Applied Corporate Finance

Compliments of: VOLUME 29 | NUMBER 4 | FALL 2017 Journal of APPLIED CORPORATE FINANCE In This Issue: Financial Regulation Has Financial Regulation Been a Flop? (or How to Reform Dodd-Frank) 8 Charles W. Calomiris, Columbia University Statement of the Financial Economists Roundtable 25 Charles W. Calomiris, Columbia University; Larry Harris, Uni- Bank Capital as a Substitute for Prudential Regulation versity of Southern California; Catherine Schrand, University of Pennsylvania; Roman L. Weil, University of Chicago High Frequency Trading and the New Stock Market: 30 Merritt B. Fox, Columbia Law School, Lawrence R. Glosten, Sense and Nonsense Columbia Business School, and Gabriel V. Rauterberg, Michigan Law School Shadow Banking, Risk Transfer, and Financial Stability 45 Christopher L. Culp, Johns Hopkins Institute for Applied Economics, and Andrea M. P. Neves, Seven Consulting Why European Banks Are Undercapitalized and What Should Be Done About It 65 John D. Finnerty, Fordham University, and Laura Gonzalez, California State University, Long Beach Bloomberg Intelligence Roundtable on 72 Participants: Clifford Smith, Gregory Milano, Joel Levington, The Theory and Practice of Capital Structure Management Asthika Goonewardene, Gina Martin Adams, Michael Holland, and Jonathan Palmer. Moderated by Don Chew. Leverage and Taxes: Evidence from the Real Estate Industry 86 Michael J. Barclay, University of Rochester, Shane M. Heitzman, University of Southern California, Clifford W. Smith, University of Rochester Formulaic Transparency: The Hidden Enabler of Exceptional U.S. Securitization 96 Amar Bhidé, Tufts University How Investment Opportunities Affect Optimal Capital Structure 112 Stanley Myint, BNP Paribas and University of Oxford, Antonio Lupi, BNP Paribas, and Dimitrios P. Tsomocos, University of Oxford How to Integrate ESG into Investment Decision-Making: 125 Robert G. Eccles, Arabesque Partners, and Results of a Global Survey of Institutional Investors Mirtha D. Kastrapeli, and Stephanie J. Potter, State Street Maximum Withdrawal Rates: A Novel and Useful Tool 134 Javier Estrada, IESE Business School Bloomberg Intelligence Roundtable on The Theory and Practice of Capital Structure Management Bloomberg Headquarters | New York City | October 25, 2017 72 Journal of Applied Corporate Finance • Volume 29 Number 4 Fall 2017 ROUNDTABLE Don Chew: Good morning, I’m Don Chew, they need outside financing, they use debt. in the fields of corporate finance, financial Editor of the Journal of Applied Corporate Equity is viewed only as a very expensive institutions, and risk management that Finance. And I want to join Joel Leving- last resort, something to be avoided unless has led to 15 books and some 100 articles ton, our host and Head of Fixed Income and until their debt capacity has been in leading finance and economics jour- Research here at Bloomberg Intelligence, completely exhausted. And third and last, nals. And to go along with his research, in welcoming you all to this discussion of there’s a variant of the pecking order called Cliff has received 30 Superior Teaching the theory and practice of capital struc- “the market timing hypothesis,” which Awards while at the Simon School. Cliff ture management. The main question we says in effect that if market conditions also has considerable experience working want to address is this: How can corporate favor the use of debt, then issue debt, and with companies and serving on boards. In executives manage their capital structure as much as you can—but if equity markets fact, he recently finished a 21-year stint as and payout policies to increase the value of are strong and stock prices are high, then a member of the Board of a NYSE-listed their companies? And we want to address go with equity. REIT that was recently taken private for these questions from both a theoretical and Cliff Smith, who is the representative some $8 billion through an LBO. a practitioner perspective. academic on this panel, has done some Greg Milano is the founder and man- There are really two or three main interesting research on seasoned equity aging partner of a strategy and corporate theories coming out of the academy that offerings by U.S. public companies that finance consulting firm called Fortuna have tried to address this question. But attempts to make sense of all of these Advisors. Before that, Greg ran a corpo- before we get to them, let me start by theories, to show how each contributes to rate finance advisory group with Credit mentioning the famous Miller-Modigliani our understanding of at least some aspects Suisse, where his focus was integrating “irrelevance” propositions, which at least of corporate behavior. And I’m going to strategic issues into corporate financial seem to say that neither capital structure ask Cliff to start us off this morning by policy. And before that, he was my co- nor dividends matter. The M&M propo- providing a brief review of the theory and partner at Stern Stewart & Company, the sitions show that if we make some very then tell us about this relatively new piece corporate finance consulting firm best restrictive assumptions—like no corporate of research that tries to bring all these the- known for popularizing a measure of per- income taxes or bankruptcy costs, and no ories together. formance known as “EVA.” I should also effects of leverage or dividend policies on But before I do that, let me just go mention that Greg has written a really nice corporate investment decisions—then around the table very quickly and intro- piece on financing and the drivers of value neither a company’s capital structure or duce everyone. in the pharma industry that appeared in its payouts would affect its value. And let’s start with Joel Levington, who the most recent issue of the JACF—and But for those who think that capital as I mentioned is head of Fixed Income I’ve asked him to talk about capital struc- structure does—or at least can—have Research here at Bloomberg Intelligence, ture from that perspective. significant effects on corporate values, and who is both the host and principal Rounding out our group are four ana- there are two, or maybe three, other main organizer of this discussion. Before join- lysts from Bloomberg Intelligence. These theories that get serious attention from ing Bloomberg five years ago, Joel was analysts cover a diversity of investment academics. One is typically referred to a managing director at Brookfield Asset and capital structure types—and, as Joel as the “trade-off” theory, and it says that Management and, prior to that, a Director tells me, they bring to the table over 100 companies weigh the tax and control ben- at S&P Global. years of collective, practical experience in efits of more debt against the increase in Cliff Smith is the Henry and Louise the capital markets analyzing capital struc- the expected costs of financial distress. Epstein Professor of Business Adminis- tures and financing instruments. And then there is the so-called “pecking tration, Finance, and Economics at the Asthika Goonewardene is Bloomberg order” theory, which says that companies University of Rochester’s Simon School Intelligence’s bio-tech equity analyst. The tend to take the path of least resistance by of Business. Since joining the Simon companies he covers range from the big- using internal funds when available; and if School in 1974, Cliff has done research cap biotechs such as Amgen, Gilead, and Journal of Applied Corporate Finance • Volume 29 Number 4 Fall 2017 73 ROUNDTABLE Celgene down to smaller, development- financing policies, as Modigliani and showed that a dollar of dividends paid is stage or early commercial biotechs like Miller suggested back in 1958, pretty a dollar of capital gains lost, and overall Juno, Clovis, and Bluebird. Before joining much “irrelevant”? value again is unchanged. Bloomberg, Asthika was a management Now, these are explanations for why consultant at Datamonitor Heathcare Cliff Smith: I agree that Modigliani and capital structure and dividends don’t Consulting and, before that, an equity Miller is the logical place to begin this dis- matter. But what they say to me is that research analyst at Piper Jaffray. cussion. Their 1958 paper basically said if you want to understand how and why Gina Martin is the Chief U.S. Equity that if you give me three assumptions—no financial decisions might matter, then you Strategist for Bloomberg Intelligence, taxes paid by the corporation or its inves- should start by taking these M&M state- a research platform that provides con- tors, no bankruptcy or other “contracting” ments and turning them on their heads. text on markets, industries, companies, costs, and no effect of financing choices That is, if changes in capital structure and government policy. Prior to joining on managers’ investment and operating and dividends are going to affect corpo- Bloomberg, she was the head of U.S. decisions—the current market value of rate market values, they’re going to do Equity Strategy for Wells Fargo Securities. the firm should not be affected by how so mainly for one of the reasons M&M Mike Holland covers high-yield debt in you structure the liability side of the firm’s assumed away. This means that, to under- the healthcare industry, and spends a good balance sheet, by whether companies stand why capital structure and dividends deal of his time working with Bloomberg’s choose to finance their activities mainly might matter, we want to explore the pos- distressed debt teams. Before joining with equity, or with large amounts of debt. sibility that the firm’s choice of financing Bloomberg, Mike worked at UBS and Given these assumptions, M&M showed and dividend policies can affect the taxes Credit Suisse, following several years on that these financing decisions can’t have a of the firm or its investors.

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