Posts filed under ‘Financial Markets’
| Peter Klein |
The new issue of the Academy of Management Perspectives features a symposium, edited by Mike Wright, on “Private Equity: Managerial and Policy Implications.” The symposium includes “Private Equity, HRM, and Employment” by Mike with Nick Bacon, Rod Ball, and Miguel Meuleman; “The Evolution and Strategic Positioning of Private Equity Firms” by Robert E. Hoskisson, Wei Shi, Xiwei Yi, and Jing Jin; and “Private Equity and Entrepreneurial Governance: Time for a Balanced View” by John L. Chapman, Mario P. Mondelli, and me. The symposium came out very nicely, if I may say so, covering a variety of strategic, entrepreneurial, and organizational issues related to private equity firms and companies receiving private equity finance.
In his introduction Mike highlights five main contributions:
First, the papers address the need to consider the systematic evidence on the managerial and strategic aspects of PE, in relation to both portfolio firms and PE firms, which has been largely fragmented if not nonexistent. Second, the papers analyze the impact of PE during economic downturns and demonstrate the underlying resilience of PE-backed portfolio firms. Third, the symposium provides an opportunity to develop insights that compare the managerial impact of PE with different forms of ownership and governance. Fourth, the articles in this symposium highlight the heterogeneity of the private equity phenomenon. Finally, in the context of continuing public attention to PE, which has been heightened by the U.S. presidential race and the global recession, the evidence presented in this symposium paints a rather more positive view than the hyperbole of some of the industry’s critics would suggest. Taken together, these contributions indicate a need for caution in attempts to tighten the regulation of PE lest the economic, financial, and social benefits be lost.
| Peter Klein |
From my colleague John Howe. Here’s the news item:
MarketWatch (June 20, Orol), meanwhile, has learned that “regulatory observers urged policy makers on Wednesday to require companies to make road-show discussions available to the broader public.” Among them was Ann Sherman, associate professor of finance at DePaul University. She spoke at the Senate Banking Committee hearing that was devoted to whether the IPO process was working for ordinary investors and stated: “It is very important that we try to give everyone the same information.” Lise Buyer, founder of Class V Group LLC, a firm that guides IPO-bound companies, agreed with Sherman. She added that one way to improve the flow of information would be to require companies on a road show to hold a scheduled “Ask the Management” Q&A session via the Internet.
Do people actually think we can level the information playing field? Not only is that naive (stupid), but it leads small/individual investors to the wrong conclusion — that they are not at a comparative disadvantage in the financial markets. They are, and they’re better off knowing it.
| Peter Klein |
Reminder: Proposals for the Managerial and Decision Economics special issue on “Effects of Alternative Investments on Entrepreneurship, Innovation, and Growth” are due 15 June 2012. Don Siegel, Nick Wilson, Mike Wright, and I are editing the special issue and organizing a paper-development conference 29 October 2012 at the SUNY Global Center in Manhattan. Click the link above or go here for further details. We look forward to your submissions!
| Peter Klein |
Two years ago I was in D.C. on Hayek-Klein day and found myself on an elevator with Ben Bernanke, upon which I persuaded him to sing me a few bars of Happy Birthday. True story. This year I was in D.C. again, this time to give an organizational economist’s perspective on the Federal Reserve System to the House Financial Services Committee’s Subcommittee on Domestic Monetary Policy and Technology. You can read my written testimony here and see the oral remarks at C-SPAN which has archived the event.
That’s Jeff Herbener to my right and John Taylor to my left, with Jamie Galbraith by Taylor. The one on the end is not Yoda, but Alice Rivlin.
Because the hearing was televised, I can truthfully say, “I’m not a macroeconomist, but I play one on TV.”
| Peter Klein |
Along with Don Siegel, Nick Wilson, and Mike Wright, I am guest editing a special issue of Managerial and Decision Economics on the “Effects of Alternative Investments on Entrepreneurship, Innovation, and Growth.” Proposals are due 15 June 2011. A special issue conference for developing the papers is planned for 29 October 2011 at the SUNY Global Center in Manhattan. The conference is jointly sponsored by the SUNY-Albany School of Business, the Centre for Private Equity Research at Imperial College Business School, and the McQuinn Center for Entrepreneurial Leadership. Further details and submission guidelines are below the fold. (more…)
| Peter Klein |
Raghu Rajan’s AFA presidential address is now online as an NBER working paper:
The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain rights over going-concern surplus. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.
| Peter Klein |
Mitt Romney’s time as head of Bain Capital has put private equity in the public spotlight. Jonathan Macey gave a vigorous defense of PE in Friday’s WSJ. I am certainly a fan, though of course PE as a governance mechanism has benefits and costs, like all organizational structures. For a great overview of the industry and its role in job creation and economic growth, listen to last Thursday’s Diane Rehm show, where Steve Kaplan gave a terrific presentation emphasizing the data and challenging popular myths about takeovers and layoffs.
| Peter Klein |
According to the latest Kauffman Foundation survey of “top” economics bloggers. (I participate, so it’s not that exclusive a club.)
Full report available here. As Kauffman’s Tim Kane notes, “The economics blogging community has proven to be very insightful with rich and diverse viewpoints, but by nature they understand the importance of entrepreneurship because that’s ultimately who they are.” I agree, with the caveat that many of us don’t exactly have a lot of skin in the game. . . .
| Peter Klein |
Two recent review-type papers from NBER:
Behavioral Corporate Finance: An Updated Survey
Malcolm Baker, Jeffrey Wurgler
NBER Working Paper No. 17333
Issued in August 2011
We survey the theory and evidence of behavioral corporate finance, which generally takes one of two approaches. The market timing and catering approach views managerial financing and investment decisions as rational managerial responses to securities mispricing. The managerial biases approach studies the direct effects of managers’ biases and nonstandard preferences on their decisions. We review relevant psychology, economic theory and predictions, empirical challenges, empirical evidence, new directions such as behavioral signaling, and open questions.
A Brief History of Regulations Regarding Financial Markets in the United States: 1789 to 2009
Alejandro Komai, Gary Richardson
NBER Working Paper No. 17443
Issued in September 2011
In the United States today, the system of financial regulation is complex and fragmented. Responsibility to regulate the financial services industry is split between about a dozen federal agencies, hundreds of state agencies, and numerous industry-sponsored self-governing associations. Regulatory jurisdictions often overlap, so that most financial firms report to multiple regulators; but gaps exist in the supervisory structure, so that some firms report to few, and at times, no regulator. The overlapping jumble of standards; laws; and federal, state, and private jurisdictions can confuse even the most sophisticated student of the system. This article explains how that confusion arose. The story begins with the Constitutional Convention and the foundation of our nation. Our founding fathers fragmented authority over financial markets between federal and state governments. That legacy survives today, complicating efforts to create a financial system that can function effectively during the twenty-first century.
| Peter Klein |
The idea of a renegotiation-proof equilibrium — a situation in which all commitments are credible such that no party has an incentive to alter the arrangement — became popular in the game-theoretic contract literature in the 1980s. A recent paper by Michael Roberts shows that renegotiation is much more common in bank lending than is commonly recognized (by academics), suggesting that in many cases, formal financial contracting arrangements should be seen as starting points for future negotiation, not equilibrium agreements.
We show that bank loans are repeatedly renegotiated by the borrower in an effort to loosen contractual constraints designed to mitigate information asymmetry. The typical loan is renegotiated every eight months, or four times during the life of the contract. The frequency of renegotiation is closely linked to the restrictiveness of the initial contact and the degree of information asymmetry between borrower and lender. In addition to significantly altering the terms of the contract, renegotiation reduces the speed of information revelation – more anticipated renegotiation rounds lead to longer durations between those renegotiations as information evolves more slowly. Consequently, later renegotiation rounds are more sensitive to new information regarding the borrower and their outside options than early rounds. An important by-product of our study is to show that many of the observations in the Dealscan database correspond to renegotiations of the same credit agreement, as opposed to originations of new loans.
| Peter Lewin |
From management professor Richard Rumelt. This is very interesting.
Today, households carry a much greater relative debt burden than they did in 1929, largely due to a 25-year mortgage binge. Between 1980 and 2007, disposable income grew at 5.9% per year while household indebtedness grew at 8.7% per year — a clearly unsustainable situation. As in 1939, this hangover of debt blocks new rounds of consumption and dulls the impact of fiscal and monetary stimuli.
From today’s WSJ: here.
| Peter Klein |
Frivolous commentary on the US debt crisis (like this) attributes to opponents of raising the debt ceiling the view that “defaults don’t matter.” Sensible people recognize, of course, that default (and even repudiation) are policy options that have benefits and costs, just as continuing to borrow and increasing the debt have benefits and costs. Reasonable people can disagree about the relevant magnitudes, but comparative institutional analysis is obviously the way to go here. (Unfortunately, most of the academic discussion has focused entirely on the possible short-term costs of default, with almost no attention paid to the almost certain long-term costs of continued borrowing.)
I’m a bit surprised no one has brought up William English’s 1996 AER paper, “Understanding the Costs of Sovereign Default: American State Debts in the 1840′s,” which provides very interesting evidence on US state defaults. It’s not a natural experiment, exactly, but does a nice job exploring the variety of default and repudiation practices among states that were otherwise pretty similar. Here’s the meat:
Between 1841 and 1843 eight states and one territory defaulted on their obligations, and by the end of the decade four states and one territory had repudiated all or part of their debts. These debts are properly seen as sovereign debts both because the United States Constitution precludes suits against states to enforce the payment of debts, and because most of the state debts were held by residents of other states and other countries (primarily Britain). . . .
In spite of the inability of the foreign creditors to impose direct sanctions, most U.S. states repaid their debts. It appears that states repaid in order to maintain their access to international capital markets, much like in reputational models. The states that repaid were able to borrow more in the years leading up to the Civil War. while those that did not repav were, for the most part, unable to do so. States that defaulted temporarily were able to regain access to the credit market by settling their old debts. More surprisingly, two states that repudiated a part of their debt were able to regain access to capital markets after servicing the remainder of their debt for a time.
Amazingly, the earth did not crash into the sun, nor did the citizens of the delinquent states experience locusts, boils, or Nancy Grace. Bond yields of course rose in the repudiating, defaulting, and partially defaulting states, but not to “catastrophic” levels. There were complex restructuring deals and other transactions to try to mitigate harms.
A recent CNBC story on Europe cited “the realization that sovereign risk, and particularly developed market sovereign risk exists, because most developed world sovereign was basically treated as entirely risk free,” quoting a principal at BlackRock Investment Institute. “With hindsight, we can say . . . that they have never been risk free, it’s just that we have been living in a quiet time over the last 20 years.” Doesn’t sound like Apocalypse to me.
| Peter Klein |
“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom,” Adam Smith famously observed. I noted in an earlier post on raising the debt ceiling that restructuring US government securities is hardly the “nuclear” option it’s portrayed in the pundit world; bankrupt firms, like bankrupt families and firms, restructure their debt obligations all the time. The notion of T-Bills as a sort of sacred relic, to be once and forever “risk-free,” seems more like religion than economics to me.
But, more important, there is another option for entities struggling to make their interest payments: asset sales. Just in the last couple days Bob Murphy, David Friedman, and Steve Horwitz have made this point. Public discussion on the US debt crisis assumes that the only options for meeting US debt obligations are increasing taxes, cutting spending, or both. But asset sales are another viable option. There’s a huge literature on this in corporate finance (e.g., Shleifer and Vishny, 1992; Brown, James, and Mooradian, 1994; John and Ofek, 1995), exploring the benefits and costs of asset sales as a source of liquidity for financially distressed firms. Of course, selling assets under dire circumstances, at fire-sale prices, is far from a first-best option but, as this literature points out, often better than bankruptcy or liquidation. (One of the best-known results, from John and Ofek, is that asset sales tend to increase firm value when they result in an increase in focus. Would it really be so bad if the US government sold off some foreign treasuries and currency, the strategic petroleum reserve, its vast holdings of commercial land, and other elements of a highly diversified, and unaccountably bloated, portfolio?)
| Peter Klein |
Not surprisingly — private interests:
Coups, Corporations, and Classified Information
Arindrajit Dube, Ethan Kaplan, Suresh Naidu
NBER Working Paper No. 16952, April 2011
We estimate the impact of coups and top-secret coup authorizations on asset prices of partially nationalized multinational companies that stood to benefit from US-backed coups. Stock returns of highly exposed firms reacted to coup authorizations classified as top-secret. The average cumulative abnormal return to a coup authorization was 9% over 4 days for a fully nationalized company, rising to more than 13% over sixteen days. Pre-coup authorizations accounted for a larger share of stock price increases than the actual coup events themselves.There is no effect in the case of the widely publicized, poorly executed Cuban operations, consistent with abnormal returns to coup authorizations reflecting credible private information. We also introduce two new intuitive and easy to implement nonparametric tests that do not rely on asymptotic justifications.
In what can only be a pure coincidence, the following item appeared just below the NBER paper in my RSS reader: “Halliburton Profit More Than Doubles.”
| Peter Klein |
Matching Firms, Managers, and Incentives
Oriana Bandiera, Andrea Prat, Luigi Guiso, Raffaella Sadun
We exploit a unique combination of administrative sources and survey data to study the match between firms and managers. The data includes manager characteristics, such as risk aversion and talent; firm characteristics, such as ownership; detailed measures of managerial practices relative to incentives, dismissals and promotions; and measurable outcomes, for the firm and for the manager. A parsimonious model of matching and incentive provision generates an array of implications that can be tested with our data. Our contribution is twofold. We disentangle the role of risk-aversion and talent in determining how firms select and motivate managers. In particular, risk-averse managers are matched with firms that offer low-powered contracts. We also show that empirical findings linking governance, incentives, and performance that are typically observed in isolation, can instead be interpreted within a simple unified matching framework.
Business Failures by Industry in the United States, 1895 to 1939: A Statistical History
Gary Richardson, Michael Gou
Dun’s Review began publishing monthly data on bankruptcies by branch of business during the 1890s. This essay reconstructs that series, links it to its successors, and discusses how it can be used for economic analysis.
The Consequences of Financial Innovation: A Counterfactual Research Agenda
Josh Lerner, Peter Tufano
Financial innovation has been both praised as the engine of growth of society and castigated for being the source of the weakness of the economy. In this paper, we review the literature on financial innovation and highlight the similarities and differences between financial innovation and other forms of innovation. We also propose a research agenda to systematically address the social welfare implications of financial innovation. To complement existing empirical and theoretical methods, we propose that scholars examine case studies of systemic (widely adopted) innovations, explicitly considering counterfactual histories had the innovations never been invented or adopted.
| Peter Klein |
Industrial conglomerate ITT announced in January a split into three more focused companies, one concentrated in hotels and gaming, one in education (technical training centers), and a slimmed-down ITT Corporation containing the remaining manufacturing businesses. This is the second major restructuring for ITT, once the poster child of the conglomerate movement of the 1960s and early 1970s.
The Wall Street Journal’s article of 13 January contains a nice graphic on the firm’s history, including a picture of Harold Geneen, the quintessential “management by the numbers” CEO (click to enlarge). It also includes ruminations on the conglomerate form more generally, about which I have a continuing research interest. Yale’s Jeffrey Sonnenfeld says conglomerates represented “an unholy mix of opportunistic investment bankers, misguided consultants and the vanities of CEOs.” A companion article puts it this way: “Conglomerates blossomed five decades ago, when favorable interest rates made it relatively easy to boost revenue and stock prices with serial acquisitions. But they fell out of favor when the stock increases slowed and investors began to question whether promised efficiencies would materialize.”
But this is not quite right. In fact, the research literature finds little evidence that conglomerate growth was fueled mainly by cheap credit and rising stock prices. (more…)
| Peter Klein |
Alan Blinder’s defense of QE2 is as feeble as Mankiw’s defense of “emergency measures” more generally. Blinder’s argument is simply that QE2 isn’t all that different from standard Keynesian fine-tuning (true) and that Ben Bernanke is smarter than critics like Sarah Palin (duh).”To create the fearsome inflation rates envisioned by the more extreme critics, the Fed would have to be incredibly incompetent, which it is not.” This reminds me of Janet Yellen’s unfortunate 2009 statement that “the Fed’s analytical prowess is top-notch and our forecasting record is second to none. . . . With respect to our tool kit, we certainly have the means to unwind the stimulus when the time is right.”
Blinder apparently thinks that the anti-Keynesian backlash is just some quibbles about this little jot or tittle. He cannot grasp that the growing sentiment against monetary central planning, against fine-tuning, against the whole statist monetary establishment, is a rejection of Keynesianism at the most fundamental level. People are tired of the philosopher kings and their pretense of knowledge.
But this is folly to kings. Consider Blinder’s criticism of Bernanke:
What the Fed proposes to do is neither foolproof nor perfect. Frankly, it’s not the policy I would choose. As I’ve written on this page, I’d like the Fed to purchase private securities and to reduce the interest rate it pays on reserves, even turning it negative. The latter would blast reserves out of banks into some productive uses.
Ah, to think like a king! But the days of the monetary monarchy may be numbered.
| Dick Langlois |
In Cities and the Wealth of Nations, Jane Jacobs argued that currencies should be promulgated by cities not nation states. If, for example, the currency of Detroit (the cadillac, let us say) could have floated against the currency of San Francisco (the silicon) during the late 20th century, there would have been another margin (other than the movement of capital and people) on which adjustments to technological change and shifting relative prices could have taken place, perhaps making Detroit less of a disaster area. I always found this idea appealing; but, not being a monetary economist and not having heard the idea discussed within professional economics, I wondered whether I might be missing some obvious counter-argument. Recently, however, I saw an NBER Working paper by Barry Eichengreen and Peter Temin that seems to make a similar point. Called “Fetters of Gold and Paper,” it argues that the euro and the dollar-renminbi peg are fixed-exchange-rate regimes like the gold standard. Such fixed-rate regimes may lower transaction costs in good times, but they prevent necessary adjustments in bad times, potentially leading to crises. Adjustment takes place via deflation that would otherwise have taken place through exchange-rate movement.
This is essentially the Eichengreen-Temin story about the Great Depression, which (to oversimplify) isn’t really very different from the Monetarist version. The Monetarists essentially say that gold wasn’t a fetter because there was never a real gold standard; it was a badly manipulated facsimile, which the Fed mismanaged. Eichengreen and Temin acknowledge this, but apply spin so that it was the mentalité of the gold standard that caused monetary authorities to behave as they did. In any case, as Eichengreen and Temin point out, the euro is actually a much stronger version of the fetters problem, since there is no adjustment mechanism akin to gold flows, however imperfect that mechanism might have been. Moreover, countries could (and eventually did) go off the gold standard; but there is no mechanism for countries to pull out of the euro without causing a major crisis. Interestingly, they see Bretton Woods as less of a problem, since there were international adjustment mechanisms in place. Also interestingly (for two economists of a Keynesian bent), they worry at length about the federal budget deficit and the level of government spending in the face of the renminbi peg and the current-account deficit. Usually, free-market economists worry about the budget deficit but not the current-account deficit, whereas left-of-center economists worry about the current account but not the budget. The renminbi peg makes them linked problems.
Which brings us back to Jacobs. The American dollar — one currency for all 50 states — was a prime model for the euro. And a Google search brings up dozens of comparisons between California and Greece. Why should the nation-state — whether the US or Europe — be the appropriate geographical domain of a currency?
| Peter Klein |
The latest issue of the History of Economics Review contains Geoffrey Poitras and Jovanovic’s interesting paper, “Pioneers of Financial Economics: Das Adam Smith Irrelevanzproblem?” (published version not available online; working-paper version here, presentation slides here). Despite the subtitle the paper isn’t about Adam Smith, but the (very) early history of financial economics. Here’s an excerpt:
In the case of financial economics, the roots of this field stretch back to antiquity, involving the valuation of financial transactions, such as determining payment on a loan or distributing profits from a partnership. Poitras (2000) uses the late fifteenth century as a starting point for the early or pre-classical history of financial economics, more than three centuries prior to the publication of the [Wealth of Nations]. As early as Fibonacci (1170?-1250?), elements of financial economics were being disseminated among the merchant classes in the commercial arithmetics that, by the fifteenth century, formed the core of the reckoning school curriculum, e.g., Swetz (1987). A fundamental historical demarcation point appears with Christian Huygens’s (1629-1695) seminal introduction of the modern theory of expectations.
From this point, until the appearance of the WN, the founding work of classical political economy, financial economics underwent a dramatic transformation. By the time the Theory of Moral Sentiments appeared, sophisticated methods for pricing contingent claims, such as the life annuities sold by various individuals, municipalities and national governments in western Europe, had been developed and were being applied to the establishment of actuarially sound life insurance plans and pension funds. Hald (1990), Poitras (2006), Lewin (2003) and Rubinstein (2003) among others identify the earliest pioneers of modern financial economics, the beginning of classical financial economics, from the contributors that developed these pricing methods. As such, there is a close connection between the classical histories of financial economics, statistics, and actuarial science.
In other words, this is a field in which theory and practice appear to have co-evolved quite closely, which raises interesting questions for the performativity crowd. Modern financial economics is in many ways similar: theories of market efficiency were both shaped by, and helped to shape (e.g., through options-pricing formulas) actual market behavior.
| Dick Langlois |
I seem to be on the “communitarianism” mailing list of Amitai Etzioni, missives from which are usually good for a cold frisson of annoyance. The most recent one seemed promising, however, as it touted a paper revisiting the capture theory of regulation. Many people have rightly criticized the Dodd-Frank Act for piling on unnecessary administrative regulation despite the fact that (A) regulation was already extensive and provided all the powers that would have been needed to avert the crisis and (B) much of the new regulation is aimed at activities that have nothing to do with the financial crisis. Etzioni points out that the potential for regulatory capture is an additional reason for concern. Quite so. Dependably, however, Etzioni comes to the wrong conclusion about the nature of the problem and how to fix it. To Etzioni, the problem is not the inherent liabilities of administrative regulation but the specter of private money corrupting the system. (Notably, his examples do not include the money of labor unions, which have captured, at the very least, vast swaths of the Labor and Education Departments.) As political speech is a topic on which I have already fulminated at some length, I will just add that, even in a world in which regulators were somehow insulated from financial temptation, there would still be capture: the operation of regulatory agencies depends on the possession of large amounts of specialized knowledge in whose generation the subjects of regulation have considerable, and oftentimes overwhelming, advantage.