Thursday, August 28, 2008

U.S. Moves Toward International Accounting Rules -

It will be interesting to see how fastthis actually happens, but moving towards a single standard is great news as it will eventually result in lower transactions costs.

U.S. Moves Toward International Accounting Rules -
"The Securities and Exchange Commission moved Wednesday to allow some large American companies to begin using international accounting standards as early as next year, and to require all American companies to do so by 2016....The adoption of international accounting standards by the United States would move the world toward one set of standards, which should make it easier for investors to compare companies operating in differing regions, and make it easier for companies to raise capital in whatever market seems most attractive"
From the Economist:
"GAAP was the beancounter’s gold standard for decades, but it is now widely seen as cumbersome....For several years, the SEC and the London-based International Accounting Standards Board (IASB), which oversees the international rules, focused on steadily bringing the two sets of standards together. But it has been a struggle, largely thanks to the Byzantine nature of the American system. Mr Cox embraced the more radical approach approved this week in the belief that it would boost the competitiveness of American firms."
People will no doubt argue whether the right standard was chosen, but those things can be sorted out later if the need arises.

From Forbes:
"To ensure that the international rules meet the SEC's standards, the agency set 2011 as a date to evaluate critical milestones and decide on mandating IFRS.

The SEC's milestones include steps to ensure that international accounting rule maker London-based International Accounting Standards Board (IASB) and its trustees are accountable and independent."

What are some of the differences?

From the WSJ:
"The IFRS system is generally considered more flexible, and giving companies the choice could spell the end of GAAP, experts believe. The international standards are deemed especially desirable for large U.S. companies with foreign subsidiaries, which now must maintain two different sets of books...."Tax considerations are another potential accounting has no equivalent to U.S. accounting for inventory on a last-in, first-out basis, for instance. So-called "LIFO" accounting shields companies from heftier taxes when inventory costs increase due to inflation...."
From Yahoo (the AP):
"The IFRS system is generally considered more flexible, and giving companies the choice could spell the end of GAAP, experts believe."
From the Economist:
"IFRS allows fewer securitised assets to be kept off the books than GAAP does, for instance—a matter of import for banks."
Uh, wait, that horse just left...oh well.

Stay tuned, this one will be playing out for many years.

Wednesday, August 27, 2008

Is it rational to give to charity? Yes!

Giving can be its own reward? Yes!

Being leader of BonaResponds (coolest volunteer group in the world! Ok, maybe I am slightly biased) has led me into some interesting discussions on charitable giving. Some strict classic economists have argued that charity and other selfless acts do not make economic sense. To that argument I always remind them that people (and I guess monkeys too!) maximize utility and not money. Here are some recent articles that give further credence to the charitable giving can be economically justified and what at first glance appears irrational may be just the would-be economist looking at the wrong metric.

Neural Responses to Taxation and Voluntary Giving Reveal Motives for Charitable Donations
" consistent with warm glow, neural activity further increases when people make transfers voluntarily. Both pure altruism and warm-glow motives appear to determine the hedonic consequences of financial transfers"
Monkeys Enjoy Giving To Others, Study Finds:
"Researchers at the Yerkes National Primate Research Center, Emory University, have shown capuchin monkeys, just like humans, find giving to be a satisfying experience. This finding comes on the coattails of a recent imaging study in humans that documented activity in reward centers of the brain after humans gave to charity."
NowWeAreTalking offers still more evidence of the benefits of giving.
"...researchers at the University of British Columbia and the Harvard Business School found that individuals report significantly greater happiness if they make charitable donations or give gifts to others rather than spending on themselves (March 21 edition, Science)."
Which is really just to say that some of the things that appear irrational, are actually rational when utility and not just risk and return are considered. Need other examples? Excess trading, buying high flying stocks to be able to brack about them, even lottery tickets if they allow you to dream of winning big.

BTW if all of this talk about giving makes you want to be happier, BonaResponds is always ready to accept any and all donations of money, food, tools, just about anything. As the leader, I will guarantee it gets put to good use!

Tuesday, August 26, 2008

Does Social Security Increase Poverty?

One of the real dangers of writing a blog is becoming political. I do not want to at all. In fact I have purposely not said anything about Social Security for that reason. It is the proverbial third rail. That said, it came up in class yesterday when we were talking about the importance of compounding on future values, plus it has been a hot issue for years with friends and is covered in quite a bit of detail in Real Change (one of the books I am ristening (risten= Read and listen).), so I will at least point this article out that deals with some of the issues you generally do not hear from politicians who are trying to scare up every vote possible.

Social Security Increases Poverty: Newsroom: The Independent Institute:
"Social Security affects poverty among the elderly in two offsetting ways. While it reduces poverty by providing income to retired persons, it discourages private saving during the working years....The net effect of this is increased poverty among the retired population.

To understand this conclusion, it is important to compare the rate of return on taxes paid that is generated by Social Security to the rate of return people could receive on their private saving. For those retiring in 2008, the average implicit real (inflation-adjusted) rate of return on Social Security taxes paid was slightly below 3 percent—and it is scheduled to decline to under 2 percent in the next forty years. In contrast, if people retiring in 2008 had invested the taxes they paid into Social Security in a balanced portfolio (60 percent stocks and 40 percent bonds), they would have received a return of 5.5 percent."
One problem with this of course is that the past is not likely to repeat itself and market returns may be much lower (see for instance Paul Krugman's piece from NY Times in 2005). That said, returns that are less than two percent and in many cases negative (even before being concerned with the solvency of the Social Security System) makes it likely (although not certain), that you could earn more elsewhere than through social security.

While I can not vouch for its accuracy, here is an interesting calculator that estimates how much you will earn on your "investment".

SSRN-A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies by James Kolari, Seppo Pynnonen

This one may not be of wide general interest but it definitely will be for those who do academic financial research. From the abstract:

SSRN-A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies by James Kolari, Seppo Pynnonen:
"This paper proposes a generalized rank test that can be used both for testing cumulative abnormal returns as well as single abnormal returns. Empirical properties of the test statistics are studied with simulations using CRSP returns. The results show that the popular test statistics, like Patell, BMP, Corrado, as well as the adjusted Corrado-Zivney test tend to under-reject the null hypothesis as the CAR period increases. The suggested generalized rank test seems to avoid this bias. Furthermore, it is robust against the event imposed volatility and cross-correlation due to the event day clustering, and foremost it is more powerful than the standard parametric tests of Patell and BMP."
Cite: Kolari, James W. and Pynnonen, Seppo,A Generalized Rank Test for Testing Cumulative Abnormal Returns In Event Studies(August 25, 2008).
Available at SSRN:

Monday, August 25, 2008

Finance Crossword Puzzle

Custom Crossword Puzzle---

I thought a crossword puzzle would be a unique way to review for class, so I made this one up. Sort of fun. It is probably too easy but really have no experience, so figured easy is preferred to hard.

The answers are here.

SSRN-Executive Pay, Talent and Firm Size by Jaeyoung Sung, Peter Swan

Sung and Swan examine the pay, performance, and size relation using panel data and find that firm size matters but maybe not as much as previous authors had suggested.

SSRN-Executive Pay, Talent and Firm Size by Jaeyoung Sung, Peter Swan:

The authors model a pay relationship and find support for their model. Without getting into the gory details of the modeling, consider two firms (one large, one small) and two managers (one talented, one less so) whose abilities are unknown but can be learned via observation. How much the firms would pay (their reservation price) and how much the managers would accept (their reservation price) are examined.
"...panel data for 1992-2006 exclusive of time factors, which strikingly suggest that the average talent level of small firm CEOs is only slightly lower than that of large firm CEOs, but the talent variability of small firm CEOs is far greater than that of large firms."
A few look-ins.
"...each firm would like to hire an agent who would produce an expected profit to the firm at least as great as the other agent would. However, each firm’s decision can also affect/be affected by the other firm’s decision."
and in examining the pay and performance relation the authors report:
"CEOs employed by firms with positive performance capture over 67% their
exceptional talent in the form of higher pay. By contrast, for negative performers the
relationship is insignificant indicating the absence of penalty for poor performance.
This would indicate that incentive contracts treat negative performance as having a
component of bad luck with less severe penalties in place which is more conducive to
They also report (and I find myself thinking of professional sports teams here) that large firms can afford to hire some lower level talent and essentially overpay.
"...when a large firm hires a low-ability manager, the expected pay for the low ability manager can be higher than that for a high-ability manager who is hired by a small firm, if the large firm’s productivity and the firm size are sufficiently higher and larger than those of the small firm"
Moreover the authors examine the informational effect of having worked at one firm and then switching. (Intuitively, consider that a manager with low skills will be 'found out' by larger firms. Thus switching firms at least potentially signals lower abilities). To protect themselves, the smaller firms would want to make a more incentive laden contract. To wit:
"..that a manager who previously worked for a large firm will be given a contract with a higher sensitivity than a manager who previously worked for a small firm. We find significant statistical support for this hypothesis."
Interesting stuff. If I were a general manager of a professional sports team, I would definitely want to read this one.

Cite: Sung, Jaeyoung and Swan, Peter L.,Executive Pay, Talent and Firm Size(August 23, 2008).
Available at SSRN:

Friday, August 22, 2008

Study Examines The Psychology Behind Students Who Don't Cheat

Study Examines The Psychology Behind Students Who Don't Cheat:
"People who don’t cheat “have a more positive view of others,” said Sara Staats, co-author of the research and professor of psychology at Ohio State University’s Newark campus.

“They don’t see as much difference between themselves and others.”

In contrast, those who scored lower on courage, empathy and honesty – and who are more likely to report that they have cheated -- see other students as cheating much more often than they do, rationalizing their own behavior, Staats said"
Interesting from a classroom perspective, but also there has to be a some similar relationship with respect to on cheating on taxes, or not disclosing real information, or lying to regulators/auditors etc.

Some interesting stats stemming from Mortgage Meltdown

The topic that dominated last year's classes is still at the center of attention as classes begin here this Monday. The names have changed (last August we were talking about Bear), but the basic underlying story is the same. Moreover, the size of the problem is better known now.

Burdened by Mortgages, Lehman’s Options Narrow -
"In the last 12 months, Freddie’s stock price has dropped 95 percent. During that period, Lehman has fallen 76 percent. The Standard & Poor’s financial index has lost 42 percent...Merrill Lynch is down 68 percent and Citigroup is down 64 percent"
While the article focuses on Lehman who has problems due to its smaller size and concentration of mortgages, some of the more interesting stats are industry-wide numbers. Some short look-ins:
"According to data Standard & Poor’s...more than 41 percent of the subprime mortgages made in 2006 are delinquent....Mortgages to people with credit one rung higher than subprime, called Alt-A, are also being hammered. Standard & Poor’s estimates that more than 21 percent of such mortgages made in 2006 are delinquent."
Of course the mortgage problems have led to other problems for Wall Street firms. For instance fewer new issues are being sold which reduces fee income to the banks.
"According to Goldman Sachs research, debt underwriting...has fallen off a cliff....asset- backed issues have fallen 80 percent...and mortgage-backed offerings are off 87 percent."

Wednesday, August 20, 2008

Hedging jet fuel prices at airlines

Airline hedging has been a topic of discussion on the FinanceProfessorblog since its inception. With volatile energy prices, it is now a hot topic within the airlines as well. Here is a look at the discussion from FlightGlobal.

Hedge your bets:
"A large part of deciding whether or not to hedge comes down to the way in which ­airlines view hedging. Those that see it as an insurance policy which enables them to ­foresee exactly what they will be paying for fuel, therefore avoiding any nasty shocks, are the most likely to implement long-term fuel hedging strategies.

'Airlines should look at hedging as a ­strategic device that keeps them on an even keel and avoids extremes,' says Leo Drollas, deputy executive director and chief ­economist at the London-based Centre for Global Energy Studies. But he adds that there is a tendency for airlines to hedge tactically rather than ­strategically, meaning they are 'either too heavily hedged or too light on hedging, so they lurch from one situation to another'."
The article also gives some real world examples. For instance from Lufthansa (who I recently flew to Barcelona)

"One airline that follows a strategic approach to fuel hedging and has done so since 1990 is Lufthansa. "Our hedging programme is designed to shield the airline from the adverse impact of the market," says Lufthansa vice-president corporate fuel management Helmut Fredrich. "Our strategy is that we are not ­speculating if there is a low [fuel] price environment. The aim is to mitigate the effects of changing oil prices to give Lufthansa time to adjust to different levels. We start 24 months out, building up our hedges by 5% a month so that after 18 months up to 85-90% of demand is hedged." This means 90% of Lufthansa's fuel is hedged for the coming six months, while 54% is so far hedged for 2009."
Good stuff. Well worth the read (it is fast).

Thursday, August 14, 2008

SEC short selling rule made little impact: studies | Deals | Regulatory News | Reuters

Do you remember in July when regulators imposed short sale restrictions on 19 financial stocks due to fears of the stocks collapsing and thus leading to a market-wide panic? Well the constraints were recently lifted and now Arturo Bris finds that the regulations did little good and even hurt efficiency.

SEC short selling rule made little impact: studies | Deals | Regulatory News | Reuters: "study from Arturo Bris, a finance professor at IMD business school in Lausanne, Switzerland, found that, even controlling for short selling, market efficiency had deteriorated more for the 19 stocks affected by the rule than for other comparable U.S. financial stocks."

Bris finds, among other things, that while the 19 stocks fell more than their matches, they did not have significantly worse accounting performances, they did not have significantly different short selling activity prior to the rule, and that liquidity and informational efficiency both fell seemingly as a result of the regulations.

From the article:
"from the pre‐EO period to the post‐EO period, relative quoted spreads for G19 stocks have increased from 18 percent to 48 percent, but they have increased only from 11 percent to 29 percent for comparable US financial stocks."
"...significant volatility increases: open‐to‐close and close‐to‐close volatility increase 158 percent and 188 respectively. Trade price range increases 4.37 percent in the post‐EO period."


The WSJ also reports on this story here.

Wednesday, August 13, 2008

Damodaran Online: Home Page for Aswath Damodaran

Damodaran Online: Aswath Damodaran Ok so I am biased. I have watched him spreak several times at conference and we are using his VAluation text in Fin 410. That said, his website definitely gets top billing! Take a while and look it over. You will be amazed at what you learn.

Study Tallies Corporations Not Paying Income Tax -

While it might be more of an accounting piece, it is still sort of interesting for corporate finance classes. And definitely draws into question using stated (as opposed to effective) tax rates for computing cost of capital etc.

Study Tallies Corporations Not Paying Income Tax - "Two out of every three United States corporations paid no federal income taxes from 1998 through 2005, according to a report released Tuesday by the Government Accountability Office, the investigative arm of Congress."

In the article (which is not the best), transfer prices are brought up. And since that is always a topic in class, the following is worth noting:
"...the G.A.O. said that it did not have enough data to address the role of what some policy experts say is a crucial factor in profits sent overseas.

That factor, known as transfer pricing, involves corporations’ charging their overseas subsidiaries lower prices for goods and services, a common move that lowers a corporation’s tax bill. A number of corporations are in transfer-pricing disputes with the Internal Revenue Service."

While this is interesting, I would much rather see how much they paid. For instance the article said that larger firms were more apt to pay taxes, but does not say if that is 1% or 34% etc. But in spite of the problems it is still worth reading and shows that the money paid to accountants and tax lawyers is not for nothing.

Tuesday, August 12, 2008

SSRN-Do Behavioral Biases Adversely Affect the Macro-Economy? by George Korniotis, Alok Kumar

Talk about ambitious! Korniotis and Kumar apparently have found a link between behavioral finance and economic difference across different US States.

SSRN-Do Behavioral Biases Adversely Affect the Macro-Economy? by George Korniotis, Alok Kumar: "
This study investigates whether the adverse effects of investors' behavioral biases extend beyond the domain of financial markets to the broad macro-economy. Our results demonstrate that risk sharing (RS) levels are higher in U.S. states in which investors have higher cognitive abilities and exhibit weaker behavioral biases"
A few look-ins:
"examine whether the systematic effects of behavioral biases extend beyond the domain of financial markets to the aggregate macro economy. Specifically, we investigate whether behavioral frictions adversely affect the level of interstate risk sharing (i.e., state-level income smoothing) that can be achieved using financial markets. To our knowledge, this is the first paper that examines whether systematic behavioral biases can in‡fluence broader macro-economic indicators such as state-level risk sharing"
Looking at cognitive abilities:
"Because direct measures of cognitive abilities of stock market participants are not available, we use the demographic characteristics of the brokerage investors (e.g., income, education, age, social networks, etc.) to define a cognitive ability or “smartness” proxy for each investor and use these imputed cognitive ability measures to obtain aggregated state-level measures of cognitive abilities."
The findings? That behavioral finance does seem to impact economic measures.
"The average RS in states with less sophisticated investors (= 0.131) is less than half of the average RS in states with greater investor sophistication (= 0.324). Collectively, our evidence indicates that the aggregate behavioral biases of individual investors infl‡uence the level of risk sharing across the U.S. states."
Which partially explains the finding that state's risk sharing is quite different from state to state.
"For example, states such as Iowa, South Dakota and Kentucky achieve very low (less than 10%) levels of risk sharing using financial assets. In contrast, states such as Delaware, New Mexico and Oregon attain risk sharing levels of about 50%.""
Interesting! Which is at least consistent with the view that behavioral finance does influence the economy. Surely not the last word on this one.

Citation: Korniotis, George M. and Kumar, Alok,Do Behavioral Biases Adversely Affect the Macro-Economy? (August 12, 2008).
Available at SSRN:

FMA annual Conference

FMA Conference
Just a reminder the FMA conference is October 8-11 this year. It is in Grapevine Texas. See you there!