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Valuation lies at the heart of much of what we do in finance, whether it is the study of market efficiency and questions about corporate governance or the comparison of different investment decision rules in capital budgeting. In this paper, we consider the theory and evidence on valuation approaches. We begin by surveying the literature on discounted cash flow valuation models, ranging from the first mentions of the dividend discount model to value stocks to the use of excess return models in more recent years. In the second part of the paper, we examine relative valuation models and, in particular, the use of multiples and comparables in valuation and evaluate whether relative valuation models yield more or less precise estimates of value than discounted cash flow models. In the final part of the paper, we set the stage for further research in valuation by noting the estimation challenges we face as companies globalize and become exposed to risk in multiple countries.
The price at which a stock is traded in the market reflects the ability of the firm to generate cash flow and the risks associated with generating the expected future cash flows. The authors point to the limits of widely used valuation techniques. The most important of these limits is the inability to forecast cash flows and to determine the appropriate discount rate. Another important limit is the inability to determine absolute value. Widely used valuation techniques such as market multiples - the price-to-earnings ratio, firm value multiples or a use of multiple ratios, for example - capture only relative value, that is, the value of a firm's stocks related to the value of comparable firms (assuming that comparable firms can be identified). The study underlines additional problems when it comes to valuing IPOs and private equity: Both are sensitive to the timing of the offer, suffer from information asymmetry, and are more subject to behavioral elements than is the case for shares of listed firms. In the case of IPOs in particular, the authors discuss how communication strategies and media hype play an important role in the IPO valuation/pricing process.
The purpose of this monograph is to provide an overview of the IPO literature since 2000. The fewer numbers of companies going public in recent years has raised many questions regarding the IPO process, in both academic and regulatory circles. As we all strive to understand these changes in the market, it is especially important to understand the dynamics underlying the IPO process. If the process of going public is too costly or the IPO mechanism is plagued by too many conflicts of interest among the various intermediaries, then private companies may rationally choose other methods of raising capital. In a related vein, it is imperative that new regulations not be based on research focusing solely on large, more mature firms. Newly public firms have unique characteristics, and an increased understanding of such issues will contribute positively to well-functioning public markets and further growth of the entrepreneurial sector. We also provide a detailed guide to researchers on how to obtain a research-quality sample of IPOs, from standard data sources. Related to this, we tabulate important corrections to these standard data sources.
Financial Markets and the Real Economy reviews the current academic literature on the macroeconomics of finance.
The Prudential Regulation of Banks applies modern economic theory to prudential regulation of financial intermediaries. Dewatripont and Tirole tackle the key problem of providing the right incentives to management in banks by looking at how external intervention by claimholders (holders of equity or debt) affects managerial incentives and how that intervention might ideally be implemented. Their primary focus is the regulation of commercial banks and S&Ls, but many of the implications of their theory are also valid for other intermediaries such as insurance companies, pension funds, and securities funds. Observing that the main concern of the regulation of intermediaries is solvency (the relation between equity, debt, and asset riskiness), the authors provide institutional background and develop a case for regulation as performing the monitoring functions (screening, auditing, convenant writing, and intervention) that dispersed depositors are unable or unwilling to perform. They also illustrate the dangers of regulatory failure in a summary of the S&L crisis of the 1980s. Following a survey of banking theory, Dewatripont and Tirole develop their model of the capital structure of banks and show how optimal regulation can be achieved using capital adequacy requirements and external intervention when banks are violated. They explain how regulation can be designed to minimize risks of accounting manipulations and to insulate bank managers from macroeconomic shocks, which are beyond their control. Finally, they provide a detailed evaluation of the existing regulation and of potential alternatives, such as rating agencies, private deposit insurance, and large private depositors. They show that these reforms are, at best, a complement, rather than a substitute, to the existing regulation which combines capital ratios with external intervention in case of insolvency. The Prudential Regulation of Banks is part of the Walras Pareto Lectures, from the Universiy of Lausanne.