How Important is Financial Risk?
Introduction
The financial crisis of 2008 has brought significant attention to the effects of financial leverage. There is no doubt that the high levels of debt financing by financial in stituti ons and houholds sig nifica ntly con tributed to the crisis. In deed, evide nce indicates that excessive leverage orchestrated by major global banks (e.g., through the mortgage lending and collateralized debt obligations) and the so-called “ shadow banking system ” may be the underlying cau of the recent economic and financial dislocation. Less obvious is the role of financial leverage among nonfinancial firms. To date, problems in the U.S. non-financial ctor have been minor compared to the distress in the financial ctor despite the izing of capital markets during the crisis. For example, non-financial bankruptcies have been limited given that the economic decline is the largest since the great depression of the 1930s. In fact, bankruptcy filings of non-financial firms have occurred mostly in U.S. industries (e.g., automotive manu facturi ng, n ewspapers, and real estate) that faced fun dame ntal econo mic pressures prior to the financial crisis. This surprising fact begs the question, “ How important is financial risk for non-financial firms?” At the heart of this issue is the uncertainty about the determinants of total firm risk as well as components of firm risk.
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Recent academic rearch in both ast pricing and corporate finance has rekindled an interest in analyzing equity price risk. A current strand of the ast pricing literature examines the finding of Campbell et al. (2001) that firm-specific (idios yn cratic) risk has ten ded to in crea over the last 40 years. Other work suggests that idios yn cratic risk may be a priced risk factor (e Goyal and San ta-Clara, 2003, among others). Also related to the studies is work by P$tor and Veronesi (2003) show ing how inv estor un certa inty about firm profitability is an importa nt determ inant of idiosyncratic risk and firm value. Other rearch has examined the role of equity volatility in bond pricing (e.g., Dichev, 1998, Campbell, Hilscher, and Szilagyi, 2008).
However, much of the empirical work examining equity price risk takes the risk of astsas given or tries to explain the trend in idiosyncratic risk. In contrast, this paper takes a different tack in the investigation of equity price risk. First, we ek to un dersta nd the determ inants of equity price risk at the firm level by con sideri ng total risk as the product of risks in here nt in the firms
我在唯品会工作了四年operati ons (i.e., econo mic or bus in ess risks) and risks associated with financing the firms operations (i.e., financial risks). Second, we attempt to asss the relative importa nee of econo mic and finan cial risks and the implications for financial policy.清炖白条鸡
Early rearch by Modigliani and Miller (1958) suggests that financial policy may be largely irrelevant for firm value becau investors can replicate many financial decisi ons by the firm at a low cost (i.e., via homemade leverage) and well-fu nctio ning capital markets should be able to distinguish between financial and economic distress. Nonetheless, financial policies, such as adding debt to the capital structure, can magnify the risk of equity .In con trast, rece nt rearch on corporate risk man ageme nt suggests that firms may also be able to reduce risks and in crea value with finan cial policies such as hedging with financial derivatives. However, this rearch is often motivated by substantial deadweight costs associated with financial distress or other market imperfecti ons associated with finan cial leverage. Empirical rearch provides conflicting accounts of how costly financial distress can be for a typical publicly traded firm.
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We attempt to directly address the roles of economic and financial risk by exam ining determi nants of total firm risk. In our an alysis we utilize a large sample of non-financial firms in the United States. Our goal of identifying the most important determi nan ts of equity price risk (volatility) relies on viewi ng finan cial policy as transforming ast volatility into equity volatility via financial leverage. Thus, throughout the paper, we consider financial leverage as the wedge between ast volatility and equity volatility. For example, in a static tting, debt provides financial leverage that magnifies opera
ting cash flow volatility. Becau financial policy is determ ined by owners (and man agers), we are careful to exam ine the effects of firms ast and operating characteristics on financial policy. Specifically, we examine a variety of characteristics suggested by previous rearch and, as clearly as possible, dist in guish betwee n tho associated with the operati ons of the compa ny (i.e. factors determ ining econo mic risk) and tho associated with financing the firm (i.e. factors determ ining finan cial risk). We the n allow econo mic risk to be a determ inant of finan cial policy in the structural framework of Lela nd and Toft (1996), or alter natively, in a reduced form model of financial leverage. An advantage of the structural model approach is that we are able to account for both the possibility of financial and operati ng implicati ons of some factors (e.g., divide nds), as well as the en doge nous n ature of the ban kruptcy decisi on and finan cial policy in gen eral.
Our proxy for firm risk is the volatility of com mon stock returns derived from calculating the standard deviation of daily equity returns. Our proxies for economic risk are designed to capture the esntial characteristics of the firms 'perations and asts that determ ine the cash flow gen
erati ng process for the firm. For example, firm size and age provide measures of line of- bus in ess maturity; tan gible asts(pla nt, property, and equipment) rve as a proxy for the
‘ hardness ' of a firm ' s asts; capital expenditures measure capital intensity as well as growth potential. Operating profitability and operating profit volatility rve as measures of the timeliness and risk in ess of cash flows. To un dersta nd how finan cial factors affect firm risk, we exam ine total debt, debt maturity, divide nd payouts, and holdi ngs of cash and short-term in vestme nts.
The primary result of our analysis is surprising: factors determining economic risk for a typical company explain the vast majority of the variation in equity volatility. Correspondingly, measures of implied financial leverage are much lower than obrved debt ratios. Specifically, in our sample covering 1964-2008 average actual net financial (market) leverage is about 1.50 compared to our estimates of between 1.03 and 1.11 (depending on model specification and estimation technique). This suggests that firms may un dertake other finan cial policies to man age finan cial risk and thus lower effective leverage to n early n egligible levels. The policies might in clude dynamically adjusting financial variables such as debt levels, debt maturity, or cash holdings (e, for example, Acharya, Almeida, and Campello, 2007). In addition, many firms also utilize explicit financial risk management techniques such as the u of finan cial derivatives, con tractual arran geme nts with inv estors (e.g. li nes of credit, call provisi ons in debt con tracts, or con ti ngen cies in supplier con tracts), special purpo vehicles (SPVs), or other alter native risk tran sfer tech niq ues.
The effects of our econo mic risk factors on equity volatility are gen erally highly statistically sig nifica nt, with predicted sig ns. In additi on, the magn itudes of the effects are substantial. We find that volatility of equity decreas with the size and age of the firm. This is intuitive since large and mature firms typically have more stable lines of bus in ess, which should be reflected in the volatility of equity returns. Equity volatility tends to decrea with capital expe nditures though the effect is weak. Con siste nt with the predictions of Pastor and Veronesi (2003), we find that firms with higher profitability and lower profit volatility have lower equity volatility. This suggests that companies with higher and more stable operating cash flows are less likely to go bankrupt, and therefore are potentially less risky. Among economic risk variables, the effects of firm size, profit volatility, and divide nd policy on equity volatility sta nd out. Un like some previous studies, our careful treatme nt of the en doge neity of finan cial policy con firms that leverage in creas total firm risk. Otherwi, finan cial risk factors are not reliably related to total risk.桥这篇课文
Given the large literature on financial policy, it is no surpri that financial variables are,at least in part, determined by the economic risks firms take. However, some of the specific findings
十字街口are unexpected. For example, in a simple model of capital structure, divide nd payouts should in crea finan cial leverage since they repre nt an outflow of cash from the firm (i.e., in crea net d
ebt). We find that divide nds are associated with lower risk. This suggests that pay ing divide nds is not as much a product of financial policy as a characteristic of a firm ' operations (e.g., a mature company with limited growth opportunities). We also estimate how nsitivities to different risk factors have changed over time. Our results indicate that most relations are fairly stable. One exception is firm age which prior to 1983 tends to be positively related to risk and has since been consistently negatively related to risk. This is related to findings by Brown and Kapadia (2007) that recent trends in idiosyncratic risk are related to stock listings by younger and riskier firms.
Perhaps the most interesting result from our analysis is that our measures of implied financial leverage have declined over the last 30 years at the same time that measures of equity price risk (such as idiosyncratic risk) appear to have been increasing. In fact, measures of implied financial leverage from our structural model ttle n ear 1.0 (i.e., no leverage) by the end of our sample. There are veral possible reasons for this. First, total debt ratios for non-financial firms have declined steadily over the last 30 years, so our measure of implied leverage should also decli ne. Second, firms have sig nifica ntly in cread cash holdi ngs, so measures of net debt (debt minus cash and short-term investments) have also declined. Third, the composition of publicly traded firms has cha nged with more risky (especially tech no logy-orie nted) firms becoming publicly listed. Thes
e firms tend to have less debt in their capital structure. Fourth, as mentioned above, firms can undertake a variety of financial risk man ageme nt activities. To the exte nt that the activities have in cread over the last few decades, firms will have become less expod to finan cial risk factors.
We con duct some additi onal tests to provide a reality check of our results. First, we repeat our an alysis with a reduced form model that impos mi nimum structural rigidity on our estimation and find very similar results. This indicates that our results are unlikely to be driven by model misspecification. We also compare our results with trends in aggregate debt levels for all U.S. non-financial firms and find evidence con siste nt with our con clusi ons. Fin ally, we look at characteristics of publicly traded non-financial firms that file for bankruptcy around the last three recessions and find evidence suggesting that the firms are increasingly being affected by economic distress as oppod to finan cial distress.
Conclusion
In short, our results suggest that, as a practical matter, residual financial risk is now relatively
unimportant for the typical U.S. firm. This rais questions about the level of expected financial distress costs since the probability of financial distress is likely to be lower tha n com monly thought f
or most compa ni es. For example, our results suggest that estimates of the level of systematic risk in bond pricing may be biad if they do not take into acco unt the trend in implied finan cial leverage (e.g., Dichev, 1998). Our results also bring into question the appropriateness of financial models ud to estimate default probabilities, since finan cial policies that may be difficult to obrve appear to sig nifica ntly reduce risk. Lastly, our results imply that the fun dame ntal risks born by shareholders are primarily related to un derly ing econo mic risks which should lead to a relatively efficie nt allocati on of capital.
Some readers may be tempted to in terpret our results as in dicat ing that finan cial risk does not matter. This is not the proper in terpretati on. In stead, our results suggest that firms are able to man age finan cial risk so that the result ing exposure to shareholders is low compared to economic risks. Of cour, financial risk is important to firms that choo to take on such risks either through high debt levels or a lack of risk management. In contrast, our study suggests that the typical non-financial firm choos not to take the risks. In short, gross financial risk may be important, but firms can man age it. This con trasts with fun dame ntal econo mic and bus in ess risks that are more difficult (or un desirable) to hedge becau they repre nt the mecha nism
by which the firm earns econo mic profits.
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