Corporate Finance

America's health care system is the envy of the world, but it faces serious challenges. The costs of care are rising rapidly, the number of uninsured Americans is at an all-time high, and public dissatisfaction is steadily increasing. How can we preserve the strengths of our current system while correcting its weaknesses? Three of American's leading health-care scholars answer that question in Healthy, Wealthy, and Wise. Poorly conceived federal tax policies, insurance regulations, and barriers to entry have distorted health-care markets and inhibited competition.

This paper develops a theory of control as a signal of congruence of objectives, and applies it to financial contracting between an investor and a privately informed entrepreneur. We show that formal investor control is (i) increasing in the information asymmetries ex ante, (ii) increasing in the uncertainty surrounding the venture ex post, (iii) decreasing in the entrepreneur's resources, and (iv) increasing in the entrepreneur's incentive conflict. In contrast, real investor control—that is, actual investor interference—is decreasing in information asymmetries.

A quarter-century ago, Miles and Ezzell (1980) solved the valuation problem of a firm that follows a constant leverage ratio L = D/S. However, to this day, the proper discounting of free cash flows and the computation of WACC are often misunderstood by scholars and practitioners alike. For example, it is common for textbooks and fairness opinions to discount free cash flows at WACC with beta input Beta(S) = [1 + (1 - Tax Rate)L]Beta(U), although the latter is not consistent with the assumption of constant leverage.

Focusing on asset returns governed by a factor structure, the APT is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model.

I analyze corporate social responsibility (CSR) from economic and financial perspectives, and suggest how it is reflected in financial markets. CSR is defined as a programme of actions to reduce externalized costs or to avoid distributional conflicts. It has evolved in response to market failures, a Coasian solution to problems associated with social costs. The analysis suggests that there is a resource-allocation role for CSR programmes in cases of market failure through private-social cost differentials, and also where distributional disagreements are strong.

We show that equity market liberalizations, on average, lead to a one percent increase in annual real economic growth over a five-year period. The effect is robust to alternative definitions of liberalization and does not reflect variation in the world business cycle. The effect also remains intact when liberalization is instrumented with quality of institutions-variables that explain liberalization but not growth and when a growth opportunity measure is included in the regression. Capital account liberalization has a less robust effect on growth than equity market liberalization has.

We propose a measure of capital market integration arising from a conditional regime-switching model. Our measure allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. We find that a number of emerging markets exhibit time-varying integration. Some markets appear more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets.

We provide a formal treatment of both static and dynamic portfolio choice using the Disappointment Aversion preferences of Gul (1991. Econometrica 59(3), 667-686), which imply asymmetric aversion to gains versus losses. Our dynamic formulation nests the standard CRRA asset allocation problem as a special case. Using realistic data generating processes, we find reasonable equity portfolio allocations for disappointment averse investors with utility functions exhibiting low curvature.