Wednesday, September 27, 2006

Amaranth update

Interesting. Things could have been worse. U.S.: "The New York Mercantile Exchange told Amaranth Advisors LLC that the hedge fund's natural gas bets were too big a month before the trades led to a $6 billion loss, said two people with knowledge of the meeting.

Amaranth unwound some of its natural gas positions after the warnings, according to the people, who asked not to be named because the communications were confidential."

Also from the same Bloomberg story:
First the predictable politcal intervention:
"Members of Congress .... want greater authority for the Commodity Futures Trading Commission to monitor energy trading, especially on the all-electronic Intercontinental Exchange Inc.

And then an update on Brian Hunter the Amaranth trader responsible fo "the biggest-ever hedge fund loss" "no longer works at Amaranth, the Financial Times reported earlier today, citing unidentified people close to the matter.""

Tuesday, September 26, 2006

Time to throw a penalty flag

First, the good part: Tuesday Morning QB does a great job of laying out the issue and demonstating one problem with boards setting pay .

From last week's TMQ which appeared on Page 2 : The five-month NFL forecast:
"Much news and sports commentary focuses on the ever-larger paychecks of professional athletes. But even Peyton Manning is a day laborer compared to the modern Fortune 500 CEO....Over his last five years at the helm, he got $162 million, even as Pfizer earnings faltered. Carol Hymowitz of the Wall Street Journal reported that the head of Pfizer's "compensation committee" defended McKinnell's windfall on grounds of market forces in executive pay -- which in this context appears to mean, "CEOs at other companies are picking shareholders' pockets, too."....McKinnell's pay for his tenure atop Pfizer equates to $130,000 per work day."
and slightly later:
"...consider that executive income usually is rubber-stamped by boards of directors whose members may be engaged in self-dealings with the firm, or who have a self-interest in rising CEO pay. As Julie Creswell noted in the New York Times, "Five of the six active Home Depot board members are current or former chief executives of public corporations … CEOs benefit from one another's pay increases, because compensation packages are often based on surveys detailing what their peers are making....The board members know the more they inflate CEO pay, the more they themselves will be able to pilfer from their own shareholders"
Ignoring the use of the word 'pilfer', this is a well-presented valid point. However, Easterbrook's next point deserves a yellow penalty flag and further review:
"Recently the Business Roundtable released a study purporting to show that CEO pay rose 9.6 percent annually from 1995-2005, while stockholder returns rose 9.9 percent in the same period. So things aren't so bad, eh? The Business Roundtable said the study 'sets the record straight.' The Business Roundtable is, by its own description, 'an association of chief executive officers of leading U.S. companies.' As Gretchen Morgenson, dean of Wall Street journalists, laid it out in the New York Times, the study systematically understated the income of CEOs... 'The study counts only the value of the options and restricted stock received by executives on the dates the awards were made.'"
Uh, wait, isn't that what we should be doing?

True, we should take into account the non normality of the stock distribution (induced both by rewriting underwater options and by the now famous back dating of options) which causes the Black-Scholes formula to understate the true value of the grant, BUT the value at grant is what we should consider. We can debate whether the Black-Scholes formula is correct or not, but theoretically the value at grant (again presuming a fair grant) is what matters.

Moreover, while it is true that the Business Roundtable is made up of CEOs, that should not be grounds for dismissal. The actual study does have several valid, and overlooked points. Notably that medians should be used, that the media "sometimes summarizes the pay practices for all CEOs from only the very largest companies", and the seemingly inarguable point that "pay statistics should be referenced accurately and applied responsibly".

Like other things, I will take the bad with the good. Overall
Tuesday Morning QB is still my favorite sports article. Its author is Gregg Easterbrook who is a former Buffalo School teacher and who wrote the Progress Paradox, does a great job weaving many topics together in a funny, witty manner. That said, I guess I can no longer count TMQ as "finance reading". LOL.

Monday, September 25, 2006

Continuing the inflation theme

Continuing the inflation theme:

While inflation can obviously lead to many problems, there is an important bias that must be considered (especially when you think of inflation measured by government statisticians.) As the NY Times so aptly points out, this problem can be illustrated with the humble snow-blower.

Life Is Better; It Isn't Better. Which Is It? - New York Times:
"...the benefits of the snow blower, namely more free time and less health risk, are largely missing from the government'’s attempts to determine Americans'’ economic well-being. The same goes for dozens of other inventions, be they air-conditioners, cellphones or medical devices...."
Why? In part because new inventions, or improvements of existing items, can take years to show up in official indicies.

Again from the NY Times:
"The cellphone and the air-conditioner also improved middle-class life, and also took years to get into the inflation numbers, by which point their prices had plummeted. Wal-Mart’s effect on prices is another blind spot in the index, which considers something sold at a discount to be lower quality (and, therefore, not truly a bargain) than something sold at full price...."
The result? Official inflation numbers are overstated. Not only does it enter our mental math on whether we are better off or not than past generations (we are contrary to what some will tell you), it has become a campaign issue, and can have major implications to cost of living adjustments (COLAs).

Best advice, realize CPI and other government inflation indicies overstate the actual inflation rate.

BTW be sure to look at the NY Times Graphic that shows how large of impact the inflation bias can have on "real" income.

And you think the Fed has it tough?

Post WW I Germany often is the example of hyperinflation used in Money and Banking texts, but for a more timely example you may want to consider Zimbabwe.

BBC NEWS | Business | Zimbabwe's inflation tops 1,200%:
"Zimbabwe's annual inflation rate continues its upward surge, reaching a record high of 1,204.6% in August, and adding greater strain to the economy."
Why is hyperinflation such a problem? Ignoring the impact it has on debt holders (they would get paid back with money that is next to worthless), try to imagine how inflation like that would affect your own behavior.

No longer would you hold any cash, you would want to spend any check immediately, you would want to be paid on a daily basis, etc. You forgo money and the economy falls back in to a barter system. All of this is inefficient and takes a toll on the economy.

More importantly, those who had saved money (especially in fixed income investments), will see their savings evaporate. This creates a sense of panic and increased risk premiums.

As people take their money out of banks, that source of capital disappears. This too hurts the economy and often leads to further government borrowing (which gives the central bank the incentive to monetize the debt).

Further, the sense of uncertainty and decline in value of the currency leads to hoarding of supplies (and accompanying shortages).

Which is a long winded way of saying that hyper-inflation is not merely "moving the decimal place" but that it does have serious economic repercussions.

Friday, September 22, 2006

The sleuth who exposed backdating scandal

I always like to see finance professors in the news!

Philadelphia Inquirer | 09/21/2006 | Sleuth who exposed backdating scandal:

A few "look-ins":
"From his second-floor office at Iowa's Tippie College of Business, [Erik] Lie spent months analyzing data to demonstrate how companies were illegally and retroactively timing, or backdating, stock option grants to fatten bonuses paid to top executives.

"He's uncovered a scandal that has just mushroomed," said Adam C. Pritchard, a former attorney at the Securities and Exchange Commission and now a law professor at the University of Michigan.

and later in the article:
"'The Enron stuff is very sexy, but that type of fraud was not pervasive,' said Andrew Metrick, a professor of finance and corporate governance at the Wharton School in Philadelphia. 'This is widespread, pervasive. I think when this is all said and done, the total amount of dollars that we'll find have been stolen from the corporate till is larger here than any other case we've seen.'"
Read the entire article here.

Basketball superstar meets superstar investor

I'd guess it was a pretty big tip for the waitress!

LeBron shoots the breeze with Letterman, Buffett - NBA - Yahoo! Sports:
"A few days earlier, James had lunch in Omaha, Neb., with billionaire Warren Buffett. ...James, who signed a three-year, $60 million contract extension with the Cavaliers in July, may have been seeking some off-the-court business advice from Buffett, the self-made billionaire investor.

Last year, in an interview with The Associated Press, James said one of his primary goals was to 'be the richest man in the world.' James, who will turn 22 in December, already has endorsement deals worth an estimated $150 million.

Buffett sported a full Cavaliers uniform, complete with a jersey bearing his name, during his lunch with James....James ordered a bacon cheeseburger, french fries and an Arnold Palmer, a drink concocted of lemonade and iced tea. Bubarek said he topped off his meal with an Oreo cookie milkshake delivered by a Buffett staffer."

Thursday, September 21, 2006

HP Spy Scandal Hits New Weirdness Level: Financial News - Yahoo! Finance

This just keeps getting more bizzarre! Like I said two weeks ago, I want movie rights!

HP Spy Scandal Hits New Weirdness Level: Financial News - Yahoo! Finance:
"Not only did investigators impersonate board members, employees and journalists to obtain their phone records, but according to multiple reports, they also surveilled an HP director and a reporter for CNet Networks Inc....

They even snooped on the phone records of former CEO and Chairwoman Carly Fiorina....

And in a twist that might seem preposterous if it happened in a movie, The New York Times reported that HP consultants considered hiring spies to pose as clerical or custodial workers at CNet and The Wall Street Journal"

Breaking Down Silos at Yale

While curriculum discussions generally bore me, this one is the exception for the size of the changes and the potential ramifications. Yale's business school has done a major facelift to its offerings. Some look-ins thanks to Business Week:

Breaking Down Silos at Yale:
"...not just at Yale, but at any of the curricula that you would look at any of the major business schools, they were broken down by functional silos: a course in marketing, a course in accounting, a course in organizational behavior. But if you talk to any leader of a major corporation, they will tell you that the real value to be added is in working across those silos, and the disciplinary delivery got in the way of educating students in a way that could maximize their ability to add value to the organizations of which they are a part."
and also:
"We now offer a course on the customer rather than a course in marketing, a course on the investor rather than a course in finance. All of them are multidisciplinary in both their design and their delivery. And then we have a course called the integrated leadership perspective at the end which sort of brings together all the different perspectives."
While I am not taking any position on the new design, I will say that even in a traditional finance class it is important to understand the other functional areas. Indeed, every class I teach starts with that discussion AND it is yet another reason why no matter what your major is, there really are no "blow off" classes. You just never know when the material from a class is going to be valuable later in life.

Wednesday, September 20, 2006

Deja vu all over again? Hedge Fund Shifts to Salvage Mode - New York Times

As Yogi Berra would say "Deja vu all over again." Amaranth's troubles may be more serious than previously thought. Indeed, they have the potential of being the next Long Term Capital Management.

Hedge Fund Shifts to Salvage Mode - New York Times:
"Last night, as it had been since the weekend, Amaranth was locked in an effort to sell its energy portfolio to try to keep the fund company afloat.

At the same time, it was working with commodity exchange officials to reassign trades to try to minimize disruptions to the market.

The fund’s investors, locked into their holdings by Amaranth’s stringent liquidation terms, awaited further word on the status of the fund’s holdings, while regulators and traders watched for signs that the hedge fund’s losses might disrupt markets beyond those relating to energy"
Sound familiar? Hedge fund does well, then bets go bad, and suddenly the fund (and possibly market) is in trouble. Sure sounds like we've seen this one before.

Another similarity? Among the reported causes is the fact that it looks like El Nino is returning which keeps temperatures lower and hence leads to less demand. Once again, something that many people would have left out of their models.

FRB: Testimony, Braunstein--Non-traditional mortgage products--September 20, 2006

Sandra Braunstein is the Fed's Director of Consumer and Community Affairs. She spoke before a Senate Subcommittee today. The comments largely focued on the truth in lending law, but also discussed various "non traditional morgtage instruments and the Fed's efforts to assure that borrowers know what they are getting into.

FRB: Testimony, Braunstein--Non-traditional mortgage products--September 20, 2006:
"Nontraditional mortgage products have increased the range of financing options available to consumers and have grown in popularity over the past few years. With traditional thirty-year fixed-rate loans, consumers have equal monthly payments that are sufficient to cover the accrued interest and pay down the principal. In contrast, interest-only loans allow consumers to defer the payment of principal and make only interest payments for an initial period. Option-ARMs allow consumers to make 'minimum payments' of less than the accrued interest, which causes the loan balance to increase ('negative amortization').

Some consumers may benefit from these products and the more flexible payment options, for example, consumers with seasonal or irregular income. For consumers who expect their incomes to increase, the initially lower monthly payment with these loans may enable them to purchase homes that they otherwise might not be able to afford. But these loan products are not appropriate for everyone, depending on their individual circumstances. When monthly payments increase, sometimes substantially, consumers may face 'payment shock.' Thus, it is important for consumers to have the information necessary to understand the features and risks associated with these types of mortgages...."
"The Federal Reserve plays several roles and engages in various activities to ensure that consumers understand credit terms and the options available to them when they are shopping for mortgage credit."
She concludes:

"The Federal Reserve is actively engaged in efforts to ensure that consumers understand the terms and features of nontraditional mortgage products. Improving federally required disclosures under TILA is one aspect of this endeavor. We are also pursuing other opportunities, such as consumer education publications and interagency regulatory guidance that will include recommended best practices for depository institutions. We expect the Board will continue these efforts over time as mortgage products evolve in response to consumers' changing needs."

Teaching note: this would be a great fit for an institutions, money and banking, or commerical banking class. Or even a real estate class.

Hedge Funds Flirt With Heresy: Going Public - New York Times

Going public allows a firm access to more funding. However, this funding comes at the cost of required SEC filings aimed at reducing transparency and secrecy.

Hedge funds are famous for their desire for secrecy which makes the fact that Fortress Investment Group was considering an IPO al the more interesting. It must be that the desire to access capital trumps the desire for secrecy.

From the NY Times:

Hedge Funds Flirt With Heresy: Going Public - New York Times:
"Hedge funds...— are known for their secrecy....being private and secretive also enables them to develop investment strategies and manage their business, big fees included, without [outsiders]...criticizing their outsize pay. So it is not without some irony that a hedge fund named the Fortress Investment Group may be the first to tear down those walls of secrecy. Fortress is considering an initial public offering this fall in a deal that could value the company from $5 billion to $7 billion...."
An interesting research question that arises from this if in fact the IPO occurs is who will buy these shares. I would not be surprised if, like closed end funds, these are held largely by individuals. In fact, in this case likely owners would be small investors who are forbidden from investing in hedge funds themselves.

Ironically the news comes on the same day that the transparency issue was also in the news as volatile energy markets create huge losses at some hedge funds rasing the possibility of a fund going being unable to meet its obligations. From the BBC:
"Amaranth Advisors, said it was now "aggressively reducing" its exposure to natural gas to protect its investors...US natural gas prices, called futures, have slipped 40% since August. They had risen sharply after hurricanes disrupted supplies last year....Amaranth made around $1bn on the surging energy prices last year but lost more than $3bn in the recent downturn, the New York Times reported.

"Last week Amaranth multi-strategy funds experienced significant losses in their energy-related investments following a dramatic move in natural gas prices," the fund said in a letter to investors that has been seen by the Reuters news agency."

Tuesday, September 19, 2006

SSRN-102 Errors in Company Valuations (102 Errores en Valoraciones de Empresas) by Pablo Fernández

Want to practice your Spanish while studying Finance as well? This paper provides you the opportunity! It examines common mistakes that we tend to make in valuation.

I won't try to translate it for you (I actually suprised myself as I could read most of it!) but fortunately the abstract is in English.

SSRN-102 Errors in Company Valuations (102 Errores en Valoraciones de Empresas) by Pablo Fernández:
"This paper contains a collection and classification of 96 errors seen in company valuations performed by financial analysts, investment banks and financial consultants. The author had access to most of the valuations referred to in this paper in his capacity as a consultant in company acquisitions, sales, mergers, and arbitrage processes.

We classify the errors in six main categories: 1) Errors in the discount rate calculation and concerning the riskiness of the company; 2) Errors when calculating or forecasting the expected cash flows; 3) Errors in the calculation of the residual value; 4) Inconsistencies and conceptual errors; 5) Errors when interpreting the valuation; and 6) Organizational errors"

Guardian Unlimited Technology | Technology | Google to appeal, as court rules news site is illegal

Copyright protections are always a touchy topic. On one hand the creators of the information deserve to rewarded for their work. On the other hand, too strict of protections limits sharing and reduces the impact.

This is playing out with Google now.

Guardian Unlimited Technology | Technology | Google to appeal, as court rules news site is illegal:
"The case was brought by Copiepress, an organisation that manages copyright for the French and German-speaking Belgian press, including La Derniére Heure, La Libre Belgique and Le Soir.

In its judgment...the court said Google would be liable for a fine of €1m (£675,000) for every day it did not remove the offending content from the recently-launched Belgian site....

While many media groups have welcomed Google News as a means of boosting traffic, others believe they are benefiting the Google brand and boosting its user figures without any recompense.

Last year Agence France-Presse (AFP) sued Google in France over a similar dispute, claiming that it had removed photo credits and copyright notices. Google subsequently removed all of the agency's con"
While the potential damage is quite small now, currently the case is isolated to a few sources from Beligium, but could set a precident that would change the way articles, papers, and pictures are shared.

Monday, September 18, 2006

A look at the AMEX

The american Stock Exchange came up in class last week. Thus this article from Fortune, via NY Times is pretty relevant for my classes!

"...the Amex has shrunk to 427 domestic companies, 9 percent of all listed U.S. stocks. Its $565 billion in total market cap disappears in the shadows of the N.Y.S.E. ($22.6 trillion) and the Nasdaq ($3.8 trillion). An average day’s worth of trading on the Amex — 90 million shares — can be handled in half an hour at its bigger and more technically savvy rivals. It costs only $211,000 to buy a seat on the exchange, a 65 percent plunge since 2001.
Which is about what we saw last year when the finance club toured the AMEX.

Thursday, September 14, 2006

Airline Hedging

You probably have noticed that oil prices have dropped significantly over the past month. However, the Washington Post points out that many airlines are still paying the higher price because they locked in when prices were high.

A look in:
"Like insurance policies, hedging contracts protect against risk, allowing companies to manage damaging price swings....If the market price for oil is above a price limit arranged in a hedging contract, the airline gets the difference, which offsets higher jet fuel costs -- the biggest expense for most airlines.
Of course as this suggests that at times when prices are falling the airlines pay more (unless options are used):
"If the price of oil is below a preset price floor, the airline ends up paying more than the market price...."

"That's the risk you take with hedging," said AMR spokesman Tim Wagner, who would not comment on whether the airline was losing money on its third-quarter hedge. "When it was at $78 dollars per barrel, it looked like you had great deals."

But this "loss" comes when the overall firm is in a better position to handle it, which is exactly what a hedge is designed to do:
"...the airline greatly prefers falling oil prices even if it means some of its fuel hedges are rendered useless, he said...Despite the risk of paying up on some hedges, falling oil prices are a big boost to airlines and eases concerns about slowing demand."
BTW I will use this as an opportunity to mention my favorite airline hedging paper as well. It is by Carter, Rogers, and Simkins. Super short version: hedging is good for you.

MIght there be more oil than previously thought?

A quick look at the oil market:

Saudi official: 82% of crude is untapped - The Boston Globe:
"The world has tapped only 18 percent of the total global supply of crude, a leading Saudi oil executive said yesterday, challenging the notion that supplies are petering out."
And from the Gulf Times:
"Jum’ah’s estimates show a potential of 4.7tn barrels of oil, “or more than 140 years of supply at today’s current rate of production.’"
But of course, demand will also pick up:

Rex W. Tillerson, chairman of Exxon Mobil Corp., said world demand for oil will increase by 50 percent in the next decade."

And of course there are still global warming concerns. But minimally this shows the difficulty in forecasting.

Tuesday, September 12, 2006

Bringing the news to class

Several news stories today that could easily be incorporated into various finance classes:

* Nobel Prize winner Joseph Stiglitz has been in the news quite a bit over the past week. He is advocating more intevention (at least in the form of safety nets) when it comes to globalization. A look-in:
"Some countries have benefited from globalisation like China and India where the economy is booming. Other places like Africa have faired badly and measures may need to be put in place that are painful now, but might be best in the long run. Change is difficult, change has to be managed carefully, so even if the long run a change might be beneficial, we have to worry about, in the short there could be losers, and we have to figure out ways that we minimise the numbers of losers, ways we support the losers, by providing for example safety nets.""
* Another international finance story centers on transfer pricing. Transfer pricing is the price that firms charge themselves for internally transfering product within the firm. This gets particularly sticky when intellectual property is what is being transfered. While firms are "supposed to" charge a fair "arms length price", the temptation is always there to use transfer pricing to recognize gains in nations with a lower tax rate. Not surprisingly, the IRS is not a big fan of this (It is reported that nearly $10 Billion of pending court cases are based on transfer pricing). Yesterday the IRS and GlaxoSmithKline settled their transfer pricing case for $3.4 billion.

* HP is back in the news. Following their recent troubles Patricia Dunn the chair of the Board of Directors has stepped down. Interestingly, Mark Hurd the new chair is also the CEO. Which flies in the face of current conventional wisdom.

* Board shake-ups were also the main news at Bristol Myers Squib where at the urging of a court appointed "federal monitor" the board of directors replaced the Chair and the chief legal counsel. A look-in:
"The company confirmed reports that Judge Frederick B. Lacey, appointed the federal monitor under the company's deferred prosecution agreement in an accounting scandal, recommended the firings, and that Christopher J. Christie, U.S. Attorney for New Jersey, concurred....Lacey was appointed monitor of the company in June 2005 after Bristol-Myers settled federal charges for an accounting scandal that ended up costing the company $800 million. Under the agreement, charges would be dropped against the company if it met certain standards until 2007. The apparent last straw was Dolan's and Willard's conduct stemming from a failed agreement with Canadian drug maker Apotex to keep generic Plavix off the market."
* Need an institutions story? Rest assured that is in the news today too! There is a growing concern that financial institutions are overstating their trading to seem more important. (what, puffery, say it's not true!!!). From the NY Times Deal Book:
"On any given day, the difference between what Wall Street’s biggest firms say they trade and what the exchanges report is more than 30 million shares. Now, the widening disparity of data has prompted NASD to begin a preliminary investigation into whether brokerages routinely inflate their trading on behalf of customers.

“We’re concerned that firms might be providing misleading information into the marketplace that makes them appear as a bigger player than they are,” said Tom Gira, NASD’s executive vice president for market regulation.

and now it is time for me to get to class!

Monday, September 11, 2006

Advice for learning finance (and pretty much anything else)

A student emailed me the following today. I figured I would share my answer.

"I wondered if you might have any advice for those of us in the MBA program who have undergraduate degrees not related to business?"

Of course I have advice, how effective it is may be up for debate ;)

I would start by saying to think about what you already know and use it to help process what you are learning. Research on how people learn is full of evidence that we learn best when we can form relationships between the new information and things we already know. (The way I was taught it is that we form semantic networks that help us to store and retrieve the new knowledge. In fact this is a big reason I try to use sports examples as many people have at least some experience with sports.)

How to use this? Students in any class (even non finance classes) should try to tie new information would be to tie things to what you know. For instance, think of business through the eyes of a customer. The next time you go shopping stop and visualize everything that must go into the shopping experience. That, in a nutshell is what we are trying to do in any business class. We aim to teach people how to meet customer needs in an efficient manner.

Now turn it around and think of starting a company to meet these needs. Imagine everything you need to satisfy a customer: a product or service (architectural plans, food, or whatever), employees, a means of delivering the product or service. Now consider where the money for these things must come from.

That is finance. We figure out ways to help firms raise money to meet customer needs. Of course this is not as simple as it may seem at first glance. We must know the various alternatives for raising money, where to do so, the tax implications of the alternatives, and how to value the claims we are selling to raise money. And that is just from the corporate side! We also look at things from the investors’ point of view: what do they demand for the use of their money, how do they view risk (can they change the risk with derivatives?), what alternatives exist for their money, how do taxes effect them, and much more.

This seems like a great deal to know, and it is, but when you keep the bigger framework (that is what you know) always in mind, you can go back and see where each topic fits into the bigger picture. And that makes learning (and remembering) new things much easier and usually much more fun as well!

Hope this helps!


Friday, September 08, 2006

Math review: an application of NOT reinventing the wheel

MBA math review PDF file

When I first began (and thought it was going to mainly about class notes) I remember having a conversation where I mentioned that I did not want to reinvent the wheel but would rather serve as a directory of links where I would try to weave the best finance sites together.

That conversation came rushing back to me this morning as I tried to put notes together for a MBA math review. Why? Because I stumbled upon these notes from Ken Kavajecz's notes for his MBA math review class. What a piece of work! Great job!

Link to PDF file.

Thursday, September 07, 2006

Catching up on the news and some blogs

Catching up on mailbox and some articles I have been meaning to mention:

* Add ETNs to your list of "need to know acronyms". ETN: Exchange Traded Note. From the SmartMoney:
"MAKING DIFFICULT-TO-ACCESS asset classes such as oil and currencies easier to invest in has been one of the biggest developments this year for exchange-traded funds. Barclays, already the leading provider of ETFs thanks to its iShares offerings, is taking the evolution one step further with the rollout of exchange-traded notes, or ETNs, that track various commodities.

While ETNs might seem on the surface to be the same as ETFs, especially considering the similar-sounding names and a common issuer, the two are very different animals. Both trade daily on an exchange and can be shorted like stocks, but unlike ETFs, which are typically collateralized by underlying securities, ETNs are unsecured debt issued by Barclays. That means the notes are only good as long as the issuer stays solvent"
*FreeMoney Finance looks at the never ending question of how much money is needed to retire. A look-in:
"Middle-income households tend to need a [income] replacement rate of 70% to 75% instead of 100% mostly because only part of Social Security is taxed and because saving for retirement usually ends once a person enters retirement."
* Cyberlibris points to an absolutely great series of videos from the AFA! They are interviews with the founders of finance--"edited versions of interviews with Harry Markowitz, William Sharpe, Paul Samuelson and Robert Merton " In a word, GREAT! I learned a lot. Go watch!

* Continuing on the history path, Google's News archive now goes back 200 years! Really quite amazing. Yes you have to pay for many of the old articles (ex. Washington Post etc), but if you like history, want to get a different perspective, or are doing research going back into pre WW II, this is going to be a big help! BTW for more on this see the (Speaking of Google, the company was incorporated on this day in 1998. So happy birthday to Google!)

* Need another example of why safety and the economy are so inter related? Locally our news has been totally dominated by Bucky Philips an escaped convict who has been on the lam for about 5 months. Last week he shot two troopers killing one. On Tuesday it was reported he might be in the area. With roadblocks, troopers everywhere, and warnings to stay inside etc, the streets seemed deserted. That was caused by one person who may or may not be near by. Consider the risks associated with being on the streets in Baghdad and you begin to appreciate the troubles the economy in Iraq is facing.

* HS asked me, and I will ask you, the following: "Is there any good site to get historic option and futures prices?" My suggestion was to contact the market where they trade, but if anyone has a better idea, please let me know.

*The governance crisis that is HP has degraded into a comedy of errors. Where to start? A board member leaks news so the firm spies on board members. Like I said about Enron, I want movie rights! Stay tuned. I am sure we will be hearing more about it.

* I am teaching a MBA math review. In preparation I have been watching Change and Motion: Calculus Made Clear. It is a series of lectures by Michael Starbird of the University of Texas produced and sold by The Teaching Company (which is a great idea!). While a tad slower than I would like, it is very well done and easy to understand. And an added benefit is that the history of the science is fascinating. In hindsight the groundwork for Newton and Leibniz was laid for nearly two thousand years!

* The day after I taught about the various US markets, the NASDAQ makes my notes outdated by saying they will get into option trading by 2007. The CBOE can't be thrilled with that news flash.

* As a free market believer, I was saddened to see the chairman of Sportingbet "detained". Not sure why governments (via lotteries, OTB), Native Americans, and casinos should get special treatment.)
Time to get ready for class!

Wednesday, September 06, 2006

Executive Governance: Congressional Hearings and more

I worked at home this morning in order to watch the Senate Finance Committee's meeting on Executive Compensation. It was interesting but did not cut much new ground.

Predictably, the session began with the numbers (for instance that CEOs made more than 300 times the average employee in 2004), the problems of backdating options (including the need to redo tax records), and the principle-agent conflicts that arise when executives are paid large amounts of money.

Why are taxes so important of issue here? One reason is that firms can deduct over $1 million per executive only if that pay is incentive based. Back-dating the options loses that incentive component and thus disallows the deduction.

Consider the following from Business Week:
"Known as Section 162(m) of the Internal Revenue Code, that provision limits the tax deductibility of pay for the five highest-paid executives at public companies to $1 million, unless the pay is determined to be "performance-based." To qualify as performance-based pay, compensation committees must set "pre-established" and "objective" performance goals. Shareholders must approve the goals, and the compensation committee must certify they were met.....

But corporate governance experts, academics, and some members of Congress contend that many big companies have figured out how to bypass the rule by setting easy-to-reach goals that make the lion's share of executive pay —from bonuses to stock grants "performance-based" so they can write those payments off on tax returns.

BILLIONS IN LOST TAXES. The net effect, say critics, is that many companies now deduct almost all of their top executives' compensation"

C-Span also covered the Finance Committe's panel question and answer period. Some highlights from the panel discussion.
  • Charles Elson of Univ Of Delaware was possibly the best speaker. He commented on why congress should care--short version: if shareholder confidence is lost, they quit investing.
  • Steven Balsam a Temple Accounting Professor was also excellent. He called for more disclosure and consistent tax treatment.
  • Lucian Bebchuk of Harvard Law emphasized the size of the compensation and that there were conflicts and rules. Moreover, how deferred compensation was taxed advantaged to the executive but not the firm.
  • Nell Minow of the Corporate Library seemed more rehersed. She continually painted the gloomiest picture that governance was not working and more oversight was needed. She even commented on how airfare was taxed. That said, it is sad that she was generally right.
Senatore Grassely who led the meeting concluded by saying he will be asking for board minutes of firms that did backdate options.

Interesting discussion. I wish I had recorded it. Hopefully it will be online soon.

This meeting came on the heels of a NY Times report that backdating was a more serious problem than previously thought:
"A new study estimates that the stock options backdating scandal may cost shareholders hundreds of millions of dollars. The study was released on the eve of two Senate committee hearings that plan to examine the scope of the widening investigation into improper options practices.

Three researchers at the University of Michigan estimated that backdating stock options between 2000 and 2004 helped sweeten the average executive'’s pay by more than 1.25 percent, or about $600,000. But the fallout from the recent options investigations has caused those executives'’ companies to fall in market value by an average of 8 percent, or $500 million each.

“For about $600,000 a year to the executives, shareholders are being put at risk to the tune of $500 million,” the study concludes."

Tuesday, September 05, 2006

Confllicts of interest-- Take II: college football

Heisman Candidate Michael Bush's Injury Reminds Many That College Athletes Should be Paid, says Professor:
"“It makes no sense that half of the players come from poverty, and their starving families get almost nothing in return,” says Watkins, who was a recent guest on ESPN’s “Quite Frankly with Stephen A. Smith”.

Bush, the star running back at The University of Louisville, broke his leg in the team’s first game against The University of Kentucky. Bush was expected to be a high draft pick had he left for the NFL last year, and he was also considered by experts to be a strong candidate for the Heisman Trophy. Dr. Watkins, a Louisville native and graduate of The University of Kentucky, knows the experience of the college athlete all too well. He has taught at The University of Kentucky, The Ohio State University and now Syracuse University, all of whom have major athletics programs. “The NCAA has signed an 11 billion dollar TV rights deal for the NCAA tournament alone,” says Watkins, who wrote a scientific study last year calculating the economic value of the black male athlete to the NCAA. “Athletes take the greatest risk, they are distracted from their educations to play sports, and they get almost none of the rewards.”
To make matters worse, often when athletes do decide to turn pro early, they are seen as somehow unethical and making a short-term decision by foregoing their college education. This of course is an image that college's have every reason to maintain.

The only thing that makes this slightly better is that it looks like the surgery went well and he does have a $2million insurance policy on a career ending injury.

Conflicts of interest in the real estate market

The real estate market fascinates me. Not only is real estate often the largest holding of many people, but the lack of liquidity, lack of transparency, and vested interests of various players tells us much about people and markets.

For instance, while some observers may balk at the idea that corporate managers would purposely fight transparency, we see much evidence of the same behavior by real estate brokers who fight to maintain their competitive advantage that the lack of transparency brings.

For instance, from the NY Times:

"The Internet has radically changed the way consumers buy books and airline tickets, trade stock and learn news. But the real estate industry has resisted change -- and protected its commission structure-- by controlling the information on its Multiple Listing Service database of properties for sale.

“You can find out more on the Internet about an eBay Beanie Baby than you can about a $1 million house,” said Glenn Kelman, chief executive of Redfin, a licensed broker in Washington State and California.

The M.L.S. is the only place that contains nearly all the homes for sale in a community. Only brokers can post there, but agents can also display selected information about a listing on their own Web sites and on"

Of course it is changing, albeit slowly (e.g. Zillow lists prices of most homes), but it sure is taking longer than many so-called experts would have expected.

Blogging problems

I am not sure what setting was wrong, but appears to be fixed now. I just got a new computer and for some reason, I could not post to FinanceProfessor...oh is fixed now.

Classes have started here and it seems that the weather knows it and has decided to get wet and cold.

I am teaching two advanced corp fin classes and two graduate introductory finance courses this semester. So it should be a good semester.

And now back to your regularly scheduled blog. :)