comments on: “external financing, access to debt markets and stock returns” by f.y. eric c. lam...

Comments on:“External Financing, Access to Debt Markets

and Stock Returns”by F.Y. Eric C. Lam and K.C. John Wei

Santiago BazdreschUniversity of Minnesota

November 13th, 200920th Financial Economics and Accounting Conference

Comments on "External Fnancing, Access to Debt Markets, and Stock Returns” 2

• Summary– Overview– Highlight results– Contribution

• Evaluation– Contributions– Concerns

• Suggestions

Index


Overview

• Objective: – Establish External Financing Anomaly (XFin) independence of

Asset Growth (AG) and of Accruals (Ac)– Find ‘mechanism’ behind it

• Method:– Compare returns of firms based on firm characteristics:

• EF, Asset Growth, Total Accruals, Size, Book to Market, Momentum

– Show in which firms the EF effect is concentrated – Find the mechanism for the EF effect by contrasting

characteristics of these firms with the average firm


Highlight #1• The XFin anomaly is there after controlling for AG, Ac

and everything: else

∆XFIN TAC TAG Ret RetSZ RetSZ,BM α Panel A: Net external financing (∆XFIN) decile portfolios

1 (low) -15.98** -4.43** -0.34 1.60** 0.36** 0.27** 0.44** 10 (high) 46.35** 26.98** 87.64** 0.29 -0.86** -0.68** -0.64** 1 – 10 -62.33** -31.41** -87.99** 1.31** 1.22** 0.95** 1.08** (-18.96) (-27.07) (-14.42) (7.33) (7.31) (7.54) (7.14)

Model Intercept ∆XFIN ∆XFINr TAC TACr TAG 6 0.004 -0.114 -0.096 -0.040 (0.80) (-6.78) (-3.00) (-3.12)

TAC Low Mid High TAG TAG TAG Low Mid High Low Mid High Low Mid High Average

Low ∆XFIN minus high ∆XFIN RetSZ,BM 0.30 0.49* 0.37 0.12 0.40** 0.27 -0.38 0.41** 0.48** 0.27** (1.61) (2.10) (1.48) (0.54) (3.77) (1.70) (-1.10) (2.79) (4.50) (2.81) α 0.33 0.65* 0.44 0.19 0.39 0.30 -0.29 0.47** 0.39** 0.32* (1.40) (2.28) (1.53) (0.71) (3.12) (1.76) (-0.75) (3.10) (3.64) (2.44)

•Table IV, row 6: Fama-MacBeth regressions show significant coefficients

•Table I, Panel A: EF Decile portfolios show significantly different alphas

•Table II, Triple sorts show significantly different alphas


Highlight #2

• The XFin anomaly is driven by unrated firms:

∆XFINr Ranking 1 2 3 4 5 6 7 8 9 10 1 – 10

Panel C: Differences between stocks unrated and stocks rated by credit analyst Ret -0.12 -0.00 0.04 0.04 0.21 0.11 -0.00 0.12 -0.36 -0.72** 0.60** (-0.79) (-0.02) (0.29) (0.30) (1.36) (0.62) (-0.01) (0.59) (-1.69) (-2.94) (3.00) RetSZ -0.23* -0.12 -0.05 -0.05 0.09 -0.02 -0.20 -0.07 -0.61** -0.87** 0.64** (-2.28) (-1.45) (-0.49) (-0.55) (0.92) (-0.18) (-1.47) (-0.49) (-4.23) (-4.31) (3.08) RetSZ,BM -0.26** -0.18* -0.10 -0.09 -0.00 -0.09 -0.24* -0.06 -0.48** -0.68** 0.42* (-2.75) (-2.26) (-1.17) (-1.18) (-0.01) (-1.04) (-2.17) (-0.50) (-3.96) (-4.09) (2.25) Alpha -0.29 -0.11 -0.07 -0.00 0.15 -0.00 -0.04 0.02 -0.40 -0.78** 0.50* (-1.92) (-0.86) (-0.48) (-0.04) (1.00) (-0.02) (-0.21) (0.10) (-1.87) (-3.07) (2.35)

•Table V, Panel C


Highlight #3

• High XFin, unrated firms, are very special:

•Table VII, Panel C


Contribution

• Powerful evidence that small, unrated firms with lots of R&D are the key to understanding external finance anomaly

Contribution

• An alternative (and more appealing) story to market timing:– It is consistent with the net external finance

anomaly (debt and equity)– It ‘explains’ the original overvaluation of the

firms


Contribution/Concern

• A AG and Ac free XFin measure: XFinr – I’m not sure why this is important– If XFin is a relevant variable, why do we want to keep

only the part orthogonal to AG and Ac?– Why do we think a linear model for XFin is a good

choice? It’s a bad/bad situation because if it is a goodm odel then XFin is easy to explain, but if it is a bad model, then you’re not capturing any of XFin…



Concerns• On statistics/robustness:

– We want the right tests of differences in the coefficients, not of individual significance

– Results based on XFinr show large heteroscedasticity in the sample: this needs to be addressed and/or discussed.

– Portfolios should be built by sequentially separating in terciles (first Ac then AG then XFinr ): out-of-the-diagonal coefficients would be more significant then. Since you are aiming to show that it is independent you want the XFinr anomaly to be present in all nine portfolios right?

– Temporary overvaluation should also show up as a short-lived anomaly: It should disappear if you look backward or forward in time, unless it is not overvaluation…

– Must use GMM for Fama-MacBeth since errors are likely to be dependent over time

Concerns• It’s a hard, ugly part of the job, but still, the paper

could do a better job of contrasting its story with the literature and with other simple stories:– Contrast with Li,Lividan and Zhang, 2009.– Contrast with papers rejecting the independence of

the XFin anomaly.– Contrast with intangible capital story (Hall, 2004)– Contrast with errors in variables story:

XFint = ax + bxYt + ext

AGt = aAG + bAGYt+ eAGt

Act = aAc + bAcYt + eAct


Concerns

• Behavioral story does not explain why the announcement day returns of rated firms is significantly higher that average. Overvaluation test shows undervaluation of the rest of the firms? How is that explained?: It can’t be that the contribution of the paper is that is shows the source of the external anomaly is this test of overvaluation and then you don’t mention the other big result in the test.



Suggestions

MORE FOCUS:• Focus on performing direct tests that distinguish

between different rational and behavioral explanations of XFin anomaly– Test: is the XFin anomaly temporary? Does it

disappear if I look further backward or forward?

• Or, focus on describing the risk and return facts around unrated, high XFin firms.


Suggestions

• Correlation and causality:– High R&D and high equity finance can be caused by

low expected returns.– Need a model, I’d be happy to talk more about this…

• Efficient markets models:– Costly external finance (Li, Lividan, Zhang,09)– Decreasing returns to scale– Real options (Berk, Green and Naik,98)


Suggestions

• Use XFinr as robustness test only

• Use relevance measure: form portfolios based on Fama-MacBeth regressions with and without XFinr and see the difference in the realized ‘portfolio based’ return. (see my paper with Belo and Lin for an example).


Conclusion• Good paper!• Very interesting facts uncovered and suggestive

interpretation– Strong evidence of unrated, high XFin firms as key to

anomaly– Suggestive interpretation of facts as alternative to

market timing– Strong evidence of XFin anomaly independence of

AG and Ac


Conclusion

• BUT, my prior is still market efficiency: It must be some kind of lower risk that is driving the lower returns of the high XFin firms…


Small issues• Must detail the results of the auxiliary regressions used • Very hard to interpret results based on XFinr, specially without

knowing how good the regression is or how it splits the sample• XFinr might just be reflecting intangible asset investment• How much mixing is there over time between portfolios? If firms stay

in the XFin10 portfolio for long, then its one story, if they are there only one period, then its another.

• Language: Investment vs. Investment Growth vs. Asset Growth, its not always clear what you mean

• Triple sort portfolio differences are not significantly different from each other

• Speculation about ‘aggressive growth strategies’ is unwarranted: firms could well be doing R&D to survive rather than to grow

• ‘Unknown risks’ not corrected for, they are unknown…• Provide results with XFin and XFInr to compare

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