A model that recognizes the possibility of total shareholder loss in the aftermath of bankruptcy reveals simultaneously the stock price effects of diversification and of the option to abandon assets to creditors. In essence the model integrates security pricing behavior predicted by the CAPM and...

In a one-period limited liability economy, in which securities are fairly priced according to the CAPM, two, and only two, firm-specific characteristics affect stock returns: bankruptcy risk and cyclicality. The effects of expected cash flows, business risk, and leverage on returns are entirely...

Two conditions are necessary for reliable valuation: (i) value produced by the discounted cash flow approach must be identical to value produced by the residual income approach; and (ii) the value of the firm must be equal to the combined value of its debt and equity securities. Based on these...

A drawback of the indirect method of presenting the statement of cash flows is that it requires knowledge of a myriad of special adjustments to income. Compounding the problem, current descriptions of the method are incomplete, confusing and often incorrect. I propose a simplified implementation...

Assuming that investors have limited liability has strong implications for asset pricing: it allows equity to be valued as a call option within the CAPM's framework; predicts that investors who ignore bankruptcy will find an upward bias in the intercept of stocks' characteristic lines; and is...

The admission of bankruptcy risk into a single-period CAPM economy leads to two surprising results. First, OLS beta is a biased measure of systematic risk. Second, the expected return conditional on the market is no longer a linear function of beta alone. Instead, it is a linear function of the...

We evaluate six commonly used free cash flow metrics in terms of their accuracy, bias, and ability to predict value using a sample of 6171 valuations covering the period 1988 to 2010. We find that free cash flow measured as cash distributed to claimholders, adjusted for accounting distortions...

The CAPM is consistent with bankruptcy and limited liability, but only if expected dividends and required rates of return take into account the possibility of bankruptcy. I argue, in this paper, that traditional measures of systematic risk and expected returns are flawed in this regard, and...