Abstract In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.

Multiple activities may be separated financially, allowing each to optimize its financial structure, or combined in a firm with a single optimal financial structure. We consider activities with nonsynergistic operational cash flows, and examine the purely financial benefits of separation versus merger. The magnitude of financial synergies depends upon tax rates, default costs, relative size, and the riskiness and correlation of cash flows. Contrary to accepted wisdom, financial synergies from mergers can be negative if firms have quite different risks or default costs. The results provide a rationale for structured finance techniques such as asset securitization and project finance. DECISIONS THAT ALTER THE SCOPE of the firm are among the most important faced by management, and among the most studied by academics. Mergers and spinoffs are classic examples of such decisions. More recently, structured finance has seen explosive growth: Asset securitization exceeded $6.8 trillion in 2004, and Esty and Christov (2002) report that in 2001, more than half of capital investments with costs exceeding $500 million were financed on a separate project basis. 1 Yetfinancial theory has made little headway in explaining structured finance. Positive or negative operational synergies are often cited as a prime motivation for decisions that change the scope of the firm. A rich literature addresses the roles of economies of scope and scale, market power, incomplete contracting, property rights, and agency costs in determining the optimal boundaries of the firm. 2 But operational synergies are difficult to identify in the case of asset securitization and structured finance.

This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset’s unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project’s debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate cost of capital for discounting unlevered cash flows so as to account for the value of the tax shield. Perhaps the most popular application of financial theory is capital budgeting. Virtually every student of finance starts his education in the field by learning how to discount future cash flows. By the end of a first course, the student has developed the basic tools to implement a discounted cash flow analysis in a real world setting. Because the real world setting must account for the relative advantage of debt financing, arising from the debt interest tax subsidy, students of finance generally learn that such subsidies can be accounted for by discounting unlevered cash flows (also referred to as “free cash flows”) at a tax-adjusted weighted average cost of capital (or W ACC). Such tax adjustments to the discount rate

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Debt Policy, Corporate Taxes, and Discount Rates This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset’s unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project’s debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate cost of capital for discounting unlevered cash flows so as to account for the value of the tax shield. Perhaps the most popular application of financial theory is capital budgeting. Virtually every student of finance starts his education in the field by learning how to discount future cash flows. By the end of a first course, the student has developed the basic tools to imple-ment a discounted cash flow analysis in a real world setting. Because the real world setting must account for the relative advantage of debt financing, arising from the debt interest

This paper explores the influence of company specific and capital market factors on corporate financing decisions and shows how they are related to a company’s market value. By using a capital-structure portfolio model, a company specific time-variant optimal capital-structure range is determined for companies in developed and developing countries over the period from 1996 – 2005. Results show that a company’s market value significantly increases (decreases) if its capital-structure enters (leaves) its optimal capital-structure range.