Main ideas (2020)

Question 1

Wisdom of Crowds: The Value of Stock Opinions

Transmitted Through Social Media

Answer 1

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.

Question 2

The U.S. Equity Return Premium: Past, Present,

and Future

Answer 2

This paper overviews the existing facts and explanations of the equity return premium puzzle (long term investments in stocks have received higher returns than in bonds without more risk).

PEOPLE SHOULD INVEST IN STOCKS, BUT INVEST IN BONDS. WHY?
POSSIBLE EXPLANATIONS:
1) Expected utility theory - Risk & loss aversion,
2) Transaction Costs (TC) and Investor Heterogeneity
3) Lower Tail Risk (catastrophes)
4) Learning About the Return Distribution

Question 3

… and the Cross-Section of Expected Returns

Answer 3

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

Question 4

Two Pillars of Asset Pricing

Answer 4

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.

Question 5

Behavioural Economics: Past, Present, and
Future

Thaler

Answer 5

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.

Question 6

Anomalies: The Law of One Price in Financial

Markets

Answer 6

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
2. 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.

Question 7

Forensic Finance

Answer 7

Forensic investigators apply their own specialized knowledge of prices, quantities, timing, and market institutions and sometimes discover or substantiate evidence that is used by regulatory or criminal enforcement agencies.

Cases looked at:

1) Late Trading of mutual funds
2) Employee Stock Option Backdating
3) Spinnings of IPOs
4) Rewriting the History of Market Recommendations

Question 8

Hedge Funds: Past, Present, and Future

Answer 8

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)

Question 9

Bitcoin: Economics, Technology, and Governance

Answer 9

The article presents the platform’s design principles and properties for a nontechnical audience; reviews its past, present, and future uses; and points out risks and regulatory issues as Bitcoin interacts with the conventional financial system and the real economy.

Question 10

Prone to Fail: The Pre-Crisis Financial System

Answer 10

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.

Question 11

Moore’s Law versus Murphy’s Law: Algorithmic

Trading and Its Discontents

Answer 11

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)

Question 12

The Economic Consequences of Legal Origins

Answer 12

In the last decade, economists have produced a considerable body of research suggesting that the historical origin of a country’s laws is highly correlated with a broad range of its legal rules and regulations, as well as with economic outcomes. We SUMMARISE this EVIDENCE and ATTEMPT a UNIFIED INTERPRETATION. We also address several objections to the empirical claim that legal origins matter.

Common-Law leads to better economic outcomes on average. Shall the world remain peaceful and orderly, globalisation will likely drive the world towards more common law-type solutions in the future

Question 13

Towards a Political Theory of the Firm

Zingales

Answer 13

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

Question 14

A Survey of Corporate Governance

Answer 14

Looks at the agency problem of corporate governance - Financiers face the difficulty in assuring that their funds are not expropriated or wasted on unattractive projects.

Ideally, a financier would sign a contract with a manager that specifies the division of profits and manager’s actions in all states of the world. But such contracts are infeasible!

Looks at the bad things managers can do, evidence of agency costs (e.g. manager’s death and share price increase)

Looks at EXPLANATIONS WHY INVESTORS INVEST AT ALL:

1) Reputation Building & Excessive investor optimism
2) Legal Protection
3) Large Investors presence

Successful corporate governance systems, such as those of the United States, Germany, and Japan, combine significant legal protection of at least some investors with an important role for large investors.

Question 15

Private Benefits of Control: An International Comparison

Answer 15

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).

Question 16

Behind the Scenes: The Corporate Governance Preferences of Institutional Investor

Answer 16

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.

Question 17

Active Ownership

Answer 17

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.

Question 18

The Agency Problems of Institutional Investors

Answer 18

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.

Question 19

Extreme Governance: An Analysis of Dual-Class

Companies in the United States

Answer 19

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.

Question 20

The bonding hypothesis of takeover

defenses: Evidence from IPO firms

Answer 20

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

Question 21

On the Foundations of Corporate Social Responsibility

Answer 21

Main question: Why do firms in some countries systematically invest more in CSR than firms in other countries?

Simply put: Due to their stakeholder-orientated perspective, civil law systems support CSR to a larger extent than common law regimes. So, why do companies bother doing good for the society? If you find yourself in the civil law system, you do not have a choice.

A little deeper: CSR adoption in common law countries is typically a voluntary decision, while CSR adoption in civil law countries is determined by rules. In general, CSR level in a country is a result of the tradeoff concerning the rights and preferences of shareholders and other stakeholders.
Consistent with theoretical prediction, on average firms under a civil law system have a higher CSR score than those under the common law.

Question 22

Do Investors Value Sustainability? A Natural

Experiment Examining Ranking and Fund Flows

Answer 22

In March 2016 Morningstar, a leading financial research firm, introduced sustainability ratings covering more than 20,000 funds with $8 trillion in assets. Funds are ranked depending on their holdings of sustainable stocks.

If a fund is generally viewed as more desirable after its rating becomes public, money will flow in to it and it will grow. If it is viewed as less desirable, we will see money flow out of it and it will shrink. Therefore, fund flows are likely to explain the sustainability preferences of investors. In contrast, individual stocks have a fixed supply in the short run and therefore do not provide such a direct measure of investor responses.

Investors mostly look at globe ratings rather than pure measure of percentile or sustainability score, i.e investors often focus on discrete rather than continuous measures. Also, they focus on extreme outcomes. In this case, one globe and five globe rating funds see the largest impact.

The authors examine whether investors invested in higher globe ratings because of rational expectations that funds will perform better or they just assume tht they will perform better. Authors find that performance f the funds is not necessarily better, thus, investors hold irrational expectations and act on nonpecuniary motives (e.g. altruism).

Question 23

Corporate Political Contributions and Stock Returns

Answer 23

Despite a constant rant on special business interests shaping the politics system of the US it is still viewed as relatively fair and impartial form of government. Business seems to increase the welfare of legislators, but does this in return benefit corporate contributors.

In general, stock price responses of connected firms to different political news are greater in more corrupt countries.

RESULTS: There is a strong and robust positive correlation between corporate political contributions and firm’s abnormal future returns. Real performance, measured by ROE, is also enlarged. The effect is stronger for firms that support higher number of
candidates holding office in the same state the firm is based in.

Question 24

The safe assets shortage conundrum

Answer 24

Safe assets are ones that preserve their value during bad times (adverse systemic events). Demand for safe assets exceeds the supply of safe assets (supply is concentrated in advanced economies (U.S.).
Proposed solutions:
1) Exchange Rate appreciation
2) Issuance of public debt
3) Pooling and trenching infrastructure investment among quasi-safe assets
4) Production of private safe assets
5) Reducing the demand for safe assets

Question 25

The economics of structured finance

Answer 25

Structured finance is a sector of finance, specifically financial law that manages leverage and risk. Expanded dramatically 2004-2007 because of CDOs, strong economic growth, minimum capital requirements. The paper mainly talks about CDOs, the rise, advantages, disadvantages and the fall of them.
CDO - investment banks gather cash flow-generating assets (mortgages, bonds, and other types of debt) and repackage them into discrete classes, or tranches based on the level of credit risk assumed by the investor.

Question 26

Exchange - traded funds 101 for economists

Answer 26

Paper talks about structure and organization of ETFs and mutual funds.
ETFs - no direct interaction with capital markets, trade at market-determined prices, greater transparency, reduced transaction costs. Types - equity, fixed income, commodity.
Mutual funds - direct interaction with capital markets, trades at the end of the day at the net asset value, cannot short shares, buy on margin.

Paper talks about misconceptions and concerns (closures of ETFs, short selling of ETFs, securities lending by ETFs, Flash Crash, Liquidity mismatch, impact of underlying markets).

Question 27

Is the US public corporation in trouble?

Answer 27

Paper examines the evolution of public firms, looks at:

1) The number and age of public firms (less than predicted and old).
2) Valuation and concentration of public firms (fewer but large firms, very concentrated)
3) Investment (lower CAPEX, high R&D expenditures. Small fixed assets, big cash, big intangible assets (big brain).
4) Profitability (dramatic increase in the concentration of profits and assets)
5) How capital is provided (increase in R&D has led to decrease in firm leverage - firms have more cash than debt, bank loans less important, mostly bonds or private debt).
6) Ownership - institutional ownership of stock is much higher, large firms are preferred.
7) Payout policies - firms often retain earnings, share repurchases are more and more popular, there is a lack of investment opportunities.

Implications:

1) less efficient firms are acquired by more efficient firms. (only among the public firms).
2) regulatory burden with being public has increased
3) The fraction of small firms has dropped dramatically.

Question 28

Capital Structure

Answer 28

Paper attempts to explain a mix of financing sources used by corporations to finance real investment and provides a review of the tradeoff, pecking order and free cash flow theories of capital structure.

1) Trade-off theory → emphasizes taxes
2) Pecking order theory → emphasizes the difference in information
3) Free cash flow theory → emphasizes agency costs

Question 29

Corporate payout policy (3, 8, 9, 10, 13)

Answer 29

The paper describes dividend payout theories, reasons for paying high dividends as well as the advantages of stock repurchases

Question 30

Fiduciary duties and equity-debtholder conflicts

Answer 30

BACKGROUND:
For solvent firms, fiduciary duties are owed to the firm as a whole and to its owners, but not to other
firm stakeholders (such as creditors), but if a firm becomes insolvent, fiduciary duties are owed to all interested parties (including creditors)

DELAWARE court’s ruling:
• 1991 Credit Lyonnais v. Pathe Communications → when a firm is not insolvent, but in the “zone of
insolvency”, duties are already owed to creditors → when a company is in serious trouble, the
director’s responsibilities shift somewhat in the direction of the creditors.

IMPACT:
Paper looks at how this ruling affected investment, Equity issues and payout, risk and volatility, capital structure, debt covenants, valuation