Chapter Outline,13.1 Can Financing Decisions Create Value? 13.2 A Description of Efficient Capital Markets 13.3 The Different Types of Efficiency 13.4 The Evidence 13.5 Implications for Corporate Finance 13.6 Summary and Conclusions,13.1 Can Financing Decisions Create Value?,Earlier parts of the book show how to evaluate investment projects according the NPV criterion. The next five chapters concern financing decisions.,What Sort of Financing Decisions?,Typical financing decisions include: How much debt and equity to sell When (or if) to pay dividends When to sell debt and equity Just as we can use NPV criteria to evaluate investment decisions, we can use NPV to evaluate financing decisions.,How to Create Value through Financing,Fool Investors Empirical evidence suggests that it is hard to fool investors consistently. Reduce Costs or Increase Subsidies Certain forms of financing have tax advantages or carry other subsidies. Create a New Security Sometimes a firm can find a previously-unsatisfied clientele and issue new securities at favorable prices. In the long-run, this value creation is relatively small, however.,13.2 A Description of Efficient Capital Markets,An efficient capital market is one in which stock prices fully reflect available information. The EMH has implications for investors and firms. Since information is reflected in security prices quickly, knowing information when it is released does an investor no good. Firms should expect to receive the fair value for securities that they sell. Firms cannot profit from fooling investors in an efficient market.,Reaction of Stock Price to New Information in Efficient and Inefficient Markets,Stock Price,-30 -20 -10 0 +10 +20 +30,Days before (-) and after (+) announcement,Efficient market response to “good news”,Overreaction to “good news” with reversion,Delayed response to “good news”,Reaction of Stock Price to New Information in Efficient and Inefficient Markets,Stock Price,-30 -20 -10 0 +10 +20 +30,Days before (-) and after (+) announcement,Efficient market response to “bad news”,Overreaction to “bad news” with reversion,Delayed response to “bad news”,13.3 The Different Types of Efficiency,Weak Form Security prices reflect all information found in past prices and volume. Semi-Strong Form Security prices reflect all publicly available information. Strong Form Security prices reflect all informationpublic and private.,Weak Form Market Efficiency,Security prices reflect all information found in past prices and volume. If the weak form of market efficiency holds, then technical analysis is of no value. Often weak-form efficiency is represented as Pt = Pt-1 + Expected return + random error t Since stock prices only respond to new information, which by definition arrives randomly, stock prices are said to follow a random walk.,Why Technical Analysis Fails,Stock Price,Time,Investor behavior tends to eliminate any profit opportunity associated with stock price patterns.,If it were possible to make big money simply by finding “the pattern” in the stock price movements, everyone would do it and the profits would be competed away.,Semi-Strong Form Market Efficiency,Security Prices reflect all publicly available information. Publicly available information includes: Historical price and volume information Published accounting statements. Information found in annual reports.,Strong Form Market Efficiency,Security Prices reflect all informationpublic and private. Strong form efficiency incorporates weak and semi-strong form efficiency. Strong form efficiency says that anything pertinent to the stock and known to at least one investor is already incorporated into the securitys price.,Relationship among Three Different Information Sets,Some Common Misconceptions,Much of the criticism of the EMH has been based on a misunderstanding of the hypothesis says and does not say.,What the EMH Does and Does NOT Say,Investors can throw darts to select stocks. This is almost, but not quite, true. An investor must still decide how risky a portfolio he wants based on risk aversion and the level of expected return. Prices are random or uncaused. Prices reflect information. The price CHANGE is driven by new information, which by definition arrives randomly. Therefore, financial managers cannot “time” stock and bond sales.,13.4 The Evidence,The record on the EMH is extensive, and in large measure it is reassuring to advocates of the efficiency of markets. Studies fall into three broad categories: Are changes in stock prices random? Are there profitable “trading rules”? Event studies: does the market quickly and accurately respond to new information? The record of professionally managed investment firms.,Are Changes in Stock Prices Random?,Can we really tell? Many psychologists and statisticians believe that most people want to see patterns even when faced with pure randomness. People claiming to see patterns in stock price movements ar