MBA 610

BEFORE PANIC SETS IN:

Yes, there is a great deal of reading and watching videos. However, I am sure you can handle it. I really only want you to be able to get the top one of two things from each article. From many of the links you do not even need to do that, but rather the links serve as means of documenting things for class (so you know that I am not just making things up;))

 YOU DO NOT HAVE TO READ EVERY WORD!  If you get the main point (or in some cases a couple of points) from the papers, I am generally quite happy.  :)

 I would much rather you learn the material than worry about a grade. Learn the material and the test should take care of itself.  But really know the material.  become an expert it will help you and make it more fun at the same time.

Notes:

These notes are constant works in process.  They will likely be updated repeatedly throughout the semester.  They serve as a much better indicator of what is due when then does the syllabus (which is made once and then does not change).  For that reason you should make a practice of checking back frequently.

Welcome to class!

This section SHOULD BE review:

Audio: https://soundcloud.com/jim-mahar/welcome-to-mba-610-it-starts

My Video Intro #1,  video intro #2

Please read the Summaries  of each chapter we cover (the introductions and conclusions couldn't hurt either for the real ambitious).  It will help give you an idea of what is coming in the class.

In past semesters I  had several requests for review material, so here some links from my introductory corporate finance page that should help. We will not spend much time on these, but you are expected to know it.  

Review material that you may find useful:

video: http://youtu.be/DIsoTp0T0v4


This is where our class will start:

Financial system and why markets are important

Model of the financial system

  Foundation to everything:

     

Introduction to Corporate finance (conflicts) and why contracts and forms matter

Organizational forms

Financial System video

Financial Intermediary video

Where in the financial system is this class?

(If you had me for 517/604, this may look VERY familiar)

We will spend quite a bit of time here

(Examples, explanations, and implications)

Pulling the goalie:

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

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

Want a football example?  Hail of Mary pass.  Click here.

Boards of directors

Read the intro: http://www.nber.org/papers/w14486.pdf

http://boardroomresources.com/episode/commonsense-corporate-governance-principles-what-happens-now/

Ethics:

        Short version:

 think WIN WIN!  Acting ethically is good for shareholders and good for you!

Would you dump toxic wastes in the river? Ok, how about withhold information?  Stretch the truth? Hide bad numbers?  

Are you sure?  What might influence you?  Money (traditional), overload, stress? “everyone else is doing it?”  Behavioral influence.

Helpified tool set: Why do Ethics matter in finance? FYI we will spend quite a bit of time on the CFA ethic section from this, so definitely read it!

 

The Market as a disciplinarian

The case of Solomon Brothers

How you draw up contracts matters:

Convertible, callable, and Putable debt

https://helpified.com/paths/callable-and-puttable-debt

an analysis of bond covenants by Cliff Smith

See Becker Stiglitz 1974 on law enforcement

Why low pay, then big retirement pay?

Examples:

Smith, Brickley, and Zimmerman--a must read summary

EXECUTIVE COMPENSATION

CEO Pay  AFL CIO executive paywatch website, some links from the financeprofessorblog, more restricted shares seem to be working,

Here is a pretty cool podcast on this from Planet Money:

http://www.npr.org/sections/money/2016/02/05/465747726/-682-when-ceo-pay-exploded

Governance matters:

CEO pay and Bankers on Board

Firm behavior at employee owned firms

and now a quick review of the science (math) of finance)

Risk and return

        History:

  1. http://stockcharts.com/freecharts/historical/djia1900.html
  2. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
  3. http://www.1stock1.com/1stock1_112.htm
  4. http://www.moneychimp.com/features/market_cagr.htm

A first look at risk and return (a history of returns):

Returns =( Price at end of period + dividend (or income) - Price at beginning of the period)

                divided by the  price at beginning of period

Some basics:

   Arithmetic returns  vs  Geometric returns

A video from Bionic Turtle on how to measure "periodic" returns.

can’t do it yourself?  here is a calculator

What is a market index:  Price weighted vs Market weighted

my toolset on this:

http://www.helpified.com/toolsets/stock-indexes-or-indicies-if-you-prefer

Bonds and stocks

First some data:

http://www.sifma.org/research/statistics.aspx for bonds

-review of time value of money and valuation

Spreadsheet:

https://www.dropbox.com/s/7bzyu6295bfh4zg/TIMEVALUE%20OF%20MONEY%20SCREEN%20CAPTURE.mov?dl=0

Valuation

Finding what something is worth-

--->putting it all together--

-->the hardest thing to do in all of finance :

Bond Valuation: (chapter 4)

Don’t forget the bond market!  

http://learnbonds.com/how-big-is-the-bond-market/

A video from class on Bond Pricing

and one on that includes what happens when interest rates change

My helpfied toolset on bond pricing:

http://www.helpified.com/toolsets/bond-pricing

Spreadsheet for bonds

Spreadsheet to calculate price of bonds and duration  (be sure to see each sheet)

I love this picture of duration:

https://en.wikipedia.org/wiki/Bond_duration#/media/File:%D9%85%D8%AB%D8%A7%D9%84_%D8%AF%DB%8C%D8%B1%D8%B4_%D9%85%DA%A9%D8%A7%D9%84%DB%8C.jpeg

Convexity and duration

        http://people.stern.nyu.edu/igiddy/duration.htm

Bond pricing template to make multiple choice questions

Bogle on “stuff” http://financeprofessorblog.blogspot.com/2011/01/john-bogle-talks-about-stock-and-bond.html

Stock Valuation: (Chapter 5)

My Video introduction to stock valuation

 Want another angle on it?  Here are some videos that might help:

From SavingandInvesting, PE ratio valuation,

Capital budgeting:

My Video

Capital Budgeting “extras”: on cannibalism, agency costs, and different lives

Spreadsheet covering NPV, IRR, etc--

this will be the bulk of what we do on capital budgeting (chapters 12,13,14)

*Be sure to note how similar this is to valuation

What is the correct discount rate?  

First a few caveats:

What is “Normal”?  Discussion of Normal distribution 

Are stock returns normal? Fat tails.  On log normal returns.

new notes on fat tails: https://helpified.com/paths/fat-tails-a-look-at-non-normal-distributions

Review of Portfolio Math and Valuation

Diversification: the basics (Don’t put all your eggs in one basket)  It is simple advice, but many do not follow it!

International:

Modern portfolio theory (Enter Markowitz)

but then again, maybe 1/N is not that bad?

So why do people not diversify as much as they “should”?

Why?  Statman suggests it is a behavioral story (much like swinging for the fences)

 Moreover in bad times diversification often does not work as well as expected.  (Butler paper on same topic). Here is a good article from Fidelity reminding us that while correlations go up, they do not go to one and there is still a large benefit to diversification.  

(What about options?)

RISK and Return--what is risk? Systematic vs non systematic

Risk aversion (video), 

More on Risk aversion (bit easier from Wikipedia

A visual look at correlation coefficients

Portfolio standard deviations as n gets large

Markowitz from Yahoo.

Much math discussion here.  Hold on, it looks worse than it is!

What's it all means: diversify!,international correlations (home country bias),commodities, real estate, market neutral hedge funds, easier one on hedge funds

Notes on CAPM

Leading up to CAPM

CAPM

Fama French multifactor model on International Markets

More notes from Investopedia:

From Investopedia

Why study CAPM if it doesn't work?  Long answer but theory is important and the idea that systematic risk is important.

Sharpe,

Ok, so CAPM may or may not work.  There is still a soft spot in my heart for CAPM.  Why? Because it is such an important and elegant model and I still think it should work.  But of course most research over the last decade suggests it does not work very well (example Fama And French!). Now why it does not work is the real fun. Is it the model? The market? The researcher? Or some combination of the above? Research from Ang and Chen finds that the time period studied matters as well. For instance, from 1963 on there appears to be a Value anomaly. However, this disappears when the 1926-2001 period is examined and “the market factor alone is able to explain the spread of average returns of these portfolios.” [note the portfolios were created based on book to market values.] Further they find evidence of a time-varying beta relationship where value stocks (i.e. high book to market or equivalently and more commonly in the popular press low market to book ratios) “were risky in the early part of sample, but not in the latter part. This could be really big.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=346600

Fama-French Three Factor Model from Wikipedia, from MoneyChimp,

Links likely to be useful to you:

Market efficiency:

 A quick video  introduction (by me)

Market Efficiency

A fascinating (well to me) interview with Eugene Fama (Nobel prize 2013)

The wisdom of crowds video Video on Wisdom of Crowds

Dean Labaron provides a good introduction, Damodoran has a bit more academic look.

Overview: Class notes

Market efficiency and sophisticated investors (video)

Summaries

Behavioral finance

Primer on Behavioral Finance: http://yes.you.is/jezzper/Discussions.nsf/f72637182738a22ec1257082007010ef/6c8109397472e6e5c1257180007db601/$FILE/Behavioral%20Finance-%20Ritter.pdf

Videos:

http://www.ted.com/talks/dan_ariely_asks_are_we_in_control_of_our_own_decisions

Priming: http://www.youtube.com/watch?v=efOF60dv5KQ

Prospect theory from Copenhagen Business School: https://www.youtube.com/watch?v=VjRfcFxzxEs 

Prospect theory and framing behavior:  http://youtu.be/Ng9V2JneJ68 (BBC)

Prospect theory (From Yale) http://youtu.be/fyOA2nbjVVQ

Kahneman on Prospect theory https://www.youtube.com/watch?v=VorB7X5L8ZY 

Monkey Fairness #1:  https://www.youtube.com/watch?v=3XXQMDGErL0 

Monkey Fairness #2   http://youtu.be/2BYJf2xSONc

Monkey fairness #3  https://www.youtube.com/watch?v=3XXQMDGErL0 

Marshmallow study: http://youtu.be/QX_oy9614HQ

Laurie Santos on Monkey Economy: http://youtu.be/DUd8XA-5HEk

NeuroScience

my tool set:

https://helpified.com/toolsets/a-look-at-the-brain-neuroscience-comes-to-finance-econ-business

        more on neuroscience: https://helpified.com/toolsets/more-on-neuroscience

Can we read minds?

FMRI and mind reading: http://youtu.be/8jc8URRxPIg

oxytocin: http://youtu.be/rFAdlU2ETjU

is oxytocin bad?  maybe not, but not always good either:

http://blogs.discovermagazine.com/notrocketscience/2010/11/29/the-dark-side-of-oxytocin-much-more-than-just-a-love-hormone/#.UzNfJvm-2So

http://www.sciencedaily.com/releases/2011/08/110801160306.htm

Oxytocin and autism link?  Maybe?  http://www.autismspeaks.org/blog/2013/12/02/oxytocin-treating-autism-not-so-fast-%E2%80%A6

Why this matters to finance? (gee this would make a great essay)

http://www.youtube.com/watch?v=6c_xXZq32XM

I can pay more!

http://usatoday30.usatoday.com/tech/techinvestor/2007-07-17-economists-study-ebay-buyers_N.htm

Applying the lessons:

https://helpified.com/toolsets/using-lessons-from-behavioral-finance-economics

Nudge:

http://youtu.be/p9lPBqvN_u4

Corporate finance and behavioral finance

Drive:

video:  on motivation

http://www.youtube.com/watch?v=rrkrvAUbU9Y&feature=player_embedded

 

Football, Baseball, Weather, and more on behavioral finance

optional: (YOU DO NOT NEED TO read the whole thing of these)

Barber and Odean: http://faculty.haas.berkeley.edu/odean/papers/gender/BoysWillBeBoys.pdf

Decision making under stress:

http://osil.psy.ua.edu:16080/~rosanna/soc_inf/week10/keinan.pdf

Debondt and Thaler

http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1987.tb04569.x/abstract

Behavioral and investment strategy:

http://youtu.be/ERDEozGpV74

Behavioral finance:

some from Wikipedia

Capital Structure

Capital Structure: Capital structure decisions are basic part of doing business yet often misunderstood.  In terms of modern financial theory and EMH it should not matter what we issue as there is a zero NPV.  Managers, however, spend much time worrying about what to issue and when.  Why?   Partially because some of the assumptions we use in developing EMH do not hold, partially because of transaction costs, partially for agency cost reasons, and partially because the Investment banking community is convinced that what firms issue does matter.

Chapter 14 notes : essentially definitions/review of what financing alternatives are available

Debt ratios are down since the GFC:  

http://www.businessinsider.com/sp-500-leverage-2015-5

Screenshot 2016-03-14 08.59.34.png

Notes on Capital Structure

Videos

videos by me

Capital Structure 1

Capital Structure 2,

intro video if you need to hear it from someone else

http://youtu.be/Fw-_JDNU9Tg

Best way to remember it:

debt makes good times great, bad times horrible

Levered beta =

      (Notice the higher the debt, the higher the levered beta)

Pizza story

Efficient markets and capital structure--Modigliani and Miller

Does it hold in practice?

In a Modigliani and Miller world when corporate taxes are introduced, the optimal debt level increases. Desai, Foley, and Hines have a cool paper that finds, among other things, that this positive relationship between tax rates and interest does hold. FWIW one of the “other  things” that influences debt financing is the interest rate: the higher the interest rate, the less debt firms use, which fits nicely with the  story above! (BTW, yes this is predominantly intended as an International Finance article, but it is cross-listed here because it is so relevant.)

http://papers.ssrn.com/abstract_id=405023

Philippon examines firms' capital structure empirically and  theoretically. He finds that firm value does not exactly fit the static  trade-off model. Specifically he finds that low levels of debt are not accompanied by as low of firm values as would be expected. However, in  other areas, what we have been teaching seems exactly right: more growth  options means less debt, highly profitable firms do have higher target debt ratios (even though they may not all be at the targets), and expected future financing deficits makes financial slack more valuable.

Interestingly, he also finds some evidence that managerial power (as proxied by CEO tenure) is associated with lower levels of debt. READ IT!!! :)

http://papers.ssrn.com/paper.taf?abstract_id=503863

Capital Structure Debt is good, debt is bad ("Debt makes good times great, bad times horrible")

Financial Distress costs and investments-- Whited 1992

Pecking order--Myers and Majluf.  The "Quess what I am thinking" game!

Types of debt-

Why are there so many types of securities?

a look at Convertible Debt, Callable debt, Puttable debt

Non investment grade debt

Private vs. Public

International Differences

Types of equity

Common- what rights do you get?

Prefered - why does it exist? If it looks like debt and smells like debt, ut is not necessarily debt!

Super shares--letter stock

Does the Pecking Order still hold?  A mini lesson.

So if it is not the pecking order, what is it?  A closer look at debt financing

What else influences the type of debt a firm uses?

Denis and Mihov find that the largest determinant is the credit rating of the firm. In their

JFE article, they report that high quality firms are more likely to opt for a public issuance while medium rated firms take the

bank debt route and low credit rated firms go for private debt placements. However, credit quality is by no means the only

determinant.http://jfe.rochester.edu/02195.pdf

For example (Barclay and Smith 1995) report that riskier firms use shorter term debt and Petersen and Rajan 1994 found that bank relationships are especially important for smaller firms.

Kisgen reports that managers manage capital structure in a way to prevent downgrades and to get upgrades. For instance firms that "are near a change in credit rating" make moves to improve their rating by issuing less debt and retiring more debt.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=355680

Want still more on debt financing? Ok, but only since you are nice. ;)  Baker, Greenwood, and Wurgler report in a JFE piece that firms also time debt obligations. When long-term rates are low, the firms try to capture these “low” rates, by issuing longer-term debt. Which, while not surprising, may be further evidence that market efficiency is not market perfection and that the financing waves we see may make sense (and cents) after all.

http://jfe.rochester.edu/02219.pdf

Several papers have shown that capital structure does impact operations.  For instance a few papers have looked at grocery stores and leverage.  For instance after LBOs, stores raised their prices and another paper has found that those with high debt had more out of stocks.  

Famous " Smith-Masulis " papers

Capital Structure articles from the Blog.

Introduction to Security Issuance

Asquith and Mullins have the classic paper in this area. It is a tad dated (1986) but is still pretty much the gold standard.

Rights issues

Capital structure review--

  Harris and Raviv is as close to mandatory on the area as possible: http://www.eco.sdu.edu.cn/jrtzx/uploadfile/pdf/corporatefinance/27.pdf

   Raising capital continued--IPOs--some blog entries on IPOs

Recent IPO filings: from IPO Monitor

The Bernie Ebbers story: http://wealthmanagement.com/archive/broker-inside-ipo-scandal

Insider Trading

What is Insider Trading? From the SEC

What is Insider Trading from the UK video from Marketplace

From Wikipedia:

http://en.wikipedia.org/wiki/Insider_trading

Is it Good or bad?

legal and illegal: http://www.seclaw.com/docs/insidertrading033104.htm

http://www.zerohedge.com/news/2014-02-27/want-outperform-market-just-trade-alongside-sec

http://www.huffingtonpost.com/2011/05/24/members-of-congress-get-a_n_866387.html

http://www.darden.virginia.edu/web/uploadedFiles/RajgopalSECtradingpaper.PDF

See if insiders at your firm have been trading,  

http://www.insider-monitor.com/

Good description of what is and is not allowed

Will talk about the following in class, but do not worry too much about the specifics until then

          http://papers.ssrn.com/sol3/papers.cfm?abstract_id=440380

          http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=216210

Fascinating cases:

https://www.fool.com/Rogue/1997/Rogue970703.htm

Heard on the street:

http://en.wikipedia.org/wiki/R._Foster_Winans

Accused does not mean guilty: Mark Cuban case

http://youtu.be/F82EHPP3bkM

More on Mark Cuban: http://www.businessinsider.com/how-mark-cuban-defeated-the-sec-2013-10

A good look at Insider Trading and anonymity

http://www.forbes.com/sites/realspin/2014/03/25/insider-trading-on-the-dark-web/

 

International Insider Trading

Insider trading in China: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2334552

Insider trading is now illegal in Russia:  http://www.bloomberg.com/news/2013-07-02/russia-claims-first-insider-trading-case-in-unilever-s-kalina.html

Some cases of insider trading from India https://corporateinsiderstrading.wordpress.com/category/famous-cases/

More on high frequency trading

60 minutes:

http://www.cbsnews.com/news/is-the-us-stock-market-rigged/

Great article:

http://www.forbes.com/sites/richardfinger/2013/09/30/high-frequency-trading-is-it-a-dark-force-against-ordinary-human-traders-and-investors/2/

Daily Show:

http://thedailyshow.cc.com/guests/michael-lewis

    More specifically: http://thedailyshow.cc.com/guests/michael-lewis/pwz0fa/exclusive---michael-lewis-extended-interview-pt--1

tasty trade:

https://www.tastytrade.com/tt/episodes/keyword/hft

Mark Cuban on HFT:

http://www.huffingtonpost.com/mark-cuban/high-frequency-trading_b_5086685.html

Panther energy: http://www.cftc.gov/PressRoom/PressReleases/pr6649-13

        Dividends and Buybacks-

What are dividends?

What are buybacks?

Probably the best recap of dividends is by Brav, Graham, and Harvey (2005)

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=571046

Here is a newer working paper by Farre-Mensa, Michaely, and Schmalz

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2400618

Which is better?  The debate is seemingly never ending:

* A buyback index outperforms the overall market plus a look at buybacks in 2013

* In 2013, Dividends seem to continue their comeback (the comeback was first documented by Julio and Ikenberry 2005): http://www.usatoday.com/story/money/business/2013/05/31/buybacks-dividends-cash-sp-500/2145333/

Dividends can act as a signal---

Venkatesh

Do Dividends and Buybacks improve operating performance?

 Maybe.  Why?  best guess better incentives and lower FCF problem.

Grullion and Michaely in in a journal of finance article give us an in depth look at stock repurchases. They find more buybacks and that the buybacks reduce the free cash flow problem. They also find that buybacks apparently do not signal improved operating performance in the future.

Cool factoid:

"between 1984 and 2000 corporations spent approximately 26 percent of their annual earnings on repurchases." Additionally, the paper brings up some interesting questions. Probably the most interesting question is why stock repurchases lead to lower systemic risk?! My guess is that there is a confounding variable at work. Specifically, suppose that firms who have seen recent increases in slack (so lower leverage) are more apt to do buy backs. These same firms would be more likely than their peers (who have not seen their leverage drop) to have lower systemic risk. Which is a bit of a stretch, but is consistent with the finding.

http://www.afajof.org/Pdf/forthcoming/repurchases.pdf

On the other hand, in the Journal of Financial Intermediation, Hirtle finds that profitability at banks who do repurchases does in fact increase following the repurchase.

http://www.olin.wustl.edu/jfi/vol12.htm#Repurchases

History of dividend yields:

http://www.multpl.com/s-p-500-dividend-yield/

Fama and French (1998) on dividends (and debt).

Optional:

The math behind buyback vs dividend decision (CFA review)

http://youtu.be/2ZT0g_h9RG8

A video look at dividend dates (and other dates that are useful to know):

http://youtu.be/SuV57Og64J8

Leasing

Types of Leases: Operating vs Capital (Financial)

Comes down to which is cheaper.  Many financial calculators to help you decide.  Looking for positive NAL (Net Advantage to Lease)

     

  Smith and Wakeman's 1985 paper still helps clarify my thinking on leasing more than just about anything else on this topic.  

Why lease?  

There are many reasons firms lease but in the end they mainly boil down to lower taxes or lower transaction costs.

Forbes has a very basic (does not really live up to their usual standards) look at leasing. One highlight:

"The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without significantly affecting your cash flow"

 

        Other (admittedly biased) resources are Lease Source, Why lease? here is what Capital Resources says: http://www.cr-ny.com/whylease.html

Derivatives: 

Section 1: what is a financial derivative:

http://www.youtube.com/watch?v=veVQqcnoooI&feature=share&list=UUTiP30x1INhn57HKKn3rDEw  by Jim

another example of “what are derivatives”

https://www.youtube.com/watch?v=Wjlw7ZpZVK4

Paddy Hirsh on derivatives (Turkey example)

http://www.youtube.com/watch?v=m3im-iJdhv4

Do you prefer seeing a class taught traditionally?  here is a 75 min introduction to Derivatives class from Finance 401  that lays out the basic building blocks.  Video quality is not the best, but the class was really good.  http://sbu.hosted.panopto.com/Panopto/Pages/Viewer/Default.aspx?id=f023eae2-2c20-495d-a4b1-0500f5049173

What are they?,  notes on how to price them using the Black Scholes formula, Put call parity

How to use them: DRAW PAYOFF DIAGRAMS!

Why use them? Speculating (leverage gives you much power), stock options can help align incentives (with some problems)

LINKS NOT RIGHT

Helpified path: https://helpified.com/links/binomial

Hedging (operational hedging and  financial hedging) can lowers risk, can positively impact cashflows, lowers expected taxes, make it easier to monitor management, and allow management to do what they do best and not worry about what is beyond their control.  Hedging can also allow firms better access to capital markets (SEE Simkins, Carter, and Rogers and Allayanis and Weston 1998)

Why studying them is important even if you do not personally plan to use them:

Derivatives are explosive, zero-sum games.  Used correctly they can be powerful tools, used incorrectly they can blow up in your face.  Knowing this may allow you to prevent the problems from happening at your firm or firms you do business with.  

Here are just a few of the debacles,: Orange County, Barings, LTCM, Bankers Trust (although this argues for being stupid!)            

                         

Reading the entrails, a look at Implied Volatilities (there are hundreds of others but I might as well use my one ;) )

In sum, Derivatives are powerful tools.  Used correctly they help greatly, used incorrectly they really can hurt!

Long Term Capital Management is a particularly good case dealing at least some with derivatives.  If no one selects it as a case to present in week 5, we will spend some time going over it in class.

  from erisk.com LTCM

  from The Risk Institute Long Term Capital Management case

  the view from the Fed's Patrick Parkinson

  the cry for more regulation was not widely accepted.

Corporate Governance

Talk about hot topics!  Corporate Governance has been on the front page of all major papers and has attracted much attention in academic world as well.  It boils down to conflicts within the Nexus.  Generally this focuses on manager and shareholder conflicts.

http://www.nber.org/papers/w14486.pdf

Here are a few notes on the topic from past newsletters, a speech by Alan Greenspan on the topic, an  independent study paper by Joe Haller (former SBU MBA student) and a class project on the topic from Andy Bubbs (former SBU student).

Does governance matter? Definitely, but it is often difficult to measure how much it matters. For instance looking at studies that show separate CEO-Chair positions are often driven by multiple factors and the choice is somewhat endogenous.

However there is much evidence suggests that governance matters.  Looking at cross listing literature, Nofsinger and Weaver (2003) report that that one reason firms cross list (especially to the US) is to increased investor protections--Caveat, this is not universally held. Additionally, there is much other international evidence (where the difference between strong and weak governance is more pronounced than in the US) that shows that governance does matter.  For example  Black, Jang, and Kim report that shareholder wealth is strongly positively related to strong governance.  Similarly Black finds the same evidence in looking at Russian Firms.   And a whole bunch of people do the same for Chinese firms.

Practically, governance issues often come down to disagreements about Executive pay, shareholder voting, poison pills and other areas of entrenchment..

Transparency and Governance

 Where does auditing fit into this?  Can't improve things unless we know what is going on.

Better earnings quality and transparency lead to lower underpricing in IPOs.

 Chaney and Phillpich (JAR 2002)  find that stock prices dropped as Andersen's reputation worsened.  Also Callen and Morel as well who find that with a similar results with a slightly different sample,  Godbey and Mahar (RIF 2004) find that auditor reputation helps mitigate the information asymmetry problem.

(FWIW this is an early edition of the paper, I am not sure how to get around copyright laws, so I just put up working papers)

What is Wrong with Corporate Governance?

See Enron, Adelphia, Tyco, NYSE, etc., etc.  The list goes on and on.  We will talk about some of the cases in class.  

Too high of stock prices?

Jensen talks about what led to the governance crises we saw at Tyco, Enron, etc. A big part of the answer  may be overpriced equity. Why? A stock price that is overvalued is caused when investors have overly optimistic expectations. Thus, if the investors were to learn the truth, the stock price would fall. This creates an incentive to hide information from investors. Moreover, to keep the stock price high, management may be willing to take more chances and further hide the bad results. Typical control mechanisms fail to work on this problem. For instance, stock based pay makes the problem worse and the takeover market fails miserably since no one would want to take over an overpriced stock. Jensen suggests one solution: the board providing more information (including to short sellers).

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=480421

Lack of transparency is likely the most severe problem.

What is Right with Corporate Governance?

Bauer, Guenster, and Otten look at the governance practices of European firms. By grouping the firms into portfolios, the authors

find that valuation and governance are “positively related.”  Interestingly, they do not find the same relationship when various

“earning based performance measures” were examined. (my guess as to why the latter finding exists: fewer accounting games are played where there

is good governance. This game playing would skew any ratio comparison based on accounting numbers.)   Link does not work---

US' system good but can be improved.

A few sites that you may find useful:

Executive Compensation

Executive compensation notes

Much of both the level and form of pay can be quickly summarized in these simple models.

LOWER---------------------Level of Pay----------------------------------HIGH

Assets in place                                                                                Growth options

Small                                                                                                 Large

Regulated                                                                                  Unregulated

            ---------------------------Form of Pay---------------------------

Straight Salary is a higher proportion                                          Market-based pay is more important

                                                                                                           

Assets in place                                                                      firms with many growth options

Small Firms                                                                                         larger firms

Regulated Firms                                                                                   unregulated firms

 

The SEC's information on executive compensation 

Executive Compensation Resources

the AFL-CIO's site, while biased, is a good resource

Papers

Erickson,Hanlon, and Maydew---GREAT!!!!

A look at where we have failed---ok, so it is cynical and somewhat anti-market

It's the form,. not the level--Jensen and Murphy

Blog entries

Gibson and Chesney point ou that call options are a staple in Executive pay packages, but the use of the options has come under attack for giving managers the  incentive to take advantage of their informational advantages to the detriment of shareholders and other stakeholders. In fact the authors go even further and find that use of options can worsen what they call an “incentive to cheat.”   Interestingly one suggestion they have for

solving this problem? Make the pay package include put options! This might lessen the incentive to “cheat” but would likely open a whole

other set of problems by creating an incentive to lower stock prices.

http://papers.ssrn.com/paper.taf?abstract_id=488565

For a more “real world” look at options, CFO.com provides a survey that  documents that at least some of the problems Gibson and Chesney suggest do in fact happen. READ IT!

http://www.cfo.com/Article?article=14397

Required Readings:

Adelphia:

Springfield Power Case 

Market for corporate Control (mergers, takeovers, etc)

The Market for Corporate Control:  in some ways this is what happens if internal measures do not work.

Off line Readings:

Is American Corporate Governance Fatally Flawed? –Merton Miller

Takeovers:

Types

Horizontal merger_acquiring competitor

Conglomerate merger--diversifying

Vertical mergers--taking over a supplier or distributor.  Why?  Be careful!  

Fan and Goyal find that there are positive abnormal returns from vertical acquisitions.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296435

 

 Takeover waves (and types)

   

History lesson

1898 to early 1900s--Horizontal mergers  

1920s--vertical mergers

1940s--regulatory driven

1960s conglomeration

1980s Leveraged bust ups

late 1990s to now: private equity, tech and regulatory as well as vertical

These in  part of can be explained by the Agency costs and by stock price overvaluation.  

These latter hypotheses won support from Gugler, Mueller, and Yurtoglu (2003)

  Hostile or Friendly?

   LBO--Opler finds improved performance following deal.  Why?  Best guess is better incentives

   Laws

   How a merger can create value

  1. Economies of scale
  2. Economies of vertical integration (lower Transaction costs)
  3. Combining complementary assets (drug company and sales force)
  4. Synergy
  5. Marketing or distribution
  6. Market power--Esp with horizontal mergers
  7. Elimination of poor management
  8. Access to a. materials    b. customers, c. capital

Generally overall value is created.  Most of this goes to shareholders of target.

From Jensen and Ruback (1983)

                       Target %      Bidder %

Tender offer     30%                4%

Merger             20                           0 %

Proxy contest    8%                      NA

Unsuccessful bids may have value if they improve management or if they put firm in play.  Bradley, Desai, and Kim (1983) find that those firms who do not receive another bid give up their abnormal returns in 2 years.

Updated Helpified path I made:

https://helpified.com/paths/mergers-and-acquistions

How a merger can destroy value

    Dissynergy--Comment and Jarrell---can you say deworsifcation

   Megginson, Morgan, and Nail find that focus decreasing (i.e diversifying deals) destroy value.

   Maybe they destroy value by signalling overvaluation?  That is one interpretation of  Loughran and Vijh (1997)

Corporate culture

  Chrysler

  Hostile vs friendly

    Hostile deals get the publicity

     Most deals are friendly

how to fight acquisitions

shark repellants

Super majority

Fair Price Amendments

Staggered Boards

Poison Pills

Asset restructuring --selling crown's jewels,

one time dividend

Buyback--possibly greenmail

Litigation-sue everyone

Make it political

Pac men and White Knights

Other forms of restructuring:

        Carve-outs--selling a division (generally part of division) to public in form of IPO

    Spin-offs--giving shares to existing shareholders

        Tracking stock

Key questions

Discussion of Junk Bonds and Milken

International differences

Corporate Ownership and control in the UK, Germany, and France—Franks

Break time

Multinational finance

Why do business internationally?

Benefits

Risks

        Country Risk-unexpected changes in country's business environment

Political from taxes to nationalization, protectionism, and expropriation

Financial--currency risk--MUCH easier to hedge

Hedging --why?  

net or by division?

What to hedge?

Transaction exposure--easy

Operating Exposure-more difficult

Translation exposure-marginal usefulness

Differences

Cultural

Legal and infrastructure

Investor protections  

Insider trading laws

Bribery

Environmental

Should US laws pertain to US firms?

Government involvement

How to do business internationally

Continuum from using agents to foreign branches to licencing (franchising) to Joint Venture/Merger

International Corporate finance

International Capital Budgeting

Raising capital internationally

Blocked funds

Cost of capital

Taxes

Mergers and Acquistions

Executive pay--A look at Japan--from Kato

Case: NatWest Takeover Battle-definitely not the final version.

         An excel file of stock prices--just hit cancel when it asks for a password

         A longer and earlier version (sorry for mistakes) but it has more tables

Catch-up/review

Trends in finance

What we know what we do not know

Tying it back together

Using finance in life