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Corporate financial Policy and R&D Management - Second Edition
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Second Edition
JOHN B. GUERARD JR.
John Wiley & Sons, Inc.
Corporate
Financial Policy and
R&D Management
Corporate
Financial Policy and
R&D Management
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Second Edition
JOHN B. GUERARD JR.
John Wiley & Sons, Inc.
Corporate
Financial Policy and
R&D Management
Copyright © 2005 by John B. Guerard Jr. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
ISBN-13 978-0-471-45823-4
ISBN-10 0-471-45823-6
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
Contents
Preface ix
About the Author xi
CHAPTER 1
Corporate Financial Policy and R&D Management 1
CHAPTER 2
An Introduction to Financial Statements 3
The Balance Sheet 3
Assets 4
Liabilities and Capital 10
Current Liabilities 10
Long-Term Debt 11
Capital Section of the Balance Sheet 12
Book Value of Common Stock 14
Consolidated Balance Sheets 14
The Operating Statements: The Income Statement
and Sources and Uses of Funds 18
Sources and Uses of Funds 24
CHAPTER 3
Ratio Analysis 31
Ratio Analysis and the Firm’s Perceived Financial Health 31
Current Analysis Ratios 32
Leverage Ratio 33
Sales Efficiency Ratio 34
Profitability Ratios 34
Financial Ratios and the Perceived Financial Health of Firms 35
Time Series of Ratios in the United States, 1970–2003 37
Limitations of Ratio Analysis 38
v
CHAPTER 4
Debt, Equity, Financial Structure, and the Investment Decision 41
Definition of Leverage—Profits and Financial Risk 42
The Pure Theory of the Optimal Financial Structure 44
Modigliani and Miller—Constant Capital Costs 46
The Optimal Capital Structure and the M&M Hypothesis 48
Empirical Factors Influencing Financial Structures 49
Cost of Capital 50
Real Options and the Investment Decision 53
Abandonment Value 54
Option to Delay a Project 66
Implications of Viewing the Right to Delay a Project as
an Option 67
CHAPTER 5
An Introduction to Statistical Analysis and Simultaneous Equations 69
The Linear Regression Model 71
Multiple Regression 79
Least Squares Estimates of the Regression Coefficients 80
Multiple Coefficient of Determination 81
Estimation of Simultaneous Equations Systems 82
Estimation of Parameters in Multiple Equation
(Regression) Models 84
Two-Stage Least Squares (2SLS) 86
Three-Stage Least Squares (3SLS) 89
The Three-Stage Least Squares Estimator 89
CHAPTER 6
Interdependencies among Corporate Financial Policies 93
The Model 94
The Data 178
Estimated Simultaneous Equations Results 178
CHAPTER 7
Comparing Census/National Science Foundation R&D Data with
Compustat R&D Data 181
Innovation, R&D, and Stockholder Wealth 182
Financial Decision Estimation Results 183
Comparison of R&D Expenditure Data 186
Comparison of Regression Results 188
Relation of Current Results to Prior Research 193
Extensions of the Simultaneous Equations Approach 195
vi CONTENTS
Summary and Conclusions 197
Suggestions for Future Research 198
CHAPTER 8
The Use of Financial Information in the Risk and Return of Equity 201
Introduction to Modern Portfolio Theory 209
Determinants of Stock Selection Models 212
Further Estimations of a Composite Equity Valuation Model 213
Appendix 8.A: Multifactor Risk Models 218
BARRA Model Mathematics 219
Risk Prediction with Multiple-Factor Models 220
Appendix 8.B: US-E3 Descriptor Definitions 227
Volatility 227
Momentum 229
Size 229
Size Nonlinearity 229
Trading Activity 229
Growth 230
Earnings Yield 232
Value 232
Earnings Variability 233
Leverage 233
Currency Sensitivity 234
Dividend Yield 235
Non-Estimation Universe Indicator 235
CHAPTER 9
The Optimization of Efficient Portfolios: How the R&D Quadratic
Term Enhances Stockholder Wealth 237
Efficient Portfolio Optimization Results 238
CHAPTER 10
The (Not So Special) Case of Social Investing 249
Stock Selection in Unscreened and Screened Universes 253
Stock Selection and the Domini Social Index Securities 258
Recent Socially Responsible Research 258
Summary and Conclusions 259
CHAPTER 11
R&D Management and Corporate Financial Policy: Conclusions 261
Exercises 263
Contents vii
Notes 265
References 271
About the CD-ROM 281
Index 283
viii CONTENTS
Preface
I
n this monograph, the financial determinants of corporate research and
development (R&D) and the impact of these expenditures on stockholder
wealth are examined. The reader is introduced to financial statements and
ratios for decision making. A discussion of the sources and uses of funds
analysis leads to an econometric analysis of the interdependencies among
the firm’s financial decisions, including the dividend, capital investment,
R&D, and new debt issuance decisions. The establishment of the R&D decision as a financial decision leads one to ask how the marketplace values
and assesses the firm’s R&D expenditures. A multifactor risk model analysis allows one to establish a statistically significant relationship between
R&D expenditures and increases in stockholder wealth. R&D enhances
stockholder wealth, particularly for larger capitalized firms.
The author would like to thank several co-authors of studies that serve
as the basis of several chapters in this text: Al Bean, formerly of Lehigh University, and Steven Andrews, of the Bureau of the Census, worked with the
author on econometric modeling of the R&D decision; Andrew Mark, of
GlobeFlex Capital Management, worked with the author on the R&D and
stockholder wealth analysis; John Blin and Steve Bender of APT, a Wall Street
firm specializing in risk management; Bernell Stone, of Brigham Young University; and Mustafa Gultekin, of the University of North Carolina.
The author wishes to thank his wife, Julie, for her support, and his children, Richard, now off at college, Katherine, and Stephanie, for their support. The author acknowledges his parents, John and Dorothy, for their
loving support. The author worked many weekend hours on this project,
often chasing the kids off the computer on Sunday mornings and evenings
to complete the project.
ix
About the Author
John B. Guerard Jr. is faculty member in the finance and economics department at Rutgers Business School, where he teaches Advanced Financial Management and Investments. He serves on the Virtual Research team
of GlobeFlex Capital Management, in San Diego, and consults to several
other financial institutions, including a hedge fund. Mr. Guerard earned his
AB in Economics, cum laude, at Duke University, an MA in Economics
from the University of Virginia, an MSIM from the Georgia Institute of
Technology, and his Ph.D. in Finance from the University of Texas, Austin.
He served on the faculties at the University of Virginia and Lehigh University, and worked in the equity research departments at Drexel, Burnham
and Lambert and Daiwa Securities Trust. Mr. Guerard was Director of
Quantitative Research at Vantage Global Advisors, in New York City,
when he was awarded the first Moskowitz Prize for outstanding research in
socially responsible investing (SRI). He serves as an associate editor of the
International Journal of Forecasting and the Journal of Investing. His articles have been published in Management Science, the International Journal
of Forecasting, the Journal of Forecasting, Research in Finance, European
Journal of Operations Research, Journal of the Operational Research Society, Research Policy, and the Journal of Investing. His research interests are
in modeling R&D and financial decisions of firms, developing and estimating stock selection models, and estimating and forecasting time series models. He is the author, or co-author, of four textbooks. Mr. Guerard used the
first edition of this monograph in his R&D Management and Corporate Financial Management class at the Executive Master in Engineering Management (EMTM) program, the University of Pennsylvania.
Mr. Guerard lives in Chatham, New Jersey, with his wife and three
children.
xi