Oliver Hart and Bengt Holmstrom Share the 2016 Nobel Price in Economics

The Nobel committee announced today that for their work in contract theory Oliver Hart and Bengt Holmström won the 2016 Sveriges Riksbank Prize in Economic Science in Honor of Alfred Nobel. Charles Duxbury and Mike Bird report on it in the Wall Street Journal today. Moreover the Journal reported in a video:

Evan Peterson, "Why Bengt Holmström, is An Economist You Should Know," Open Markets, October 21, 201.

Chian's deceleration: What Should the CFO Worry about?

The Chinese economy grew averaged double digit growth for two decades. Recently that has slowed to 7-8 percent.The Conference Board has identified a set of structural factors that indicate a long “soft fall” to 3 to 4 percent growth. Ethan Cramer-Flood explains what this implies for pricing, credit, and compliance.

Will New Lease Accounting Bring On the Apocalyse?

In Monday's Wall Street Journal, congressmen Brad Sherman and Peter King claim that the proposed changes in Lease accounting will cost 3.3 million jobs. This seems a bit extreme. Furthermore Emily Chasan writes that changes are coming soon.  In a separate article she writes the change could add $2 trillion (yes that is with a "T") to corporate balance sheets and that "adding assets and liabilities for store leases, airplanes and the like could force companies to renegotiate the terms of their loans with lenders. Banks and lenders often require companies to maintain covenants, such as a specific debt-to-equity ratio, fixed-asset ratio or earnings metric, which could all be thrown out of whack by such a significant accounting change"

Buying Back Corporate America

Are U.S. corporations pulling up the drawbridge? Finding an alternative to dividends? or Overlevering themselves? 

The Economist argues that share buybacks may be encouraging shorttermism and that by "reducing the number of shares outstanding, buy-back schemes can also artificially boost a firm’s earnings per share."  Based on its survey, buyback activity "in the S&P 500 index" reached $500 billion in 2013, "close to the high reached in the bubble year of 2007:" that is a third of U.S. corporate cashflow. Furthermore, the Economist notes that "buy-backs have usurped dividends as the main way listed American firms give money back to their owners, accounting for 60% of cash returns last year." 

James McIntosh stresses the levering that buybacks are driving and warns investors, in this September 9th video,  that equity markets may seem calm but the cashflow, and debt raising seem ominously like 2007: the calm before the storm. Mackintosh, the FT's investment editor, charts the close relationship among buybacks, debt raising, and cashflow. Corporate share repurchases have been converting cashflow surpluses into deficits which firms are financing with ever more debt.  The result is more levered balance sheets.

Was Janet Yellen's goal in driving down interest rate to relever corporate balance sheets?




 

Dividends: To Pay or Not To Pay, That Is the Question.

Dividends do not matter

Oct 9, 2013 : Low bond yields have led investors to place more importance on stock dividends. John Authers argues that these are special circumstances, and that there is still some truth in the Miller & Modigliani theorem – which implies dividends do not matter.  He is referring to the M&M Dividend Irrelevance, as opposed to the M&M capital structure irrelevance:

Is Koch overpaying for Molex?

Yesterday's (9/9) Wall Street Journal proclaimed that Koch Industries (a "conglomerate known for unglamorous industries") is buying Molex.  Koch, privately held, is one of Wichita's largest employers and one of the two largest privately held U.S. companies.  Cargill is the other.

The current Merger and Acquisition market is pricey, if not frothy.  According to the Journal, Koch is paying 38.50 a share or $7.2 billion.  Given the scanty numbers in the article, that seems rich: about twice sales, thirty times earnings, and 1.78 times enterprise value.

Nevertheless, Koch only buys companies when it thinks its Market Based Management philosophy can produce positive results.  It has found that it has a core competence in managing process business.  Still this is an industry with powerful customers including Apple (14% of Molex's revenues) and the automotive industry.  They do not roll over for suppliers.

James Haggerty and Bob Tita report in the Wall Street Journal, "Molex, based in Lisle, Ill., makes products including connectors, sockets, antennas and switches used in cars, computers, cellphones and factory equipment, among other things."

MOLEX is traded on the NASDAQ. You can find their SEC filings online.

U.S. High Yield Default Spread Premia

March 10 2010  John Authers says that it is good news that the credit market is much less newsworthy than it used to be.  What are junk spreads compared to likely losses form default?  Deutche Banks provides some estimates and the trends.  (2m 57sec)

On FT/com: Good CFO

Numbers guys you can count on

By Luke Johnson

I have hired quite a few finance directors over the years. Some were outstanding; others did not work out so well. Inevitably, I have acquired some views about what makes a great numbers guy.

I prefer working with someone fundamentally conservative. Bullish chief finance officers are dangerous. The leader of a business needs to be an optimist, and sales-oriented. But every business needs at least one person at the top alongside them to worry about the downside. I insist that the senior finance person is a qualified accountant. Whether they are a certified public accountant or a chartered accountant, they will have been taught how vital prudence is when preparing accounts, budgets and so forth. I am always astonished at how huge US corporations, like Enron and leading investment banks, can hire go-go MBAs as their CFOs. No wonder they got into trouble.

The CFO must be able to assemble and analyse financial statements themselves: I do not want a quick-talking professional who has risen so far that they do not understand the business’s accounting systems. But they must also be able to see the whole picture and not get so immersed in detail that they overlook major issues – a surprisingly common failing.

The CFO must also be able to explain treatments, policies and consequences so that every executive can understand them. The best accountants do not hide behind jargon or technical mumbo-jumbo. Great accountants are so familiar with the company’s books that they can swiftly identify each entry, liabilities and assets, every item of income and expense, flows of cash, margins and all the rest, where material.

Some CFOs get bored with things like management accounts, and really want to be corporate financiers. They would rather be doing deals, having power lunches and indulging in the whole merry-go-round, rather than crunching the numbers. Those tasks have their place, but they are not the first order of business. Principally, the CFO must be in absolute command of the figures and financial basics, such as tax, debt and key ratios. Only once they have total mastery of vital administration should they be thinking about the sexy stuff like M&As.

As well as highly numerate, a modern CFO must be something of an IT expert. There are still a surprising number of finance professionals who struggle to use even unsophisticated accounting software. It must be a devastating disadvantage for anyone performing a high level finance job in the 21st century. Similarly, a rounded CFO will have a thorough knowledge of property – leases, financing and the rest – and insurance, as well as a good grounding in corporate law and company secretarial affairs.

The best CFOs have a close, mutually respectful, but not subservient relationship with the chief executive. Those who never disagree and do not stand up to their boss on key matters are not worth having. Ultimately, shareholders and the board place huge faith in the CFO. Whoever fills the post must be independently minded and a strong enough character to deliver the truth to the owners and non-executives – no matter how unpalatable. While every CFO should be a partner to the CEO, they should always believe they report to the board and owners of a corporation.

As with every senior role, an ability to manage people and a sense of humour are critical. But with a CFO, absolute integrity and a capacity for hard work are even more important. During difficult times the role cannot be executed in 40 hours a week and a holiday entitlement of six weeks. Periods of crisis call for all hands to the pump. CFOs are the ones who are managing costs, coping with foreign exchange risks, dealing with pressing bankers and covenants, collecting overdue money and ensuring the auditors do not qualify the accounts. A proper company cannot function without a decent finance director at the helm, supervising, informing and warning.

They may not win all the applause as corporate heroes, but without their contribution even the sexiest business would soon be in trouble.

Copyright The Financial Times Limited 2009

How Business Schools Have Failed Business

Why not more education on the responsibility of boards?

Wall Street Journal: April 24, 2009


By Michael Jacobs
As we try to understand why our economy is so troubled, fingers are increasingly being pointed at the academic institutions that educated those who got us into this mess. What have business schools failed to teach our business leaders and policy makers? There are three profound failures of sound business practices at the root of the economic crisis, and none of them have been adequately addressed by our business schools.

Just about everyone agrees that misaligned incentive programs are at the core of what brought our financial system to its knees. Countless individuals became multimillionaires by gambling away shareholders' money. Incentive systems that rewarded short-term gain took precedence over those designed for long-term value creation.

We could chalk this all up to greed, as many pundits have. But first we should ask how many of the business schools attended by America's CEOs and directors educate their students about the best way to design management compensation systems. Amazingly, this subject is not systematically addressed at most business schools, and not even discussed at others.

Secondly, as Washington scrambles to restructure the financial regulatory system, those who still believe in the private sector are asking why corporate boards were AWOL as institution after institution crumbled. Why did it take rumors of nationalization and a drop in Citicorp stock to below $2 a share to inspire Citigroup to nominate directors with experience in financial markets?

American icon General Electric was stripped of its coveted AAA-rating because of problems emanating from its financial services unit. Yet its board has only one director with experience in a financial institution. If it is the board's job to oversee a corporation, it seems logical that there would be a segment in the core curriculum of every business school devoted to board structure, composition and processes. But most programs don't cover the topic.

The third breakdown came in the investment community. Nearly 20 years ago I wrote a book titled "Short-Term America" that warned about the growing chasm between those who provide capital and the companies who use it. The concept is simple: When money provided to homeowners or businesses comes from an anonymous source, possibly half way around the world, there are serious challenges to operating a functioning system of accountability.

Nationally, finance departments at business schools offer hundreds of courses in asset securitization and portfolio diversification. They have taught a generation of financial leaders that risk can be diversified away. But in their B-school days, few investment bankers examined the notion of "agency costs." That concept explains that as the gulf between the provider and the user of capital widens, the risks involved with selecting and monitoring the participants in the portfolio increase. It should come as no surprise that financial institutions amassed securities that consist of a diversified portfolio of deadbeats.

About 70% of the shares of American corporations are held by institutional investors such as pension and mutual funds. These organizations are brimming with MBAs. But how many of these MBAs took a class devoted to how shareholders should exercise their rights and obligations as the owners of America's corporations? Few, if any. When shareholders are uneducated about their obligations, how can a corporate accountability system function properly?

Recently, when I delivered a guest lecture at another school, a distraught-looking student pulled me aside after class. She explained that my talk was very disturbing to her. After investing two years and $100,000, she was only weeks away from receiving her MBA. But prior to our class, she had never heard a discussion about board responsibilities or the rights of shareholders. She said she felt cheated.

By failing to teach the principles of corporate governance, our business schools have failed our students. And by not internalizing sound principles of governance and accountability, B-school graduates have matured into executives and investment bankers who have failed American workers and retirees who have witnessed their jobs and savings vanish.

Most B-schools paper over the topic by requiring first-year students to take a compulsory ethics class, which is necessary, but not sufficient. Would Bernie Madoff have acted differently if he had aced his ethics final?

Could we have avoided most of the economic problems we now face if we had a generation of business leaders who were trained in designing compensation systems that promote long-term value? And who were educated in the proper make-up and responsibilities of boards? And who were enlightened as to how shareholders can use their proxies to affect accountability? I think we could have.

America's business schools need to rethink what we are teaching -- and not teaching -- the next generation of leaders.

Mr. Jacobs, a professor at the University of North Carolina's Kenan-Flagler Business School, was director of corporate finance policy at the U.S. Treasury from 1989 to 1991.