power. Using the stock return predictability that we uncover, we find that international versions of conditional asset pricing models perform well. The world capital to output ratio also predicts bond returns, interest rate changes, and credit spreads. The results highlight the importance of world business conditions for financial markets.
Do earnings targets and managerial incentives affect sticky costs?, Journal of Accounting Research, 51(1), 201-224, 2013 doi: 10.1111/j.1475-679X.2012.00471.x
I. Kama and D. Weiss
(Reprint No. 233)
Research No. 02010100
This study explores motivations underlying managers' resource adjustments. We focus on the impact of incentives to meet earnings targets on resource adjustments and the ensuing cost structures. We find that, when managers face incentives to avoid losses or earnings decreases, or to meet financial analysts' earnings forecasts, they expedite downward adjustment of slack resources for sales decreases. These deliberate decisions lessen the degree of cost stickiness rather than induce cost stickiness. The results suggest that efforts to understand determinants of firms' cost structures should be made in light of the managers' motivations, particularly agency-driven incentives underlying resource adjustment decisions.
Information manipulation and rational investment booms and busts, Journal of Monetary Economics 60 408-425, 2013.
P. Kumar and N. Langberg
(Reprint No. 248)
A model of endogenous investment booms and busts with rational agents is presented where outside investors are uncertain about both industry (aggregate) and firm-specific capital productivity, and insiders manipulate information through strategic productivity disclosures. For intermediate and high levels of agency conflict, there are aggregate investment distortions along the equilibrium path, investment dynamics are history-dependent, and depict patterns of persistent investment booms or investment busts even though investors design optimal incentive contracts based on Bayes-rational beliefs. Moreover, the aggregate uncertainty may not be resolved in the limit, as the number of firms and disclosures gets arbitrarily large.
Earnings variability and disclosure of R&D: Evidence from press releases, Accounting and Finance, 53, 837-865, 2013.
D. Weiss, H. Falk and U. Ben Zion
(Reprint No. 269)
This study explores press releases in the pharmaceutical industry to expand our understanding of how investments in R&D outlays influence uncertainty of future earnings. The findings make two contributions to the literature. First, they provide evidence that equal investments in different R&D ventures are associated with differential variability of future earnings. This result suggests that non-financial information contained in press releases captures attributes of firm-specific R&D investments that are not revealed through R&D expenditures reported in financial statements. Second, prior studies have indicated that investments in pharmaceutical R&D are associated with the highest variability of future earnings among all industries. The results, however, suggest that for a large class of low-risk pharmaceutical R&D investments, the relative variability of future earnings is low and similar to that generated by capital expenditures. The findings hold when we control for endogeneity in voluntary disclosure of press releases.
