Thursday, April 27, 2006

What to do when you can't vote out management. And Does stock price trump governance?

Do you need a class example of how shareholders can influence management behavior even when management controls the majority of the board.

Is the Times In Play on Wall Street? - April 27, 2006 - The New York Sun - NY News:
"Morgan Stanley Investment Management announced last week that it withheld votes for the company's class A director nominees at the April 18 annual meeting, prompting much speculation. In all, 31% of class A shareholders - a hefty percentage - declined to vote for management's nominees."

"The family owns 19% of the 144.3 million shares outstanding, and 91% of 834,242 class B shares, or 20% overall. Class B shares are convertible into class A shares on a one-for-one basis, but are entitled to select nine of 13 directors, thus giving control to class B holders.

Nonetheless, management will likely be prodded into making some changes....two moves by management in recent years appear to have especially angered investors. First, the decision to build a monumental headquarters building strikes some as having been a misuse of the company's capital. Second, management's expenditure of $2.9 billion in stock repurchase programs from 1997 to 2004, at considerably higher prices, has come under fire."
In a much related article the Washington Post has a very interesting look at another firm with high insider control but with much less criticism: Google. By Allan Sloan in Monday's paper:
"Consider, if you will, the differing ways the Street is treating the New York Times Co. and Google, both of which have high-voting stock for insiders and low-voting stock for regular old public shareholders"
So what's different?
"Stock price. Times Co. stock has been setting new multiyear lows and is depressed even by the depressed standards of newspaper stocks. Google, by contrast, is up about 30 percent in the past month and more than 400 percent from its initial public offering price less than two years ago."
This idea that stock price dominates all of else does have support in the financial literature (for instance it is broadly consistent with Jensen's "Agency Costs of Overvalued Equity").

Good news from Africa: EA Bourses to Be Integrated and Vigin gives millions to Africa's poor

A few quick news items of note on Africa

Reading Jeff Sach's "The End of Poverty" coupled with my brothers' (Pat's) trip to Ghana as part of a medical group that worked in hospitals and an orphange have brought the suffering that occurs in Africa to the forefront of my thinking of late (and adding to my RSS readers didn't hurt either!), so today I will share some good news from the often forgotten continent. East Africa: EA Bourses to Be Integrated By Year's End:
"Nairobi: The three East African bourses will before the end of the year be integrated through automated trading systems that will allow electronic trading.

The automated trading systems will be installed at the Uganda Securities Exchange (USE), Nairobi Stock Exchange (NSE) and the Dar es Salaam Stock Exchange (DSE) to make trade faster and more efficient for investors who will also hold electronic accounts.

The automated systems will be a culmination of a project of the East African Securities Regulatory Authority that was started in 1997 and will be a milestone in the integration of the region's capital markets"
The second article is on Richard Branson's efforts to help the African poor.

"BBC NEWS | Magazine | Branson on wealth:

"How does it feel to go to an impoverished part of Africa when you're a multi-millionaire?

'Anyone would feel an enormous sense of guilt going to one of these places - and if you're in a position to do something about it you've got to make an effort,' says Sir Richard Branson.

The Virgin boss... is increasingly engaged in the serious business of supporting health and education projects in Africa"

Wednesday, April 26, 2006

Enter the Neuro-Economists: Why Do Investors Do What They Do? - New York Times

Behaviorial Finance at its best!

Enter the Neuro-Economists: Why Do Investors Do What They Do? - New York Times:
"...economists are studying these phenomena scientifically. The economists are using a new technology that allows them to trace the activity of neurons inside the brain and thereby study how emotions influence our choices, including economic choices like gambles and investments.

For instance, when humans are in a 'positive arousal state,' they think about prospective benefits and enjoy the feeling of risk. All of us are familiar with the giddy excitement that accompanies a triumph. Camelia Kuhnen and Brian Knutson, two researchers at Stanford University, have found that people are more likely to take a foolish risk when their brains show this kind of activation.

But when people think about costs, they use different brain modules and become more anxious. They play it too safe"
A true must read!

VC firms bet on clean energy deals - Apr. 26, 2006

Want to see a good side of higher energy prices? Here you go:

VC firms bet on clean energy deals - Apr. 26, 2006:
"Venture capital investors are flocking to clean energy technologies, a market expected to grow to $167 billion worldwide in the next decade, but some in the sector worry about too much money chasing too few deals.

Venture capitalists have been pumping increasing amounts of money into so-called clean energy technologies, ranging from solar power to alternative fuels and battery solutions. Venture capital funds invested $917 million in U.S.-based firms in the sector last year, up 22 percent from the previous year, according to Nth Power, a venture capital fund that focuses on energy technologies."

A Penny for Your Thoughts, and 1.4 Cents for the Penny - New York Times

A Penny for Your Thoughts, and 1.4 Cents for the Penny - New York Times:
"This week the cost of the metals in a penny rose above 0.8 cents, more than twice the value of last fall. Because the government spends at least another six-tenths of a cent — above and beyond the cost of the metal — to make each penny, it will lose nearly half a cent on each new one it mints.

The real problem could come if metals prices rise so high that it would be economical to melt down pennies for the metals they contain."
Sort of a Money and Banking topic, but interesting even if not totally related to class.

Tuesday, April 25, 2006

Buffalo News - Big trend on campus: podcasting

Buffalo News - Big trend on campus: podcasting:
"Podcasting - audio or video recordings posted online for use on computers or devices like iPods - has become a trendy academic tool on the nation's campuses, including UB, St. Bonaventure University and Buffalo State College......Why attend class if you can view or listen to the podcast?

"That hasn't been an issue, at least not yet," said James Mahar, an assistant professor of finance at St. Bonaventure, who introduced podcasting in his class last semester.

Mahar - who has audio recordings of his finance management classes posted to his web site - sees the technology more as a course supplement for the students who miss a class or want to review.

It's ideal for students who are falling behind or who speak English as a second language.

"It will enable people to learn in a way that they are most comfortable," Mahar said. "Some people like to read, whereas others are better auditory learners. This will enable each to pick the way that best suits them."

Housing Futures

More good news from the world of financial innovation!

Thanks to MoneyScience for pointing out the following from Robert Shiller:

The Korea Herald : The Nation's No.1 English Newspaper:
"Within a month, the Chicago Mercantile Exchange (CME), in collaboration with [other companies]... will launch futures and options contracts on home prices in ten cities in the United States. The contracts will be settled on the S&P/Case-Shiller Home Price Indices,.... For many years we have been campaigning for housing futures, but no exchange wanted to use such indices to create a futures market until now."

"....A fundamental principle of financial theory, "diversification" or "risk spreading,

"....People and businesses in New York, for example, are overexposed to their local real estate risks, so they should reduce this risk by selling New York home price futures."

I really hope this catches on! It could be a great step in reducing the exposure on what to many is their largest asset.

Monday, April 24, 2006

MSN Money - 'Superperks' sweeten executives' pay

Dave sent me the following. It will definitely liven up class discussions! $890,000 for race car driving lessons? I hope he got to keep the car!

MSN Money - 'Superperks' sweeten executives' pay:
"The corporate gravy train is still rolling, and its contents are as odd as ever. A sampling: $890,000 worth of race-car driving lessons for one president's sons, maid service, lawn sprinklers, Bermuda homes and in-home computer maintenance. "
THe $890,000 is from "furniture-rental chain Aaron Rents... for driving instruction for two sons of William Butler Jr. He is a director and president of sales and lease ownership at Aaron Rents."

A close read suggests that the money is only in part for lessons, but still. Oh and the question everyone is asking: what do you get for the money? If race results are any indication, not much:
"Brett Butler places 28th in USAR’s southern division of the Hooters Series, while Ken ranks 32nd in the northern division."

Thanks Dave!

Financial Engineering News Cartoon: FENtoon

What the world really needs is more finance cartoons! So here is one from Financial Engineering News Cartoon: FENtoon

It is especially well timed as we JUST did derivatives in class.

Sunday, April 23, 2006

Snow urges end to lend-and-forgive cycle - Yahoo! News

Following up on yesterday's story of the forgiveness of Nigeria's is today's speech by US Treasury Secretary John Snow who stressed that debt forgivenss alone is not enough:

Snow urges end to lend-and-forgive cycle - Yahoo! News:
"'The clearance of unsustainable debt is a critical component of the broader solution,' Snow said in prepared remarks to the Development Committee of the World Bank and International Monetary Fund.
He later largely parroted World Bank President Paul Wolfowitz' comments that corruption must end. That corruption must end is of course true, but if that alone is enough is debateable.

Wolfowitz's comments
"we must continue to stress the importance of good governance and our mutual responsibility for achieving it. Governance is critical to improving and sustaining development outcomes. Responsibility for this lies both with developing countries and with donors and IFIs through international law enforcement and support for global anti-corruption treaties, as well as strengthening national anti-corruption efforts."
Interesting on this Earth Day weekend, there was also a discussion of the energy side of things:
"What we are looking for is a “double dividend” —to meet the energy needs that are essential to fuel growth and to fight poverty on the one hand while preserving the environment - globally and locally - on the other. In the long run these are not conflicting goals. The economic impacts of climate change and the costs of adapting to climate variability impact poor countries disproportionately."
Stay tuned. This will obviously take years and years to sort out, but at least we are moving in the right direction. (The pace is a bit slow for my likes, but....)

Saturday, April 22, 2006 Nigeria: Govt Free of Most Foreign Debt, Pledges Social Investments Nigeria: Govt Free of Most Foreign Debt, Pledges Social Investments: "Dr. Ngozi Okonjo-Iweala, the finance minister of Nigeria, says that a significant portion of the nation's revenues can be re-targeted to improve the lives of Nigerians, now that most international debt has been retired. She says health care and education are areas where the government aims to make significant investments towards meeting the United National Millennium Development Goals of reducing extreme poverty around the world."

Friday, April 21, 2006

And here is leadership

Note, I am not against CEOs making much money. That said, from a leadership position, making MUCH more than others can be demotivating, so in that light I have a new found respect for Susan Lyne the Chief executive of Martha Stewart Living Omnimedia (even if she did it for PR opportunity!).

From BusinessWeek:

No Hair Shirts, But Still...:
"Lyne got a cash bonus of $625,500 last year. Instead of pocketing it, though, she asked the board to give $200,000 to a bonus pool for employees and convert the rest into restricted shares that won't fully vest until 2009."
and then later in the article:
"There was a period of time in the 1990s when the bigger your pay package, the more people respected you,' says Lyne, who earned a $900,000 salary in 2005. 'I think that has changed -- dramatically. There's a very different sense of what makes a good leader of a public company.'"

BTW what is a Hair shirt????

First Bank to Settle I.P.O. Suit - New York Times

This one fits in perfectly with a recent class discussion on how Investment Bankers might "bribe" firms' CEOs for future business. From the NY Times:

First Bank to Settle I.P.O. Suit - New York Times:
"J. P. Morgan Chase said yesterday that it would pay $425 million to settle its part of a class-action lawsuit that contends dozens of banks cheated investors out of hundreds of millions of dollars from initial public offerings during the 1990's market boom."

and later
"The lawsuit against the banks contends that during the technology bubble, the banks awarded shares of hot initial offerings to favored clients in return for lucrative investment banking business. It also contends that the banks made deals with investors so that they would buy shares in the aftermarket to drive up prices artificially and created misleading research to lure investors into buying."

For Interns, It's Nice to Feel Wanted Again - New York Times

Good news for students looking for finance jobs and internships!

For Interns, It's Nice to Feel Wanted Again - New York Times:
"Recruiters, along with college career counselors, say that the growth in financial jobs coupled with recruitment drives by hedge funds and other firms have given students a strong hand this year.

'Those firms that had to reduce their numbers in 2000 and 2001 are now back to their hiring numbers in the late 1990's, and we have begun to notice more recruiting from consulting firms, and in the last year particularly, hedge funds, which are beginning to take students away from us,' said Danielle Domingue, a recruiter at J. P. Morgan Chase"

Thursday, April 20, 2006

Foreign Stocks Are In, and So Is Indexing - Knowledge@Wharton

As per normal, the Wharton people did another great job with this issue! My favorite:

Foreign Stocks Are In, and So Is Indexing - Knowledge@Wharton:
"In February...investors poured nearly $19 billion into foreign-stock mutual funds, compared to $8.4 billion for U.S. stock funds.

......American investors have also grown enamored of indexers, which now hold about 15% of assets invested in foreign-stock funds, up from about 5% in 2001, according to AMG Data Services. 'People want diversification at the cheapest cost,' notes Wharton finance professor Jeremy Siegel, who talks about the latest economic developments in a podcast included in this issue.....It probably will continue.'

Siegel says the typical American investor should have 40% of his or her equity portfolio in foreign don't want to confine yourself to one country....I really advise broad diversification.'"

Wednesday, April 19, 2006

FMA Online--Cliff Smith

Probably the most underrated finance website is the FMA Online e-Journal. It has videos, papers, and much more. It really is a great resource. While I have mentioned it before, but the new update is amazing. Winter, 2005 FMA Online:

It has video presentation of Cliff Smith's (University of Rochester) lecture on Corporate Governance and Organizational Architecture. As I have told him, I do not think any finance professor has shaped my financial thinking (and even teaching style) more than Cliff has. I HIGHLY recommend it!!!!!

There are many other cool videos as well, but I have not seen all of them yet. I did start the Sheridan Titman video and it is of course also very good. I will mention more on it within the next few days.

My hat is off to Betty Simkins who is the executive editor of the journal she has done a wonderful job again with this issue. (In the interest of full disclosure, yes I am an associate editor, but my contributions are so minor as to not be worth mentioning.)

Growth Options, Beta, and Cost of Capital

Growth Options, Beta, and the Cost of Capital Object) by Antonio Bernardo, Bhagwan Chowdry, and Amit Goyal.

This is a good one! It looks at the betas of firms' assets in place relative to the betas of their growth options and finds that the growth options have significantly higher betas. The authors then show that this difference in betas can lead to significant differences in cost of capital calculations.

Longer version:

In the author's own words, the paper
"...demonstrate[s] empirically that growth opportunities are a very important determinant of a firm's beta, even after controlling for operating and financial leverage, and the failure to account for this can lead to misestimation of the cost of equity capital by as much as 3% depending on the industry.
The paper begins with a discussion of why CAPM is still popular in spite of its many problems and explains the standard procedures for using CAPM to get cost of capitals for untraded projects.

To "disentangle the betas of assets-in-place and of growth opportunities..." the authors assume that Market to Book ratios proxy for growth and that the betas of growth and asstes-in-place are constant for all firms in a given industry (they use Fama & French's industry classifications) at any given point.

Building on Carlson, Fisher, and Giammarion (2004), the authors use the Black-Scholes Option pricing model to demonstrate that the Beta of Growth options must be greater than the beta of assets in place. The explanation:
"the firm's growth opportunity is an option on its assets-in-place and since this option has implicit leverage the beta of its growth opportunity is greater than the beta of its assets-in-place"
Given this, the paper then uses a large sample of firms from 1977 to 2004 and finds " the difference between the beta of growth opportunities and the beta of assets-in-place is positive and statistically significant, at the 95% level, in 34 of 37 industry classifications"

Moreover, this appears to be economically significant as well:
"....consider the Computer industry. For the period 2000-2004, the mean unlevered firm beta in this industry is 1.608; however, a firm at the 25th percentile in market-to-book has an unlevered beta of 1.430 while a firm at the 75th percentile in market-to-book has an unlevered beta of 1.785. This difference in beta of 0.355 represents a roughly 2% higher cost of capital for a project with relatively high growth opportunities relative to a project with relatively low growth opportunities (when using a 6% market equity risk premium)."
Which deseves a wow!

BTW: Table 1 alone is worth the price of admission. Not only does it show this great breakdown along Market to Book ratios for each industry, it also shows that industry betas are NOT constant accross time periods. Check it out!

Cite: Antonio Bernardo, Bhagwan Chowdry, and Amit Goya, March 2005. UCLA Working paper: Growth Options, Beta, and the Cost of Capital.

(note to my class: the introduction is EXCELLENT!--READ IT ;) Even undergrad studens will have no problems with it!)

Monday, April 17, 2006

Responsible Fools? The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings by Jennifer Huang, Gene Amromin, Clemens Sialm

Have a few extra dollars? Debating whether to pay down your mortgage or invest a bit more in your retirement account? A working paper by Huang, Amromin, and Sialm suggests the latter may be a wiser choice.

SSRN-Responsible Fools? The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings by Jennifer Huang, Gene Amromin, Clemens Sialm:
"a significant number of households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts (TDA). Using data from the three latest Surveys of Consumer Finances, we show that more than 45% of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice."
Why would people pass up the tax savings? It may be that people have been so ingrained that debt is bad that they merely want to pay it down as soon as possible. In the authors'' words:
"self-reported debt aversion and risk aversion variables explain to some extent the household preference for paying off their debt obligations early at the expense of forgoing the tax arbitrage. We term these households responsible fools" since they are motivated to reduce their debt obligations in spite of incurring considerable monetary losses in the process."
Additionally, the auhtors point out that "[t]his propensity of debt-averse households to forgo this tax arbitrage is related to the findings in Graham (2000), who shows that many corporations forgo substantial tax benefits by holding too little debt."

The paper goes on to show that this is also consistent with the findings that people segment their accounts and do not consider retirement and housing accounts as substitutes.

Interesting paper.

Huang, Jennifer C., Amromin, Gene and Sialm, Clemens , "Responsible Fools? The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings" (March 15, 2006). Available at SSRN:

FRB: Speech, Ferguson--Thoughts on Financial Stability and Central Banking--April 17, 2006

Fed Vice Chairman Roger Fergusons' remarks this morning are perfect for a Money and Banking or Financial Institutions class!

FRB: Speech, Ferguson--Thoughts on Financial Stability and Central Banking--April 17, 2006:

Some Highlights:

* "Few subjects are more important for central bankers than the efficiency and stability of our financial system....Ironically, our interest in financial stability seem to have increased in recent years even as real (that is, inflation-adjusted) variability in economic aggregates seems to have decreased. Since 1985, the volatility of real growth in gross domestic product (GDP) has been only about half of what it was during the preceding twenty-five years. In addition, as shown in a number of papers, the volatility of many components of GDP and of other measures of aggregate economic activity also declined sharply between these periods.

* "The source of the moderation in the real economy is unclear....The leading explanations of the moderation are that (1) economic shocks have been milder; (2) inventory management has improved; (3) financial innovations such as improved risk assessment and risk-based pricing have made credit more widely available, even during economic downturns; and (4) monetary policy has been better."

* "The first explanation--milder economic shocks--has seemed less persuasive following the events of the late 1990s and early 2000s. From the Asian financial crisis to the September 11 attacks to the corporate governance scandals to the surge in oil prices, powerful economic shocks have marked the past few years."

* "As for the second explanation--better inventory management--changes in inventory dynamics have indeed contributed significantly to the reduced volatility of GDP growth...."

* "Regarding the third explanation--better availability of credit--Karen Dynan, Doug Elmendorf and Dan Sichel, of the Board's staff, present evidence in a recent paper that financial innovation has been partly responsible for the reduced variability of real activity"

* As for the "fourth explanation, that monetary policy has been better. I think it has indeed been better. We are better at understanding how the economy operates (and therefore, at evaluating the appropriate stance of monetary policy) and we are more determined to pursue the goal of price stability. But secondarily, I think the greater dominance of market-based finance, combined with a greater transparency by the Federal Reserve, has made both the mechanism of monetary policy and the intentions of the central bank more understandable to market participants....The greater transparency of central banks also seems to have led to improved economic performance. Market expectations are more likely to remain anchored in the face of various shocks when investors can see more clearly that central bankers are committed to long-run objectives such as price stability and sustainable economic growth. This commitment feeds into the planning and execution of investments by firms and households."

Well worth reading! Even if you are not in a Money and Banking course! ;)

Tulip Bulb Mania

It's spring in Western New York so what better to talk about than the Tulip Bubble of the late 16th Century?

From the Stock-Market-Crash blog's section on Famous Bubbles:

Tulip Bulb Mania:
"In less than one month, the price of tulip bulbs went up twenty-fold! To put that into perspective, if you had invested $1,000 and came back on month later, your investment would have ballooned to $20,000! Now you can understand the mad rush to buy tulip bulbs at any cost. Tulip bulb mania"
and later:
"The price of tulips at the height of the mania was $76,000; 6 weeks later they were valued at less than one dollar!"
While it looks like a bubble to most, there are those who disagree. For instance, Day (1994) claims that the events of the period have been overblown and, contrary to most other reports, the economy did not suffer that much following the price decline.

Mmm, it sure looks like a bubble to me.

Friday, April 14, 2006

History of Wall Street and the Stock Markets

AtoZ Investments gets the Link of the Week for its 4-page history of Wall Street. Very interesting!

History of Wall Street and the Stock Markets:
"It was just a matter of time before our new country, The United States of America, would organize formal stock and bond trading. 1792 was the year. In 1792, New York City's population was about 34,000, not including Brooklyn and Queens which were still separate towns. Much of Manhattan had just been rebuilt with brick buildings after the devastating Great Fire of 1776.

Wall Street was New York's center of commerce. Just a few blocks long, from Broadway on the west to the East River at the other end, Wall Street was not yet paved or even lined with cobblestones. There were warehouses for furs, coffee and tea, and other goods from all over the world. To the south, streets were crowded with slaughter houses and tanneries."

"The first organized stock exchange was created in 1792, when under a buttonwood tree in Castle Garden (now called Battery Park), John Sutton, Benjamin Jay, and 22 other financial leaders signed an agreement of rules, regulations and fees."
Read MUCH more about the history on their page!

Pension Rule Could Lower Net Worths - New York Times

Pension Rule Could Lower Net Worths - New York Times:
"The study, by the Milliman actuarial firm, of the 100 largest companies with pension plans, showed that most had understated their obligations even though they complied with the current rules.

That included not only weak companies like airlines and automakers but also strong ones....Over all...adopting the proposed accounting change would wipe away about 8 percent of corporate America's net worth, revealing hidden weaknesses all across corporate America....

The new rule, proposed by the Financial Accounting Standards Board, would eliminate the pension numbers that now appear on corporate balance sheets...would replace those figures with current, market-based numbers."

Thursday, April 13, 2006

Good news today, bad news later.

My guess is that this surprises NO ONE, ;), but it is interesting to see it in writing.

Short version: managers don't like to tell bad news.

SSRN-Do Managers Withhold Bad News? by S.P. Kothari, Susan Shu, Peter Wysocki:
"In this study, we examine whether managers delay disclosure of bad news relative to good news. If managers accumulate and withhold bad news up to a certain threshold, but leak and immediately reveal good news to investors, then we expect the magnitude of the negative stock price reaction to bad news disclosures to be greater than the magnitude of the positive stock price reaction to good news disclosures. We present evidence consistent with this prediction. Our analysis suggests that management, on average, delays the release of bad news to investors."
While several potential explanations are given to the larger price drop (including agency cost stories), it is possible that the more pronounced stock price declines might be caused by non-symmetry in investor utility curves.

The authors said to include the copyright, so here it is:
the paper is © 2005 by S.P. Kothari, Susan Shu, Peter Wysocki.

a more traditional cite:

Kothari, S.P., Shu, Susan and Wysocki, Peter D., "Do Managers Withhold Bad News?" (September 2005). MIT Sloan Research Paper No. 4556-05 Available at SSRN:

Wednesday, April 12, 2006

Does Jensen’s Free Cash Flow Hypothesis Explain European LBOs Today? by AndreBetzer

SSRN-Does Jensen’s Free Cash Flow Hypothesis Explain European LBOs Today? by Andre Betzer:

Andre Betzer looks at European Leveraged Buyouts (financed with at least 50% debt) to determine if Jensen's Free Cash Flow (FCF) Hypothesis can explain (or predict) the the LBO.

Jensen's FCF hypothesis is that firms with high levels of Cash flow will waste it on negative NPV projects. From this, it has been theorized that Leveraged Buyouts solve the problem by not only removing management (at least in some cases) but also the debt associated with the LBO reduces management's discretion when it comes to the cash (thus they can not waste the cash flow).

Betzer's findings? Largely (but not completely) along lines of Jensen's hypothesis.

Specifically Betzer finds that firms with low P/Es and high cash flow are more likely targets:
"univariate and multivariate findings indicate that European companies with high Cash Flows before distribution and few investment opportunities whose P/E ratio is significantly lower than that of their industry peer group are more likely to be an LBO target."
Which is consistent with what the FCF hypothesis. However, he does not find evidence of agency costs (although I might submit that agency costs may be the reason for the lower P/E ratio and are just not being captured in the proxies):
"all variables proxying for agency problems (namely FCF (AD), CAPEX and Free Float) in the multivariate analysis are insignificant."
Definitely not the last word, but interesting!

Betzer, André, "Does Jensen’s Free Cash Flow Hypothesis Explain European LBOs Today?" (March 2006). Available at SSRN:

Insider trading case of the decade

You have to read this! It has everything any insider trading case could want---from a retired seamstress, to classified ads placed to hire accomplices, to the theft of advance copies of BusinessWeek, to strippers, to Russian baths. (I am not making this up!)

From the Globe and Mail:
"The case is “one of the most extensive insider trader cases in this district in decades,” Michael Garcia, the U.S. Attorney for the Southern District of New York, said during a press conference."
From the NY Times: 2 Wall Street Employees Charged With Insider Trading - New York Times:
"it was $2 million in profits made by a 63-year-old retired seamstress in Croatia that tipped off the Securities and Exchange Commission about an ambitious and unusually creative insider trading ring, investigators say. That lead culminated in the arrests yesterday of two junior-level employees at Goldman Sachs and Merrill Lynch."
Later in the same article:
"According to the charges against two employees there, Juan Renteria, 20, of Milwaukee and Nickolaus Shuster, 24, now of Lexington, Tenn., stole advance copies of the magazine and gave Mr. Plotkin and Mr. Pajcin the names of stocks mentioned in the "Inside Wall Street" column, information which, if favorable, often sends the prices of those stocks up."
Again from the Globe and Mail:
"According to court filings, the two hatched a scheme to hire exotic dancers to ply investment bankers for information (that didn't appear to go very far, but one dancer allegedly participated in some of the illegal trading)."
From the Buffalo News:
"We've never seen before a case involving so many different attempts to obtain information illegally," said Mark Schonfeld, regional director of the Securities and Exchange Commission, which brought civil charges against 13 people.

He said the case was discovered by regulators who noticed unusually high trading volume before a merger announcement. A closer look showed that a 63-year-old retired seamstress in Croatia - the aunt of one of the defendants - had made more than $2 million.

Schonfeld said she was "either the most successful investor in the history of Wall Street or something more nefarious had taken place.""

From TheAge:
"Plotkin and Pajcin led a trading ring that netted $US6.4 million on the tips, according to Mr Garcia's suit. With advance notice of "stocks favourably mentioned in BusinessWeek's 'Inside Wall Street' column", they made $US340,000, the Government said"
From the Sarbanes-Oxley Compliance Journal:
"This case demonstrates that despite all the advances in technology and electronic security, businesses remain as vulnerable to infiltration as the people they employ."

Oh and less you think this story was missing the Russian Baths, according to both the Globe and Mail and TheAge , at least some of the dealings at Spa88 in NY.

From TheAge:
"Shpigelman was a summer intern at Merrill in 2000 and 2002. Plotkin and Pajcin recruited him for the insider-trading scheme in 2004 during a meeting at Club 88, a day spa and Russian sauna in Manhattan, according to the complaint."
See, this story has everything. it really doesn't get much better than this! We'll be talking about it in classes for years to come! Or as the Boston Herald puts it:
" a cross between a Ken Follett novel and “The Sopranos.” "
For a more permanent archive: try the BBC's coverage.

Tuesday, April 11, 2006 Business - Nasdaq increases LSE stake to 15%

Wow, talk about a toe hold! Business - Nasdaq increases LSE stake to 15%:
"THE London Stock Exchange was thrown dramatically back into takeover play late yesterday when its largest institutional shareholder, Threadneedle Investments, sold its entire 12 per cent stake to the Nasdaq stock market.

With other purchases, the US stock market confirmed last night that it had spent £448 million for 14.99 per cent of the London exchange, Europe's largest stock market.

It comes less than two weeks after Nasdaq announced it had withdrawn its £2.43 billion takeover approach for the LSE after being rebuffed by the target's management...."

Monday, April 10, 2006

Active Intermediation of Non-Underwritten Rights Offerings by Mark Peterson

Rights Issues are a way of issuing new equity. They involve the firm giving rights to existing shareholders. These rights entitle the holder to purchase new shares at the subscription price (which is lower than the current market price).

Much research has look at rights issues. This has largely looked at who uses them, how they work, and why we don't see more of them (this latter point is often called the rights offering paradox of Smith 1977).

Mark Peterson offers new insights into this by examining shareholder behavior around rights issues by closed end funds.

SSRN-Active Intermediation of Non-Underwritten Rights Offerings by Mark Peterson:

His findings? That shareholders behave much like the the financial intermediaries (i.e. underwrites) studied by Singh (1997). That is, the shareholders appear to subscribe to more shares when there is an overallotment option (which is rational since the over allotment option allows those who fully subscribe to buy more shares), and actively hedge their positions by shorting shares.

In his words:
"The evidence presented is consistent with shareholders and brokers actively intermediating these offerings in a way similar to that of underwriters in underwritten rights offerings (Singh 1997). That is, intermediaries hedge the shares they purchase in the offering by simultaneously short selling the underlying stock."
Moreover, Peterson suggests that the costs associated with these strategies may explain the rights paradox. Notably:
"Large negative returns during the offering period, evidence of wealth transfers from non-participating shareholders to intermediaries, and difficulties associated with shareholder intermediation make the non-underwritten rights method highly impractical for widely held firms and may partially explain the rights offering paradox."
The paper also has some other "cool things about rights offers" that you may not have known. For instance,

* "Herzfeld (1996), in a survey of closed-end funds that issued rights, reports primary subscription rates of 50-60% for non-transferable offerings and 70-95% for transferable

*"The offering of additional shares at a discount through the oversubscription privilege and over-allotment option provides incentives for current shareholders to attempt to purchase more than their pro rata allotment of shares and, therefore, receive a wealth transfer from non-participating shareholders."

*"54% of the non-transferable offerings and 69% of the transferable offerings include fees paid to brokers to aid in the solicitation of rights. In these offerings, the fee, typically 2.5% of the subscription price, is paid to brokers when they or their clients subscribe to the offering."

* and from footnote #7: "Subject to narrow exceptions, closed-end funds are prohibited...from issuing stock to the public at a price that is less than the net asset value. Because closed-end funds typically trade at a discount, a rights offering is frequently the only viable offering method. The SEC (1977)
discouraged the use of an underwriter in rights offerings, suggesting that such offerings were effectively offerings directed to the public."

I^3! (Interesting, Informative, and Important!) It will definitely force me to change my class notes!

Peterson, Mark A., "Active Intermediation of Non-Underwritten Rights Offerings" (March 15, 2006). Available at SSRN:

Friday, April 07, 2006

CEO pay in the news

CEO pay is back in the news (does it ever really leave?) with several stories in the last few days. Most articles have been centering on calls for more disclosure.

First the issue: CEO pay increases much faster than the average worker's pay AND this is not due to market forces but a "stacked deck". While the first is true, there well may be reasons for it (technology, flatter levels of management, increased importance of CEOs, etc), there is growing evidence of the latter as well.

"In a preliminary analysis of executive compensation, Corporate Library senior research associate Paul Hodgson found that total CEO compensation rose a median of 11.3 percent in fiscal year 2005, far below the 30.2 percent growth rate in last year's survey.

Total CEO compensation includes salary, bonus, perquisites, long-term incentive payouts, the value of realized stock options and restricted stock. Just in terms of CEOs' base salary, the average increase was 8.5 percent, still multiples above that for workers, for whom the average pay increase in 2005 was 3.4 percent, according to Hewitt Associates."

From the MercuryNews:

"Some experts say that rising pay is the fair and square result of a free market where companies compete for a manager's services. But while executives get to fend for themselves at the bargaining table, irate investors can't get their point across to the people representing them, from the board of directors to mutual fund managers."

The paper they are speaking of is cited at CNNMoney and is available at the Corporate Library (which has an annoying habit of charging $100 for its papers so get there before they start charging! ;).

From the The Sun Herald (Biloxi) A chance to curb excessive CEO pay:
"CEO compensation varies dramatically, even among similar companies in the same industry. Indeed, you often find a CEO at a company whose stock is doing well, such as Lowe's, making less than a CEO at a company that's doing badly, such as Home Depot. That's the opposite of the result you'd expect in an efficient marketplace.

Fixing this problem is a tall order that will require corporate-governance changes to assure that directors better represent shareholders' interests."
NY Times DealBook blog:
"we went to the Securities and Exchange Commission’s Web site and picked out some of the more incendiary comments from the public responses to the rule, which would force companies to spell out in greater detail the perks given to certain top executives and directors"
Obviously this issue will never go away, but I will definitely join hte call for more disclosure. Letting everyone see the playing field is a necessary condition for letting markets work.

Thursday, April 06, 2006 - U.S. teenagers lack financial literacy - U.S. teenagers lack financial literacy:
"U.S. teenagers are making little headway when it comes to financial literacy, a survey out Wednesday shows.

High school seniors on average answered 52.4% of a 30-question financial survey correctly. That was up from 52.3% when the survey was last conducted two years ago but down from 57% in 1997, the first year for the survey, according to the Jump$tart Coalition for Personal Financial Literacy.
'Financial literacy is still a very significant problem. It doesn't seem to be getting any better,' says Lewis Mandell, a professor at SUNY Buffalo School of Management who oversaw the survey, which was conducted in December and January. It includes topics such as investing and managing personal finances."
BTW they have sample questions on the left side of the article.

Mmm, we should be able to help solve this. What do you think? Maybe start volunteering once a month at local High Schools? Sounds like a GREAT service opportunity for finance clubs!

Are Commodities Futures Too Risky for Your Portfolio? Hogwash! - Knowledge@Wharton

This article is by Gorton and Rouwenhorst. The quote is from the Knowledge@Wharton April 2006 Newsletter.

Are Commodities Futures Too Risky for Your Portfolio?

"are commodities really that risky? A shortage of data has left that question unanswered. Until now. Using the most comprehensive data on commodities futures returns ever assembled....Gorton and ...Rouwenhorst have reached a surprising conclusion: Commodities offer the same returns as investors are accustomed to receiving with stocks...."
The authors also report that while commodities have about the same risk as stocks, commodities tend to be negatively correlated with the both stocks and bonds and therefore make an ideal investment for diversification purposes.

And besides, who hasn't wanted to say they trade Orange Juice like Eddie Murphy!

Working paper cite:
Rouwenhorst, K. Geert and Gorton, Gary B., "Facts and Fantasies about Commodity Futures" (February 28, 2005). Yale ICF Working Paper No. 04-20. Available at SSRN:

What a day! Two great articles. No wonder finance is so fun! Every day there are new articles to read! It's like a candy store without the calories!

Wednesday, April 05, 2006

The importance of good governance: the Eastern European Evidence

Financial Globalization, Corporate Governance, and Easten Europe

Some look-ins:
"Friedman (2005) makes the case that globalization leads to a flat world....Assuredly, the world is not flat yet. Nevertheless, the metaphor is helpful....For many countries, the most significant explicit barriers to trade in financial assets have been knocked down. "
And yet:

"Despite a dramatic increase in cross-border trade in financial assets, the positive impact of financial globalization has been surprisingly limited....In fact, over the recent past, capital has come rushing into the U.S., when one would expect it instead to flow to emerging countries. According to data from the IMF, the cumulative sum of net equity flows to less developed countries from 1996 to 2004 is a negative $67.4 billion."
"[The] twin agency problems (see Stulz (2005)), poor corporate governance and high political risk, stand in the way of countries getting the full benefit of financial globalization."
For instance:
"poor governance in Eastern Europe is accompanied, as expected, by high corporate ownership concentration, low firm valuation, poor financial development, and low foreign participation"
VERY interesting paper! Read it yourself!

For the record, this is much like his previous work on governance and globalization which I HIGHLY recommend.

Free Money Finance: Saving for Retirement the Second Hardest Thing to Do in Life

Free Money Finance: Saving for Retirement the Second Hardest Thing to Do in Life

Free Money Finance found an interesting article on the difficulty in saving for retirement that coincidentally has some interesting links on the cost savings of not smoking. Ironically, in my Intro classes we do something very similar to show the importance of saving "early and often" (of course such a calculation is flawed by its sensitivty to various assumptions, but it is none-the-less worthwhile to consider as a starting point.)

Real Estate

Yesterday in my undergrad class (FIN 422) we covered real estate as an investment. Hence a few stories and links you may find interesting:

From the Washington Post: Economy too reliant on housing? - Highlights -
"The U.S. economy is more dependent on housing than it has been in a half-century, as the sector fuels consumer spending and has accounted for nearly three-quarters of the nation's job growth in the past five years."
And later in same article:
"Nationally, the number of homes sold declined every month from August to January, according to the National Association of Realtors. Builders started work on 4.8 percent fewer units of housing in February than a year earlier, following years of sharp increases in construction.

So far, the housing slump appears not to have caused much economic distress, but the consensus of Wall Street economists' predictions is that growth will slow in the second half of the year, in part due to the housing slowdown."


"Americans snapping up second homes — as investments or vacation properties — accounted for four out of every 10 sales of existing homes last year....Nearly 28% of homes bought last year were for investment purposes, and an additional 12% were vacation homes...."

Some evidence of low correlations between stocks and real estate can be found in this paper by Quan and Titman as well as Goetzmann.

And finally a list of real estate related indices from Dow Jones.

Tuesday, April 04, 2006

Behavioural Finance

Website of the week:

It has nothing but tons and tons of great Behavioural (yes with the 'u') cites. If you are interested in the field or doing a paper that realtes, this is a GREAT starting point.

Behavioural Finance:
"'This area of enquiry is sometimes referred to as 'behavioral finance,' but we call it 'behavioral economics.' Behavioral economics combines the twin disciplines of psychology and economics to explain why and how people make seemimgly irrational or illogical decisions when they spend, invest, save, and borrow money.'" Belsky and Gilovich (1999)

Great retirement expectations, not great preparations - Apr. 4, 2006

Overconfidence and behavorial finance have a rich and growing history. It might be time to add the idea that we have enough for retirment to that growing list.

From CNN:
EBRI: Great retirement expectations, not great preparations - Apr. 4, 2006:
"...among those in the very confident group, 22 percent said they aren't currently saving for retirement and 39 percent said they have less than $50,000 in savings"

"59 percent of all workers say they'd like to enjoy a standard of living in retirement that is the same or better than the standard of living they have in their working years.

But half the respondents think they can manage that on 70 percent or less of their pre-retirement income.

That doesn't square with financial experts' recommendation that you should plan to live on at least 70 percent of your pre-retirement income. Nor does it square with the 55 percent of present-day retirees surveyed who said they live on 95 percent or more of their pre-retirement income."

Monday, April 03, 2006

Does Ethics training work? Maybe

From I Am Joe's Conscience - CFO Magazine - March Issue 2006 -

Do training and new regulations lead to more ethical behavior? Maybe, Maybe not.

On the "no side":
"But is there any reason to believe all these codes and classes and scenarios do any good? The evidence is mixed. A recent survey of more than 4,000 employees found that reports of misdeeds have not diminished. In fact, nearly three-quarters of the employees involved in the survey, which was conducted by accounting firm KPMG, said they had observed misconduct in the prior year. That's about the same level of wrongdoing reported in a pre-Sarbanes-Oxley survey."
Evidence that says the training does work include:
"The KPMG survey does suggest that the most rigorous corporate-ethics programs have some value. Survey subjects who indicated their employers have a comprehensive ethics program (about 11 percent of respondents) reported fewer instances of misconduct, felt less pressure to bend the rules, and were more comfortable about reporting misdeeds to their supervisors. Ethics programs, concludes Richard Girgenti, partner in charge of forensic services for KPMG (Americas), "can have a positive impact.""

Sunday, April 02, 2006

Less Can Be More When It Comes to Overseas Stocks - New York Times

The "Home Country Bias" is the finding that investors invest more in their home country than would be justified on a risk-return basis. Today's NY Times suggests that this bias may be growing less powerful.

Less Can Be More When It Comes to Overseas Stocks - New York Times:
"So far this year, about 70 cents of every new dollar invested in equity funds has been directed to internationally oriented portfolios, according to the mutual fund tracker AMG Data Services. And emerging-market stock funds — by far the hottest foreign category — have pulled in more new money in the first three months of 2006 than they did in all of 2003, 2004 and 2005 combined."

"Having some foreign exposure clearly helps diversify a portfolio. From 1970 to 2005, a portfolio invested entirely in domestic stocks had a standard deviation — a popular measure of volatility — of 16.8 percent, according to S.& P. By comparison, a portfolio that was 75 percent invested in domestic stocks and 25 percent in foreign shares had a standard deviation of 16.4 percent, implying a slightly less bumpy ride."

Saturday, April 01, 2006

Free Trade pact?

This would be great! It should definitely help to end "End [Extreme] Poverty" in the long run! And the signal it sends is likewise good!

From the BBC:
"Brazil, India and South Africa are working to set up a free trade area they hope will eventually take in the continents they represent.

The three made the pact at talks ahead of an informal World Trade Organization (WTO) meeting in Rio de Janeiro.

The action is on a separate track from the WTO's continuing efforts to free trade between rich and poor nations.

"The final objective of our three countries is a free trade agreement," India's external affairs minister said."

Sach's websites:

Google prices offering of 5.3 mln shares at $389.75 - Yahoo! News

Google prices offering of 5.3 mln shares at $389.75 - Yahoo! News:
"Google...said it would sell as many as 5.3 million shares to offset the impact of its inclusion in the widely held Standard & Poor's 500 Index.

It will be the second follow-on offering Google has made since it went public in August 2004 at $85 per share. Google's share price has more than quadrupled since then, resulting in the amount raised from the two secondary offerings outstripping proceeds of the IPO."