Fundamental Investment Analysis

We integrate the financial architecture into the theory of investment by building on two strands of literature: irreversible investment and debt pricing/capital structure. We extend the real options approach to investment, pioneered by Michael J. Brennan and Eduardo S. Schwartz (1985) and Robert McDonald and Daniel Siegel (1986), to allow for capital structure decisions under strategic debt service. We also draw insights from corporate debt pricing/capital structure literature, which focuses on leverage and security pricing after investment has already been made (Robert C.

Ernst & Young hosted this 2007 roundtable with the goal of providing a better understanding of the challenges and best practices of using valuation analysis to support executive decisions. Panelists included Richard Ruback of the Harvard Business School, Trevor Harris of Morgan Stanley, Aileen Stockburger of Johnson & Johnson, Dino Mauricio of General Electric, Christian Roch of BNP Paribas, Ken Meyers of Siemens Corporation, and Charles Kantor of Lehman Brothers. Jeff Green of Ernst & Young moderated.

This paper studies the application of fair value accounting in bank holding companies in the United States with the purpose of evaluating the effects of expanding fair value accounting in the banking industry.

Recent deliberations by both the International Accounting Standards Board (IASB) and the Financial Accounting Standard Board (FASB) in the United States have focused on how fair values of assets and liabilities should be measured. The issue of when, rather than how, fair value measurement should be applied is still far from resolved, however.

In this paper, we propose a method of accounting for stock options that tracks the effect of the options on shareholder value. The accounting approach we outline can be applied not only to employee stock options but to all claims that are effectively convertible into common shares, including convertible preferred stock, warrants, and call and put options on the firm's own stock. Our proposal also aims to make accounting consistent with stock prices, since the market surely takes account of the (potential) valuation effects of these claims when setting stock prices.

This paper yields a summary score that informs about the sustainability (or persistence) of earnings and about the trailing P/E ratio. The score is delivered from a model that identifies unsustainable earnings from the financial statements by exploiting accounting relations that require that unsustainable earnings leave a trail in the accounts. The paper also builds a P/E model that recognizes that investors buy future earnings, so should pay less for current earnings if those earnings cannot be sustained in the future.

We develop a dynamic incomplete-markets model where an entrenched insider, facing imperfect investor protection and non-diversifiable illiquid business risk, makes interdependent consumption, portfolio choice, expropriation, corporate investment, ownership, and business exit decisions.

The role of private equity in global capital markets appears to be expanding at an extraordinary rate. Morgan Stanley estimates that there are now some 2,700 private equity funds that either have raised, or are in the process of raising, a total of $500 billion. With this abundance of available equity capital, the willingness of private equity firms to participate in "club" deals, and the leverage that can be put on top of the equity, private equity buyers now appear able and willing to pay higher prices for assets than ever before.

Many corporate executives view private equity as a last resort, as expensive capital that should be tapped only by companies that don't have access to presumably cheaper public equity. The reality of private equity, however, is more complex, and potentially quite rewarding, for both shareholders and management. This paper surveys some of the academic work on the costs and benefits of public vs. private equity, contrasting the private equity investment process with its public counterpart and exploring how such a process may add value.