Persistent low economic output leads to disinflation, weak labor markets, slowing wage growth (IMF paper)
Q2 2010 U.S. Retail E-Commerce Spending Up 9 Percent vs. Year Ago (comScore)
MIT: Cap-and -trade legislation to limit carbon emissions would not disadvantage those with lower incomes
Economists in Financial Times propose “living wills” for big banks to curtail “too-big -to-fail”
Alacra Pulse Prognosis: AstraZeneca 12-Month Analyst Price Targets – Median at 3300p
Technorati Tags: (AZN), AstraZeneca, big banks, cap, e-commerce, economic growth
Research Recap will be dialing back for the next week. When we pick up again, we will be shifting our emphasis to keeping you informed via Twitter. Now would be a great time to start following us there, if you don’t already.
In a recent working paper, MIT economist Parag Pathak and two Harvard researchers, John Y. Campbell and Stefano Giglio, have put a price tag on foreclosures.
In the study, “Forced Sales and House Prices,” to be published in the American Economic Review, Pathak, Campbell and Giglio examined 1.8 million home sales in Massachusetts from 1987 to 2009.
By looking in granular detail at real-estate prices, the researchers have concluded that a foreclosure reduces the value of a house by 27 percent, on average.
“It’s not surprising that there is a discount due to foreclosure,” says Pathak. “But it is surprising that it’s so large.”
By contrast, other types of forced sales lower home prices by smaller amounts. When a house is sold after the death of an owner, Pathak and his co-authors found, the price drops 5 to 7 percent on average. When an owner declares bankruptcy, the value sinks 3 percent.
The researchers believe that their discovery of the gaps between these various price reductions is a key to isolating the effects of foreclosures. Because the declines in value are so disparate, yet occur among comparable homes in the same times and places, the reductions in value are not all attributable to the same overarching economic conditions. Instead, the researchers suggest in the paper, a central cause of the larger foreclosure discount is that the condition of foreclosed houses often deteriorates much more than it does for other kinds of houses whose ownership changes hands.
This tendency of foreclosed homes to fall into disrepair lies behind the other main finding of Pathak, Campbell and Giglio: The presence of a foreclosed house in a neighborhood reduces the value of the homes around it. In their estimation, the value of a home drops by 1 percent, on average, if it is within roughly 250 feet of a foreclosed home. This paper represents the first time economists have been able to cleanly quantify how much nearby foreclosures affect prices of inhabited homes.
Technorati Tags: foreclosures, home prices, housing
Multinational firms handled the financial crisis better than local ones, according to new working paper from Harvard Business School.
Key findings from: Surviving the Global Financial Crisis: Foreign Direct Investment and Establishment Performance by Laura Alfaro (George Washington University and Maggie Chen, HBS)
Responses to the crisis differed sharply between multinational and local firms. On average, establishments with multinational ownership performed better than local competitors, but there was considerable differentiation in the role of foreign direct investment.
- Multinationals located in host countries that have experienced sharper declines in aggregate demand and credit conditions displayed a greater advantage over local firms in economic performance.
- Multinationals headquartered in countries with a greater incidence of the crisis, including lower demand and worse credit conditions, fared less satisfactorily overseas, suggesting a potential spillover of home-country shocks.
- Multinational corporation subsidiaries that share vertical production linkages with parent firms exhibited more resilient performance while horizontally linked subsidiaries responded less positively.
- The size of multinational networks matters. Being part of a larger multinational network, on average, was associated with superior economic performance during the crisis. But there was a negative interdependence across establishments with horizontal production linkages.
A previously featured paper from Harvard found that diversified firms increased in value relative to single-segment firms during the financial crisis.
Technorati Tags: conglomerates, diversification, diversified industrial companies, investment-strategy, multinationals
“Smart grid” will allow real-time pricing of energy for appliances by 2050 (BigThink)
MIT’s Simon Johnson says OTC derivatives will be illegal by 50 years from now (BigThink)
US economy to be more urban, but less real-estate-driven by 2050 (Big Think)
New drugs are not contributing much to pharmaceutical industry earnings (CMR research study)
Study: Nearly One in Five Mortgage Defaults Are ‘Strategic’ (WSJ Developments blog)
Central banks warn of new crisis if exit left too late (BIS)
Nomura positive on UK banks, with caveats: Lloyds a Buy via @FTAlphaville
Technorati Tags: (lloy), derivatives, energy, Lloyds Banking Group, Pharmaceuticals, SmartGrid, twitter updates, UK banks
On a day when the US Supreme Court struck down a provision of the Sarbanes-Oxley Act of 2002 that was supposed to strengthen corporate governance, Audit Integrity notes that the law has failed to prevent an increase in breadth and depth of corporate fraud .
Audit Integrity cites a recent study from The Committee of Sponsoring Organizations of the Treadway Commission analyzing fraudulent financial reporting for the period 1998 to 2007.
In its review of the COSO study, Audit Integrity highlights the following observations:
The most commonly cited motives for fraud included the need to meet external/internal earnings expectations; an attempt to conceal the company’s deteriorating financial condition; the need to bolster performance for pending equity or debt financing; or the desire to increase management compensation.
- The dollar value of fraudulent financial reporting soared in the last decade (despite the implementation of Sarbanes-Oxley).
- The companies engaging in Fraud were much larger than those observed in an earlier study, for the period 1988-1997.
- The SEC named the CEO and/or CFO for some level of involvement in 89% of fraud cases studied.
- The most common fraud techniques involved improper Revenue Recognition, followed by Overstatement of Assets, followed by Expense Recognition.
- Initial news in the press of an alleged fraud resulted in an average 16.7% abnormal stock price decline in the two days surrounding the news announcement.
- News of an SEC or Department of Justice investigation resulted in an average 7.3% abnormal stock price decline.
- Long-term negative consequences of fraud included bankruptcy; de-listing from a stock exchange; or material asset sales.
- The number of fraud cases between 1998 and 2007 increased compared to the prior 10-year study.
- The industries where fraud occurred most frequently included computer hardware/software.
- Most frauds were not isolated to a single fiscal period. Fraud periods averaged 31 months.
- There appears to be no difference between the number or character of frauds since the passage of the Sarbanes-Oxley Act of 2002. [Author’s note: the sample periods after 2002 are shorter than prior to 2002.]
- Fraudulent firms disclosed significantly more related party transactions than non- fraudulent firms.
- All of the 347 fraudulent firms received an unqualified opinion from their auditors on the last set of fraudulently misstated financial statements.
Audit Integrity’s conclusions:
- Fraud continues to increase in breadth and depth despite Sarbanes-Oxley.
- The motivation for committing fraud continues unabated.
- The methods of committing financial fraud have not materially changed.
- Traditional measures of corporate governance have limited impact on predicting fraud.
Audit Integrity’s full analysis is available here.
The COSO study is available here.
Technorati Tags: audit, corporate-fraud, corporate-governance, Sarbanes-Oxley, SOX
Financial market speculation did not cause the price bubble in agricultural futures markets in 2007-08, according to a preliminary study prepared by two US academics for the OECD.
Professors Scott Irwin, of the University of Illinois, and Dwight Sanders, of the University of Southern Illinois found the amount of money flowing into commodity index funds increased substantially in the period from 2006 to 2008. But although this increase represents a major structural change in investor participation in agricultural commodities futures, it has not increased price volatility, according to the study.
The paper said there is “no convincing evidence that positions held by index traders or swap dealers impact market returns.
These results tilt the weight of the evidence even further in favour of the argument that index funds did not cause a bubble in commodity futures prices.
Earlier OECD work has identified a range of market factors and policy actions that combined to explain the spikes in agricultural commodity and food prices between 2007-08. These included supply shortfalls (mainly due to drought in major exporting countries) coupled with low global stocks, increased demand for food, feed and non-food uses (such as biofuel production), relatively high oil prices, a relatively high US dollar, and various government policy responses (such as export restrictions) that exacerbated initial price increases.
Irwin, S. H. and D. R. Sanders (2010), The Impact of Index and Swap Funds on Commodity Futures Markets: Preliminary Results
Technorati Tags: agricultural commodities, bubble, commodity-prices
A new working paper from Harvard suggests investors may benefit if investment banks are forced to spin off their private equity operations as may occur under pending financial reform.
The paper attempts to address recent regulatory efforts to limit the ability of banks to undertake proprietary investing and trading activities.
Highlights from : “An Unfair Advantage”? Combining Banking with Private Equity Investing by Lily Fang, Victoria Ivashina, Josh Lerner
Examining 7,902 transactions between 1978 and 2009, we find that 26% of all private equity investments involved bank-affiliated private equity groups. The evidence seems consistent with important advantages for the bank affiliates.
Prior to the transaction, targets of bank-affiliated funds have significantly better operating performance than other targets. These deals were financed at significantly better terms than other deals when the parent bank of the affiliated private equity group is one of key lenders in the lending syndicate.
We show that having a private equity subsidiary as an investor in a deal significantly increases the odds of the parent bank being chosen as a future lender, M&A advisor, or equity underwriter. However, “cross- selling” of bank businesses is an unlikely explanation for the better loan terms given that this superior financing primarily occurs during the peaks of the private equity market.
It is also unlikely that better financing terms for bank-related private equity groups are explained by access to better targets. Despite the fact that bank groups’ targets have superior performance before the investment, exit outcomes are mixed, with slightly poorer performance in bank-related investments. Importantly, the under-performance is particularly true for investments made in peak years. Larger deals, commercial-bank-led transactions, and investments involving both bank-affiliated investors and stand-alone private equity firms done at the peaks of the market face significantly higher odds of bankruptcy.
Overall, the cyclicality of bank-affiliated transactions, the time-varying pattern of the financing benefit enjoyed by affiliated deals, and the generally worse outcomes of these deals done at market peaks raise questions about the desirability of combining banking with private equity investing.
Private equity is highly cyclical, with investments during peak period exhibiting problematic performance on a variety of measures. The involvement of bank-affiliated funds appears to exacerbate this cyclicality, and to introduce significant risks into the system. While there is some evidence that banks enjoy some information related synergies in that their target firms tend to have better ex ante characteristics, our overall findings seem to indicate that their involvement pose significant issues as well.
Technorati Tags: financial-regulation, investment banks, private-equity, Volcker Rule
A new paper from Harvard finds that diversified firms increased in value relative to single-segment firms during the financial crisis.
The paper also finds that the increase did not simply reflect changes in investor perceptions but real differences in corporate finance and investment, through two different channels: a “more money” effect arising from the debt coinsurance feature of conglomerates, and a “smarter money” effect arising from more efficient internal capital allocation.
Excerpts from Does Diversification Create Value in the Presence of External Financing Constraints? Evidence from the 2008–2009 Financial Crisis by Venkat Kuppuswamy and Belén Villalonga, Harvard Business School
In support of an emergent popular view that conglomerates are ready for a comeback, we find that the value of diversified firms relative to single-segment firms significantly increased during the crisis.
Using treatment effects models and switching regressions models, we confirm that these results are not driven by firm’s self- selection into the diversified status. Moreover, because the financial crisis represented an exogenous shock to external capital markets, our results cannot be attributed either to endogenous differences in firms’ financing constraints. We are thus able to provide evidence of a causal link between external financing constraints and the value of corporate diversification and internal capital allocation.
We also find that the increase did not simply reflect changes in investor sentiment or perceptions but real differences in corporate finance and investment. Specifically, we find evidence of two channels through which the financial crisis increased the intrinsic value of corporate diversification: greater access to credit markets as a result of the debt coinsurance provided by conglomerates, and access to (and/or more efficient use of) internal capital markets. While these financing alternatives are always available to diversified firms, the evidence suggests that they became particularly valuable during the crisis.
A question open for future research is whether the value advantage gained by conglomerates during the crisis will persist or disappear once the crisis is over. On the one hand, as credit becomes cheaper and more broadly available, both diversified and single-segment firms are likely to revert to their equilibrium leverage levels. The value of internal capital markets is also likely to decline as external capital markets return to their pre-crisis levels of efficiency and availability––partly because of the increased efficiency of external markets and partly because of the reduced pressure to allocate internal funds efficiently.
On the other hand, the financing advantage that conglomerates have enjoyed during the crisis may have allowed them to tackle unique investment opportunities that can give them a sustainable competitive advantage over their focused rivals––or even put some of those rivals out of business. While it is too early for us to be able to analyze in this study some of these long-term effects, the shift in the relative pricing of diversified and single-segment firms suggests that the stock market anticipates that the advantage gained by conglomerates will last well beyond the crisis.
Technorati Tags: conglomerates, diversification, diversified industrial companies, investment-strategy
A new working paper from Harvard finds that equity analysts don’t do a very good job of making accurate forecasts for subsidiaries of companies that are spun off.
Excerpts from When Do Analysts Add Value? Evidence from Corporate Spinoffs by Emilie Feldman, Stuart Gilson and Belén Villalonga of Harvard Business School.
We investigate equity analysts’ coverage of pending corporate spinoffs, and analyze whether equity analysts provide investors with useful information about the valuation consequences of these transactions. Spinoffs provide an interesting context in which to study the information content of analysts’ research, because the degree of information asymmetry between corporate insiders and investors is especially high in these situations.
Analysts who have followed these firms for an extended time prior to the completion of these spinoffs should have a comparative advantage in forecasting the future stand-alone performance of the parent and subsidiary companies, and in assessing how the spinoffs might impact firms’ market values. At the same time, however, these restructurings are complex, and they may coincide with significant changes in firms’ strategies or markets, potentially limiting analysts’ ability to generate useful information for investors.
We use manually collected data from 1,793 analyst reports that were issued around 62 spinoffs and tracking stock issues to provide detailed empirical evidence about the quantity, type, and quality of research performed by analysts. We find that analysts pay relatively little attention in their reports to the subsidiaries that will be spun off (measured, for example, by page counts, or by whether the reports include explicit forecasts of post-spinoff EPS), even though subsidiaries generally account for an economically significant share of firms’ operations before the spinoff––a result we label as “the forgotten child effect.
Consistent with this lack of attention to subsidiaries, we find that when analysts do provide forecasts of subsidiary EPS, the forecasts are less accurate than corresponding parent EPS forecasts.
Analysts’ forecasts of post-spinoff stock prices for both parents and subsidiaries tend to be less accurate than their EPS forecasts. We show that forecasts of parent EPS are more accurate when analysts or their investment banks have more experience covering the firm or its industry, and when analysts pay relatively more attention to and provide more detailed information about the parent in their reports. Similar cross-sectional variation is not observed in the case of subsidiary EPS forecast errors, however.
Moreover, we establish that when analysts make less accurate forecasts about subsidiaries, they in turn make less accurate forecasts about their parents, providing evidence that by forgetting about the child in their reports, analysts also neglect the parent companies.
Finally, we illustrate that both the EPS and price forecast errors in our sample of spinoffs exceed forecast errors previously documented in the context of other corporate restructuring transactions, such as IPOs, mergers, and bankruptcies. We conclude that the complexity associated with forecasting earnings and stock prices in the context of corporate spinoffs, combined with analysts’ apparent disregard for subsidiaries in their analysis of corporate spinoffs, seem to limit analysts’ ability to add value as information intermediaries in this setting.
Technorati Tags: analysts, Equity Research, spinoffs
