Thursday, May 31, 2012

Testosterone and Behavioral Finance

Work by Dr. John Coates on the neuroscience behind successes on Wall Street is a potential explanation for at least part of behavioral finance. In one of his studies, Dr. Coates found that when a trader had a higher level of testosterone in his system in the morning, he went on to make more money than when his testosterone level was lower. Winning increases testosterone levels further, which lead to more aggressive investments. Similarly, losing increases the cortisol level in the body, which leads to further risk aversion.

King Cash

A basic tenet of Finance is that cash is king, especially in difficult economic environments. A recent survey sponsored by CFO shows how working capital management has changed in mid-sized companies since the recent recession began. A couple of interesting findings: Companies surveyed feel that their working capital positions have improved over the past three years (page 7), receivables and inventory management are key working capital priorities going forward (page 8), and larger firms are forcing smaller companies to accept longer receivables periods (pages 10 and 11).

Wednesday, May 30, 2012

IPO Flops

Just because a company undergoes an IPO doesn't mean that is is a good investment. Here are 10 recent IPOs that flopped after going public, including a couple of bankruptcies only a few of years after the IPO.

Wednesday, May 23, 2012

Lease Accounting

Accounting for leasing can be complicated, with both capital leases and operating leases. FASB and the IASB have been working together for the past six years in order to standardize lease accounting and bring more than $2 trillion of leases to companies' balance sheets. A major sticking point between the accounting boards and companies is how leases will be treated on the income statement.

Monday, May 21, 2012

JPMorgan Nixes Stock Repurchases

In the text, we argue that stock repurchases are a close substitute for cash dividends. However, an important caveat is that this is true when a stock repurchase is made, not when it is announced. JPMorgan announced today that it is suspending its stock repurchase plan, which was expected to be $13 billion through 2013. While stock repurchases have increased, so has the cancellation of previously announced stock repurchase plans.

U.S. Corporate Tax Rates Increase

A report by accounting firm PricewaterhouseCoopers found that the average effective three-year corporate tax rate for U.S. based corporations rose to 26.3 percent, up 0.7 percent from the previous year. The effective tax rate is the tax rate after expenses and tax offsets.

Sunday, May 20, 2012

The IPO Guy and Facebook

On May 17, 2012, Facebook sold its shares in the IPO market for $38 each and the shares began trading on the NASDAQ the next day at a price of $42.05, a relatively modest price increase of about 11 percent. Unfortunately for shareholders, the stock price dropped to $38.23 by the end of the day. All in all, the Facebook IPO was relatively mild by IPO standards. Because of the pricing of the stock prior to the IPO, we would have expected a bigger first-day "pop" in the stock price. For an explanation of the partial adjustment effect and more on Facebook, you can watch this interview with world-renowned IPO expert Professor Jay R. Ritter.

Thursday, May 17, 2012

Completing a New Project

So your company has accepted a new project and you are put in charge of seeing the project through to completion. What are the some of the challenges and pitfalls in your way? A recent article in CFO discusses some of these practical matters.

Wednesday, May 16, 2012

Evaulating the PE Ratio

As we noted, the evaluation of any ratio must be undertaken with great care. For example, did you know that if we look at two companies that are exactly the same except for the amount of debt, the company with higher debt will have a lower PE ratio? A recent article in McKinsey Quarterly outlines the reason this occurs, but more importantly points out that that a management goal of increasing the PE ratio does not generally result in shareholder wealth creation.

Betting Against Yourself

Betting against yourself doesn't seem to make much sense, but maybe sometimes it can. Part of the $2 billion loss recently disclosed by JPMorgan Chase can be attributed to one trader who was selling insurance on corporate debt, also known as a credit default swap (CDS). But what is surprising is that a purchaser of these CDSs was one of the company's mutual funds! While this seems counterintuitive for two divisions of the same company to be making opposite trades, in this case it is perfectly acceptable. The trader for JPMorgan was attempting to make a profitable trade for the company, while the mutual fund was acting on behalf of clients. The fact that this trade made money for the clients at a cost to the company shows that the two divisions were acting separately, which should be the case for these two divisions.

Tuesday, May 8, 2012

Real Options Are Everywhere

If you haven't realized from our textbook discussion, real options are everywhere. In fact, a classic episode of Seinfeld discusses a real option, although the episode never mentions this as a real option. An interesting question about real options is exactly how to value them. In a recent paper, the great Avinash Dixit, a Princeton economist, takes a mathematical approach to this spongy topic. While we respect Dr. Dixit, we should also point out the importance of assumptions in any mathematical model. In his model, Dr. Dixit assumes Elaine has an infinite life. We would argue that the life of the model should be limited to the shelf-life of the sponge, not Elaine's life, since they are worthless after the expiration date and do have a finite life.

Monday, May 7, 2012

Did Their Mother Make Them?

As a child, most people dreaded being told they needed a haircut. Of course, for these companies, a haircut is more painful. In IPO parlance, a hair cut occurs when the offering price, or offering price range, is lowered.