"We provide a large-scale investigation of financial reporting quality (FRQ) among U.S. private firms. Private firms are vital to the economy but have received limited attention from researchers due to a lack of available data. Using a new database that contains accounting data for a large sample of U.S. private firms, we provide interesting new evidence on their FRQ. Relative to publicly traded companies, we find that private firms have lower FRQ as proxied for by several commonly used FRQ measures and are less conservative. Further, we provide the first exploration of cross-sectional variations in the FRQ of private firms. Specifically, we show that private firms with greater external financing needs and a greater presence of long-term debt have higher FRQ and greater conservatism. Private firms with greater owner-manager separation (i.e., C corporations) tend to exhibit lower FRQ but more conservatism."
Interesting and will make it to class, but I am not sure how surprising. Firstly the need for quality information may be lower in private firms so a lower level of financial reporting quality may be optimal (managers know what is going on already even given the c-corp control). And secondly, bonuses are more common (make up a larger percentage of pay since no stock options) in private firms and as these are often tied to income, one would expect less conservatism.
Not too much, not too little, but somewhere in the middle.
"Zak and two graduate students published their research in the January issue of PLoS One, an online science journal. The researchers conducted their study by comparing the genetic codes of working Wall Street traders to a control group of business students.
The researchers found evidence that genes affecting the way the brain processes dopamine, a chemical linked to risk-taking behavior, may be associated with success on Wall Street.
Traders who had successful careers, as measured by length of employment, tended to have genetic backgrounds linked to moderate levels of dopamine.
In other words, a good trader is likely to have a genetic code that influences a person's behavior toward competitiveness, but not the kind of thrill-seeking behavior in which risk taking becomes an addiction."
And people thought I was far-fetched last year when I asked how long before Wall Street Money Managers had to undergo a brain scan and blood work prior to being allowed to manage money.
"Besides the Madoff saga, Marquet International, a consultancy, has identified more than 300 sizeable Ponzi schemes from the past ten years, with combined losses for investors of $23 billion. It estimates that up to half of those were affinity-based. No one has a reliable number for smaller frauds over the same period, but guesses range from $5 billion to $20 billion. In all, affinity-fraud losses in America could be as much as $50 billion."
"Using a panel of 212 large U.S. bank holding companies over the period 1997-2004, we examine if board structure (board size, composition and gender diversity) in banks relate to their performance. After controlling for relevant sources of endogeneity (simultaneity, reverse causality and unobserved heterogeneity) via system generalized method of moments (GMM), we find that board structure in banks affect their performance. Particularly, the results show a negative association between board size in banks and their performance. We also find evidence of a negative relation between board independence and performance. In addition, our results support a positive association between gender diversity and bank performance."
By now you probably have seen the series of articles the NY Times is running on China and Apples. If not, I HIGHLY recommend you read them and realize why so many jobs went overseas (pun intended). The first article sets the stage by recounting a conversation with President Obama and the late Steve Jobs where Jobs basically said the jobs the US lost are not coming back.
"The article, by Charles Duhigg and Keith Bradsher, is difficult to summarize. If you care at all about the economy and future of the American workforce, you should read it for yourself. But the main takeaway is that other countries, particularly China, offered Apple something not available here: A cheaper, more compliant workforce. This anecdote captured the situation well:
"One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.
A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.
“The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”"
What you may not know (at least I didn't) that the articles were also posted in China. The comments are very interesting and on both sides of the issue.
Those attacking Apple (and China for allowing such conditions to exist):
"It’s ridiculous that the local government is trying to promote the city’s image while horrible accidents are still happening like this. If what is prohibited in the U.S. is highly protected here by the local authorities, we will never be treated with dignity. — 安吉丽娜朱莉的男朋友"
or
"...everything is driven only by G.D.P., so which government official would dare supervise those companies? They (the governments) have long reduced themselves to the servant of the giant enterprises. — Occasional Think"
But on the other hand:
"Without Apple, Chinese workers will be worse off. I hope China can some day soon have dozens of its own companies like Apple, who (only) work on high-end research and development and send manufacturing lines to Africa. — Anonymous"
and
"If more rigorous labor protection standards and 8-5 working time protocol are being strictly executed, we can expect a plunge of the workers’ wages. If labor organizations with monopoly rights are established, those rural migrant workers who cannot find a position in the organization will be forced back to their hopeless villages..... — YeyeGem"
and
"If people saw what kind of life workers lived before they found a job at Foxconn, they would come to an opposite conclusion of this story: that Apple is such a philanthropist. — Zhengchu1982"
Which reminds me of this clip from Milton Friedman (the entire thing is an excellent defense of Capitalism) but the part that begins at 1:00 is totally apt for this discussion. (HT Susan A)
Who is right? Who is wrong? There are no easy answers. In a free society with no information asymmetries, by definition if someone takes a job FREELY, and can leave FREELY, then it must be that the employee is better off with the job than without. And clearly factories like these (and by no means is it only Apple) do lift the standard of living. But if the people are not working there freely or are working under false auspices and can not quit, then all bets are off.
A good explanation of why long term contracts may increase investments but at the cost of worse short-term performance.
"This paper uses a new dataset of 3,717 US CEO employment contracts to study the time horizon of CEOs. Longer contracts offer better protection against dismissals: turnover probability increases by 20% each year that passes towards contract expiration. In theory, this should encourage CEOs to pursue long-term projects. Using an instrumental variable approach based on inter-state judicial differences, I show that contract horizon is indeed positively correlated with investment. However, longer contracts also make it harder to dismiss undisciplined managers and therefore impose less discipline. Consistent with this argument, CEOs under short-term contracts perform better in (the fewer) acquisitions that they make, and CEOs under longer contracts enjoy more salary increases and perquisites. Overall, firm value does not differ across contract types."
"The latest issue of the Chicago Booth/Kellogg School Financial Trust Index released today finds that only 23 percent of Americans say they trust the country's financial system. And, trust for banks continues to slide downward."
Warning: this makes for fertile ground for stricter regulations.
"Royal Bank of Scotland announced on Thursday that it would pay its chief executive, Stephen Hester, an all-stock bonus of £963,000, or $1.5 million, less than half what he received last year.
The bank, which is 82 percent owned by British taxpayers, had come under pressure from the country’s prime minister, David Cameron, to rein in bonuses for top executives."
If you care, you already saw that Natural Gas prices were up on Monday. Why? Well in part because our previous estimates of the natural gas potential in the Marcellus Shale were WAY off :(
The U.S. Energy Department cut its estimate for natural gas reserves in the Marcellus shale formation by 66 percent, citing improved data on drilling and production......The estimated Marcellus reserves would meet U.S. gas demand for about six years, using 2010 consumption data, according to the Energy Department, down from 17 years in the previous outlook.
It should be noted that many experts, including US Geological Survey had been cutting forecasts since August as wells were not producing up to previous expectations.
The "why" for vertical mergers just got more cloudy. Vertical mergers are those that go up or down a firm's supply chain. For instance buying your supplier or buying your customer.
The standard explanation for the "value added" by such a deal has been a reduction of transaction costs (negotiation, cost or reneging, etc) as well as control of a supply source and quality etc issues. And they MAY still be the explanations, but they are at least drawn more into question by new findings from University of Chicago economists Hortacsu and Syverson who examine where firms buy from and sell to (the flows of the article). There finding? More often than not even after a vertical acquisition the firm does not buy from nor sell to its new "relative".
"If most vertically integrated companies aren’t supplying themselves, then why do they own production chains? It is harder to get a clear answer to this question from the data, but there are some clues to an explanation. Trying to understand why companies own production chains by looking at the way goods flow along the chain could be misleading. Instead, it might be the things we can’t see -- managerial oversight, marketing know-how, customer contacts, intellectual property, and other information- based capital -- that drive most vertical integration.
By integrating, companies can spread these types of capital over the production chain. Integrated firms appear to let the market and contracted suppliers handle most of the flow of tangible goods along the chain, while using control through ownership to apply the necessary intangible capital, which is by nature harder to write contracts over."
Ironically we covered vertical mergers TODAY in class. Guess I better update my notes.
I hope no one is surprised by this: managers seemingly try to influence analysts and shareholders by providing good news just prior to the firm's annual meeting. That is the conclusion on a paper by Dimitrov and Jain that examines the 40 days prior to the firm's annual shareholder meeting.
The pre-meeting returns are significantly higher when shareholder discontent with managerial performance is likely to be stronger. The decile of companies with the worst past stock price performance exhibits average cumulative abnormal returns of 3.4% and buy-and-hold returns of 7.0% during the 40-day pre-meeting period. Companies with poor past performance exhibit even higher pre-meeting returns when shareholder pressure on management is greater, such as when institutional ownership is high, when CEO compensation is high, and when shareholders submit proxy proposals on corporate governance. We complement the evidence based on CARs by showing how managers of poorly performing firms manage the timing and content of earnings announcements and management forecast announcements before the annual shareholder meetings. Overall, the results suggest that managers attempt to influence shareholders before annual shareholder meetings through positive news.
One caveat that I would like strengthened a bit: reversion to the mean. If a firm is in worst performing decile, it may get better just by chance/bid ask bounce, etc.
My BonaResponds work and a conversation on yesterday's run got me thinking as to how much early life events affect adults. That there are generational poverty type issues is well known, but I had never really thought about the type of assets held controlling for wealth but Christelis, Dobrescu, and Motta had: (emphasis mine)
"Using life-history survey data from eleven European countries, we investigate whether childhood conditions, such as socioeconomic status, cognitive abilities and health problems influence portfolio choice and risk attitudes later in life. After controlling for the corresponding conditions in adulthood, we find that superior cognitive skills in childhood (especially mathematical abilities) are positively associated with stock and mutual fund ownership. Childhood socioeconomic status, as indicated by the number of rooms and by having at least some books in the house during childhood, is also positively associated with the ownership of stocks, mutual funds and individual retirement accounts, as well as with the willingness to take financial risks. On the other hand, less risky assets like bonds are not affected by early childhood conditions. We find only weak effects of childhood health problems on portfolio choice in adulthood. Finally, favorable childhood conditions affect the transition in and out of risky asset ownership, both by making divesting less likely and by facilitating investing (i.e., transitioning from non-ownership to ownership)."
"...was a humbling year for the $1.7 trillion hedge fund industry, with the average fund dropping 4.8 percent and some stock-focused funds suffering an average 19 percent decline, according to research compiled by Hedge Fund Research and Bank of America Merrill Lynch analysts.
Investors who sidestepped hedge funds and instead chose mutual funds fared much better. For example, the Vanguard 500 Index fund gained 2 percent, and PIMCO's StocksPLUS Long Duration Fund, 2011's best performing mutual fund, enjoyed a 21.2 percent return...."
Now any analysis of return without a mention of risk measures is incomplete, but this at least shows once again that hedge funds are not the automatic way to make money that many seemingly believed in only a few years ago.
Ties together some behavioral finance and some traditional finance:
"The truth is that while most economists assume that stock movements are largely random, there's plenty of debate about how far that randomness goes.
What should an individual investor make of that? Assume stocks are too unpredictable for you to be a profitable trader, but lower your expectations for how much you'll earn from buy-and-hold too.
You should also keep in mind that the risk of owning stocks remains real. Most investors in midcareer -- and many in retirement -- take comfort in the fact that over long stretches like 15, 20, or 30 years, stock investors have never lost money.
Boston U.'s Bodie has argued that the safety of long-run averages is a statistical illusion. As years pass, the chances of stock returns falling short of a risk-free investment get slimmer, but the potential size of your losses also gets bigger. You might be part of an unlucky generation that sees a long string of losing years."
Any article that cites both Zvi Bodie and Meir Statmen is almost guaranteed to be mentioned! Both are great finance professors/writers whom I am lucky enough to know.
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