Laarni T. Bulan

Irreversible investment, real options, and competition: Evidence from real estate development

We examine the extent to which uncertainty delays investment, and the effect of competition on this relationship, using a sample of 1214 condominium developments in Vancouver, Canada built from 1979-1998. We find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments. Empirically, a one-standard deviation increase in the return volatility reduces the probability of investment by 13 percent, equivalent to a 9 percent decline in real prices. Increases in the number of potential competitors located near a project negate the negative relationship between idiosyncratic risk and development. These results support models in which competition erodes option values and provide clear evidence for the real options framework over alternatives such as simple risk aversion.

Firm Maturity and the Pecking Order Theory

We identify firms according to two life cycle stages, namely growth and maturity, and test the pecking order theory of financing. We find a strong maturity effect, i.e., the pecking order theory describes the financing behavior of mature firms better than growth firms. Our findings show that firm maturity is an alternative proxy for debt capacity. In particular, mature firms are older, more stable, and highly profitable with good credit histories. Thus, they naturally have greater debt capacity. After controlling for firm maturity, the pecking order theory describes the financing behavior of firms fairly well.

A Closer Look at Dividend Omissions: Payout Policy, Investment and Financial Flexibility

We adopt a comprehensive approach to studying dividend omissions to better understand the motivation behind this important policy decision. We find that poor operating performance, poor financial flexibility, high investment and increased risk are factors that affect the likelihood of a dividend omission. Not all dividend omissions, however, are the same. For 25% of dividend omitting firms, the omission signals a quick turnaround in their operating performance and results in a resumption of dividends within three years from the omission. Our analysis suggests these firms use the dividend omission strategically to improve their financial flexibility, allowing them to pursue valuable investment opportunities. The remaining firms continue to be financially constrained and under-perform their peers after the omission. One possible explanation for this divergence in performance is the quality of their management.

Regulatory Risk, Market Risk and Capital Structure: Evidence from U.S. Electric Utilities

There is a sharp contrast when one compares firm leverage ratios between U.S. and British electric utilities, which have both been deregulated in the past decade. In the U.S., leverage ratios have been declining while in the U.K., they show a marked increase. To better understand the decline in leverage of U.S. investor owned electric utilities, this paper investigates the impact of deregulation on the capital structure decisions of these firms. We find that the heightened uncertainty created by the deregulation process and the associated increase in both regulatory and market risks have resulted in firms reducing their leverage ratios. Specifically, we find that the most important factors that impact capital structure are: 1) the stranded cost recovery and divestiture policies and 2) the potential loss of market share due to competition and fears of downward pressure on prices i.e. market risk. We also find that belonging to a holding company lowers leverage while the possibility of a merger decreases leverage. Identifying the importance of these variables for a firms financing decisions not only furthers our understanding of capital structure choice but also sheds light on the financial effects of deregulation, which have not been previously documented.

Innovation, R&D and Managerial Compensation

This paper investigates whether aligning manager and owner incentives can improve the innovation performance of firms. We find that pay-sensitivity works to align managerial actions to shareholder interests. As managerial wealth becomes more sensitive to the firm’s stock price the innovation performance of a firm improves. Entrenched managers, however, are more likely to act myopically and follow strategies that result in a large number of low quality patents. Short-term incentives have little impact on innovation. Higher managerial tenure increases the probability of R&D spending and innovation quality and thus better aligns the managers’ actions with a firm’s long-term goals. CEO control of the firm, however, decreases its innovation performance.

Incentivizing Managers to Build Innovative Firms

We investigate whether the equity-linked components of top executive pay have an effect on patenting activity within a firm. We find a positive relationship between firm patenting activity and managerial alignment incentives created by stock and stock option grants. Prior work has shown that the market value of a firm reflects the value of its patents. Thus, our finding suggests innovation is one such channel through which equity alignment incentives positively impact firm value. On the other hand, we find that the risk-taking incentive from stock options does not increase patenting.

Is There Room for Growth? Debt, Growth Opportunities and the Deregulation of U.S. Electric Utilities

We investigate the impact of growth opportunities on the financing decisions of investor-owned electric utilities in the U.S. when the electricity sector was deregulated. We find that the relationship between leverage and growth opportunities can be positive or negative, depending on the nature of the growth opportunity. Despite these opposing effects on leverage ratios, we find that electric utilities are issuing new debt in response to the same growth opportunities. Our results highlight that financing choice is not a simple one-period decision but a dynamic occurrence and that conventional leverage regressions cannot fully capture this dynamic response.