Mark Tippett

An Induced Theory of Financial Ratios

Abstract In recent years, a considerable volume of research has emerged on the analytical, empirical and statistical properties of financial ratios. In the present paper the methods of continuous time stochastic calculus are applied to the modelling of financial ratios. Two standard stochastic processes are examined and applied, namely the geometric Brownian motion and the elastic random walk. The properties of aggregate or ‘industry ratios’ and the reasonableness or otherwise of the ‘proportionality assumption’ are also examined. Typically, the approach of this paper implies that accounting ratios will be non-linear functions of time and normality will be the exception rather than the rule.

The plight of accounting education in Australia: a review article ∗

This paper summarizes the history and effects of the Australian Governments higher education lsquo;reformrsquo; agenda on the accounting discipline. After providing a brief historical perspective, the paper summarizes the contents of the Task Force for Accounting Education in Australia, a Report commissioned by the two major Australian professional accounting bodies. An overview of the Governments higher education Green and White Papers and their implications for the accounting discipline in higher education, is then provided. We then survey some of the key recommendations of the Report of the Review of the Accounting Discipline in Higher Education(The Mathews Report), an enquiry commissioned by the Australian Government after an intensive lobbying campaign by the accounting profession. The paper concludes with summary contents.

Portfolio insurance: a simulation under different market conditions

Abstract In recent years, considerable interest has arisen over the methods and effects of equity portfolio insurance. The present paper outlines a simple method for implementing portfolio insurance and then reports the results of Monte Carlo simulations based on recent experience in the Australian equities market. The simulations are applied to three decision variables, namely; the rebalancing trigger, the locking in of gains and the insurance period. The decision variables were evaluated on the basis of their implementation costs, path dependency and the incidence of negative returns. Our analysis indicates that the technique outlined in the paper is robust with respect to a variety of market conditions, including the stock market crash of October, 1987.

The Components of Accounting Ratios as Co-integrated Variables

Time series of accounting variables may often be non-stationary, i.e. they have a unit root, as in the common example of a random walk. This can lead to spurious results in time series regression analysis which uses such variables. The problem is overcome if the variables are co-integrated. This paper examines and tests the proposition that, where the variables are expressed in logarithmic form, calculating a ratio may capture the effects of co-integration. Thus, accounting ratios (calculated in logarithmic form) might be stationary, and therefore exempt from the econometric pathology associated with their component variables. Copyright Blackwell Publishers Ltd 1999.

Economic and Accounting Rates of Return A Statistical Model

Abstract This paper develops a number of statistical procedures than can be used to determine whether a firms ex post accounting rate of return (ARR) is likely to provide guidance as to the economic return the firm will earn over its remaining life. The paper argues that if a corporations future process cash flows are generated by some form of stochastic process, then the probability density function induced by this can be used to assess whether the ARR provides a reasonable reflection of the economic return the corporation is likely to earn over its remaining life. Five large listed companies are used as case studies to illustrate the models application.

On the ‘Steady State’ Properties of Financial Ratios

Abstract This paper uses the methods of continuous time stochastic calculus to investigate the ‘steady state’ properties of financial ratios. Basing our analysis on previous work in the area, we show that, if a financial ratio can be characterised as a diffusion process which possesses an asymptotic equilibrium, then the Fokker-Kolmogorov-Planck forward equation may be used to ‘retrieve’ its probability density. The approach is ‘flexible’ enough to incorporate a wide variety of density functions, many of which have not been investigated in the literature. We demonstrate the procedures which may be used to derive both the cross-sectional and time series tests implied by these distributions. The paper also includes a section dealing with the methods which may be used for parameter estimation, once the underlying distribution has been determined.

Share Option Rewards and Managerial Performance: an Abnormal Performance Index Model

Abstract Managerial share option schemes are widely used as a means of motivating and rewarding corporate performance. Such schemes normally adopt a static exercise price; when additional exercise criteria are employed they are often based on earnings per share. A static exercise price does not adjust for economic changes outside the control of management, and earnings per share hurdles have similar limitations. This paper presents a ‘phantom’ managerial option based on relative performance, together with a pricing model for the valuation of the option. The option is developed and demonstrated using an abnormal performance index. It offers a structure which could be used for different forms of performance measurement, and resolves some important criticisms of the reward and incentive effects of traditional schemes.

Analytic solutions for the value of the option to (dis)invest

Publisher Summary The realization that investment opportunities also carry embedded options has revolutionized the theory of capital investment analysis. Unfortunately, it has also complicated project evaluation to the point where optimal investment decisions invariably depend on a series of intractable valuation expressions. In such cases, custom dictates that numerical evaluation is the most practical (and often the only) way of determining optimal investment expenditures. However, it is often possible to use power series expansions to obtain analytic expressions for the value of a firms investment opportunities. These permit a somewhat deeper investigation of the criteria leading to the optimal investment decisions made by firms. Furthermore, they can often identify the specialized circumstances under which it will be possible to obtain closed-form expressions for the value of a firms investment opportunities. Another stochastic process is the scaled distribution of Praetz and Blattberg and Gonedes. This process is based on the assumption that expected changes in operating cash flows are always towards a long-run mean, are potentially negative and have a variance, which depends on the difference between the ‘current’ and long-run operating cash flows. Hence, the uncertainty associated with future cash flows depends on the current level of the operating cash flow—something that intuition suggests ought to be the case.

A stop loss approach to portfolio insurance

A way to overcome errors in estimating volatility and excessive dependence on the path of the portfolios value during the insurance period.

The Garman-Ohlson structural system

The Garman-Ohlson structural model assumes the evolution of corporate earnings, dividends and book values are generated by a simultaneous equation system which links financial statement information to underlying equity value. However, little is known about the consistency of empirical outcomes with the models underlying analytical properties. A continuous time interpretation of the model implies that solutions fall into one of three categories: (i) all eigenvalues of the structural model are real and distinct; (ii) some eigenvalues may be complex, and (iii) there are repeated eigenvalues. Maximum likelihood techniques can be used to estimate structural models and likelihood ratio tests can then be used to assess the validity of alternative specifications. We demonstrate both likelihood procedures by applying them to a sample of 214 UK companies covering the twenty one year period ending in 1994. Copyright Blackwell Publishers Ltd 1997.