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Summary of business news and analysis

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10/10/07


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Why firms opt out of public markets

Permalink 06:51:40 am, by editor of MarketObservation.com, 244 words   English (US)

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Categories: Market Characteristics

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Why Do Firms Use Private Equity to Opt Out of Public Markets?, Sreedhar T. Bharath, Amy K. Dittmar, University of Michigan, August 2007

In attached paper it is investigated how firms weigh the costs and benefits of being a public firm in the decision to opt out of the public market and go private.

Key findings are twofold:

  • First, support is found for the importance of many of the costs and benefits of being a public firm. Particularly, researchers find strong support for the importance
    of theories that stress information and liquidity considerations.
  • They also find support for the role of free cash flow, primarily in the pre-1990s period and support for control and access to capital considerations.
  • The model developed is quite accurate, predicting who will go private 83.4% of the time.
  • Second, despite the fact that the sample firms remain public for over thirteen years, one can reliably predict that they will go private already at the time of the IPO.
  • Most of the factors that signifcantly determine the duration of public life also signifcantly predict who will go private using data in the year following the IPO.
  • Using only data at the time of the IPO, researchers correctly predict who will go private 80.6% of the time.
  • This result implies that it is not only the path that the firm takes but factors inherent and observable about the firm at the time of going public that determines if it eventually will go private.

10/09/07


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Statistics on US presidential fund raising

Permalink 06:36:37 am, by editor of MarketObservation.com Email , 47 words   English (US)

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Categories: Economics United States

10/08/07


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Performance of financial sector M&A

Permalink 08:25:22 pm, by editor of MarketObservation.com Email , 237 words   English (US)

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Categories: Academic, Opinion on Specific Transactions

Royal Bank of Scotland, Fortis and Banco Santander are set to to win the battle for Dutch bank ABN AMRO. This is the world's biggest bank merger.

Shareholders of all four banks will wonder how their shares might develop in the short, medium and longer term. Tough question! A look at mergers in the financial industry in the past might give some evidence. A paper by M. Campo and I. Hernando looks at the performance record of financial industry deals that took place in the European Union between 1998-2002.

M&A Performance in the European Financial Industry, J.M. Cama, University of Navarra; National Bureau of Economic Research (NBER), I. Hernando, Bank of Spain, IESE Business School, Working Paper No. 588, April 2005

Key findings were:

  • The paper reports evidence on shareholder returns from mergers. Merger announcements brought positive excess returns to the shareholders of the target company around the date of the announcement, with a slight positive excess return in the 3-month period prior to announcement.
  • Returns to shareholders of the acquiring firms were essentially zero around announcement.
  • One year after the announcement, excess returns were not significantly different from zero for either targets or acquirers.
  • The transactions resulted in significant improvements in the target banks' performance, beginning on average two years after the transaction was completed.
  • Return on equity of the target companies increased by an average of 7%, and the same firms also experienced efficiency improvements.
Permalink 01:11:07 pm, by editor of MarketObservation.com, 295 words   English (US)
Categories: Market Characteristics

Hedge Funds vs. Private Equity Funds as Shareholder Activists – Differences in Value Creation, M. Mietzner, D. Schweizer, European Business School (Germany),September 2007

Attached paper analyzes market reactions triggered by announcements that hedge funds and private equity investors purchase large blocks of voting rights. Researchers argue that shareholder's wealth is created by a reduction of agency costs through active holders of share blocks.

The investigation is based on a unique data set of German public listed companies and relates their short-term stock performance
to several corporate and market variables. Additionally, researchers examine ownership structure specific effects besides mid-term returns.

Key findings are:

  • There is evidence of substantial positive abnormal returns triggered by an announcement that a hedge funds or a private equity fund acquired at least 5% of a company’s voting rights.
  • Distinguishing between companies targeted by hedge fund and private equity funds provides evidence that hedge funds target smaller companies and acquire lower stakes.
  • Hedge funds seek targets that have more blockholders in the quarter before the acquisitions and prefer targets with hedge funds being the biggest blockholders.
  • An explanation for this herding effect might be that hedge funds need support from other investors due to their relatively small stake of voting rights.
  • Both hedge funds and private equity firms provide comparable possibilities to reduce agency costs.
  • The findings support the market’s perception that a private equity funds capability for reducing agency costs is lower when the target already has active blockholders.
  • Researchers find statistically significant negative benchmark adjusted buy-and-hold returns(BAHR) for both samples at the end of 250-days after the event. However, the market participants do not believe that hedge fund activism creates wealth effects comparable to private
    equity engagements since the negative long-term performance of hedge funds targets is more distinctive.

10/07/07


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Historic perspective on financial crises

Permalink 08:45:29 pm, by editor of MarketObservation.com Email , 114 words   English (US)

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Categories: Academic

Sometimes a historical perspective is needed to understand the events of the present.
Franklin Allen from University of Pennsylvania and Douglas Gale, New York University, provide a valuable overview on financial crises over the last decades. They refer to research which has been done on the explanation of crises. One view they mention is that "crises occur spontaneously as the result of mob psychology or panic" (Panic based models).

Another view they mention is that crises are an intrinsic part of economic cycles and result from shocks to economic fundamentals (models with real intrinsic shocks).

Both models and research which has been done so far are explained in the paper by Allen and Gale.

10/03/07

Researchers from Turin University analyzed the impact of public policy on venture market activity. They formalized "innovation ratios" and explore the possibility of excess supply of venture capital.

Public Policy and the Creation of Active Venture Capital Markets, Marco Da Rin, Giovanna Nicodano, Alessandro Sembenelli, Turin University, ECGI and IGIER, December, 2004

Key findings:

  • Interestingly enough their data analysis gives evidence that channeling more funds into venture capital markets does not significantly increase the share of early stage and high tech investments
  • A policy which aims at improving the entrepreneurial framework is much more promising
  • The availability of stock markets targeted at entrepreneurial companies–which provide a lucrative exit channel–and a decrease in capital gains taxation both raise the share of early stage
    and high-tech investments.
  • A reduction in some barriers to entrepreneurship leads to a large increase in the high-tech ratio.
  • The stock of public R&D holds no effect on the innovation ratios.
  • The findings of the Turin Univ. Researchers seem to give evidence that not to a lack of funding or of attractive technological opportunities leads to low high-tech ratios, but rather barriers to create new companies and make profits from them
  • Thus, policy should consider a wider set of policies than
    simply channeling more funds into venture capital.

_______________________________________________

Further data on entrepreneurship:

Taxes and entrepreneurial activity

10/02/07

Permalink 09:04:19 pm, by editor of MarketObservation.com, 341 words   English (US)
Categories: Investment, Academic

UBS has announced a CEO change this summer without giving detailed reason. Yesterday they announced that they have to make provisions of approximately Swiss francs 4 billion mainly due to losses in subprime investments. The financial community is asking whether the CEO change has been due to this bad investments (which seems to be obvious) and whether bad news has been delayed. We do not know for sure.

S.P. Kothari, S. Shu and P. Wysocki from MIT examine whether managers delay the disclosure of bad news relative to good news. They infer the relative timeliness of bad and good news disclosures from the magnitude of stock price reactions to such disclosures.

Key findings are:

  • If managers accumulate and withhold bad news up to a certain threshold, but leak and immediately reveal good news to investors, then we expect the magnitude of the negative stock price reaction to bad news disclosures to be greater than the magnitude of the positive stock price reaction to good news disclosures.
  • Management, on average, delays the release of bad news to investors.
  • The magnitude of the 5-day market reaction to bad news announcements such as negative dividend and pessimistic managerial forecasts of earnings exceeds that of good news announcements such as positive dividend changes and optimistic managerial forecasts of earnings.
  • These results hold even after controlling for the magnitude of
    the news announcement.
  • Researchers find evidence that the asymmetric market reactions to good vs. bad news vary predictably across firms depending on managers’ incentives and opportunities to withhold bad news.
  • Empirical evidence suggests that, on average, withholding of bad news and
    leaking good news early is pervasive across various types of firms.

UBS stock has improved approximately 10% since yesterday's announcement of the subprime losses in the third quarter. It will be interesting to see how the share price will develop in the next 3 days. Announcing the losses together with further management changes (CFO, CIO..) was definitely not the worst thing to do. It demonstrated that the new CEO is willing to act resolutely in crisis situations.

09/30/07


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Separate farm policy from energy policy

Permalink 08:12:49 pm, by editor of MarketObservation.com Email , 424 words   English (US)

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Categories: Global natural Resources Trends, Politics

Source: "Biofuels - at what Costs by Dough Koplow

Ethanol's Boom Stalling as Glut depresses Price, NYT, Sept. 30, 2007

Attached article from the online section of the New York Times clearly demonstrates how subsidies in many cases lead to market distortions. Subsidizing ethanol production obviously lead to overinvestment in ethanol distilleries.

It can also be questioned whether the subsidizing of ethanol production is meaningful from an environmental point of view: the carbon dioxide produced by burning ethanol has been in the atmosphere. Putting it back into the air has overall no adverse effect on the climate. However, ethanol is not a very effective fuel. By burning a litre of ethanol you get a third less heat than by burning a litre of petrol. Various research institutions and firms are currently working on developing a better fuel. As an example, researchers try to develop techniques which turn living organisms into chemical reactors, finally making fuel which has better qualities than ethanol.

The question arises whether taxpayer's money should rather be invested in the not so efficient ethanol production or in promising new projects.

The study "Biofuels – At What Cost? Government support for ethanol and biodiesel in the United States", by Dough Koplow addresses the consequences of biofuel subsidies in various countries. Due to a lack of information regarding consequences of such subsidies the report makes amongst others following recommendations:

  • Improve information on subsidies to energy, including biofuels
  • Declare a moratorium on new subsidies; and develop a plan to sharply reduce or eliminate subsidies to all transport fuels
  • More research into the consequences—intended and not—from current support policies for liquid biofuels is needed
  • More research into the effects of continuing to subsidize and protect domestic production of liquid biofuels is sorely needed
  • Good research requires data, and that in turn necessitates that governments be much more transparent than they have been so far with information on subsidies to biofuels
  • What is needed is amounts of expenditure associated with these programs, and suitable
    metrics that would allow evaluation of the cost-effectiveness of current and proposed policies
  • There is an urgent need to examine the claimed benefits from biofuel subsidies, and to compare them with the costs of meeting the same goals in other ways
  • Farm policy should be separated from energy policy

_____________________________________

Further reading:

href="http://www.card.iastate.edu/publications/synopsis.aspx?id=1029">Long-Run Impact of Corn-Based Ethanol on the Grain, Oilseed, and Livestock Sectors: A Preliminary Assessment, Amani Elobeid, Simla Tokgoz, Dermot J. Hayes, Bruce A. Babcock, Chad E. Hart, Iowa State University, November 2006

09/29/07

Firm Failures as a Determinant of New Entry: Is There Evidence of Local Creative Destruction? Aviad Pe'er, Tuck School of Business at Dartmouth, Ilan Vertinsky, University of British Columbia - Sauder School of Business, June 2005, Tuck School of Business Working Paper No. 2005-30 Sauder School of Business Working Paper

Relating to the previous post and the possible destruction of firms ..... there will always be new opportunities as attached paper explains:

Selection of key findings:

  • Business creation is an important element of economic growth and regional
    innovation.
  • Entrepreneurs must recognize, interpret and take an action to follow an
    opportunity
  • The probability of opportunity recognition depends on the intensity of the search, the attention and alertness to new opportunities
  • Failures of firms in a location may intensify search for entrepreneurial opportunities and/or generate more opportunities in that location thus, attracting new entry.
  • Relating to Schumpeter’s hypothesis of creative destruction: exit of older firms stimulate entry and renewal.
  • Researchers mention that this process is anchored in relatively small spaces and that they can not test whether the new deployment of resource by entrants is indeed creative.
  • Entrepreneurs make their choices within the region, in part, on the basis of relative risks.
  • Local competition leads to elimination of abnormal returns, thus reducing the attractiveness of a place.
  • Competition is also associated with innovation

09/28/07

Permalink 08:37:01 pm, by editor of MarketObservation.com Email , 285 words   English (US)
Categories: Wisdom, Analysts

Particularly in times of volatile financial markets it is sometimes helpful to lean back and to think about the strength of sustainable and successful firms and institutions.

Our concept (referring to the basic idea underlying this blog) is not to reinvent the world but to post highly valuable ideas, articles and papers which we find useful for the practitioner. Attached article definitely belongs to this category:

Just Say No To Wall Street, M.C. Jensen, Harvard Business School, J.H. Fuller, The Monitor Company,Journal of Applied Corporate Finance, Vol. 14, No. 4, pp. 41-46, Winter 2002

A selection of key messages:

  • Managers must confront the capital markets with courage and conviction. They must not collude with analysts’ expectations that don’t fit with their strategies and the underlying characteristics of their markets.
  • They must not bow to analysts’ demands for highly predictable earnings. The art of analysis includes the capacity to understand phenomena like seasonality, cyclicality, and random events.
  • In the long run, conforming to pressures to satisfy the market’s desire for impossible predictability and unwise growth leads to the destruction of corporate value, shortened careers, humiliation, and damaged companies.
  • Managers must recognize that an overvalued stock can be damaging to the long-run health of the company, particularly when it serves as a pretext for overpriced acquisitions.
  • Buying overpriced companies with overvalued stock not only fails to add value, but can end up demoralizing once successful organizations.
  • Managers would be wise to remember that analysts are not always wrong. In fact, analysts have a vital monitoring role to play in a market economy.
  • Both analysts and managers bring important information and important perspectives
    to the conversation and both sides benefit when each does their task well.
Permalink 11:56:05 am, by editor of MarketObservation.com, 248 words   English (US)
Categories: Analysts

Decision Processes in German Mutual Fund Companies: Evidence from a Telephone Survey, K. Drachter, A. Kempf, M. Wagner, Centre for Financial Research, Unviversity of Cologne, June 2007

Researchers from the University of Cologne analyzed the decision making process of German mutual fund managers on the basis of a telephone survey. We find interesting that there seems to be a behavior difference between managers of large mutual funds and those of small and medium sized mutual funds. Key findings are:

  • Fund investors and rating agencies base their decisions not only on the past performance of mutual funds, but also on the investment management process employed by these funds.
  • The behavior of managers depends heavily on the characteristics of the funds and the characteristics of the fund company.
  • For example, the evidence shows that most managers of large funds believe that conversations with company executives are important in beating their benchmark.
  • This strategy, however, does not enable them to outperform their peers.
  • The findings for managers of small funds are different. Managers at small funds are divided in their judgment of whether conversations
    with company management are important, but the managers that do gather this information perform better than those that don’t rely on such information.

An interesting question would be why there seems to be a tendency that managers of smaller funds do not necessarily see the value of contact with company managements. Might there just be a lack of critical mass to act in the most professional way?

09/26/07


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Explanations for changes in home ownership rate

Permalink 10:59:56 pm, by editor of MarketObservation.com Email , 188 words   English (US)
Categories: Market research, Market characteristics

Home Ownership Rates for the US from 1965 to present

Source: United States Statistical Abstracts

Accounting for Changes in the Homeownership Rate, M. Chambers, C. Garriga,D.. Schlagenhauf, Working Paper 2007-21, Federal Reserve Bank of Atlanta, September 2007

Key findings:

  • After years of stagnation, homeownership rate steadily increased in the US between 1994 and 2005.
  • The long-run importance of demographic effects for the aggregate homeowner-
    ship rate is in the range of 16 to 31 percent. The effect of the introduction of new mortgage products range between 56 and 70 percent.
  • The transitional analysis suggests that demographic factors play a more dominant role the further away from the long-run equilibrium.
  • The new loan products are known as the combo loan and are characterized by lower downpayment requirements. It is found that combo loans tend to be the contract
    of choice of for younger cohorts which explains an important part of the increase in the aggregate homeownership rate observed since 1994.
  • Demographic factors are especially important in understanding participation rate changes of households older than age 50.
  • The model suggests that fifty percent of the increase in homeownership can be attributed to the introduction of the new mortgage product.

09/25/07

Permalink 07:15:20 am, by editor of MarketObservation.com, 161 words   English (US)
Categories: Wisdom, Analysts

Marc Thornton, an economist with Austrian school background, philosophizes about the predictability of stock market bubbles by economic professionals. He has identified two groups which predicted the 2000 stock market decline:

Whow predicted the bubble who predicted the crash, M. Thornton, The independent Review, 2004

  • The first group being based on on the analysis of valuation. Using standard measures of stockmarket value, such as the price-to-earnings ratio (P/E). He counts Robert
    Shiller to this group
  • Not surprisingly the second group mentioned are several economists of the Austrian school. Mr. Thornton mentions that Austrians tend to have a negative view in general, and that they are quick to emphasize the negative aspects of economic conditions and that they also distinguish bubbles and business cycles clearly from other economic phenomena and
    trends.

We attach this paper as it contains some very valuable quotes about the phenomena of bubbles and their predictability.
_____________________________________________________

Further reading about bubbles:

Bubbles and Public Policy, R. Shiller, Tobin Project, May 2007

09/23/07

Permalink 08:14:22 pm, by editor of MarketObservation.com Email , 76 words   English (US)
Categories: Market characteristics

Source: Christopher L. Peterson, Univ. of Florida

We particularly recommend to read chapter I of attached paper which gives a very valuable insight into the evolution of mortgage securitization in a historical context.

Subprime Mortgage Market Turmoil: Examining the Role of Securitization – A hearing before the U.S. Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Securities, Insurance, and Investment Written Testimony of Christopher L. Peterson, Associate Professor of Law, University of Florida, April 17, 2007

09/22/07

Permalink 10:55:11 am, by editor of MarketObservation.com, 10 words   English (US)
Categories: Wisdom
Permalink 10:19:48 am, by editor of MarketObservation.com, 459 words   English (US)
Categories: News

Mervyn King, governor of the Bank of England, has defended his handling of the Northern Rock crisis in front of a panel of MPs.

Key elements were:

  • Governor King believes that it would have been irresponsible to have intervened earlier to save the Northern Rock bank.
  • He admitted that he might have got the balance wrong when the run started.
  • Mr. King said worried customers were not being illogical
  • He denied that he was influenced by the government when he decided to make a U-turn on monetary policy after Northern Rock got into difficulties.
  • He believes that that the Northern Rock crisis will not have a lasting damage for the British banking system
  • Mr. King called for a major overhaul of legislation that protects savers from losing their money if a bank goes bust.
  • He thinks that it would have been irresponsible for the Bank of England to intervene already during August as it would have undermined confidence in the banking system
  • Mr. King mentioned the pictures on television showing people queing up in front of Northern Rock to get back their money back, a moment where the Bank of England had to step in to restore confidence
  • He mentioned that at this stage only a 100% government guarantee for retail savings deposits could prevent a further run on the bank.
  • Mr King said people withdrawing their savings were acting rationally, given the weakness of current legislation protecting savers.
  • Mr. King said that he would have preferred to give covert aid to Northern Rock, without the public being aware of the Bank's intervention, but that would have been illegal.
  • He sees the intervention as a decisive action on the right scale at the right time
  • Mr. King blamed the EU "market abuses" directive, which would have required the directors of Northern Rock to disclose any support they received from the Bank, as being part of the problem.
  • He said that it was a "difficult balance" to strike between the need to secure the integrity of the banking system, and avoiding "moral hazard" - where banks believe they can behave irresponsibly because they will always be bailed out.
  • Governor King also admitted that in retrospect he might have got the balance wrong.

Questions that might arise from this case:

- Mistakes in communication policy by the Bank of England?
- Effect of the event on future pricing of risk?
- Consequences for the management of Northern Rock in order to avoid future excessive
risk behavior of banking managements?
- What other measures, if any, could be taken instead of tighter regulation?
- What can be learnt for possible interventions in the future?
- Impact of the "EU policy directive" mentioned above on central bank behavior? Is there a
need for adaption?

09/20/07

Permalink 07:11:25 am, by editor of MarketObservation.com, 246 words   English (US)
Categories: News

Speech by SIR John Gieve, Deputy Governor, Bank of England, "Uncertainty, policy and financial markets", at the Barbican Centre, Tuesday 24 July 2007:

"The knock on effects of defaults in the US sub prime market and the impact of big investors on asset prices are factors we need to assess not just in trying to
understand the financial sector and the stresses it faces but in gauging the state of
the economy more widely."

Mervyn King, the central bank's governor, in week 37, 2007:

"The provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behavior," he said in prepared remarks to a government committee. "That encourages excessive risk-taking, and sows the seeds of a future financial crisis."

Bank of England injects £4.4bn into money markets, Independent, Sept. 19, 2007: "The Bank of England injected £4.4bn in emergency loans into the financial system yesterday, marking yet another departure from the hard line that the central bank had initially taken on the crisis. The Bank said that it released the funds – its first exceptional finetuning of the market since the global credit crunch began – to offset the spike in overnight lending rates that worsened in the wake of the run on Northern Rock. The injection brought the overnight lending rate down to 6.14250 per cent yesterday from 6.46875. The three-month Libor rate – the key rate at which banks will lend to each other – continued to move down as signs increased of easing in the commercial paper markets."

09/19/07

Permalink 09:44:00 pm, by editor of MarketObservation.com Email , 57 words   English (US)
Categories: Wisdom

It might be interesting for certain blog visitors to read a paper of the St. Louis Fed about Milton Friedman’s views and predictions regarding U.S. monetary policy developments after 1960. The author evaluates these interpretations and predictions in light of subsequent events.

Milton Friedman and U.S. Monetary History: 1961-2006, Edward Nelson, St. Louis Fed, May 2007

09/18/07

Permalink 02:26:01 pm, by editor of MarketObservation.com, 363 words   English (US)
Categories: News, Corporate Governance

Resolution of banking crises: a review, G. Hoggarth (Financial Industry and Regulation Division, Bank of England), J. Reidhill1 (US Federal Deposit Insurance Corporation), P. Sinclair (University of Birmingham)

A 2003 article of the Bank of England describes some of the principles that banking authorities should consider when they have to resolve banking crises. Although 4 years old the article has become actual as the British banking system is facing the Northern Rock debacle. Among many other aspects the article deals with potential medium- and longterm effects of government intervention in a banking crisis. Some of the major conclusions (out of the articles summary) are listed below:

  • Banking crises can have a dramatic adverse impact on the economy, in the absence of intervention.
  • Keeping the fiscal costs low, and avoiding moral hazard in the future, are also prime factors in determining the appropriate scale and character of intervention.
  • With individual bank failures, the authorities usually first seek a private sector solution.
  • Any losses are first passed to existing shareholders, managers and, in some cases, uninsured creditors; and not to taxpayers.
  • Restructuring policies are transparent with only viable institutions kept open while unviable ones are liquidated.
  • In system-wide crises, short-term problem solution through private action is hard. So there has been more reliance on foreign takeovers and government intervention.
  • Temporary government assistance is often preferred to liquidation, to avoid selling bank assets at ‘fire sale’ prices.
  • Also, because of concerns of widespread liquidity runs, blanket guarantees are usually given early to all bank creditors.
  • In most recent systemic crises the central bank or government agency has intervened early to provide liquidity to failing banks and blanket guarantees to depositors.
  • In nearly all cases investor panics have been quelled but at a cost to the budget and from greater moral hazard in the future.
  • It seems that open-ended liquidity support has prolonged banking
    crises, thus increasing, not reducing, the output costs to the economy.
  • Shareholders have usually lost their capital and senior managers their jobs, but creditors, including uninsured ones, have rarely made losses.
  • Consequently, insuring that the financial system is robust in the face of even substantial shocks should be a key objective of financial stability policy.

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