tag:blogger.com,1999:blog-29692358369742076432024-03-13T21:07:01.445-07:00Access to FinanceThe goal of this blog is to make academic finance research accessible to a wide audience,
in particular people with non-finance backgrounds who might not normally be interested in finance. This idea spun out of the "Extra-Curricular Topics" I teach in my MBA classes, a 10-minute interlude where I teach an academic paper with significant real-world relevance.
In addition to academic research, I also aim to feature real-world events (e.g. the current economic outlook or an M+A deal).Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.comBlogger21125tag:blogger.com,1999:blog-2969235836974207643.post-42589296692746966502016-02-21T14:01:00.004-08:002016-02-21T14:01:56.682-08:00This blog has been moved to www.alexedmans.com/blog<div dir="ltr" style="text-align: left;" trbidi="on">
Thank you very much to everyone who has been reading my blog. Now that I have launched my own website, going forwards the blog will be integrated into the website and all new posts will be made there. The new website is www.alexedmans.com/blog.</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com1tag:blogger.com,1999:blog-2969235836974207643.post-37073160348024113312015-09-06T06:05:00.001-07:002015-09-06T06:06:10.376-07:00Using Behavioral Economics to Keep Resolutions<div dir="ltr" style="text-align: left;" trbidi="on">
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In 2010, David Cameron set up the “Behavioral Insights Team” (nicknamed the “Nudge Unit”) to use behavioural economics to “nudge” individuals to take superior decisions for themselves and society, e.g. save more, register as organ donors, or give to charity. It uses Randomized Control Trials (RCTs) to find the method that best works – similar to clinical trials in medicine. The establishment of BIT was inspired by Cameron reading the book “Nudge” by Richard Thaler and Cass Sunstein, and Thaler (one of the pioneers of behavioural economics) was heavily involved. BIT had their annual “Behavioural Exchange” <a href="http://www.bx2015.org/" style="border: 0px rgb(225, 225, 225); box-sizing: border-box; color: #0e7291; font-family: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; max-width: 100%; outline: 0px; padding: 0px; vertical-align: baseline;">conference</a> in Westminster in September 2015 and I was privileged to give a shortened version of my <a href="http://bit.ly/csrtedx" style="border: 0px rgb(225, 225, 225); box-sizing: border-box; color: #0e7291; font-family: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; max-width: 100%; outline: 0px; padding: 0px; vertical-align: baseline;">TEDx </a>talk showing that social responsibility improves profit, in contrast to the conventional view that it’s at the expense of profit. But, the greater privilege was the chance to learn from the leading behavioural thinkers in the world, e.g. Thaler, Daniel Kahneman (Nobel Laureate), Dan Ariely (author of Predictably Irrational), Hal Varian (Chief Economist of Google). Over the next few blog posts I will share the leading insights of the conference.<br />
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Today I’ll start with what I thought to be the single most powerful idea, which I immediately started using in my own life. It’s from Dan Ariely, one of my favorite behavioral thinkers and giver of some of my very favorite TED talks (<a href="http://alexedmans.com/top-ten-ted-talks/" style="border: 0px rgb(225, 225, 225); box-sizing: border-box; color: #0e7291; font-family: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; max-width: 100%; outline: 0px; padding: 0px; vertical-align: baseline;">here</a> is a blog post on my top 10 TED talks). It was in a session entitled “Nudging for International Development” – but the idea turned out to be one that you can apply just as much to individual habits as world economic problems.<br />
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Here’s the experiment he ran. He used a RCT to study the best way to persuade adults in a developing country to save money. Here are the different treatments he used:<br />
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1) A text message saying “Please try to save 100 shillings by the end of the week”<br />
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2) A text message signed by their kids saying “Hey Mom/Dad, please try to save 100 shillings by the end of the week”. (The text still came from the experimenters – the parents knew that their kids don’t have cellphones – but signing it with their kids’ names prompted them to think of their kids when making the saving decision).<br />
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3) A 10% or 20% post-match – i.e. the experimenter gave you an extra 10% or 20% (depending on the treatment) of what you saved by the end of the week.<br />
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4) A 10% or 20% pre-match. Similar to the above, but you’re given the bonus at the start of the week, and it’s taken away from you if you fail to save 100 shillings. This is intended to exploit the “endowment effect”. People value something more highly if they have it than if they don’t, so giving them a reward and threatening to take it away may be more powerful than giving it at the end.<br />
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5) A gold coin. At the end of the day, you used the coin to scratch either a “Yes” or “No” box according to what you saved that day.<br />
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Dan asked the audience which they thought worked the best. The audience seemed split between 2), 4), and 5) (with a bit less suggesting 3). But, the coin turned out to be the most effective by a substantial margin. Here’s why. The coin scratch is much more salient and timely. The bonus pays off only at the end of the week. So, it encourages procrastination – you can spend today, and dupe yourself into thinking you’ll save tomorrow. The same goes for the text message – you think you’ll recover and still hit the weekly target. The coin scratch encourages you to save every day. And it “gamifies” saving. Adults feel they’ve achieved something when, at the end of the day, they scratch the “Yes” box. Note that, if they don’t save, they don’t simply do nothing – they’re asked to actively scratch the “No” box, i.e. admit to themselves that they’ve failed to save.<br />
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Although Dan didn’t explicitly draw the implications for our own lives (he only had 8 minutes), I thought that this is something we can instantly apply to develop good habits. That same evening, I created a spreadsheet with a list of things that I would like to achieve each day. Every day, at the end of the day, I have to put a tick or a cross according to whether I’ve achieved it. These goals will vary from person to person, but I’m happy to share a few of mine:<br />
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1) Did I end the day with zero emails in my inbox? Typically, I don’t, which leads to the inbox getting more and more cluttered over time. (Note, this doesn’t mean I reply to every email – that’s unrealistic – but I file them for future reply by a particular deadline. See an earlier blog post, “<a href="http://alexedmans.com/time-management-tips-to-boost-your-productivity/" style="border: 0px rgb(225, 225, 225); box-sizing: border-box; color: #0e7291; font-family: inherit; font-size: inherit; font-stretch: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; max-width: 100%; outline: 0px; padding: 0px; vertical-align: baseline;">Time Management Tips to Improve Your Productivity</a>“, for more on dealing with email).<br />
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2) Did I go to bed before midnight? If I don’t, I don’t just write a cross, I have to write the number of minutes I exceeded the target by. This is to avoid what Dan called in another session the “what the hell” effect – if I know I’ve missed the deadline, I might as well stay up until 3am.<br />
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3) Did I do athletics practice today? (plus a similar box for music practice). We often set resolutions to lose weight, or get better at the guitar. But, these are long-term goals; without daily accountability, they get deprioritized.<br />
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4) How many times did I check my iPhone that day? I have an app called Checky which records the number of times I check my phone. I try to get below 20 each day.<br />
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5) How much time did I spend on my iPhone that day? Tracked with an app called Moment.<br />
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Can a silly little tick or cross – on a sheet of paper no-one else sees – really affect how grown adults behave? Can something intellectually equivalent to a gold star we give to kids make a big difference? Actually, yes. As emphasized by one of my favorite authors Stephen Covey (especially in his books “7 Habits of Highly Effective People” and “First Things First”), people act differently when they keep score. You run faster if you’re carrying a Garmin, you row faster if the display shows your split time. No-one else sees these things but you, but they make a big difference. If you play a racket sport, you’ll play differently in an actual game versus just hitting about, even though only you and your opponent see the score and the score has zero effect on your life. People (including me) invest time playing Fantasy Football even though you win absolutely nothing and the game doesn’t matter – because the score has meaning. So, why don’t we apply the idea of scorekeeping to things that do matter?</div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com1tag:blogger.com,1999:blog-2969235836974207643.post-31218398908451295032015-04-26T03:11:00.003-07:002015-04-26T03:17:23.677-07:00Predicting Mutual Fund Performance Using (Legal) Inside Information<div dir="ltr" style="text-align: left;" trbidi="on">
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<span style="font-family: Arial, Helvetica, sans-serif;">How does an investor choose which mutual fund to
invest in? She’ll want a measure of the fund manager’s skill, and the most
natural measure is his past performance. But, a ton of research has
systematically found that past performance doesn’t predict future performance –
it’s irrelevant in choosing a mutual fund.<o:p></o:p></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">How can this be? One interpretation is that fund
managers aren’t skilled to begin with, and instead any good performance is due
to luck. The thinking goes as follows. Skill is permanent. If good past
performance were due to skill, performance should stay strong in the future.
But, luck’s temporary. If good past performance were due to luck,
performance should revert to the average in the future. Since future
performance appears unpredictable, this seems to support the luck explanation.
This has huge implications for investors – if mutual fund managers indeed have
no skill, there’s no point paying the high fees (around 1.5% per year)
associated with actively-managed funds. Instead, put your money in passive
index funds (where fees can be as low as 0.1%). Perhaps due to this thinking,
passive index funds have grown substantially in recent years.<o:p></o:p></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">But an influential 2004 <a href="http://finance.martinsewell.com/fund-performance/BerkGreen2004.pdf"><span style="color: blue;">paper</span></a> by Jonathan Berk (Stanford) and Rick Green (Carnegie Mellon)
reached a different conclusion. Fund managers are skilled, and good past
performance <i>is</i> a signal of skill. But, because everyone else
is trying to invest with a skilled manager, managers with good past performance
enjoy a flood of new funds coming in. This increases the fund manager’s assets
under management (AuM) and thus his fees (which are a percentage of AuM) and so
he won’t discourage the new flows. But, it will worsen his performance next
year, because of diminishing returns to scale in investing. The manager has to
put the new funds to work. But, he’s already investing in his top stock picks.
He can’t put all of the new money in the same stocks, because there’s not
enough liquidity in the market to accommodate this extra demand. So, he’ll have
to choose his next-best picks, which will do worse. Thus, even though past
performance is an indicator of skill, it’s not an indicator of future
performance.<o:p></o:p></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">What’s the problem here? The analogy is choosing an
individual stock. Choosing a stock on the basis of an attractive characteristic
that’s known to everyone (e.g. buying Facebook because it’s a leader in social
media) won’t be fruitful. Since everyone else is aware of that characteristic,
they will have bought into the stock and driven the stock price up – the
“Efficient Markets Hypothesis”. Similarly, identifying fund manager skill using
a dimension that’s known to everyone (e.g. past performance) is also not
fruitful. Since everyone else is aware of past performance, they will have
bought into the fund and driven its AuM up, worsening its future performance.<o:p></o:p></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">The key to picking a stock is thus to identify
positive attributes that might aren’t known to others. Similarly, the key to
choosing a mutual fund is to find a measure of skill that isn’t known to others
– to have a measure of skill based on private (but legal) inside information.
This is where an ingenious new <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2409915"><span style="color: blue;">paper</span></a> by Jonathan, together with Jules van Binsbergen (Wharton) and
Binying Liu (Kellogg), entitled “Matching Capital and Labor”, comes in.</span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">A mutual fund is part of a fund family. For
example, the Fidelity South East Asia Fund and the Fidelity Low Priced Stock
Fund are both part of Fidelity. One of Fidelity’s jobs as a fund family is to
evaluate the performance of each fund manager, to decide whether to promote her
(i.e. give her an additional fund to manage, or move her to a larger fund) or
demote her (take away one of her funds). They have access to a ton of
information over and above past performance figures – just like scouting out a
baseball player gives you much more information than you’d get from the
statistics. For example, they can engage in subjective evaluations of her
performance based on on-the-job observation, or assess whether poor performance
might actually be due to good long-run investments that just haven’t paid off
yet. Thus, a promotion signals positive
private information, and a demotion signals negative private information. </span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">As an example, take Morris Smith. He joined Fidelity in 1982 and, from 1984-6, ran Fidelity's Select Leisure Fund, which soared from $500k to $350m under his management. In 1986 he was promoted to the Fidelity Over-the-Counter Fund and managed an average of $1b. After further good performance he was promoted to Fidelity's flagship fund in 1990 with assets of $13b.</span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">In short, by observing promotion and demotion
decisions (which we can, using data sources such as Morningstar and CRSP), we
can infer the fund family’s private information.<o:p></o:p></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;">Jonathan, Jules, and Binying find that:</span></div>
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<li><span style="font-family: Arial, Helvetica, sans-serif; text-indent: -0.25in;">Promotion and demotion decisions can’t be predicted
using data on past performance. In other words, observing such decisions gives
investors, additional information over and above what we’d get from past
performance figures. It allows us to (legally) infer the fund family’s private
information.</span></li>
<li><span style="font-family: Arial, Helvetica, sans-serif;"><span style="text-indent: -0.25in;">Promotion and demotion
decisions both increase the fund manager’s value added.</span><span style="text-indent: -0.25in;"> </span><span style="text-indent: -0.25in;">The authors measure value added using a
metric introduced by an earlier paper by Jonathan and Jules.</span><span style="text-indent: -0.25in;"> </span><span style="text-indent: -0.25in;">This equal’s the fund’s “gross alpha” (its
actual return before fees and expenses, minus the return from passively holding
the benchmark) multiplied by its assets under management (“AUM”).</span><span style="text-indent: -0.25in;"> </span><span style="text-indent: -0.25in;">This gives a dollar measure of how much value
is added (or subtracted) by active management.</span><span style="text-indent: -0.25in;">
</span><span style="text-indent: -0.25in;">That both promotions and demotions increase future value added suggests
that promotions give more capital to a skilled manager who can use it
effectively, and demotions pull the plug from an unskilled manager who was
using capital wastefully.</span><span style="text-indent: -0.25in;"> </span><span style="text-indent: -0.25in;">Thus, the
information that promotion/demotion decisions give is not only </span><i style="text-indent: -0.25in;">incremental</i><span style="text-indent: -0.25in;"> (to
past performance), but also </span><i style="text-indent: -0.25in;">useful</i><span style="text-indent: -0.25in;">.</span></span></li>
<li><span style="font-family: Arial, Helvetica, sans-serif;"><span style="text-indent: -0.25in;">It’s inside information
that drives the results.</span><span style="text-indent: -0.25in;"> </span><span style="text-indent: -0.25in;">“External”
promotions or demotions (a manager leaving to a new fund family and managing a
fund with higher or lower AUM than he did before) have no effect on future
value added.</span></span></li>
<li><span style="font-family: Arial, Helvetica, sans-serif; text-indent: -0.25in;">These effects are large. The fund family’s decision
to promote or demote a manager adds value of $715,000 per manager per month.
Thus, 30% of the value that a mutual fund manager adds comes from the fund
family giving her the right amount of capital.</span></li>
</ol>
<span style="font-family: Arial, Helvetica, sans-serif;">Why doesn’t the decision to give a manager a second
fund lead to the problem in Berk/Green, that the fund manager now has too much
money under her control? Because, the fund family – through its extensive
monitoring – estimates the optimal amount of funds to give each manager. It
chooses to promote managers who previously had been underallocated funds, so
that promotion does not lead to the problem of diminishing returns to scale.</span><br />
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<span style="font-family: Arial, Helvetica, sans-serif;">Decades of academic research have failed to find an
answer to one of the most important practical questions for investors – how to
predict mutual fund performance. Jonathan, Jules, and Binying may have just
found a way.</span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com1tag:blogger.com,1999:blog-2969235836974207643.post-67555565207838721142015-02-15T15:20:00.002-08:002015-02-21T01:31:58.102-08:00If Money Doesn't Buy You Happiness, You're Not Spending It Right<div dir="ltr" style="text-align: left;" trbidi="on">
A good chunk of traditional finance research teaches us how to make money, such as optimal investment strategies. But, there's very little on how to spend it. Studies show surprisingly little relationship between money and happiness. One interpretation is that things that make you truly happy can't be bought - but money can allow people to afford healthier food, better medical care, more varied pastimes, better education, and leisure time with friends and family. So an alternative interpretation is that people don't know how to spend it.<br />
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That's where behavioral economists and psychologists come in. Elizabeth Dunn (UBC), Daniel Gilbert (Harvard) and Timothy Wilson (Virginia)'s excellent <i>Journal of Consumer Psychology </i>article, "<a href="http://www.wjh.harvard.edu/~dtg/DUNN%20GILBERT%20&%20WILSON%20%282011%29.pdf">If Money Doesn't Make You Happy, Then You Probably Aren't Spending It Right</a>" surveys a ton of research and distills it to eight succinct guidelines. I summarize five of them here.<br />
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1) Buy More Experiences and Fewer Material Goods.<br />
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People who fritter their money away on holidays or expensive dinners are seen as wasteful, as there's nothing to show for it afterwards. Renovating your house or buying a better car are more prudent. But, it's actually the former that has the greater effect than happiness. We adapt to things (such as a new conservatory or a flashier car) quickly. But, the memory of an experience (e.g. an African safari) remains with you long after the fact, and the anticipation of the experience also bring utility.<br />
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Moreover, "mindfulness" studies systematically find that unhappiness is correlated with mind-wandering. Experiences absorb you and keep you focused on the here and now, but you can be distracted by a dozen things while driving your car.<br />
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2) Spend Money on Others Rather Than Yourself.<br />
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Scientists believe that one major reason for humans' large brain size is that we are more social than nearly any other animal. Thus, our happiness depends markedly on the quality of our social relationships. The "prosocial behavior" literature consistently finds that subjects report greater happiness after spending money on others rather than themselves - even though they anticipated that they would be happier doing the latter.<br />
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3) Buy Many Small Pleasures Instead Of Few Large Ones.<br />
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A variety of frequently small pleasures (in the authors' words, "double lattes, uptown pedicures, and high thread-count socks") dominate one big-ticket purchase, such as a front-row concert ticket. This is the well-known economic principle of diminishing marginal utility - a two-week vacation is less enjoyable than two separate one-week vacations. Indeed, studies show that happiness is more associated with the frequency rather than intensity of experiences.<br />
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The main reason is the surprise factor of a new experience. Two smaller vacations allow you to explore two different places. Moreover, variety exists even for "everyday" experiences - a beer after work is never the same as the last one, since it will feature different people and different conversations.<br />
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4) Buy Less Insurance<br />
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This principle doesn't just apply to literal insurance, e.g. over-priced extensive warranties, but also the "insurance" that comes with a generous return policy. Customers prefer Amazon to eBay and Craigslist, despite it being more expensive, because of the option to return a product they don't like. But, as Dan Gilbert discussed in his excellent TED talk <a href="https://www.youtube.com/watch?v=4q1dgn_C0AU">The Surprising Science of Happiness</a> (see <a href="http://alexedmans.blogspot.co.uk/2014/04/top-ten-ted-talks.html">here</a> for my list of top ten TED talks), whether we like something or not doesn't just depend on the item's attributes - we can consciously choose to like it. Indeed, studies show that you like an item more if you don't have the option to return it.<br />
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5) Beware of Comparison Shopping<br />
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Websites allow you to compare products on tiny details, which leads to consumers fixating on very small differences and ignoring the similarities on the major characteristics. They can thus miss the forest for the trees and choose the wrong product based on a minor attribute. In addition, doing so wastes substantial time on minutiae, particularly since we typically grow to end up liking the product we buy anyway if its major characteristics are correct (see point 4). </div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com3tag:blogger.com,1999:blog-2969235836974207643.post-53122025318724993562015-01-25T05:27:00.000-08:002015-01-25T05:34:09.363-08:00Dangers of Using a Company-Wide Discount Rate<div dir="ltr" style="text-align: left;" trbidi="on">
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<span style="font-family: "Arial",sans-serif;">Any Finance 101 class will emphasize that the appropriate discount rate for a project depends on the project’s own
characteristics, not the firm as a whole. If a utilities firm moves into media
(e.g. Vivendi), it should use a media beta - not a utilities beta - to
calculate the </span><span style="font-family: Arial, sans-serif;">discount rate </span><span style="font-family: "Arial",sans-serif;">. However, a survey found that 58% of firms use a single
company-wide </span><span style="font-family: Arial, sans-serif;">discount rate </span><span style="font-family: "Arial",sans-serif;">for all projects, rather than a </span><span style="font-family: Arial, sans-serif;">discount rate </span><span style="font-family: "Arial",sans-serif;">specific to the
project’s characteristics. Indeed, when I was in investment banking, several clients would use their own cost of capital to discount a potential M&A target's cash flows. </span></div>
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<span style="font-family: "Arial",sans-serif;">But the
important question is – does this really matter? Perhaps an ivory-tower
academic will tell you the correct weighted average cost of capital (WACC) is 11.524% but if you use 10%, is that
good enough? Given the cash flows of a project are so difficult to estimate to
begin with, it seems pointless to “fine-tune” the WACC calculation. <o:p></o:p></span></div>
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<br /></div>
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<span style="font-family: "Arial",sans-serif;">An interesting
paper, entitled “<a href="http://ssrn.com/abstract=1764024">The WACC Fallacy: The Real Effects of Using a Unique Discount Rate</a>”, addresses the question. The paper is forthcoming in the <i>Journal of Finance</i> and co-authored </span><span lang="EN-GB" style="font-family: Arial, sans-serif;">by </span><span style="font-family: Arial, sans-serif;">Philipp Krueger of
Geneva, Augustin Landier of Toulouse and David Thesmar of HEC Paris. </span></div>
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<span style="font-family: "Arial",sans-serif;">This paper
shows that it matters. The authors first looked at organic investment (capital expenditure, or "capex"). If your
core business is utilities and the non-core division is media, you should be
using a media discount rate for non-core capex. But, if you incorrectly use a
utilities discount rate, the discount rate is too low and you'll be taking too
many projects. The authors indeed find that capex in a non-core division is
greater if the non-core division has a higher beta than the core division.
Moreover, they find the effect is smaller (a) in recent years, consistent with
the increase in finance education (e.g. MBAs), (b) for larger
divisions – if the non-core division is large, then management puts the effort
into getting it right, (c) when management has high equity incentives, as these also give them incentives to get it right.<o:p></o:p></span></div>
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<br /></div>
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<span style="font-family: "Arial",sans-serif;">The authors then turn
to M&A. They find that conglomerates tend to buy high-WACC targets rather
than low-WACC targets, again consistent with them erroneously using their own
WACC to value a target, when they should be using the target’s own high WACC.
Moreover, the attraction of studying M&A is the authors can measure the stock
market’s reaction to the deal, to quantify how much value is destroyed. They find
that shareholder returns are 0.8% lower when the target’s WACC is higher than
the acquirer’s WACC. They study 6,115 deals and the average acquirer size is
$2bn. Thus, the value destruction is 0.8% * $2bn * 6,115 = $98bn lost to
acquirers in aggregate because they don’t apply a simple principle taught in Finance 101!</span></div>
<br />
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<span style="font-family: "Arial",sans-serif;">We often wonder whether textbook finance theory is relevant in the real world – perhaps you don’t need the “academically” right answer and it's sufficient to be close enough. But t</span><span style="font-family: Arial, sans-serif;">his paper shows that “getting it right” does make a big difference.</span><span style="font-family: Arial, sans-serif;"> </span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com1tag:blogger.com,1999:blog-2969235836974207643.post-18232741794602130802014-11-21T06:16:00.002-08:002014-11-22T04:49:37.382-08:00Why Banks Should Use Less Debt Financing<div dir="ltr" style="text-align: left;" trbidi="on">
In the aftermath of the financial crisis, there have been numerous calls for banks to finance themselves less with debt and more with equity, to reduce the risk of another crisis. But this has been met with great resistance by bankers. They argue that equity is costlier than debt, and so forcing them to use more equity will make it more expensive for them to raise capital. If they can't raise as much capital, they won't be able to lend as much to small businesses and homeowners; if it's more expensive to raise capital, they'll need to take on riskier projects to generate a high enough return to meet their cost of capital. For example, Jamie Dimon of JP Morgan has said (paraphrased): "If they force us to hold more equity, we will have to take on riskier projects to hit our required return on equity".<br />
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The Modigliani-Miller theorem, taught in undergrad or MBA finance 101, tells us that (under certain conditions), firm value is independent of capital structure - equity is no more costly than debt. Indeed, Jamie Dimon's seemingly intuitive argument involves not one, not two, but three violations of basic finance theory:<br />
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<ol style="text-align: left;">
<li>It treats the required return on equity as a constant (as if it were pi or Avogadro's number). But, basic finance theory tells us that it depends on <i>financial risk</i>. If the firm is financed by more equity, it's less risky, and so shareholders demand a lower return on equity. Banks won't need to take on more risk, because the target will have fallen.</li>
<li>Basic finance theory tells us that the required return on equity also depends on <i>business risk</i>. If the firm "takes on riskier projects", shareholders will demand a higher return as a result. Thus, banks won't have an incentive to take on more risk, because this will cause the target to rise.</li>
<li>Equity is not something that you "hold". It doesn't sit idly on the balance sheet doing nothing - the bank can invest or lend the money raised by equity. Equity isn't an asset, it's a liability - it's how a bank finances itself. If a firm finances itself with equity rather than debt (changes its liability mix), it needn't change the projects it invests in (its asset mix).</li>
</ol>
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The fallacies inherent in most bankers' arguments are exposed in Anat Admati and Martin Hellwig's influential book "<a href="http://bankersnewclothes.com/">The Bankers' New Clothes</a>"; see this <a href="http://www.gsb.stanford.edu/faculty-research/excessive-leverage">link</a> for non-technical articles on this topic. However, some bankers may counter that the Modigliani-Miller theorem doesn't hold in the real world. There are valid reasons for why it's advantageous to finance with debt rather than equity - debt gives tax shields, and incentivizes management to work harder to avoid bankruptcy.<br />
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But a new <a href="http://ssrn.com/abstract=2280453">paper</a> by Roni Kisin and Asaf Manela of the Olin School of Business at Washington University in St. Louis exposes these arguments - using banks' own actions! They find that bankers' own behavior suggests that they don't view debt as useful - that the above advantages of debt are small in the real world. Their identification is clever. They exploit the fact that, prior to the crisis, banks had access to a loophole - asset-backed commercial paper conduits (a form of securitization) that allowed them to lower their equity capital requirements by 90%.<br />
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Using these conduits was costly - the interest rate on asset-backed commercial paper is higher than that on directly-issued commercial paper (which didn't benefit from the loophole). Thus, banks traded off the benefits (of reducing equity capital requirements) with the costs of using the conduit. If financing themselves with equity, rather than debt, truly was costly, banks would have used the conduits to a large degree - particularly since the availability of the loophole was well-known to all banks.<br />
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But they didn't. Roni and Asaf estimate that, based on the limited usage of these conduits, it's not costly for banks to finance themselves with equity. Even if banks were to increase their equity ratios from 6% to 16%, this would cost all U.S. banks in aggregate $3.7 billion. The average cost per bank is $143 million, or 4% of annual profits. Lending interest rates would rise by 0.03% and quantities would decrease by 1.5%. While the above numbers are not small, they are far lower than the numbers branded around by bankers, and arguably a small price to pay to substantially reduce the risk of another crisis.<br />
<br />
One caveat is that the authors are clear that they quantify the cost of increasing <i>equity capital requirements</i>, rather than the cost of increasing <i>equity capital</i>. It may be that the cost of increasing equity capital requirements is low, not because the cost of raising equity is low, but because banks have other ways of complying with the requirements (e.g. other loopholes, or changing the riskiness of the assets they invest in). Nevertheless, the paper provides innovative evidence that increasing capital requirements is much lower than what many banks claim.</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com2tag:blogger.com,1999:blog-2969235836974207643.post-57574351339582877942014-10-25T01:06:00.000-07:002014-10-25T01:06:45.206-07:00How Corporate Credit Ratings Induce Short-Termism<div dir="ltr" style="text-align: left;" trbidi="on">
Credit rating agencies were under particular scrutiny in the recent financial crisis, as critics argue they gave too high ratings to securities that turned out to be toxic. One potential culprit is the "issuer-pays" model, where it is the company being rated that pays for credit ratings, which may encourage rating agencies to be overly-generous to win business.<br />
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But, a recent <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2404290">paper</a> by my new LBS colleague <a href="http://www.taylorbegley.com/">Taylor Begley</a> points to an important additional cost of corporate credit ratings - and one that arises even if ratings are perfectly accurate. Companies may engage in short-term behavior to achieve a particular credit rating. This problem arises because credit ratings are discrete categories (e.g. AAA, AA+, BB) rather than a continuous number (e.g. 93.2, 87.8). Thus, a company has a strong incentive to just get into the AAA- category than be at the top of the AA+ category.<br />
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In turn, a major driver of credit ratings is a company's financial ratios. For example, for firms with an excellent business risk profile, a Debt/EBITDA ratio of 1.5-2.0 typically leads to a rating of AA; a ratio of 2.0-3.0 typically leads to a rating of A. For firms with a fair business risk profile, a Debt/EBITDA ratio of 1.5-2.0 typically leads to a rating of BBB-; a ratio of 2.0-3.0 typically leads to a rating of BB+ (which is below investment-grade, i.e. has "junk" status). (Source: Standard & Poor's Business Risk / Financial Risk Matrix). <br />
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These discrete thresholds thus give companies incentives to be lie just below a threshold. They can achieve this by short-term behavior such as cutting research and development (R&D). This increases EBITDA, thus reducing the Debt/EBITDA ratio and potentially meeting the threshold. Importantly, the incentives to engage in short-termism depend on where the firm is compared to the next lowest threshold. A firm with a Debt/EBITDA ratio of 2.1 has strong incentives to engage in short-termism, because it has a high chance of being able to lower it to below 2.0, but a firm with a Debt/EBITDA ratio of 2.5 has much weaker incentives. Taylor indeed finds that firms close to a threshold are significantly more likely to cut not only R&D, but also selling, general, and administrative (SG&A) expenses, which contains expenditure in advertising, information technology, employee training, and other forms of organizational capital.<br />
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Other papers have previously found evidence of short-termism to meet other types of thresholds - for example, companies may cut R&D to ensure their earnings fall just above analyst earnings expectations. But a particularly novel finding of this paper is that Taylor is able to document negative long-run effects of such short-termism. Companies close to ratings thresholds subsequently suffer declines in the number of patents that they produce, and also the number of citations to their patents (a measure of the quality of innovation). They also experience declines in profitability and valuation ratios. <br />
<br />
The cost of credit ratings that critics typically focus upon is that inaccurate ratings lead to redistributional consequences. If the ratings of a security are too high, the buyer pays too much for them. Thus, the seller wins and the buyer loses. While these redistributional concerns are clearly very important, they don't directly affect the overall size of the pie (sellers get a larger slice, buyers a smaller slice). In contrast, Taylor shows that credit ratings have efficiency (rather than just redistributional) consequences - they affect the overall size of the pie. If companies cut investment to meet ratings thresholds, they erode their future value, making everyone worse off in the long-run. This is a particular concern for the 21st century firm, whose value is especially driven by intangible assets (such as brand strength, innovative capabilities, and corporate culture) which requires several years to build and bear fruit.<br />
<br />
The paper certainly does not argue that credit ratings should be scrapped; these costs must be weighed against their numerous benefits. Many financial targets (e.g. analyst earnings expectations) also have the potential to lead to short-termism. Rather, the paper highlights a potential cost to credit ratings that boards may be able to mitigate. One potential remedy that discussed in a <a href="http://alexedmans.blogspot.co.uk/2014/10/reforming-ceo-pay-dangers-of-short-term.html">previous post</a> is to increase the vesting period of executives' stock and options, to tie them to the long-run performance of the firm. </div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-20667355067193913712014-10-12T04:59:00.000-07:002014-10-12T04:59:01.036-07:00Reforming CEO Pay - The Dangers of Short-Term Incentives<div dir="ltr" style="text-align: left;" trbidi="on">
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<i style="font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit;">(This post originally appeared on <a href="https://www.linkedin.com/pulse/article/20140903105343-997955-reforming-ceo-pay-the-dangers-of-short-term-incentives">LinkedIn</a>)</i></div>
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Executive pay is a high-profile topic about which almost everyone has an opinion. Many shareholders, workers, and politicians believe that the entire system is broken and requires a substantial overhaul. But, despite being well-intentioned, their suggested reforms may not be targeting the elements of pay that are most critical for shareholder value and society.</div>
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<em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Level 1 Thinking: The Level of Pay</em></div>
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Much of the debate is on what I call a Level 1 issue - the <em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">level </em>of pay. For example, in September 2013, the SEC mandated disclosure of the ratio of the CEO’s pay to the median employee’s pay. The European Commission is contemplating going further and requiring a binding vote on this ratio. Separately, proposals to increase taxes – most prominently made by Thomas Piketty – are a response to seemingly excessive pay levels.</div>
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While high taxes or ratio caps would indeed address income inequality (an important topic, but beyond the focus of this article), it's very unclear that they would do much to improve shareholder (or stakeholder) value. The levels of CEO pay, while very high compared to median employee pay – and thus a politically-charged issue – are actually very small compared to total firm value. For example, median CEO pay in a large US firm is $10 million – only 0.05% of a $20 billion firm. That’s not to say that it’s not important – a firm can't be blasé about $10 million – but that other dimensions may be more important.</div>
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<em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Level 2 Thinking: The Sensitivity of Pay</em></div>
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Instead, what matters for firm value isn't the level of pay, but the incentives that it provides to CEOs: as Jensen and Murphy (1990) famously argued, “it’s not how much you pay, but how”. Level 2 thinking studies the <em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">sensitivity</em> of pay to performance. Specifically, it looks at how much of a manager’s total pay is comprised of stock and options (which are sensitive to firm value) rather than cash salary (which is less so). As the thinking goes, greater stock and options align the CEO more with shareholders and thus provide superior incentives. Indeed, Jensen and Murphy bemoaned the low equity incentives at the time as evidence that CEOs were “paid like bureaucrats”.</div>
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However, while seemingly intuitive, the idea that better-incented CEOs perform better is unclear. Out of all the banks, Lehman Brothers had arguably the compensation scheme closest to what Level 2 thinkers argued is the ideal – very high employee stock ownership. Using a larger sample, Fahlenbrach and Stulz (2011) “find some evidence that banks with CEOs whose incentives were better aligned with the interests of shareholders performed worse and no evidence that they performed better.” Indeed, the European Commission has recently capped banker bonuses at two times salary, seemingly reducing bankers’ incentives to perform well – but also reducing their punishment if things go badly.</div>
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<em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Level 3 Thinking: The Structure of Pay</em></div>
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The concern with high equity incentives is that they encourage CEOs to pump up the short-term stock price at the expense of long-run value – for example, writing sub-prime loans and then cashing out their equity before the loans become delinquent. But, the root cause of this problem isn't the amount of stock and options that the CEO has, but their vesting horizon – whether they vest in the short-term or long-term, and thus whether they align the CEO with short-term or long-term shareholder value. Level 3 thinking thus focuses on the <em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">structure</em> of pay.<a href="https://www.blogger.com/null" rel="nofollow" style="border: 0px; box-sizing: border-box; color: #0077b5; font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;" target="_blank"><br style="box-sizing: border-box;" /></a></div>
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There's anecdotal evidence that horizons mattered in the financial crisis. Angelo Mozilo, the former Countrywide CEO, made $129 million from stock sales in the twelve months prior to the start of the crisis; a <em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Wall Street Journal</em> article entitled “Before the Bust, These CEOs Took Money Off the Table” documented similar practices among other bank CEOs. But, we can't form policy based on a handful of anecdotes - it's important to undertake a systematic study.</div>
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<span style="font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit;">In </span>this <a href="http://ssrn.com/abstract=2270027" rel="nofollow" style="border: 0px; box-sizing: border-box; color: #7b539d; font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;" target="_blank">paper</a><span style="font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit;">, Vivian Fang (Minnesota), Katharina Lewellen (Dartmouth) and I study how a CEO behaves in years in which he has a significant amount of shares and options vesting. CEOs typically sell their equity upon vesting to diversify, and so vesting equity makes them particularly concerned about the short-term stock price.</span></div>
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We find that, in years in which the CEO has significant equity vesting, he cuts investment in many forms - R&D, advertising, and capital expenditure. Moreover, in these years, he's more likely to exactly meet or just beat analyst earnings’ forecasts – if the forecast is $1.27 per share, he reports earnings of $1.27 or $1.28. Indeed, the magnitude of the investment cuts is just enough to allow the CEO to meet the target. Thus, vesting equity induces the CEO to act myopically – to cut investment to meet short-term targets. These results are robust to controlling for the CEO’s other equity incentives, such as his unvested equity and voluntary holdings of already-vested equity.</div>
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In this <a href="http://ssrn.com/abstract=2489152" rel="nofollow" style="border: 0px; box-sizing: border-box; color: #7b539d; font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;" target="_blank">paper</a>, Luis Goncalves-Pinto (National University of Singapore), Yanbo Wang (INSEAD), Moqi Xu (LSE) and I show that, in months in which the CEO has vesting equity, he releases more news. This is an easy way to pump up the short-term stock price, as news attracts attention to the stock. This attention also increases trading volume, which allows the CEO to cash out his equity in a more liquid market. Indeed, we find that these news releases lead to significant increases in the stock price and trading volume in a 16-day window, but the effect dies down over 31 days, consistent with a temporary attention boost. The median CEO cashes out all of his vesting equity within 7 days, so within the window of inflation.</div>
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The increase in news releases only relates to discretionary news (such as conferences, client and product announcements, and special dividends), which are within the CEO’s control, and not non-discretionary news (such as scheduled earnings announcements). Moreover, the CEO reduces discretionary news releases in both the month before and the month after the vesting month, suggesting a strategic reallocation of news into the vesting month and away from adjacent months. In addition to releasing more news items in the vesting month, the CEO releases more positive news – media articles immediately following these news releases contain significantly more positive words than normal.</div>
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<em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Why Do We Care?</em></div>
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Both consequences of vesting equity are important. Investment is critical to the long-run health of a company. Indeed, in the 21st century, most firms compete on product quality rather than cost efficiency, for which intangible assets – such as brand strength and innovative capabilities – are particularly important. Building such intangibles requires sustained investment, particularly in R&D and advertising. Moving to news, many stakeholders, such as employees, suppliers, customers, and investors, base their decision on whether to initiate, continue, or terminate their relationship with a firm on news, or on stock prices that are affected by news. In addition to these efficiency consequences, news also has distributional consequences by affecting the price at which shareholders trade. Indeed, Regulation FD aims to “level the playing field” between investors by prohibiting selective disclosure of information. Public news releases to all shareholders achieve this goal – but the CEO may delay news until months in which he has vesting equity.</div>
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<em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">What Can Be Done?</em></div>
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One solution is to lengthen vesting periods. While increasing vesting horizons from (say) 3 to 5 years may not be as politically alluring to voters as a rant about the level of pay, it will likely have a much greater effect on shareholder value and society. For example, such a change will now incentivize the CEO to engage in a long-term investment with a 4-year horizon.</div>
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Can clawbacks achieve the same thing, e.g. pay out a bonus upon good short-term performance and then claw it back if long-term performance lags? Despite being widely heralded and attracting much fanfare, the legality of clawbacks is very unclear: I know of no cases in which a clawback has been successfully implemented. The CEO may have spent the money, or transferred it to a spouse or a relative. Trying to claw back a bonus that you have prematurely paid (based on short-term performance) is like shutting the barn door after the horse has bolted. The best solution is not to pay out the bonus in the first place, but wait until 5 years.</div>
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Is the lengthening of a vesting horizon simply kicking the can down the road? All equity has to vest at some point, and doesn’t this mean that the CEO will now act myopically in 5 years’ time rather than 3 years’ time? I have some sympathy with this concern – indeed, one of the other implications of our papers is that boards of directors, and other stakeholders, should scrutinize CEOs in months (or years) in which they have significant equity vesting. Since most of the current focus is on Levels 1 and 2 of the CEO’s contract, most stakeholders don’t pay attention to vesting horizons. But, the main benefit will be on the CEO’s behavior <em style="border: 0px; box-sizing: border-box; font-family: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">today</em> – such a lengthening will now encourage him to take that 4 year project.</div>
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In short, paying CEOs according to the long-term will ensure they have the long-term interests of the firm at heart.</div>
</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-66531623902083514422014-08-23T09:12:00.006-07:002014-08-23T09:12:47.733-07:00Time Management Tips to Boost Your Productivity<div dir="ltr" style="text-align: left;" trbidi="on">
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<span style="font-family: Arial, Helvetica, sans-serif;"><span style="background-color: white; font-size: 17px; line-height: 23.799999237060547px;">(A shorter version of this article was originally published in </span><a href="http://www.cityam.com/1408326337/secrets-time-management">CityAM</a><span style="background-color: white; font-size: 17px; line-height: 23.799999237060547px;">. A talk on time management and personal leadership is </span><a href="http://bit.ly/leadershipthroughfreedom">here</a><span style="background-color: white; font-size: 17px; line-height: 23.799999237060547px;">.)</span></span></div>
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<span style="font-family: Arial, Helvetica, sans-serif;"><span style="font-size: 12pt; line-height: 115%;">At work, often the last
thing you can do is work.</span><span style="font-size: 12pt; line-height: 115%;"> </span><span style="font-size: 12pt; line-height: 115%;">Emails flood
in, colleagues make urgent requests, and fires need to be fought.</span><span style="font-size: 12pt; line-height: 115%;"> </span><span style="font-size: 12pt; line-height: 115%;">But, a few pointers can help us get the most
out of each day.</span></span></div>
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<i><span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Focus on the Important, not the Urgent<o:p></o:p></span></span></i></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Traditional time management
involves writing a “To Do” list and doing the Urgent tasks first. It’s extremely addictive to tick Urgent
things off your list – but you may end the day having done 9 Urgent tasks, but
not the 10<sup>th</sup>, most important one.
Stephen Covey, in his excellent book “The Seven Habits of Highly
Effective People”, instead advocates tackling the Important tasks first. Urgent tasks are those that you <i>have</i> to do, externally imposed by
others, and often low-hanging fruit – so it’s tempting to start with them. Important tasks are those that you <i>want </i>to do, internally generated by you,
such as developing a new idea. No-one’s
nagging you to do them, and they take significant time. So if we don’t prioritize them, they’ll get
swept aside by the Urgent. <o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Covey also emphasised that
people act differently when keeping score: you’ll run faster if wearing a
stopwatch. The same is true for
work. Have a stopwatch on your desk, and
start it when working on an Important task.
Stop it when you’re distracted to surf the internet, or respond to an
Urgent email. Set yourself a target of
how much <i>real</i> work you aim to get
done that day. It will change your behaviour. <o:p></o:p></span></span></div>
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<i><span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Control Your Email<o:p></o:p></span></span></i></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Urgent email burns a hole in
your inbox and demands to be attended to.
How can you focus on the Important, but still meet your deadlines? Create a sub-folder called “Today”, and
another called “This Week”. When urgent
emails come in, file them in the appropriate subfolder. When they’re out of sight, they’re out of
mind, freeing you to do the Important tasks.
Then, in the late afternoon, after the Important duties have been
accomplished and when your mind is less sharp, you can turn your attention to
these folders. <o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">What if the Important tasks
involve writing email? Select “Work
Offline” so that you’re not distracted by incoming email when doing so. Change your settings so that you don’t have
the “new email” little envelope in the bottom right, which demands to be
clicked on. Remove the “new email” chime
for the same reason.<o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Emails to mailing list (e.g.
advertising special offers) are neither Urgent nor Important. Such emails will have “Unsubscribe” at the
bottom. Create a new sub-folder called
“Mailing Lists”, and use a filter rule (in Outlook, go to File – Manage Rules
and Alerts) to automatically move messages with the word “Unsubscribe” into
this sub-folder. You can read them at
the end of the day. <o:p></o:p></span></span></div>
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<i><span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Outsource and Automate<o:p></o:p></span></span></i></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Many emails you send will
contain stock phrases, e.g. directions to your office. In an Outlook email, go to Insert – Quick
Parts, and save these phrases, so that you can paste them into an email at a
flash. <o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">For incoming email that you
can give a standard response to, but don’t trust an auto-responder, create a
sub-folder that your secretary has access to.
File these emails into the sub-folder, and inform your secretary of the
stock responses to such emails. <o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">For non-work-related admin,
use a virtual assistant (e.g. AskSunday or GetFriday). For example, a virtual assistant could
download all talks from a website, or delete duplicate photos from your
computer. <o:p></o:p></span></span></div>
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<i><span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">Use Natural Stimuli<o:p></o:p></span></span></i></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">On the hour, every hour, do
a short physical activity – a set of press-ups if you have your own office, a
brief walk if not. This accomplishes two
goals. First, the actual activity is
energizing. Second, you’ll try to
complete the task in hand before the next enforced break. I dislike doing press-ups, so if it’s
10:50am, I think “I only have 10 minutes before an unpleasant activity” and
make the best use of them. <o:p></o:p></span></span></div>
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<span style="font-size: 12pt; line-height: 115%;"><span style="font-family: Arial, Helvetica, sans-serif;">As an alternative to coffee,
Jamie Oliver recommends a fresh chilli. One
or two seeds will give you a pick-me up.
Sounds maverick? Maybe so, but a lot of punch can come from something
very little. That’s the art of time
management.</span></span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com5tag:blogger.com,1999:blog-2969235836974207643.post-12874224696841258602014-06-26T00:07:00.004-07:002014-07-15T16:50:49.161-07:00The Effect of the 2014 World Cup on Stock Markets So Far<div dir="ltr" style="text-align: left;" trbidi="on">
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(Update 15 July)<br />
<br />
The 2014 World Cup is now over. After Argentina's loss in the final, its market was up 0.2%, underperforming the world index which rose by 0.6%. Germany's index rose 1.2% - the biggest gainer among the major European indices.<br />
<br />
Excluding the anomalous Brazil defeat (which is explained below), out of the 39 losses by a country with an active stock market, 26 (= two thirds) were followed by the national market underperforming the world market. A loss was followed by underperformance by 0.2% on average; a loss by the "big seven" soccer nations (England, France, Germany, Italy, Spain, Argentina, Brazil) was followed by underperformance by 0.4% on average.<br />
<br />
Thanks to everyone who followed this post as the World Cup unfolded. A series of three interviews that I did on CNN on the effect of the 2014 World Cup on stock markets is <a href="http://youtu.be/awUtTTX7uZU">here</a>.<br />
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(Update 11 July)<br />
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So far this World Cup, most defeats have been met by national stock market declines. Indeed, Holland's market fell by 1.7% on Thursday after being eliminated by Argentina on Wednesday, while the world market fell only 0.7%. But, after Brazil's 7-1 humiliation by Germany on Tuesday, the stock market <i>rose</i> 1.8% on Thursday (the market was closed on Wednesday), while the world market fell 0.4% over Wednesday and Thursday. Surely this disproves the theory?!<br />
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Actually, the Brazil situation has an interesting twist. Here, the market rose because the defeat was so bad that investors think it significantly increases the chances that socialist President Dilma Rousseff will be ousted in October's elections and be replaced by Aecio Neves, the leader of the more pro-business PSDB party. The economy has been mired in stagflation under Rousseff's presidency. Her popularity may be particularly tied to the soccer team because she chose to spend billions on stadiums for the World Cup instead of keeping her pre-election promises to spend on schools, hospitals, and general infrastructure.<br />
<br />
Is this just clutching at straws to make an excuse for a major contradictory data point? In fact, this hypothesis was predicted even before the start of the World Cup. UBS analysts argued that a Brazilian exit would boost the stock market by hindering Rousseff's re-election bid, and Brazil's Ibovespa stock index had risen 19% from a low on March 14 due to speculation that the economy's poor performance would lead to her being ousted. Overall, out of the 38 losses by a country with an active stock market, 25 have been followed by the national stock market doing worse than the world market.<br />
<br />
Moreover, the stock market increase upon seemingly bad news is consistent with a more general phenomenon studied in one of my other <a href="http://faculty.london.edu/aedmans/Feedback.pdf">papers</a>, with Itay Goldstein (Wharton) and Wei Jiang (Columbia). Typically, we think that a high stock price suggests that the CEO is doing well. But in fact, a high stock price may suggest that the CEO is doing badly - so badly that investors think that the firm will be the target of a hostile takeover, and so bid up the price. Thus, there's an interesting two-way relationship between prices and real decisions. A low price may trigger a corrective action (e.g. hostile takeover of a CEO, replacement of a President) - but the expectation of the corrective action drives the price up.<br />
<br />
Indeed, Commerzbank was a takeover target around the financial crisis due to its poor performance. It was believed to have adopted a rather unusual takeover defense - it spread rumors that it was a takeover target, to increase its stock price, preventing a takeover from ultimately occurring! Thus, stock prices may be self-defeating - prices prevent the very actions that they anticipate.<br />
<br />
As Shakespeare's Hamlet said, "thinking makes it so". But in financial markets, "thinking may make it not so".<br />
<br />
(Update 9 July)<br />
<br />
At the time of writing, Germany is the only major European stock market that's up - all other European stock markets are down due to negative economic news. Luckily for Brazil, their stock market is closed for a public holiday to mark a constitutional revolt in 1932.<br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">(Updated 8 July)</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
In an earlier <a href="http://alexedmans.blogspot.co.uk/2014/06/world-cup-fever-why-england-loss-will.html">post</a> I summarized my <a href="http://faculty.london.edu/aedmans/SteelJF.pdf">paper</a> (with Diego Garcia and Oyvind Norli) which shows that international football defeats lead to declines in the national stock market index. Controlling for other drivers of stock returns, a World Cup defeat leads to a next-day fall of 0.4%, and a defeat in the elimination stages leads to a next-day fall of 0.5%. We also found that the effect was stronger in England, France, Germany, Spain, Italy, Argentina, and Brazil. A brief, humorous, 5-minute talk about the paper is <a href="https://www.youtube.com/watch?v=vAlCcVegtp0">here</a>. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
How has this theory played out in the 2014 World Cup so far? Typically you find that stock market effects get weaker after a paper is published, because investors are aware of the effect and trade against it. However, we have indeed seen stock market declines after defeats in this World Cup. Across all countries with a stock market index, a defeat has led to the index falling by 0.2% faster than the MSCI World index. Moreover, defeats by the "big seven" countries (notably England, Spain, and Italy) have led to declines of 0.5%. Out of the 36 defeats by countries with an active stock market, 24 have been followed by market declines faster than the MSCI World.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
Let's look at some of the most negative stock market responses:</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
Spain 1-5 Netherlands. The Spanish market fell by 1% the next day, while the world
market went up by 0.1%. This was a crushing and surprising defeat by the reigning world champions. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">England 0-1 Italy. The English market fell by 0.4%, while the world
market was flat.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Japan 1-2 Ivory Coast. The Japanese market fell by 1%, while the world market was flat. Japan went
into the tournament with high expectations since the general consensus was that
they had an easy group.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Italy 0-1 Costa Rica. The Italian market fell by 1.5%, while the world market was flat. This was perhaps the biggest shock of the World Cup so far, and
severely jeopardized Italy’s chances of qualifying.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Switzerland 2-5 France. The Swiss market fell by 0.7%, while the world market was flat. While this loss wasn't too unexpected, the magnitude of the defeat was severe - Switzerland were down 0-5 until late in the game. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
Italy 0-1 Uruguay. The Italian market fell by 0.5%, while the world market was flat. Italy were eliminated from the World Cup.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Japan 1-4 Colombia. The Japanese market fell by 0.7%, while the world market was flat. Japan were eliminated from the World Cup. A win would have seen them through against an already-qualified Colombia team that rested several players.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Korea 0-1 Belgium. The Korean market fell by 0.3%, while the world market was up 0.2%. Korea were eliminated from the World Cup by a Belgian side that rested several players and was down to ten men for half of the match.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Nigeria 0-2 France. The Nigerian market rose 0.3%, while the world market rose 0.7%. Nigeria were eliminated from the World Cup. </span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">France 0-1 Germany. The French market fell by 1.4%, while the world market fell 0.5%. Clash of two leading nations in the quarter-finals, both of which harbored hopes of winning the competition.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">However, not every result has been consistent with the theory. Some losses have been accompanied by stock market increases, perhaps because these losses actually boosted national mood:</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Croatia 1-3 Brazil. The Croatian market rose 0.4%, while the world market rose by 0.3%. This result did not worsen Croatian national mood, as they were believed to have played well and lost to unlucky refereeing decisions. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Bosnia 1-2 Argentina. The Bosnian market rose 0.5%, while the world market was flat. This was Bosnia's first appearance in a World Cup and the consensus was they played very well.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">Australia 2-3 Netherlands. The Australian market rose 1.5%, while the world market rose 0.9%. Australia's performance was widely praised by the press afterwards, in contrast to the significant negative coverage of the team before the tournament. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
Greece 1-1 Costa Rica (3-5 on penalties). The Greek market rose 0.4%, while the world market rose 0.1%. This was the first time Greece advanced through the group stages and so the nation was happy with the team's performance in the overall World Cup. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
However, there were a couple of losses that did lead to a decline in national mood, yet still were accompanied by stock market increases. Clearly, football results aren't the only factor that drives stock returns, because there may be some major economic news. For example, when Spain lost 2-0 to Chile, the market went up by 0.7% the next day (while the world market rose 0.5%), due to news of a new king. </span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">
In addition, there have been losses that were accompanied by stock price declines and thus consistent with the theory, but likely these declines were caused by other factors. For example, when Nigeria lost 3-2 to Argentina, the market fell 0.6% the next day. However, Nigeria had already qualified so the loss wasn't particularly painful; the market decline was likely due to the terror attack in the capital on the same day.</span></div>
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<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;">While there might be particular occasions where economic news overshadows the mood impact of a football result, these idiosyncratic events will even out in a large sample. Thus, the initial paper studied 1,100 football matches (plus 1,500 matches in rugby, cricket, basketball, and ice hockey) to find the average effect of football defeats on the stock market. A football loss won't lead to a stock market decline in every single case, but it does on average, and this has been borne out by the 2014 World Cup so far. </span></div>
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(Thanks to LBS PhD student David Schoenherr for his help in gathering the data for this World Cup.)</span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-25519425813107665532014-06-12T03:17:00.001-07:002014-06-12T03:20:10.313-07:00World Cup fever: Why an England loss will wipe billions off the stock market<div dir="ltr" style="text-align: left;" trbidi="on">
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(This article was originally published in <a href="http://www.cityam.com/article/1402423069/world-cup-fever-why-england-loss-will-wipe-billions-stock-market">CityAM</a>. A brief, humorous, five-minute talk on the paper is <a href="https://www.youtube.com/watch?v=vAlCcVegtp0">here</a>.)</div>
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THE WORLD Cup, which starts today, will spark a huge range of human emotions, from the excitement of victory to the despair of defeat. The effect of football results on national mood is so strong that it can spill over into the stock market and cause swings of billions of pounds. Why?</div>
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While the World Cup pits arch-rivals against each other, raring to settle scores of decades past (did Geoff Hurst’s shot cross the line in 1966? Frank Lampard’s in 2010?), there are also long-standing feuds in the halls of academia. The equivalent of England-Germany is the debate over what drives financial markets. The “efficient markets” camp argues that the price of a share incorporates every single piece of relevant information: management quality, product mix, growth options, and so on. Prices end up at the theoretically “correct” fundamental value, as if calculated by an infinitely powerful computer.</div>
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The “behavioural finance” team points out that traders aren’t computers, but humans. They’re prone to mistakes and psychological biases. Thus, share prices are affected not only by fundamentals, but also by emotions. Internet shares were wildly expensive in the late 1990s, not because these companies’ prospects were stellar, but because investors had become irrationally exuberant.</div>
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Refereeing the “efficient” versus “behavioural” match is extremely difficult. One way to settle the tie would be to compare actual prices against the theoretical “correct” value based on fundamentals. But we don’t know what the “correct” value is. It could be that, based on information at the time, internet shares were fairly valued in the late 1990s, and the subsequent crash only occurred because bad news unexpectedly came out afterwards.</div>
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But there is another tactic we can use – study whether prices are affected by emotions. Previous papers looked at whether weather affects the stock market. However, weather isn’t correlated across a country. If it’s sunny in Bristol but cloudy in Manchester, it’s not clear what will happen to the overall stock market. Moreover, the effect of weather is unlikely to be strong enough to drive your trading behaviour, particularly since traders work in insulated offices.</div>
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That’s why I chose to look at sports. Sports have huge effects on people’s emotions, these are far stronger than the effects of weather, and they can’t simply be neutralised by the office environment. When England lost to Argentina in the 1998 World Cup, heart attacks increased over the next few days. Suicides rise in Canada when the Montreal ice hockey team loses in the Stanley Cup, and murders go up when the local American Football team loses in the playoffs. International sports, like the World Cup, affect the whole nation in the same way, and lead to a large effect on national mood that is correlated across a country.</div>
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Together with co-authors Diego Garcia and Oyvind Norli, I investigated the link between 1,100 international football matches and stock returns in 39 countries in our paper <a href="http://faculty.london.edu/aedmans/SteelJF.pdf">Sports Sentiment and Stock Returns</a>. The results were striking. Being eliminated from the World Cup leads to the national market falling by 0.5 per cent on the next day – controlling for everything else that might drive stock returns. Applied to the UK stock market, this translates into £10bn wiped off the market in a single day, just because England loses another penalty shootout.</div>
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The effect is stronger in the World Cup than the European Championship, which makes sense because the World Cup is the bigger stage and conjures up even more emotion. It’s stronger in the elimination stages than the group stages, because if you lose you’re instantly out. It’s also stronger in football-crazy countries like England, France, Germany, Spain, Italy, Argentina and Brazil. We also studied 1,500 other international sports matches and found a similar effect in one-day cricket, rugby, and basketball. We ruled out the explanation that the market declines are due to the economic effects of losses (e.g. reduced sales of replica merchandise, or reduced worker productivity).</div>
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Depressingly, we found no effect of a win in any sport. One reason could be that sports fans are notoriously over-optimistic about their team’s prospects. If fans go into each game expecting they’ll win, there’s little effect if they do win, but they become depressed if they lose. Another is the asymmetry of the competition: winning an elimination game merely sends you into the next round, but losing leads to instant exit. </div>
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Let’s hope the Three Lions not only give us some cheer on the pitch, but also help to maintain the value of our portfolios.</div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-56510888643261936042014-06-07T05:03:00.001-07:002014-06-07T09:04:38.446-07:00Underperformance of Companies Holding Meetings in Remote Locations<div dir="ltr" style="text-align: left;" trbidi="on">
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If a company has bad news that it wishes to hide, where will
it hold its shareholder meeting? As far away as possible! That’s the hypothesis
of an ingenious paper entitled “<a href="http://ssrn.com/abstract=2409627">Evasive Shareholder Meetings</a>”, by Yuanzhi Li
(Temple) and David Yermack (NYU Stern) that I saw at the <a href="http://www.eur.nl/ese/english/expertise/ese_conferences/executive_compensation/programme/">Rotterdam Workshop on Executive Compensation and Corporate Governance</a> yesterday.<o:p></o:p></div>
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Companies are forced to hold shareholder meetings once a
year. But, such meetings can be notoriously inconvenient for management. For
example, at McDonald’s 2013 shareholder meeting, a 9-year old girl was famously
planted to tell CEO Don Thompson "it would be nice if you stopped trying to trick kids into wanting to eat your food all the time". Thompson's spontaneous response, "we don't sell junk food", went viral and was <a href="http://www.csmonitor.com/The-Culture/Family/Modern-Parenthood/2013/0530/We-don-t-sell-junk-food-McDonald-s-CEO-s-comment-sparks-backlash-against-9-year-old">ridiculed</a> by the media. </div>
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Thus, if the company expects
trouble brewing, it can choose to hold its meeting at an inconvenient location,
to deter shareholders or the press from attending. This in turn implies a trading strategy for
astute investors – short companies with remote meetings. <o:p></o:p></div>
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70% of shareholder meetings are non-evasive, occurring
within 5 miles of the headquarters. But at
the other extreme, Li and Yermack found 34 meetings that took place overseas. General Cable is headquartered in Kentucky but has held its annual meetings in Spain, Costa Rica, and Germany; a mining company held a meeting at one of its mines. Even
for domestic meetings, the company can choose to hold it hundreds of miles from
a major airport. For example, TRW Automotive held its 2007 meeting in McAllen, Texas, at the Southern tip of the continental United States near the Mexican border - 1,400 miles from the company's headquarters outside Detroit, and 300 miles from the nearest major airport (Houston). </div>
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Particularly suspicious are companies that hold the meeting
at the same location every year, but make a one-time deviation. For example, 9 out 10 years, the regional bank KeyCorp held its annual meeting close to its Cleveland headquarters, but in one hear it held it at an art museum in Portland, Maine. The authors found that firms that
hold these exceptional meetings - that involve one-time deviations - underperform their peers by 11.7% over the next
six months. Similarly, companies that
hold their meetings at remote locations (defined as 50 miles from their
headquarters and 50 miles from a Tier 1 airport) underperform by 6.8%. Moreover, the future underperformance goes up
with both distance measures. </div>
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<o:p></o:p></div>
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Most shareholder meetings take place in May. Thus, the
subsequent 6-month period typically includes the firm’s Quarter 2 and Quarter 3
earnings announcements. Over the whole
sample, the average return to an earnings announcement is +0.41%, because firms
typically meet or beat their earnings target.
However, firms that hold exceptional meetings (a one-time deviation from
the standard location) suffer returns of -2.24% at future earnings
announcements, suggesting that they miss their targets. <o:p></o:p></div>
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The idea of evasive management is related to this earlier
<a href="http://alexedmans.blogspot.co.uk/2014/04/trading-strategies-based-on-analyst.html">post</a> on a paper showing that companies who avoid questions from pessimistic analysts (during earnings calls) subsequently underperform. Both papers are very clever ways to identify
shifty managers with something to hide, and use this to form a profitable
trading strategy.<br />
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<o:p></o:p></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-87775054418530155452014-06-01T03:05:00.000-07:002014-06-01T03:05:50.353-07:00Profiting from momentum strategies - Part 2<div dir="ltr" style="text-align: left;" trbidi="on">
The <a href="http://alexedmans.blogspot.co.uk/2014/05/profiting-from-momentum-strategies-part.html">previous post</a> concerned momentum - a strategy of buying past winners and selling past losers. It discussed how this strategy does well on average, but on rare occasions (recent market downturns and high market volatility) does very poorly.<br />
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Another reason why momentum may perform poorly is because other investors are chasing the same strategy. One of the "behavioral" explanations for momentum is underreaction, and goes as follows. Suppose a company experiences good news, which increases its true value by 10%. However, the stock price may only rise by 6%, because (a) only some investors notice the news, due to limited attention - they follow hundreds of stocks, and cannot notice what happens to every single stock on a particular day, and/or (b) investors do notice the news, but have stubborn prior beliefs - an investor may have a long-standing belief that the stock is of low-quality, and may cling to this belief even after receiving the news. </div>
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Regardless of the explanation, momentum works. You should buy a company that has risen by 6% over the past six months, because its true value has increased by 10%, and so it may gain the final 4% over the next six months.</div>
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However, what if all investors think like that? Then, they may pile into a stock that has risen by 6%. This extra buying pressure causes it to rise another 5% - so that the total increase is now 11% and so it has overshot. How does a would-be momentum investor ensure that he hasn't bought a stock that has overshot?</div>
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Christopher Polk and Dong Lou of the London School of Economics study this question in an interesting paper entitled "<a href="http://personal.lse.ac.uk/polk/research/Comomentum.pdf">Comomentum</a>". The idea is as follows. If investors are trying to exploit momentum (causing stocks to overshoot), they would have piled into <i>many </i>past winners, and equivalent sold <i>many </i>past losers. Then, the stock returns of past winners will covary with each other (i.e. move up together), and similarly the stock returns of past losers will covary with each other. They introduce a new measure, comomentum, which is the abnormal correlations among past winners and past losers - the stocks the momentum trader will trade on. When comomentum is high, this suggests that lots of investors are piling into momentum trades, and so the trades are less profitable. </div>
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Indeed, they find that their comomentum measure significantly predicts the future profitability of momentum. The effects are economically large. When comomentum is in the top 20% of its range, the momentum strategy earns 10.4% lower returns in its first year than when it is in the bottom 20% of its range. Simply put, when comomentum is high, other investors are pursuing the momentum strategy. This strategy is now crowded, so you should get out. </div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-78255348934684198212014-05-10T04:01:00.001-07:002014-05-10T04:02:44.910-07:00Profiting from momentum strategies - Part 1<div dir="ltr" style="text-align: left;" trbidi="on">
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;"><a href="http://en.wikipedia.org/wiki/Momentum_(finance)">Momentum </a>is arguably the most well-known trading strategy. A simple strategy of buying </span><span style="font-family: Arial, sans-serif; font-size: 10pt;">stocks that have done well over the past 6 months ("winners"), and
shorting stocks that have done badly ("losers"), earns a 1%/month return over the next 6 months. While other trading strategies stop being profitable once they have been discovered (because investors start exploiting them, removing the profit opportunity), momentum has remained surprisingly lucrative ever since <a href="http://www.bauer.uh.edu/rsusmel/phd/jegadeesh-titman93.pdf">Jegadeesh and Titma<u>n</u> (1993)</a> first documented it. </span></div>
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<span style="font-family: Arial, sans-serif; font-size: 13px;">A momentum strategy is attractive because it is market-neutral - since you're buying some shares and shorting others, it can make money in up markets and down markets.</span><span style="font-family: Arial, sans-serif; font-size: 13px;"> Thus, it is relatively immune to market risk. The Sharpe Ratio (a measure of the risk-adjusted return to a trading strategy) of momentum is about 0.6, compared to 0.3-0.4 for just holding the market. I attempt to exploit momentum myself, </span><span style="font-family: Arial, sans-serif; font-size: 10pt;">through the AQR Momentum ETF (ticker AMOMX).</span></div>
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<span style="font-family: Arial, sans-serif; font-size: 10pt;">Momentum is also pervasive - it works not only in stocks, but
also bonds, commodities and exchange rates as shown by <a href="https://noppa.oulu.fi/noppa/kurssi/721383s/materiaali/721383S_value_and_momentum_everywhere.pdf">Asness, Moskowitz, and Pedersen (2013)</a>. That we see it in so many assets suggests that momentum is due to investors making mistakes - popularized by a branch of research known as "behavioral finance". The main psychological explanation is that </span><span style="font-family: Arial, sans-serif; font-size: 10pt;">investors are slow to react to information - thus, good news takes time to
be incorporated in prices, and ditto for bad news. </span></div>
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<span style="font-family: Arial, sans-serif; font-size: 10pt;">However, even
though the momentum strategy does well on average, there are some periods where
it does very badly, such as in the recent hedge fund crisis - some hedge funds
went under because they followed momentum strategies that tanked. For example, between March and May 2009, the "losers" generated 163% returns, but the "winners" generated only 8% returns. </span><span style="font-family: Arial, sans-serif; font-size: 10pt;">Thus, a
momentum strategy is somewhat like selling options - it makes money on average,
but sometimes does really badly.</span></div>
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;">This new <a href="http://www.kentdaniel.net/papers/unpublished/mom10.pdf">paper</a> by Kent Daniel of Columbia GSB, a former Managing Director in Sachs Asset Management and Toby Moskowitz of Chicago Booth, a former winner of the Fischer Black Prize for outstanding contributions to finance research by someone under 40, shows you when to get out of momentum strategies - and thus how to make momentum even more profitable. </span></div>
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;">The answer is
surprisingly simple - get out of the momentum strategy in times of market stress, when 1) the market has recently declined, and 2) market volatility (measured by the VIX volatility index) is high. Here's a simple intuition. If the market has recently declined, the "loser" portfolio must have declined much faster than the broader market. Thus, it has a high beta (= sensitivity to the market). The "winner" portfolio has a relatively low beta, which is why it didn't decline so much. After times of market stress, the market typically recovers. Thus, the "loser" portfolio, which has high beta stocks that are sensitive to the market, does especially well in the market recovery, and so you want to get out of the momentum strategy. Kent and Toby find that this surprisingly simple enhancement to the momentum strategy doubles the Sharpe ratio from 0.6 to 1.2.</span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com6tag:blogger.com,1999:blog-2969235836974207643.post-36033736344795301562014-05-03T04:21:00.001-07:002014-05-03T04:22:33.363-07:00Does corporate social responsibility improve firm value?<div dir="ltr" style="text-align: left;" trbidi="on">
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<i>Below is an article I wrote two months ago for the World Economic Forum. Since it's posted on the password-protected section of the WEF website, I reproduce it here.</i></div>
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Does corporate social responsibility (“CSR”) improve firm value? When companies make decisions, should they care only about shareholders or should they take other stakeholders (e.g. employees, customers, the environment) into account? This is a decades-old debate, but despite many cogent views on both sides, there’s surprisingly little hard evidence. </div>
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In 1970, Milton Friedman famously wrote that “the social responsibility of business is to increase its profits”. This view isn’t as hard-hearted as it may sound. Friedman argued that a company can only increase its profits by taking other stakeholders into account – producing high-quality products, treating its employees fairly, and having a good environmental reputation. Under this view, firms should focus exclusively on profits, and everything else will fall into place. Considering other stakeholders beyond the profit implication is at the expense of shareholders: a dollar spent on reducing pollution (beyond the level that will avoid an environmental lawsuit) is a dollar that cannot be paid as dividends. </div>
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However, advocates of CSR argue that the Friedman view only holds in theory. In practice, it’s extremely difficult to quantify the profit implications of most socially responsible actions. A company could decide whether to grant an employee compassionate leave by trying to calculate the potential loss in morale and productivity if the leave was withheld, but these consequences are very hard to quantify. The CSR approach would be to grant the leave simply because it’s the right thing to do – because the goal of the company isn’t only to maximise profits, but to treat stakeholders with compassion. Treating employees fairly will eventually manifest in greater staff retention and future productivity. However, these long-run effects are difficult to quantify, so a firm focused exclusively on profits will not invest in its stakeholders.</div>
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Whether CSR improves firm value has been studied extensively by management scholars. Most studies find a positive correlation between CSR and measures of firm performance, such as profits. However, correlation doesn’t imply causation. It may not be that CSR causes a firm to perform better, but instead that firm performance causes CSR – only firms that are performing well can afford to spend money on its other stakeholders. In addition, some studies consider only one industry, or a short time period, and so are hard to generalize.</div>
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I decided to tackle this long-standing management question using a methodology from a different field – finance. This approach involves linking CSR not to profits, but to future stock returns, which reduces reverse causality concerns. If it was high profits that caused CSR, then the high profits would mean the company’s stock price would already be high today, and so we shouldn’t expect higher stock returns going forward. </div>
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The next decision is how to measure CSR. The main challenge is that CSR is extremely difficult to measure objectively, as it’s intangible. Tangible measures do exist – for example, one could measure workplace diversity by whether there’s a minority on the board. However, tangible measures are relatively superficial and thus easy to manipulate. For example, a company that cared little about workplace diversity could put a token minority on the board to “check the box”. A separate challenge is that CSR comprises of many different dimensions – responsibility to employees, customers, the environment, etc, and it’s unclear how to weight these different constituencies. </div>
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I thus focused on one particular dimension of social responsibility – employee satisfaction. I chose this dimension as a very thorough measure of it exists. Since 1984, there has been a list of the “100 Best Companies to Work for In America”. This list is compiled by surveying the employees themselves – it’s the ultimate in fundamental, grass-roots analysis. Two hundred and fifty employees are randomly selected in a firm and asked 57 questions on various aspects of employee satisfaction (credibility, respect, fairness, pride/camaraderie), which had been developed through extensive discussions with managers, employees and workplace experts. As a result, it’s arguably the most respected measure of employee satisfaction. Equally importantly, it has been available since 1984, and thus I have a long time-series which comprises both recessions and booms. </div>
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The first list came out in a book in March 1984, then another book in February 1993, and then in the January edition of Fortune magazine every year from 1998. My methodology involves buying a the Best Companies in April 1984, rebalancing the portfolio in March 1993 to take the new list into account, and then rebalancing it every February from 1998. The one month delay is because I wish to test not only that employee satisfaction improves firm value, but also whether the market recognizes this link. Even if employee satisfaction improves firm value, my strategy should earn no returns if the market recognizes this link. As soon as a company appears in the Best Companies list, its stock price should go up, so I shouldn’t be able to generate returns by buying it one month too late. </div>
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I compare the returns of the Best Companies not only to the overall market, but also to companies in the same industry. For example, Google is frequently in the Best Companies list, but its high returns could be due to the tech industry doing well, rather than its employee satisfaction. I also compare each company to peer firms with similar characteristics (e.g. size, dividend yield, recent performance, valuation ratios). In short, I try to control for as much as possible, to isolate the effect of employee satisfaction. I also remove the effect of outliers, to ensure that any superior performance of the Best Companies isn’t due to a few star performers such as Google.</div>
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I find that the Best Companies beat the market by 2-3%/year, over a 26-year period from 1984-2009. This outperformance is highly statistically significant, and also economically meaningful – a fund manager who beats the market by 1%/year for 5 years is considered to be skilled. Moreover, this outperformance is based on a very simple trading strategy using public information on large firms.</div>
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The results have three main implications. First, they suggest that employee satisfaction is beneficial for firm value. While it may seem natural that companies should do better if their workers are happier, this is far from obvious. Indeed, the 20th century way of managing workers is to view them as any other input – just as manager shouldn’t overpay for or underutilize raw materials, they shouldn’t do so with workers. High worker satisfaction may be a sign that workers are overpaid or underworked. However, the world is different nowadays. Human capital is the main asset in many firms, and employee welfare can improve productivity, retention, and recruitment.</div>
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Second, even though employee satisfaction may be beneficial in the modern firm, the market doesn’t recognize this link. Even though I wait a month before forming my portfolios, the strategy generates superior returns. Similarly, the Best Companies typically report earnings that beat analyst expectations – analysts aren’t aware of the benefits of worker welfare. Indeed, I show that it takes 4-5 years before the market fully incorporates the value of employee satisfaction. This may be because traditional methods of valuing companies are based on the 20th century firm, and emphasize tangible factors such as short-term profits. This result has broader implications for firms’ incentives to invest for the long-run. If investors continue to value companies based on short-term profit, then managers will pursue short-term profit rather than long-run growth.</div>
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Third, Socially Responsible Investing (SRI) – incorporating social considerations into portfolio choice – can add value. The traditional view is that SRI is costly to investment performance, as it involves screening out good investments and screening in bad investments. However, the Best Companies strategy generates high returns while supporting companies who treat employees responsibly – investors can do well and do good. This result is a consequence of the first two implications – employee satisfaction is beneficial (the first implication) but the market doesn’t recognise that it’s beneficial (the second implication).</div>
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In concluding, it’s worth highlighting some caveats to my study. First, I’ve only shown a link between stock returns and employee satisfaction, and not other dimensions of CSR. Further research must be done to study whether there’s any link with environmental protection, animal rights, etc. However, since the traditional view is that no dimension of CSR should add value, the results are an important first step towards demonstrating the benefits of CSR more broadly. Second, while I control for many observable factors (industry performance, firm size, dividend yield, etc.), I can’t rule out the explanation that an unobservable variable (e.g. good management) causes both employee satisfaction and superior returns. If so, my first implication is no longer causal – improving employee satisfaction (without changing management) won’t improve stock returns. However, the other two implications remain. It remains the case that the stock market misvalues intangibles – just that the intangible being misvalued is good management rather than employee satisfaction. It also remains the case that a socially responsible investor could have bought companies that treat their employees well and earned superior returns.</div>
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<em style="border: 0px; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Further reading:</em></div>
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<em style="border: 0px; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Edmans, Alex (2011): “<a href="http://faculty.london.edu/aedmans/Rowe.pdf" style="border: 0px; color: #40a0d0; font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;" target="_blank">Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices</a>”. Journal of Financial Economics 101(3), 621-640</em></div>
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<em style="border: 0px; font-variant: inherit; line-height: inherit; margin: 0px; padding: 0px; vertical-align: baseline;">Edmans, Alex (2012): “<a href="http://faculty.london.edu/aedmans/RoweAMP.pdf" style="border: 0px; color: #40a0d0; font-family: inherit; font-style: inherit; font-variant: inherit; font-weight: inherit; line-height: inherit; margin: 0px; padding: 0px; text-decoration: none; vertical-align: baseline;" target="_blank">The Link Between Job Satisfaction and Firm Value, With Implications for Corporate Social Responsibility</a>.” Academy of Management Perspectives 26(4), 1-19</em></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-21646560257214716822014-04-27T04:18:00.002-07:002014-04-27T06:41:01.881-07:00Trading Strategies Based on Analyst Conference Calls<div dir="ltr" style="text-align: left;" trbidi="on">
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;">The idea from this blog came from the "Extra-Curricular Topics" I teach in my MBA classes, a 10-minute interlude where I teach an academic paper with significant real-world relevance. This expanded to an opt-in Google Group where I wrote to former students summarizing an interesting paper that I come across in a seminar or conference, and from there came this blog. However, the first few blog posts ended up being on different topics - this is the first post on the intended theme. </span></div>
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<span style="font-size: 10pt;"><span style="font-family: Arial, sans-serif;">One very interesting paper I saw presented at the LBS external seminar series is </span></span><a href="http://www.people.hbs.edu/cmalloy/pdffiles/malcolou.pdf" style="font-family: Arial, sans-serif; font-size: 10pt;"><span style="color: windowtext;">http://www.people.hbs.edu/cmalloy/pdffiles/malcolou.pdf</span></a><span style="font-family: Arial, sans-serif; font-size: 10pt;"> by Lauren Cohen (HBS), Dong Lou (LSE), and Chris Malloy (HBS). It uses analyst conference calls to form
a trading strategy. After Regulation FD, firms are no longer allowed to
disclose information selectively to certain groups of investors and not others,
so analyst conference calls are an important way in which they disseminate
information. All analysts are allowed to participate. </span></div>
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<span style="font-family: Arial, sans-serif; font-size: 10pt;">However, what I didn’t
know until I saw the talk, was that firms can choose which analysts they would
like to speak and ask questions in the meeting. Analysts can signal if they
would like to ask a question, but the firm has full discretion on which
analysts to call upon. The paper shows that certain firms will selectively
choose optimistic analysts (i.e. those who give them high ratings) and prevent
pessimistic analysts from doing this. Such a strategy is bad in the long-run,
because analysts that are not allowed to speak may end up dropping their
coverage of the firm (and analyst coverage is useful for boosting stock
liquidity). However, myopic firms who are focused on boosting the short-term
stock price may engage in this strategy – indeed, these are firms that are just
about to issue equity (so they want to prop up the short-term stock price) and
end up announcing earnings that just meet the earnings forecast or beat it by 1
cent (suggesting they’ve done something myopic like cut R&D to meet the
target).</span></div>
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;">The conference call information is public information
which can be used to form a long-short strategy: sell the firms that engage in
such manipulation and buy the firms that don’t. This strategy earns 95 basis
points per month, nearly 12% per year, which is huge alpha. The manipulating
firms also end up having negative earnings announcements in the future, having
to restate previously announced earnings (implying that the previous earnings
were falsified), and using discretionary accounting accruals to artificially
boost earnings. This paper is a great example of using a clever institutional
detail (the fact that it’s the firm who gets to decide who speaks on a
conference call) to find an extremely profitable trading strategy.<o:p></o:p></span></div>
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<span lang="EN-US" style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-ansi-language: EN-US;">You might think - shouldn't the SEC ban companies from being allowed to selectively pick and choose who speaks? Well, actually there's a good reason for allowing companies this discretion. It allows them to stop Bruce Wayne from Wayne Enterprises from calling in (see p13 of <a href="http://dealbreaker.com/uploads/2013/05/ARCHER_OL-Transcript-2013-05-30T12_001.pdf">http://dealbreaker.com/uploads/2013/05/ARCHER_OL-Transcript-2013-05-30T12_001.pdf</a>). </span></div>
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Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com2tag:blogger.com,1999:blog-2969235836974207643.post-70324668153583798092014-04-05T03:43:00.001-07:002014-04-05T03:43:23.549-07:00Top Ten TED Talks<div dir="ltr" style="text-align: left;" trbidi="on">
London is a great city, but one of its downsides is that it takes a long time to get to most places. The TED Talks app has significantly enriched my commutes. Here are my top ten TED talks:<br />
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1) <a href="http://www.youtube.com/watch?v=nLeeTVmVrtA">The Family I Lost in North Korea, and the Family I Gained</a> (Joseph Kim). Perhaps the most poignant TED talk I've heard, about a boy who list his family in North Korea. About how simple acts of kindness can transform someone's life.<br />
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2) <a href="https://www.youtube.com/watch?v=9X68dm92HVI">Are We In Control Of Our Decisions?</a> (Dan Ariely). On how "nudges" (e.g. by companies selling products, or policymakers) can radically affect people's behavior. One of the leading lights in behavioral economics; his other TED talks are also excellent.<br />
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3) <a href="https://www.youtube.com/watch?v=iueVZJVEmEs">Perspective Is Everything</a> (Rory Sutherland). Fascinating talk on "framing" (a concept in behavioral economics on how you present a concept). By a top advertising professional, as knowledgeable as any top behavioral economist on this field; his other TED talks are also excellent.<br />
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4) <a href="https://www.youtube.com/watch?v=rrkrvAUbU9Y">The Puzzle of Motivation</a> (Dan Pink). How intrinsic motivation is much more powerful than extrinsic motivation (using rewards). I thought I already knew this idea, but this went into far greater depth than what I'd heard before. 3 million views.<br />
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5) <a href="https://www.youtube.com/watch?v=qp0HIF3SfI4">How Great Leaders Inspire Action</a> (Simon Sinek). Leadership and inspiration doesn't require you to do superhuman feats (what you do), but stem from how and why you do something. 2.5 million views.<br />
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6) <a href="https://www.youtube.com/watch?v=Ks-_Mh1QhMc">Your Body Language Shapes Who You Are</a> (Amy Cuddy). How adopting particular body language has a causal effect on your performance. This is something I was naturally skeptical about, being an dull economist, but this was an illuminating talk based on scientific evidence.<br />
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7) <a href="https://www.youtube.com/watch?v=bfAzi6D5FpM">The Way We Think About Charity is Dead Wrong</a> (Dan Pallotta). We often think that charities shouldn't spend on advertising, on hiring good managers - but such investment pays many times over.<br />
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8) <a href="https://www.youtube.com/watch?v=go_QOzc79Uc">Teach Every Child About Food</a> (Jamie Oliver). The critical importance of nutrition for health. You may think that you've heard it all before, but this is powerfully and cogently argued, and has the potential to change your everyday life.<br />
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9) <a href="https://www.youtube.com/watch?v=RDIy58g9n2k">Building US-China Relations By Banjo</a> (Abigail Washburn). The power of music to create community and cross boundaries - that diplomats, politicians and economists couldn't cross.<br />
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10) <a href="https://www.youtube.com/watch?v=4q1dgn_C0AU">The Surprising Science of Happiness</a> (Dan Gilbert). We spend our whole lives chasing after happiness, but we can actually manufacture it ourselves.</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com1tag:blogger.com,1999:blog-2969235836974207643.post-66573796591762244402014-03-29T05:11:00.002-07:002015-02-18T05:11:29.272-08:00Davos in a Nutshell (Non-Economics Sessions)<div dir="ltr" style="text-align: left;" trbidi="on">
Perhaps the most illuminating sessions in Davos were ones unrelated to economics, and thus gave me insights into topics that I would not normally get the chance to learn about. Here is a short summary.<br />
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While these sessions were on quite different topics, one common theme to many was the "neuroplasticity" of the brain. The brain is not fully formed after childhood, but you can keep developing it, e.g. through meditation, mindfulness (paying attention rather than being distracted).<br />
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<u><span lang="EN-US">Meditation</span></u><br />
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A Buddhist monk led a session on "compassionate" meditation, which is quite different from standard meditation:</div>
<ul>
<li>Picture a loved one in suffering, and being relieved of this suffering. Then, move to acquaintances, strangers, enemies, and dictators. This simple practice helps us show compassion in our everyday life</li>
<li>A little bit of meditation every day is better than 8 hours once a week. You water plants every day rather than throwing a bucket once a week.</li>
</ul>
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<u><span lang="EN-US">Exploring Our Limits: Workshop on Creativity</span></u><br />
<ul style="text-align: left;">
<li>Jeremy Balkin (Karma Capital, Give While You Live, 5x marathon runner)</li>
<ul>
<li>Modern society tells kids to conform, to color within the lines, but we need risk</li>
<li>For each of us, there's one thing we haven't done because we're scared. Think what this is, and do it</li>
<li>We're all born as naked vulnerable beings, and we'll all die as naked vulnerable beings. What matters is what we do in between. And we don't know at what point death will come</li>
<li>We're told that running 26 miles is physiologically dangerous. But, humans used to run to get food. And technology is evolving (e.g. better shoes) to help us. The world has changed a lot in the past 5 years, even in the past year. There's almost nothing we can't do</li>
</ul>
<li>Lewis Pugh (first person to swim across the North Pole)</li>
<ul>
<li>Jeremy Clarkson doesn't get his ideas for Top Gear by sitting in the BBC studio, but going to the pub, having a few beers and allow his imagination to get wild</li>
<li>Lewis himself decided to swim the North Pole and Everest in creative moments, on a whim</li>
<li>Creativity and imagination never takes place in the office, but with friends. You don't make a wild decision based on an economic cost-benefit analysis, but on a whim</li>
<li>Use the "4am test". If a crazy idea makes sense to you at 4am in the morning, it's probably a good idea</li>
</ul>
<li>Bobby Ghosh (TIME magazine World Editor)</li>
<ul>
<li>10 years from now, you'd like to think "I'm proud I did this wild and dangerous thing", but also "I'm proud I did <i>not</i> do this wild and dangerous thing". We often extol the virtues of being wild and crazy, but judgement is also required. Sometimes <i>not</i> doing something wild is the boldest decision</li>
<li>Ask yourself: "When is the last time you did something for the first time?" Hopefully, the answer is "recently"</li>
</ul>
<li>Celine Cousteau (granddaughter of Jacques Cousteau)</li>
<ul>
<li>You need a team of people to help you - you can't do it alone. We like to promote the "self-made millionaire". No-one is self-made. Entrepreneurs have customers, employees</li>
<li>Must connect with the hearts and guts with everyone in your team. This principle also guides you on choosing your team-mates: are they in?</li>
<li>You need to give yourself <i>space</i> for creativity to happen. We're obsessed with doing things. Don't do, just be</li>
</ul>
<li>Tina Seelig (Stanford, moderator)</li>
<ul>
<li>Privilege. If you're an MBA student (or professor) at a top business school, you're privileged, There are others who should be here who aren't here</li>
<li>Platform. We are lucky to have a platform - use it to help those in need</li>
<li>Perseverance. Nothing comes for free</li>
<li>In baseball, if you hit 0.300, you're a great hitter. Encourage people to make mistakes when stakes are low: don't be a perfectionist on small things</li>
</ul>
</ul>
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<u>Making Better Decisions</u><br />
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This was the session that I served as a discussion leader (on behavioral finance). Sendhil Mullainathan of Harvard was one of the co-facilitators (with Eldar Shafir of Princeton, his coauthor on a book called "Scarcity"). He talked about two topics: bandwidth and scarcity:<br />
<br />
<i>Bandwidth</i><br />
<ul style="text-align: left;">
<li>We talk a lot about time management, but what's more important is "bandwidth" management. You only have a limited capacity for difficult tasks</li>
<li>The biggest predictor of a plane crash is whether the pilot is in a bad relationship</li>
<li>Tools to manage bandwidth</li>
<ul>
<li>Delegate unimportant decisions to others</li>
<li>Manage expectations. If others know that you may not reply to email instantly, this removes the mental burden of having to constantly check email</li>
<li>Don't pack every item in your schedule. You can't go from one meeting on a hard topic to another meeting on a hard topic. Your mind will wander and you will lose focus. You need to build in "bandwidth breaks" during a day, else you'll be ineffective</li>
</ul>
<li>Respect other people's bandwidth. We think it's unacceptable to charge kids $100 to apply for a scholarship, but it's OK to make them fill in a 40-page form</li>
<li>Listen to <i>hear</i> the other person, rather than to prepare your reply to the other person. You can't do both, as you have limited bandwidth</li>
</ul>
<div>
<i>Scarcity</i></div>
<ul style="text-align: left;">
<li>If you're overcommitted, you may think you should drop everything from your schedule so that you have lots of time. But, then you'll take on unnecessary commitments</li>
<li>A woman with lots of debt still keeps spending. She's a bad debtor of money, spending money she doesn't have</li>
<ul>
<li>We're often bad debtors of time, spending time we don't have</li>
</ul>
<li>The tagline of their book "Scarcity" is "Why having too little means so much". When we experience scarcity, we focus on the one thing to make ends meet right now</li>
<ul>
<li>Sometimes it works: we can be super-productive when you have a deadline</li>
<li>But, long-term consequences: spending money you don't have involves taking payday loans</li>
<li>Thus, there's an optimum amount of scarcity - not too much, nor too little</li>
</ul>
</ul>
<div>
<u><span lang="EN-US">Mindfulness (Goldie Hawn)</span></u></div>
<ul style="text-align: left;">
<li>For further color, read the TIME Magazine article "The Mindful Revolution", <a href="http://sfinsight.org/MindfulRevolutionTIME.pdf">http://sfinsight.org/MindfulRevolutionTIME.pdf</a>.</li>
<li>The more attentive you are, the more your brain circuits wire together and fire together. Mindfulness has been scientifically proven to change the neuroplasticity of the brain</li>
<li>Mindfulness - focusing on one thing - teaches self-control, and ensures that you can control your emotions rather than being reactive</li>
<ul>
<li>Hot cognition: you make decisions based on emotion</li>
<li>Cold cognition: you can distance emotion from decisions</li>
</ul>
<li>The "<a href="http://en.wikipedia.org/wiki/Stanford_marshmallow_experiment">Stanford marshmallow experiment</a>" showed that, whether kids were able to resist eating a marshmallow, was a significant predictor of future success</li>
<ul>
<li>Being distracted (e.g. checking phone during dinner, or doing urgent stuff over important stuff) is like eating a marshmallow or not controlling your hot cognition</li>
</ul>
<li>Psychology used to be about fixing broken things. Nowadays, positive psychology is about building on the good things in people. This involves attentiveness and focus</li>
</ul>
<div>
<u><span lang="EN-US">Mindfulness Dinner</span></u></div>
<ul style="text-align: left;">
<li>Otto Scharmer (MIT): the success of an intervention depends on the internal state of the interviewer </li>
<ul>
<li>For someone to be a good leader or teacher, the people he's leading or teaching must be mindful</li>
</ul>
<li>Tania Singer (Max Planck Institute): mindfulness isn't just attention (like being a sniper). It doesn't just make you more efficient</li>
<ul>
<li>Mindfulness has an ethical dimension. Being present and aware of what it exists, and accepting what exists: compassion for others, self-acceptance for yourself</li>
</ul>
<li>Buddhist monk: mindfulness isn't just being aware of your thoughts, but also countering bad thoughts</li>
<ul>
<li>People are born with traits. However, by accumulating moods, you scientifically modify your traits by changing the neuroplasticity of the brain.</li>
<li>Being a restless monkey all the time is bad. Be deeply aware of what's going on </li>
</ul>
<li>The founder of Twitter mediates for 10 minutes a day, even though Twitter seems the opposite of mindfulness</li>
</ul>
<u>Should Drugs Be Legalized?</u><br />
<div>
<ul style="text-align: left;">
<li>Governor Rick Perry (Texas): I'm the only one on this panel against the legalization of drugs, but I come to this debate with an open mind</li>
<li>Kenneth Roth (Human Rights Watch): decriminalize drugs, so that we can regulate them like alcohol, tobacco</li>
<ul>
<li>Treatment is key, but treatment is undermined by criminalization, so victims run away from treatment</li>
</ul>
<li>Kofi Annan: drugs have destroyed many people, but government policies have destroyed many more. </li>
<ul>
<li>The US spends more money on prisons than education</li>
<li>We don't need to legalize drugs, but we should decriminalize them - there's an important difference. You can decriminalize possession, but still keep supply illegal (as in Colorado)</li>
</ul>
<li>Juan Manuel Santos (President of Columbia): drug policy is currently decided by law enforcement people, but it should be discussed by public health people</li>
<ul>
<li>Criminalization creates drug cartels and the potential for huge profits. This leads to murders - profits are so high that people are literally willing to kill for them</li>
<li>Tobacco and alcohol firms make normal profits because these substances are legalized</li>
<li>The Surgeon-General of the US said 8 million deaths have been prevented by the legalization of tobacco</li>
</ul>
<li>Roth: decriminalization doesn't mean throwing your hands up and giving carte blanche. Use education, drug substitutes</li>
<li>Perry: I won't jump in front of the parade just because this is the way public opinion is going. Instead, science should lead us</li>
<ul>
<li>In the 5 years since decriminalization of drugs in Portugal, the murder rate has risen 40%</li>
<li>Marijuana today is much more potent than in the past - it's genetically modified</li>
<li>The fact that Texas is stricter than other states doesn't mean that Texas is too strict, or that the other states are too lax. The 10th Amendment was to give states authority to set laws, and then people can choose where to live. We shouldn't have the "one-size-fits-all" mentality that seems to come out of DC.</li>
</ul>
<li>Perry: something must certainly be done, but there are other steps we can take besides criminalization</li>
<ul>
<li>Go after the money. Crack down on banks who allow money laundering </li>
<li>Science can create drug substitutes. Decriminalization dissuades drug users from moving off drugs onto substitutes.</li>
</ul>
<li>Annan: decriminalize consumers, stay harsh on suppliers</li>
<li>Audience question: does it apply to all drugs?</li>
<ul>
<li>Santos: we need a different approach for each different drug, since each drug is different</li>
<li>Perry: the others on this panel have used economic arguments for legalizing drugs - that legalization will remove cartels. But, if so, the economic argument would apply to all drugs. This exposes the fallacy of a purely economic argument. Instead, we should look at the science of each drug. We should also think about the medical cost of sending the message that it's OK to smoke marijuana</li>
<li>Roth: but we're not sending the message that tobacco is OK. Packets say "smoking kills"</li>
<li>Perry: but that used to be the message. Films, celebrities portrayed the image of smoking being cool. We haven't spent enough since then to reverse this image. </li>
</ul>
</ul>
<div>
<u><span lang="EN-US">Closing Address</span></u><br />
<ul>
<li>Pope Francis: humanity should be served by wealth, not ruled by it</li>
<li>Jim Wallis: Hope is believing in spite of the evidence, and then seeing the evidence change</li>
<li>When we return home, we will be confronted by the tyranny of the urgent - but we need to be mindful of what's morally urgent</li>
<li>Think about: what's the one thing I will commit to right now to help support the World Economic Forum's mission to improve the state of the world?</li>
</ul>
</div>
</div>
</div>
</div>
</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-43846230097313063972014-03-25T06:52:00.000-07:002014-03-29T05:09:33.217-07:00Eradicating World Poverty: Inspiring a New Generation to Act<div dir="ltr" style="text-align: left;" trbidi="on">
<div>
This is a summary of a Davos session on "The Post-2015 Goals: Inspiring a New Generation to Act" on the eradication of world poverty and the millennium development goals. It featured, among others, David Cameron, Bono, and Ngozi Okonjo-Iweala (the Nigerian Finance Minister and the most impressive person I heard at Davos):</div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">David Cameron: tackling poverty is a holistic issue. We can't tackle poverty without tackling climate change, governance, corruption, justice, democracy, gender equality. Many of these reasons are why North Korea is poor but South Korea is rich</span></li>
<ul>
<li style="margin-bottom: 0.1em;">Growth is insufficient. It must be in areas that create jobs for poor people (e.g. agriculture, housing), and we must create a social safety net</li>
<li style="margin-bottom: 0.1em;">People want two things: a job, and a voice. Can't just focus on the former</li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">As a result, the Millennium Development Goals (established following the 2000 Millennium Summit of the United Nations) cover eight different areas:</span></li>
<ul>
<li style="margin-bottom: 0.1em;">Eradicate extreme poverty and hunger</li>
<li style="margin-bottom: 0.1em;">Achieve universal primary education</li>
<li style="margin-bottom: 0.1em;">Promote gender equality and empowering women</li>
<li style="margin-bottom: 0.1em;">Reduce child mortality</li>
<li style="margin-bottom: 0.1em;">Improve maternal health</li>
<li style="margin-bottom: 0.1em;">Combat HIV/AIDS, malaria, other diseases</li>
<li style="margin-bottom: 0.1em;">Ensure environmental sustainability</li>
<li style="margin-bottom: 0.1em;">Develop a global partnership for development</li>
</ul>
<li style="margin-bottom: 0.1em;">Bono: I write lyrics like I write poetry. But, goals must be the opposite: hard and precise.</li>
<li style="margin-bottom: 0.1em;"><span style="line-height: 12pt; text-indent: -18pt;">Bono: </span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">We should get out of the way of poor people. Ask them what they want, rather than presuming that we know</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Capitalism can be a great creative force, but also a great destructive force. Even if it's not immoral, it's amoral</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Bono: to me, transparency is even more important than debt cancelation</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">If a firm is registered on the NYSE, it must publish what it pays executives. But, declared and actual pay is different. </span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Companies always lobby against transparency. The American Petroleum Institute lobbied against the Extractive Industries Transparency Initiative, which requires oil, gas, and mining companies to disclose the payments they make to governments for extractive projects</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">The government must also be open. The question shouldn't be "are we open for business?" but "are we open"?</span></li>
</ul>
<li><span style="line-height: 16px;">Ngozi Okonjo-Iweala (Nigerian Finance Minister):</span></li>
<ul>
<li><span style="line-height: 16px;">Nigeria is forward-thinking compared to the rest of Africa, but shouldn't try to be an oasis in a desert, because the desert always wins</span></li>
<li><span style="line-height: 16px;">Africa needs to move beyond extracting resources and use them to create wealth and equality</span></li>
<li><span style="line-height: 16px;">Nigeria's policies are targeted. Use conditional cash transfers to encourage kids to attend school. Don't just receive aid, but use it to leverage private sector resources better</span></li>
<li><span style="line-height: 16px;">We write off whole countries when there's a bit of sectarian conflict. But, even in such countries, we can try to get kids into school. As peace is being brokered, the next generation can get an education</span></li>
</ul>
<li>Cameron: </li>
<ul>
<li>I reallocated the aid budget from India and China to other countries. India and China have resources to help themselves</li>
<li>Some of the fastest-growing countries in the world are in Africa. But, there's lots of red tape hindering trade between African countries. Thus, lots of infrastructure has been build to export goods out of Africa, rather than trade within Africa</li>
</ul>
<li>Ngozi: gender inequality isn't limited to developing countries. Only 15% of Davos is female. But, because Nigeria is poorer, we can least afford it. I have to take the bull by the horns</li>
<ul>
<li>Girls' literacy is key. With the UK's Department For International Development, we pioneered conditional cash transfers to get kids into school. Attendance rose 40%</li>
</ul>
<li>Ngozi: everyone agrees we should invest in developing countries</li>
<ul>
<li>But, we typically think of investment being in hard assets - building schools and infrastructure</li>
<li>We need to invest in soft skills: training midwives, teaching a mother to give water to a baby with diarrhea</li>
<li>An educated woman has 2.1 kids, an uneducated woman 8.9</li>
</ul>
<li>Cameron: the UN must agree on a set of specific, measurable, inspiring goals that apply to everyone. We shouldn't have separate goals for the rich and poor. Anti-corruption, justice, transparency are goals for all countries</li>
<ul>
<li>Jasmine Whitbread (CEO of Save the Children): goals are universal, but the strategy to achieve them may differ across countries. </li>
</ul>
<li>Tidjane Thiam (CEO of Prudential): we don't want to talk about Africa changing. Africa is still the same - it's weather and resources are the same. Instead, we want to talk about Africans changing - a change in people's attitude</li>
<li>Bono: next year will be the 30th year of Live Aid. I hope that Bob Geldof and I are just guests - that we won't need Live Aid any more</li>
</ul>
</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-23026132480431033542014-02-15T01:51:00.000-08:002014-03-25T06:42:33.017-07:00Davos in a Nutshell (Part 2)<div dir="ltr" style="text-align: left;" trbidi="on">
<div>
Here are key takeaways from additional sessions I attended in Davos. The last blog mainly covered sessions that were statements of fact (e.g. current economic indicators); here I cover sessions on which there was an exchange of opinions - in particular, different viewpoints around the world on what economic policies to adopt.<br />
<br />
<div>
<u><span lang="EN-US">Economic Policy Around The World</span></u></div>
<ul style="text-align: left;">
<li>Mark Carney became governor of the Bank of England and adopted forward guidance - indicated that he would not raise rates until unemployment fell below 7%. He expected this to take 3 years, but it's likely to take 6 months - unemployment is currently at 7.1%. </li>
<ul>
<li>Thus, just before Davos he issued a statement saying he wouldn't automatically raise once unemployment fell below 7%</li>
<li>Since then he's said that he will use the output gap (the difference between actual GDP and potential GDP), rather than unemployment to guide policy</li>
</ul>
<li>Geoff Cutmore (CNBC anchor, moderator of this session): is this back-tracking a sign that monetary policy has failed?</li>
<ul>
<li>George Osborne: no. We're only discussing this because unemployment has fallen rapidly to 7.1% - because the exceptionally supportive monetary policy has worked</li>
<li>7% was never going to be a trigger for action, merely a threshold - one of many things that the Bank of England would consider when deciding whether to raise rates</li>
<li>Moreover, the interest rate isn't the Bank of England's only tool. It has tightened the mortgage approval process and used the Funding For Lending scheme. The Bank of England is second to none in having all the relevant tools at its disposal - the interest rate and a variety of macroprudential tools</li>
</ul>
<li>Larry Summers: I'm worried about macroprudential complacency, due to human error</li>
<ul>
<li>Governments missed the 1987 stock market crash, the 2007 financial crisis. </li>
<li>Spain's countercyclical capital requirements didn't protect it against the real estate bubble</li>
</ul>
<li>Thomas Jordan (governor of Swiss National Bank): we don't do forward guidance, but this doesn't mean it's bad. Different policies are good for different countries. </li>
<ul>
<li>Switzerland targets the exchange rate </li>
<li>Also has tried to rein in the property bubble through bank capital regulations, rather than interest rates</li>
</ul>
<li>Cutmore: the UK has seen a fall in the savings rate, and a housing market recovery, but no increase in exports nor productivity: rapid fall in unemployment despite modest rise in GDP suggests productivity hasn't risen. Growth has been bubbly, not balanced. </li>
<ul>
<li>Osborne: the job is indeed only half-done. But, the progress has been good. The recovery has indeed been generated by the consumer, but income-generated, not debt-generated. Now we must hand over to business investment and exports</li>
</ul>
<li>Haruhiko Kuroda (Governor of the Bank of Japan): Abenomics contains three arrows: </li>
<ul>
<li>Flexible fiscal policy: short-term fiscal stimulus, but the government aims to eliminate the deficit by 2020</li>
<li>Supportive monetary policy: Quantitative and Qualitative Easing (QQE)</li>
<li>Structural reforms</li>
</ul>
<li>Kuroda: Abenomics has worked so far. It aimed to achieve a 2% inflation target in 2 years. We're 9 months in, and consumer price inflation is at 1.2% (excluding fresh food)</li>
<ul>
<li>There's still a way to go; it's premature to discuss tapering. But, we're watching how other banks (e.g. Fed) are managing the tapering process</li>
</ul>
<li>The Fed only started tapering the second time around. The first time around, it blinked: in September 2013, Bernanke decided not to taper. In December, it reduced QE by $10bn/month to $75bn, and said it would wind down QE by end of 2014</li>
<li>Monetary policy shouldn't be conducted in isolation. As we taper monetary policy, we can't do too much fiscal contraction </li>
<li>Larry Summers: </li>
<ul>
<li>We are way better off than in 1929 due to good policy, but growth has only kept pace with population growth</li>
<li>We have significant structural issues: structural unemployment leads to hysteresis, meaning that US output is way less than potential. </li>
<li>We don't know how to have sustainable growth. The growth in 2003-6 was said to be good because unemployment fell without inflation rising, but this was due to credit expansion and a fall in lending standards. </li>
</ul>
<li>Summers: the good news of the past year allows us to shift focus from the public deficit to other deficits in the economy, such as the public investment deficit</li>
<ul>
<li>Construction unemployment is in double-digits. The US can borrow for 30 years at 3% in a currency that we print ourselves. Why not fix JFK airport?</li>
<li>We spend 25% less on life sciences than 5 years ago. That's a deficit too</li>
<li>Deficit isn't just financial debt, but other debts we bequeath to future generations</li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Jordan: businesses will only invest when the feel confident; the near-death of the Euro made this much harder. </span><span style="line-height: 12pt; text-indent: -18pt;">Policymakers can't force a company in a free market to invest, but they can do everything to create conditions that support investment.</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Cutmore (to Osborne): Why are businesses not investing? What do they fear?</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">That your government won't be around to follow through on its policies?</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">The U-turn on forward guidance, which creates policy uncertainty?</span></li>
</ul>
<li><span style="line-height: 16px;">Osborne: we're building nuclear power stations and investing in fracking, which other governments aren't. The UK is prepared to take difficult decisions</span></li>
</ul>
<u><span lang="EN-US">Rebuilding Banking in Europe</span></u></div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">A few months ago, probability of Italian default was 40%; the world had stopped funding some European firms. Credit default spreads were high, liquidity and bank capital were low</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">So we've come a long way in a short space of time. The ECB took decisive action, and fiscal policy became more credible</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Tail risks (e.g. fear countries exiting the Euro) have been alleviated. As of January 2014 we now have more members of the Euro (Latvia has joined, so now 18 members) not fewer</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">But, there's still a long way to go</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Anshu Jain (Deutsche Bank): 3/4 of credit in Europe comes from banks, not capital markets, so banks are key to the health of the overall economy</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">While the European economy has recovered a little, this hasn't manifested in greater lending, either to businesses or households. Some people think that one more push (e.g. the Asset Quality Review) will finally get lending going again. </span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">But, this is wishful thinking. The problem isn't insufficient supply of loans (we've already had a huge fall in bank funding costs which has increased loan supply), but an insufficient demand for loans. </span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Businesses won't demand loans for investment while there's still uncertainty over policy, and uncompetitive labor markets. </span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">The European Central Bank will be the single regulator of all banks in the Eurozone from 2014. It will conduct an Asset Quality Review throughout Europe to "stress test" banks' portfolios, to see if banks are healthy.</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Are you worried that it will unveil severe problems? Jeroen Dijseelbloem (Dutch Minister of Finance): I hope so! We <i>want</i> to find problems so that we can fix them. </span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Having banks fail will show that the stress tests were done seriously. Europe first did some stress tests in 2010, but they were viewed as not tough enough. National supervisors did them independently, with little coordination. Thus, they had incentives to hide problems. This is why Ireland and Spain didn't fail more banks</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">However, we must realize that stress tests aren't a panacea. They can't tell you definitively the quality of a bank's loan portfolio - this quality keeps changing. This is why bank capital is necessary, to help prepare for the unpredictable.</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Interbank lending is low, even with in Europe. The world's willingness to lend to European banks is also low. A stringent stress test will encourage lending to banks that pass the tests.</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Lord Adair Turner </span><span style="line-height: 16px; text-indent: -24px;">(former Chairman of the UK Financial Services Authority): t</span><span style="line-height: 12pt; text-indent: -18pt;">he US's stress tests in 2009 were very successful as they were stringent. Also, it was very clear what would happen if a bank failed: it would be given a certain number of months to raise capital privately; if it failed to do so, there would be a public recapitalization.</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Dijseelbloem: but EU does have a clear set of next steps if a bank fails the stress test. It will be given time to deal with its problems. If unsuccessful, it must engage in a "bail-in", where existing bondholders see part of their debt written off (this happened in Cyprus). Only if it's undertaken a bail-in can it request government funds as a last resort. If the government can't recapitalize the bank because it's too big, it will have to request a loan from </span><span style="line-height: 16px; text-indent: -24px;">the European Stability Mechanism, the eurozone's government bailout fund.</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">December 2013: EU finance ministers created a Single Resolution Mechanism. It imposes levies on banks to build up national resolution funds, which will be gradually merged over 10 years into one European pot worth €55bn. This will act as a financial backstop</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">When a bank fails, its shareholders and creditors (rather than the taxpayer) should pick up the bill. But, the resolution process may require outside funds, e.g. to recapitalize key parts of a bank before selling it, or provide liquidity. This is what the backstop is for</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">While the resolution funds are being built up, the backstop will be the national government (and thus the ESM if the government has insufficient funds)</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">€55bn pot criticized as being too small. The Spanish bailout cost €40 bn, ant that's only one country</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">But this fund is only the last line of defense. We have been building up other lines of defense. Bank capital is the first line of defense, and banks have been recapitalizing. We also have national resolution funds</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Lord Adair Turner : we need to go further than the mutualization of a guarantee scheme</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">We need a single banking union, just like in the US. It's not the case that New York banks just lend to New York, and New York depositors rely only on New York for deposit insurance</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">We can't just close down a very large bank that's failing. We will need to put in public capital. This is why the Resolution Fund (financial backstop) is key. Until the fund is in place, we're still in danger</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">In the US, there's a pan-US response if a bank fails. In Europe, it's a national response</span></li>
</ul>
<li><span style="line-height: 16px;">Trust is a huge issue in banks at the moment:</span></li>
<ul>
<li><span style="line-height: 16px;">LIBOR and Forex benchmark manipulation</span></li>
<li><span style="line-height: 16px;">Commission-oriented salespeople sold Payment Protection Insurance that wasn't needed</span></li>
<li><span style="line-height: 16px;">Banker bonuses despite losses</span></li>
</ul>
<li><span style="line-height: 16px;">David Rubinstein (Carlyle): not clear that popularity is the relevant criterion. Even in good times, the public never loves banks or PE. Unlike Apple or Starbucks, most people's relationship with banks involves paying fees </span></li>
<li><span style="line-height: 16px;">Lord Turner: the collapse of the financial system isn't a problem just for industry, but also for regulators and academic economists</span></li>
<ul>
<li><span style="line-height: 16px;">Policymakers used to think that more innovation, more efficiency is always better - they overly believed in market efficiency</span></li>
<li><span style="line-height: 16px;">Central bankers thought the financial system unimportant for the real economy</span></li>
<li><span style="line-height: 16px;">Most academic models don't contain a financial sector</span></li>
</ul>
</ul>
<div>
<div>
<u><span lang="EN-US">Coperation Between China, Europe, and the US</span></u></div>
<div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">Theme of session: these are the three largest economies. If they can work together, we can guarantee global growth and world peace. But, how can we foster cooperation?</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Nick Clegg: GATT reflected the old world order. Now, the balance of power has shifted from the west to the east. Thus, trade agreements are bilateral, not global</span></li>
<ul>
<li>Must ensure regionalism and bilateralism don't undermine multinatinoal agreements</li>
</ul>
<li>Lloyd Blankfein: trade is always a win-win. Everyone has a stake in everyone else. If oil is discovered anywhere in the world, it's best for the country that discovered it, but it's good for other countries too. The same goes for growth: any growth in the world is good for the rest of the world. </li>
<ul>
<li>China will grow, but we have to manage our expectations. This is quite natural - if China would definitely grow and there are no risks involved, the market would be inefficient</li>
</ul>
<li>Angel Gurria (Secretary-General of OECD): it's OK to build brick-by-brick, as long as bricks fit into a coherent bubble</li>
<ul>
<li>Agreements should be not just on trade, but intellectual property rights and procurement</li>
<li>State-owned companies must be on a level playing field with private companies. Common labor and disclosure rules. Need to pay dividends to the Ministry of Finance</li>
</ul>
<li>Joseph Nye: we must include Japan in these discussions, and not let tension between China and Japan get in the way</li>
<li>Clegg: any open economy requires China; the UK is one of the most open economies. Chinese investment in the UK in the last 18 months has exceeded the investment in the prior 30 years</li>
<ul>
<li>Thus, UK must stay in the EU to be able to negotiate with clout with countries like China. UK is 60m people, Europe is 500m. </li>
</ul>
<li>Clegg on trade: there's no future in protectionism, but we need to be true to our values. We can't ignore human rights.</li>
<ul>
<li>It's insufficient to sign up to new agreements; we must adhere to them, and have teeth in case countries don't adhere</li>
<li>We've gone beyond haggling tariffs; we're now discussing norms and standards</li>
</ul>
<li>Should China see its future with the BRICs rather than the west, because the west isn't growing so fast?</li>
<ul>
<li>No, that would be very short-sighted. The US will still be huge. Even though China GDP will soon overtake the US's, China GDP/capita won't for a while, and this is a measure of economic effectiveness.</li>
</ul>
<li>Clegg: China should recognize that it's own future depends on sustainability. It can't ignore the environment</li>
<ul>
<li>Gurria: China is a big user of coal, which is very bad for the environment.</li>
<li>China is so large that any actions that it take have global implications.</li>
</ul>
</ul>
<div>
<div>
<u><span lang="EN-US">Challenges Facing US Competitiveness</span></u></div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">The World Economic Forum ranks the US #5 in global competitiveness, up from #7</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">There are concerns that the government should stay arm's length with the private sector</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Michael Porter: </span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">The US faces structural competitiveness challenges. The few jobs they are generating are in areas insulated from international competition, suggesting that the US is losing international competitiveness</span></li>
<li>The problem isn't that the US doesn't have strengths (it has science, technology, entrepreneurship, innovation) but that it has allowed weaknesses to crop up: regulatory complexity, poor infrastructure, public education, tax complexity. Complying with regulations costs $17tr, $10k per employee. The tax system is so complex that companies would rather invest overseas</li>
</ul>
<li>Glenn Hutchins (Silver Lake): </li>
<ul>
<li>There will be a global equalization of wage rates as China, former Soviet Union come into competitive markets. This will push US wages down, so wages may not be there to support consumption</li>
<li>Employment has to be reformed. Unemployment benefit is not means-tested</li>
</ul>
<li>There's great opportunities to do trade agreements - no President since FDR has had such ability to negotiate trade, but little has been done.</li>
<li>Healthcare costs are out of whack; Obamacare didn't get at the cost structure.</li>
<li>The US will gain 35m workers, of which 43m (> 100%) will come from immigration. China will lose workers due to its 1 child policy</li>
<li>Eric Cantor (House Majority Leader): we believe in a global economy as it reduces costs for consumers, but access to the US market requires reciprocity in turn</li>
<li>Porter: the US is complacent. We think we're rich and will be rich foerever, while other countries are fixing regulation, investing more</li>
<ul>
<li>Unfunded Medicare liabilities seriously worsen the deficit</li>
<li>Need to transfer from Defined Benefit to Defined Contribution pension plans, but the president won't go there</li>
</ul>
</ul>
</div>
</div>
</div>
</div>
Anonymoushttp://www.blogger.com/profile/07416755166195900709noreply@blogger.com0tag:blogger.com,1999:blog-2969235836974207643.post-8939392930064554822014-01-28T08:51:00.005-08:002014-02-03T07:24:09.307-08:00Davos in a Nutshell<div dir="ltr" style="text-align: left;" trbidi="on">
<div style="text-align: left;">
I was very fortunate to have had the opportunity to attend the World Economic Forum in Davos last week, co-leading a session entitled "Making Better Decisions" on behavioral economics. My focus is mainly on microeconomics, and so I was grateful to learn about the current macroeconomic climate from leading policymakers, executives, and commentators. I wanted to create this posting to share what I learned. I will subdivide the post into different categories, but there will naturally be some overlap.<br />
<br />
<u><span lang="EN-US">European Economy</span></u></div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">General upbeat mood, as tail risks (e.g. likelihood of collapse of Euro) have been significantly reduced</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">But, more a feeling of relief (absence
of negative news that people feared this time last year) than optimism
(presence of definitively positive news)</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Europe looks solid only
compared to recent poor performance</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">The US has done much better than Europe. Unemployment is below the pre-crisis level, the stock market is higher, and GDP is higher. In Europe, Germany is the only country that satisfies all three criteria</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Euro-area GDP growth at 1% is
still anemic, and uneven across the Euro-zone: concentrated in the poorest
countries</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Short-term growth has resulted
from monetary and fiscal stimulus. Long-term growth will depend on structural
issues: technology, innovation, trade, supply-side factors, which are weak</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Structural reforms needed to address these supply-side issues, but governments are notoriously sluggish</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Youth unemployment is a major
supply-side concern in many countries: > 50% in Spain and Italy, 25% in
France. Failure to get a job a year or two after leaving school / university
substantially reduces the chance of getting one later</span></li>
<ul>
<li><span lang="EN-US" style="line-height: 12pt; text-indent: -18pt;">Some technological changes (e.g. 3D printing) will lead to a substantial loss of jobs in some sectors, but the creation of jobs in others. Governments should be prepared</span></li>
</ul>
<li><span style="line-height: 16px;">Short-term risks</span></li>
<ul>
<li><span style="line-height: 16px;">European Parliament elections could see some Euro-skeptics being elected, which may have similar effects as the Tea Party in the US</span></li>
<li><span style="line-height: 16px;">Imminent Asset Quality Review of European Banks; some may not pass</span></li>
</ul>
<li>Is more regulation is the optimal solution to a financial crisis?</li>
<ul>
<li>Axel Weber (UBS): Some regulations (on leverage and the banking system) were indeed necessary. Taxpayers were uncomfortable with the amount of risk that was being taken. But, need to remember that the goal of the banking system is to foster growth (by lending money), so we mustn't over-regulate</li>
<ul>
<li>Same applies to non-finance regulations. Freeing up access to data (e.g. medical records) can be helpful for growth</li>
</ul>
<li>Sir Martin Sorrell (WPP): best regulatory change would be to increase labor market flexibility. Firms are unable to lay off workers without excessive severance pay, so they don't hire to begin with</li>
</ul>
</ul>
<div>
<div class="MsoNormal">
<div class="MsoNormal">
<u><span lang="EN-US">Deflation Concerns</span></u></div>
</div>
<div>
<ul style="text-align: left;">
<li><span style="line-height: 16px;">All OECD countries (except Turkey and Hungary) are below their inflation targets</span></li>
<ul>
<li><span style="line-height: 16px;">Why is deflation bad? </span></li>
<ul>
<li>Households will postpone purchases if they think prices are going to fall</li>
<li>Real (i.e. inflation-adjusted) debt rises when prices fall. This makes borrowers even more in debt, and makes them less likely to spend. The government is a major borrower, and deflation increases the real amount of public debt</li>
<li>For the above reasons, low inflation may <i>cause</i> weak economic growth, rather than merely being a <i>symptom</i> of weak economic growth</li>
</ul>
<li><span style="line-height: 16px;">OK, I understand that negative inflation is bad, but shouldn't we target 0% inflation, not 2% inflation?</span></li>
<ul>
<li><span style="line-height: 16px;">Quality of goods rises over time, so 2% inflation is really 0% inflation, and this is not fully captured in updates to inflation calculations </span></li>
<li>Positive inflation allows real wages to fall even if nominal wages don't fall</li>
</ul>
</ul>
<li><span style="line-height: 16px;">Some may argue that low "headline" inflation is because shale revolution has driven down energy prices, but "core" inflation figures (which exclude energy prices) are also low</span></li>
<li><span style="line-height: 16px;">Policymakers feared that Quantitative Easing would lead to inflation, but QE has had a much bigger effect on the prices of financial assets (e.g. stocks) than real goods and services</span></li>
<li><span style="line-height: 16px;">Major cause of deflation is debt overhang: firms have so much debt that they have few incentives to invest</span></li>
<ul>
<li><span style="line-height: 16px;">We don't know how to cure debt overhang, we only know how to move debt from the public sector to the private sector</span></li>
<li><span style="line-height: 16px;">View that debt overhang is important suggests that the demand side, rather than the supply side, is key to avoiding deflation</span></li>
<li><span style="line-height: 16px;">Monetarists (who advocate focusing on the supply side) predicted that quantitative easing would lead to inflation. But it didn't, it only reduced downside risks. This shows that demand-side considerations are important</span></li>
</ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Economies only grew in the last decade due to debt. Private credit grew much faster than GDP. UK household debt/GDP was 15% in 1964 and 95% in 2008. Policymakers don't know how to growth without taking on debt</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Germany was the only country we could think of that has grown without debt, but they have grown due to a current account surplus: China has taken on debt to buy German goods. Thus, they've also required debt to achieve growth</span></li>
</ul>
<li><span style="line-height: 16px;">Earnings haven't yet risen, which is one of the key drivers of inflation</span></li>
<li><span style="line-height: 16px;">Good deflation is where prices fall relative to wages, but here we have low wage growth</span></li>
<ul>
<li><span style="line-height: 16px;">Even though UK and US unemployment data are good, wage growth is surprisingly weak</span></li>
</ul>
<li>Yen fell in 2012 in anticipation of QE; Pound fell in 2008 for the same reason. Led to inflation the following year since input prices rose. Similarly, it led to other countries having falling inflation. Thus, QE in one country "exports" deflation elsewhere - it passes on the problem</li>
<ul>
<li>But, if all countries engage in QE together, this can stimulate the global economy.</li>
</ul>
</ul>
<div>
<div class="MsoNormal">
<u><span lang="EN-US">European Bank Regulation<o:p></o:p></span></u></div>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">European Central Bank will be a common regulator across all European banks</span></li>
<li>Uncertainty over whether there will be a common deposit guarantee</li>
<li>Further political reform, and fiscal union, will further solidify Europe, but there are many opponents</li>
<li>Is the financial system safer now?</li>
<ul>
<li>Anthony Jenkins (Barclays): yes, we understand risk better now, and there's closer supervision. However, whether the system is safer is not the only important question; we must also ask if it supports growth.</li>
<li>Anat Admati (Stanford): no. The changes that have happened have been like reducing the speed limit from 90 to 85. Financial crises aren't exogenous natural disasters (like hurricanes) that we can do little about; they are man-made disasters created by faulty laws</li>
<li>Paul Singer (Elliott Management): no. Banks still engage in substantial proprietary trading; they are 10 times more leveraged than his own hedge fund, and don't understand their risks (e.g. complex derivatives).</li>
<li>Douglas Flint (HSBC): Move risk into places that it's transparent and understood (e.g. banks) than leaving it with people who don't understand it (e.g. leave a small business vulnerable to exchange rate risk as it's unable to hedge itself using derivatives.)</li>
<li>Anthony Jenkins (Barclays): Northern Rock (building society), HBOS, RBS (commercial banking) failed, and these were not active in derivatives. Derivatives are socially useful for risk management. </li>
<ul>
<li>It's unrealistic to think that banks should just get rid of risk, as this is impossible. However clever people are with algorithms, you can't spin straw into gold - you can't turn risky stuff into a AAA bond. They can't eliminate risk, but they perform a useful function by taking risk off others' hands (even though this means that they end up risky themselves)</li>
<li>Thus, the goal should not be for banks to be safe, but just to understand the risks they are taking.</li>
</ul>
</ul>
</ul>
<div>
<div class="MsoNormal">
<u><span lang="EN-US">French Economy<o:p></o:p></span></u></div>
<ul style="text-align: left;">
<li><span style="line-height: 12pt; text-indent: -18pt;">GDP growth of 0.0% in 2012, fell 0.1% in Q3 2013</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Weak government fiscal position</span></li>
<ul>
<li><span style="line-height: 12pt; text-indent: -18pt;">Government spending at 53% of GDP is highest in G7</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Debt/GDP was 91% in mid-2012, versus the 60% target in the Stability Pact</span></li>
<li><span style="line-height: 12pt; text-indent: -18pt;">Huge unfunded pensions. As US states are finding, pay-as-you-go is another word for a pyramid scheme</span></li>
</ul>
<li><span style="line-height: 16px;">S&P downgraded France to AA, Moody's to Aa1. Fitch downgraded France and upgraded Spain at the same time</span></li>
<li><span style="line-height: 16px;">Since creation of Euro, France has grown 0.8%/year versus Germany's 1.3%</span></li>
<li><span style="line-height: 16px;">Unemployment rate of 10.9% (versus 5% in Germany), highest in 16 years. Youth unemployment of 25%</span></li>
<li><span style="line-height: 16px;">Rigid product and service markets according to OECD surveys</span></li>
<li><span style="line-height: 16px;">Rigid labor markets</span></li>
<ul>
<li><span style="line-height: 16px;">Strong employment laws make dismissals hard. Dismissals often challenged in court; workers have long time window to contest dismissals</span></li>
<li><span style="line-height: 16px;">High minimum wage (€9.53/hour), beyond the productive power of many workers</span></li>
<li><span style="line-height: 16px;">35 hour work week, 60 year old retirement age</span></li>
<li><span style="line-height: 16px;">High welfare and unemployment benefits discourage work</span></li>
</ul>
<li><span style="line-height: 16px;">Unexpected worsening in current account deficit in November 2013. Exports weak due to</span></li>
<ul>
<li><span style="line-height: 16px;">Rigidities in product, service, and labor markets</span></li>
<li><span style="line-height: 16px;">Weakness in key trading partners (Italy, Spain). France is heavily exposed to Europe due to trade linkages and banking system; Germany, in contrast, exports outside Europe</span></li>
<li><span style="line-height: 16px;">Due to the Euro, France can't devalue to maintain competitiveness. An increase in prices combined with a constant nominal exchange rate leads to a higher real exchange rate</span></li>
</ul>
<li>Since Hollande's election in mid-2012, little action</li>
<ul>
<li>Responded indignantly to IMF, OECD calls for France to reform its budget deficits, claiming that outsiders should not tell France how to run its economy</li>
<li>Muddled policies. Increased business tax relief, but also reversed some tax reliefs of previous government and increased income tax to 75% above €1m</li>
<li>No efforts to improve investment, innovation, eliminate 35 hour work week</li>
</ul>
<li>January 2014 announced €30b of payroll tax cuts. "Responsibility Pact" that, if businesses invest in France and hire young and old workers, they will get more tax cuts and fewer constraints on business activity</li>
<ul>
<li>Goal is to create 1.8m jobs to cut unemployment to 7% by 2018</li>
<li>Tax cuts are welcome, and show pragmatism (as Socialist governments are not typically associated with supply-side reforms). Big question is how to finance it. Government can't borrow, as France is already indebted. Announced €53b of spending cuts over the next three years, but few details. Hollande has shown he can raise income tax, but cutting expenditure is much harder</li>
</ul>
</ul>
</div>
</div>
</div>
</div>
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