papers

Here’s sort of a pleasing paper on equity research analysts. The background is basically that there’s this constellation of questions that reduce to “do public markets make companies Bad?,” and one of the main mechanisms by which that might happen would be if markets make companies focus on short-term earnings and shareholder distributions rather than long-term value creation for all stakeholders through sustainable innovation. So you try to find ways to measure (1) how public a company is and (2) how innovative it is, more or less, and then see how they interact. Analyst coverage is sort of a proxy for, like, intensity of public-ness,1 while patents are sort of a proxy for innovation.2 So does more research coverage make companies more or less innovative?

In terms of economic significance, our analysis suggests that an exogenous average loss of one analyst following a firm causes it to generate 18.2% more patents over a three-year window than a similar firm without any decrease in analyst coverage.

Read more »

Would you have predicted this?

This paper investigates the impact of credit rating changes on the sovereign spreads in the European Union and investigates the macro and financial factors that account for the time varying effects of a given credit rating change. We find that changes of ratings are informative, economically important and highly statistically significant in panel models even after controlling for a host of domestic and global fundamental factors and investigating various functional forms, time and country groupings and dynamic structures. Dynamic panel model estimates indicate that a credit rating upgrade decreases CDS spreads by about 45 basis points, on average, for EU countries.

I would not have! Perhaps I am biased from living in a country where credit ratings are a contrary indicator of sovereign interest rates, and where municipal defaults inevitably lead to helpful comments from ratings agencies like “If the payment doesn’t get made, we would downgrade the rating.” Apparently, though, sovereign ratings matter, at least in Europe and at least at some points on the ratings scale.1 Read more »

  • 07 May 2013 at 12:11 PM
  • Banks

Who Would You Rather Trust: Bankers Or Regulators?

A simple model of banking regulation and, like, counter-regulation goes something like this:

  • Regulators are conservative and dumb, and want to safeguard banks from bad risks even at the cost of preventing good risks,
  • Bankers are aggressive and smart, and want to take lots of good risks even at the cost of taking some bad risks, and
  • Sometimes bankers can find people to put up with their shit and sometimes they can’t.

“Put up with their shit” is meant in the broadest sense – Can banks defeat Dodd-Frank? Brown-Vitter? Is Lloyd Blankfein a hero or a villain? Jamie Dimon? Etc. – but one particularly interesting question is, if you’re trying to do trades that evade or bend or optimize or whatever regulation, will someone do those trades with you? You could write a history of recent finance with the answer to that question: in 2007 you could chuck all of your mortgage risk off-balance sheet via securitizations, in 2008 you … could not, and in 2013 if you’re looking for someone to provide regulatory capital relief all you have to do is call a Regulatory Capital Relief Fund. Six years peak-to-peak, same as the S&P.

You could probably use words like “bubble” in characterizing that cycle but I prefer the approach taken in this new NBER paper by Guillermo Ordoñez of Penn (free version here), both because it mathematically formalizes that basic model of regulation and counter-regulation in an interesting way, and because it is congenially cynical. As he puts it, “banks can always find ways around regulation when self-regulation becomes feasible, and it is indeed efficient for them to do so.” Bankers, of course, always think that it would be efficient for them to find ways around regulation. They only do so when they can find someone to trade with them. Read more »

Yesterday’s delightful insider trading settlement with Richard Moore, the CIBC banker who deduced the identity of a buyout target through sheer clingyness, is a good reminder that insider trading is weird. Nobody told Moore any material nonpublic information, but he got in trouble anyway.

It’s also a good reminder of this new-ish (March 2013) paper that I came across the other day, in which some academics went and interviewed sell-side research analysts about how they do their jobs. They don’t say anything all that surprising, though I guess if you’ve never met a sell-side analyst it’s sociologically interesting. But it’s a nice counterpoint Richard Moore: reading smoke signals and figuring out an acquisition is illegal insider trading, but having the company tell you stuff and then using it to make trading decisions isn’t. If you do it right.

Why would you talk to management? There are a bunch of reasons but one is surely that they might tell you stuff.1 And they will, though the phrasing is careful: Read more »

The Brown-Vitter bill, which two senators plan to introduce in an effort to dramatically raise bank capital requirements, has caused a range of fairly predictable reactions, and a few strange ones. Here, for instance, is a lobbyist complaining about “raising required capital to comically high levels,” but the comedy is perhaps elusive. But one stylized fact about bank capital that I find a little funny is that it is always the same; after a certain number of drinks this chart is hilarious:

What that says – perhaps a bit unclearly – is that if a bank is going to add some assets, it will do it by taking on debt; and if it’s going to reduce its debt, it will do so by selling assets; and the one thing that it won’t ever do is change the amount of equity it has. Capital ratios change, but capital amounts basically don’t (except to grow verrrrrrry slowly and steadily over time); all the action is in the denominator.

Consider what that chart means for Brown-Vitter: on Friday I calculated that the bill would require adding, in round numbers, $1.2 trillion of capital at the top 6 banks, all at once.1 But that holds bank assets constant, which is not how it generally works. Of course it’s possible that this new law would break the pattern of banks always having the same amount of equity and just adjusting their debt, and cause them to actually increase their equity dramatically; I suspect that’s roughly speaking the intention.

Another possibility is that banks would keep doing what they’ve always done and bring up equity ratios by reducing assets; the amount of equity would remain constant, as it has in the past. On that math, the six big banks would have to reduce assets by $7 trillion. Out of a total of $9.5 trillion currently. So like a 72% reduction in bank lending and investing and what-have-you.2 Eep?

Perhaps there is comedy there though I’m not sure. That chart has been floating around various places but I swiped it just now from this paper,3 by Tobias Adrian of the NY Fed and Hyun Song Shin of Princeton, musing about why it might be. Or, rather, they just assume the constantness of bank equity, and question why amounts of bank debt change. What they come up with is that leverage moves inversely to value-at-risk, which you can sort of see in this chart: Read more »

Yesterday we talked a little about Dell and its vague desire to escape the short-term obsessions of the public equity market yesterday. Today I came upon this new paper by Harvard Law professor Jesse Fried, about how long-term shareholders are really just as bad as the short-term ones. The argument is:

  • companies like to talk about favoring long-term shareholders over short-term ones, because
  • they think (er, say) that short-term shareholders want things (slashing R&D, earnings manipulation) that reduce the overall economic value of the firm, while long-termers only want to grow its value, but
  • in fact long-term shareholders also want things that reduce the overall economic value of the firm, so
  • maybe favoring the long-term isn’t as good an idea as people think.

The particular things that long-term shareholders prefer that are value-destructive involve transacting in the company’s stock. On the buyback side, favoring long-term shareholders can mean using money to buy back stock when it’s underpriced, even if spending that money on productive investments would be better for shareholders as a whole. It can also mean manipulating earnings lower to get more profitable buyback opportunities. There is some evidence that these things happen.1

On the issuance side, favoring long-term shareholders means issuing more stock when it’s overpriced, for instance to engage in otherwise value-destructive M&A. Amusingly, Fried’s example of this is AOL Time Warner, famously the worst M&A transaction from the invention of the corporate form until Countrywide; he argues that, despite this value destruction, AOL’s long-term shareholders were enriched by AOL’s purchase of Time Warner.2 Read more »

So there’s this fight over what Apple should do with its money and I think it boils down to:

  • Lots of people think that Apple is undervalued,
  • Some of those people say: “so, since the market undervalues you, a dollar in your hands is valued less than a dollar in shareholders’ hands, and since you have Just. So. Many. Dollars. in your hands, why not give some back to shareholders, like in the form of colossal dividends, or even more amusingly in the form of tens or hundreds of billions of dollars of preferred stock?”
  • Others say: “no, the market’s valuation is irrelevant, you should stealthily keep investing your zillions of dollars into building wrist computers or whatever, and one day your stock will catch up.”

If these arguments sound familiar that’s because they are; you can pretty much always find an activist who thinks that a company should return cash to shareholders feuding with a management who thinks they should be investing that cash in growing the business. And they’re endless because they’re tough to adjudicate: everyone is sort of talking their own book. There is a pile of money, and some people say “we should have the money,” and others say “no we should have the money,” and, y’know, duh they’d say that. Are return-the-cash activist shareholders just greedy short-termers destroying long-term value? Are managers who prefer to invest the cash just blinkered empire-builders who don’t care about the welfare of the people actually funding their wrist-computer adventures?

I dunno. Here are some hypotheses: Read more »

  • 01 Feb 2013 at 12:12 PM

Banks May Have Manipulated Euribor Out Of Modesty

The Libor scandal’s little brother, the Euribor scandal, is different from the Libor scandal in one important way. With Libor, banks are asked where they can borrow, and so if they can borrow at 2.5% and submit 2.4% then they’re lying. With Euribor, banks are asked where a prime bank can borrow, and so if they can borrow at 2.5% and submit 2.4% then … I mean, then who knows? Maybe they’re not prime? What’s a prime bank? This imprecision made Euribor impossible to manipulate, for some shady tautological meaning of “impossible to manipulate,” and so everyone felt very clever about avoiding scandals until they didn’t.

So when Libor rates were kept artificially low in 2007-2008, as banks tried to avoid seeming weak by submitting high rates: that was fraud. But when Euribor rates were kept artificially low, that was defensible. The intuition would be “well, last year we could all borrow at 3%, this year most of us can borrow at 4%, but we don’t look as prime as we used to. The best of us can still borrow at 3%, so Euribor = 3%.” That’s the intuition behind this amusing Banca d’Italia working paper by Marco Taboga:

Euribor rates are averages of survey responses by banks that are asked the following question: what is the interest rate that, to the best of your knowledge, a prime bank would charge another prime bank on an unsecured loan? The keyword in this question is “prime bank”. Before the crisis started, the concept of prime bank was probably rather unambiguous: there were dozens of large and internationally active banks that enjoyed AAA ratings and had tiny CDS premia (around or below ten basis points); any one of these banks would be easily recognized as a prime bank. During the crisis, however, most of these banks experienced deteriorations in their credit ratings and surges in their credit spreads. Which of them are still to be considered prime? In the absence of a standard de…finition of prime bank, this is a question that calls for quite a bit of subjective judgement. Therefore, it is conceivable that after 2007 Euribor rates might have been infl‡uenced also by changes in the survey respondents’’ perception of what a prime bank is. This paper provides empirical evidence in favor of this hypothesis.

The empirical evidence is more suggestive than definitive, and the effects are more visible post-2008 than during the crisis, but still. Here’s the picture: Read more »