The problem comes because of a classic agency problem: divisional managers are compensated in part on the basis of the financial performance of their division. Shareholder, in contrast don't care which division the costs and revenues are allocated to, since they have a claim on the cash flows of the entire company. So, the interests of the agents (the managers) diverge from those of the shareholders (the principals) and voila: the managers take actions that shareholders would prefer they didn't.
Now I have the perfect Dilbert cartoon to illustrate the concept:
HT: The Conglomerate Blog.
- A move back to our "homeland" in the Northeast USA, which puts us within 80 miles or so of both parents and all myriad nephews, nieces, etc...
- A new school for me. This part is particularly good, since whenI first went on the job market in my final year of grad school, I identified 3 schools I would love to be at. This was one of them (it took 8 years to get here, but hey - some things take time).
- I'm teaching two new classes in a different sub-field fo finance. It's a lot more work, but I'm learning new things.
- I'm also teaching CFA prep classes, which helps to pay for our oversized mortgage (Northeast real estate prices are high).
- The Unknown Son goes to a new new school which is much better than his old one (after all, it's a University town). Even better, the two little darlings that used to pick on him in his last school are no longer around.
- The Unknown Daughter is now in kindergarten, and loves it. It's part of the same school as the Unknown Son's, so they get to ride the bus together.
- We're now in a neighborhood that we simply love, with plenty of young families with kids and dogs (for the Unknown daughter to walk).
- Of course, I have to work a lot harder here than in my last school, but I also have a 2 mile commute rather than the hour it used to take. So, it's a lot easier to pop home for a bite or to play with the kids for a bit before night classes.
And thanks for stopping by.
Read the whole thing here.
A look at recent buyout deals shows not only that they are getting bigger in dollar terms, but also that larger companies are being pushed to pile on increasingly heavy loads of debt.
Private-equity investors -- which make money by buying control of companies in the hopes of cashing out through a stock offering or outright sale -- have been emboldened by low interest rates and generous credit markets. They are pushing companies further out on a limb in the process. In some cases, this gives their newly private companies little breathing room to execute growth plans and stay afloat were economic and market conditions to turn sour.
In many cases, companies will need to devote at least half their yearly cash flow to meeting interest payments on their debt.
Corporations that were acquired in leveraged buyouts in the fourth quarter have a ratio of debt to cash flow of 5.7 times on average, according to Standard & Poor's Leveraged Commentary & Data Group. That is up from an average of 5.3 times in 2005. In 2002, when lenders were less willing to finance risky deals, this ratio was close to four.
The last time leverage in buyout deals averaged 5.7 times cash flow was during the merger boom of the mid-to-late 1990s. In the years that followed, some debt-heavy companies, like barbecue-products maker Diamond Brands and animal-feed producer Purina Mills, defaulted on their debt when their bets went wrong.
It's not all that surprising that these firms are highly levered - that's what the "L" in LBO stands for. In an LBO, the acquirer (a "private equity", or "PE" firm) takes a firm with decent cash flows that is arguably underleveraged and gears it up with more debt. This potentially creates value through a number of channels:
- The old risk-return tradeoff: Increased debt levels makes the firm's equity riskier, but magnifies returns in good times. So, why don't the managers of the public firm do this themselves? They might be too risk-averse to take the debt up to ooptimal levels. If a firm restructures in banckruptcy, the CEO is often out of a job, and may have difficulty getting another one. Hence, too little debt.
- Tax shields - interest on debt is tax-deductible (this is known as the "tax shield" of debt).
- Debt helps manage agency problems: having a lot of cash makes a company's future less sensitive to recent performance. taking on more debt means that the firms has to look at every decision more closely, since they're walking a tightrope.
But, the process is full of risk. With greater risk comes a greater chance of failure. This is why PE forms make so much money - they're willing to take on the huge levels of risk that managers of publicly-held companies aren't.
Now that I'm on this side of the table, I have a lot more respect for what I put my own professors through. Forgive me, for I knew not what I was doing...
Having done that, it's time to blog. There were some interesting pieces in the news (or in the blogosphere) lately. Here they are:
There's a must-read piece in yesterday's Wall Street Journal on the history of executive stock options. If you want to understand some of the issues related to back-dating, reloading, and so on, this is the piece for you.Enjoy.
Ticker Sense has a list of analysts' price forecasts for the S&P 500.
Business Week lists The Big Private Equity winners of 2006.
This week's Carnival of The Capitalists is up at Worker Bees Blog. My picks of the week are Dan Melson's piece Choosing Buyer's Agents By Commission Rebate: Penny Wise, Pound Foolish and Free Money Finance's how to make our children into millionaires
Finally, from Seeking Alpha, we have two conflicting indicators as to what will happen in the market: Yaser Anwer tells us that Short interest declined (that's a bullish indicator), while John Hussman tells us that insider selling is up and money managers are overwhelmingly bullish (both are bearish indicators). So take your pick - it reminds me of the need for "one-handed" economists".
The first was the Peanuts Christmas special, and the second was (of course) It's a Wonderful Life.
Thanks to Youtube, here they are.
Linus' Reading of The Christmas Story.
The Ending of It's A Wonderful Life.
When you get off track this season, apply both liberally as needed.
And a very Merry Christmas to all of you and yours from the Unknown Household.
First, here's a Wall Stree Journal editorial by Michael Malone titled The Pump-and-Dump Economy. He lays out some pretty good arguments showing how the VC and Private equity world have been affected by Sarbanes-Oxley, Regulation FD, and the calls for options expensing. As a result, he argues that they'll end up having far-reaching effects on the rest of the economy.as one of my econ professors always said, the Law of Unintended Consequences is like the law of gravity - you can tell yourself it's not there, but it'll get whether you believe it or not.
Batting in second place is another article from the WSJ titled "Venture Capital's New Adventure". It discusses how the slowdown in IPOs from Sarbanes Oxley has made VCs job much harder. In particular, it highlights the case of Drew Lanza, a tech VC who's recently started doing roll-ups in the chip industry.
Finally, the NYtimes tells us that VCs are looking overseas for exits. It seems that the increased regulation in the U.S. market is making foreign markets more preferable for staging IPOs for exits.
No, this has nothing to do with Finance or Economics, and Yes, I'm avoiding doing some work. Bad Professor!
- Is it good if a vacuum really sucks?
- Why is the third hand on the watch called the second hand?
- If a word is misspelled in the dictionary, how would we ever know?
- If Webster wrote the first dictionary, where did he find the words?
- Why do we say something is out of whack? What is a whack?
- Why does "slow down" and "slow up" mean the same thing?
- Why does "fat chance" and "slim chance" mean the same thing?
- Why do "tug" boats push their barges?
- Why do we sing "Take me out to the ball game" when we are already there?
- Why are they called "stands" when they are made for sitting?
- Why is it called "after dark" when it really is "after light"?
- Doesn't "expecting the unexpected" make the unexpected expected?
- Why are a "wise man" and a "wise guy" opposites?
- Why do "overlook" and "oversee" mean opposite things?
- Why is "phonics" not spelled the way it sounds?
- If work is so terrific, why do they have to pay you to do it?
- If all the world is a stage, where is the audience sitting?
- If you are cross-eyed and have dyslexia, can you read all right?
- Why do you press harder on the buttons of a remote control when you know the batteries are dead?
- Why do we put suits in garment bags and garments in a suitcase?
- How come abbreviated is such a long word?
- Why do we wash bath towels? Aren't we clean when we use them?
- Why doesn't glue stick to the inside of the bottle?
- Why do they call it a TV set when you only have one?
Mary McKinney at Academic coach talks about procrasdistraction - this is the phenomenon of when you finally sit down to a task you've been avoiding and a list of all the OTHER things you have to do springs to mind.Off to work - I've procrasdistracted enough for now...
Joe Carter of Evangelical Outlook has a great piece about the philosophical contrasts between It's A Wonderful Life and The Fountainhead.
Finally, Tyler Cowen Marginal Revolution discusses a paper that shows what many of us already know, but it's good to see it measured: hard-working coworkers make us work harder.
I'm looking forward to the break so I can spend more time on research - I realized that I'm not doing nearly as much as I should be. In fact, I think I'll go back to logging my time and my output (i.e. how much time spend each day with fingers to keyboard and how many pages of product). The times I did that last year were among the most productive I've had in recent vintage. And I'll post my results here weekly in the spirit of transparency (and maybe get some of you to do likewise).
For the Finance & Accounting academics among you: yesterday, I finally figured out how to use SAS to remote access the Wharton Research Data System (WRDS) databases we have access to. For years, I'd done it the "old fashioned" way - used the WRDS web interface to download the data and then massage it locally using SAS. I finally bit the bullet and worked through the system documentation - it was surprisingly easy. Now I can do all the work on the Wharton system and use their resources to massage the data and merely download the finished product. Unfortunately, I lost track of time until Unknown Wife called me at 6:30 (oops).
This should help since some of the things I'm working on are real memory hogs. They should execute much faster using the servers at Wharton than they do on my relatively dinky system --it'll be nice to use up Wharton's resources instead of mine.
Today it's time for Christmas shopping and grading those last few projects.
Read the whole thing here.We begin our analysis with data on faculty in all top 35 U.S. economics departments. Faculty with earlier surname initials are significantly more likely to receive tenure at top ten economics departments, are significantly more likely to become fellows of the Econometric Society, and, to a lesser extent, are more likely to receive the Clark Medal and the Nobel Prize. These statistically significant differences remain the same even after we control for country of origin, ethnicity, religion or departmental fixed effects. All these effects gradually fade as we increase the sample to include our entire set of top 35 departments.
We suspect the "alphabetical discrimination" reported in this paper is linked to the norm in the economics profession prescribing alphabetical ordering of credits on coauthored publications. As a test, we replicate our analysis for faculty in the top 35 U.S. psychology departments, for which coauthorships are not normatively ordered alphabetically. We find no relationship between alphabetical placement and tenure status in psychology.
It reminds me of back in the day when I used to do some tax and bookeeping services. Of course, I choose the name AAA Business Services.
From now on, call me Arvin Arpad Aardvark.
HT: Smart Graduate School Applications.
I'm only linking to a few things today - mostly M&A related stuff, with the obligatory reference to options backdating. It's interesting to see the NYT pieces, since we discussed similar things in my doctoral program.
So, here are today's links:
According to BusinessWeek, hostile takeover bids are on the rise. That's probably a good thing - things were getting a bit too comfy for the last few years. They give some reasons.
Enough blogging - I have exams and projects to grade, and some writing to do (and let's not forget the doctor's appointment at 3:30).
The NY Times has a couple of good pieces: one reports on a new study by Bebchuck, Grinstein, and Peyer that finds that options backdating wasn't limited to top executives - directors appeared to have gotten into he game too.
And a second NYT piece by Mark Hulbert discusses whether the current merger wave means that markets are overpriced. He does a good job of explaining the theories behind an overvaluation/acquisition link.
Jeff Cornwall is hosting the Christmas edition of the Carnival of The Capitalists.
And finally, for all you doctoral students on the job market, Craig Newmark links to "the ultimate rejection letter".
About four years ago, Dave Cummings moved his trading firm's computers from a storefront in this Kansas City suburb to buildings in New York and New Jersey that house central computers for two big electronic stock exchanges.Read the whole thing here
The move shaved a precious fraction of a second from the time it takes Mr. Cummings's firm, Tradebot Systems Inc., to buy or sell a stock on computer-based exchanges like Archipelago. It now takes Tradebot about 1/1000 of a second to trade a stock, compared with 20/1000 before the move -- a difference of about the time it takes a computer signal to zip at nearly the speed of light from Kansas City to New York and back.
It's pretty amazing when you think about it - the company moved its computers from the Midwest to the same zip code as the exchange to save the time it takes an electronic message to travel from the Midwest to New York.
It turns out that electronic trading systems allow Cummings to effectively act as an exchange specialist - he's constantly trading in and out of stocks, and is fast enough to cut in front of exchange specialists - to the tune of over $100 million a year in profits (a penny a share at a time). And better yet, he makes markets more efficient, since he only gets to trade when someone needs fast execution. According to the article, on some days, his company accounts for 5% of all Nasdaq trading volume, and 5% of the trading in Microsoft.
The only ones unhappy are the specialists.
The School of Business had it's holiday party from 5-7, just before the exam. I've discovered that exams go much better when I've had a couple of glasses of wine beforehand. Luckily, the students didn't have too many questions (gee, our professor must really like giving exams - he seems pretty happy).
Anyway, here are some of the tidbits that have been accumulating while I've been a slacker in the blogging world:
Michael Lewis at Bloomberg.com has a good piece contrasting the private and public equity worlds. Here's the money quote: "In effect, the smartest, best-connected money has separated itself from the rest of the stock market, and has gone into the business of trading against that market. It seeks to buy from the stock market cheap, and sell to the stock market dear, and if you need evidence that this is possible you need only look to the returns on private equity, which have been running three times the returns of the public stock market."That';s enough for now. Blogging will pick up next week - I have about a day's worth of grading, and then I'm done with my first semester at the new school.
In a related vein, the Wall Street Journal reports on "loan to own" PE investors. Larry Ribstein has further comments here.
CXO Advisory group reviews a paper on a potential way to exploit the "small firm effect"(for the unitiated, small cap firms tend to outperform on a CAPM risk-adjusted basis). Given that my student managed fund may be moving to a small-cap value style (with a few tweaks), this could be one for them to read.
The almost-always-on-target Flexo at Consumerism Commentary says that Freecreditreport.com is a scam.
Concurring Opinions has no trouble grading exams. Maybe I can adapt it to my student's investment analysis projects.
Rob Sama is hosting this week's Carnival of the Capitalists. Unfortunately, I don't have time to highlight my picks of the week this time around. Maybe later.
Finally, how many of you know the differences between Shiite and Sunni Muslims? Joe Carter at Evangelical Outpost does, and he has this great primer on the topic.
And then I'll have time to placate all my coauthors who've been hounding me...
He'd had an enormous amount of success as an academic - got his Ph.D. at age 24, published a phenomenal volume of research in top journals such as the American Economic Review and the Journal of Finance (multiple times). He'd been a visiting scholar at top universities and was a scholar in residence at the Federal Reserve Bank for years.
But publications fade over time. What was even more impressive (and will endure) was the impact he'd had on so many doctoral students. Many of them are now faculty around the country, and they dropped everything to fly across the country (and in the final week of the semester, yet) to honor the guy.
After getting my degree, I subsequently had the opportunity to visit at my alma mater for a while, and got to know him as a colleague and friend as well as a mentor. He was truly a class act, and whenever I needed advice on how to handle something, he was one of the first I'd go to.
I hope I can have even a small fraction of his impact.
Godspeed, Steve -- you'll be sorely missed.
I figured out a number of things I need to change in both classes next semester, which always happens the first time I teach a class. So all in all, it seems like I'll survive my first semester without serious damage to either me, my colleagues, or my students.
I've got some writing to do (as always). But in the meantime, here are some links to keep y'all busy.
John Carney at Dealbreaker has a piece on how PE firms are starting to get loans with fewer (or even no) covenants. It's a good example of how PE firms get to interact with credit markets on different terms than do traditional companies.That's all for now, folks. Enjoy.
In a second related PE piece, the Boston Globe seems surprised that bondholders often lose in PE deals. Maybe they should have thought of that when they put the covenants together.
Mike Moffatt at About Economics has a nice explanation on how markets use information to set prices.
Joe Carter at Evangelical Outpost has put up another installment of his Yak Shaving Razor series. This one's the "How To" edition.
And last but not least, the Phantom Professor has a link to a very cool video on Post-Its - it reminds me of old-style ClayMation.
Tonight we take the clan walking down the main street of our town - they've done up the store fronts with lights and decorations, and there are cheese, cider, and carriage rides to be had.
And my investments class has only a little more material to cover. So, I'm almost done except for exams.
While I work on my class material, here are a few things to keep you busy:
James Hamilton at Econbrowser explains why the inverted yeild curve might not signal a recession. His answer - foreign purchases of treasuries.Enough blogging - back to work.
Private Equity (over at Going Private, one of my favorite blogs) takes a few well aimed shots at the recent Market Watch piece I recently highlighted on dual-class shares.
Information Arbitrage discussses a New York Times article on how to interpret stock buybacks.
Steven Dubner at the Freakonomics Blog points to a really creative use of the Web - a YouTube For Data.
According to Calculated Risk, implied probabilities from options on Fed fund futures indicate a 75% chance of a Fed rate cut at the March meeting.
And finally, Sound Money Tips has a great list of resources for using the web in finding people at no (or low) cost.
Having said that, here are today's links. Some are from the weekend, but at least I've now cleared out my feed reader. Enjoy:
Want to make a humorous poster easily? Go to hetemeel.com (HT: Market Power)
Marketwatch.com has a piece on companies with dual-class shares that concentrate voting power in management's hands. These are interesting from a governance standpoint - the usual justification for the dual class structure is to insulate management from the supposed short-term focus of the market.
Dealbook tells us how investment banker compensation incentives result in so many deals being announced near the end of the year.
The WSJ seems to be doing a lot of pieces lately with an international investing flair. In this piece they talk about investors turning to currency funds to hedge risks. The investment results to this strategy haven't been all that great lately.
Finally, this Week's Carnival of The Capitalists is hosted at Show Me The Money. There wasn't that much in the finance realm, so I won't give a pick of the week this time around.
My two children had very different reactions: Unknown Daughter was all excited and started making plans make a snowman after school.
Unknown Son, however, was pounding the pillow becasue there wasn't enough snow to cancel school.
Don't worry, U.S. -- where we are there'll be plenty of opportunities to skip school because of snow.
So, to follow that up, I thought I'd highlight a second piece from the Journal, on investing in emerging markets. It's titled "Exotic Markets Survival Guide", and is also from the Saturday Journal. Here's a snippet:
As more Americans invest abroad, the past year has served as a cautionary tale about the promise -- and risk -- of such a strategy. In May and June, emerging markets plunged amid worries over rising U.S. and Japanese interest rates and a possible global slowdown.It's definitely worth reading the whole thing. Here are a few thoughts (in no particular order, like most of my thoughts:
But within months, the markets rebounded. The MSCI Emerging Markets Index is up 23.7% in dollar terms this year -- just 1% away from its all-time high. The Dow Jones Industrial Average is up 14%.
Emerging markets have benefited from accelerated economic growth, large and youthful populations, and little-known but profitable companies. The category includes much of the world outside the U.S., western Europe, and Japan, encompassing countries as big as China and as small as the Czech Republic.
In the past, investors were wary of political upheaval, poor infrastructure, and shaky economic fundamentals that sometimes erupted into a full-blown financial crisis in such markets. Geopolitical risk still disquiets investors, who worry Middle East turmoil could spill over into Turkey, for example.
- There's a huge variation in performance for the various individual emerging markets. Rather than try to pick winners, it's best to invest in a broad cross-section of markets-- ideally in an index fund or ETF.
- A good part of the performance in the last year is due to exchange-rate fluctuations. Whenever the dollar weakens, it increases the "US Dollar" returns relative to the returns in the emerging market's own currency. For example, MSCI index is up 20.9% in local currency terms, but has returned 23.7% in dollar terms.
- There are risks to investing in emerging markets (political risk, the risk that the emerging market's home economy will collapse, and so on. So, it's best to DIVERSIFY.
Though the idea may not be for everyone, the formula is easy enough: One index fund to cover U.S. stocks, another for the international markets and a third for the U.S. bond market. Together, this trio has rivaled U.S. stock returns over one-, three- and five-year spans, and with more stable returns year-to-year than the broad market.
With thousands of fund options, it may seem hard to believe that a portfolio that doesn't even try to beat the market can do a better job than most professional money managers. But in this case, less is more.
The three-fund strategy "makes sense," says Meir Statman, a Santa Clara (California) University finance professor who studies investor behavior. "What makes it hard is that it seems too simple to actually be a winner."
Make no mistake: A blend of bland index funds isn't going to provide you with scintillating cocktail-party conversation to dazzle your friends who own hedge funds or hot sector offerings.
"It's a 'cold shower' portfolio," Mr. Statman says. "You'll do fine, but you'll not have the biggest house in the fanciest neighborhood."
The idea has a lot going for it.
First, by diversifying across domestic stocks and bonds, you lose some potential for lagrge returns, but end up with much lower volatility. That's more improtant than you might think, because the amount you have in the future is based on geometric, not arithmetic returns.
To see the difference, consider a simple case where you invest $100 and gain 30% one year, then lose 10% the next. Your arithmetic return is simply (0.30 + (-0.10))/2, or 10%. However, your "true" return is the geometric return - you end up turning $100 into $117 over two years (the $100 grows to $130 in the first year, then drops to $117 in the second. So, your geometric average annual return is actually 8.17%. In case you're wondering how I got that figure, to calculate the geometric average return, first take the annual return for each year and add 1. Then multiply the "1+return" for each year, and then take the "nth" root. Then subtract 1.
So, for two years, in an Excel spreadsheet the return would be:
[(1.+0.30)(1 + (-0.10))]^(0.5) - 1The higher the volatility of returns (i.e. the more returns fluctuate from year to year), the lower the geometric average return will be relative to the arithmetic average. So, reducing volatility could have a big impact on your future account value.
= [(1.30)(0.90)]^(0.5) - 1 = 0.0817, or 8.17%
Adding some international exposure could also further decrease the riskiness of your portfolio, since international equity markets have a fairly low correlation with domestic markets. In addition, there's a good chance that they'll add some return "spice" to your portfolio, since many international markets have higher growth potential due to the higher growth rates of their countries' economies.
Like the article says, it's not a "sexy" portfolio, and it won't give you bragging rights around the water cooler. But it will probably outperform a great many of the alternatives.
Today, I have class to teach, students to work with, a paper to edit (and no, it's not done yet), and a research presentation to go to. Luckily, whenever we have a presentation, we take the speaker out to the local watering hole afterwards for what we call "Faculty Professional Development" .
So, here are a few things to keep y'all busy while I try to get through the day:
Robin Hanson is discussing why men and women complain in different amounts. He blogs at Overcoming Bias, which is well worth a look - they've got some extremely smart on their roster. In fact, I think it should be added to the blogroll. And a Hat tip to Bryan Caplan at Econlog for the link.That's enough blogging for now -- back to work!
In another "men and women are different" piece, Dr. Paul Irwing's research indicates that men generally score about 5 points higher on IQ tests. Let the comments begin!
Joe Carter at Evangelical Outpost has posted the latest installment of his Yak Shaving Razor Series. They're full of useful tips and tools. In fact, I just downloaded the undelete tool he mentioned.
Private Equity (at Going Private) is beating the whole "MBOs are unfair" idea like a pinata.
And finally, Richard Kang is commenting on options for replicating hedge fund performance without all the high fees.
Well, I didn't get much research done, and I didn't get too much done on my classes either. I did meet with a student for about an hour while on a presentation that my class has to give to our outside advisory board.
But other than that, I didn't get much done. But I'm happy anyway.
Why? Because I just saved a bunch of money on my mortgage. I refinanced it from its initial 6.25% rate to a new rate of 5.75%. Total costs (once the escrow gets paid back in about a month) were about $1500. So, the decrease in the mortgage payment means I pay back costs in about a year, and after that I'm $1,500 to the good each year.
Not bad. The Unknown Wife and I are trying to save some money, but we celebrated by going out to the loval Java shop for a couple of good cups (Kona for her, a Latte for me) and an extremely rich pastry.
Yeah-- with two kids (and a still hefty, but less so after today mortgage), this is about as much as we end up splurging.
Most chemotherapy works primarily by attacking ALL fast-growing cells, and he's had a lot of it. So, it often has implications for childhood growth. Unknown Wife and I are both on the smallish side, so we didn't expect U.S. to be a giant in any case. But he's by far the smallest in his class (most people guess him to be about 6 instead of 8, at least until he open his mouth). In addition, he probably has some slight neuropathy (nerve damage), which is a common side effect of pediatric chemo. Both U.W. and I have the reflexes of tree sloths, but U.S. is even more uncoordinated.
In any event, the new oncologist has specialized in late-stage effects of chemo. She actually did "write the book". So, we'll be consulting with her today to determine what options we have, or even if we need to be concerned.
Meanwhile, here's some stuff to keep you busy:
CXO Advisory group has been going back and forth with Jim Cramer on his investment performance. I think they've gotten under his skin.Enough bloggery - back to work.
Theresa Lo is guest blogging at Alpha and Omega about "computer-replicated hedge funds". It seems that there are a couple of groups that are trying to do it on an automated basis that claim they can do it better than a flesh-and-blood manager.
Worthwhile Canadian Initiative has some good advice on how to present (or discuss) an academic paper.
John Prestbo at Marketwatch.com goes over the ins, outs, ups, and downs of hedge fund indexes. To quote Inigo Montoya, "I don't think that means what you think it means".
I still have hopes of getting a paper out to a journal by the end of the semester. Stuff submitted just before the break always seems to take longer to get a referee report back on, but if I wait until we get back for the spring semester it'll be even longer. So I might as well punch it out and get it situated on some editor's desk (so he can get it on a reviewer's desk).
While I'm finishing up the edits, here are some links to keep y'all busy:
The Wall Street Journal has a piece titled "The November Effect"that says that the stock prices of big winners (and losers) reverse course in November. I'm not aware of any academic research that shows this, but I'm more of a corporate guy. Still, it's interesting.Enough bloggery - back to work.
Matthew Goldstein of Thestreet.com is reporting on leveraged private-equity backed IPOs (or LIPOs, as they're commonly known). PE-backed IPOs accounted for 42% of all offereings this year, so they've become a significant part of the IPO market.
This week's Carnival of the Capitalists is up at Blueprint For Financial Prosperity. My pick of the week is the post by gongol.com that claims that responding to penny-stock internet spam may be unwittingly funding terrorism.
The Wall Street Journal online has a piece on Information networks.
It seems that there are now companies that pay industry "consultants" to gain superior information about the firms (or industries). Larry Ribstein says it's the inevitable consequence of Reg FD.
Eszter Hargittai gives a primer on how to send emails to academics correctly. If you're a reporter or someone trying to get help from one of my tribe read it - it's got some very good info.
Marketwatch.com reports on "Fundamental etf's" - ETFs that base portfolio wieghts not on market cap, but on factors like sales, market-book, market share, and so on.
Then last night, Unknown Wife and Kids took advantage of the opportunity to stay with Unknown Sister-In-Law and her family (we'd planned it earlier this week). So, I drove back, got an early night's sleep, and will work on research and classes until Saturday and their return (it's the end of the semester, so everything gets backed up).
In the meanwhile, here are a few links for your reading pleasure:
Abnormal Returns has done a very nice piece on the Five C's of Private Equity Buyouts. It discusses some of the factors that have led to the growth of PE as a major force in the market. They areFinally, here's a quote by J.R.R. Tolkien to think about for the remainder of the day: "I don't know half of you half as well as I should like; and I like less than half of you half as well as you deserve."Now back to work!
Read the whole thing here, and a follow up piece here.
Jim Mahar at FinanceProfessor.com links to a piece by Brav, Graham, Harvey, and Michaely on payout (i.e. dividned and repurchase) policy. Anyone teaching advanced corporate finance should read it and give it to their class. It's another of Graham's great survey pieces, and shows what managers actually do (and what a surprise: sometimes it's different from what finance textbooks say they should do). And if you want to read more of Graham's research, click here. He also has a good survey piece that covers a broader range of topics in general corporate finance,
In addition, CXO Advisory Group discusses a piece by Lyandres, Sun and Zhang, titled "The New Issues Puzzle: Testing the Investment-Based Explanation". It argues that corporate investments patterns should be included when constructing benchmark returns (because issuing firms invest more than non-issuers). Once they do, much of the long-term underperformance for these firjms dissappears.
One of my readers sent this link to Consumer's Union (the non-profit publisher of Consumer Reports). They're trying to encourage legislators to make credit card disclosures more transparent, and to rein in some of the more abusive credit card company practices.
They've got a great short animated video titled "It's Always Christmas Time For Visa". Check it out.
Then sign the petition, if you're so inclined.
On today's research menu:
- I have to get data to a student at my former school (I sit on her dissertation committee). As I mentioned before, she knew I was coming here, so she chose her topic to take advantage of the new resources I'd have access to (pretty smart on her part). So, I'll pull some of the data from the big Hansen data set and send it to her.
- I'm still editing a paper that my coaters have send me. One knows the literature in the area phenomenally well (she's written a book), and the other's doing the empirical part. But I'm the only one who speaks (and writes) English as a cradle language. So I get to be the editor. They've actually written a very good first draft (as far as the basic story), but it needs polishing. So, I get to be what I call the "grammar & word nerd". I never thought I'd get so much mileage out of having my writing terrorized by nuns in my formative years.
- Finally, I'm pulling data for another project. It involves merging data together from three different databases and then sending it off to my coauthors for further torture. We got the idea at a recent conference when the three of us had a few beers one night - they were colleagues of a classmate of mine, and I knew them only in passing. But that's the great thing about conferences (and having a few beers) - you start talking and the ideas start flowing. And before you know it, you have a new research project.
Corporate Dealmaker highlights a study by investment bank Houlihan Lokey.Enough bloggery - it's time to head in to the office and get some research done. I've got data (and the English language) to torture!
The study finds that termination fees in mergers are slightly lower than they were in previous years. If it's a continuing trend (and not driven by a few data points), it might make for a good research topic -- it could have a lot of implications for the corporate control market.
Everyone's Illusion (a relatively new blog that looks like it's worth checking out) has a great, short post on hedge funds, tail risk, and loss aversion.
This week's Carnival of The Capitalists is up at Gongol. Posts of note include The Big Picture with links to the most influential of Milton Friedman's works
and James Hamilton of Econbrowser on how the yield curve indicates slower growth ahead but less chance of a recession.
Real Returns reports on a recent trend - share buybacks are increasing. He makes a good point-- that buybacks increase EPS even if earnings are flat.
The NY Times has an interesting piece titled Rewriting the Rules for Buyouts. It notes that minority shareholders don't share much in the gains to MBOs. However, one reason for the unequal sharing is that the managers in an MBO take on a great deal of risk. So, they might just be getting compensation for that risk. The article suggests some "cures", but I'm not sure they wouldn't do more harm than good. HT: Jim Mahar at FinanceProfessor.com.
And before I go further, I didn't have more than one.
But for some reason, any alcohol in the hour or two before bed messes up my sleep cycle. And I know this from experience. So I woke up at 3:00, and tossed and turned for the next 3 1/2 hours. Of course, today is my long teaching day.
Tomorrow is a research day. I've got a data set I have toget together for a student at my previous school who's working on her dissertation (I'm on her committee). We have the data she needs here at Unknown University version 2.0, but not at U.U. version 1.0 (in fact, since we knew I was coming here, the knowledge that I'd have access to the data was a major determinant in her choosing the topic). So, I'll make a cut of the data set and send it to her and she takes it from there.
I've also got an exam to give at 6:30, and the early version of the same at 3:00. So I'll be around all day (and evening).
In other words, I'll need breaks. So I'll post more tomorrow. For now, I'm going to bed.
Hopefully, the light schedule for next week will allow me to catch up a bit. The first semester at a new school is always a bit hectic, and this one certainly ran true to form.
In any event, here are today's links:
CXO Advisory group reviews some academic research on "synthetic hedge funds"Enough blogging. Back to research or no soup for you!
JLP at AllFinancialMatters has a short tutorial on how to get refreshable stock quotes in an Excell spreadsheet.
The traditional hedge fund compensation is "2 and 20" (i.e. a 2% annual fee of aasets under management and 20% of the profits). The NY Times Online reports on a hedge fund that has a very different compensation structure-0 ti's based on performance over multi-year windows.
The NYT also has another article where they profile a paper by Bebchuck, Grinstein, and Peyer. It indicates that options backdating wasn't just limited to high-tech firms. there was also a lot of it going on at old-line companies. HT: Jim Mahar at Financeprofessor.com.
Both his admirers and his detractors have pointed out that his world view was essentially simple: a passionate belief in personal freedom combined with a conviction that free markets were the best way of co-ordinating the activities of dispersed individuals to their mutual enrichment. Where he shone was in his ability to derive interesting and unexpected consequences from simple ideas. As I knew from my postbag, part of his appeal lay in his willingness to come out with home truths which had occurred to many other people who had not dared to utter them. Friedman would then go on, however, to defend these maxims against the massed forces of economic correctness; and in the course of those defences he, almost unintentionally, added to knowledge.
We're definitely the poorer for his passing.
The SEC has released a new and improved search tool for EDGAR (the online repository for company filings). HT: Jack Ciesielski at AAO Weblog for the pointer.Hopefully, I'll have more to say later.
Know a concept but can't think of the word for it? Here's a handyreverse dictionary from onelook.com to help you out.
A couple of days ago, I linked to a paper that claimed the IBES had subsequently anonymized analyst forecasts. According to Thomson, the matter's been resolved, and the paper's been withdrawn.
Marshall Loeb of Marketwatch.com explains why cancelling your credit card might not always help your credit score.
Joe Carter at Evangelical Outpost has the latest installment in his Yak Shaving Razor series.
However, if you want more things to read, go amuse yourself with Scott Adams' blog (yes- the creator of Dilbert has a blog). He's even funnier on the blog than in his cartoons.
And last but not least, I have RESEARCH to do. I've got a paper to carve up and rewrite. The initial draft of the paper was written by my colleagues -- a very good theorist, and a very young but promising empiricist. But the other two "ain't from around these parts". So, since I'm the only one who speaks (and writes) English as a first language, I get to be the writer/editor. Luckily, I like editing.
It's even more interesting, since our study extends some seminal work by someone who's likely to be the referee. So I have to be vewwy, vewwy careful to be complimentary of his contributions (after all, while I'm not hunting Wabbits, I AM hunting publications). Ah well, that's what Chapstick is for.
So, here are some links to keep you busy while I try to be productive:
Stockpickr has a list of the Top 100 Business Blogs (and no, FR isn't on it - sniff!).Back to work -- I don't have tenure yet!
CFO.com discusses some issues related to spreadsheet security.
What should you call the payouts an executive receives following a merger? Footnoted.org has some examples from recent mergers.
Banks are talking about developing "Death derivatives". If they can get the right data, it could potentially provide pension funds another tool for hedging mortality risk.
Finally, for the "inside baseball" post of the day, it looks like discrimination in higher education is still around. But now it's against Asian American Students. After all, it wouldn't be fair to make admissions decisions strictly based on merits now, would it?
This week's Carnival of The Capitalists is hosted at Casey Software. My favorite piece of the week was Undoing Roth IRA Contribution Mistakes from Fivecentnickel.com.I may blog later today, but I feel a low-pressure system and lack of sleep migraine coming on. So probably not.
Richard Kang at SeekingAlpha.com tells us about some new leveraged ETFs from Rydex they seek to provide double the return of an index, the inverse of the index's return, and double the inverse of the index's return. They'll be linked to various equity indexes.
Finally, Mary Mckinney at Academic Coach is talking about the benefits of using an editor.
Since the 30th isn't such a big deal, there were only about 30 of my classmates there (out of about 145 graduates). Most of the people there were either those who never left my small town or the group who held all the class offices, played on the teams, and so on.
The first group was kind of sad, and mostly got very, very drunk. The second, however, had lived pretty interesting lives (they'd left town, gone to college, and then moved back to nearby towns). One had cycled from New England to Anchorage, Alaska, another had lived on an Indian Reservation and was now a priest, and another had crewed a sailboat to South America and now taught Social Studies in a rural part of the state. The classmate we shared a table with was a pretty quiet guy in high school that mostly partied and barely made it through. After spinning his wheels for a bit, he ended first going to a community college and ended up with an engineering degree. He and his family (he married his high school sweetheart) visit a new major league baseball stadium each summer.
So all in all, it was a pretty good weekend.
We got back this afternoon (we stayed at my mom's place last night). So, since I've pretty much finished my preparation for the week (I still have to put the finishing touches on a quiz for tomorrow, but that shouldn't take long), it's time to veg out a bit.
This afternoon, Unknown Son has a soccer game, and later this afternoon we drive about 90 minutes to Unknown Grandma's house (incidentally, we do cross a river and go through a wooded area). She'll watch them for the evening while we go to my 30th high-school reunion.
So, since later blogging is unlikely, here are today's links:
According to the Wall Street Journal, political junkies are trading in political futures markets like Tradesports.That's all for today, folks. I have a few errands to run before we get overrun by little girls.
The NY Times reports on how companies targeted by hedge fund short-sellers are starting to fight back using the courts.
About Economics has a good primer on Foreign Exchange Rates and FX Markets.
I won't even describe this stunt except to say Do. Not. Try. This. HT: The very strange lads at Catallarchy.
Lisa Fairfax at The Conglomerate discusses a recent study by TIAA-CREF that indicates that having women on corporate boards changes governance dynamics.
James Hamilton at Econbrowser has studied the effects of Fed interest rate changes on the housing market. He finds that an interest rate change affects new home sales for up to five months later.
Ljungqvist, Malloy, and Marston have done a very interesting study of IBES forecasts titled Rewriting History. They find that the some "bad" analysts reports on IBES are subsequently removed from the database in later versions:
Comparing two snapshots of the entire I/B/E/S analyst stock recommendations database, taken in 2002 and 2004 but each covering the same time period 1993-2002, we identify nearly twenty thousand changes of an unusual nature: the selective removal of analyst names from historic recommendations ("anonymizations"). This practice turns out to be pervasive and non-random: Bolder recommendations are more likely to be anonymized, as are recommendations from more senior analysts, Institutional Investor "all-stars," and those who remain in the industry beyond 2002. Abnormal stock returns following subsequently anonymized buy recommendations are significantly lower (by up to 11.0% p.a.) than those following buy recommendations that remain untouched, suggesting that particularly embarrassing recommendations are most likely to be anonymized. Analysts whose track records appear brighter due to anonymizations experience more favorable career outcomes over the 2003-2005 period than their track records and abilities would otherwise warrant.
I know it's got me thinking about how this affects my current IBES-based project.
HT: The New Economist
Update: I just received an email from a representative of Thomson (the company that puts IBES together). In the interest of fairness, I thought I'd post it here:
“The conclusions of the report are wrong. The integrity of Thomson Financial’s I/B/E/S database is without question and all analyst ID’s and their recommendations are maintained in the master I/B/E/S database. This particular report was based on an incomplete data set. The analyst data in question was however, available in other subfiles, which were accessible to the researchers. While we are disappointed the report was issued as is, we have reached out to the authors to ensure they both understand the data and alternate mechanisms to access the data they were originally looking for.”
But I must say, I'm impressed that the Thomson p.r. department understands enough about reputation and the internet to monitor the blogosphere.
All it took was Tom Cruise, and Going Private is back! Once again EquityPrivate is talking about "Vegetable Capital". And it doesn't refer to this.And now, it's time to do some research ( Maybe on IBES data...).
There are a couple of Carnivals to go to. City Girl is hosting The Carnival of Personal Finance (my personal favorite is 10 Ways To Save On Beer (with beer calculator ). And the Carnival of the Capitalists is up at Gill blog. Make sure to check out Dan Melson's post on Sellers Lending to Buyers and Selling the Note and Sox First on accountants pushing to get government protection from shareholders who might want to sue them for doing bad audits.
EconLog highlights research by Hausman on WalMart. He finds that Walmart is good for economic efficiency - it cuts suppliers' margins and passes the savings along to customers, thereby driving producers closer to marginal costs. And it benefits the poor more than the rich.
I learned about another financial instrument today The Financial Times discusses the how and why of CPDOs (Constant Proportion Debt Obligations). The new products and strategies created by financial engineers never cease to amaze me.
And for a chuckle, Dan Melson at Searchlight Crusade links to a way of dealing with telemarketers I wish I'd though of.
Since today is election day, I thought I'd put a link up to Tradesports. For those of you who've never heard of it, Tradesports runs a futures market that allows you to bet on various events. Since the contract pays $1 if the event occurs, some fairly basic algebra shows that its fair price is essentially the probability that the event will occur.
To illustrate this, let's look at the contracts for Republican Control of the House and Senate. They're trading at $0.17 and $0.698 at the time of this posting. This implies that the traders in these markets currently assess the probability of Republicans retaining control of the House at 17% and of the Senate at 69.8%.
To see how information affects the contracts' prices, assume a trader had information that led him to believe that the chance of Republicans retaining House control was actually much higher than 17% (let's say 45%, for example). If so, he'd consider the current price a real bargain, and would start buying contracts. This would drive the price up until his information was fully reflected in the price.
Like I've said before, they're not a perfect predictor. But I do trust them much more than polls. I have several friends who make it a point to answer incorrectly whenever a pollster calls -- just so the polls will be less useful. Granted, I have a pretty contrarian bunch of friends, but I doubt they're alone.
In contract, in a prrediction market, the traders' own personal ideologies wouldn't matter - if they thought the probabilities were off, they'd trade in the contracts to make money.
Any one trader could be wrong. But if there are enough players in the market, the prices would be pretty good aggregators of everyone's info.
So check into Tradesports throughout the day, and see how the prices (and hence, the probabilities) change.
Updated 11/8: As of 10:15 a.m., Tradesports gave the Republicans between a 10.5% and 12.5% chance of retaining control in the Senate (obviously, trading in the House Control contract has closed).
But, it gets even stranger - since classes on Tuesday were skipped, tomorrow (which is Wednesday anywhere else) becomes Tuedsay and Wednesday disappears into some academic black hole. Other times, if we have a Monday off, Tuesday becomes Monday. It has something to do with making sure all days meet an equal amount of time, but it does get a bit surreal at times.
So, without further calendarial confusion, here's the Tuesday (or whatever it is this week) Link Dump:
In addition to being one of the smartest economists around, Kevin Murphy of the U of Chicago also had one of the more unusual goals in life - to be the "world's best coauthor." He's done that HT: Marginal RevolutionBack to the world of research. I'll get back to teaching stuff on Wednesday (er, ah, Tuesday. Or whatever they call it this week).
Barry Rehfeld of the NY Times online discusses the Long-term investment performance of spinoffs
Craig Newmark links to a list of 50 Things for professors to do on the first day of class. Maybe next semester.
Since I just linked to an interview of Eugene Fama yesterday, it's only fitting that I link today to a Wall Street Journal Article on Dimesionsl Fund Advisors. It's run by former Fama students who use a lot of his work, and Fama sits on the board.
There's a story in Marketwatch.com about a new search engine called Powerset. It's not publicly available yet, but it sounds very interesting - it allows "natural language" queries and seems to understand the context of a question.
Click here to read an interview of Fama by Nina Mehtais in Financial Engineeering News.
Fama does a great job of explaining the way the development of the CAPM affected the discussion of market efficiency:
There's much, much more in the article. Read the whole thing -- it's short, and well worth it.Nobody realized before that if the market was working properly, you had to say something about what the market was doing in setting prices in terms of the relation between expected return and risk. Something like the Capital Asset Pricing Model was necessary before you could really test market efficiency. If you look back, you can see primitive statements about expected returns that were built into tests people were doing. But they didn’t realize they were making these statements.
FEN: What are you referring to?
EF: If you say autocorrelations must be close to zero, what you’re really saying is that expected returns are constant, so that’s a statement about equilibrium right there.
Unfortunately, I also had to fill out faculty evaluation forms for other faculty. Yes, that's right -- at Unknown University, ALL college members get to chime in on ALL tenure and promotion cases.
So, we end up in the ridiculous situation of a brand new untenured assistant professor filling out an evaluation of whether or not an Associate should be promoted to Full. And better yet - the associate professor can ask to see the untenured assistant professor's evaluations (after the fact, but still, it's a possibility).
Since I'm brand new, I decided not to fill out evaluations for anyone but the two assistant professors in my area that are going up for tenure, and a couple of other assistant professors who have regular annual reviews (I know their work, so it's pretty easy). Both should be shoo-ins for tenure, but stranger things have happened. As for the others, if I'm challenged for not having filled out an evaluation, I'll just say that I'm not comfortable with my ability to make a decision that carries so much importance.
In any event, here are some links to keep y'all busy while I go out for a Strongbow's Cider ( or two) with some colleagues (who aren't up for either tenure or full):
Ever wonder what GDP, CPI, and all those other acronyms mean? About Economis has a good primer on economic indicators.Enough blogging - pass the StrongBows.
The scheduled host of the Carnival of the Capitalists screwed up. So, the fine folks who run the Carnival have posted it here.
And last but not least, Seeking Alpha discusses ETFs with 12b-1 fees. Now THAT's an investment to avoid.
What's a rule based portfolio? It's a portfolio constructed based on some rule, or algorithm. An example might be "the stocks in the lowest decile of Earnings-price ratios" or "all mid cap stocks that have had 5 years of greater than 10% annual revenue growth".
So what's the difference between a "rule based portfolio and an actively managed one? I can't see one, but the proponents of these funds say that the algorithm will be executed entirely by computer, so there's no human judgement or discretion involved.
It's an interesting concept, and one that might spark a lot of classroom discussion. Here are a few questions I'll be asking my investments class:
1) What's the difference between a rule-based ETF and an actively managed mutual fund?
2) What role might these funds play in an investment portfolio?
3) If these ETFs become more popular (and I bet they will), how will it change the nature of the investment process (for either individuals or professional money managers)?
4) Will these ETFs eliminate the need for security analysis?
As I said, interesting stuff. And they pay me to do this. Amazing.
I figured something had hit the news, but didn't have to time to figure out what. Now I know:
Michael O. Pickens, 52, admitted to three counts of securities fraud related to the scheme in a hearing in Manhattan federal court before U.S. District Judge Loretta Preska.
For the whole story, (from Reuters.com), click here.
He had also faced five counts of wire fraud, but the government dropped those charges as part of his plea agreement. Both the government and Pickens' attorney agreed to a sentence range of 57 to 71 months in prison.
According to an indictment filed in July 2005, Pickens enticed investors to buy shares of thinly traded companies Infinium Labs Inc., Soleil Film Inc. and Data Evolution Holdings Inc. (DTEV.PK: Quote, Profile, Research) by sending handwritten hoax faxes meant to fool investors into thinking they had mistakenly received a hot stock tip. Infinium has since changed its name to Phantom Entertainment Inc. (PHEI.OB: Quote, Profile, Research).
It's got to be tough to be a well-known parent (or even being the son of one). I and my brothers all got in trouble when we were younger, with violations ranging from the minor to the severe (and one that involved jail time).
But luckily, our father wasn't a nationally known figure. So while we ended up in the local paper, that's as far as the bad publicity went.
I seem to be getting a fair bit of traffic from being linked on Investor Village. If you've come here from there, welcome - I hope you enjoy your stay and check back often. To find out more about Financial Rounds, click here to go the FAQ page. To get back to the main page, either click on the masthead above or click here. And if you want to subscribe to my RSS feed, I've put buttons for most popular feed readers on the right hand side (near the top).
Matt Goldstein of TheStreet.com reports that the air seems to have gone out of "blank check" IPOs.That's enough for now. I have papers to grade and data to torture.
John Spence of Marketwatch.com talks about the new Powershares Listed Private Equity Portfolio (AMEX: PSP). It's an ETF that tracks not Private equity investments, but public companies that invest in private equity deals. It's an interesting concept, but I think the execution has a whole lot of problems.
Dan Melson at Searchlight Crusade gives a pretty good overview of some of the issues surrounding contingent real estate sales.
Finally, one of Andy Samwick's colleagues seems to have stumbled across one of my students.