2010 - Working Papers: Finance, Accounting and Insurance
Portfolio optimization using a block structure for the covariance matrix, 31 pp.
D. Disatnik
(Working Paper No. 2/2010)
Implementing in practice the classical mean-variance theory for portfolio selection often results in obtaining portfolios with large short sale positions. Also, recent papers show that, due to estimation errors, existing and rather advanced mean-variance theory-based portfolio strategies do not consistently outperform the naïve 1/N portfolio that invests equally across N risky assets. In this paper, I introduce a portfolio strategy that generates a portfolio, with no short sale positions, that can outperform the 1/N portfolio. The strategy is investing in a global minimum variance portfolio (GMVP) that is constructed using an easy to calculate block structure for the covariance matrix of asset returns. Using this new block structure, the weights of the stocks in the GMVP can be found analytically, and as long as simple and directly computable conditions are met, these weights are positive.
Do managers’ deliberate decisions induce sticky costs? 42 pp.
I. Kama and D. Weiss
(Working Paper No. 6/2010)
This study explores motivations underlying managers' resource adjustments. We examine asymmetric costs resulting from current resource adjustments made intentionally to meet earnings targets under constraints set by past technology choices aimed to maximize firm value. Findings indicate that early technology choices induce cost stickiness in the absence of incentives to meet earnings targets. Costs exhibit greater stickiness in the presence of hard technological constraints than in the presence of weak technological constraints. However, resource adjustments made intentionally to meet earnings targets wash away, rather than induce, cost stickiness imposed by pre-determined technological constraints, resulting in symmetric costs. The findings suggest that some deliberate decisions induce sticky costs while other deliberate decisions diminish sticky costs depending on the underlying motivations.
Valuing employee stock options and restricted stock in the presence of market imperfections, 22 pp.
M Abudy and S. Benninga
(Working Paper No. 17/2010)
We develop a new technology for valuing financial assets such as employee stock options and restricted stocks. Our model takes explicit account of the non-diversification of the owner of the asset. The model is an extension of the common binomial pricing model and is relatively easy to implement. This paper explains the issues and uses a database of employee stock options to estimate the model parameters.
Biased voluntary disclosure, 38 pp.
E. Einhorn and A. Ziv
(Working Paper No. 20/2010)
We provide a bridge between the voluntary disclosure and the earnings management literature. Voluntary disclosure models focus on managers’ discretion in deciding whether or not to provide truthful voluntary disclosure to the capital market. Earnings management models, on the other hand, concentrate on managers’ discretion in deciding how to bias their mandatory disclosure. By analyzing managers’ disclosure strategy when disclosure is voluntary and not necessarily truthful, we show the robustness of voluntary disclosure theory to the relaxation of the standard assumption of truthful reporting. We also demonstrate the sensitivity of earnings management theory to the commonly made mandatory disclosure assumption.
Non-marketability and the value of equity based compensation, 32 pp.
M. Abudy and S. Benninga
(Working Paper No. 11/2009/R)
Research No. 01700100
This paper uses the Benninga-Helmantel-Sarig (2005) framework to value employee stock options (ESOs) and restricted stocks units (RSU) in a framework which takes explicit account of employee non-diversification in addition to the standard features of vesting and forfeit of the stock options. This framework provides an endogenous explanation of early exercise of employee stock options. Incorporating non-diversification, we find that the pricing model is aligned with empirical findings of ESOs and results in lower values compare to alternative employee option pricing models such the widely-used Hull-White (2004) model. This pricing has implication for the FAS 123(R) for estimating the fair value of equity based compensation.
Equity Valuation in the Presence of Accounting Noise: Empirical Evidence using Profit Margins, 54 pp.
E. Amir, E. Einhorn and I. Kama
(Working Paper No. 17/2009/R)
We investigate the way investors utilize accounting data in equity valuation in the presence of various sources of accounting noises that impede the persistence and the predictive value of reported earnings. Our empirical findings are consistent with the hypothesis that investors implement ratio analysis of disaggregated earnings data to imperfectly detect accounting noises of various types and adjust for them when pricing firms’ equity. In appears that investors look at deviations of reported earnings components from their expected fundamental ratios, using them as imperfect indicators of hidden nonrecurring earnings items arising from reporting manipulations, measurement biases and economic events of a transitory nature. These indicators assist investors to partially clear reported earnings of noises and elicit the persistent kernel of earnings as an improved basis for equity valuation. The empirical evidence also suggests that investors rely more heavily on this process of clearing accounting earnings of noises when pricing firms with relatively stable financial ratios.
