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Topics. 29. Globalization, Corporate Finance, and the Cost of Capital R. M. Stulz. Globalization can increase firm value. Nestl é (A Swiss firm) Before November 1988 Bearer shares: Available for both local and foreign investors Registered shares: Available only for local investors

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  1. Topics • 29. Globalization, Corporate Finance, and the Cost of Capital R. M. Stulz Hu - Globalization

  2. Globalization can increase firm value • Nestlé (A Swiss firm) • Before November 1988 • Bearer shares: Available for both local and foreign investors • Registered shares: Available only for local investors • Same dividends, same voting rights • Registered shares price is only half of the bearer shares price Hu - Globalization

  3. Globalization can increase firm value • Nestlé (A Swiss firm) • November 17, 1988 • Company announced to remove ownership restriction • Announcement effect: • 36% for registered share and -25% for bearer share • 10% in total Hu - Globalization

  4. Globalization can increase firm value • 12 countries with capital market liberalization (Henry, 2000) • Average stock price increases 30% from four months before liberalization announcement to three months after that • ADR listing • 1.2% - 2.6% around the announcement or listing Hu - Globalization

  5. Globalization reduces the cost of capital • CAPM • E(Ri) = Rf + bi * [E(Rm) - Rf] • E(Ri): Expected return for firm I • Rf: Riskfree rate • bi: Market beta, which equals Cov(Ri, Rm) / Var(Rm) • E(Rm) – Rf: Market risk premium Hu - Globalization

  6. Globalization reduces the cost of capital • Local CAPM • E(RC) = Rf + bH * [E(RH) - Rf] • Global CAPM • E(RG) = Rf + bG * [E(RG) - Rf] • E(RG) – Rf: Global market risk premium • Return of the Morgan Stanley Capital International world index • 6.6% annual risk premium from 1970/2 to 1989/5 Hu - Globalization

  7. Globalization reduces the cost of capital • E(RG) < E(RC) because • [E(RG) - Rf] < [E(RH) - Rf] • bG < bH Hu - Globalization

  8. Globalization reduces the cost of capitalA lower market risk premium • [E(RG) - Rf] < [E(RH) - Rf] • Determined by risk and risk premium • Risk • The risk of global portfolio is smaller than the risk of home portfolio • Risk premium per unit of risk • Determined by investors’ risk attitude • The risk will be shared by more people who have different risk attitude Hu - Globalization

  9. Globalization reduces the cost of capital Giorgio de Santis and Bruno Gerard, 1997,International Asset Pricing and Portfolio Diversification with Time-Varying Risk, The Journal of Finance, Vol. 52, No. 5. (Dec., 1997), pp. 1881-1912. Hu - Globalization

  10. Bekaert, Geert; Harvey, Campbell R., 1997, Emerging equity market volatility,Journal of Financial Economics 43: 1, pp. 29-77 Hu - Globalization

  11. Globalization reduces the cost of capitalA lower market risk premium • [E(RG) - Rf] < [E(RH) - Rf] • Global portfolio is less correlated with personal human wealth Hu - Globalization

  12. Globalization reduces the cost of capital Hu - Globalization

  13. Globalization reduces the cost of capitalA lower market beta • bG < bH • Nestlé bG = 0.6, bH = 0.9 Hu - Globalization

  14. Globalization reduces the cost of capitalA lower transaction cost • Transaction cost and cost of capital • A lower transaction cost means a lower expected return required by investors • Globalization can reduce transaction costs • It can increase investor pool • It can reduce the probability of insider trading • Companies can choose the exchange with the lowest transaction cost Hu - Globalization

  15. Globalization can also increase expected cash flowsBetter governance, stronger monitoring • Stronger monitoring • Reduce information asymmetry • Reduce agency costs • Asset substitution • Underinvestment • Overinvestment Hu - Globalization

  16. Globalization can also increase expected cash flows Better governance, better monitoring • Board • Using foreigners • A greater pool of talents • Capital market • Using outside professionals, e.g., investment banks • Global knowledge • Higher reputation to protect Hu - Globalization

  17. Globalization can also increase expected cash flows Better governance, better monitoring • Legal system • Limit on expropriation from major shareholders • Class actions • Provide mechanism for shareholder monitoring • Active shareholders • Large shareholders • Institutional shareholders Hu - Globalization

  18. Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Hu - Globalization

  19. Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Hu - Globalization

  20. Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Hu - Globalization

  21. Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Hu - Globalization

  22. Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Hu - Globalization

  23. Standard and Poor’s criteria • Ownership Structure and External Influences • Transparency of Ownership Structure • Concentration and Influence of Ownership and External Stakeholders • Shareholder Rights and Stakeholder Relations • Shareholder Meeting and Voting Procedures • Ownership Rights and Takeover Defenses • Stakeholder Relations • Transparency, Disclosure and Audit • Content of Public Disclosure • Timing of, and Access to, Public Disclosure • The Audit Process • Board Structure and Effectiveness • Board Structure and Independence • Role and Effectiveness of the Board • Director and Senior Executive Compensation Hu - Globalization

  24. Globalization can also increase expected cash flows Better governance, better monitoring • Market for corporate control • Greater competition for control • Greater pressure to open the market for control • Disclosure • Transparency • Cross-listing or listing in foreign exchanges can commit to disclose Hu - Globalization

  25. Globalization can also increase expected cash flows Better governance, better monitoring • Companies need to choose • Companies that participate global market • Companies that do not participate Hu - Globalization

  26. Globalization reduces transaction costs Hu - Globalization

  27. Globalization reduces the cost of capital Hu - Globalization

  28. Globalization reduces the cost of capital Hu - Globalization

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