VI, Decentralized and Corporate Finance

Question 1

Cryptocurrencies and Decentralized Finance (DeFi)
Makarov, Igor and Antoinette Schoar, 2022

Question 2

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

In their paper it is shown that the number and percentage of small public firms has dropped dramatically during the recent years. Explain the main reasons why small companies have become less interested in going public.

Answer 2

○ firms don’t want to disclose their projects to large investor audience and potential competitors
○ markets have become dominated by institutional investors (institutional investors pay little attention to small firms)
○ developments in financial intermediation have made it easier to raise funds as a private firm (from PE and VCs)
○ economies of scale hypothesis: small firms have become less able to grow on their own→ better off selling themselves to large organizations that can bring a product to market faster and realize economies of scale
○ increased concentration could also make it harder for small firms to succeed on their own
○ Via renting and outsourcing, it has become easier to put a new product on the market without hard assets. Hence, capex is smaller and not much need to go public to raise large amounts of money.

Question 3

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What is a “listing gap” in US?

Answer 3

Compared to other countries with similar institutions and economic development, the U.S. now has significantly fewer publicly listed firms (1997-2012).

Question 4

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Why do firms get delisted?

Answer 4

● It no longer meets the listing requirements, which is typically due to financial distress.
● It has been acquired (There is evidence that mergers are the dominant reason for delisting).
● It voluntarily delists.

Question 5

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What are the ways to measure the age of the firm?

Answer 5

● from the date of registering as a company (lacking in databases)
● from the date the firm went public (downward biased)

Question 6

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

There has been a concern that with fewer but larger firms is that concentration within industries can increase. What kind of effect is possible?

Answer 6

It could possibly adversely affect competition (difficult to enter the market for small firms).

Question 7

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Investment in intangible assets have decreased overall. However, there has been an increase in the importance of intangible assets.

Answer 7

The listed firms have a much lower average ratio of capital expenditures to assets and a much higher ratio of R&D expenditures to assets in 2015 (vs in 1975).
However, the rise in R&D does not offset the decrease in capital investment.

Question 8

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What is “just-in-time” deliver and how does it affect inventories?

Answer 8

Inventory holdings fall due to the introduction of just-in-time production processes (firms receive goods only when needed).

Question 9

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What kind of effects does R&D expenditures have on firms’?

Answer 9

Public firms hold more cash, especially firms with more intangible assets and more R&D expenditures (the increase in R&D expenditures helps explain the increase in cash holdings).
R&D is difficult to finance with debt, as the value of R&D in process is hard to ascertain by creditors, thus a firm has less collateral.
Increase in R&D should lead to a decrease in firm leverage:
○ leverage falls dramatically for an equally weighted measure of leverage
○ asset weighted book leverage ratio rises, but drops sharply after the financial crisis
○ “net leverage ratio” (debt minus cash over total assets) - falls steadily
○ None of these leverage measures are elevated in 2015. Concerns about corporate leverage are less relevant for public firms

Question 10

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Balance sheets have became less informative. What is the reason for that?

Answer 10

Investments in intangible assets are not recorded on firm’s balance sheets. The more the emphasis of firms’ investment decision on intangible assets, the less informative BS becomes.

Question 11

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Data indicates that the Net income is often negative and CF/Assets ratio has been decreasing overall. However there is an exception. Name it.

Answer 11

Larger firms have a higher ratio of cash flow to assets.

Question 12

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Why the Operating Cash Flows measure has been declining?

Answer 12

R&D spending is the factor contributing to declining OCF (R&D is expensed not capitalized). Using “adjusted operating cash flow” i.e. adding back R&D expense, on average decline in operating cash flow is lower.

Question 13

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What has happened to profit concentration over the past 40 years?

Answer 13

There has been a dramatic increase in the concentration of the profits and assets of US firms: top 30 firms earn 50% of the total earnings of the US public firm, compared to 1975 when top 109 firms earned 50% of all profits.

Question 14

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

How does issuance of equity vary between different sizes of firms?

Answer 14

Smaller firms tend to issue more equity than they buy back, whereas larger firms buy back more shares than they issue (maybe because of the life cycle).

Question 15

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Institutional investment is gaining popularity. What kind of trends does that impose?

Answer 15

Institutional ownership of common stock is much higher
now. Institutions tend to prefer large firms, so institutional ownership is higher for the asset-weighted
average than for the equally weighted average.
It is now much more common for a firm to have an
institutional investor who controls 10% or more of the
shares (blockholders) - the percentage of US firms with
a 10% institutional shareholder has increased more than twice in the past 40 years.

Question 16

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What are the possible ways to use free cash flows? What do managers choose to do & what kind of impact does it have on shareholders’ wealth?

Answer 16

Profitable firms can use their cash flows to pay dividends, buy back shares, increase their cash holdings, or invest. However, managers of public firms often retain earnings (payout rates are too low) even when they cannot reinvest them profitably, which destroys shareholder wealth.

Question 17

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

What does consolidation theory suggests? What is the problem with this theory?

Answer 17

Less-efficient firms are acquired by more-efficient firms (consolidation), which would explain the concentration and smaller number of public firms in the US. However, if consolidation theory was true, we would see the total number of firms decreasing, not only the number of public firms. In reality, only the public companies decreases.

Question 18

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

The drop in the propensity to be listed suggests that there is a problem with being a public firm. Why not be public? What is the problem with the suggested explanation?

Answer 18

Probably regulatory burden associated with being public increased. However, it is only part of the explanation, as:
○ drop starts before regulatory changes
○ more firms are delisted because of mergers than went private

Question 19

Is the US public corporation in trouble?
Kahle, Kathleen, and Rene Stulz, 2017

Why are smaller firms reluctant to public?

Answer 19

○ firms don’t want to disclose their projects to large investor audience and potential competitors
○ markets have become dominated by institutional investors (institutional investors pay little attention to small firms)
○ developments in financial intermediation have made it easier to raise funds as a private firm (from PE and VCs)
○ economies of scale hypothesis: small firms have become less able to grow on their own→ better off selling themselves to large organizations that can bring a product to market faster and realize economies of scale
○ increased concentration could also make it harder for small firms to succeed on their own
○ Via renting and outsourcing, it has become easier to put a new product on the market without hard assets. Hence, capex is smaller and not much need to go public to raise large amounts of money.

Question 20

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What implications does central bank digital currency have for monetary policy?

Answer 20

The data on money circulation will be more insightful, promising more effective monetary policies. Also, given the central bank will have full supervision over the digital currencies, it will be much easier to impose
negative interest rate policies - people will not be able to store the digital money under the mattress anyways.

Question 21

Fintech and banking: What do we know?
Thakor, Anjan, 2020

The article discusses the rise and development of the fintech sector and its impact on the banking system.
What is a smart contract and what are its advantages over traditional contracts? Provide an example.

Answer 21

A smart contract is a technological agreement between two parties which does require a counterparty’s assistance.
1. lower costs (transaction, verification)
2. more efficient (economies of scale)

Question 22

Fintech and banking: What do we know?
Thakor, Anjan, 2020

Discuss what factors are favourable for the rapid expansion of fintech companies?

Answer 22

Development of country, banks concentration in the country, higher lending rates in the country.

Question 23

Fintech and banking: What do we know?
Thakor, Anjan, 2020

One of the most prominent developments of the fintech boom has been the emergence of many P2P (peer-to-peer) lending platforms. What risks do these platforms pose for the financial system?

Question 24

Fintech and banking: What do we know?
Thakor, Anjan, 2020

Explain how the existence of P2P platforms can reduce inequality? You may also refer to “DeFi and the Future of Finance”.

Question 25

Fintech and banking: What do we know?
Thakor, Anjan, 2020

How might P2P platforms change lending behaviour of banks?

Answer 25

If banks wanted more profitability they might start reducing their lending rates as well as adapt and shift to riskier loans.

Question 26

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What kind environment is incentivising the FinTech emerging?

Answer 26

Investments in fintech companies are higher
● in more financially-developed countries in countries
● with less competitive (more concentrated) banking systems
● in countries with higher lending interest rates and lower deposit interest

Question 27

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What are the advantages of FinTech compared to traditional financial institutions?

Answer 27

● Lower search costs of matching transacting parties.
● Achieve economies of scale in gathering and using large data.
● Achieve cheaper and more secure information transmission.
● Reduce verification costs.

Question 28

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What could be an example of a FinTech service?

Answer 28

● Credit, deposits and capital raising services
○ P2P(peer to peer) lending This is a non-intermediated business model in finance, when there is no bank between investors and borrowers and rather, fintech platform connect the two. The compensation comes in the form of fees occurring when loan is originated and also late payment fees.
○ Shadow Banks
They provide commercial bank services but do not finance with deposits.
● Payments, clearing and settlement services: Cryptocurrencies and DeFi architectures
● Investment management services: High-frequency trading platforms, e-trading, copy tradings, Robo advising for diversification benefits
● Insurance products: Big data, and IoT (internet of things) allow for more precise insurance contracts

Question 29

Fintech and banking: What do we know?
Thakor, Anjan, 2020

How do we modify financial intermediation theories to accommodate banks, shadow banks and non-intermediated solutions?

Answer 29

● Incentive conflicts in P2P platforms
P2P business often have little incentives to regulate their platforms. For instance, there is inadequate screening of originated loans. P2P service providers have no skin in the game in the form of equity. Hence,
investors have concerns about trust.
One way this could be solved with is if platform was collecting part of borrower’s repayment, instead. Loan
origination fees promote aggressive growing and engaging in overlending (profit from repayment, not
issuing)
● Differences between P2Pplatforms and banks
Banks are trusted to make careful loans and wider array of intermediation services. There is also such thing
as relationship banking. However, P2Pplatform have advantage that is lower operating costs

Question 30

Fintech and banking: What do we know?
Thakor, Anjan, 2020

There is a trend of loan migration from banks to P2P. Can P2P lending replace bank lending? Why P2P lending might be riskier than lending/borrowing from the bank?

Answer 30

The loans in P2P are risker, but not necessarily cheaper. P2P and Banks are not always complements. If the person is not allowed to take loan in the bank, they might go to P2P platform and get the desired loan, thought at a substantial cost. Banks retain advantage with deposit insurance and people’s demand for safe assets. Banks also have better funding access and trust. This effect of migration is more pronounced in countries where fewer people use banking services.

Question 31

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What effects does P2P lending have on banks? What about the economy?

Answer 31

Competition lowers the banks’ fees. Hence, the banks, to make more profit might get attracted to riskier loans. If there is a competition which lowers the interests, hence makes the borrowing cheap, the borrowers have decreased incentives to risk shifting. Hence, this decreased the default risk, which is good for economy. Empirically, banks improve profitability, asset quality and stability when facing competition. Hence, P2P might actually not be the end for bank lending.

Question 32

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What are digital wallets? What effects do they impose on banks.

Answer 32

They combine various services payments, keys, tickets, IDs. Hence, to certain extent come in competition with banks. Moreover, their role is even more important in developing countries, where people sometimes have limited access to financing.

Question 33

Fintech and banking: What do we know?
Thakor, Anjan, 2020

Why it might not be wise to view cryptocurrencies as form of payment?

Answer 33

Cryptocurrency already act as payments and banks do not (yet) incorporate them in their services. Hence, cryptos have a competitive edge BUT but it has volatility problems. Hence, it might be wiser to perceive cryptos as investment.

Question 34

Fintech and banking: What do we know?
Thakor, Anjan, 2020

Producing cash is inefficient and significantly more expensive than electronic payments. Hence, CB are already adapting to the fintech to a certain extent by introducing digital currencies (DC). What are the advantages of DC and what is the benefit for the banks of adopting such currency?

Answer 34

1. enhance settlement efficiency for transactions.
2. it is expected that Central Banks will control commercial bank better (digital EURO).
3. the data on money circulation will be more insightful, promising more effective monetary policies.
4. given the central bank will have full supervision over the digital currencies, it will be much easier to impose negative interest rate policies - people will not be able to store the digital money under the mattress anyways.

Question 35

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What kind of benefits does blockchain bring to the table?

Answer 35

1. Further expansion of the space for feasible contracts. It enables the agents who have no trust in each other to collaborate without having to go through a central authority.
2. Blockchain improves efficiency by lowering the contracting costs, intermediary costs, verification costs and other types of costs.
3. Applications that increase accuracy and offer more tailored experience. E.g: car insurance can be embedded in the car itself. As the driver drives, the data is generated which can be fed continuously to the insurance contracts, so it adjusts the terms of the contract based on this data.

Question 36

Fintech and banking: What do we know?
Thakor, Anjan, 2020

What is the bank role with the emergence of Blockchain?

Answer 36

Banks will adapt and become the providers of the smart contracts. The adaption is likely because banks are more trusted with things such as data the smart contract is gathering. Due to data collection, there will be privacy concerns also.

Question 37

Fintech and access to finance
Bollaert, Helen, Florencio Lopez-de-Silanes, and Armin Schwienbacher, 2021

What are the funding sources of FinTech?

Answer 37

● Crowdfunding
There are four to five main types: lending-based (loans through a special platform, used when start-ups can sustain paying interest, analysed together with P2P), reward-based (backers receive a pre-determined reward if the project is successful, like a unit of product), equity (start-ups issue shares or convertible notes, typically when cannot pay interest yet), royalty-based,real estate
● Fintech lending (including P2P)
Crowdfunding and other P2P lending platforms connect investors and firms directly, eliminating the intermediaries. Fintech lending has risen recently, and the growth is expected to be sustained
● Initial Coin Offerings (ICOs)
ICOs do not rely on traditional platforms, they rather utilize Distributed Ledger Technology (DLT) to raise funds. Utility tokens are sold (like an IPO, although more restricted) at a very early stage in an exchange for future services provided. It is typically used by DLT start-ups and is quite a small market, as compared to P2P loans.

Question 38

Fintech and access to finance
Bollaert, Helen, Florencio Lopez-de-Silanes, and Armin Schwienbacher, 2021

How does firms benefit from Fintech services?

Answer 38

Fintech’s lenders risk-adjusted interest rates are lower than those of traditional banks, creating better opportunities
In general, fintech allows for better financial inclusion, reaching firms that are credit-rationed or underserved, located in areas doing poorly economically, or where banks are more concentrated, providing better access to different firms, creating an opportunity to eliminate inefficiencies, where interesting projects lack funding.

Question 39

Fintech and access to finance
Bollaert, Helen, Florencio Lopez-de-Silanes, and Armin Schwienbacher, 2021

What are the effects on investors by FinTech?

Answer 39

Allow retail investors to gain exposure on asset classes that are generally available only to institutional or accredited investors.

Question 40

!!!????

Fintech and access to finance
Bollaert, Helen, Florencio Lopez-de-Silanes, and Armin Schwienbacher, 2021

How can the accessibility for investor be a disadvantage?

Answer 40

International investment due to certain regulations, high minimum tickets a lack of information. ICOs can help to mitigate this issue somewhat, as they are fully digitalized and have little barriers to entry; they do have some liquidity issues, as it might be restricted at first to exchange them (and costly in the future)
The goal of democratizing investments through fintech was aimed primarily on retail investors, but the number of institutional investors is rapidly increasing, especially in crowdlending, where they constitute a majority (together with hedge funds). Dread it, run from it, institutional investors still arrive
The discrimination is not fully eliminated in fintech, unfortunately. Democratization should allow for access to everybody, yet fintech investors seem to discriminate based on appearance and perceived trustworthiness

Question 41

Fintech and access to finance
Bollaert, Helen, Florencio Lopez-de-Silanes, and Armin Schwienbacher, 2021

Answer 41

Fintech suffers from a lack of regulation at the moment, which might lead to limited scalability of technological innovations and uncertainty
For investors, create a level (or close to) playing field for domestic and international investors, but also introduce limits on who can invest and how
For firms, require firms to publish white papers before ICOs to avoid scams, some restrictions should be implemented for a better project-level governance, provide clear disclosure rules
For intermediaries (platforms), require to carry out checks on firm/project quality or investor profile
Similarly to blockchain, regulation might take away certain freedom, but authors argue that it must be done to eliminate obvious risks.

Question 42

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

An alternative to conventional monetary policy is unconventional monetary policy such as having central banks directly intervene in markets by buying financial securities. In response to the COVID pandemic, such intervention happened by many central banks on a large scale. The article “Feverish stock price reactions to COVID-19” by Ramelli and Wagner (2020) describes the US Fed buying mainly investment grade bonds at the start of its liquidity support programme. Why was this problematic? Think about the issues discussed in the articles “The COVID-19 pandemic crisis and corporate finance” by Ellul, Erel, and Rajan (2020) and “The safe assets shortage conundrum” by Caballero, Fahri, and Gourinchas (2017)

Question 43

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

The article “The COVID-19 pandemic crisis and corporate finance” by Ellul, Erel and Rajan
(2020) touches upon the issue of zombie firms in the wake of unprecedented stimulus and support
measures for companies. Describe what is a zombie firm and what risks it poses for the economy.

Question 44

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

The COVID-19, out of the three shocks to the US economy (COVID, GFC and 9/11) is seen as the most severe - expected global GDP shrunk is to be around 5%. How did the firms defend themselves against the risk of default?

Answer 44

Banks are the first line of defense. The firms drew funds from preexisting lines of credit at an unpresented scale, with large banks providing most of the required funding

Notably, the banks now are in much more stable position to deal with shock than during GFC

Question 45

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

What does the term “Fallen angel” mean? What is specific of them?

Answer 45

The firm whose bonds have been downgraded, it is most likely to aggressively borrow.

Question 46

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

How did the downgrade affect the firms’ behaviour?

Answer 46

BBB-rated and non-investment-grade firms mostly drew down their credit lines with banks.

AAA-to A-rated firms managed to maintain access to public capital markets and issued both bonds and equity.

Question 47

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

What was the setting of bond issuance and purchasing during the COVID-19?

Answer 47

○ There was a substantial increases for bonds rated A or higher as well as for bonds rated BBB or lower.
○ Firms chose to issue bonds with longer maturities during the crisis while equity issues slowed.
○ Fed’s corporate bond purchases helped raise money cheaply.

Question 48

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

What policies do help recover firms after the downturn?

Answer 48

Debt better be raised in the short term because the long-term debt will lead to debt overhang: when the entity cannot take any more debt to finance the future project, and this in turn will slow the recovery.

Question 49

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

What were the results of the pandemic?

Answer 49

○ Firms face an aggregate annual profit decrease of €170 billion (approximately 10% of the 2018 GDP).
○ The shock will force about 13,500 firms to have negative net worth, putting at risk the employment of over 800,000 workers.
○ Subsidized financing creates the problem of zombie firms i.e. the companies that survive on credit. The zombie thing becomes a larger problem the longer lock downs, recessions last and FED programs last.

Question 50

The COVID-19 pandemic crisis and corporate finance
Ellul, Andrew, Isil Erel, and Uday Rajan, 2020

Answer 50

○ Firms in the United States with high ES scores suffered lower stock price declines and lower volatility compared to other firms
○ Higher operating profit margins of firms with high ES scores, even at a time when the economy as a whole was suffering through the first stages of a contraction

Question 51

Equity valuation using multiples
Liu, Jing, Doron Nissim, and Jacob Thomas, 2002

What are multiples?

Answer 51

Multiples are a simple valuation technique that is used widely in practice but there is very little empirical research on it.
1. bypasses explicit projections and present value calculations
2. relies on the same principle as other models such as: value is an increasing function of future payoffs and a
decreasing function of risk

Question 52

Equity valuation using multiples
Liu, Jing, Doron Nissim, and Jacob Thomas, 2002

What are value drivers?

Answer 52

Measures of historical cash flow, and historical accrual based measures, such as sales, earnings, and book value of equity.

Question 53

Capital structure
Myers, Stewart C., 2001

What are the main ideas of trade-off, pecking order and free cash flow theories?

Answer 53

1. firm will borrow up to the point where the marginal value of tax shields on the additional debt is just off setted by the increase in the costs of possible distress.
2. firms borrow less - because such firms have more
   internal financing available.
3. explains why managers do not fully exploit the tax advantages of borrowing. Possible solution to minimize the agency costs is to increase leverage.