Managing A Firm's Systematic Risk Through Sales Variability Minimization- A Test of Three Competing Techniques

Transcription

1 Global Econoy & Finance Journal Vol. No. March 009 Pp Managing A Fir's Syseaic Risk Through Sales Variabiliy Miniizaion- A Tes of Three Copeing Techniques Fraydoon Rahnaay Roodposhi, Hashe Nikoara and Zahra Airhosseini In his paper, we will inend o inroduce he Degree of Econoic Leverage (DEL) and is usage as one of he new echniques in explanaion of Bea coefficien and idenificaion of he syseaic risk and profi planning goal in leverage heoreical concepual sudies as well. Meanwhile, we will consider and analyze i hrough experienal esing for increasing is usificaion explanaory poency. Afer heoreical concepual sudies,i was confired ha here is no inverse and eaningful relaion beween ineres rae and a fir's sale, bu here is a eaningful difference beween easure of he Bea calculaing by DEL and he Bea copuing by CAPM and D-CAPM. Filed of Research: Finance and Econoics 1. Inroducion This paper anages a fir's syseaic risk hrough sales variabiliy iniizaion and inroduces Degree of Econoic Leverage. We exend ha original work by separaing econoic risk fro business risk, and we epirically represen he econoic risk consruc hrough he use of he er, degree of econoic leverage.to beer undersand he role of sales variabiliy iniizaion in anaging a fir's syseaic risk, he uliple diensions of syseaic risk us be concepually analyzed. Dr. Fraydoon Rahnaay Roodposhi, Associae Professor, Science and Research Branch, Islaic Azad Universiy, Tehran, Iran, eail: rahnaa@iau.ir, Corresponding Auhor. Dr. Hashe Nikoara, Associae Professor, Science and Research Branch, Islaic Azad Universiy, Tehran, Iran Zahra Airhosseini, Ph.D. Suden of Business adinisraion on financial anageen, Science and Research Branch, Islaic Azad Universiy, Tehran, Iran, eail: airhosseini_1354@yahoo.co

2 Hawawini and Vialle (1999) provided such an analysis in figure(1) by illusraing financial risk as he relaion beween earning afer axes (EAT) and earnings before ineres and axes (EBIT), and operaional risk as he relaion beween EBIT and sales. (Griffin & Dugan, 003). They furher specified ha sales vary as a resul of he uncerainies in he econoic, poliical, social, and copeiive environen in which firs operae. Hence, hey characerized econoic risk as he risk faced by all firs and inerpre he cobined effec of econoic risk and operaional risk as business risk. 64 Figure 1: Analysis of Muliple Diensions of Syseaic Risk. -Econoic condiions -poliical & social environens SALES Less variable and Fixed expenses Earnings before ineres and axes Less fixed ineres and variable ax expenses Earning afer Tax -arke - Fir's srucure copeiive posiion ECONOMIC RISK OPERATIONAL RISK BUSINESS RISK FINANCIAL RISK Fro: Finance for Execuives (1 s ed.), by G.Hawawini and C.Vialle Mandelker and Rhee (1984) deonsraed ha boh operaional risk and financial risk can be proxied hrough he respecive use of he degree of operaing leverage (DOL) and he degree of financial leverage (DFL). Rhee (1986) was he firs o decopose syseaic risk ino a hree-coponen odel: business risk, operaing risk, financial risk. Rhee suggesed ha he business risk coponen is deerined by he arke-relaed porion of deand uncerainy, as evidenced by sales variabiliy. Blazenko (1999) recognized he suscepibiliy o and ipac of econoic shocks on sales and earnings. Given he inforaion value of fir earnings, Blazenko hypohesized a relaion beween rading of a fir's shares and fir's sales and added an "econoic perurbance" er o his odel o accoun for his relaion. Whereas, nowadays, he financing for aerial enioned as a sraegy and all of he researched copanies in he auoobile indusry apply his sraegy, so we can expec increasing financial expenses as well as enhancing he ineres rae. Therefore, we can forecas if financial expenses increase, producs cos will increase oo. So we will have disadvanage goods and will lose sales. Thus,

3 esing he effec of he ineres rae as an exogenous econoic disurbance sees o be necessary. 65. Lieraure Review.1. Degree of Econoic Leverage (DEL) Leverage is he use of fixed cos in an aep o increase profiabiliy. The Mandelker's and Rhee's odel (1984) provided he heoreical fraework for he Degree of econoic leverage hrough heir explici deconsrucion of bea ino is coponen pars of inrinsic business risk and operaing and financial leverage. The degree of econoic leverage is he percenage change in a fir's sales resuling fro a uni percenage change aribuable o an exogenous econoic disurbance ( Ζ ). The evidence suppors he DEL's role in explaining syseaic risk a boh he indusry and porfolio levels, and ixed resuls a he fir level. (Griffin & Dugan, 003).. Classical Capial Asse Pricing Model (CAPM) For over 30 years, acadeics and praciioners have been debaing he eris of he CAPM, focusing on wheher bea is an appropriae easure of risk. CAPM is he resul of he foraion and developen of he capial arke heory which was esablished by Markowiz wih he inroducion of porfolio heory. Mos of hese discussions are by and large epirical; ha is, hey focus on coparing he abiliy of bea o explain he cross secion of reurns o ha of alernaive risk variables. Mos of hese discussions, however, overlook where bea as a easure of risk coes fro, naely, fro equilibriu in which invesors display ean-variance behavior (MVB). In oher words, fro an equilibriu in which invesors axiize a uiliy funcion ha depends on he ean and variance of reurns of heir porfolio. CAPM explains he relaion beween risk reurn and asse according o arke reurn. By his odel, during a period of ie, reurn rae of coon sock is easured when sock price is available and he resul is used as arke indices for easureen of sock operaion. In CAPM ehod, all of he asses are considered. Bu pracically here are soe probles for easureen of reurn of all he asses or gaining general arke index. In order o eeing o he goals, coon sock is used for explaining of he odel. Firs hypohesis of CAPM is a kind of linear relaionship beween sock reurn of each aciviy and sock arke reurn during soe periods. (Reilly & Brown, 004)

4 Model calculaion forula, by a leas squares su (regression analysis) is as follows: K = α + βk + e Where: K = reurn rae of coon sock in copany, α = consan value, β = sensiiveness coefficien (bea), e = error in regression equaion, K = reurn rae of arke porfolio. According o aheaical expecaion supposiion, error is equal o zero in regression equaion (poins disances fro esiaed line). In CAPM, bea coefficien is very iporan for experienal ess. Because i is used for porfolio assessen and i is useful. The ain reason is ha bea coefficien of a share is less consan owards porfolio bea fro one period o anoher period. In addiion, researchers have shown ha bea of coon share during a long period (ore han a period) ends o one. CAPM has been fored on he base of arke risk preiu (risk preiu) odel. I eans i is supposed ha invesors expec o gain higher reurn by acceping ore risks. Also, hey expec o gain accepable reurn fro he asse which can be risked. In CAPM, if we suppose shor er reasury papers of a copany as an asse which can be risked, according o his odel, invesors should gain a reurn ore han reurn of reasury paper, because hey accep ore risk. According o CAPM supposiion he equaion is used for line calculaion of securiies arke: K = RF + β ( RM RF ) Where: R F = risk free rae of reurn, β = bea coefficien, R M = reurn rae based on arke index, RM RF = preiu or excessive reurn of arke (risk preiu) owards risk free rae of reurn. CAPM explains ha expeced reurn rae of an asse is a funcion of wo pars: risk free rae of reurn and risk preiu. So: K i = Risk free rae of reurn + Risk preiu The ain variable of his odel is bea coefficien ha deerines he aoun of deanded preiu (bonus) by invesors for porfolio invesen, for each of he securiies; bea coefficien is easured according o sensiiveness coefficien of securiies reurn rae owards arke. CAPM can relae expeced reurn rae of each of securiies like i (or P porfolio) wih suiable sandard of securiies risk, i.e. is bea. Bea is suiable sandard of risk ha can no change i hrough variey and invesors should consider is own porfolio anageen in decision processes.in he classical CAPM fraework, an invesor's uiliy is fully deerined by he ean-variance reurns of he porfolio, i.e. he higher he reurn is and he lower he risk is, he beer he invesen would be. The risk of an asse i if aken individually is hen easured by he asse's sandard deviaion of reurns ( δ i ), which is calculaed as: (Esrada, 00) 66

5 67 δ [ μ ) ] i = E ( R i i Where R denoes reurns and μ denoes ean reurns of a sock. Sandard deviaion of reurns is one of he risk facors ha we will regress reurns wih. When asse i is us one ou of he any in a fully-diversified porfolio, however, is risk is easured by is covariance wih respec o he arke porfolio ( δ im ): δ im = E [( R μ ) ( R μ )] i i M M Where indexes represen he arke porfolio. Bea as asse i ( β ) hen equals he covariance beween asse i and he arke porfolio divided by he variance of he arke porfolio: δ im E[ ( Ri μi ) ( R μ )] β = = δ E ( R μ ) M [ ].3. Downside Capial Asse Pricing Model (D-CAPM) There are only a few non-capm based odels, of which he bes known and os relevan is developed by Esrada (00). I overcoes one of he os serious weaknesses of he CAPM; specifically, ha invesors are assued o be averse o variance or oal risk. In fac, as already enioned, invesors are oivaed by heir aversion o downside risk, ha is, downside and upside swings are no equally iporan for he invesors, as his or her pivoal goal when selecing an invesen arge is a desire o avoid an econoic loss. (Esrada, 003). Esrada (00) inroduced he Downside Capial Asse Pricing Model (hereinafer referred o as he D-CAPM) o deal wih he above enioned proble. In general, he cos of equiy calculaed under he D-CAPM is higher han ha of he CAPM and lower han ha of he odels double-couning he risk; herefore he D-CAPM should no only explain reurns in developed counries, bu in eerging arke as well. The usage of sei-variance and downside bea is he only difference beween he D-CAPM and he CAPM. The forula of he cos of equiy under he D-CAPM herefore is as follows: D K = RF + β ( RM RF ) D Where β is he downside bea. (Devyzis & Jankauskas, 004) In he D-CAPM, ean-sei variance (or downside variance) reurns of he invesor's porfolio deerines is uiliy. The risk of an asse i aken individually is easured by he asse's downside sandard deviaion ( Si sei deviaion) of reurns, calculaed as; { Min[ ( R μ ), O] } Si = E i i Where μi is he ean reurn of asse i, which can be replaced wih any benchark reurn. Downside covariance (coseivariance) of asse i o he arke porfolio is hen:

6 { Min[ ( R μ ), O] Min[ ( R O] } δ i, = E i i μ ), Consequenly, downside bea of asse i, equivalenly o he CAPM bea, is equal o coseivariance divided by he arke's seivariance of reurns: D δ i E{ Min[ ( Ri μi ), O] Min[ ( R μ ), O] } β = = δ E Min ( R μ ), O { [ ] } The Effec of Financial Leverage on Bea A sock s expeced reurn, is dividend yield plus expeced price appreciaion is relaed o risk. Risk-avers invesors us be copensaed wih higher expeced reurns for bearing risk. The presence of deb in a fir s capial srucure has an ipac on he risk borne by is shareholders. Wih financial leverage, he bea on a fir s sock reflecs boh business and financial risk. This bea is called levered L bea, β. In he absence of deb, shareholders are subeced only o basic business or operaing risk. The socks bea herefore reflecs he syseaic risk inheren in he fir s basic business operaions. Wih no financial leverage, his U bea is he sock s unlevered bea, β. This business risk is deerined by facors such as he volailiy of a fir s sales and is level of operaing leverage. As copensaion for incurring business risk, invesors require he preiu in excess of he reurn hey could earn on a riskless securiy such as a Treasury bill. Thus, in he absence of financial leverage, a sock s expeced reurn can be hough of as he risk-free rae plus a preiu for business risk. For invesors o hold he shares of firs wih deb in heir capial srucures, hey us be copensaed for he addiional risk generaed by financial leverage. The addiional risk preiu associaed wih he presence of deb in a fir s capial srucure is he financial risk preiu. (Keser, 005). The expeced reurn on a fir s sock is he risk free rae plus a preiu for risk: Expeced reurn = Risk-free rae + Risk preiu The risk preiu consiss of a preiu for business risk and a preiu for financial risk. Expeced reurn = Risk-free rae + Business risk preiu + Financial risk preiu This relaion can be forulaed as follow: R = R + BRP FRP s f + This relaion is illusraed graphically in figure (). F

7 69 igure : The Relaion beween a Fir's Financial Leverage and he Expeced Reurn on Is Sock. Expeced Reurn on he Fir s R f R s Financial Risk Preiu Business Risk Preiu Risk-Free Rae The Fir s Raio of Deb o Equiy Fro: Keser, W., 005. Case Probles in Finance. Mc Graw-Hill, firs ediion, 473. Under he assupions of he CAPM, here is a siple relaion beween levered and unlevered beas: L U D β = β (1 + ) E Alernaively, L U β β = D 1+ E The CAPM can be eployed o decopose a sock s expeced reurn ino is basic coponens. This can be accoplished by cobining he equaion relaing levered and unlevered bea and he basic CAPM expression, he SML. The general and CAPM version of his decoposiion are: U U D RS = RF + β ( RM RF ) + β ( )( RM RF ) E Alernaively, U L U R = R + β R R ) + ( β β )( R R ) S F ( M F M F Thus, he expeced reurn on a sock can be decoposed ino: 1. The risk-free rae.. a business risk preiu presened wih no deb in a fir s capial srucure

8 3. The addiional risk preiu creaed by he exisence of deb in he capial srucure. 3. Mehodology The obecive of he presen research is o deonsrae he degree of econoic leverage as a deerinae of syseaic risk, and he assessen of he increenal explanaory power of he DEL hrough epirical esing. Research ehod is according o survey ehod and is of a correlaion ype which is ain goal is o definie he relaionship aong soe quaniaive variables. Populaion of his research is all he acceped auoobile and auooive pars anufacure copanies in Tehran Sock Exchange which have operaed for 10 years, since 1 March 1996 o 1 March 006. Iranian auoobile and auooive pars secor is 3 copanies. 18 copanies have operaed on he years are under sudy. We use Mandelker and Rhee odel o provide he heoreical fraework for he DEL. ~ Q, 1 % ΔQ Q, 1 DEL = = % Δ ~ 1) Z Z, 1 Z, 1 70 β ) o = ( DEL)( DFL)( DOL β ) Where β o π COV Z =, 1, ~, R,, 1 E, 1 δ ~ Z, 3) The firs er wihin he covariance is a consan ha represens he las period's earnings afer axes ( π, 1 ) ha already reflec he econoic disurbance ( Z, 1 ) ha ay have occurred in ha period. The second er wihin he covariance includes an expecaion ha a fir's equiy arke value ( E, 1 ) already reflecs ~ anicipaed fuure econoic disurbance ( Z, ). I is he covariance of he produc of hese wo ers wih he arke reurn ha represens he inrinsic business o risk faced by he fir. This β is differen fro siilar ers expressed in he o analyical odels of Rhee (1986) or Mandelker and Rhee (1984). The Rhee β represens a fir's inrinsic risk afer he business, operaing, and financial risk

9 71 o are isolaed. The Mandelker and Rhee β represen a fir's inrinsic risk in he absence of operaing and financial leverage Based on he above lieraure, his sudy seeks o es he following hypoheses: H 1 : There is a eaningful relaion beween ineres rae and copany's sale. H : The explanaory power of he DEL hrough arke reurn is ore han DFL and DOL. H 3 : The explanaory power of he DEL hrough expeced reurn is ore han DFL and DOL. H 4 : There is a eaningful differeniaion beween accuulaed bea by DEL and accuulaed bea by CAPM and D-CAPM. 4. Hypohesis Tesing Correlaion and regression analysis were conduced on he daa o es he hypohesis one o four. Resuls of correlaion in able 1 provide a suppor o hypohesis 1 which saes he exisence a concepual relaion beween sale and ineres rae wih confidence level of 95% is no acceped. Hypohesis ha saes "explanaion abiliy of degree of econoic leverage wih arke reurn is higher han he considered degree of operaional leverage and degree of financial leverage" has acceped. Table represens a suppor o he hypohesis, firs he relaion beween degree of econoic, operaional and financial leverages wih arke reurn are easured by Spearan correlaion es and hen he correlaion aoun beween he variables obained by his es are copared wih one anoher. The obained P aoun for he enire variables in a concepual level is greaer han 0.05 ha i proves he non-exisence of a concepual relaion beween hese variables by he confidence level of 95%. Bu in relaion o he explanaion abiliy of hese variables, because he obained Spearan correlaion coefficien beween he degree of econoic leverage and arke reurn is higher han wo operaional and financial leverages, he explanaion abiliy of his leverage wih he arke reurn is higher han he explanaion abiliy of degree of financial leverage and degree of operaional leverage. Hypohesis 3 ha saes "explanaion abiliy of degree of econoic leverage wih expeced reurn is higher han he considered degree of operaional leverage and degree of financial leverage" has acceped. Table 3 provides a suppor o his hypohesis as well as able. Resuls of coparing levered and unlevered bea and expeced reurn in real and predicable anner hrough DEL, CAPM, D-CAPM odels have been suarized in able 4; respond o he ain quesion of research which is he purpose of research. The clai is he exisence a concepual difference beween he calculaed Bea by DEL and he calculaed Bea by he wo oher ehods. For his purpose, firs by using he annual real daa, we have calculaed he aoun of Bea fro hree ehods of DEL, CAPM and D-CAPM for years 001 o 006 and hen by using he average of five-year growh rae ( ), we have prediced each of he variables for years 001 o 006 and he aoun of

10 Bea has been prediced fro each hree enioned ehods for his period of l ie. Finally, by using he real and prediced lever Bea ( β ), he aoun of non u lever Bea ( β ) and expeced reurn ( R s ) for hese five years has been realiy and predicabiliy calculaed and copared. Through coparing he real and prediced aouns in each hree ehods, we will aain his resul ha oal prediced aouns of all variables (lever Bea, non lever Bea and expeced reurn) are closer o he realiy in copare wih oher wo ehods hrough helping of DEL ehod for all exisen copanies and our clai will be acceped in his hypohesis, ha is he calculaed Bea by DEL has a concepual difference wih he calculaed Bea by CAPM, D-CAPM ehod. Furherore, i is considerable ha no only he calculaed prediced reurn by DEL is closer o he realiy in copare wih he wo oher ehods, bu also we can say ha he reason of his issue is he inerference of he nuber of very iporan variables o such as financial expense and ne ineres in he β accouning ehod and as a resul he calculaed Bea aoun. Table 1: Tesing correlaion beween sale & ineres Correlaions: R-%SALE; R-%I Spearan correlaion of R-%SALE and R-%I = P-Value = Table : Tesing correlaion beween Marke Reurn & DEL, DOL, and DFL Correlaions: R- DEL; R - R Spearan correlaion of R- DEL and R - R = P-Value = 0.13 Correlaions: R- DOL; R - R Spearan correlaion of R- DOL and R - R = 0.06 P-Value = Correlaions: R- DFL; R - R Spearan correlaion of R- DFL and R - R = P-Value = Table 3: Tesing correlaion beween Expeced Reurn & DEL, DOL, and DFL Correlaions: R - Rs; R- DEL Spearan correlaion of R - Rs and R- DEL = 0.0 P-Value = Correlaions: R - Rs; R- DOL Spearan correlaion of R - Rs and R- DOL = P-Value = Correlaions: R - Rs; R- DFL Spearan correlaion of R - Rs and R- DFL = P-Value = 0.150

11 Table 4: Coparing Levered and Unlevered Bea and Expeced Reurn in Real and Predicable Manner hrough DEL, CAPM, D-CAPM Models 73 DEL CAPM D-CAPM Differen ce Forecas Acual Differen ce Forecas Acual Differen ce Forecas Acual Variable l B u B (%) R S Conclusion and Recoendaion Afer heoreical concepual sudies by using Regression analysis and Pearson correlaion esing, he firs hypohesis, which is he inverse and eaningful relaion beween ineres rae and a fir's sales, was no achieved. Fro anoher hypohesis es i was confired ha here is no relaion beween Degree of Econoic Leverage and arke reurn and expeced reurn. Degree of Econoic Leverage explains boh he expeced reurn and he arke reurn beer han Degree of Operaional Leverage and Degree of Financial Leverage. Also here is a eaningful difference beween easure of he Bea calculaing by DEL and he Bea copuing by CAPM and D-CAPM. By cobining CAPM wih leverages (financial, operaional and econoic leverages), we found a new odel which we will call i Revised CAPM (R-CAPM). In his odel o achieve ore accurae prospecing prediced reurn, we focus on syseaic and unsyseaic risk as well as hisorical and esiaing daa copleely. Regarding he resuls of research, i is suggesed ha, he bea Coefficien of degree of econoic leverage is used for deerining he syseaic risk and predicing he expeced reurn rae and also he econoic leverage is used beside oher leverages for aking decision abou sale changes and profiableness of copanies. References Blazenko, G.W Corporae Sales, Equiy Trading, and Risk', Journal of Business Finance and Accouning, vol. 6, pp Devyzis, L. & Jankauskas, G Explaining he cos of Equiy in Cenral and Easern Europe', Rigas Ekonoikas Augsskola, pp Esrada, J The Cos of Equiy in Eerging Markes: a Downside Risk Approach', Eerging Markes Quarerly, pp

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