MAIN IDEAS Flashcards
Wisdom of Crowds: The Value of Stock Opinions
Transmitted Through Social Media
This paper researches the extent to which investor opinions transmitted through SOCIAL MEDIA (seekingalpha.com) predict future stock returns and earnings surprises.
Conclusion: Views expressed in both articles and commentaries predict future stock returns and earnings surprises.
… and the Cross-Section of Expected Returns
313 articles have found 316 factors that attempt to explain the cross-section of expected returns. Given extensive data mining, it does not make sense to use the usual criteria for establishing significance - most claimed research findings in financial economics are likely false.
The paper introduces a new multiple testing framework and provides historical cutoffs from the first empirical tests in 1967 to today.
A new factor needs a t-statistic greater than 3.0.
The factors that are good enough for them:
1. HML - book-to-market
2. MOM - momentum
3. DCG - durable consumption goods
4. SRV - short-run volatility
5. MRT - market beta
Two Pillars of Asset Pricing
The two pillars:
1) Work of efficient capital MARKETS
2) Work on Asset Pricing MODELS
The question is: Whether the properties of expected returns implied by the assumed model of market equilibrium are observed in actual returns? If not, either the market is indeed inefficient or the chosen asset pricing model is bad - Joint Hypothesis Problem.
Behavioural Economics: Past, Present, and
Future
Thaler
The paper looks at what is behavioral economics, what are the economist defenses to behavioralists giving them a hard time (explainawaytions), look at financial markets as the most efficient markets, yet still find many anomalies in behavior in such a liquid and efficient market - what does it imply for other markets? (nothing good)
The rise of behavioral economics is sometimes characterized as a kind of paradigm-shifting revolution within economics, but Thaler thinks that is a misreading of the history of economic thought. It would be more accurate to say that the methodology of behavioral economics returns economic thinking to the way it began, with Adam Smith.
Anomalies: The Law of One Price in Financial
Markets
The paper overviews the law of one price and its violations in the financial markets due to:
1. Some agents falsely believing that there are real differences between two identical goods
- Arbitrageurs are facing obstacles preventing them from profiting from the mispricing
They look at Closed-end country funds, ADRs, Twin Shares, Dual Class Shares, Corporate Spinoffs.
Hedge Funds: Past, Present, and Future
The paper compares mutual funds and hedge funds and tackles the question of whether they will continue to coexist. Over recent years, the hedge fund industry has grown sharply and regulatory concerns about the industry have increased - this may lead to hedge funds becoming more similar to mutual funds, being forced to disclose more, and becoming less profitable (as more people are going after similar profit potential)
Prone to Fail: The Pre-Crisis Financial System
The paper reviews key VULNERABILITIES of the PRE-CRISIS financial system: over-leveraged homeowners, weak supervision and regulation of banks, securities and derivatives markets, run-prone designs, reliance on market discipline and too-big-to-fail idea.
The paper outlines major REGULATORY CHANGES since the crisis: higher cost of debt (discouraged leverage, less too-big-to-fail assumption), regulations of derivatives markets (clearinghouses), all major banks are under FED supervision.
The paper touches upon the remaining challenges: no plan if clearinghouses fail - they are the new “too big to fail” financial firms, fading memory of the costs of crisis.
Moore’s Law versus Murphy’s Law: Algorithmic
Trading and Its Discontents
A brief survey of algorithmic trading, review of the major
drivers of its emergence (1. Greater complexity is a consequence of general economic growth and globalisation, 2. Quantitative modelling, 3. Computer technology) and POPULARITY (1. Quantitative models in finance 2. The emergence and rapid growth of index funds 3. Arbitrage trading activities 4. The push for lower costs of intermediation and execution 5. The growth of high-frequency trading) and explore some of the challenges and unintended consequences. (Quant Meltdown, The Flash Crash, Facebook & BATS, Knight Capital Group, High-Frequency Manipulation)
Key problem: financial regulatory framework has become antiquated and obsolete in the face of rapid technological advances that drastically reduced costs to intermediation, but have not correspondingly increased or distributed the benefits of greater immediacy
Moore’s Law in financial markets: from 1929 to 2009 the total market capitalisation of the US stock market has been doubling every decade
Murphy’s Law: “whatever can go wrong will go wrong” (faster and with worse consequences when computers are involved)
Towards a Political Theory of the Firm
Zingales
The interaction of concentrated corporate power
and politics is a threat to the functioning of the free market economy and to the economic prosperity it can generate, and a threat to democracy as well.
In a list combining both corporate and government revenues for 2015, ten companies appear in the largest 30 entities in the world. All ten of these companies had annual revenue higher than the governments of Switzerland, Norway, and Russia in 2015 ->
Companies have large security forces, public relations offices and resources (political influence), lacking only the direct power to wage war and the legal power of detaining people.
The size of many corporations exceeds the modern state. As such, they run the risk of transforming small and even medium-sized states into modern versions of banana republics, while posing economic and political risks even for the large high-income economies
Private Benefits of Control: An International Comparison
Looks at MEASURING PBOC: control premium & price difference between shares in a dual-class system
Looks at EFFECTS on the SIZE of PBOC PREMIUM: The size of block traded (51 s 30 %), Presence of another large shareholder, Sellers bargaining power, Industry, Intangibility of assets
Looks at PBOC EFFECTS ON FINANCIAL SYSTEM: Fewer companies are public, thus the equity markets are underdeveloped which hinders firm financing)
Looks at what CURBS PBOC: LEGAL institutions (Legal environment, disclosure standards, enforcement) & EXTRA-LEGAL institutions (public market competition, public opinion pressure, moral norms, labor as monitor, Government as a monitor through tax enforcement
Looks at legal origins: PBOC are the highest in former communist countries (36% extra value on equity).
Behind the Scenes: The Corporate Governance Preferences of Institutional Investor
There is little knowledge how institutional investors engage with their portfolio companies, because most of the interactions occur behind the scenes. Two ways of interaction - VOICE AND EXIT. The paper SURVEYS 143 large institutional investors to assess the importance of these actions in INSTITUTIONAL INVESTORS INTERACTING WITH MANAGEMENT.
FINDINGS: Institutional investors are active overall: only 19% of the surveyed have not taken any corrective actions in the past 5 years.
Determinants of voice intensity: Liquidity, Investment Horizon, Size.
The paper finds robust positive correlation between voice and exit, suggesting that they are complements.
Paper talks about what encourages (fraud, excessive compensation of managers, disagreement with strategy contributions to politicians) and what discourages (free rider problem, inadequate legal rules, conflicts of interest, compensation problems) shareholder activism, and touches upon proxy advisors.
Active Ownership
SOCIALLY RESPONSIBLE INVESTING that seeks to deliver SOCIAL as well as FINANCIAL BENEFITS, has attracted increasing attention. RESEARCH OF ESG ACTIVITIES ON FIRM’S SUCCESS.
Paper determines the THEORETICAL EFFECTS of Corporate social activity: Focus on long-term strategy, Channel to express personal beliefs, Agency problems.
CHANNELS OF ESG VALUE ENHANCEMENT: Consumers, Employees, Morals, Progressiveness
Engagements on environmental and social issues have
considerably lower success rate (13.1%) than on corporate governance (24.2%).
DETERMINANTS OF SUCCESSFUL ESG ENGAGEMENT:
Large and mature firms, Institutional ownership, Underperforming firms, Consumer Industries
ESG activism increases stakeholder value when engagements are successful and does not destroy value even when activism fails. It’s a WIN-WIN lottery.
The Agency Problems of Institutional Investors
Looks at Index funds (Passive), Active funds (most of them are “closet indexers”), Hedge funds (very active).
The agency problem: Intitutional investors might not act in the best interest of their clients – institutional investors might not engage in stewardship activities or might not invest enough in stewardship activities because they have no incentives to do so.
Costs & Compensation, Index Tracking, “Active Funds”, Private Costs.
Hedge Funds are often superior in stewardship activities because they get direct return back, not shared with others, devote more resources, no conflicts on interests.
Conclusion: Agency problems of institutional investors prevent the full realization of the potential benefits of the increased concentration of shareholders. Modern corporations suffer not from too much shareholder
intervention, but rather from too little.
Extreme Governance: An Analysis of Dual-Class
Companies in the United States
The research summarizes dual-class firms in the US, provides reasons for their existence and insights about the valuation of such companies.
A superior class of shares is usually owned by company insiders (e.g. managers). It provides insiders with a majority of votes despite much lower cash flow rights in their possession. Insiders of dual-class firms have effective control over all corporate decisions. It makes them virtually immune to HOSTILE TAKEOVERS.
Determinants of dual-class status: Name, Media, Activity of the founder, Firms in the area (only game in town)
The paper finds:
Firm value is positively associated with insiders’ cash flow rights.
Firm value is negatively associated with insiders voting rights.
Firm value is negatively associated with the wedge between the two (insider voting rights – insider cash flow rights).
Despite the evidence that dual-class system can reduce the value of the firm, a majority owner of a private company can still rationally choose to sacrifice some of the firm value to maintain PBOC. Personal utility from controlling a newspaper, news agency or brand identity can well outweigh the financial losses of the firm.
The bonding hypothesis of takeover
defenses: Evidence from IPO firms
CONVENTIONAL WISDOM: antitakeover defenses entrench managers who run firms inefficiently and/or consume large PBOC. This leads to a DECREASE in firm’s value through lower operating performance.
The paper investigates BONDING hypothesis proposing that this is not true: Defenses commit firm to a prearranged business strategy whose reversal is complicated and costly. This ensures company’s business partners that the company will not act opportunistically and appropriate them, encouraging partners to make relation-specific investments. This allows the company to gain favorable contract terms with its partners, which INCREASES firm value. Evidence and effects of bonding is more pronounced in the IPO firms.
Relationships worth defending: Large Customer, Dependent supplier, Strategic alliance.
Support for bonding hypothesis: Social links, Pre-IPO relationship length, Long-term contracts, % of customer’s COGS.
Pemstar and IBM example
