Consistently one of the most popular pages on FinanceProfessor.com is the Islamic Finance page. One reason I beleive is that so few people understand what Islamic Finance is.
From the executive summary on FinanceProfessor Islamic Finance page:
"Islamic Finance is based on interpretations from the Qua ran. Its two central tenants are no interest can be earned on loans and socially responsible investing. The key difference from a financial perspective is the no-interest rule since the Islamic socially responsible investing paradigm is not much different than what other religions do."
Islamic finance, and the majority of all socially responsible investing (SRI), is different from "regular investing" that ignores social factors. SRI is based on the premise that by investng responsibly, we can improve the world. SRI has taken on many aspects: economic, environmental, social, and even whether the firm encourages gambling, drugs, or other so-called vices.
Many of the differences in Islamic Finance (especially Islamic banking) revolve around the no interest (no-riba) principle. For example, Islamic banks must take equity positions in homes rather than taking a traditional mortgage. Others examples include profit sharing plans, leasing, and repurchase plans. These allow the financial institution to make money while satisfying the no-interest principle.
While still a relatively small percentage of the overall financial market, Islamic Finance is a fascinating, important, and often overlooked area. Moreover, its importance will only increase as nations with large Islamic populations play a increasing role in world markets.
Therefore, I was quite excited when I received a link to AIF Investor Services. AIF is designed to help make Islamic Investment easier by not only explaining what Islamic Finance is, but also by rating firms (only a few at the present) on how well they abide by Islamic rules.
While making recommendations on for-profit firms is well beyond the scope of this blog, I can say I learned several things by reading their site and especially will recommend the FAQ page on Islamic Investing. It is good!
Sunday, December 19, 2004
Monday, December 13, 2004
Google Gives Employees Another Option
Google Gives Employees Another Option:
"Google (GOOG) plans to give employees a novel method of cashing in their options starting next April. The search giant will let employees sell their vested stock options, which give the holder the right to reap the difference between the initial price and the current price, to selected financial institutions in an auction marketplace it's setting up with Morgan Stanley"
"Google (GOOG) plans to give employees a novel method of cashing in their options starting next April. The search giant will let employees sell their vested stock options, which give the holder the right to reap the difference between the initial price and the current price, to selected financial institutions in an auction marketplace it's setting up with Morgan Stanley"
Thursday, October 28, 2004
Still looking for Finance and Accounting news?
AccountingWEB - News and resources for accountants and accounting professionals.
A few weeks ago I apologized that because of a lack of time and the proliferation of anti-spam software, the FinanceProfessor.com newsletter was not really working as I had hoped. Thus, I offered my view that the blog was the future. Not surprisingly, I had a few complaints from those who liked the newsletter format better.
However, I also got a few subscribers saying that they would like more news (instead of reviewing academic articles. To this I would say that there are so many good sites out there, I am not sure what value I can add. Specifically, I suggest the NY Times Deal Book which is how I start most days. Sign up for it!! It is free and HIGHLY RECOMMENDED!
That said, I know many of you are also interested in accounting stories, so I would like to suggest the Financial Accounting Blog and the newsletter from AccountingWEB.com. Both are very informative and interesting! I read the blog through my MYYahoo page and have subscribed to the AccountingWEB weekly newsletter!
BTW, no I do not get anything for these plugs, I am just trying to help! And to lessen the complaint letters that I get! ;)
A few weeks ago I apologized that because of a lack of time and the proliferation of anti-spam software, the FinanceProfessor.com newsletter was not really working as I had hoped. Thus, I offered my view that the blog was the future. Not surprisingly, I had a few complaints from those who liked the newsletter format better.
However, I also got a few subscribers saying that they would like more news (instead of reviewing academic articles. To this I would say that there are so many good sites out there, I am not sure what value I can add. Specifically, I suggest the NY Times Deal Book which is how I start most days. Sign up for it!! It is free and HIGHLY RECOMMENDED!
That said, I know many of you are also interested in accounting stories, so I would like to suggest the Financial Accounting Blog and the newsletter from AccountingWEB.com. Both are very informative and interesting! I read the blog through my MYYahoo page and have subscribed to the AccountingWEB weekly newsletter!
BTW, no I do not get anything for these plugs, I am just trying to help! And to lessen the complaint letters that I get! ;)
Thursday, August 26, 2004
The Politics of Internal Capital Markets
As we have repeatedly seen, conglomerate firms trade at a discount to focused firms. This is not new. (See Comment and Jarrell 1995 for more). The short version of the discount is that for some reason, 1+1 =1.5
With such an important finding, there are of course many potential explanations as to why the discount exists. A far from complete list includes:
Poor managerial incentives
Poor Monitoring and a lack of transparency (hard to tell who is doing what, so why not shirk)
Inefficient internal capital markets (so money is wasted through misallocation)
A lack of loyalty on mangers' and employees' behalves---this would lead to reduced performance and higher expenses.
There really is little doubt that all of these play a role in the discount. Moreover, we should still consider the possibility that there may not be a real discount since the firms do freely chose to become conglomerates. This endogeneity may be the result of a discount that would have been larger had the firms not become conglomerates. (A view which I doubt, but do consider worthy of attention).
At the upcoming FMA convention in New Orleans, McNeil and Smythe will present their paper that supports the view that internal capital markets are not as efficient as many would like to believe.
The authors report what every upper and middle level manager in the world already knows: that politics matter.
More specifically McNeil and Smythe write that lobbying by divisional managers plays a role in the allocation of capital. This is a problem because if the internal market were perfect, the allocation decision would be based soley on the merits (the risk and returns) of each project.
In their words:
"To test the Lobbying Power Hypothesis, we examine the sensitivity of business
segment capital expenditures to segment manager characteristics expected to
contribute to a manager's lobbying power for a sample of firms that have
identifiable division/segment managers....There are several division manager
characteristics, such as tenure as suggested by Wulf (2002b), that could be
connected to lobbying power. We collect information on division manager tenure
with the firm, time in position, salary level relative to the CEO, membership on
the board of directors, age, and whether the manager is one of the firm’s top
five executives. Each characteristic could indicate and/or impact the degree of
a manager's lobbying power. In the analysis, we examine the association between
division capital expenditures and each of the aforementioned division manager
characteristics."
and the findings?
"We find evidence that segment level capital expenditures are associated with
division manager characteristics which, we argue, reflect division manager
lobbying power. For example, the results indicate that relatively high q
segments receive lower capital expend itures when headed by a manager with low
tenure or by a manager competing with multiple top executive/segment
managers."
VERY INTERESTING!!!!
http://207.36.165.114/NewOrleans/Papers/1101756.pdf
With such an important finding, there are of course many potential explanations as to why the discount exists. A far from complete list includes:
Poor managerial incentives
Poor Monitoring and a lack of transparency (hard to tell who is doing what, so why not shirk)
Inefficient internal capital markets (so money is wasted through misallocation)
A lack of loyalty on mangers' and employees' behalves---this would lead to reduced performance and higher expenses.
There really is little doubt that all of these play a role in the discount. Moreover, we should still consider the possibility that there may not be a real discount since the firms do freely chose to become conglomerates. This endogeneity may be the result of a discount that would have been larger had the firms not become conglomerates. (A view which I doubt, but do consider worthy of attention).
At the upcoming FMA convention in New Orleans, McNeil and Smythe will present their paper that supports the view that internal capital markets are not as efficient as many would like to believe.
The authors report what every upper and middle level manager in the world already knows: that politics matter.
More specifically McNeil and Smythe write that lobbying by divisional managers plays a role in the allocation of capital. This is a problem because if the internal market were perfect, the allocation decision would be based soley on the merits (the risk and returns) of each project.
In their words:
"To test the Lobbying Power Hypothesis, we examine the sensitivity of business
segment capital expenditures to segment manager characteristics expected to
contribute to a manager's lobbying power for a sample of firms that have
identifiable division/segment managers....There are several division manager
characteristics, such as tenure as suggested by Wulf (2002b), that could be
connected to lobbying power. We collect information on division manager tenure
with the firm, time in position, salary level relative to the CEO, membership on
the board of directors, age, and whether the manager is one of the firm’s top
five executives. Each characteristic could indicate and/or impact the degree of
a manager's lobbying power. In the analysis, we examine the association between
division capital expenditures and each of the aforementioned division manager
characteristics."
and the findings?
"We find evidence that segment level capital expenditures are associated with
division manager characteristics which, we argue, reflect division manager
lobbying power. For example, the results indicate that relatively high q
segments receive lower capital expend itures when headed by a manager with low
tenure or by a manager competing with multiple top executive/segment
managers."
VERY INTERESTING!!!!
http://207.36.165.114/NewOrleans/Papers/1101756.pdf
Friday, July 16, 2004
SSRN-Which Institutional Investors Monitor? Evidence from Acquisition Activity by Lily Qiu
SSRN-Which Institutional Investors Monitor? Evidence from Acquisition Activity by Lily Qiu: "Which Institutional Investors Monitor? Evidence from Acquisition Activity by LILY QIU "
There has been quite a bit of evidence of late that all shareholders do not do equal jobs of monitoring management. For example Barclay, Holderness, and Sheehan find that private placements (which have been long seen as a means of improving monitoring) may actually reduce monitoring and help to entrench managers because many of those purchasing the blocks are not actively monitoring management.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=471720
Yale’s Lily Qiu dives into this question further and finds evidence that suggests that large public pension funds (PPF) may do a better job monitoring than insurance or mutual funds. Qiu's case is built on the finding that firms with large public pension fund holdings “engage in less merger and acquisitions activity.” Moreover, when M&A deals are done, Qiu reports that “The presence of PPF ownership is…significantly and positively associated with long-term M&A abnormal returns…[and]with post-M&A improvement in asset turnover rates.”
Not convinced yet? Qiu is not done: “the negative association between PPF ownership and M&A likelihood is concentrated among cash-rich and low Q firms; among M&A firms, those with higher PPF ownership are less likely to engage in "buying growth" acquisitions.”
A quick explanation of the last sentence? Ok, low Q values (technically Tobin's Q which is market value divided by replacement value) and high cash firms are often cited as being where the Free cash flow problem (see Jensen 1986) is the worst.
Thus, at these firms mergers and acquisitions are often seen as negative projects that only serve to make managers better off. That it is at this
type of firm where the PPF influence seems the strongest, suggests that PPF are stronger monitors of management than other blockholders.
http://papers.ssrn.com/paper.taf?abstract_id=521803
Cite: Qiu, Lily, "Which Institutional Investors Monitor? Evidence from Acquisition Activity" (December 2003).
Yale ICF Working Paper No. 04-15. http://ssrn.com/abstract=521803
There has been quite a bit of evidence of late that all shareholders do not do equal jobs of monitoring management. For example Barclay, Holderness, and Sheehan find that private placements (which have been long seen as a means of improving monitoring) may actually reduce monitoring and help to entrench managers because many of those purchasing the blocks are not actively monitoring management.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=471720
Yale’s Lily Qiu dives into this question further and finds evidence that suggests that large public pension funds (PPF) may do a better job monitoring than insurance or mutual funds. Qiu's case is built on the finding that firms with large public pension fund holdings “engage in less merger and acquisitions activity.” Moreover, when M&A deals are done, Qiu reports that “The presence of PPF ownership is…significantly and positively associated with long-term M&A abnormal returns…[and]with post-M&A improvement in asset turnover rates.”
Not convinced yet? Qiu is not done: “the negative association between PPF ownership and M&A likelihood is concentrated among cash-rich and low Q firms; among M&A firms, those with higher PPF ownership are less likely to engage in "buying growth" acquisitions.”
A quick explanation of the last sentence? Ok, low Q values (technically Tobin's Q which is market value divided by replacement value) and high cash firms are often cited as being where the Free cash flow problem (see Jensen 1986) is the worst.
Thus, at these firms mergers and acquisitions are often seen as negative projects that only serve to make managers better off. That it is at this
type of firm where the PPF influence seems the strongest, suggests that PPF are stronger monitors of management than other blockholders.
http://papers.ssrn.com/paper.taf?abstract_id=521803
Cite: Qiu, Lily, "Which Institutional Investors Monitor? Evidence from Acquisition Activity" (December 2003).
Yale ICF Working Paper No. 04-15. http://ssrn.com/abstract=521803
Wednesday, June 16, 2004
BBC NEWS | Business | Mr Greenspan's balancing act
BBC NEWS | Business | Mr Greenspan's balancing actWhy does inflation seem higher than economists are reporting? A big reason is that economists are more concerned with what is called teh core inflation rate. This core ignores volatile food and energy prices. You and I however have to eat and drive, so those prices appear in our mental calculation of inflation.
Morocco signs Free Trade Agreement with U.S
In a move that will no doubt pay dividends to both countries, Morocco and the US agreed to "immediately eliminate tariffs on more than 95 percent of bilateral trade in consumer and industrial products. All remaining tariffs on these goods are to be eliminated within nine years - the best market access package of any U.S. free trade agreement with a developing country signed to date. The agreement also significantly reduces
Wednesday, April 21, 2004
Another look at retirement planning. Are equities the way to go?
As hoped and expected, the recent post on Ahmet Tezel's article in the Journal of Financial Planning on how much a retiree could safely take out of his/her retirement account has sparked further discussion.
SSRN-Irrational Optimism by Elroy Dimson, Paul Marsh, Mike Staunton: "Although the probable rewards from equity investment are attractive, stocks did not and cannot offer a guaranteed superior performance over the investment horizon of most investors. Furthermore, their prospective returns are lower than many investors project, whereas their risk is higher than many investors appreciate. Investors who assume that favorable equity returns can be relied on in the long term or that stocks are safe so long as they are held for 20 years are optimists. Their optimism is irrational. "
On one hand it is true that given the track record of equities, the more money invested in equities, the more that can generally be taken out. But equities are also risky so the more invested, the higher probability of the portfolio suffering economically significant declines. (that word generally will always get you in trouble ;) )
This is particularly important because we do not know the future and any model we use is "assumption dependent." These assumptions are not as easy to make as some may believe. For instance, consider without searching the web or a book, what is the historical return on equity investments? No doubt many of you (myself included) figured somewhere around 12% for large stocks (see virtually any investment text for these numbers) which corresponds to a risk premium of around 8%. (keeping math simple ;) )
However, Dimson, Marsh, and Staunton report that this is probably an overly optimistic number. Not because the expected equity risk premium is expected to fall in the future because the market is currently overvalued as those in the Campbell-Schiller camp believe (although it may be), but because we are not looking at the right historical returns! (BTW for more on the Campbell-Schiller view see the January FinanceProfessor newsletter Investments section)
So what is wrong? Virtually every finance text book dutifully reports US equity returns from 1926 to the present. However, this is a period where the US stock market was a very strong performer. Dimson, Marsh, and Staunton do two things to adjust for this: 1. they go back further--to 1926 and 2. they look at global returns and not just US returns. Their findings? Stocks have had lower returns and higher risks.
For instance, it has been widely reported that in the US the stock market has never lagged inflation over a 20 year period. Many have concluded therefore that stocks are safer than they really are. However, looking more globally this is not true. As the authors write: "We find only three non-US equity markets (with a fourth on the borderline) that never experienced a shortfall in real returns over a 20-year period. The worst 20-year real returns of 11 countries were negative. Historically, in 6 of the 16 countries, investors would need to have waited more than 50 years to be assured of a positive return."
Therefore, the authors conclude that investors who rely on the optimistic US-only data are irrational: "prospective returns are lower than many investors project, whereas their risk is higher than many investors appreciate. Investors who assume that favorable equity returns can be relied on in the long term or that stocks are safe so long as they are held for 20 years are optimists. Their optimism is irrational."
So what is one to do? My favorite idea comes from Zvi Bodie who applies modern hedging theories to retirement planning. As he wrote in in 2001 Retirement Planning: a New Approach paper the first part of the plan is to assure some minimum standard of living (this is the minimum amount that you will need) by investing in "inflation-protected bonds and annuities as the way to guarantee a minimum standard of living in retirement."
The second part is to determine when you will need the money. Obviously the longer you wait to start taking money out, the more you can take out and the more risks you would be willing to live with. Bit he is careful to warn that just because you have a longer holding period, it does not mean that equities are the right investment: their risk goes up as well. This is driven home in his interview with Financial Advisor Magazine: "If stocks are safer the longer you hold them, Bodie says, a put option should be cheaper with a longer time horizon. But the cost of put options generally rise proportionally to the number of years going out."
Finally, and maybe most importantly, Bodie suggests that rather than merely investing the remainder of your portfolio in equities, you "use call options to lever potential income gains." That is, you buy long term call options to allow you to participate in stock gains without putting as much of your money at risk. This solution is not costless as options are generally not available in maturities matching the investor needs so they will have to be periodically updated, but overall it is a great (and very low risk) strategy!
Still unclear? Bodie has written a great deal on this issue. Financial Advisor Magazine has a very good article on Bodie's strategy. I highly recommend it (both the article and the strategy!)
Bodie did an interesting interview with Business Week on his strategy and of course his book Worry Free Investing focuses on the issue. (FTR I have not read his book--Sorry!)
http://www.financialadvisormagazine.com/articles/jan_2004_stocks.html
SSRN Cite:
Dimson, Elroy, Marsh, Paul and Staunton, Mike, "Irrational Optimism" (December 2003). LBS Institute of Finance and Accounting Working Paper No. IFA397. http://ssrn.com/abstract=476981
SSRN-Irrational Optimism by Elroy Dimson, Paul Marsh, Mike Staunton: "Although the probable rewards from equity investment are attractive, stocks did not and cannot offer a guaranteed superior performance over the investment horizon of most investors. Furthermore, their prospective returns are lower than many investors project, whereas their risk is higher than many investors appreciate. Investors who assume that favorable equity returns can be relied on in the long term or that stocks are safe so long as they are held for 20 years are optimists. Their optimism is irrational. "
On one hand it is true that given the track record of equities, the more money invested in equities, the more that can generally be taken out. But equities are also risky so the more invested, the higher probability of the portfolio suffering economically significant declines. (that word generally will always get you in trouble ;) )
This is particularly important because we do not know the future and any model we use is "assumption dependent." These assumptions are not as easy to make as some may believe. For instance, consider without searching the web or a book, what is the historical return on equity investments? No doubt many of you (myself included) figured somewhere around 12% for large stocks (see virtually any investment text for these numbers) which corresponds to a risk premium of around 8%. (keeping math simple ;) )
However, Dimson, Marsh, and Staunton report that this is probably an overly optimistic number. Not because the expected equity risk premium is expected to fall in the future because the market is currently overvalued as those in the Campbell-Schiller camp believe (although it may be), but because we are not looking at the right historical returns! (BTW for more on the Campbell-Schiller view see the January FinanceProfessor newsletter Investments section)
So what is wrong? Virtually every finance text book dutifully reports US equity returns from 1926 to the present. However, this is a period where the US stock market was a very strong performer. Dimson, Marsh, and Staunton do two things to adjust for this: 1. they go back further--to 1926 and 2. they look at global returns and not just US returns. Their findings? Stocks have had lower returns and higher risks.
For instance, it has been widely reported that in the US the stock market has never lagged inflation over a 20 year period. Many have concluded therefore that stocks are safer than they really are. However, looking more globally this is not true. As the authors write: "We find only three non-US equity markets (with a fourth on the borderline) that never experienced a shortfall in real returns over a 20-year period. The worst 20-year real returns of 11 countries were negative. Historically, in 6 of the 16 countries, investors would need to have waited more than 50 years to be assured of a positive return."
Therefore, the authors conclude that investors who rely on the optimistic US-only data are irrational: "prospective returns are lower than many investors project, whereas their risk is higher than many investors appreciate. Investors who assume that favorable equity returns can be relied on in the long term or that stocks are safe so long as they are held for 20 years are optimists. Their optimism is irrational."
So what is one to do? My favorite idea comes from Zvi Bodie who applies modern hedging theories to retirement planning. As he wrote in in 2001 Retirement Planning: a New Approach paper the first part of the plan is to assure some minimum standard of living (this is the minimum amount that you will need) by investing in "inflation-protected bonds and annuities as the way to guarantee a minimum standard of living in retirement."
The second part is to determine when you will need the money. Obviously the longer you wait to start taking money out, the more you can take out and the more risks you would be willing to live with. Bit he is careful to warn that just because you have a longer holding period, it does not mean that equities are the right investment: their risk goes up as well. This is driven home in his interview with Financial Advisor Magazine: "If stocks are safer the longer you hold them, Bodie says, a put option should be cheaper with a longer time horizon. But the cost of put options generally rise proportionally to the number of years going out."
Finally, and maybe most importantly, Bodie suggests that rather than merely investing the remainder of your portfolio in equities, you "use call options to lever potential income gains." That is, you buy long term call options to allow you to participate in stock gains without putting as much of your money at risk. This solution is not costless as options are generally not available in maturities matching the investor needs so they will have to be periodically updated, but overall it is a great (and very low risk) strategy!
Still unclear? Bodie has written a great deal on this issue. Financial Advisor Magazine has a very good article on Bodie's strategy. I highly recommend it (both the article and the strategy!)
Bodie did an interesting interview with Business Week on his strategy and of course his book Worry Free Investing focuses on the issue. (FTR I have not read his book--Sorry!)
http://www.financialadvisormagazine.com/articles/jan_2004_stocks.html
SSRN Cite:
Dimson, Elroy, Marsh, Paul and Staunton, Mike, "Irrational Optimism" (December 2003). LBS Institute of Finance and Accounting Working Paper No. IFA397. http://ssrn.com/abstract=476981
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