Monday, February 28, 2005

Interested in Islamic Finance? Interested in going to Australia?

This sounds like quite the opportunity for some of you!

Afshan Mantoo is organizing a conference in Melbourne Australia on Islamic Finance. And the best part? Some expenses may be paid for qualified participants! What could be better? A finance conference in Australia that is partially paid!

She is looking for those interested in participating. Obviously you must be qualified to speak on Islamic finance and you should be fluent in English.

If you know of an Islamic Finance expert or if you are one yourself, please contact Afshan Mantoo.

BTW I would like to add my congratulations to Afshan for being named citizen of the year in Moreland AU. To quote the article:

"Afshan Mantoo has been the driving force behind the Islamic Girls and Women’s Group, a not-for-profit group in Moreland that addresses social, economic, justice and employment issues.

Afshan has been praised by people of many faiths and backgrounds, and her history of involving people from different faiths supports the diversity that we hold dear in Moreland,” Cr Higginbotham said."

Afsan Mantoo may be contacted by email.

Refund-anticipation loans still a lousy deal--from Houston Chronicle

Personal finance tip: don't use refund-anticipation loans! - Refund-anticipation loans still a lousy deal: "A refund-anticipation loan is a bank loan, short-term borrowing based on the amount you expect from your federal tax refund. It is also a popular marketing tool for the big tax-preparation companies, appealing especially to people living from paycheck to paycheck.... But for most people, 'they're completely unnecessary, an extremely expensive drain on expected refund money,' said Jean Ann Fox, director of consumer protection at the Consumer Federation of America.

....With classic refund-anticipation loans, consumers get their money in one to two days, Block spokeswoman Nancy Wagoner said. An instant refund-anticipation loan, which costs an extra $20, means you get the money the same day.

Either way, that translates into rates between 31 percent and 520 percent — that is not a typo — and that doesn't even count the $24.95 upfront fee.

The rates are somewhat skewed because the percentage is calculated on an annualized basis, even though the loan is outstanding for about 10 days. Still, you'll pay anywhere from $29.95 to $129.90....."

As I said, be patient,don't use these! - If you haven't been saving for retirement, start now

An interesting (non technical) article that reminds people while earlier is better, late is better than never! Start now! - If you haven't been saving for retirement, start now

"Financial adviser David Bach also advocates that people try to break up the big task of saving for retirement into manageable portions.

Bach, author of the book Start Late, Finish Rich, says there are strategies to build a retirement cushion, regardless of the age people start.

For example, can you wring just $10 a day out of your budget to set aside in a savings account, perhaps by cutting out expensive coffees or carrying your lunch or reducing cell phone use? That seemingly small amount can build to more than $227,000 in 20 years, assuming a 10 percent annual return, Bach calculates. Bump the savings up to $15 a day, and the results grow to nearly $342,000.

Bach recommends that workers aim at putting the equivalent of one hour a day of income into a retirement account. If you earn $50,000 a year, that works out to about $25 an hour, so your goal should be setting aside $25 a day in retirement savings."

Thursday, February 24, 2005

Muhammad Yunus, Banker to the World's Poorest Citizens, Makes His Case - Knowledge@Wharton

Muhammad Yunus, Banker to the World's Poorest Citizens, Makes His Case - Knowledge@Wharton
Sometimes finance need not be about millions of dollars. A perfect example is in microlending. Often by giving only a few hundred dollars of financing, microlenders can make a huge difference. Wharton and the Nightly Business Report provide fascinating interview with Muhammad Yunus, managing director of Grameen Bank in Bangladesh and a pioneer in the practice of microcredit lending.

It is well worth your time!

A few highlights:

* "I saw how people suffered for a tiny amount of money....So I made a list of people who needed just a little bit of money. And when the list was complete, there were 42 names. The total amount of money they needed was $27. I was shocked. Here we were talking about economic development, about investing billions of dollars in various programs, and I could see it wasn't billions of dollars people needed right away. They needed a tiny amount of money."

* "This is business money. Business money is limitless. And then, you can reach out to many more people than you would otherwise do....This is not charity. This is business: business with a social objective, which is to help people get out of poverty. Other banks were not giving loans to these people. "

* "If we start with that $27, and you add on all the money that we have loaned, it's nearly $5 billion that we have given over time. Now we have come to a stage where every two years we are giving $1 billion. So half a billion dollars a year. That's the stage we are in."

* "NBR: We have recently seen elections in Iraq for the first time. Self determination is the hope there. In a sense, is that what your program does? It changes people?

Yunus: Definitely. Actually, if you look at it one way, the microcredit we give to the women is a tool to explore one's self, how much capacity that is stored up inside: 'I never knew that I had the capacity. That creativity. That ingenuity. To make money to express myself. So that money gives, for the first time, an occasion for me to find out how much I can do.' When you were successful in the first round, when you took tiny amounts -- $30, $35 -- and went into business and paid back the loan, you are now much more equipped to do better. Bigger. So you ask for a $50 loan, a $60 loan, because you think you can do bigger business and more challenging business than when you first took out an easy loan.

NBR: It gives you that self confidence."

To those of you who think financiers are just bad people, read the full article, it will change your mind. Finance is important and done correctly really does make the world a better place :)

Wednesday, February 23, 2005

BBC NEWS | Business | Leeson's legacy lives on in Singapore

It has been ten years since Nick Leeson brought down the Barings bank. TNow the BBC looks back at the events of 2005. VERY interesting! Watch the video :)
BBC NEWS | Business | Leeson's legacy lives on in Singapore

Why acting ethically is good business.

In my corporate finance classes I always make a point to stress that in the absence of large information asymmetries, acting ethically is generally also acting in shareholders' best long-run interests.

Why? Because the market place is a hard disciplinarian and few people (customers, suppliers, or investors) want to do business with firms that are not acting ethically.

Consider for a second, if you knew XYZ company was dumping toxic wastes, would you willingly do business with them when there are alternatives? MBA Depot (which incidentally is just a great site) provided a bit more evidence on this topic this week with a 2003 paper by Montgomery and Ramus, they conclude:
"more than 97% of the MBAs in the sample said they were willing to forgo financial benefits to work for an organization with a better reputation for corporate social responsibility and ethics."
Of course any survey is at least somewhat suspect and it is easy to say one thing and do another, but 97% is a pretty high number! It is also pretty encouraging!

Competition, credit crunch push Winn-Dixie to Chapt. 11 - Food - Food & Beverages - Company Announcements

Competition, credit crunch push Winn-Dixie to Chapt. 11 - Food - Food & Beverages - Company Announcements

Given my background (my family owns a grocery store), it is always sad to see a grocery store declare bankruptcy. However at least the timing was good for my classes as we do capital structure and bankruptcy.

A few things to note from the article:

*Credit ratings do matter in the since that other creditors are less willing to lend money(in this case reducing trade credit). As the article says: "...widening losses...led to credit downgrades and a tightening of the screws by its vendors, further cutting into cash availability"

*Bankruptcy allows the firm to get out of many contracts. For instance "Winn-Dixie also said it would seek a bankruptcy judge's permission to immediately terminate the leases of two warehouses and 150 stores that could save about $60 million annually. "

*As a marketing observation it is worth noting that this is another example of how difficult it is to compete with Wal Mart and how Wal Mart has changed the once stable industry. (It should also be noted that increased competition from restaurants---about 50% of US food dollar is now spent at restaurants--has also played a major role.)

Tuesday, February 22, 2005

SSRN-Who Receives IPO Allocations? An Analysis of 'Regular' Investors by Ekkehart Boehmer, Raymond Fishe

SSRN-Who Receives IPO Allocations? An Analysis of 'Regular' Investors by Ekkehart Boehmer, Raymond Fishe

Boehmer and Fishe examine IPO participation. Consistent with previous literature, they find that there are regular (that is those who frequently participate) customers. These "regulars" are made up of both institutions and retail clients.

These regulars do not get their favored status for free as they often have to buy shares in "cold" IPOs as well as being allowed to buy in for hot IPOs.

A few highlights:
*"sample IPOs were completed during a “hot” cycle in the U.S. IPO market (Ritter and Welch (2002)). Although this period is unusual, there is no reason to believe that regular investors are treated differently during this period."

*""We find a sizable set of both institutional and retail investors who receive frequent allocations in IPOs. These regular investors receive greater monetary first-day gains, but lower average returns than other investors. This suggests that underwriters require regular investors to participate in weak offerings, but compensate them with continued access to underpriced shares."

* "...those accounts receiving only one allocation represent 22.8% of the sample....we find that nearly 39% of the sample receives allocations in nine or more IPOs. This increases to 55.6% for institutions and decreases to 34% for retail investors."

* "Thus, institutions receive more frequent allocations. What is surprising is that there are a large absolute percentage of retail investors in the higher allocation count quintiles. In terms of numbers, the top two quintiles contain twice as many retail as institutional accounts. This suggests that underwriters value both institutional and retail accounts as regular investors."

*"Overall, our results show that regular investors are an important beneficiary of initial IPO returns. They obtain larger wealth gains than infrequent investors, which are due to more frequent (but smaller) allocations in the best-performing IPOs....These results are generally consistent with Cornelli and Goldreich (2001) and Jenkinson and Jones (2002), who find that frequent participants receive more favorable allocations relative to investors’ demand schedules. Our analysis complements their results in that we can show that a cross-section of U.S. underwriters also treats regular investors favorably."

Interesting stuff!

Suggested Citation
Boehmer, Ekkehart and Fishe, Raymond P.H., "Who Receives IPO Allocations? An Analysis of 'Regular' Investors" (March 14, 2004). AFA 2005 Philadelphia Meetings.

SSRN-Municipal Bond Liquidity by Lawrence Harris, Michael Piwowar

SSRN-Municipal Bond Liquidity by Lawrence Harris, Michael Piwowar:

Harris and Piwowar look at the liquidity of Municipal Bonds. Not surprisingly they find that the bonds are not as liquid as stocks and that transaction costs are MUCH higher.

While much of this illiquidty may be a function of the market itself, at least some may be blamed on the issuers (and more importantly their investment bankers). How? The authors report that transactions costs increase with the complexity of the bonds. Why? If people do not understand what the bond is offering, they are less likely to buy it. As more people do not understand the bond, liquidity drops, and the investors who are willing to trade the security demand a higher premium. So it appears that simple plain vanilla bonds may be a better option afterall.

In the authors' words:
"Unlike in equities, municipal bond transaction costs decrease with trade size and do not depend significantly on trade frequency. Municipal bond trades are also substantially more expensive than similar sized equity trades. We attribute these results to the general lack of price transparency in the bond markets. Additional cross-sectional analyses show that bond liquidity increases with credit quality and decreases with instrument complexity, time to maturity, and time since issuance. The results suggest that investors, and perhaps ultimately issuers, could benefit if issuers issued simpler bonds. "
Interestingly this topic and, indirectly, this study was recently (2/17/05) mentioned in the Houston Chronicle. Why? Because new changes (Undoubtedly brought about in part by this study) have increased the transparency (and hopefully will bring down the transactions costs for the muni-bond market.

The rule change?
With the real-time pricing, which began Jan. 31, dealers are required to report all trades within 15 minutes to the Municipal Securities Rulemaking Board, which oversees the muni market. The board posts the information on its Web site,
The Houston Chronicle reports that the new rule is working:

"Things have gotten better with next-day price transparency," Olson says. "There aren't as many rogue practices. Brokers and traders know they're being watched."

So it appears that Harris and Piwowar have helped to make a difference! Good job!

Suggested Citation
Harris, Lawrence and Piwowar, Michael S., "Municipal Bond Liquidity" (February 13, 2004). AFA 2005 Philadelphia Meetings.

Friday, February 18, 2005

Wall Street Bonus Babies (Gotham Gazette. January, 2005)

You know the stereotype: Work on Wall Street, get rich. The Gotham Gazette shows a differing view.

The article points out that while average compensation is very high, this is skewed by a relative few who make a great deal. Using medians and quartile data from the 2000 Census, sociologist Andrew Beveridge shows that not everyone on Wall Street is rich. (Be forewarned, this is not a finance article, but a newspaper piece).

Wall Street Bonus Babies (Gotham Gazette. January, 2005)

A quick taste of the article:

"So who are the Wall Street bonus babies?

Overwhelmingly they are involved in securities and investments, according to an analysis of Census and other data. They either help make markets, make sales, make deals, or give advice – brokers, investment bankers, traders, financial analysts, financial advisers, portfolio managers, and a few chief executive officers.

Working on Wall Street does not guarantee a high income, as most any Wall Street secretary, food service worker, or techie can attest. So can the average auditor and accountant; one-quarter of the 11,000 auditors and accountants who work in the investment and securities industries in Manhattan make $38,500 or less; the worst-paid brokers make little more than that."

"An investment banking analyst right out of college will make about $65,000 salary, plus a $35,000 bonus, while an associate just out of business school might make $85,000 in salary and $115,000 in bonus."

A few of his other findings:
* Finance-related jobs are significantly better paying than other positions.
* 93% of those making over $347,000 are white while 86% are male--two facts that none of us should be proud of.
* 93% of those making over $347,000 have at least 4 year college degrees.

SSRN expands database :)

There is research site that I use more than SSRN so I was glad to get the following from Michael Jensen:

SSRN's Economic Research Network is pleased to
announce that theWorld Bank will now post their working papers in SSRN's Government & Public Agency Research Paper Series. This new series enables Government & Public Agencies to disseminate their research worldwide and to encourage the exchange of ideas about development issues, governance, and their relation to the behavior and performance of banks, the structure of the U.S. banking system, and other national banking systems as well as the international banking
system, and the interaction between financial institutions and the real economy.

The new World Bank Research Paper Series (which now contains over 1,900 working papers) can be viewed at the [...]:

SSRN's searchable electronic library contains
abstracts, full
bibliographic data, and author contact information for
more than
88,000 papers, over 46,500 authors, and full text for
over 62,000
papers. The elibrary can be accessed at

Thursday, February 17, 2005

SSRN-Disclosure Standards and Market Efficiency: Evidence from Analysts' Forecasts by Hui Tong

SSRN-Disclosure Standards and Market Efficiency: Evidence from Analysts' Forecasts by Hui Tong:

Short version: increased transparency reduces need (and hence profitability) of analysts. Therefore following increased disclosure rules, the number of analysts falls. Overall the net effect of increased transparency rules is unclear.
The author "examine[s] the effect of transparency by focusing on the interaction between
public information availability and private information acquisition"

With this in mind, Tong examines what happens when countries adopt stricter disclosure requirements that increase transparency. Of course, you know my basic stance that transparency is good. But Tong makes me re-examine that position. My conclusion? Transparency is still good, but increasing transparency is not without its costs.

Longer version: Unintended consequences...often when one thing changes, other things (that at first were seen as unaffected) change as well. This is one danger of static analysis: we might overestimate the benefits of some change.

Hui Toing "examine[s] the effect of transparency by focusing on the interaction between
public information availability and private information acquisition"

Rather than using spreads (a transparency measure used by previous researchers), Tong " considers how international standards affect analysts’ forecasts of listed companies’ earnings, where the accuracy (dispersion) of these forecasts is used as a measure of information accuracy (dispersion)."

Tong finds "that disclosure standards enhance forecast accuracy directly but at the same time reduce the number of analysts per stock (the variable that serves as my proxy for private investments in information). The net effect of disclosure standards on forecast accuracy and dispersion thus ranges from weak to nonexistent"

That is really an important insight! But I maintain that increasing transparency is still good even if dispersion is not significantly increased, this same level is being achieved with fewer analysts (and hence lower costs--of course this assumes that the regulations that increased the transparency are not more costly than the cost of employing the analysts, but that topic will have to wait) .

Suggested Citation
Tong, Hui, "Disclosure Standards and Market Efficiency: Evidence from Analysts' Forecasts" (March 8, 2004). AFA 2005 Philadelphia Meetings.

Wednesday, February 16, 2005

SSRN-Corporate Bond Market Transparency and Transaction Costs by Amy Edwards, Lawrence Harris, Michael Piwowar

SSRN-Corporate Bond Market Transparency and Transaction Costs by Amy Edwards, Lawrence Harris, Michael Piwowar

YES! If you love it when theory is found to be true as much as I do, then Edwards, Harris, and Piwowar have given us a reason to celebrate!

Not only do they show that transaction costs for corporate bonds are higher than for equities (a finding which helps explain the preference for firms to have less leverage than other models would suggest), but they also show that transaction costs of corporate bonds decrease when transparency increases! Yeah!!!

Private Retirement Accounts--by Jim Finnegan at FEN

Ever since the election we have been bombarded with largely emotional and in some cases purely idiotic comments on the proposed social security reforms. (indeed there have been some so bad that I could not even force myself to read them--I will not give you names but if you search the Buffalo News you may find the articles. Be forewarned, they are really really bad.

I have pondered a reply. Indeed I almost thought about writing to the Buffalo News criticizing their choice of articles. However, true to form I ran out of time. ANd it is a good thing I did for now Jim Finnegan writing his editorial in Financial Engineering News says largely what I would have said and says it much better than I would have!

Private Retirement Accounts Could Use Some Financial Engineering

Some highlights:

  • "What if private retirement accounts had existed when I first entered the workforce and began Social Security contributions (in 1975 as a college student summer shift worker in a factory)? How would I have fared?"
  • "Personally, I favor private retirement accounts despite three key concerns:
    1. The short-term saving caps and longer-term four percent of earnings savings limit in the current plan are insufficient to provide most workers with even the opportunity to build a meaningful “nest egg” for retirement needs.
    2. The real transition costs will be much more than the $750 billion White House report estimate (And, I recognize this concern and the former one about limited rates of contributions are directly correlated.)
    3. The shift to private retirement accounts could discourage personal risk taking and entrepreneurship: As I noted earlier, I’m a 49 year old entrepreneur investing in FEN with very little current income to divert to a private investment account- when retirement is certainly on my mind.
  • "Not withstanding these concerns, I believe the existing transfer payment system (current workers paying for today’s retiree benefits) looks more like a collapsing Ponzi scheme as the ratio of workers to retirees continues to decline."
  • "But when it comes to their retirement, I don’t believe most people want to own a lifecycle retirement fund worth an uncertain future dollar value "
  • The field of financial engineering has the tools to bridge this gap between private retirement accounts that offer an “uncertain future value” versus “certain future financial security.”

WELL SAID!!! Read the entire letter here.

BBC NEWS | Business | Japan economy slides to recession

BBC NEWS | Business | Japan economy slides to recession

In my portfolio class we were recently discussing international investing and the benefits of diversification. This led to a brief discussion of the Japanese stock market. Few markets and economies have ever had such a long downward ride: from near 39,000 at the end of 1989 to about 11,600 currently.

Thus, today's news that the Japanese economy has slipped into its 4th recession in a decade came as only a small surprise.

Thursday, February 10, 2005

A follow up to yesterday's Sarbanes-Oxley piece

Everyone obviously did not agree with yesterday's piece from Financial Engineering Today that suggested that the (net) costs of Sarbanes-Oxley may have been overstated. I am sure we will see more about the actual costs in the coming years, but I will admit that the costs can be far reaching and come from seemingly unexpected areas (but so too can be the benefits!).

For now we can say that for nearly all firms the actual costs of compliance have increased. What we can not yet see are the benefits.

Some of the higher costs include higher audit fees, and for some firms the costs include finding a new auditor. As if for evidence of this latter cost, the NY Times writes that many firms are being dropped by their auditors not for being problem clients, but because the auditors are merely too busy.

The New York Times > Business > Your Money > Sorry, the Auditor Said, but We Want a Divorce: "A growing number of companies are looking like unsuspecting spouses being left for trophy partners. That's because the top accounting and audit firms - PricewaterhouseCoopers, KPMG, Ernst & Young and Deloitte & Touche - are dropping their corporate clients in droves"

"The top auditing firms, collectively known as the Big Four, declined to say how much more the new law was costing their clients, though they all said it had sharply increased the amount of work they must do for clients, and the fees they charge. BDO Seidman, a so-called second-tier firm, says its fees have increased by 40 percent to 100 percent, if it agrees to retain the client at all"

The whole article is available here.

Wednesday, February 09, 2005

Sarbanes Oxley- SOX It To Them

This week's Financial Engineering Today newsletter has a great review and update on the Sarbanes-Oxley Corporate Responsibilty Act.
Sarbanes-Oxley- SOX It To Them

A few highlights:
  • **"The stated objective of the act was “to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws.” In plain English, the point of the law is to make companies more transparent and executives more accountable"
  • **"The reaction of most chief executives, at least in private, was that the act was a knee-jerk reaction to the scandals, that the act was hastily drawn up without sufficient thought, that compliance to the requirements would be daunting "
  • **"Despite these and other drawbacks, with compliance around the corner the sky has not fallen. While admittedly expensive to implement, examination of some of the claims CEOs have made about the cost of compliance leaves one scratching his head. One publicly traded company with $300,000 in earnings estimated that it would cost $250,000 "
  • **There have been other "benefits" as well. For instance "Smart companies have used compliance as an opportunity to get a standardized financial reporting system in place across a company’s business units." While true to a degree, I have reservations with this since if there were these great benefits, firms would rationally adopt them with or without the law. (or at least in theory they would)
  • **and finally, if transparency increases, so too should firm value.

The article is by Paul Schaafsma. Definitely worth your time!

Tuesday, February 08, 2005

Behind the Scenes at the FOMC: How the Federal Reserve Determines Monetary Policy

Want to see what the Fed does and how it does it? Fed Governor Susan Schmidt Bies gave a speech at the University of Tennessee Martin that gives us an very interesting look at the life as a Fed Governor and answers many of the questions you may have.

FRB: Speech, Bies--Behind the Scenes at the FOMC: How the Federal Reserve Determines Monetary Policy--February 7, 2005:

In her speech she " overview of the broad range of purposes and functions of the Federal Reserve System, as well as an insider's view of what happens behind the scenes at the FOMC."

A must for any Money and Banking student/teacher!

Oh and by the way, it is interesting too!!

Monday, February 07, 2005

What happened to the people at Drexel? Tie to MLB

On the 15th anniversary of Drexel's demise The New York Times has an interesting article on what happened to those who worked there.

You may have kept tabs on Milken:

"Michael R. Milken, the firm's legendary junk-bond trader, was indicted on 98 charges, including racketeering. He later pleaded guilty to six felony counts, paid $600 million in fines and restitution and served two years in prison." Mr. Milken, who has since survived cancer, established two major foundations devoted to cancer research and become a major investor in an education initiative, Knowledge Universe Inc."

But what about the others? Many of them landed on their feet and are doing very well.

"Interviews with more than two dozen former employees showed that, far from being embarrassed by their connection to Drexel, most retain an almost cultlike devotion to the firm and much of what it stood for. Few of them were crucial players in building Drexel's core franchise, junk bonds. And few of them were especially close to Milken."

Interesting! I had no idea of what happened to the rest of them at Drexel. I guess I should have--one now owns the Milwaukee Brewers!

Sunday, February 06, 2005

Super Bowl Commercials

While I had posted this back in October, given the topic, it is worth re-running.

Paper is by Fehle, Tsyplakov, and Zdorovtsov

Short version: Super Bowl advertisers outperform the market by about a half a percentage point on Super Bowl Monday. This increase, which apparently is permanent, is concentrated in heavy advertisers and caused by buying activity by individual investors. This is consistent with a behavorial finance view of the world.

Longer version: Fehle, Tsyplakov, and Zdorovtsov study the stock price of firms that advertise during the Super Bowl. While overall there is no abnormal return, there is a positive abnormal return of slightly less than a half a percent for heavy advertisers. The stock price jump does not appear to be driven by either increased expected sales or enhanced liquidity.

To establish the mood and to tie this paper to behavioral finance, the authors begin by showing that previous research has shown that investor mood and attention, and not just financial variables, may influence stock prices. For example "Hirshleifer and Shumway (2003) document that the good mood associated with the weather...can still affect investor behavior."Once this link is established, the authors state that this same type of link can exist with Super Bowl advertising.

Again in their words:
"There are good reasons to believe that mood and attention effects on investorbehavior may exist as a result of advertising. Extensive marketing literature suggests that a person exposed to an affect-evoking advertisement about anyobject, tends to change his or her attitude toward a more favorableconsideration of the object. Thus, advertising promoting the company image maycreate a positive mood in the minds of investors and also potentially renderthem more optimistic in their evaluation of a company’s fundamentals. [footnotesremoved]"

The authors then set out to find this relationship. And sure enough they find it. For instance:
"While there do not appear to be significant abnormal returns for the overallsample on average, abnormal returns are greater for firms readily identifiablefrom the ad contents and increase in the number of ads employed....Forrecognizable companies with the number of ads greater than the sample mean oftwo, the event is followed by an average abnormal Monday return of 45 basispoints. Interestingly, the effect appears to be non-transitory in nature as the20-day post-event cumulative abnormal returns for this subset average 2%."

What might be more important is the finding that this increase in price is caused by buying concentrated in small buyers. This is interpreted as supportive of the view that investors, in particular small investors, are making decisions based on the ad and not on the underlying economics of the firm. This is understood to be consistent with a behavioral finance view of the world.

The authors correctly note that there are alternative explanations to these findings. For instance:

1. The ads are of higher than expected quality and high quality ads lead to more sales, and hence a higher stock price.
2. The ads reduce information costs and therefore lead to a more diffused shareholder base and higher liquidity.

These explanations are considered and then refuted. The easiest refutation is that if there is a response to information costs and liquidity stories, then the stock price should move on the announcement of the ads, and not on the Monday following the game.The authors comment on this:

"Given that Super Bowl ads are pre-announced, we expect that any positive or negative effect of the ad on sales is priced in before the Super Bowl. The only unexpected component of the sales effect could be due to the quality of the ad.However, there is no reason to believe that investors’ expectations of adquality should be biased and therefore we do not expect abnormal returns in thecross-section after ad quality is revealed."

What may be most interesting is the suggestion that the advertising firms know this relation exists and are running the ad as a means of raising stock prices. "...the decision to run a commercial can be viewed as a costly, endogenous and possibly strategic choice by firms that may aim to exploit investors’ misreaction. The potential for such strategic advertising suggests a possible link between behavioral finance and traditional corporate finance topics."

My view: “Getting noticed” is a factor in pricing. And yes one aspect of advertising is to get noticed. However, it is not a major determinant in asset pricing (the abnormal returns were less than ½ a percentage point). Given transaction costs (both information costs and trading costs), it is probably not worth it for investors to readjust their portfolios prior to when the advertisement actually runs. Additionally, this “getting noticed” is, as the authors suggest, arguably more important for smaller firms. This size story would also be consistent with the finding that the price jump is driven by small trades since larger trades would gravitate to larger firms.

That said, I am ALMOST convinced. This ALMOST is quite a concession from a market efficiency adherent and testament of a job well done by the authors. When I first read the abstract, I defensively thought of several explanations other than the behavioral finance story. But the authors addressed these arguments. So I am forced to admit that the behavioral finance angle is compelling.

The paper is available here

Greenspan on Adam Smith--February 6, 2005

Alan Greenspan gave a great tribute to Adam Smith! Fascinating!

FRB: Speech, Greenspan Adam Smith February 6, 2005 Some of the highlights:
"In the broad sweep of history, it is ideas that matter. Indeed, the world is ruled by little else. As John Maynard Keynes famously observed: "Practical men, who believe themselves to be quite exempt from intellectual influences, are usually the slaves of some defunct economist....In his Wealth of Nations, Smith reached far beyond the insights of his predecessors to frame a global view of how market economies, just then emerging, worked. In so doing, he supported changes in societal organization that were to measurably enhance world standards of living."
Later Greenspan notes
"For most of recorded history, people appear to have acquiesced in, and in some ways embraced, a society that was static and predictable. A young twelfth-century vassal could look forward to tilling the same plot of his landlord's soil until disease, famine, natural disaster, or violence ended his life....Smith lived at a time when market forces were beginning to erode the rigidities of the remaining feudal and medieval practices and the mercantilism that followed them....For the first time, modern notions of political and economic freedom began to gain traction....gave rise to a vision of a society in which individuals guided by reason were free to choose their destinies unshackled from repressive restrictions and custom.
Adam Smith played a key role in the progression of this economic thought:
"In 1776, Smith produced one of the great achievements in human intellectual history: An Inquiry into the Nature and Causes of the Wealth of Nations. Most of Smith's free-market paradigm remains applicable to this day"
Great Stuff! I definitely recommend you read the whole speech!

The winner for best writer in the annual report category is .......

The winner for best writer in the annual report category is .......[Insert drumroll] Warren Buffett!!

While it may not have all of the excitement of the Grammys or the ESPYs, it is still quite the honor.

MSNBC - Billionaire Buffett gets an award for writing:

The National Commission on Writing for America’s Families, Schools, and Colleges is honoring Buffett for his "easy to undertand" annual reports.

"Buffett says he writes his annual report as though he were explaining Berkshire to a sister who has been away for a long time. Often the reports are sprinkled with humor."

Want to read them? The annual reports from 1995 to 2003 are available here.

Saturday, February 05, 2005

Ralcorp Holdings, Inc. Announces a Variable Forward Contract on Ralcorp Stock by Chairman William P. Stiritz

Ralcorp Holdings, Inc. Announces a Variable Forward Contract on Ralcorp Stock by Chairman William P. Stiritz

What do you do when you are an insider and want to diversify your holdings but not sell your shares and give investors a bad signal? One alternative is to enter a Variable Forward contract. That is what William P. Stiritz, Ralcorp's Chairman.
"The VFC transaction provides the ability to benefit from future upside appreciation, up to an agreed upon amount, in the Company's share price over the next seven and a half years. The VFC also provides protection against declines in share value exceeding an agreed upon downside floor (set initially below the current market price) over the same period. Under certain circumstances, Mr. Stiritz can elect to retain the shares of Ralcorp stock involved in the VFC transaction, and settle the agreement with cash."

Friday, February 04, 2005

SSRN-Taxes and Financing Decisions by Jonathan Lewellen, Katharina Lewellen

SSRN-Taxes and Financing Decisions by Jonathan Lewellen, Katharina Lewellen

Next week in class we begin capital structure, so I simply could not pass up this article by Lewellen and Lewellen on capital structure and taxes.

Short Version: The authors show that internal equity has tax advantages. Moreover, "The trade-off between debt, retained earnings, and external equity depends critically on the tax basis of investors' shares relative to current price." Their paper suggest that much of what we thought we knew about capital structure, may not be quite right! "These predictions would all be contrary to the way trade-off theory is often interpreted"

Longer Version: The paper develops the consequences of Miller's 1977 paper that showed the tax benefits of debt are overstated when personal taxes are ignored. In their current paper, Lewellen and Lewellen (LL) build on this insight.

LL summarize the reson for their paper in a nice succient parapgraph:

"Our results follow from a simple observation whose importance for capital structure seems largelyunappreciated: when a firm distributes cash to shareholders, using either dividends or repurchases, thepayout triggers personal taxes that could otherwise be delayed. Thus, using internal cash for investment, rather than paying it out to equityholders, has a tax advantage – the deferral of personal taxes – thatpartially offsets the double-taxation costs of equity. An immediate implication is that internal equity is less costly than external equity for tax reasons."

Of course this is not new. Other have looked at this and have shown that external equity has some tax disadvantages, what is different in this paper is that looks not only at differing capital gains rates, but also is based in part on what the tax basis of the shares are to investors.

"Most clearly, our results show that the traditional view of debt and taxes, as exemplified by Miller (1977), is valid only when capital gains are taxed on accrual.... The main features of the
traditional view are (i) internal and external equity are assumed to be equivalent, and (ii) the tax cost of equity depends on the total taxation of equity relative to debt, (1 – τc)(1 – τe) – (1 – τi). The first statement is generally false and the second is, at best, incomplete (it misses the distinction between internal and external equity and it is unclear about τe)."

A consequence of this is that the tax advantages often get swept under the rug and we look elsewhere for explanations. As teh authors state:

"Thus, capital structure dynamics in these models are driven by agency problems and adjustment costs – the focus of the studies –not by a tax advantage of internal over external equity. The literature sometimes acknowledges that, because capital gains are not taxed until they are realized, the effective tax rate on capital gains is less than the statutory rate. But simply allowing for a low effective tax rate isn’t sufficient because it misses
the differential tax costs of internal and external equity."

So what does this all mean? Firms may have less of a reason to increase debt and a firm's capital structure is a function of not only firm characteristics, but also investor characteristics (such as effective tax rate).

And then the kicker! The model helps to explain the currrent problems we see with the trade-off theories:

"Indeed, our model suggests a kind of tax-induced pecking order, with debt and internal equity both preferred to external equity (the ordering of debt and internal equity is ambiguous and could change over time, for example, as a function of current leverage). Thus, our model might help explain two findings that have been described as ‘major failures’ of trade-off theory: (i) profitable firms seem to have too little leverage, and (ii) changes in debt largely absorb short-run variation in internal cash surpluses and deficits (e.g.,Shyam-Sunder and Myers, 1999; Fama and French, 2002)." (pp. 17-18)

Wow. I^3 (Informative, Important, and Interesting!)

Suggested Citation
Lewellen, Jonathan W. and Lewellen, Katharina, "Taxes and Financing Decisions" (October 2004). AFA 2005 Philadelphia Meetings Paper.

Enron transcripts show unethical behavior for years

Money & Business:

"Enron Corp. was running scams to drive up the cost of power years before the 2000-01 West Coast energy crisis, according to audio transcripts and documents unveiled Thursday by a public utility north of Seattle."

"By November 1997, Enron apparently knew of loopholes in California's ill-advised deregulation plan, and by May 1998 - a month after the plan took effect - Enron was already falsifying transmission schedules to inflate prices, Snohomish County Public Utility District officials said Thursday as they unveiled new evidence at a news conference"

"The district is hoping to prove that an exorbitant contract it entered with Enron in January 2001, at the height of the crisis, should be considered fraudulent because of Enron's manipulation"

More from the NY Times

Thursday, February 03, 2005

Michael Brennan on stock market

There is an early front-runner for top story in the next newsletter! What a great interview!

Kim Snider interviewed Michael Brennan on how the internet bubble happend. The interview discusses the various changes that had come about leading up to the bubble, agency costs, unrealistic expectations, and lessons we can learn from the bubble.

Great stuff!!! and you can even listen to it!

Wednesday, February 02, 2005

Several short news items of note

Three interesting finance related stories:

1. "Last week...the National Association of Securities Dealers'.... board of governors approved a change in arbitration procedures that will let investors involved in a dispute request an explanation of why their claim was tossed....Under the current rules, arbitrators aren't required to explain their decisions."

2. What causes people to declare bankruptcy? Very often it is an illness. That is the finding of a study by Elizabeth Warren of Harvard Law School. From the Houston Chronicle: "Illness and medical bills now cause roughly half of all bankruptcies in the United States, more than a 23-fold increase since 1981, according to a new study." The skeptic in me questions a 23 fold jump in anything, but the fact that nearly half of all bankruptcies are caused by "illness and medical bills" is interesting and important. In a more recent study Warren also reports that "more than 90 percent of the families in bankruptcy qualify as middle class."

3. The NYSE was ordered (and complied) to release the details of Rochard Grasso's pay package. Grasso of course was forced out as a result of the pay package that was deemed excessive and as further evidence of poor governance at the NYSE. From the NY Times:
"The New York Stock Exchange on Wednesday released a previously confidential report detailing how former chairman Richard A. Grasso received his controversial $187.5 million pay package. The release came five days after a New York state judge ruled the contents of the 127-page report could not be shielded from the public by attorney-client privilege." - Home equity used to finance Super Bowl trips

A home equity loan is when you use your house as collateral for your loan. This idea would be anathema for anyone who lived through the Great Depression. But now home equity loans are very common. So common in fact that some are even using them to pay for Super Bowl tickets: - Home equity used to finance Super Bowl trips:
"Some Philadelphians are so desperate to get down to Jacksonville for the big game that they're borrowing against their homes to pay for the tickets....Mortgage bankers in Philadelphia and southern New Jersey say that Eagles fans have been inquiring about re- financing mortgages, or taking out home equity loans or home equity credit lines, to pay for what O'Donoghue calls "the chance of a lifetime." "
BTW : I was just putting the newsletter together (probably out today, maybe tomorrow) when I stumbled upon this. My guess is that today I will have severfal of these short "newsy" posts. This one might be useful for a money and banking class.