What is I^3?

I^3 papers are those papers that I feel are extra special. The I^3 moniker stands for Interesting, Informative, and Important. You could do much worse than reading them. They really are good. Here are some past winners.

IPO Underpricing, Earnings Quality, and more

Another FMA paper. This one looks at IPO underpricing and Earnings Quality and is by Thomas J. Boulton, Scott B. Smart, Chad J. Zutter.

The shortest version is that using international evidence the authors find underpricing is greater where earnings quality (transparency) and liquidity are lower.

The abstract says it best:

"Examining 7,306 IPOs from 34 countries, we find less underpricing in countries with higher earnings quality. This finding persists after controlling for other deal- and country-specific factors, and it is not driven by large, relatively transparent markets such as the U.S. and U.K. Firms in countries with lower earnings quality can reduce underpricing by choosing higher quality underwriters. We also observe lower underpricing in countries that allow banks to hold equity in nonfinancial firms and in countries with more liquid markets. Finally, we provide results that suggest investors assign lower valuations to IPOs in countries with lower earnings quality."

As the title suggests, the authors first look at earnings quality and sure enough find the greater the transparency, the lower the underpricing. In their words:

"...sample’s mean first-day return is 27.5 percent, and a one standard deviation improvement in earnings quality reduces underpricing by about 4 percentage points."

Next on the agenda is whether bank ownership may affect underpricing. How? Read on:

"Through their lending relationships with firms, commercial banks gain access to private information. When they choose to invest in the equity of IPO firms, banks send a valuable signal to other market participants and, thereby, reduce information asymmetries....In countries with fewer restrictions on bank equity holdings, we observe less underpricing."

WOW. Great stuff. A definite I^3!!!! (Interesting, Informative, and Important)


Cite: Earnings Quality and International IPO Underpricing Thomas J. Boulton, Scott B. Smart, Chad J. Zutter. Working Paper: presented at FMA conference Orlando Florida.

The News-Gazette.com:Top salaries continue to rise as UI competes for talent

Well this was sent to me, it is not to as a means of saying so and so gets too much, merely to report that it really is a different world. This is from the University of Illinois.

The News-Gazette.com:Top salaries continue to rise as UI competes for talent :

"As of fall 2006, the average salary for a full-time professor at the UI was $95,700, up $13,400 or 16 percent since 2002. When comparing that average salary to those at the 21 institutions, the UI ranks third from the bottom, behind Michigan, Texas and North Carolina but ahead of Washington and Wisconsin....In recent years, as turnovers have occurred in high-level positions at the university, salaries for new employees have often risen well above the predecessor's pay. Four years ago, the UI's vice president for technology and economic development, David Chicoine, earned $262,500. UI College of Business Dean Avijit Ghosh will assume that post in January and earn $339,000....Of the more than 100 people who earn $200,000 or more at the UI, many are in the business and law schools. And many hold endowed chairs, meaning some of the salary is funded by a donor.Such top faculty earners include finance Professor Jeff Brown, who has the title of William Karnes Professor of Mergers and Acquisitions, and a salary of $245,000;"

This does show how much salaries can vary. At small schools (such as SBU) it may take the sum of four years to make that much. :( Oh well...having traveled to mid Ohio, Orlando, and NYC in the last three weeks, I can definitely say I would not want to trade places.

Financial Rounds

I know I mention him all the time, but I actually saw him at FMAs (did not get to speak as he was presenting and I had to leave early for an interview, but the Unknown Professor over at the FinancialRounds has put up some thoughts on the FMA interviews he did as well as his FAQ which even mentions this blog :)

Do Mutual Funds vote responsibly? Evidence from Proxy voting

Another paper from the FMAs:

Do Mutual Funds vote Responsibly? Evidence from Proxy Voting by Ng, Wang, and Zaiats

Multiple Choice answer: Sometimes

Short Answer Answer: Mutual funds frequently vote in a manner that does not appear to be in shareholders' best interest.

Essay Answer: How mutual fund managers vote the shares of their fund is a hot topic both because of the growing emphasis on corporate governance and the tremendous growth mutual funds have experienced. This mix, coupled with a few years of voting since the SEC mandated voting disclosure in 2003, is a perfect environment to study whether agency costs problems or higher stock valuation of the fund's holdings dominate when it comes to proxy voting.

It is well known that agency costs may lead fund managers to vote shares in ways that may not be value enhancing to the fund's investors. For example, suppose the parent company of the mutual fund has an investment banking arm. Voting the fund's shares against management could lead to a loss of lucrative investment banking business. So the fund's management is tempted to vote with management even if the fund's investors may not want that.

In Do Mutual Funds vote Responsibly? Evidence from Proxy Voting, Ng, Wang, and Zaiats examine the question and report that often Mutual Funds vote in a way that appears to conflict with their investors' best interests. Specifically, the authors find that funds support a majority of management sponsored proposals for anti-takeover amendments, board related votes, and award proposals. But before any indictment, there must be more convincing evidence, so the authors find that many regular shareholders also appear to vote for these proposals.

To investigate this further, proposals are broken into groups based on the ISS recommendation. (negative recommendations are counted as bad for shareholders). Again the authors find that mutual funds regularly vote for so-called negative proposals. But not at a level that is significantly different than shareholders in general.

As an aside, if I were a reviewer, I might suggest breaking the votes into groups based on how the shares did on the announcement of the vote.

Overall funds appear to disregard past performance in most of their votes but there are two noteworthy exceptions--executive pay and board related proposals are at least tied to how well the firm has done.

Conclusion:

Ng, Wang, and Zaiats do present evidence suggesting agency cost problems affects the voting behavior of mutual funds but the evidence is not the final word and also brings into question the voting behavior of other shareholder groups.

Stay tuned, we've not heard the last word on this topic!


BTW I did see this presented at the FMAs. It was good.

Do Finance Profs practice what they preach?

Sometimes the most important finding of an article is not played up while lesser items (especially those that appear to more exciting or controversial) are given more play. For instance from SmartMoney:

Finance Profs Reveal How They Invest Own Money (The Pro Shop) | SmartMoney.com:

"Colby Wright, assistant professor of finance at Central Michigan University and James Doran, finance professor at Florida State University, [survey] ... finance professors. After all, they're arguably the most educated and well-informed people when it comes to understanding the mysteries behind stock price movements. [I think the article somehow left out 'best looking", funniest, and "nicest" as well.] So Wright and Doran set out to survey all the professors of finance in the U.S. and ask what's most important to them when investing their own money. The survey resulted in 642 usable responses. They published their results earlier this year in a paper titled 'What Really Matters When Buying and Selling Stocks?"

The findings were not exactly what we would think. For instance the survey suggests that PE ratios, market multiples, and momentum investing are among the keys and not CAPM, efficient markets and the market risk factors.

"Out of 43 variables given, the most important were a company's price/earnings ratio and how close a stock is to its 52-week high to low. Considering the material most finance professors teach their students as a way of explaining stock price movements — like the capital asset pricing model and discounted cash flows — Wright calls the findings surprising"

Which is true to a degree, but virtually all finance classes also cover market multiples, such as PE ratios, in some format. For instance in my classes I harp on the fact that both Discounted CAsh Flow analysis and multiples are really doing something very similar just in a different way and there is a place for both. In fact, we generally say that the time to perform a DCF projection is often not worth it for small investments.

Had that been the entire story it MIGHT have been blog worthy. However, after reading the actual article it screamed "Blog me!"

It could be argued that the main finding of the paper was not the reported use of mutliples and momentum investing, but that "...over two-thirds of the sample are passive investors, and not because they don’t have the time to invest."

Thus, the headline grabbing headlines were not from the entire sample but only a small subsample of active investors.

Which to my biased reading suggests that the majority of finance professors do appear to practice what they preach!

Whew ;)

Interesting article.

Cite:
Doran, James S. and Wright, Colbrin, "What Really Matters When Buying and Selling Stocks?" (4/13/2007). Available at SSRN: http://ssrn.com/abstract=980364

The Science Education Myth - Yahoo! News

For those who have read the World is Flat I thought you might be interested in this one even if the jury is still out.

The Science Education Myth - Yahoo! News:

"The authors of the report, the Urban Institute's Hal Salzman and Georgetown
University professor Lindsay Lowell, show that math, science, and reading test
scores at the primary and secondary level have increased over the past two
decades, and U.S. students are now close to the top of international rankings.
Perhaps just as surprising, the report finds that our education system actually
produces more science and engineering graduates than the market demands."

FTC Appeals to Court to Undo Whole Foods-Wild Oats Merger - WSJ.com

FTC Appeals to Court to Undo Whole Foods-Wild Oats Merger - WSJ.com:

"In an unusual move, the Federal Trade Commission is trying to disrupt the merger of natural-foods grocers Whole Foods Market Inc. and Wild Oats Markets Inc. after the deal has already been consummated. The FTC is asking a Washington appellate court to review a federal-district court ruling in August that allowed the $565 million deal to proceed. The agency, which opposes the combination on antitrust grounds, is asking for an expedited ruling. Its appeal is considered a long shot."

I know I said it back in June, but I still do not see why this deal should not be allowed to go through despite the idiotic comments made by the CEO.

Catching up after FMAs before Finance club trip to NYC

Whew...and I thought I became a teacher in part to avoid business travel. LOL...After spending a week in Ohio with BonaResponds, a trip to Orlando for the FMAs, and now to NYC with the finance club should make me ready to stay home for a while.

The FMAs were great. I apologize for not getting more online about them already. I have a notebook full of papers to summarize, just need a few minutes to breathe. From a quality of paper point of view, it may have been the best FMA conference I have been to.

I have not counted how many papers were presented, but it had to be somewhere about 400-500. At any given point there were 25-30 sessions going. Each author had about 20 minutes to discuss the paper and then a discussant had 7 minutes to make comments. For the last few minutes it was then "thrown open" to the crowd for comments. In most of the sessions there were three papers. So it was utterly impossible to see it all.

Combine the many sessions with interviewing (have I mentioned we are hiring ? ;) ) and I only got to see a very small fraction. But I tried to get to the papers that would either help with class or my own research, or just seemed too interesting to pass up. So I think I had a good mix. (of course I had to leave sessions now and then and if I skipped out of yours, I apologize. I assure you it was nothing you said!)

Over the next few weeks I will recap and summarize the best of these so that you too can enjoy some of the conference (of course without having to travel to Orlando, which cemented its place into my least favorite US city list).

Hopefully these summaries will start later this afternoon, but with a NYC trip (I leave at 3:00 AM) and a student life meeting at 4:00 PM, no guarantees ;).

My favorite presentation of the day-Friday

Hard to say today as I had several interviews and missed more presentations than yesterday (we are hiring--if interested, let me know!). The ones I did get to go to were very good.

Probably my favorite was session 148 where Robert Monks and Michael Jensen spoke on corporate governance. Nothing super earth shattering as each said what would be expected if you have read their work, but fascinating none the less.

A few Look-ins:

* Jensen commented that executive stock options should have a strike price that grows each year by the cost of equity. This is better than indexing to overall market or industry (especially in the case where managers can pick the industry).

* One reason why private equity has been so successful is that it avoids the silly game of worrying about quarterly earnings and the all to frequent gamesmanship (which after the latter lecture by Jensen (see below) really should be called lying) of earnings management and the like. (Especially interesting here was the discussion by Jensen on Warren Buffett who is seen as a great manager yet when it comes to not offering earnings guidance, many think he is quirky).

* There is a worry that conflict of interests similar to those at accounting firms may exist in some compensation firms. For instance, if they say cut CEO pay, they would potentially lose the larger business of helping to set employee pay.

* Firing for cause is nearly impossible at many firms due to employment contracts-for instance less than 5% can be fired for cause even if the manager breeches fiduciary obligation. Or only about 40% can be fired for cause even after the manager is convicted of fraud. Interesting these contracts apparently grew out of laws to prevent large golden parachute payments.

* Transparency may not solve all problems, but should improve things.



BTW the quote of the day also came from Michael Jensen in his later presentation on integrity and why and how it impacts finance. The quote grew out of his heuristic "without integrity nothing works" and into "As integrity declines, workablity declines; as workability declines, value declines."

While focused on finance (he used many examples from Boards of Directors, managers, etc), his advice is valuable to all.

WSJ Video on Stock crash of 1987

A twenty year look back

Best paper I saw on Thursday

While many papers I have seen here have been very good, possibly the best was by Agarwal, Boyson, and Naik on Hedged Mutual Funds. It is a really interesting and well done paper that is forthcoming in JFQAA.

I will discuss the paper soon (have to run to next session right now), but here is some background on hedged mutual funds.

From Investopedia:

"Hedged mutual funds, although previously only available to institutional clients, are now
readily available for use in the small retail investor's toolkit. While these types of mutual funds are gaining acceptance overseas, this article will focus on their relatively new existence in the United States retail investor marketplace. As a result of the repeal of the SEC's short-short rule in 1997, these funds draw on the decades-old hedge fund strategies within the traditional mutual fund structure. (To read more about traditional hedge funds, see Introduction To Hedge Funds - Part One, Part Two and A Brief History Of The Hedge Fund.)

With this relatively new mutual fund category, the barriers to entry are much lower."

And an old article on them from Financial Planning--Hedge-Like Mutual Funds Attract Investors: Mutual funds that strive for absolute returns in all kinds of markets rather than beating a particular benchmark are gaining in popularity, according to The Wall Street Journal.:

"...offer lower fees than pure hedge funds, as well as greater transparency and
liquidity, which further guarantee money-making opportunities. They offer a
higher level of oversight, charge lower fees, and face more scrutiny from
watchdogs than most hedge funds. Investors can also withdraw and add money on a
daily basis. "

Hi from the FMAs

Hi everyone,

Just a quick note from the FMAs. I saw many good presentations today. Here is the program (it is slow to load). I will be writing on many of the papers in coming days/weeks.

Free Money Finance: Pennies Add Up to Millions

Free Money Finance has two good articles stressing the importance of small things:

Free Money Finance: Pennies Add Up to Millions:

"...$5 a day over 40 years and invested at 10% yields almost $1.1 million. Is
your daily Starbucks coffee worth a fully-funded retirement when you can drink a
cheaper version of the same thing that costs a fraction of the price? This is
the heart of what Bach talks about. And this is the heart of the post
highlighted above -- a belief that I agree with. No, I'm not saying that you
can't spend on luxuries or other things that make life fun/worth living. Who
would want to live that way anyway? But I am saying that we all have some little
bit of spending we could do without and if we do choose to do without it, saving
and investing that money can add up to a big sum."

and then how to save some of that money ...

"Yahoo Finance has a list of ten money drains along with the annual costs of each of them. I view this as a list of where we all can save a bundle of money. Here's their list as well as
the annual amounts spent on each of them (in other words, what you could save if
you eliminated them):
1. Coffee -- $360 per year.2. Cigarettes -- $1,660 a year.3. Alcohol -- $3,650 per year.4. Bottled water from convenience stores -- $365 per year.5. Manicures -- $1,068 per year.6. Car washes -- $348 per year.7. Weekday lunches out -- $2,350 a year.8. Vending machines snacks -- $260 per year.9. Interest charges on credit card bills -- $4,868 in interest (over
time).10. Unused memberships -- $480 per year"

3 Americans Win Nobel in Economics - New York Times

3 Americans Win Nobel in Economics - New York Times:

"The field of mechanism design theory strives to take into account the realities of economic life systematically. Adam Smith’s “invisible hand” is a powerful metaphor that describes how the market, in theory, will always efficiently allocate scarce resources. Yet real-world conditions tend to complicate things. Competition is not completely free, consumers are not perfectly informed, optimizing private production and consumption may have social costs, and institutions can strongly shape economic bargaining. The work begun by Mr. Hurwicz, and advanced by Mr. Maskin and Mr. Myerson, gave economists and policy makers new intellectual tools to address questions like those listed in the academy’s citation: “How well do different such institutions, or allocation mechanisms, perform? What is the optimal mechanism to reach a certain goal, such as social welfare or private profit? Is government regulation called for, and if so, how is it best designed?”"

So Fama, Jensen, et al will have to wait at least another year.

The Associated Press: Nobel Prizes Look to Economics

The Associated Press: Nobel Prizes Look to Economics:

"Speculation on this year's prize has included economists who deal with international trade, macroeconomics and the labor market, among others. Fromlet said Jagdish Bhagwati, a noted proponent of free trade and critic of opponents of globalization, was one of his favorites. 'International trade is probably worth a prize,'"

Near the end of the article is my favorite:

"Other names figuring in this year's speculation include Americans Eugene Fama"

And of course Ross and Jensen should get some attention.

100 years ago

NPR : Lessons from Wall Street's 'Panic of 1907':

"On Oct. 17, 1907, panic began to spread on Wall Street after two men tried to corner the copper market. In the months preceding the panic, the stock market was shaky at best; banks and securities firms were contending with major liquidity problems. By mid-October, Wall Street was paralyzed; for days, there were runs on several large banks. Millions of dollars were withdrawn, and banks closed their doors. New York City was on the brink of bankruptcy. By 1908, there was a severe but short-lived recession. The man who saved the day was J.P. Morgan, who brought together leading financiers and banks to bail out the ailing market."

Move forward 100 years and the news has an eery resemblance. From Reuters via Yahoo:

"Major banks including Citigroup Inc are looking at setting up a roughly $80 billion fund to buy ailing mortgage securities and other assets, in a bid to prevent the credit crunch from further hurting the global economy, sources familiar with the matter said."

Lessons from the '87 Crash

Twenty years ago....

Lessons from the '87 Crash:

"In the five trading sessions from Oct. 13 to Oct. 19, 1987, the Dow Jones industrial average lost a third of its value and about $1 trillion of U.S. stock market value was wiped out. The losses culminated in a panic-stricken 22.6% decline in the Dow on Black Monday, Oct. 19. The traumatic drop raised recession fears and had some preparing for another Great Depression."

Kimmunique – EDUCATION FOR THE SELF-DIRECTED INVESTOR

Kimmunique – EDUCATION FOR THE SELF-DIRECTED INVESTOR:

"Obsession with performance is a disease inflicting most investors. A principled, rational approach makes more sense, but the medicine is difficult to swallow for most."

Well said. Make a plan and within reason try to stick to it!

Finance rises to the top - News

Congratulations to the BC finance department!

Finance rises to the top - News:

"After years of being close, finance has finally overtaken communication as the most popular area of study at Boston College. This marks the first time in University history that a major outside of the College of Arts and Sciences has held the top spot....the Carroll School of Management's finance concentration boasts 855 enrolled students, a 25-year high..."