Summary of business news and analysis

Major firms are considering relocation from politically unstable high tax EU jurisdictions to more stable countries such as Switzerland: Coca Cola leaves Greece heading for Switzerland, Oct. 12, 2012

In an environment with tax competition and competing political systems (a favorable state, as compared to more and more central planning!) politicians in respective problem countries will only have limited possibilities to increase taxes as output could decrease substantially. The relationship between tax increases, government income and economic output is shown in following graphs:

Source: Lukas, Vogel, Tax avoidance and fiscal limits: Laffer curves in an economy with informal sector, Economic Papers 448, European Comission, January 2012

Source: Lukas, Vogel, Tax avoidance and fiscal limits: Laffer curves in an economy with informal sector, Economic Papers 448, European Comission, January 2012

"Taken at face value, the results suggest that the capacity to create additional tax revenue does not appear to be the first binding constraint on using tax increases for fiscal consolidation, because not many countries are likely to be located on the downward sloping part of the Laffer curve. This is particularly true with regard to the consumption tax. On the other hand, the model misses important aspects of tax competition, such as portfolio and profit shifting across jurisdictions".. Lukas, Vogel, Tax avoidance and fiscal limits: Laffer curves in an economy with informal sector, Economic Papers 448, European Comission, January 2012

Kewords: Tax Revenue, Laffer Curve, Output and Taxes

Related:

Cato Institute: "tax competition is a powerful mechanism to restrain the greed of the political class"

Scott R. Baker, Nicholas Bloom, Steven J. Davis, Measuring Economic Policy Uncertainty, University of Chicago Booth School of Business, Oct. 10, 2011

Why "social animals" are often not the best investors:

Roy F. Baumeister, Todd F. Heatherton, Dianne M. Tice, When Ego Threats Lead to Self-Regulation Failure: Negative Consequences of High Self-Esteem, Journal of Personality and Social Psychology 1993, Vol. 64, No. 1,141-156

The tendency for people with high self-esteem to make inflated assessments and predictions about themselves carries the risk of making commitments that exceed capabilities, thus leading to failure. Ss chose their performance contingencies in a framework where larger rewards were linked to a greater risk of failure. In the absence of ego threat, Ss with high self-esteem showed superior self-regulation: They set appropriate goals and performed effectively. Ego threat, however, caused Ss with high self-esteem to set inappropriate, risky goals that were beyond their performance capabilities so they ended up with smaller rewards than Ss with low self-esteem. The results indicate the danger of letting egotistical illusions interfere with self-regulation processes.

Keywords: Investment, Psychology, Self-Esteem

A new paper (see below) comes to surprising results. We still see a lot of value in teams of highly skilled private equity intermediaries/managers. Particularly in volatile times where firms need a lot of attention.

Fang, Lily H., Ivashina, Victoria and Lerner, Josh, The Disintermediation of Financial Markets: Direct Investing in Private Equity (October 9, 2012). Available at SSRN: http://ssrn.com/abstract=2159229

Abstract:

"One of the important issues in corporate finance is the role of financial intermediaries. In the private equity setting, institutional investors are increasingly eschewing intermediaries in favor of direct investments. To understand the trade-offs at work in this setting, we compiled proprietary dataset of direct investments from seven large institutional investors. We find that solo investments by institutions outperform co-investments and a wide-range of benchmarks for traditional private equity partnership investments. We also find that the outperformance is driven by deals where informational problems are not too great, such as more proximate transactions to the investor and later-stage deals, and by an ability to avoid the deleterious effects on returns often seen in periods with large inflows into the private equity market."

Keywords: Financial Intermediation, Private Equity

David K. Levine, Salvatore Modica, Federico Weinschelbaum, Felipe Zurita, Evolving to the Impatience Trap: The Example of the Farmer-Sheriff Game, Working Paper 2012-033A, Federal Reserve Bank of St. Louis, 2012

Abstract:

"The literature on the evolution of impatience, focusing on one-person decision problems, finds that evolutionary forces favor the more patient individuals. This paper shows that in the context of a game, this is not necessarily the case. In particular, it offers a two- population example where evolutionary forces favor impatience in one group while favoring patience in the other. Moreover, not only evolution but also efficiency may prefer impatient individuals. In our example, it is efficient for one population to evolve impatience and for the other to develop patience. Yet, evolutionary forces move the wrong populations."

Keywords: Human Behavior, Patience, Impatience

Kaplanski, Guy and Levy, Haim, Investment Choices with Envy and Altruism (September 19, 2012). Available at SSRN: http://ssrn.com/abstract=2148874

Abstract:

"Our experiment reveals that envy and altruism strongly affect the utility of investment choices: about 70% of the subjects reveal envy, 10% reveal altruism, while 20% are indifferent. Envious subjects even prefer an inferior First degree Stochastic Dominance (FSD) investment choice, provided that their peer groups lose more. We develop bivariate utility-free Stochastic Dominance (SD) rules with envy and altruism. Surprisingly, some non-pathological altruism preferences (let alone envious preferences) induce a reduction in the univariate expected utility of all parties. However, with the additive preferences, we identify important cases where the bivariate and the univariate SD efficient sets coincide."

Keywords: Investment, Investment Choices, Altruism, Greed

Interview with influential Financial Thought Leader and financial historian. James Grant will discuss why the Federal Reserve’s policies of zero interest rates and massive purchases of U.S. Treasury and mortgage-backed bonds are dangerous to the economy and damaging to savers.

Keywords: US Economy, Global Economy, European Economy, Monetary Policy, Zero Interest Rates, ECB

September 2012

Keywords: Money, Monetary System, Monetary Policy

Andrea Frazzini, David Kabiller, Lasse H. Pedersen, Buffett’s Alpha, AQR Capital Management and New York University, 2nd Draft, August 29, 2012

Berkshire Hathaway has a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha become statistically insignificant when controlling for exposures to Betting- gainst-Beta and quality factors. We estimate that Berkshire’s average leverage is about 1.6-to-1 and that it relies on unusually low-cost and stable sources of financing. Berkshire’s returns can thus largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks. We find that Berkshire’s portfolio of publicly-traded stocks outperform private companies, suggesting that Buffett’s returns are more due to stock selection than to a direct effect on management.

Keywords: Buffett, Alpha, Stock Selection, Return, Leverage

March, 2012

Keywords: Investing, Value Stocks

Source: Brookings Institution

Keywords: US Income Distribution, US Poverty, US Economy

Keywords: European Crisis, ESM

Horan Capital Advisors: Strong Stock Buyback Activity in Q2, Sept. 22, 2012

Source: Horan Capital Advisors: Strong Stock Buyback Activity in Q2, Sept. 22, 2012

Keywords: Corporate Earnings, Dividends, Share Buy Backs

Related:

Bloomberg: Grantham Calls Corporate Profits Freakish, Nov. 28, 2012

Greenhill & Co.'s CEO Scott Bok talks about the shrinking mergers and acquisitions markets. (Source: Bloomberg)

Sept. 24, 2012

Keywords: Mergers & Acquisitions, Corporate Finance, M&A Cycles

September 13, 2012

Keywords: Global Economy, European Crisis, Monetary Policy, Fiscal Policy

Mark A. Wynne, Janet Koech, One-Size-Fits-All Monetary Policy: Europe and the U.S., Federal Reserve Bank of Dallas, September 2012

"The ongoing euro-area crisis is seen by many as vindication of skeptics who said that a monetary union encompassing a disparate group of countries is doomed to fail because the countries do not constitute what economists call an optimum currency area. Thus, they argued, a one-size-fits-all monetary policy that goes with participation in an alliance such as the European Economic and Monetary Union (EMU) creates strains that ultimately prove insurmountable.

In the eyes of the skeptics, each country is better off setting its own interest rates at levels appropriate for local economic conditions. Such a contention raises the question: How far apart were the interest rates the European Central Bank (ECB) set for the euro area as a whole from those that would have been more appropriate for individual member states given their local economic conditions?" read more in an Economic Letter of the Dallas Fed

Keywords: European Interest Rates, European Monetary Policy, European Policy, ECB, Fed

Daniel L. Thornton, Greenspan’s Conundrum and the Fed’s Ability to Affect Long-Term Yields, St. Louis Fed, Sept. 2012

Abstract:

"In February 2005 Federal Reserve Chairman Alan Greenspan noticed that the 10-year Treasury yields failed to increase despite a 150-basis-point increase in the federal funds rate as a “conundrum.” This paper shows that the connection between the 10-year yield and the federal funds rate was severed in the late 1980s, well in advance of Greenspan’s observation. The paper hypothesize that the change occurred because the Federal Open Market Committee switched from using the federal funds rate as an operating instrument to using it to implement monetary policy and presents evidence from a variety of sources supporting the hypothesis. The analysis has implications for central banks’ interest rate policies."

Keywords: Long-Term Yields, Fed, Federal Funds Rate

JC of Alhambra has some doubts regarding the capabilities of the Fed to control inflation in the future:

Alhambra Partners: Fed Roots For Falling Dollar, I'm Thinking '87, by Joseph Calhoun, Alhambra, Sept. 2012

..."Currency devaluation is the last refuge of economic scoundrels and is most definitely not a policy implemented by countries with healthy economies"... go to Alhambra's blog here

Keywords: US Monetary Policy, Fed

Sept. 14, 2012

Keywords: Global Economy, Recovery, Investment Strategies

Christian Hott, Terhi Jokipii, Housing Bubbles and Interest Rates, Swiss National Bank, July 2012

Abstract:

"In this paper we assess whether persistently too low interest rates can cause housing bubbles. For a sample of 14 OECD countries, we calculate the deviations of house prices from their (theoretically implied) fundamental value and define them as bubbles. We then estimate the impact that a deviation of short term interest rates from the Taylor-implied interest rates have on house price bubbles. We additionally assess whether interest rates that have remained low for a longer period of time have a greater impact on house price overvaluation. Our results indicate that there is a strong link between low interest rates and housing bubbles. This impact is especially strong when interest rates are “too low for too long”. We argue that, by ensuring that rates do not deviate too far from Taylorimplied rates, central banks could lean against house price fluctuations without considering house price developments directly. If this is not possible, e.g. because a single monetary policy is confronted with a very heterogenous economic development within the currency area, alternative counter cyclical measures have to be considered." Source: SNB

Keywords: Interest Rates, Housing Bubble

Keywords: Jazz, Thelonius Monk