New Video Series on Cost of Capital

My next video series on Corporate Finance will discuss Cost of Capital. In the past videos, we’ve discussed cost of capital and spent time on working out expected returns for equity investors via CAPM, APT or other factor models.

Now, I’ll bring all of this together and show you how a company would estimate its own cost of capital in practice.  My approach will be very applied and focus on real data.  This can cause problems because in practice, the information we expect will be available is usually not!  However, I believe using real data is the best way to illustrate this topic for your own use.

As with all my videos, each one relates to a specific section of my textbook Corporate Finance 2e: European Edition and you should use the book as a companion to the videos if you want more detail and depth.

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Corporate Finance Course: CAPM v APT and How to Estimate a Factor APT Model

This video completes my coverage of factor models and the Arbitrage Pricing Theory.  I decided to deviate from the book a bit by illustrating using Apple inc, how to empirically estimate a 4-Factor and 1-Factor APT model.

It’s important to remember that the reason we are estimating an APT model is for its contribution in estimating the cost of capital of a company.

Key points in the video:

  • Comparison of CAPM and APT
  • A worked hypothetical example of using APT
  • A demonstration of how to estimate a Four-Factor APT model in practice

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Corporate Finance Course: Factor Models: Betas, Expected Returns and an Introduction to the Arbitrage Pricing Theory

Finally, I get round to introducing the Arbitrage Pricing Theory (APT).  My approach is intuitive because I don’t want to get hung up in the mathematics in the corporate finance course, although I may do something at some point in the future with more theoretical rigour.

Key points in the video:

  • Underpricing and Overpricing
  • Arbitrage
  • Arbitrage Pricing Theory (APT)
  • APT Market Model

 

Why Do Firms Go Dark and What Happens to Minority Shareholders?

Public to private transactions occur when a publicly listed firm is purposely delisted by a controlling owner.  This is also known as ‘going dark’ and usually happens when the company has been bought over by a private equity fund.

Why do companies go dark?

There are many reasons why a public to private transaction makes sense for a controlling shareholder.  Companies list on a stock exchange to raise new financing and aid expansion, but public listing can also bring some difficult challenges.

Share price volatility, undervaluation, greater transparency, stronger reporting requirements and the scrutiny of a regulator all come with a public listing. If there are no ongoing discernible benefits from being on a stock exchange, it can make sense to delist and run the company away from the constant glare of analysts and investors.

Are Public to Private Transactions Common and Important?

A research paper by Preqin shows that public to private transactions only make up a very small percentage of private equity buyouts and that their frequency has varied over time.

Prequin-1

However, if you look at public to private transactions from the perspective of their value, they are significantly more important. According to Preqin, they made up 49 per cent of the value of all private equity buyouts in the peak year of 2007, with value fluctuating up and down since then.

Preqin-2

What Happens to Minority Shareholders when Firms go Dark?

A major concern of public to private transactions is that minority shareholders lose most of their rights when their firm is no longer listed.  It is much more difficult to sell shares or to get information on the company’s finances or performance when there is no necessity for transparent reporting.

Along with my co-authors, Emanuele Bajo, Massimo Barbi, and Marco Bigelli, I examined the role of financial institutions in protecting minority shareholders in Italian firms when the controlling owner wants to take a firm private.

We found that institutional investors play a central role in the bid process and can protect minority shareholders from being frozen out in the bid. Specifically, tender offers in a public to private transaction are less likely to succeed when a firm has institutional investors in its ownership structure.

Furthermore, when public to private offers are accepted, bid premiums are significantly greater if a financial institution (particularly when it is foreign, independent or activist) has a stake in the firm.

Finally, threats to merge the target if the bid fails and external validation of the offer price have no impact on either the likelihood of delisting or the premium paid by the bidder.

If you are interested in reading more about public to private transactions and how institutions protect minority shareholders, the published paper can be found here:

Bajo, E., Barbi, M., Bigelli, M., & Hillier, D. (2013). The role of institutional investors in public-to-private transactions. Journal of Banking & Finance37(11), 4327-4336.

Corporate Finance Course: Factor Models and Portfolios

This video uses factor models to show the impact of diversification on portfolio risk.  I also show how portfolio returns can be decomposed into their respective components.  It’s not a long video but it is quite important in showing the power of diversification from a different angle.

Key Points in the Video:

  • Portfolio theory using factor models
  • Systematic and unsystematic risk

Corporate Finance Course: Introduction to Factor Models – Systematic Risk and Betas

I continue with my journey into Asset Pricing with a gentle introduction to Factor Models and some common extensions of these, including the Market Model and Carhart Four Factor Model.  It’s fairly intuitive stuff as I want to get the concepts across rather than spend time on the mathematics.

Key Points in the Video:

  • Factor Models
  • Factor Model Example
  • The Market Model
  • The Carhart Model
  • Criticisms of Factor Models

Corporate Finance Course: Introduction to Systematic and Unsystematic Risk

It’s been quite a while since I’ve uploaded a new video. Same old excuses of too much work! This video is a quick introduction to the concepts of risk and, in particular, systematic and unsystematic risk. It’s all part of a bigger group of lectures that takes us into factor models and eventually the Arbitrage Pricing Theory.

The reason I cover this in a Corporate Finance class is that it gives managers an insight into information, news and how this impacts upon investor perceptions.

Key Points in the video:

  • Systematic and Unsystematic Risk

Corporate Finance Course: Factor Models – Announcements, Actual Returns and Expected Returns

In this new series of videos, I’ll be spending some time on factor models, which are different ways of looking at security returns.  Because of this, we’ll reconsider concepts like risk and expected return but from a different perspective.  We’ll also be introducing the Arbitrage Pricing Theory, or APT in a few videos time.

In my books to date, I’ve treated factor models as a separate chapter but I’m seriously considering merging this with the CAPM material in future editions. This would hopefully avoid a bit of duplication and lead to a more integrated approach to asset pricing. I’d appreciate any feedback you may have on whether this is sensible.

Key points Introduced in this video:

  • Impact of Announcements on share prices
  • Expected and surprise components of returns

Corporate Finance Course: Variations of the CAPM

This video closes off my short series on the Capital Asset Pricing Model with a very brief discussion of two CAPM variations: Consumption CAPM or CCAPM and CAPM with Human Capital or HCAPM.

I’ve never used these in practice because it is so difficult to get good historical data on consumption growth and non financial assets so I only really deal with the models from a theoretical perspective. Nevertheless, they do give you insights into other perspectives of asset pricing.

I’ll continue this in future videos when I cover Asset Pricing in more detail.

Key points introduced in this video:

  • Consumption CAPM
  • CAPM with Human Capital

Corporate Finance Course: Criticisms of CAPM

Time flies when you’re busy.  I realise I haven’t updated the course for a wee while so plan to become more active again.  I’m also working hard on the 3rd Edition of Corporate Finance and my research projects so it’s natural that things tend to slip.

This video covers some criticisms of CAPM.  I’ve tried to be balanced by giving the criticisms and then the counterarguments.  Basically, I am of the view that it is pretty difficult to use ex-post data to validate an ex-ante model.  There are just too many pitfalls.

So, CAPM is a good model to give you general insights about how things work.  However, should you use it to predict the future? I’m not so sure…

Key points introduced in this video:

  • Roll’s Criticism of CAPM tests
  • Some asset pricing anomalies
  • Some arguments why it is too difficult to reliably test CAPM

Simplifying Business