Phillip R. Daves

Convertible Securities, Employee Stock Options and the Cost of Equity

We provide a method for calculating the cost of equity and the cost of capital in the presence of convertible securities and employee stock options. We demonstrate how this approach can be applied if a company already has issued convertible claims or if it is considering doing so for the first time. We provide several numerical examples illustrating the significance of errors in estimating the cost of capital that can result when (1) employee stock options are ignored or (2) the observable stock price is used as a proxy for the unobservable underlying asset.

Information release, signalling, and market competition

The present study develops a model of the firms decision to release information which may leave it at a competitive disadvantage, and tests the implications of the model. The model predicts, and the tests document, generally direct relations between the levels of traditional financial signals and market competition, indicating that greater levels of financial signalling occur when there is more market competition. As such the model provides an explanation for the cross-sectional variability in the levels of such traditional financial signals as debt level and dividend payout. Additionally, the model predicts and the tests document the presence of abnormal returns in firms about which there is little information in the market, suggesting that the level of market competition may contribute to a small firm effect.

Creating a synthetic after-tax zero-coupon bond using US Treasury STRIP bonds: implications for the true after-tax spot rate

For an individual or company that is subject to taxes, we develop a method that uses laddered Separate Trading of Registered Interest and Principal (STRIP) bonds to determine the value (and composition) of a portfolio that replicates a risk-free after-tax cash flow that will occur on a single future date. In contrast to previous approaches, our method does not require rebalancing or short sales. In addition, we show that the standard after-tax risk-free spot rate, defined as the after-tax yield on a US Treasury STRIP bond, is correct only for a flat-term structure. Using our method, we provide a true measure of the after-tax risk-free spot rate that applies to any term structure.