Welcome to the Blogosphere

A warm welcome to the Blogosphere to The Finance Blog. It is a new blog by a Peter Went a FinanceProfessor from Bucknell. I look forward to reading! In fact I just added it to my GoogleReader!

CBOE to trade stocks

Big news out of Chicago today:

From the Street.com:

"The Chicago Board Options Exchange, the nation's largest options exchange, says it intends to get into the business of trading stocks and will launch a new exchange in early 2007. The CBOE on Thursday says it has also begun converting itself into a holding company, a process that could lead to an eventual IPO...."

From the CBOE's press release:

" The CBOE Stock Exchange will feature a Hybrid market model that will combine elements of both screen and floor-based trading; and provide a new venue for the trading of New York Stock Exchange, NASDAQ Stock Market, and American Stock Exchange listed securities. CBSX is expected to launch in early 2007, pending final regulatory approval from the Securities and Exchange Commission (SEC)."

Microfinance: lesson and video

A former student who was always interested in micro finance forwarded me the following video.

A brief "lesson" on Microfinance will serve as a means of introducing this video.

What is microfinance? It is banking on a very small scale where small (often short-term) loans are made to individuals who would generally not be able to get loans from traditional financial institutions. Adding to the difference is that while the loan is made to individuals, others in the group are also responsible for the loan and hence serve to monitor behavior (lower moral hazard problems).

From Grameen (one of the leaders in the field):

"Microfinance consists of making small loans, usually less than $200, to individuals, usually women, to establish or expand a small, self-sustaining business. For example, a woman may borrow $50 to buy chickens so she can sell eggs. As the chickens multiply, she will have more eggs to sell. Soon she can sell the chicks."

From Wikipedia:

"The primary differentiator between microfinance and the conventional credit disbursal mechanism lies in the "joint liability" concept. A group of individuals (almost always women), get together to form an association of persons. The Groups in India.for instance are called "Self Help Groups' (SHG), all the members of which undergo a training programme on the basic procedures and system requirements. Loans to individuals within the SHG, is approved by the others members of the Group , who are also jointly responsible for its repayment"

While few would argue that availability of external financing is a valuable asset. There is a debate as to whether microfinancing is cost effective and whether it is really different from traditional finance except that microfinance organizations have merely figured out ways to lower the risks (credit risk in particular) while keeping transaction costs low.

While most believe these programs to work (for instance see Schreiner 2003 and Sachs 2005), this is not a universally held position. In 1998, Murdoch found that after controlling for selection bias, there appeared no difference in average income or the percentage of children attending school for those with access to micro finance and those without. However, he did find that consumption was smoothed (possibly less dependent on agriculture and weather) which was positive. He also pointed out many problems with studying the success or failure of such programs. For instance:

"An additional concern is given by non-random program placement. Upward biases arise when programs choose regions that are already doing well, and downward biases arise when programs favor disadvantaged areas."

As to whether microfinance is different than traditional finance, exactly one month ago I posted on this:

CyberLibris argues that microfinance is nothing more than finance that tight controls: "With microfinance, lenders are in the ideal situation: First, they can discriminate among borrowers, they simply don't lend (in many instances) to men (who run with the money to have a good drink). Women are reliable, hence they get the money. To make sure that the money is well-spent contractual provisions often involve the community in which the lending woman live. For instance, if she fails to pay, the community may be on the hook and have to repay for her or be punished by having a more difficult access to the next loan. The community plays a monitoring and a supportive role to ensure success. This is the dream situation for any banker!"

Which is true, but this is not necessarily a bad thing. Traditional finance is pretty good ;) and if micro-lending agencies have found ways to massage the traditional system to get meet unsatisfied needs, then whether it is different or not is largely a moot point.



Ok, so if you made it this far, you have at least an idea of what microfinance is and what it can (or can not) do. So now the video you have been waiting for:


Breaking Through Poverty with Microfinance - Grameen Foundation



Additional multimedia presentations on microfinance:

• BYU TV has a short video (for PBS) on how microfinance can lift the poor out of poverty.
  

• NPR has an interesting (short, 4 minute) NPR newscast on micro finance in which "a group of bankers and MBA students assemble to talk about micro-financing. The group tries to imagine what life would be like without insurance, credit cards and bank accounts"
  

A look around at the news

In the spirit of the old newsletter, this will have several short stories all together (out of town family (from Texas) is in town today visiting and I am not supposed to be working ;) so this is my compromise.)

1. This would defintely be fodder for my Money and Banking classes if I were teaching that this semester!
   

From the BBC:

"Monopoly money will be phased out in a new version of the game in a bid to keep up with the times.

Instead players will use mock Visa debit cards to keep track of how much money they are winning or losing.

An electronic machine is provided, which allows the banker to transfer money from players and record their earnings and payments."

2. A somewhat dated (it is from 2003) piece by Nobel Prize Winner Joseph Stiglitz on Globalization in which he attacks the IMF. This would definitely be required reading were I to be teaching International (finance or economics). (thanks to MBA Depot for pointing it out!)

"What is this phenomenon of globalization that has been subject, at the same time, to such vilification and such praise? Fundamentally, it is the closer integration of the countries and peoples of the world which has been brought about by the enormous reduction in costs of transportation and communication, and the breaking down of artificial barriers to the flows of goods, services, capital, knowledge, and people across borders...."

"If, in too many instances, the benefits of globalization have been less than its advocates claim, the price paid has been greater, as political processes have been corrupted, and the rapid pace of change has not allowed countries time for cultural adaptation. These problems are hardly new–but the increasingly vehement worldwide reaction against the policies that drive globalization is a significant change."

"By some reckonings, close to 100 countries have faced crises. Worse, many of the policies that the IMF pushed – such as premature capital market liberalization – have contributed to global instability. And once a country was in crisis, IMF programs not only failed to stabilize the situation, in many cases, they actually made
matters worse."

3. CNN on backdating of options:

"...let's dispense with the pooh-poohers, those who'd minimize the importance of this issue....At its worst, the practice is called backdating because an executive manages to move the date of a stock option back in time, presumably to when the stock price was lower....by moving back the grant date during a rising market, for example - and the option is worth even more.The scandal, however, involves far more shenanigans, and deeper nuances, than mere backdating....the system of awarding options has gone from an incentive program to an entitlement....So here's a radical proposal: Scrap the whole system."

In a related article, the SEC is investigating how to increase pay transparency.

4. Longer term and traded options to minic emplouee options? From the WSJ:

"Analysts at Wall Street's Bear Stearns Cos. have outlined a proposal for competitive pricing of employee stock options that they claim would be a better gauge of value than the models companies currently use. The idea, laid out in a recent report, calls for companies to sell 10-year options to investors to be traded alongside the stock options they grant employees."

Which would be a great idea if (and this is a giant if) there is a market for them. Looking at LEAPS, that is questionable. But 10 year options would make various investment strategies much easier to implement.

5. The SEC promised to increase regulation of hedge funds after their original regulation plans were turned down by US courts.

"The head of the US financial watchdog has vowed to continue pushing for tougher regulation of the multi-billion dollar hedge fund industry...Mr Cox told the Senate Banking Committee that he had not ruled out appealing against the June court ruling....He added that without regulation "the potential for retail investors to be harmed by hedge fund risk" was a serious concern.

Deja vu all over again?

Sometimes the more things change, the more they stay the same. NY Times Deal Book has a really interesting article on the similarities between the takeover market now and in 1988.

A quick look-in and then the link to the actual DealBook article.

"HCA’s $33 billion buyout announcement on Monday is turning up all kinds of references to the late 1980’s, which was the last time Wall Street saw a leveraged takeover on such a scale."

and

"The fallout was a buzzy excitement among investors and arbitrageurs, many of whom imagined that the next megabuyout could strike anywhere, at any time. There was also much hand-wringing among lawmakers, many of whom thought the debt-fueled RJR Nabisco transaction and others like it might harm the economy. Though similar sentiments can be heard today, it is also interesting to note how some of the heady predictions of the late 1980’s failed to come true."

For instance:

"There was also the promise by some politicians to pass laws to make L.B.O.’s more difficult. The situation had gotten “out of hand,” Senator Lloyd Bentson, chairman of the Senate Finance Committee, was quoted as saying in a New York Times article dated Dec. 5, 1988. In the same article, Representative Dan Rostenkowski, an Illinois Democrat, vowed that Congress would “do something about it.” Even Federal Reserve Chairman Alan Greenspan, just a few months into his tenure, warned banks against profligate lending to finance buyouts.

But those legislative rumblings, which included a proposal to end the deductibility of interest, largely fizzled."

Read the entire thing (including an NY Times article from 1988) here.

Yogi Berra would be so proud, it really is Deja Vu all over again!

More political connections = higher returns

I imagine this one will be making the rounds in the popular press relatively quickly. It is by Goldman, Rocholl, and So.

The super short version of their paper is that having a board member with ties to the political party in office is good for shareholders (which probably is more disappointing than shocking).

A slightly longer version:

The authors begin by stating that "in countries with a well functioning legal system the preferential treatment of companies due to their political ties should not be widespread."

After alluding to studies that have shown that political connections are important in "countries with high levels of corruption and weak legal systems", the paper examines whether political connections impact firm value in the US and find that political ties do matter.

How do they show this? In their own words

"the paper employs a unique definition of a companyÂ’s political connectedness based on new hand-collected data, detailing the former political positions held by each of the board members of all companies that are in the S&P500 during the year 2000. Information about the political background of board members is then used to sort companies into those that are more connected to the Democrats and those that are more connected to the Republicans."

The closeness of the 2000 presidential election provides an interesting test case since the results were unknown leading up to (and even after) the election.

Their main finding:

"The first main result is that a portfolio of S&P500 companies classified as having a
Republican board significantly outperforms in the post-election period a portfolio of S&P500 companies classified as having a Democrat board. This is true regardless of whether the portfolios are formed based on equal weighting or value weighting....Conversely, the Democrat portfolio exhibits a negative CAR following the election."

As a robustness check, the authors also examine donations to political parties. This data set yields some fascinating factoids. For instance:

"Most of the sample companies donate to both parties, but the relative shares vary substantially. Only 18 of the 315 sample companies donate to only one of the two major parties. The sample companies donate on average $779,985. The maximum donation made by one of the sample companies is $5,075,311...."

The findings using this donation data again support the view that political connections do matter:

"Companies with the highest donations to the Republicans experience on average more than a 3% increase in their stock price over the first seven days after the Election Day. In contrast, stock prices for companies with more donations to the Democrats decrease over the same period of time in the value-weighted average and tend to decrease in the equally-weighted average."

Still not convinced? The authors provide one more piece of evidence. They look at the stock response when a new board member with political connections is nominated to the board of directors. Their finding? Stock prices jump. This CAR is particularly significant for their value weighted portfolios which again suggests that political ties do matter and are especially pronounced for larger firms.

Which deserves a WOW!

As for what it says of the political and legal systems in the US, I will leave that for smarter people to interpret.

I^3 definitely worth reading!

Cite: Goldman, Eitan, Rocholl, Jorg and So, Jongil, "Does Political Connectedness Affect Firm Value?" (July 21, 2006). AFA 2007 Chicago Meetings Paper Available at SSRN: http://ssrn.com/abstract=891426

More entrenchment = more employee pay

Start off with the assumption that holding employee pay down is hard work (if nothing else, you are frequently criticized). This simple assumption leads to the conclusion that ceteris paribus (holding other things constant), managers would prefer to not have to do this and would pay their employees more than is optimal.

However, as residual claimants, shareholders disagree. They do not want to see their employees overpaid as this is money out of shareholder pockets. Further, if managers persist in overpaying employees, then shareholders will replace management.

So far so good?

Now enter Cronqvist, Heyman, Nilson, Svaleryd, and Vlachos who investigate whether entrenched managers pay their employees more since the threat of firing is reduced.

Their findings fit the theory to a T! Pay is higher where there are entrenched managers!

From their abstract:

"...our estimates show that CEOs with more control rights (votes) than all other large shareholders combined pay their workers about 6%, or $2,200, higher wages per year, all else equal....we interpret the higher pay as evidence of agency problems between shareholders and managers affecting workers' pay. The findings do not appear to be driven by endogeneity of managerial ownership and are robust to a series of robustness checks.

These results are consistent with an agency model in which entrenched managers pay high wages because they come with private benefits, such as lower-effort wage bargaining and better CEO-employee relations, and suggest more broadly an important link between the corporate governance of large public firms and labor market outcomes."

Which deserves a WOW!

Cite: Cronqvist, Henrik, Heyman, Fredrik, Nilsson, Mattias, Svaleryd, Helena and Vlachos, Jonas, "Do Entrenched Managers Pay Their Workers More?" (December 2, 2005). EFA 2006 Zurich Meetings Paper Available at SSRN: http://ssrn.com/abstract=845844

What I learned watching the Tour

Wow, what a Tour! As anyone who wants to know, knows, Floyd Landis won!!

While not wanting to take the fun away from the event (I simply love the Tour and think the three weeks of the event is my favorite time of year), nor to read too much into it, there are some lessons (both financial as well as non financial that we can learn from his performance.

1. Have a long term plan. Floyd understood that day-to-day fluctuations would happen. That he may not have the yellow jersey every day. He showed patience and stuck to his plan where he could. He knew that the only time frame that concerned him was end.

In this light, he planned accordingly, used resources (energy) when needed and allowed other riders to have their days.

2. Hard work generally does pay off. Of course there are exceptions (and these exceptions are all too tempting to dwell on), but generally hard work is rewarded. Now it does not mean hard work equates with winning a Tour (I could ride 23.5 hours a day from now until next July and will still not win), but that hard work does make you better.

3. Landis did not panic when it looked as if he had lost the race on the climb to La Toussuire.

Rather, he applied sound financial logic and adopted a risky strategy and broke way early the next day to claw his way back into contention. Sure this was risky, but only if you look at total time. He viewed it as the only means of winning and thus, he really had very little to lose (what is the difference between losing by 8 minutes and losing by 15 minutes?).

This is very similar to notes I use in several corporate finance classes:

"Galai and Masulis (1976) show that debt in the capital structure may give shareholders the incentive accept risky negative NPV projects and pass on safe positive NPV projects. This happens when the benefits of the project must go to pay off debt holders. The shareholders will want to take on a risky project (even if it has a negative NPV) in order to have a chance at getting paid after the debt holders have been paid."

"Chevalier and Ellison (1996) apply similar logic and show that mutual fund managers who have underperformed their benchmarks increase the risk of their selections in order to “catch-up.” This is partially because of the high correlation between cash inflows into the fund (i.e. “new money”) and recent fund performance. In both settings, the situation is similar: unless something “big” happens, the principals get no, or a dramatically reduced, return. This creates incentives to take risks that in other settings would appear irrational."

4. Have confidence. When things went bad, he did not let naysayers dominate his thinking. Landis continued to believe he could do it. The press had given up on him, indeed fellow riders had written him off, but he kept believing. To quote Journey: "Don't stop believing".

In a time of "crisis" (after a bad test, injury, family problem, paper rejection, firing, etc) it is very difficult to believe in yourself. But Floyd Landis showed us that things do occasionally turn. That with the right mix if confidence, help, and hard work things can turn around.

And while his team and coaches helped, without his own confidence, the race was over.

Most riders (even world class riders) would have packed it in and been content to wait for a future ride. Possibly due to the uncertainty surrounding his hip, Landis pushed on with a stubborness that was awe inspiring. More than physical strength (although the wattage numbers he was pedaling were simply staggering), it was this mental strength that won him the race.

5. Sports can teach us a great deal about finance and about life. For one, do not give up!! This may be the single most important lesson we can all take out of his ride. Oh sure we knew it before: "It is always darkest before the dawn" and "It's not over until its over" etc. but at the same time we all tend to occasionally forget. Or to think that those trite proverbs and sayings are just that.

Floyd Landis showed us that they are as relevant today (in whatever field we are in) as ever.

My hat is off to him. Great job!


As an aside, learning about life is just one reason why sports is so important. It provides us great reminders and learning opportunities. So the next time you think you are "wasting" time watching some sporting event, turn it around and use it as a learning opportunity that just happens to be fun!!

Socionomics and the Enron Scandal

Right after my posting of the 1952 cartoon, B. C. emailed me the following video that is a documentary on Socionomics and even has Finance Professor John Nofsinger in it speaking about Enron and other scandals!

What is socionomics?

From Socionomics.org:

"Socionomics is a new theory of social causality that offers fresh insights into collective human behavior. Over twenty years of empirical research demonstrates that social actions are not causal to changes in social mood, but rather changes in social mood motivate changes in social action."

For instance, rather than suggesting that a rising economy (or stock market) makes people happy, this takes the related, but reversed, view that the economy improves because people are happy.

While I do not want to argue the theory (for or against), Nofsinger makes an interesting point by saying that Enron and other scandals may have come when they did (after the tech bubble burst etc), not because of the scandals being worse, but because people were upset and hence "looking for trouble."

Sort of a chicken or the egg argument that has many finance and economic implications (not least of which might be a predictable component in stock markets--for instance this builds upon the Elliot Wave Theory that was mentioned via Fibonacci sequences in the DaVinci Code.).

Here is the description from video:

" The Enron and Martha Stewart scandals made headlines at about the same time. It wasn't just coincidence. This four minute clip about socionomics from History's Hidden Engine explains why some scandals make news when they do, while others go unnoticed."

I have to admit it is a thought provoking idea and it does fit some scenarios, but I am not yet willing to buy into it, although I may buy the book.

Gates to give more to Africa

Yeah, maybe I am still being biased by my reading of Jeff Sach's Ending Poverty. Or maybe it was the stories my brother (the real doctor) brought back from his service trip to Ghana. Ormy Mom's campaogn to collect and send t-shirts and money to an orphanage in Ghana. Or maybe it just seems right, but whatever the reason I agree with the Cameron Cameron Duodu of the New African (although this appears in the Guardian) that the Gates (and Buffetts) deserve priase and not criticism for giiving of money to aid African nations.

From the article:

"The pioneering role being played by Bill and Melinda Gates in applying wealth to the solution of some of the problems associated with poverty and disease, need to be supported by all people of goodwill, because quite often, their efforts are derided as an attempt to "throw money" at the problems of Africa. That is nonsense, of course, because you cannot cure tuberculosis without buying drugs, nor can you prevent diarrhoea from attacking children if you do not buy stuff that can purify the water they drink. And buying can only be done with money.

There is nothing more annoying than seeing someone who takes the availability of potable, safe water 24/7 for granted in some leafy suburb in Europe or America waxing eloquent about the wastefulness of aid. Yes, regrettably, some aid can be wasted."

Not sure where the finance/economics line is, but this is probably on the Economics side, but that is ok, class is not in session right now ;).

a few really interesting posts from Financial Rounds

The Unknown Professor over at Financial Rounds just keeps writing some really interesting posts! So on a day that I devoted to the "Tour" (I don't want to give results away, but WOW!!!! What a day!!!),

here are a few recent highlights:

Can you make money betting against Jim Cramer? Uh, it looks like it! At least in the past).

The backdating of option grants seems much more common than originally thought! Article by Lie and Heron.

Oh and what getting a PHD in Finance entails. Indeed, I wish I had read it before getting my PHD. I think it would really have helped to know what I was getting into ;).

1952 cartoon on Stock Market

Yeah I know I have not been posting much of late. A combination of research, summer, trips, and the tour. But this will make up for it. LOL! Pretty funny. And I apologize about all gender stereotypes in advance!!! Remember, it was made in 1952. "Cartoon promoting the stock market as the engine of America's prosperity." Animation in public domain and available at Archive.org. 1952.

Want to have some fun?

Ok, so this is not the usual post. It is a summer Friday afternoon, so why not. It is from Blogthings. Take a quick quiz to see if you are likely to become a "multimillionaire". Interestingly, it is totally based on actions and how you think about things (and not type of job, amount of money you are starting with, etc.) It takes about 1 minute.

I think it is overly optimistic (which based on their incentives should be expected (who wants to know that they will not be a MultiMillionaire?).

Here is their conclusion for me:

***Your Chances of Being a Multimillionaire: 88%***

It's almost certain you'll be a multimillionaire. Just keep doing what you're doing.
You are good with money, a creative thinker, and an ethical person. You might be the next Donald Trump!"

Yeah, right.

FinancialRounds:What does a professor do all day

If you are a college professor, you have been asked "what do you do all day" or told "it must be nice only having to teach X courses per semester". Similarly, if you are a student, you no doubt have thought "What an idiot! All he does is teach X courses, why can't he get grades back faster?"

Over at Financial Rounds, the Unknown Professor addresses these questions with two answers. In his first entry, he explains the teaching side of the equation and in the second entry he explains how research works.

From the teaching essay:

"There are two main differences between teaching and research schools: the normal teaching load and the expectations of the amount of research (i.e. publishing) you'll have to do to get tenure. A finance professor at a typical research school teaches a "2/2" load - that is, 2 classes in the fall, and two in the spring. For most schools, this means two or three "preps" a year."

(For comparison, I think I have 4/4 and 5 preps this year, but SBU is known as a teaching school and we have a small department and have someone on sabbatical.)

From the research essay:

"For empiricists like myself, a research project always starts with a question, like "how does the makeup of the board affect a firm's performance?", or "do firms back date their options?" The next step is to gather some data, run a number of statistical tests, write up the results, and then send the paper off to a journal. The whole process can be pretty time consuming, since you often don't know what you'll need to do until you're in the thick of it (new research is, by definition, untrod territory)."

and then later:

"Often the paper is rejected (either up front or after several rounds) at the first journal you send it to. At this point you submit it to another journal, and so on. This process can take quite some time. It's not uncommon for a couple of years to go by between the time a project is started and when it's it a study to take paper to take a well over a year. In fact, a colleague just told me she got a piece published that she started in 1990, and had sent to 6 different journals over the years. Now THAT's determination."

It is definitely worth reading all of each essay!

See, while being a financeprofessor is great, it is not necessarily as easy as you think! ;)