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What Is a Firm's Life Expectancy? Empirical Evidence in the Context of Portuguese Companies
Abstract
It isa fact that the uncertainty about a firm's future has to be measured and incorporated into a company's valuation throughout the explicit analysis period - in the continuing or terminal value within valuation models. One of the concerns that can influence the continuing value of enterprises, which is not explicitly considered in traditional valuation models, is a firm's average life expectancy. Although the literature has studied the life cycle of a firm, there is still a considerable lack of references on this topic. If we ignore the period during which a company has the ability to produce future cash flows, the valuations can fall into irreversible errors, leading to results markedly different from market values. This paper aims to provide a contribution in this area. Its main objective is to construct a mortality table for non-listed Portuguese enterprises, showing that the use of a terminal value through a mathematical expression of perpetuity of free cash flows is not adequate. We provide the use of an appropriate coefficient to perceive the number of years in which the company will continue to operate until its theoretical extinction. If well addressed regarding valuation models, this issue can be used to reduce or even to eliminate one of the main problems that cause distortions in contemporary enterprise valuation models: the premise of an enterprise's unlimited existence in time. Besides studying the companies involved in it, from their existence to their demise, our study intends to push knowledge forward by providing a consistent life and mortality expectancy table for each age of the company, presenting models with an explicitly and different survival rate for each year. Moreover, we show that, after reaching a certain age, firms can reinvent their business, acquiring maturity and consequently postponing their mortality through an additional life period.
... Life cycle management has been applied to pharmaceuticals (Modi 2017), agriculture (Ortiz-R et al. 2014;Ruviaro et al. 2012), real estate (Ristimäki and Junnila 2015), electronic systems (Hammer 1981), the health sector (Daidoji et al. 2013), corporate life cycles and their cyclical movements (Pai et al. 2014;Reis and Augusto 2015;Habib and Hasan 2018), knowledge management (Evans and Ali 2013), activity based costing (ABC) (Kallunki and Silvola 2008), the construction industry (Gundes 2016), in inventory management (Elsayed and Wahba 2016), the strategic planning methodology (Kniazieva et al. 2018), financial reporting Habib and Hasan (2018), and to SMEs (Kurczewski 2013). ...
This article investigates the suitability of 13 investor sentiment proxies as causal explanations for monthly stock returns of the European S&P 350 constituents over 45 years. We analyzed a sample of 362 companies covering 16 European countries. Analyses incorporate multiple categories of investor sentiment arising from market or survey data, as well as technical analysis, risk measures, company fundamentals and macroeconomic variables. In addition, we provide an extended review of sentiment proxy measures based on market data. This work applied general model of moments (GMM) to dynamic panel data to estimate short-run and long-run influences along with Granger causality. Our findings demonstrate the role of several investor sentiment measures in predicting stock returns even after controlling for variables such as fundamentals, macroeconomic, market and technical analysis. Together, sentiment measures of implied volatility in stock options, such as VIX and VSTOXX, put and call ratios, gold, government bond yield spreads, mispricing along with economic and confidence sentiment indicators can significantly predict how irrational behaviors of investors can determine stock returns. Co-movements between markets provide further evidence of contagion. Considering the unobservable nature of sentiment, we provide a set of sentiment proxies, and reveal new measures such as gold, government yields spread and a mispricing ratio, that serve to predict European market returns. Furthermore, to our knowledge this study is one of the few studies to apply time dynamic panel data estimation to a large set of sentiment proxies and a set of complete control variables in a long-term framework.
Topics:
1. The perpetual growth rate and firm mortality
2. The relationship between capital expenditures and depreciation
3. The appropriate treatment of amortization
4. Projections, normalization, and steady state growth
5. The trend toward using lower long-term growth rates
6. The relevance of multiples for terminal value
This presentation examines several factors that impact
terminal value and how to address them: (i) the final year of the projection, (ii) the trend toward using lower long-term growth rates, (iii) the “perpetual” growth rate and firm mortality, (iv) the use of multiples for terminal value, (v) the relationship between capital expenditures and depreciation, and (vi) the appropriate treatment of amortization
Topics:
1. The perpetual growth rate and firm mortality
2. The relationship between capital expenditures and depreciation
3. The appropriate treatment of amortization
4. Projections, normalization, and steady state growth
5. The trend toward using lower long-term growth rates
6. The relevance of multiples for terminal value
span style="font-family: "Times New Roman","serif"; font-size: 10pt; mso-fareast-font-family: 'Times New Roman'; mso-fareast-language: EN-US; mso-ansi-language: DA; mso-bidi-language: AR-SA;" lang="DA">This study focuses on methodological errors that arise when firm valuation is carried out in practice. Violation of assumptions underlying the valuation models are examples of methodological errors. We analyze valuation spreadsheets from five Danish financial institutions (i.e., stockbrokers and corporate finance departments) in order to trace if firm valuation models are properly applied. We conclude the following: (i) Methodological errors often cause valuation models to generate estimates that differ significantly from the theoretically correct value; and (ii) Firm value estimates were biased due to a variety of methodological errors. The implications of those errors may be significant. Investors are exposed to poor recommendations. Financial institutions such as investment bankers and stockbrokers may be exposed to bad reputation and lawsuits. Accounting firms that do not carry out firm valuation correctly (for example in testing goodwill for impairment) also run the risk of litigations.
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The most widely used model in multivariate analysis of survival
data is proportional hazards model proposed by Cox. While it is easy
to get and interpret the results of the model, the basic assumption of
proportional hazards model is that independent variables assumed
to remain constant throughout the observation period. Model can
give biased results in cases which this assumption is violated. One
of the methods used modelling the hazard ratio in the cases that the
proportional hazard assumption is not met is to add a time-dependent
variable showing the interaction between the predictor variable and
a parametric function of time. In this study, we investigate the factors
that affect the survival time of the firms and the time dependence of
these factors using Cox regression considering time-varying variables.
The firm data comes from Business Development Centers (İŞGEM)
which is a prominent business incubation center operating in Turkey.
The value of an asset is equal to the present value of its expected future cash flows. It is affected by the magnitude, timing
and riskiness, or volatility, of the cash flows. We hypothesize that if the expected values of two assets’ cash flows are
equal, the value of the asset with more volatile cash flows will be lower. Furthermore, we examine the impact of the volatility
of cash flows on the volatility of prices. We consider a simple experimental environment where subjects trade in an asset
which provides dividends from a known probability distribution. The expected value of the dividends is identical in all experimental
treatments. The treatments vary with respect to the volatility of dividends. We find that when dividends are more volatile,
transaction prices are lower. We also find that the volatility of prices is lower in the treatment with highly volatile dividends.
In addition, as expected, trading volume is lower when cash flows are less volatile.
KeywordsEfficient market hypothesis–Cash flow volatility–Price volatility–Experimental economics
This paper matches the sensitivity analysis of two-stage DCF models to the assumption of Long Term Steady-State. It proposes the definition of ‘Joint Sensitivity’ that measures the effect on the firm’s value of joint variations of more input parameters. The duration of the first stage of explicit forecast is one of the most important of these parameters. The assumptions leading to the definition of such length is that the company exhausts in that year its competitive advantage over the competitors and begins a period of Steady-State. So, the end of the Competitive Advantage Period, defined as the period during which the return on capital can be higher than its cost, coincides with the end of the first stage of explicit forecast of the DCF. This paper proposes an instrument (Excess Return) that measures the theoretical reliability of a valuation by verifying if the return on invested capital is asymptotically equal to its average cost.
We survey 356 valuation experts across 10 European countries with CFA or equivalent designation to gain some insights into their valuation practices. We find that while most experts use both Discounted Cash Flow (DCF) and Relative Valuation (RV) models, their assumptions and estimation methods for almost all inputs in models vary widely. For example, 65% (35%) use less (more) than three-year historical data for beta estimation; 58% (42%) use ex-post (ex-ante) market risk premium with subjective size or liquidity risk adjustments; 40% (29%) use market (book) value weights for WACC, and about 50% estimate Terminal Value by discounting a normative cash flow until infinity whereas others employ a decreasing cash flow or a multiple approach. In RV application, Firm Value/EBITDA is the most popular multiple used by 83% of experts, followed by PE (68%), Price-to-Book (45%), Firm Value/EBIT (45%), and Firm Value/Sales (45%). About half of respondents have also modified their discount rate, country risk, or liquidity risk estimation in the wake of the 2008 financial crisis. These wide disparities indicate that two valuation experts could arrive at substantially different valuation estimates, despite using the same model. While most disparities arise because theory provides little guidance on estimation, some are also a result of practitioners not following theoretical guidelines, such as using book value weights or not adjusting historical betas to make them forward looking. Our findings suggest that a serious debate is needed between academics and practitioners to make the valuation framework more “practical”.
In this study we examine whether corporate governance influences a firm's innovative success and if so, how this association is moderated by the life cycle stage of the firm. Innovative success is a broad term and is difficult to measure. Based on Mansfield (1981) we trichotomize 'innovative success' into three components, namely, technical (measured by number of patents received), commercial (measured by sales growth) and economic success (measured by Tobin's Q as based on Mansfield (1981)). We use a sample of electronic firms in Taiwan which invested in research and development covering the years 2001-2009. We find that higher levels of corporate governance have a significant effect on two components of innovative success, namely, patent productivity and a firm's value but not on commercial success as measured by sales growth. We also find that the influence of corporate governance on the three components of innovative activity is most pronounced when the firm is in the stagnant stage of its respective life cycle and least pronounced when the firm is in the growth stage. Our study adds to the discussion on the importance of corporate governance by showing that while it has a positive influence on innovative activity, its impact is contingent on the stage of the firm in its respective life cycle.
In the course of work undertaken as members of the Executive Committee of the Continuous Mortality Investigation Bureau in the preparation of graduated tables of mortality for the experiences of 1979–82, we have had occasion to make use of and develop a number of statistical techniques with which actuaries may not be familiar, and which are not fully discussed in the current textbook by Benjamin & Pollard (1980), though some of them have been referred to in previous papers by the CMI Committee (1974, 1976). We therefore felt that it would be useful to the profession if we were to present these methods comprehensively in one paper. We do this with the permission of the other members of the CMI Committee, who do not, however, take responsibility for what follows, whether good or bad.
Financial distress prediction (FDP) has always been an important issue in the business and financial management. This research proposed a novel multiple classifier ensemble model based on firm life cycle and Choquet integral for FDP, named MCELCCh-FDP, as a new approach to tackle with financial distress. Empirical study based on Chinese listed companies’ real data is conducted, and the results show that the proposed MCELCCh-FDP model has higher prediction accuracy than single classifiers. In order to verify the prediction capability of firm life cycle and Choquet integral in FDP model, comparative analysis is conducted. The experiment results indicate that the introduction of firm life cycle and Choquet integral in FDP can greatly enhance prediction accuracy.
Pre-warning of whether a corporate will fall into a decline stage in the near future is an emerging issue in financial management. Improper decision-making by firms incurs a higher possibility to cause financial crisis (distress) and deteriorates the soundness of financial markets. The aim of this study is to establish a novel prediction mechanism based on combining the sampling technique (synthetic minority over-sampling technique; SMOTE), feature selection ensemble (original, intersection, and union), extreme learning machine (ELM) ensemble and decision tree (DT). The proposed model – namely, the multiple extreme learning machines (MELMs) – shows promising performance under numerous assessing criteria, but one critical defect of the ensemble classifier is that it lacks comprehensibility. Thus, we perform a DT as the knowledge generator to extract the inherent information from the ensemble mechanism. This knowledge visualized process can assist decision makers in efficiently allocating limited financial resources and to help firms survive in an extremely competitive environment.
Some textbooks and a just a couple of articles address the problems of evaluation of so called terminal value. The term terminal value describes the value of certain set of company's capital at the point in the time, from which the company is assumed to be stable in the terms of profit growth and investments or to converge by a stable rate to the "stable state". Much of the attention is concentrated on the estimation of cost of capital.We concentrated on the other parameters of terminal value. If we accepted the assumptions that since certain point in time a company is "stable" in terms of ratio of profit to a set of capital to which the profit is attributable, that investors employ the Gordon's formula for evaluation of such a company at that point of time and finally that markets are efficient in the weak form, the proper formula for terminal value estimation is ratio of profit (earnings) attributable to that set of capital to the required return on that set of capital, but only if one complies with the condition that return on the evaluated set of capital at the time to which the terminal value is estimated, is equal to the required return rate. We derive this solution on the general conceptual framework, however the steady state validity conditions can be extended to ratio of any two items of balance sheet or income statement.
Traditional firm valuation discounts forecasted cash consequences that are understood as expected values under some scenario. It is not clear how, and to what extent, uncertainty is incorporated in the valuation. This paper constructs a new valuation model where uncertainty, in particular, bankruptcy risk, is explicitly included. At the end of each year, there is a jump to one of three possible states of the world at the end of the following year. A state is a combination of sales revenue for the firm being valued and return on the market index. The third state implies bankruptcy for the firm. The new model includes both the non-steady-state explicit forecast period and the steady-state post-horizon period and derives consistent values for the unlevered firm, the debt, the equity, the tax shields, and the levered firm. All discount rates, and the promised debt interest rate, are derived endogenously using CAPM. The model structure, in particular the manner in which sales revenue serves as driving variable, implies that one needs to perform only one discounting operation for each year, like in Fama 1977. A small annual bankruptcy probability is seen to lead to a noticeable value decrease. This paper also contains a discussion of where the bankruptcy risk is concealed in traditional firm valuation. The good news is that bankruptcy risk can actually be included in traditional firm valuation, at least approximately, by forecasting expected growth rates and discount rates that take into account the bankruptcy risk.
The record merger and acquisition activity of 2006 and 2007 ushered in renewed criticism of fairness opinions. The focus of this research is to determine whether a fairness opinion and its accompanying proxy statement provide information required for shareholders to conclude on the inherent value of the company. Our study of 105 fairness opinions supports the criticism placed on fairness opinions. We find that financial advisors provide partial information to shareholders as to the inputs used in their valuation models and similar to academic scholars, they varied greatly in their application of valuation methodologies. Shareholders are provided little information as to the inherent value of the company.
Do family firms rise and decline in three generations? Not only since Thomas Mann's “The Buddenbrooks” has the survival rate of family firms intrigued family business scholars, practitioners and consultants. In this article, we trace the family firm survival rate to its roots and discuss its empirical basis and univocal reading. We then ask how the mortality of family businesses could be measured, and which contextual factors need to be taken into account. To this end we explore the literature on firm demography, a field which is particularly concerned with age and mortality, and identify crossroads with family business studies. We conclude by suggesting a re-conceptualization of survival rates within a larger firm demographic research framework.
The development of a ‘law of mortality’, a mathematical expression for the graduation of the age pattern of mortality, has been of interest since the development of the first life tables by John Graunt (1662) and Edmund Halley (1693). Although Abraham De Moivre proposed a very simple law as early as 1725 the best known early contribution is probably that of Benjamin Gompertz (1825). Since World War II mathematical formulae have been used to graduate sections of the English Life Tables, as well as assured lives mortality, and pensioner and annuitant mortality. Reviews of attempts at finding the ‘law of mortality’ have been given by Elston and Benjamin and Haycocks.
Purpose
The purpose of this paper is to discuss the questions arising from the use of discounted cash flow (DCF) method in the context of the valuation of a Portuguese subsidiary of a German firm. The process ended up in courts. Expert valuation was called. Two points are of particular relevance. First, given the past performance of the company and the external environment it faced, what would be a reasonable growth rate for free cash flow in the residual value period. Second, what questions arise form the assumption of seeing the subsidiary as a going concern, given that the German parent company had been opening new factories in India, China, Romania and Slovakia, and its presence in Portugal was far from guaranteed.
Design/methodology/approach
The paper is based on case study which rests on a real legal and financial business situation. The case is used to illustrate the conceptual questions related to the use of the DCF method in valuing closely held firms, particularly the very significant impact of terminal value in the process of equity valuation.
Findings
It was found that very small variations in the growth rate assumed for the residual value period make a great difference in share valuation. Thus, the work of experts had to be very finely balanced, and the judge, when deciding on the fair value to be paid to the plaintiff based on expert opinion, should give careful consideration to scenarios.
Practical implications
A relevant point of the paper is to highlight the effect on business valuation of potential growth rates forecasted for the perpetual growth phase. That rate is, in this case influenced by eventual location changes that can result from globalization of industrial activity. Portuguese shareholders in foreign controlled joint ventures, and all the other stakeholders are facing important challenges from a new world economic order, and this case clearly illustrates some characteristics of this trend.
Originality/value
The paper is useful for managers that deal with business valuation cases that end in courts, by highlighting cash flow based methods and its central assumptions, and exploring critical areas that influence the final outcome of a lawsuit that is based on differences of hypothesis used in financial forecasting.
Contenido: 1. El valor de la empresa y la misión del director: ¿Por qué valorar el valor?; El gestor del valor; Principios fundamentales para la creación de valor; Los parámetros de medida: cómo sobrevivir al bombardeo de parámetros de medida del valor; El cash flow manda; Cómo generar valor; Fusiones, adquisiciones y joint ventures; ; 2. Valoración por el cash flow: una guía para profesionales: Esquemas para la valoración; Análisis de los rendimientos históricos; Estimación del coste de capital; Previsión de los resultados; Estimación del valor residual; Cálculo e interpretación de los resultados; 3. Aplicar la valoración: Valoración de empresas multinegocio; Valoración de las dot.com; Valoración de empresas cíclicas; Valoración de filiales extranjeras.
The analysis of censored failure times is considered. It is assumed that on each individual are available values of one or more explanatory variables. The hazard function (age‐specific failure rate) is taken to be a function of the explanatory variables and unknown regression coefficients multiplied by an arbitrary and unknown function of time. A conditional likelihood is obtained, leading to inferences about the unknown regression coefficients. Some generalizations are outlined.
We investigate the relative roles of key components of earnings change in explaining the value relevance of earnings across different life-cycle stages of the firm. We hypothesize that firms in different life-cycle stages take different strategic actions: change in sales is emphasized in the growth and mature stages, while in later stages, profitability is emphasized. Because payoffs to such strategies vary across the life-cycle, the stock market reaction to the success firms have in employing these strategic actions is likely to vary across the life-cycle. To test our hypotheses, we disaggregate changes in earnings into three key components: earnings change from change in sales, earnings change from change in profitability, and an interaction term comprising both sales change and profitability change. Our findings are consistent with our hypotheses: when firms are in the growth stage, the value-relevance of change in sales is relatively greater than that of change in profitability. In the mature stage, the value relevance of change in profitability increases, relative to that of change in sales. When firms are in stagnant stage, the value-relevance of changes in profitability are relatively greater than that of change in sales. Collectively, the results demonstrate a shift in the value relevance of earnings components from a growth emphasis early in the life-cycle to a profitability emphasis later in the life-cycle.
In the discounted cash flow model, free cash flow can be viewed as composed of four components: (i) after-tax sales revenue minus cash operating expense, minus (ii) increase in working capital, minus (iii) capital expenditures, plus (iv) tax savings from depreciation. It is unproblematic (although perhaps unimaginative) to forecast the first two components as constant proportions of sales revenue. The same does not hold for the last two components. Due to the long life of property, plant, and equipment (PPE), capital expenditures and tax savings from depreciation, which are derived from net PPE and depreciation, depend not only on the current revenue level, but also on the company's past growth history. Naive forecasting of net PPE and depreciation (meaning, in particular, that net PPE is a constant proportion of sales revenue) can noticeably bias the valuation result when the company expects rapid real growth in the initial explicit forecast period years, but only moderate (or no) real growth in the post-horizon period. This paper shows how net PPE and depreciation can be forecasted in an approximate fashion without explicit knowledge of the company's plans for capital expenditures. A stylized example is used throughout, in particular for demonstrating the effect of naive forecasting.
This paper investigates how firms' borrowing costs evolve as they age. Using a new panel data set of about 100,000 bank-dependent small firms for 1997-2002 and focusing on the channel of "adaptation" (i.e., surviving firms' borrowing costs decline as they age) and that of "selection" (i.e., total borrowing costs decline as defaulting firms exit), we find that the reputation hypothesis suggested by Diamond (1989) provides a more plausible explanation of the downward sloping age profile of borrowing costs than the firm dynamics (Cooley and Quadrini, 2001) or the relationship banking (Boot and Thakor, 1994) hypothesis. In addition, we examine whether the firm selection process in Japan has been natural or unnatural. Our findings suggest that it has been natural in that firms with lower quality are separated, face higher borrowing costs, and are eventually forced to exit, which contrasts with the results of previous studies on credit allocations in Japan, including Peek and Rosengren (2005). Further, we find that the evolution of borrowing costs is partially due to selection but is mainly attributable to adaptation.
Publicly Traded Equivalent ValueDiscounts for lack of Marketability and Discount for lack of LiquidityBenchmarking Methods
Empirical StudiesLiquidity as a Pricing FactorDistinction between Holding Period and Liquidation PeriodQuantitative Approaches based on CAPM and Time ValueHistoricalMarket Liquidity StatisticsPrice Pressure and Market failureMeasuring Asset LiquidityApplication of Time/Volatility (Option) Models to Discount for Lack Of LiquidityThree Option based ModelsBlack-Scholes put (BSP)Average Price Asian Put (AAP)Look Back Put (LBP)Conclusions
References
Using the life table method, we analyzed in this paper the survival of enterprises that were established from 1980 to 2007 in the Hunan province. Based on the quantile indicators, the average remaining firm lifespan in the specified period of time and the average survival time during a specific period of time, we conducted a comparative study using enterprises associated with different cities, industries, capital sizes, types of ownership and periods of establishment. The results show that there are great differences in firm survival that correlate with differences in city affiliation, industry, capital size, ownership type and period of establishment. Survival of Chinese enterprises is affected not only by the location of the business, the industry and the capital scale, which are usual players in the classical theory of industrial organization, but also by the nature of ownership and the time of establishment, which are determined by China's national context.
This paper investigates business failure of new firms. Using a multiplicative hazards model, we estimate the determinants of business failure among new manufacturing firms in Tokyo during the period 1986 to 1994. It is found that a new firm without sufficient capital or a sufficient size has a higher risk of business failure. It is also found that the new firm tends to have more difficulty surviving in an industry characterized by a high entry rate. With respect to the timing of entry, the new firm that entered just before or after the collapse of the so-called bubble economy has been more likely to fail. Furthermore, we estimate a regression model based not only on age but also on calendar time. By using a regression model based on calendar time, it is found that the firm's age has been related to business failure.
Consistent with a life-cycle theory of dividends, the fraction of publicly traded industrial firms that pay dividends is high when retained earnings are a large portion of total equity (and of total assets) and falls to near zero when most equity is contributed rather than earned. We observe a highly significant relation between the decision to pay dividends and the earned/contributed capital mix, controlling for profitability, growth, firm size, total equity, cash balances, and dividend history, a relation that also holds for dividend initiations and omissions. In our regressions, the mix of earned/contributed capital has a quantitatively greater impact than measures of profitability and growth opportunities. We document a massive increase in firms with negative retained earnings (from 11.8% of industrials in 1978 to 50.2% in 2002). Controlling for the earned/contributed capital mix, firms with negative retained earnings show virtually no change in their propensity to pay dividends from the mid-1970s to 2002, while those whose earned equity makes them reasonable candidates to pay dividends have a propensity reduction that is twice the overall reduction in Fama and French [2000, Journal of Financial Economics 76, 549–582]. Finally, our simulations show that, if well-established firms had not paid dividends, their cash balances would be enormous and their long-term debt trivial, thus granting extreme discretion to managers of these mature firms.
The aim of this paper is to shed some light on industry dynamics in Italy. For this purpose we use a large and comprehensive longitudinal data base, identifying the start-up of new manufacturing firms and their subsequent post-entry performance. This enables us to link the survival and growth of firms in each manufacturing industry specifically to their start-up size. While in a tobit regression (at the two-digit level) we find no evidence to link start-up size with survival, the growth rates are negatively and significantly correlated with initial size. As in previous studies dealing with other countries, this evidence suggests that Gibrat's Law fails to hold, at least for small, new-born manufacturing firms.
We investigate the impact of corporate life cycle on takeover activity from the perspective of acquiring firms. Using the earned/contributed capital mix as the proxy for firm life cycle, we find a highly significant and positive relation between firm life cycle and the likelihood of becoming a bidder. This finding is, however, driven by the mature rather than the old acquirers in the sample. Further we find that, whilst firm life cycle has a positive effect on the probability that a deal will be negotiated, it is negatively related to tender offers. In addition, the likelihood of making both cash and mixed deals are positively related to the corporate life cycle. Finally, we find that life cycle has a negative impact on the abnormal returns generated on the announcement of a deal although it is unable to distinguish between the returns received by firms at different stages in their life cycle.
Proposes a theory that explains why smaller firms have higher and more variable growth rates than larger firms. Relying on employer heterogeneity and market selection to generate patterns of employer growth and failure, the model states that efficient firms grow and survive while inefficient firms decline and fail, regardless of firm size. However, firms that fail are actually firms that, if given more time to succeed, would have grown more slowly. These slow growing firms are most often smaller firms. Also provided is a behavior characterization of entry and prices in equilibrium, which is defined as a pair of functions that characterize optimal output and exit behavior of firms. (SFL)
Neither the literature of finance nor the literature of valuation practitioners has taken account of the relatively short life expectancy of firms. Fewer than fifty percent of new firms live longer than ten years; yet, it is common practice to estimate firm value with a very long term horizon model such as the constant growth model. The purpose of this paper is to increase awareness of the life expectancy of firms and show how to take account of the likelihood of firm death in valuation. Data on firm death rates and life expectancy that is available in the field of industrial organization is reviewed and summarized so that valuation practitioners can take it into account in their valuations.
A limitation of Audretsch's 1991 study of new-firm survival was the level of aggregation to industries. This precluded linking establishment-specific characteristics, such as organizational structure and size, to post-entry performance. The purpose of this paper is to relate the post-entry performance of individual establishments not only to their technological and market structure environments, but also to establishment-specific characteristics. We do this by estimating a hazard duration function for more than 12,000 individual establishments in U.S. manufacturing started in 1976 by tracking their subsequent performance over a ten-year period. We conclude that establishment-specific characteristics, which Audretsch was not able to capture in his earlier study, play an important role in shaping the exposure to risk confronting new establishments. Copyright 1995 by MIT Press.
The survival rates of over 11,000 firms established in 1976 are compared across manufacturing industries. The variation in ten-year survival rates across industries is hypothesized to be the result of differences in the underlying technological regime and industry-specific characteristics, especially the extent of scale economies and capital intensity. Based on 295 four-digit standard industrial classification industries, new-firm survival is found to be promoted by the extent of small-firm innovative activity. The existence of substantial scale economies and a high capital-labor ratio tends to lower the likelihood of firm survival. However, these results apparently vary considerably with the time interval considered. Market concentration is found to promote short-run survival, while it has no impact on long-run survival. Copyright 1991 by MIT Press.
This paper examines the patterns of postentry employment growth and failure for over 200,000 plants that entered the U. S.
manufacturing sector in the 1967–1977 period. The postentry patterns of growth and failure vary significantly with observable
employer characteristics. Plant failure rates decline with size and age as do the growth rates of nonfailing plants. The expected
growth rate of a plant, which depends on the net effect of these two forces, declines with size for plants owned by single-plant
firms but increases with size for plants owned by multiplant firms.
This paper gives an empirical analysis of determinants of new-firm survival in the manufacturing sector of Baden-Wuerttemberg (Germany) from 1981 to 1994. The analysis focuses on firm- and industry-specific determinants of new-firm survival. A possible effect of regional agglomeration and of the business cycle is also tested, albeit in a very general manner. From a methodical point of view parametric and semiparametric duration models are used. Grouped duration models are estimated taking into account the problem of ties. Moreover, the problem of unobserved heterogeneity is considered which has so far been neglected in numerous studies. The empirical analyses show with respect to industry-specific effects that the risk of new-firm failure is the larger the larger an industry’ s minimum efficient scale is, the worse the sectoral demand-conditions are, the more narrow the market is, the higher dynamics of foundation within an industry are. The liability of smallness-hypothesis is confirmed for German manufacturing while with respect to firm age the results favour the liability of adolescence-hypothesis instead of a pure liability of newness. Copyright Springer 2007
Based on a longitudinal database we test the "liability of adolescence" hypothesis which states that new firm hazard rates follow an inverted U-shaped pattern. That is, the hazard rate is low for the initial period; the end of adolescence is marked by a hazard maximum, from which the rate declines monotonically. We use a log-logistic model which shows that the "liability of adolescence" argument describes the hazard rates of new establishments for all two and three-digit industries fairly well. Further, the rate shows that the desegregation of industries matters, and considerable differences are found within and across two and three-digit low-, moderate- and high-tech industries. In assessing the effect of market environment conditions on risk we find that risk to be elevated in a relatively large number of two-digit low- and high-tech industries in the presence of scale economies, but it is substantially reduced in moderate-tech industries. By contrast, the hazard rate tends to be reduced for quite a large number of three-digit low-, moderate- and high-tech industries in comparison with the two-digit industries, indicating a longer adolescence. The influence of start-up size in reducing the hazard rate is apparently similar between two and three digit low-, moderate- and high-tech industries. The impact of market growth on the risk of failure is not much different for both two and three-digit low-, moderate- and high-tech industries.
This paper examines the conditions necessary for calculating steady state terminal values in equity (company) valuation models. We make explicit use of the fact that a company's income statements and balance sheets can be modeled as a system of difference equations. From these difference equations, we derive conditions for steady state. The conditions ensure that the company remains qualitatively similar year by year after the valuation horizon and that it has a stable development of earnings, free cash flows, dividends and residual income. We show how steady state condition violations cause internal inconsistencies in valuation models and how this can have a substantial impact on the value estimates. Steady state is further a necessary condition for a free cash flow valuation, a dividend valuation and a residual income valuation to yield identical results when terminal values are used. The parameters of the model are common accounting and control concepts, and the derived conditions have accounting meaning, linking stock variables in the balance sheet with the flow variables in (and related to) the income statement.
Recent research uses census-type longitudinal data to establish many new facts about turnover, entry, and exit among competing firms. Mean regression fosters stable concentration levels. Entrants experience high infant mortality, but entry buys them options to expand. Changes in control resemble a job-matching process. These patterns are reconciled with traditional industrial organization based on equilibrium models to establish relative roles of random and structural determinants of concentration and the normative role of turnover in raising industry productivity and efficiency. The patterns vary little from country to country, except for less sunkenness (more mobility) in developing countries.
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
The forecasting of lease expense in valuation models like the discounted cash flow model and the discounted dividends model is more complex than the forecasting of non-lease cash operating expense. The reason is that lease expense depends on past real growth and inflation, due to the long lives of the leased assets, whereas non-lease cash operating expense depends only on this year's nominal sales revenue. For that reason, the recommendation is to capitalize operating leases, since that facilitates correct forecasting of lease expense. Naive forecasting (as if lease expense depends only on current nominal sales revenue) can have a noticeable impact on the calculated value of the equity, if the company is a heavy user of leased equipment and has experienced rapid real growth in recent years. An illustrative example is used throughout. This paper extends Jennergren 2008a and Jennergren 2008b.
The authors follow firms created in Portuguese manufacturing in 1983 and study the determinants of their lifetime. One fifth of them died during the first year of their lives and only 50 percent survived for four years. Duration and limited-dependent variable models are employed to ascertain the relative importance of industry- and firm-specific variables to in explaining the period between firm birth and its disappearance from economic activity. New firm failure varies negatively with firm start-up size, the number of plants operated by the firm, and the industry growth rate, and positively with the extent of entry in the industry. Copyright 1994 by Blackwell Publishing Ltd.
This paper shows that ten methods of company valuation using cash flow discounting (WACC; equity cash flow; capital cash flow; adjusted present value; residual income; EVA; business's risk-adjusted equity cash flow; business's risk-adjusted free cash flow; risk-free-adjusted equity cash flow; and risk-free-adjusted free cash flow) always give the same value when identical assumptions are used. This result is logical, since all the methods analyze the same reality based upon the same assumptions; they only differ in the cash flows taken as the starting point for the valuation. We present all ten methods allowing the required return to debt to be different from the cost of debt. Seven of them require an iterative process. Only the APV and business risk-adjusted cash flows methods do not require iteration.
A wave of empirical studies has recently emerged showing that smaller-scale entry is confronted with a lower likelihood of survival than their larger counterparts. The purpose of this paper is to examine whether the relationship between size of a firm when entering an industry and the likelihood of survival holds under different technological conditions and across the different stages of the industry life cycle. The empirical evidence suggests that the relationship between firm size and the likelihood of survival is shaped by technology and the stage of the industry life cycle. While the likelihood of survival confronting small entrants is generally less than that confronting their larger counterparts, the relationship does not hold for mature stages of the product life cycle, or in technologically intensive products. In mature industries that are still technologically intensive, entry may be less about radical innovation and possibly more about filling strategic niches, thus negating the impact of entry size on the likelihood of survival. Copyright 2001 by Blackwell Publishing Ltd