Lewis D. Johnson

Knowledge, innovation and share value

Knowledge–based enterprises (KBEs) are difficult to value owing to the relatively greater importance of their intangible assets, such as human capital and investment in innovation. Traditional valuation models rely on variables such as earnings, dividends and assets, which, for many KBEs, are either non–existent or are distorted by differing accounting practices. This paper reviews the various attempts by practitioners and academics to overcome these difficulties by such devices as different proxies for the valuation variables or different forms of the valuation equations. We then examine some theoretical approaches that provide novel approaches to valuation. Finally, we discuss the notion of the ‘fuzzy firm’, where traditional corporate boundaries have become amorphous, with the result that the firms require new valuation methodologies.

Generalized Markov Dividend Discount Models

3N6). n our Hurley-Johnson [1994] dividend hscount model (DDM), lvidends are assumed to follow a simple Markov process. The firm is assumed to I either maintain the same dividend (with probability 1 p) or increase it (with probability p). Ths process appears to be consistent with the dividend policy of a large number of firms (see Lintner [1956]). We know, however, that not all firms are able to maintain a non-decreasing dividend payout. Many firms run into dfficulty and have to either lower dividends or suspend them entirely. Even if a dwidend stream is increasing, it is rarely the case that each increase can be described by a constant geometric growth rate. To model these and other contingencies, a more complicated Markov process is required. Hence, in this note, we extend the basic Hurley-Johnson approach to more general Markov processes. We also show how to calculate these valuations with a Monte Carlo simulation that is easily implemented on a spreadsheet. Here we employ EXCEL with the add-in @RISK.

The subprime mortgage market: familiar lessons in a new context

Purpose – The purpose of this paper is to examine the recent subprime mortgage market meltdown from a theoretical and practical perspective.Design/methodology/approach – The authors apply the principles of transaction costs economics to critically evaluate the roles of lenders, borrowers, institutions, and investors.Findings – It is found that a combination of need, greed, perverse incentives, inadequate risk controls, lax regulation, and lax oversight caused a bubble in the subprime mortgage market which has inevitably burst. The principles of transaction cost economics provide a template for analysis and corrective action.Research limitations/implications – The subprime mortgage market provides a useful example of where theory can provide helpful insights. The example has implications for future research in other financial market settings.Practical implications – The results provide insight and guidance to lenders, borrowers, institutions, investors, regulators, and central bankers in how to identify an...

Stochastics Two-Phase Dividend Discount Models

Ontario (Canada K7L 3N6). D ividend payments often follow different patterns of growth as a company passes through the different phases of its life cycle. Analysts faced with the prospect of estimating a company’s dividends into the indefinite future typically follow one of two strategies: 1) assume that dividends will grow at a constant rate in all future periods (which is reasonable for utilities and many stable industrials and banks), or 2) try to forecast the future pattern of dividend payments with some form of multistage growth model. The first approach has the benefit of simplicity, but does not apply well to companies with near-term differential growth prospects, while the second approach offers more generality, but the resulting stock values are very sensitive to the input estimates (see Michaud [1985]). Starting with the work of Molodovsky, May, and Chattiner [1965], practitioners and academics have attempted to refine the modeling process for multistage growth c0mpanies.l At the same time, companies such as the Value Line Investment Survey and the Institutional Brokers Estimate System routinely provide near-term estimates of growth in dividends, earnings, and other relevant variables to facilitate the process. Analysts must, however, still deal with the problem of estimating longer-term growth prospects. This Journal has published a number of articles designed to assist practitioners in implementing models such as Molodovsky’s and in conducting sensitivity

Sources of risk and value in common stocks: Comment

n a recent article in this Journal, Estep, Hanson, and Johnson examined the relationship between risk and return for common stocks in an inflationairy environment.’ The purpose of this article is to extend their valuation model to allow for additional uncertainty. Their dividend discount model (DDM),” augmented by the inflation flowthrough constant developed at Salomon Brothers, is (their equation (9)): g

Financial Governance in the New Europe

The move to a unified European state has necessitated the harmonization and coordination of myriad activities and processes, including transporation, information systems, telecommunications and banking. An issue of vital importance to Europe’s future economic health is the structure of its financial system. A financial system (which encompasses the entire process of amassing and allocating capital and is more than just banks) is charged with the task of ensuring the provision of adequate capital for optimal economic growth (the primary market) and the subsequent allocation of ownership and control of that capital (the secondary market), and the type of financial system which is appropriate for a country or a region depends on a variety of factors discussed below.

Information and the Psychology of Investor Behaviour

In behavioural psychology the relationship between the information provided by a stimulus and an individual’s reaction thereto is widely accepted as parabolic and commonly referred to as a Wundt curve. The present paper invokes this relationship in order to examine the apparent failure of the efficient markets model as a paradigm for describing security price behaviour. Discrepancies between the prices and intrinsic values of securities are explained in terms of the amount of information entering the price determination process, with the amount required for an efficient market found to have an interior solution. The social invention of the stock market provides a convenient meeting ground in which to study the nexus between the psychology of investor behaviour and the economics of asset pricing.