A link between the firm's operating decisions and the riskiness of its stocks was established. Differences in the production process affecting the relative shares of fixed and variable costs (i.e., the operating leverage) were found, both analytically and empirically, to be associated with risk differentials. Specifically, other things equal, the higher the operating leverage (i.e., the lower the unit variable costs) the larger the overall and systematic risk of the stocks.

Various practical implications are suggested by these findings. On the firm level, it can be expected that large capital expenditures associated with an operating leverage increase will increase stock riskiness. In these cases, the cut-off rate used for the capital budgeting decision (i.e., the cost of capital) should allow for the increased risk. The use of the current cost of capital as the cut-off rate would probably result in a decrease in stock prices, adversely affecting stockholders' wealth. On the investor level, these findings might assist in the estimation of common stocks' risk given expected changes in the firm's operating leverage. Specifically, they suggest that, if a firm will experience a significant operating leverage change, the estimation of risk measures based exclusively on historical returns would be inappropriate.

This paper has examined the investment performance of the common stock portfolios of 20 property-liability insurance companies over the period 1958–1967. The performance of these portfolios was compared with the performance of both equal-weighted and value-weighted random portfolios of common stocks. The evidence indicated that the returns earned by the insurance companies were significantly lower than the returns earned by random portfolios of equivalent risk.

While this study is not precisely comparable to the previously published studies of mutual funds in terms of either the methodology employed or the time period considered, the results are quite similar. An additional group of institutional investors can be seen not to have outperformed the “market.” The presumption of inferior performance is even stronger in the case of the property-liability companies because all the comparisons in this study were made on a gross basis. Most of the studies of mutual fund performance have compared fund returns net of investment expenses to the gross returns from random investments. In those instances where comparisons were made on a gross basis, the performance of fund portfolios was found to be very similar to the performance of random investments.

Traditional planning for working capital needs is typically conducted with a relatively short time horizon. In this process, management attempts to optimize the return on existing fixed assets. The period for capital investment planning is much longer, reflecting the irreversibility of these decisions. Current research in the two areas tends to dichotomize these decision processes. The implications seem to be that working capital policies only have impact in the short run. However, it is clear that cash flows for potential capital expenditures are based on assumptions relative to expected future demand and production to meet this demand—assumptions that are necessarily tied to working capital commitments in the long run. The overall planning for credit, inventory, and liquidity should, therefore, be carried out before, or simultaneously with, the capital investment decision. It is a planning requirement that becomes an integral part of the total asset planning system. The vast majority of existing working capital models or long-term capital planning models do not allow for the explicit existence of and the simultaneous interrelationships between these two important subsystems.

Marion L. Chiattello [1] has provided additional empirical support for the suggestion that, because of the high degree of linear interdependence between many of the variables commonly used in banking regression studies, it may be necessary to interpret explanatory variables in a cross-sectional regression equation, not as representing individual influences, but as representing more general factors. Further, he has provided more empirical support for the suggestion that principal component analysis might be useful in helping to isolate and identify some of these general factors.

This paper seeks to document some simple and not-so-simple facts. My thesis is that, to an unprecedented degree, Federal Reserve (F.R.) Board Chairman Arthur Burns has engaged himself and the System in political action. Burns' leadership has contributed to politicizing the monetary control process, the dialogue concerning the nature and effects of that process, and perhaps even F.R. decisions themselves. These tactics have reduced the Federal Reserve's power to resist external political influence, a power that Chairman McCabe “bled” for in 1951 and that over the next two decades Chairman Martin labored assiduously to consolidate. On the other hand, this behavior at least maintained and probably increased Burns' standing with President Nixon.

In considering trade credit, we need to ask three questions:

1. Why do nonfinancial firms commonly participate in the process of financial intermediation by extending credit to their customers?

2. What explains differences in credit periods between firms and industries as well as over time for specific firms and industries?

3. How do changing monetary conditions affect the credit that firms extend to their customers?

To answer these questions, we first identify two reasons for credit sales: the first we might call a financing motive, and the second a transactions motive. The transactions motive can readily be understood—it costs something to match the time pattern of payment for goods with the time pattern of receipt of goods. Buyers benefit if bills are allowed to accumulate for periodic payment. Furthermore, trade credit gives buyers time to plan for the payment of unexpected purchases, enables them to forecast future cash outlays with greater certainty, and simplifies their cash management. To the extent that buyers benefit, sellers have an opportunity to sell credit. It is likely that, to a large extent, the aggregate stock of trade credit is explained by the transactions motive.

The normative procedures of Markowitz [4], Sharpe [6], and others can be utilized to determine an optimal portfolio (set of security holdings) given estimates of risk, relevant constraints, and expected returns on securities. Building on these foundations, the positive models of Sharpe [7], Lintner [3], Mossin [5], and others assume that investors form portfolios as if they were following such procedures. We observe considerable differences in portfolio composition, some of which undoubtedly stem from differences in expectations. Yet the predictions of most investors are either made implicitly or, if made explicitly, are jealously guarded and hence cannot be observed by outsiders.

The purpose of this research is to develop a model for determining the credit worthiness of commercial loan applicants in a particular troubled industrial sector of France. The model is developed with the assistance of Banque de France, which serves tne central banking function in a banking environment that has become increasingly competitive in recent years. The research assesses the combined potential of traditional financial statement analysis with several relatively modern statistical procedures to aid the commercial loan officer.

The paper represents a remarkable effort to push outward the limits of static ratio analysis for the purpose of judging commercial loan applications. I found the task of reviewing this paper by Professor Altman and his colleagues from CESA (Center for Management Education) a very useful experience because it gave me an opportunity to reacquaint myself with an area of finance to which I had paid very little attention for some time. Hopefully, these comments are still useful despite my lack of recent experience.

Intuitively, a risk averter diversifies between two investments if there is some sort of negative interdependence. In [3], Samuelson gives the example of buying shares in a coal company and an ice company. It is of interest to characterize this concept of negative interdependence more sharply.

Selection of funding levels for research and development (R & D) projects is a major problem facing the firm. Models for selecting funding levels have frequently been formulated under the assumptions that the projects can be evaluated independently (Aldrich [1], Hess [4], Lucas [6]) or that the projects are interrelated only in terms of requirements for specialized input resources (Asher [2]). In fact, the projects of a given firm are likely to be highly interdependent, either in the sense that progress on one project eases work on another (research interdependency) or in the sense that completion of one project alters the market situation of another (output interdependency). While Weingartner [8] discusses these interdependencies, he does so under the assumption that the project funding level is fixed.

Many of the typical problems encountered in forecasting a time series are alleviated when the series follows a seasonal pattern. The seasonal effect is independent of a long-term trend and cyclic effect. Furthermore, since the seasonal effect is recurrent and periodic, it is predictable. Thus, when the time series follows a seasonal pattern, the general shape of the series is known. Questions regarding the growth trend of the series, the expansion and contraction of the seasonal pattern, and random variation affecting the series are, however, left unanswered.

The current operating procedure of the Federal Reserve, as described by Richard Davis and interpreted by me, entails picking long-term growth rates (meaning six months and longer) for monetary aggregates, while simultaneously specifying short-run conditions for the federal funds rates and monetary aggregates which are felt to be consistent with long-term goals. But, he also states, because of “shorter term developments,” that the specified shorter term growth rates for monetary aggregates might not be equivalent to the desired long-term growth rate. This operating procedure disturbs me for two reasons. First, there is evidence demonstrating that different growth rates in the money stock which last as long as six months result in different levels of economic activity; thus six months should be the maximum control period not the minimum. Secondly, I don't see what meaning a long-term growth path for monetary aggregates can have if the Federal Reserve lets “shorter term” development define the short-term growth paths for money in a way which is inconsistent with the longer term goals.

Prior to 1952 there was no analytical theory available that would satisfactorily explain the well-known phenomenon of asset diversification by investors. Although the portfolio selection criteria of Markowitz [3] and that of Roy [5] both explain diversification, they are based on very different objectives. The objective of Markowitz's approach is to select the portfolio of securities that maximizes the expected utility of the investor, i.e., the EV criterion. The objective of Roy's approach is economic survival through selection of the portfolio that minimizes the probability of disaster, i.e., the safety-first (SF) criterion.

Edward Kane alleges that the Federal Reserve System recently has taken a turn for the worse, with respect to monetary policy, in that Chairman Burns has re-politicized the System beyond prudent bounds. It is interesting to note that Kane changed the title of his paper from “The Politicization of the Fed” in his first draft (and before he had heard my comments at the meeting) to “The Re-Politicization of the Fed” in his second draft (after he had heard my comments). In my view, Kane's latest title is closer to the truth–though still somewhat misleading–in that, over time, the Fed has necessarily factored political and social considerations into the formulation of economic and monetary policy. But so what, and what else is new? The examples cited by Kane to “document” his case can best be characterized as allegations that illustrate a certain behavioral pattern over time, but these examples fail to support his case that–because of the repoliticization of the Fed–recent monetary policy has been at times counterproductive to the public interest. Perhaps a more legitimate conclusion that Kane could have reached from his observations of public policy in recent years is that the appointment of Dr. Burns as Chairman of the Committee on Interest and Dividends tended to formalize the quasipolitical nature of the position of the Chairman of the Federal Reserve Board.

Certainly, the concept of skewness of returns and its role in the context of portfolio analysis has gained increasing attention in recent literature. Witness the studies by Alderfer and Bierman [1], Arditti [2, 3], Jean [4], and Simonson [5]. Each of these studies has treated skewness as the third moment of a series expansion—accordingly, skewness has been measured and interpreted as a logical extension of the traditional two-dimensional return-versus-standard deviation analysis of security evaluation.

It is widely assumed in portfolio theory that investors are risk-averse expected-utility maximizers. There is a good theoretical reason for assuming expected-utility maximization. Such behavior is well known to be consistent with several quite plausible postulates of rationality [5]. On the other hand, the main empirical foundation for such behavior in portfolio selection appears to be the observation of diversification. Risk-averse, expected-utility maximization implies diversification in portfolio selection, and investors are observed to diversify.

We are grateful for the opportunity which Professors Gressis and Remaley's Comment [1] has afforded us to clarify our analysis of the relationship between Roy's Safety First principle and the Mean-Variance expected utility rule, which unfortunately they find misleading. In our original presentation we did not explicitly analyze situations in which Roy's criterion leads to an extreme corner solution; and G-R are perfectly correct in noting that if a riskless asset exists, a “Safety-Firster” will not invest in risky securities at all if the risk-free interest rate, r, exceeds the disaster level d. The reason for this is straightforward: such an investment strategy minimizes the risk of disaster. In fact in this particular instance the investor can reduce the probability of disaster to zero.

The study initially examined the immediate effects that conglomerate acquisitions have on the beta level of conglomerate and nonconglomerate acquiring firms. An analysis was then made of the long-run beta trends of firms that actively engage in conglomerate mergers. The results of the short-term comparative analysis have indicated that systematic risk behavior tends to be responsive in varying degrees to major conglomerate merger activity—with betas changing as a function of the combined premerger values and ρ2 measures showing improvement upon acquisition. At the same time, the regression results clearly revealed that the responsiveness of β to premerger marketrelated variables was considerably greater for the nonconglomerate firms. In contrast, the results of the comparative long-term analysis suggested that the differential effects of conglomerate merger activity on systematic risk are more of a marginal or limited nature. That is, unless the firm conducted extensive merger activity, the long-run performance of β and ρ2 indicated that conglomerate mergers have only contributed to increased absolute and relative systematic risk levels—the same pattern exhibited by the nonconglomerate, nonmerging sample.

The shortcomings of a quadratic utility function are so serious and so widely known that by now one might assume that it would simply have been dropped from consideration. Arrow [1] and Pratt [6] have shown that such a function implies ever increasing absolute risk aversion, that is, reduced risk taking as wealth increases, which contradicts everyday experience. Moreover, the assumption of quadratic utility also implies ultimate satiation with respect to risk taking. This function has a well-defined maximum beyond which the marginal utility of money declines, and as a result the range of admissable returns must be restricted. Wippern [12] has focused attention on the second of the above two shortcomings. Using a rather ingenious device, based on the Sharpe-Lintner market model [8 and 5], Wippern has measured empirically the admissable range of returns implied by the quadratic utility function. Since his empirical findings imply that returns beyond as little as 1.3 standard deviations from the expected return provide negative marginal utility to investors, Wippern concludes that the Sharpe-Lintner market model, and/or the mean-variance portfolio theory upon which it is based, have “inconsistent and implausible properties.”