The effects of networks and informations on asset pricing

Abstract

The thesis explores the effects of buyer-supplier networks on asset pricing and merger activity and lays down the theory of external auditing. The dissertation is composed of three parts. In the first part we propose a structural model of firm dependence in a vertically connected network of firms based on cash-flows between the buyers and suppliers. We prove that in a closed network economy the set of equivalent martingale measures depends only on the topology of the network. Network market model induces contagion effects. We develop semi-analytical formulas for corporate debt, credit default swaps and collateralized debt obligations. We test the empirical validity of the model on the subcontractors’ network of the SwissAir Group. The yield spread average relative prediction error is 18% comparing to the 89% error of the Merton model. The second part of the dissertation examines firms’ merger activity and its effect on stock prices based on the risk mitigation by creating an internal capital market. We propose a solution concept for coalitional games without superadditivity, which extends the Shapley value, and apply it to the merger activity of firms in a network. The possibility of a merger increases the equity value of standalone firms. Higher network dependence increases merger activity and merger surplus. Increased leverage ratio generates an inverted U-shaped curve of merger activity. The merger is rarely of conglomerate type affirming previous empirical evidence and occurs predominately between either buyers or suppliers depending on which party dominates the other in number. The third part of the thesis develops a model of optimal auditing behavior when cash flows to the firm are observed imperfectly by the outside investors. An external auditor’s report produces a verifiable signal and reduces the observed cash flow volatility. Using the results in information theory we develop explicit formulas for firm’s share price under auditing. The shareholders and debtholders in a firm disagree about the optimal auditing effort which primarily shields debtholders. Under sufficiently favorable economic conditions we obtain that the first best audit contract is offered irrespective of the bargaining power and the number of auditors. Finally we develop the auditing profits and firm values for a multi-unit firm which lays ground for empirical testing. Keywords: Asset pricing, credit risk, contagion, buyer-supplier networks, network topology, mergers, coalitional games without superadditivity, optimal auditing, auditor’s revenues, entropy.
JEL (2007): C02, C16, C65, G12, G13, M42, C71, G34, C71, C78.