Articles Flashcards
Two Pillars of Asset Pricing (Fama)
What is “bubble”?
“Bubble” - an irrational strong price increase that implies a predictable strong decline.
From Efficient Markets Theory to Behavioral Finance (Shiller)
What does in mean that markets are “micro efficient but macro inefficient”?
Across firms there is predictable future path of their dividends and other movements (correspond to EMH) but in aggregate these movements are hardly predictable due to excess noise.
Hedge Funds: Past, Present, and Future (Stulz)
Name 4 popular hedge fund strategies.
- Long-short equity (identifying over-/undervalued stocks)
- Event-driven (significant transactional events such as mergers, bankruptcies etc.)
- Macro (mispriced valuations in stock markets, interest rates etc.)
- Fixed –income (arbitrage in fixed income markets)
HOW DEBT MARKETS HAVE MALFUNCTIONED IN THE CRISIS
Why do haircuts rise in crisis?
Due to lower liquidity
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Functions of CDS
allow to sell debt short
Supposed to make markets more efficient
Provide information
Agency problems at Dual- Class companies
Major economic advantages of dual- class shares?
- Allows a company to grow (selling CF rights, while keeping voting rights), founders or owners of the company can retain control, thus, influence the development of the company;
- Prices of CF shares are lower è You can receive some benefits,
- In case you are not interested in the control, but just the cashflows from company’s operations;
Survey of corporate governance
The most common manifestations of agency costs:
- Managers resist takeovers (from the target’s perspective) to protect PBoC rather than defend the interest of shareholders;
- Managers overinvest rather than return money to investors (potentially in NPV
- When an executive (bad one) dies, then share price goes up (largest for greedy corporations);
- Privatizing at a huge premium (Russia);
The market reaction to cross-listings: Does the destination market matter?
Advantages of Cross-listing
liquidity (leads to lower cost of capital) market segmentation (overcomes international barriers; matters most for emerging markets) information disclosure (requirements, more attention from media and analysts) investor protection (legislation)
The Political Economy of Finance
Interventions in financial markets happen when…
How?
WHEN?
- There is a crisis
- Pressure or political interests of the intervening party
HOW?
- Case by case basis
- Policy level
U.S. Equity return premium (De Longe, Magin)
What is “equity premium puzzle”?
The gains from equity are significantly higher, yet investment in stocks remains disproportionally low.
Two Pillars of Asset Pricing (Fama)
What is Joint hypothesis problem?
We need to know WHAT the market is supposed to do to know whether it does it. If the test fail you can’t tell which of the part failed – asset pricing model or assumptions.
Two Pillars of Asset Pricing (Fama)
Why “bubbles” are based only on beliefs and have no evidence?
- Large swings in stock prices predict real economic activity
- ”Price corrections” of bubbles usually wiped out soon after
The Law of One Price in Financial Markets (Lamont, Thaler)
Name 2 main arguments why LOOP is violated.
- Behavioural biases
- Arbitrage isn’t perfect
Forensic Finance (Ritter)
How academia can help regulators and law officials?
- Attracting attention
- Looking at long-run trends
Forensic Finance (Ritter)
What has Sarbanes–Oxley Act changed?
Sarbanes–Oxley Act requires executives to report insider trades (including receipt of stock grants) within two days of the transaction (instead of 10th day of the following month).
Hedge Funds: Past, Present, and Future (Stulz)
What is the future of hedge funds?
- Worse performance (more of them)
- More instutionalized (institutional investors need more info)
- More regulated
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Problems with CDS
no need for monitoring
perverse incentives (drive into bankruptcy)
Survey of corporate governance
Drawbacks of being a large investor?
- Bear extensive risk due to lack of diversification
- Advocate own interests sometimes at expense of other investors
- Detrimental to efficiency
- Too soft
- Own agency problems
- Want to exit (failed to terminate their position)
The politics of Financial Development: Evidence from Trade liberalization
What is political economy?
- Looks at power balances that impact the allocation of social and economic resources (instead of looking GDP, other macro variables, we look at the power, who possess it, where, when, etc. )
HOW DEBT MARKETS HAVE MALFUNCTIONED IN THE CRISIS
Three areas crucial in all debt market decisions:
risk capital and risk aversion
repo financing and haircuts
counterparty risk
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
CDS (def)
insurance against default of a company
Survey of corporate governance
Various forms of expropriation:
stealing
transfer pricing (trade with manager’s affiliates)
private benefits of control (PBoC)
entrenchment
The Political Economy of Finance
2 goals of privatization?
- Raise revenue
- promote competition and economic reform
Private benefits of control: An International Comparison
How can we measure PBoC?
Two ways:
- Control Premium approach (looking at the private negotiations where controlling blocks are sold, typically, for a premium, the question is, what premium do they sell at?);
- Voting rights approach (dual class shares and voting shares trade at a premium that includes probability of a control contest premium for control);
Leveraged buyouts and private equity
What is special about Private Equity from financial perspective?
Mgmt. incentives (give stock, make mrg invest) – equity illiquid, has to perform
Leverage – pressure not to waste money (reduces AC), increases value through TS, but can’t be too high
Agency problems at Dual- Class companies
What are the ways to allianate (expropriate) outside investors?
- Increase compensation
- Acquisition
- Invest in negative NPV projects (not favorable by all shareholders)
Capital Asset Pricing Model (Perold)
Is expected return influenced by internal company characteristics? (e.g. CFs)
E(r) is not characterized by internal company characteristics
Agency problems at Dual- Class companies
4 channels of how the difference between Cash Flow rights and insiders control rights lead to lower shareholder’s value?
In other words, how managers of the company can decrease shareholder’s value?
- Engage in value destroying activities;
- Demand excessive remuneration;
- Misuse corporate cash reserves;
- Make poor capital decisions;
Coase Versus Coasians
What is coase theory about?
What is coasians theory about?
- Coase- when there is a well defined property rights, transaction costs are zero, there are no taxes ==> you don’t need any intervention from the government. Rather market participants will organize their transactions in ways that achieve efficient outcomes
- most securities transactions involve private arrangements to achieve efficiency, need contracts. Effective and complicated contracts need effective judicial enforcement. (main assumption: judges must be able and willing to read complex contracts!!!!)
U.S. Equity return premium (De Longe, Magin)
Why equity premium is predicted to decline in the future?
- Institutional changes:
- removed constrains on investing in equities
- easier to invest
- rise of mutual funds (easier to achieve diversification benefits)
- More long-term oriented market participants
From Efficient Markets Theory to Behavioral Finance (Shiller)
What is meant under “Biased self-attribution”?
Individuals attribute events that confirm the validity of their actions to their own high ability and attribute events that disconfirm their actions to bad luck or sabotage.
Corporate ownership around the world
What are the proposed solutions for the problem of ownership concentration?
- Radically improve laws (make expropriation more difficult);
- Improve disclosure requirements;
- Change in structure of board of directors;
- Mandatory requirement- one share –one vote;
From Efficient Markets Theory to Behavioral Finance (Shiller)
Name 4 reasons why mispricing can’t always be corrected (EMH argument)?
- Rational expectations bubbles (still make sense to invest in overvalued stock because you know that stupid people will still invest and price will continue to grow)
- Noise trader risk (if I short it right now there is a risk that irrational investors will continue to increase the price)
- Switching between asset classes (other style classes still give rational investors decent returns and there is not so big incentive to correct the mispricing)
- Limits to short selling (some markets are super restrictive, expensive and have other barriers)
Forensic Finance (Ritter)
What is meant by “Spinning of IPO’s”? Why bookrunners and executives do it?
Under-priced IPOs were allocated to top executives of corporations. Typically initial offer price is less than 1st day’s closing price.
Why do book runners do it? - “Soft dollars” from commission payments.
Why do executives do it? - Agency problems + bribing
Capital structure
pecking order theory (Description)
internal CF->borrow->equity (assumes perfect markets, but investors don’t know the true value of their assets)
issue of stock only if overvalued (if undervalued – wealth goes from existing to new s/h) -> no issue when undervalued, because issue drives down prices
debt – not so big info asymmetry – price falls by less
internal financing – no loss in value
explains why profitable firms borrow less
From Efficient Markets Theory to Behavioral Finance (Shiller)
What is “macro inefficient”?
Macro inefficient – there’s excess volatility in the stock market and this holds even when we account for:
- Dividend smoothing
- Time varying discount rates
The Corporate Governance Role of Media: Evidence from Russia
What affects the decision to commit a corporate governance violation?
A manager’s expectation of the likelihood the relevant players will learn about his decision and in such an event how harshly his decision will be judged. After the decision has been made, however, what determines the probability with which this decision is reversed is the actual realization of those costs, which is greatly affected by the coverage in the media.
Capital structure
M&M Theory (Describe)
financing doesn’t matter, if perfect and frictionless capital markets; Cost of capital constant
Taxes – tax shields, but depend also on individual taxes of investors
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Disadvantages of OTC
Disorganized clearing process
Tailoring
Unknown counterparties (exposure) – don’t know who bought/sold
Leveraged buyouts and private equity
Describe all steps in a process of leverage buyout
buy a firm with premium above stock price
financed with debt (60-90%)
new mgmt. team, that also contributes to equity
take company private
improve performance
sell after 6-7 years to
strategic buyer
another PEF in SEO
IPO
Survey of corporate governance
The essence of agency problem?
separation of ownership and control
- financiers need manager’s human capital to generate returns
- manager needs financiers’ funds as he doesn’t have enough or wants to stay away
THE ECONOMICS OF STRUCTURED FINANCE
Problems with vulnerability of investors’ position
Overlap in geographical location => high default correlation and systematic risk
Deteriorating credit quality of the borrowers + “fire-sales”
CDO2 magnified effects the errors
Rank Honda Dio ZX.
Capital Asset Pricing Model (Perold)
Why does sub-optimal diversification still exist?
- Irrational investors
- Behavioural biases
- Transaction costs
Two Pillars of Asset Pricing (Fama)
What is the main issue for EMH and all asset pricing models?
MOMENTUM!
Overvalued equity and financing decisions
Arguments for rising more capital when overvalued:
Market inefficiency => exploit investors and market errors
Catering investors’ expectations- Pressure to prove that indeed there are growth perspectives
Project scale economies - Invest in large-scale projects
Investor short-termism - Overvalued equity financing is more attractive
Forensic Finance (Ritter)
Are mutual funds harmed by late trading (lower returns)?
No, because they get something in return (e.g. hedge funds investing in mutual funds with high fees)
Capital Asset Pricing Model (Perold)
How risks and expected returns are combined in CAPM?
Risks are combined nonlinearly (diversification effect) while expected returns are combined linearly (weighted average)
Survey of corporate governance
Why do investors, being informed about agency costs, etc. still rely on managers?
- Firms and managers have reputations to secure external financing;
- Investors are naive and overoptimistic (ponzi scheme, railroad);
The politics of Financial Development: Evidence from Trade liberalization
Determinants of financial development:
- Political economy
- Legal origins
- Legacy of colonization
- Culture and religions
- Social capital endowments
The Law of One Price in Financial Markets (Lamont, Thaler)
Name 3 assumptions of Law of One Price. Are they realistic?
- Transactions are costless (unrealistic)
- Competitive markets
- No barriers of trade (unrealistic)
Overvalued equity and financing decisions
Effect from High equity share in new issues
low aggregate stock returns
Agency problems at Dual- Class companies
When the CEO’s compensation is higher?
- Firm size is large;
- Leverage is lower;
- Volatility (risk) is greater;
Capital Asset Pricing Model (Perold)
CAMP empirical performance is weak, evidence show it doesn’t work, but why still used?
- Useful benchmark
- Predictor in low friction markets
- Easy-to-use
- Does give us a viable prediction about what we are moving towards to – PCM
Agency problems at Dual- Class Companies
Two classes of stocks in Dual- class companies?
- Superior- multiple votes per share, usually not publicly traded;
- Inferior- one vote per share and is publicly trade;
Should We Fear Derivatives? (Stulz)
Name 5 risks associated with derivatives
- Hard to understand & value (exotics are complicated)
- Liquidity of derivative markets (some exotic derivatives are illiquid)
- Transparency & reliability of accounting (you can hide some things away with derivatives – they are not reported)
- Perverse incentives (not punished for loses but rewarded for gains)
- Systematic risk (derivatives are very effective but if you lose you lose a lot, and whole market can lose)
Credit default swaps and the credit crisis
List benefits of CDS
Risk is borne by those who can do it
Obtain financing that otherwise is not available
Better credit risk information
Market efficiency and transparency
“Naked position”
Corporate payout policy
Benefits of own Stock Repurchases
Flexibility (can’t reduce dividends, can do only 1 repurchase)
correct stock valuation (repurchase before appreciation, procyclical, not just to exploit investors – nobody would sell)
remove low valuation stockholders (avoid takeovers)
allocation of voting rights (remove threatening blockholders, increase mgmt. ownership, remove LV investors)
increase EPS (just less shares, repurchases associated with productivity growth)
stock option plans – option values decline due to dividends, but not repurchases
transaction costs saving (less s/h)
Private benefits of control: An International Comparison
What PBoC dependent on?
- firm characteristics- size&maturity (more products you sell, the more you extract benefits)
- Whether controlling block is traded (whether one can buy a control)
- Bargaining power of involved parties
Fiduciary duties and equity-debtholder conflicts
Case of Delaware:
In 1991, Delaware Court issued a ruling, under which: if a firm is in the zone of insolvency (financial distress), directors owe duties not only to shareholders(s/h), but also to debtholders (d/h).
Corporate ownership around the world
What is a widely held corporation?
A widely held company or a publicly listed/ traded company is a company that has issued securities/ shares through an initial public offering (IPO) in the primary market, has a mandated statutory basic paid up capital, and is traded on at least one stock exchange or in the over the counter (OTC) market
The Capital Asset Pricing Model: Theory and Evidence (Fama, French)
Why CAPM is hard to test?
- No good proxy for market
- Data for all marketable assets is beyond reach
- Problem is to understand whether CAPM isn’t a real model or CAPM has weak empirical evidence due to irrational investors or both.
Forensic Finance (Ritter)
Name 4 unethical (illegal) practices investigated in the article.
- Late Trading
- Stock Option Backdating
- Spinning of IPO’s
- Rewriting history: Market Recommendations
Survey of corporate governance
Why is hostile takeovers’ effectiveness questionable?
- quite expensive, so only major flaws are likely to be addressed
- can increase agency costs – if bidding managers overpay for acquisition of PBoC
- requires liquid capital market – not always available
- political vulnerability
Two Pillars of Asset Pricing (Fama)
Write down and explain Three-factor model.
Includes Price-to-book ratio (HML) and Size ratio (SMB).
The Law of One Price in Financial Markets (Lamont, Thaler)
Why arbitrage isn’t perfect in modern world? Name 4 reasons.
- Limits on FDI
- Risk of mispricing
- Lacking ability to short sell, stock isn’t infinitely divisible
- Transaction costs, barriers for trade
From Efficient Markets Theory to Behavioral Finance (Shiller)
Describe feedback model.
When speculative prices go up, creating success for some investors, this may attract public attention, promote word-of-mouth enthusiasm and create expectations about further price increases. But as new prices are formed just on expectations they aren’t sustainable and bubble will eventually burst (e.g. tulipomania, dot.com bubble). Works also in opposite direction!
Why Russia is chosen as a subject of interest of Hermitage Fund as well as this part. research?
- Extreme corporate governance violations (change the venue just before the voting so that other voters can not vote);
- Non- existent or inefficient mechanisms to address the violations;
- Hermitage fund practicing media strategy;
- Reputational costs of a decision were low;
- Major regime shifts
- Head Hermitage Capital was a foreigner (thus, independent);
Overvalued equity and financing decisions
Sensitivity to overvaluation is bigger for
Overvalued firms
Growth firms (low B/M or high R&D)
Firms with more intangible assets and R&D
Small firms
Firms where investors have short investor horizons (catering)
Firms with high insider selling
High turnover firms (proxy for short term focus of shareholders)
Private benefits of control: An International Comparison
What are private benefits of Control?
- Pleasure of being in cotrol (non- monetary, example: family business)
- Monetary benefits
- Value of information
DEFINITION: Added value for having the controlling share (the one that can not be accessable to the non controlling shareholder)
The market reaction to cross-listings: Does the destination market matter?
Results of cross-listing (Particualry for London, Tokyo, New York and continental Europe)
returns increase in London, US, continental Europe, not in Tokyo
US: information disclosure and protection
London: segmentation and protection
Accounting standards and timeliness significant determinants
No evidence that firm-specific factors matter
Firms from emerging markets benefit more
Leveraged buyouts and private equity
Features of private equity funds
usually closed-end raises capital for the firms limited lifetime (10 years)
THE ECONOMICS OF STRUCTURED FINANCE
CDS (defenition)
CDS –an insurance contract against default of an entity (can be traded, don’t have to hold a security, indices based on CDS)
The Political Economy of Finance
Ways how Politics and banking law interfere?
- Bankruptcy laws, moratoria (legally binding halt to collect debt from the bankrupt), bail- outs (credit availability)
- Branching restrictions (foreign bank open the branch) , restrictions of deposit insurance (protection provided by government agency to depositors to insure against the risk from failure of a bank)èincreases competition between the banks
THE ECONOMICS OF STRUCTURED FINANCE
How does Safety of tranches depend on default correlation across the underlying assets?
Low default correlation =>
=\> probability of simultaneous default↓=\>
=\> safe senior claim
The Political Economy of Finance
Ways how Politics and Securities markets interfere?
- Regulations, e.g. on insider trading (some countries are not monitored)
- Development of securities markets
Leveraged buyouts and private equity
Future of leveraged buyouts
less leverage
more minority stakes (new operational engineering capabilities – better position than in the past)
decrease in activity due to crisis
Capital structure
FCF theory (Descr)
high debt level increase value despite threat of financial distress, when operating CF significantly exceeds profitable investment opportunities
Should We Fear Derivatives? (Stulz)
Name 5 benefits of derivatives
- Better risk allocation (gives more options to choose from)
- Informational efficiency (prices of derivatives can give more information about prices of other things)
- Hedging*
- Cheaper than replication (in the real world you have transaction costs, frictions etc.)
- Expands investment opportunities (taking more profitable but risky projects thus increasing overall welfare)
Fiduciary duties and equity-debtholder conflicts
Purpose of new rulling
To protect debtholders
To prevent managers from favouring shareholders at expense of debt-holders
Capital Asset Pricing Model (Perold)
On the base of which risk assets should be priced?
Assets should be priced only based on non-diversifiable risk (idiosyncratic risk)
THE ECONOMICS OF STRUCTURED FINANCE
2 main problems with structured finance products
Sensitive to agency’s estimates
Diversifiable risk => systematic risk
Corporate ownership around the world
Popular belief of Berle and Means?
Widely held corporation ) is a predominant form of ownership in the richest common law countries (especially the USA);
U.S. Equity return premium (De Longe, Magin)
What are the possible reasons for equity return premium puzzle?
- Non–time-separable utility (people ensure some level of liquidity they need)
- Higher short-term risk of equity may discourage from investing –myopia.
- Higher sensitivity to losses than to gains – loss aversion.
- Transaction costs and borrowing costs (assumptions on perfect market are not realistic => barriers on investing in stocks)
- Stock market is less predictable – ambiguity aversion.
- Misperceptions that equity returns are very risky that drove premium up are gradually correcting, thus premium will continue to decline in the future.
- Survival bias – only successful stock are taken into consideration.
Leveraged buyouts and private equity
Features of private equity firms
comparatively small
high-profile teams
Forensic Finance (Ritter)
What is meant by Stock Option Backdating?
Typically employee options are announced with a day, this gives company the ability to choose the exercise price they issue them on from the previous days.
Capital structure
List several examples of Agency costs of debt
overinvestment (risky strategies)
underinvestment
cash payouts
Fiduciary duties and equity-debtholder conflicts
Consequence of the new rule:
- Debt overhang
- Risk shifting
- Built-in protection by creditors (i.e. higher costs of debt)
- Contractual protection by creditors (debt covenants)
- Positive response of stock prices
Private benefits of control: An International Comparison
Ways how to limit PBoC? Legal? Extra legal?
Legal
- Legal environment (post communist have high PBoC, lowest in German, English, and Scandinavian legal origins, not distinguish between common law and civil law, but a bit more complex differences)
- Disclosure standards
- Enforcement
Extra Legal
- Product market competition
- Public opinion ==> higher press diffusion (more spread out, more channels) ==> less PBoC
- Moral norms ==> Use violence and religion as a proxy- Catholic countries have higher PBoC, and Protestand ones lower
- Labor as a monitor
- Tax enforcement
Coase Versus Coasians
Some differences between Poland And Czech in terms of investor protection, trading and disclosure standards, etc. (Why did Poland outperform Czech in financial market’s development?)
- Czech Republic:
Below average investor protection, Government supervises markets, easy exams, no need for „honest trading“, No real power for the commision to revoke broker’s licenses, Significant problems in financial system, Firms unable to rise capital and extensive tunneling
- Poland:
Average investor protection, Securities Commission for market supervision (independent), Licensing by testing- had to do „honest trading“ or lose license, Extensive disclosure of information, relies on administrative control- increased interest in justice relative to enforcement, regulators become informed- reduce probability of leniecy (due to decrease in cost of getting information)
Survey of corporate governance
1) (mature/young) …. firms rely on equity financing, while mature/young) firms prefer bank finance (debt)?
2) LBOs increase/ decrease efficiency?
1) Young growing firms rely on equity financing, while mature firms prefer bank finance
2) LBOs increase efficiency
Credit default swaps and the credit crisis
List problems of CDS
Lower incentives to monitor
Perverse incentives (drive into bankruptcy)
Excessive risk-taking
Possibility of web exposure
Counterparty risk
Difficult to price
Leveraged buyouts and private equity
Leveraged buyouts influences on (in macro perspective)
Employment (increase efficiency, can lay sb off – employment grows but at a slower rate)
Taxes (TS due to increased leverage)
information asymmetries (not really, but can negotiate deal better than others)
Two Pillars of Asset Pricing (Fama)
Name three arguments of Efficient Market Hypothesis (EMH).
- Investors are rational
- Irrational investors cancel each other out b/c random
- Even when they don’t cancel out, arbitreurs take advantage and the irrational make loses
The Corporate Governance Role of Media: Evidence from Russia
What is a “rational ignorance“ paradox? How it can be overcome?
Cost of getting informed is larger than the benefit you can make from being informed; can be overcomed by making political news entertaining!!!
Hedge Funds: Past, Present, and Future (Stulz)
What are main hedge fund problems?
- Lack of transparency makes it hard to evaluate
- Look for arbitrage, but when things go wrong, make big loses
- Poor investor protection
- Illiquidity risk (because lots of hedge funds take similar positions they can all mess up at the same time. -> spill overs to financial system/institutions)
- Low diversification
Corporate ownership around the world
Who own firms (some major guidelines/ trends in the world)?
36% of firms in the world are widely held;
30% family controlled;
18% state controlled;
15% cross holdings, pyramids and miscellaneous;
Two Pillars of Asset Pricing (Fama)
Name forms of Efficient Market Hypothesis (EMH).
- Strong – prices incorporate all information, public and non-public
- Semi-strong – prices implement all public information
- Weak – prices incorporate all information of past price movements
Corporate payout policy
Time varying trade-off “lifecycle theory”
Young firms retain CFs (profitable investment opportunities)
Older – pay out (to reduce agency costs)
Against “residual” theory (pays cash when has it left)
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Counterparty risk of CDS
regulations allowed to hold risky securities if had CDSs, have less capital
web exposures
exposed while replacing swaps
Survey of corporate governance
What are the main advantages of debt owner over an individual investor?
Mature firms use … rather than …
What is easier to price, debt or a stock?
- Returns (interest rate) is guaranteed
- May have claims on specific assets
- Rights to pull collateral
- May enforce some refund.
Mature firms use debt rather than equity
Debt is easier to price (just a value of collateral)
Empirical capital structure: A review, Foundations and Trends in Finance
Conclusions from emperical analyses
changes in capital structure affected by both availability of internal finance and market conditions
D/E affects corporate structure and decisions
Mgmt. matters a lot
Forensic Finance (Ritter)
Explain how late trading works?
Major announcements move prices => companies usually wait till after the market closes => trading then by using closing prices => profit
The Capital Asset Pricing Model: Theory and Evidence (Fama, French)
How even passive fund can generate abnormal returns according to CAPM? Why?
Concentrating on low beta stocks, small stocks or value stocks will tend to produce positive abnormal returns relative to the predictions of CAPM without any talent of managers. Due to the fact that empirically relation between beta and average return is flatter than predicted by the Sharpe-Lintner version of the CAPM.
The Corporate Governance Role of Media: Evidence from Russia
Where is a domestic media NOT a very powerful source of pressure on companies to behave?
most developing countries, because of lack of credible media outlets and usophisticated public opinion
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Advantages of exchanges
transparency
reduces CP risk
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Problems with CDS on Mortgage-backed securities
hard to price
sellers didn’t have ability to bear the risk they took on (thought it was smaller in CDOs)
support more risk-taking
Private benefits of control: An International Comparison
PBoC is high in former communist countries because of the following reasons:
- Lacking society values and culture
- Lacking legal institutions and shitty quality of enforcement
- Less developed capital markets
- Privately negotiated privatizations
- Ownership concentration
The Corporate Governance Role of Media: Evidence from Russia
The effectiveness of media is affected by ….
- Diffusion (number of relevant groups);
- Credibility;
- Surrounding environment;
- Companies need financing and good reputation now;
- Moral norms of media correspond to the ones of society;
Corporate payout policy
Factors that influence payout
Signaling and information distribution
Investor’s mental accounting and behavioural biases (empirical support weak)
Managerial over-confidence and biases
Taxes
Consumption/ demand
Empirical capital structure: A review, Foundations and Trends in Finance
3 aspects of debt financing
interest payments are tax-deductible
debt forces to distribute cash
debt has strong liquidation rights
THE ECONOMICS OF STRUCTURED FINANCE
List three different types of underlying assets
Non-mortgage loans (cars, credit cards)
Corporate loans
Residential/Commercial real estate loans
Capital structure
tradeoff theory (description )
debt level to balance the tax advantages of additional debt against the costs of financial distress
taxes – justifies moderate debt ratios, most profitable companies borrow the least(paradox, as should borrow more to offset taxes)
safe, tangible assets – borrow more (lower cost of distress)
Should We Fear Derivatives? (Stulz)
Name 4 dodgy benefits of derivatives.
- Smoothing accounting earnings (minimize volatility of earnings)
- Speculation
- Regulatory arbitrage
- Optimize tax (reduce the present value of tax liabilities)
Capital Asset Pricing Model (Perold)
State 4 CAPM assumtions.
- Investors are risk averse, judge based on μ and σ (rational)
- Investors make estimates and make them the same way (same discounts and calculations)
- Same investment opportunities
- Perfect Capital Markets
Capital Asset Pricing Model (Perold)
State 4 Perfect Capital Market assumptions.
- Infinitely divisible assets
- No transaction costs
- Information is costless and available to everyone
- Every can borrow and lend at a risk free rate
Corporate ownership around the world
- A better determinant of ownership concentration is a …
- Rights of minority shareholders of large corporations can be violated especially in countries with ….
- quality of investor protection
- bad shareholder protection
The Political Economy of Finance
What is a new political economy approach?
The “new political economy” approach treats policy-makers as self-interested agents responding to political incentives (explains: change in financial regulations)
Effects of media coverage/ purpose of media? When is it effective?
- Reduce the costs to stay informed;
- Solve „rational ignorance“ paradox: cost of getting informed is larger than the benefit you can make from being informed; can be overcomed by making political news entertaining!!!
- Increase the effect of reputation, which is very important;
- Increase the reputation cost of misbehavior;
Media coverage is effective only when a behavior violates norms that are widely accepted in society.
The Political Economy of Finance
Ways how politics and governance interfere?
- Agency problems
- Market for corporate control (the risk of takeovers)
- Public ownership and privatizations
- Ideological- keep passive shares
- Populist- may give shares to median voter
Leveraged buyouts and private equity
Types of compensation
annual mgmt. fee
share of profits (~ 20%)
deal and monitoring fees from the companies
Political economy
Potential cost of corporatism?
is underinvestment or at least under-provision of external finance (outside investors fear manager expropriation) and low managerial effectiveness
Coase Versus Coasians
On what depends a quality of decisions of an adjudicator?
How these costs can be reduced?
Personal costs with regard to
- Time
- Reputation&self- esteem
- Personal incentives (values, moral norms)
- Interest in justice;
Costs can be reduced by legal and regulatory mechanism (if you have any other good institution that can provide you with a qualitative information instantlyè reduction in costs of searching)
The Law of One Price in Financial Markets (Lamont, Thaler)
Name 5 examples of LOOP violations.
- Closed country funds
- Dual-class shares
- Twin shares
- Corporate spin-offs
- American depository receipts
The Capital Asset Pricing Model: Theory and Evidence (Fama, French)
Name other models besides CAPM and state their difference.
- ICAPM (Merton): Includes inter-temporal aspect apart from beta
- 3-factor (F&F): Includes size and market-to-book ratios
- 4-factor: Includes size, market-to-book and momentum
- APT (Arbitrage Pricing Model): includes mainly macro, e.g. oil shocks, GDP
ETHICS IN FINANCE
Roles of market
Provide information
Allocation
Diversification
ETHICS IN FINANCE
What makes a quality market
liquidity
informational efficiency
integrity
ETHICS IN FINANCE
Informed vs uninformed traders
informed traders - win but they pay for the information
uninformed traders loose to informed, but still have risl premium
ETHICS IN FINANCE
Characteristic of a system of ethical reasoning
Completness
Coherence
Practicability
ETHICS IN FINANCE
Theories of Unethical reasoning
Ulitarism
Dentology
Kontian ethics
Virtual ethics
ETHICS IN FINANCE
Describe Ulitarism theory
the action is moraly “right” if it maximises the total utility of a group that is affected by the action
ETHICS IN FINANCE
Describe Dentology theory
We are not concerned about outcome, we concerned about actions
ETHICS IN FINANCE
Kontian Ethics (Describe the theory)
Only act on rules that you would be willing for every one to follow
ETHICS IN FINANCE
Virtual ethics - describe the theory
one should cultivate desirable personality traits and then with these traits he/she will make ethical decision
ETHICS IN FINANCE
Six stages of moral developement
- Obedience and punishement orintation
- Self-interest orientation
- Good interpersonal relations
- Authority and social-order maintaining orientation
- Social contract and individual right orientation
- Universal ethical principles
ETHICS IN FINANCE
main issue of welfare
the greatest good for the greatest number
ETHICS IN FINANCE
Ethics issues / practice in finance
market manupulation
Insider trading
Lobbying
Rating agencies conflicts of interests
Money laundering
ETHICS IN FINANCE
Scalping (defenition)
Analysts that trade in advance of issuing recomendation
ETHICS IN FINANCE
Fynancial system (defenition)
the system that channels household savings to the corporate sector and allocate investment fund among firms
ETHICS IN FINANCE
Types of financial system
Bank oriented system
Market oriented system
ETHICS IN FINANCE
Defenition of independent board member
outside, manager of another company
ETHICS IN FINANCE
Six minority protection rules
Proxy vote by mail
Shares not blocked before meeting
Cumulative voting
Oppresed minority mechanism
Preemptive rights to new issues
Less than 10% of shares needed to call an extraordinary shareholders’ meeting
ETHICS IN FINANCE
What is meant by “Feduciary”
Involving a confidence of trust
ETHICS IN FINANCE
Two basic trade-offs
- Problem in continental Europe between controlling owners and minority shareholders
- Problems in the US and the UK: between management and minority shareholders
ETHICS IN FINANCE
Control with limited ownership (types)
Dual-class shares
Pyramids
Cross-shareholding
Shareholder-agreements
Limited voting power
ETHICS IN FINANCE
Principles of accountable corporate governance
Optimal share owner return
Accountability
Transparency
One share/One vote
Long-term vision
ETHICS IN FINANCE
Problems with existing option compensation programs
Instable incentive effect
New allocation often needed to preserve incentive effect
Too short lock-up period
ETHICS IN FINANCE
Effects of beter Corporate Governance
Easier to attract foreign capital
Easier to become integrated
Easier to mobilize nat. capital
More efficient capital allocation
What for risk premium is important?
- Allocation of portfolio investment
- Determine the apropriate risk adjusted discount rate
- discount future cash flows
