Financial Services →
- 29 Aug 2011
- Research & Ideas
Decoding Insider Information and Other Secrets of Old School Chums
Associate Professors Lauren H. Cohen and Christopher J. Malloy study how social connections affect important decisions and, ultimately, how those connections help shape the economy. Their research shows that it's possible to make better stock picks simply by knowing whether two industry players went to the same college or university. What's more, knowing whether two congressional members share an alma mater can help predict the outcome of pending legislation on the Senate floor. Open for comment; 0 Comments.
- 21 Apr 2011
- Research & Ideas
Searching for Better Practices in Social Investing
Social change requires innovation, not just in organizational practices but in funding practices, as well. This was a key message at "Social Investing: Emerging Trends in a Changing Landscape," a recent panel discussion at Harvard Business School in which several professional philanthropists explored how best to support social change. Open for comment; 0 Comments.
- 14 Mar 2011
- Research & Ideas
Keeping Credit Flowing to Consumers in Need
Regulators and policymakers are debating the best ways to revamp our damaged system of consumer and housing finance. The problem: turning the regulatory spigot too tightly could shut off the flow of needed credit to millions of lower-income Americans. A discussion with professor Nicolas P. Retsinas. Key concepts include: The economy will continue to depend on large numbers of low-wage workers. If lenders tighten credit too stringently, millions of Americans will be barred from borrowing. The challenge is to recalibrate the country's access to credit so that more responsibility for making good loans lies with lenders, and so that the burden is not almost entirely on borrowers. Open for comment; 0 Comments.
- 24 Feb 2011
- Research & Ideas
What’s Government’s Role in Regulating Home Purchase Financing?
The Obama administration recently proposed housing finance reforms to wind down Fannie Mae and Freddie Mac and bring private capital back to the mortgage markets. HBS professor David Scharfstein and doctoral student Adi Sunderam put forth a proposal to replace Fannie and Freddie and ensure a more stable supply of housing finance. Key concepts include: The two leading types of housing finance reform proposals are 1.) broad-based, explicit, properly priced government guarantees of mortgage-backed securities, and 2.) privatization. Properly priced guarantees would have little effect on mortgage interest rates relative to unguaranteed mortgage credit during normal times, and would expose taxpayers to moral-hazard risk with little benefit. Privatization reduces, but does not eliminate, the government's exposure to mortgage credit risk. It also leaves the economy and financial system exposed to destabilizing boom and bust cycles in mortgage credit. The main goal of housing finance reform should be financial stability, not the reduction of mortgage interest rates. The private market should be the main supplier of mortgage credit, but it should be carefully monitored using new approaches to regulating mortgage securitization. Moreover, the government should play a role of "guarantor of last resort" in periods of crisis. Closed for comment; 0 Comments.
- 18 Feb 2011
- Working Paper Summaries
A Behavioral Model of Demandable Deposits and Its Implications for Financial Regulation
Depositors are overconfident of their chances of recovering demandable deposits in a bank run. In a recent research paper, professor Julio J. Rotemberg reviews various government regulations available to be imposed on financial institutions—minimum capital levels, asset requirements, deposit insurance, and compulsory clawbacks—to understand how much they can help protect investors. Key concepts include: US households hold 11.4 percent of their financial assets in "transactions accounts" that are immediately available—about $3.5 trillion. Due to cognitive bias, people are overconfident about their position in line to withdraw their deposits in a bank run. Depositors who intend to spend far into the future hold demandable assets because they give investors the opportunity to change their portfolio at will on terms that are determined in advance. The paper offers a justification for various policies that governments use to regulate financial institutions, helping depositors who are too optimistic about how they will fare in a run. Closed for comment; 0 Comments.
- 02 Feb 2011
- Working Paper Summaries
Lawful but Corrupt: Gaming and the Problem of Institutional Corruption in the Private Sector
In the business world, "gaming" refers to the act of subverting the intent of rules or laws without technically breaking them--a skillful if unsavory way to achieve private gain. Harvard Business School professor emeritus Malcolm S. Salter explores how gaming the system can lead to institutional corruption, citing examples from Enron and early efforts by some banks to game the implementation of the Dodd-Frank financial reform act. Key concepts include: A Rule-Making Game involves influencing the writing of societal rules such that deliberate loopholes, exclusions, and ambiguous language provide future opportunities for sneaky behavior. A Rule-Following Game involves the actual exploitation of these gaming opportunities. Enron's story includes both types of games. The paper explores three hypotheses. First, extensive lobbying by business interests during rule-making sessions aims not only to minimize regulatory constraints, but also to ensure future gaming opportunities for the firms. Second, the gaming of rules is often fueled by the short-term goals and incentives of both corporate executives and investment managers, ignoring possible long-term consequences. Third, corporate boards become complicit in gaming when they allow gaming to take root and persist as an acceptable organizational norm, and fail to identify and monitor behavior that threatens compliance with socially mandated rules and regulations. Remedying rule-making gaming likely will require policies that address both lobbying efforts and campaign contributions. Meanwhile, extending the decision-making time horizon for investment managers and corporate executives should help to diminish rule-following gaming. Closed for comment; 0 Comments.
- 11 Jan 2011
- Working Paper Summaries
Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge
In August 2010, the Security and Exchange Commission announced a highly anticipated rule that would make it easier for investors to nominate new board members and get rid of existing ones. It allowed shareholders to have their board candidates included in the company's proxy materials--if those shareholders had owned at least 3 percent of the firm's shares for at least the prior three years. On October 4, the SEC unexpectedly and indefinitely postponed the implementation of that rule, pending the outcome of a lawsuit aimed at overturning it. This paper gauges the significance of the proxy access rule by measuring whether certain firms gained or lost market value on news of the delay. Research was conducted by Harvard Business School professors Bo Becker, Daniel Bergstresser, and Guhan Subramanian. Key concepts include: Firms that would have been most affected by the proxy access rule, based on institutional ownership, lost value on October 4, 2010, following the news of the rule's delay. This suggests that financial markets placed positive value on shareholders' access to the board. The loss in value was greatest at firms that had large positions held by activist investors. The paper's findings may help prove that the SEC has met the federal rule mandating that all proposed rules "will promote efficiency, competition, and capital formation." Closed for comment; 0 Comments.
- 08 Dec 2010
- Working Paper Summaries
Decoding Inside Information
Price setters and regulators face a difficult challenge in trying to understand the stock trading activity of corporate insiders, especially when it comes to figuring out whether the activity is a good indicator of the firm's financial future. This National Bureau of Economic Research paper discusses how to distinguish "routine" trades (which predict virtually no information about a firm's financial future) from "opportunistic" trades (which contain a great deal of predictive power). Research was conducted by Harvard Business School professors Lauren Cohen and Christopher Malloy and Lukasz Pomorski of the University of Toronto. Key concepts include: Routine traders, whose trades make up some 55 percent of insider trades (over half of the universe), are those with a pattern of placing a trade in the same calendar month for at least a few years in a row. Opportunistic traders are those insiders for whom there is no discernible pattern in the past timing of their trades. Focusing solely on opportunistic trading activity allows analysts to weed out useless signals and identify those trades that will likely predict future firm returns and events. More than half of the improvement in this predictive power comes from the superior performance of opportunistic sells relative to routine sells. Closed for comment; 0 Comments.
- 03 Nov 2010
- Working Paper Summaries
How Did Increased Competition Affect Credit Ratings?
When Fitch Ratings took on Standard & Poor's and Moody's as an alternative credit rating agency in the 1990s, there was a general assumption that the increased competition would lead to higher-quality corporate debt ratings from the incumbents. In fact, their ratings quality declined during the 10-year study period, according to Harvard Business School's Bo Becker and Washington University's Todd Milbourn. One possible cause: competition weakens reputational incentives that drive ratings quality. Key concepts include: The entry of a third major rating agency, Fitch, coincided with lower overall quality, as measured by both the levels and the informational content of incumbents' ratings. Prior to Fitch's growth into a serious competitor, S&P and Moody's faced limited competition for rating corporate bonds. A major concern for the raters was maintaining their reputation with investors as providers of honest, accurate ratings. Increasing competition may force raters to compete harder for issuers' business, reducing their focus on the long term and thereby undermining quality. This appears to have been the case with the additional competition from Fitch. Incumbents' ratings became higher and less informative in those industries where Fitch became more prominent as a rater of corporate bonds. For regulators and policymakers, it is worth considering that increasing competition in the ratings industry involves the risk of impairing the reputational mechanism that seemingly brings about the provision of good quality ratings. Closed for comment; 0 Comments.
- 20 Oct 2010
- Working Paper Summaries
Financing Risk and Bubbles of Innovation
While start-up firms are key to any technological revolution, they also run a high risk of failure. To that end, investors often provide limited capital in several careful stages, gaining confidence in a firm before doling out another round of funding. However, these investors still face the possibility that other investors won't provide follow-on funding, even when the firm's prospects remain sound. That's a big risk for individual investors who can't afford to fund a new firm all by themselves, and whose investment will flounder if others don't invest, too. Research by HBS professors Ramana Nanda and Matthew Rhodes-Kropf explores why future investors may not fund the project at its next stage even if the fundamentals of the project have not changed. Key concepts include: The paper introduces the concept of financing risk--the risk that a project cannot garner the additional funding it needs to proceed, even if its fundamentals remain sound. When investors become worried, future investors will not support the project. Withdrawing support today leads to a self-fulfilling jump to a poor financing environment. Investors face a trade-off: either providing more capital to novel ideas to protect against financing risk, or providing less funding to maximize knowledge before providing more capital. The most innovative firms face the most acute trade-off situations, and thus, funding to these firms is the most unstable. The additional capital that enters the market during "hot" times goes not only to weaker projects, but also to more innovative projects that are a good investment only when financing risk is low. Thus, the most innovative projects may need a hot funding environment to get funding at all. Closed for comment; 0 Comments.
- 18 Oct 2010
- Lessons from the Classroom
Venture Capital’s Disconnect with Clean Tech
Clean-tech start-ups depend on patience and public policy to thrive—the Internet models for VC funding don't apply. That's why Harvard Business School professor Joseph Lassiter is making an unusual recommendation to his entrepreneurship students: Spend a few years serving time in a government job. Key concepts include: MBA students and young venture capitalists often assume that all promising start-ups can grow and exit as fast as Internet start-ups, but they're mistaken. Clean-tech start-ups are often stymied by a "valley of death"—that precarious stage between researching and developing a product and going to market. The success of clean-tech companies often is dependent on public policy, so it behooves budding VCs and entrepreneurs to spend a few years learning the ropes in a government or corporate job. Closed for comment; 0 Comments.
- 13 Oct 2010
- Research & Ideas
How Government can Discourage Private Sector Reliance on Short-Term Debt
Financial institutions have relied increasingly and excessively on short-term financing--putting the overall system at risk. Should government step in? Harvard researchers Robin Greenwood, Samuel Hanson, and Jeremy C. Stein propose a "comparative advantage approach" that allows government to actively influence the corporate sector's borrowing decisions. Key concepts include: There is general agreement that the financing of large financial intermediaries puts the larger financial system at risk. The government can dissuade firms from issuing short-term debt by simply making it less attractive to do so. The government could actively influence the corporate sector's borrowing decisions by shifting its own financing between T-bills and bonds. Closed for comment; 0 Comments.
- 12 Oct 2010
- Working Paper Summaries
Crashes and Collateralized Lending
This paper presents a framework for understanding the contribution of systematic crash risk to the cost of capital for a variety of different types of securities. The framework isolates the systematic crash risk exposure of different collateral types (equities, corporate bonds, and CDO tranches), and provides a simple mechanism for allocating the cost of bearing this risk between a financing intermediary and investor. Research was conducted by Jakub W. Jurek (Bendheim Center for Finance, Princeton University) and Erik Stafford (Harvard Business School). Key concepts include: A typical loan extended by a broker to an investor for a purchase on margin is collateralized by the underlying security and protected by the investor's capital contribution (the collateral, margin, or "haircut"). The haircut protects the intermediary from changes in the liquidation value of the collateral. The researchers' focus is looking at haircuts as an effective protection against large market declines. They derive a schedule of haircuts and financing rates (spreads above the risk-free rate), which represents the intermediary's fair charge for providing leverage to the investor. The framework also can be used to stress test different types of collateral by examining the predicted financing terms as market conditions change. This systematic credit risk channel has not been explored in the banking literature, despite the growing role of collateralized borrowing in the economy (e.g. repo market) and the seeming relevance of ensuring collateral robustness in adverse economic states. Closed for comment; 0 Comments.
- 10 Sep 2010
- Working Paper Summaries
The Impact of Corporate Social Responsibility on Investment Recommendations
Security analysts are increasingly awarding more favorable ratings to firms with corporate socially responsible (CSR) strategies, according to this paper by Ioannis Ioannou and HBS professor George Serafeim. Their work explores how CSR strategies can affect value creation in public equity markets through analyst recommendations. Key concepts include: Top executives and managers interested in implementing CSR strategies in their organizations know that negative analysts' reactions, and subsequent value destruction in capital markets is a real possibility when they initially attempt to implement such strategies. Managers should be aware that not only what is communicated matters but also to whom it is communicated in the investment community. Research analysts differ in their ability to understand the implications of CSR. Among theoretical contributions, the research integrates diverse theoretical streams and offers the first empirical piece of evidence about how CSR strategies are perceived as value-creating by an important information intermediary: sell-side analysts. The work also integrates the CSR management literature with a large body of research in accounting and finance, to shed light on aspects of CSR activity for which little is known and much less is being understood; namely, the channels and the mechanisms through which the CSR impact is perceived and realized in public equity markets. Closed for comment; 0 Comments.
- 17 May 2010
- Research & Ideas
What Brazil Teaches About Investor Protection
When Brazil entered the 20th century, its companies were a model of transparency and offered investor protections that government did not. Can our financial regulators learn a lesson from history? HBS professor Aldo Musacchio shares insights from his new book. Key concepts include: Companies can overcome the shortcomings of the legal system in which they operate by offering protections to investors. Corporate disclosure is perhaps the most important necessity for investor confidence. Policymakers should seek a balance between regulation, financial development, and economic growth. Closed for comment; 0 Comments.
- 13 May 2010
- Working Paper Summaries
Just Say No to Wall Street: Putting A Stop to the Earnings Game
Over the last decade, companies have struggled to meet analysts' expectations. Analysts have challenged the companies they covered to reach for unprecedented earnings growth, and executives have often acquiesced to analysts' increasingly unrealistic projections, adopting them as a basis for setting goals for their organizations. As Monitor Group cofounder Joseph Fuller and HBS professor emeritus Michael C. Jensen write, improving future relations between Main Street and Wall Street and putting an end to the destructive "earnings game" between analysts and executives will require a new approach to disclosure based on a few simple rules of engagement. (This article originally appeared in the Journal of Applied Corporate Finance in the Winter 2002 issue.) Key concepts include: Managers must confront the capital markets with courage and conviction. Managers must be forthright and promise only those results they have a legitimate prospect of delivering, and they must be clear about the risks and uncertainties involved. 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. Managers must work to make their organizations more transparent to investors and to the markets. To limit wishful thinking, managers must reconcile their own company's projections to those of the industry and their rivals. While recent history may have obscured the analyst role, managers should not simply presume that analysts are wrong when disagreement occurs. In fact, analysts have a vital monitoring role to play in a market economy. Closed for comment; 0 Comments.
- 21 Dec 2009
- Research & Ideas
Good Banks, Bad Banks, and Government’s Role as Fixer
Government action to stem collapse of the U.S. financial system was certainly warranted, agrees professor Robert Pozen. But results include less competition and increased risk to taxpayers. A Q&A from the HBS Alumni Bulletin and book excerpt from Too Big to Save? Key concepts include: Most of the 600 institutions recapitalized by the federal government over the last year do not satisfy basic bailout criterion. The U.S. needs to get loan securitization going because that's what drives loan volume. The Fed should not be the primary risk regulator. Splitting troubled institutions into two banks is a better approach than creating heavily subsidized public-private partnerships to try to buy toxic assets. Closed for comment; 0 Comments.
- 02 Nov 2009
- Research & Ideas
Shareholders Need a Say on Pay
"Say on pay" legislation now under debate Washington D.C. can be a useful tool for shareholders to strengthen the link between CEO pay and performance when it comes to golden parachutes, says Harvard Business School professor Fabrizio Ferri. Here's a look at how the collective involvement of multiple stakeholders could shape the future of executive compensation. Key concepts include: "Say on pay" means shareholders hold an annual advisory vote on executive pay based on a report prepared by the firm's board of directors. Say on pay might create more communication and awareness between shareholders and boards because it forces both entities to grapple with an extremely complex issue. Ferri advocates tailoring executive pay to a company's individual circumstances. Closed for comment; 0 Comments.
- 28 Oct 2009
- Lessons from the Classroom
HBS Begins Teaching Consumer Finance
Last spring HBS became the first top-ranked U.S. business school to offer a course in consumer finance. Professor Peter Tufano talks about the course and his determination to make consumer finance a broadly accepted academic pursuit. From the HBS Alumni Bulletin. Key concepts include: The household sector in America represents approximately $61 trillion of assets. The course helps students understand consumers and the financial service firms that serve them. Four functions are studied: payments, movements of money from today to tomorrow (savings and investing), movements of money from tomorrow back to today (borrowing), and managing risk. Closed for comment; 0 Comments.
Doomsday Coming for Catastrophic Risk Insurers?
Insurance "reinsurers" underwrite much of the catastrophic risk insurance taken out to protect against huge disasters natural and man-made. Problem is, says Professor Kenneth A. Froot, reinsurers themselves are in danger of failing from a major catastrophic event. Key concepts include: Reinsurers are not distributing risk adequately enough to be able to cover gargantuan losses. Catastrophic reinsurance is more expensive than it needs to be, meaning fewer firms can afford to buy it. Reinsurers should act more like risk-taking investors and less like risk-averse corporations. Open for comment; 0 Comments.