Terminal value

Abstract: We examine the cross-sectional variation in the marginal value of corporate cash holdings arising from differences in corporate financial policy. We begin by providing semi-quantitative predictions for the value of an extra dollar of cash depending upon whether that dollar will most likely go to i) increasing distributions to equity, ii) reducing the amount of cash that needs to be raised in the capital markets, or iii) servicing debt or other liabilities. We then relate firm financial structure characteristics to the likelihood of firms engaging in these actions, and derive a set of intuitive hypotheses to test empirically. We generate estimates of the marginal value of cash by examining the variation in excess stock returns over the fiscal year and find results that are both qualitatively and quantitatively consistent with all hypotheses tested. In particular, we find that the marginal value of cash declines with larger cash holdings, higher leverage, better access to capital markets, and as firms choose to distribute cash via dividends rather than repurchases.

Abstract: We characterize and measure a long-term risk-return trade-off for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This trade-off features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the long-run dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics.

Abstract: We show that aggregate consumption risks embodied in cash flows can account for the puzzling differences in risk premia across book-to-market, momentum, and sizesorted portfolios. The dynamics of aggregate consumption and cash flow growth rates, modeled as a vector autoregression, are used to measure the consumption beta of discounted cash flows. Differences in these cash flow betas account for more than 60% of the cross-sectional variation in risk premia. The market price for risk in cash flows is highly significant. We argue that cash flow risk is important for interpreting differences in risk compensation across assets. THE IDEA THAT DIFFERENCES IN EXPOSURE to systematic risk should justify differences in risk premia across assets is central to asset pricing. The static CAPM (capital asset-pricing model) (see Sharpe (1964) and Lintner (1965)) implies that assets’ exposures to aggregate wealth should determine cross-sectional differences in risk premia. The work of Lucas (1978) and Breeden (1979) argues that the risk premium on an asset is determined by its ability to insure against consumption fluctuations. Hence, the exposure of asset returns to movements in aggregate consumption (i.e., the consumption betas) should determine cross-sectional differences in risk premia. Evidence presented in Hansen and Singleton (1982) for the consumption-based models, and in Fama and French (1992) for the CAPM, shows that these models have considerable difficulty in justifying the differences in observable rates of return across assets. Consequently, identifying economic sources of risks that justify differences in the measured risk premia continues to be an important economic issue. Asset prices reflect the discounted value of cash flows; return news, consequently, reflects revisions in expectations about the entire path of future