Category: Finance

Do Staggered Boards Matter for Firm Value?

Do Staggered Boards Matter for Firm Value?

In the fifth article of our Fall issue, the authors address, and attempt to settle, the heated debate over the effect of staggered boards on corporate performance.  Critics of staggered boards claim they enable the entrenchment of inefficient managements and boards; and by working in tandem with poison pills to discourage hostile takeovers of underperforming companies, such boards end up generally reducing corporate values. 

Consistent with this theory, some institutional investors and shareholder rights advocates have urged companies to eliminate their staggered boards, while the most extreme critics have gone so far as to call for a regulatory ban.  By contrast, supporters of staggered boards argue that they help increase corporate values by allowing managements and boards to focus on long-term goals, and by providing board members a degree of independence from corporate executives who might want them replaced.  The most extreme proponents of staggered boards have proposed that such boards be not only permitted, but indeed mandated.

Both sides of the debate claim to be backed by empirical studies whose findings provide sharply conflicting pictures of the consequences of staggered boards. Whereas the earlier studies found that companies with staggered boards have significantly lower values, more recent studies have concluded that staggered boards lead to higher corporate values.

The authors show that neither side of the debate has convincing empirical support. The earlier studies failed to account or control for important variables and corporate characteristics that explain corporate decisions to stagger their boards, or for changes in the companies’ characteristics over time. For example, to the extent that a company’s poor performance drives its decision to adopt or retain a staggered board provision—presumably to give it more freedom to restructure and improve its operations—the association of staggered boards with poor performance ends up confusing cause and effect.

When the authors control for variables that affect both corporate values and the choice of staggered boards in a sample of close to 3,000 U.S. companies from 1990 to 2013, they find that the effect of a staggered board on firm value becomes generally insignificant.  As the authors put it, “The effect of a staggered board is idiosyncratic; for some firms it increases value, while for other firms it is value destroying.”  On the basis of such findings, the authors caution against legal solutions advocating either wholesale adoption or repeal of staggered boards, urging managements and boards to determine the value-maximizing approach that reflects their own companies’ opportunities and circumstances.

Authored by Yakov Amihud, Markus Schmid, and Steven Davidoff Solomon

Craig Pirrong’s 2017 Predictions – Right on the Money

The LNG Market’s Transformation Continues Apace–and Right On Schedule

When he wrote about the Liquefied Natural Gas (LNG) market “racing towards an inflection point” in our Winter 2017 issue (See “Liquefying a Market: The Transition of LNG to a Traded Commodity” in Volume 29, Issue 1), University of Houston Professor Craig Pirrong made some specific but out-of-the mainstream predictions.

Those predictions turned out rather well.

As he noted in a recent blog post, he had made the following points:

  • First, the traditional linkage in long term LNG contracts to the price of oil (Brent in particular) was an atavism–a “barbarous relic” (echoing Keynes’ characterization of the gold standard) as I phrased it more provocatively in some talks I gave on the subject. The connection between oil values and gas values had become attenuated, and often broken altogether, due in large part to the virtual disappearance of oil as a fuel for electricity generation, and the rise in natural gas in generation. Oil linked contracts were sending the wrong price signals. Bad price signals lead to inefficient allocations of resources.
  • Second, the increasing diversity in LNG production and consumption was mitigating the temporal specificities that impeded the development of spot markets. The sector was evolving to the stage in which participants could rely on markets to provide security of demand and supply. Buyers were not locked into a small number of sellers, and vice versa.
  • Third, a virtuous liquidity cycle would provide a further impetus to development of shorter term trading. Liquidity begets liquidity, and reinforces the willingness of market participants to rely on markets for security of demand and supply, which in turn frees up more volumes for shorter term trading, which enhances liquidity, and so forth.
  • Fourth, development of more liquid spot markets will make market participants willing to enter into contracts indexed to prices from those markets, in lieu of oil-linkages.
  • Fifth, the development of spot markets and gas-on-gas pricing will encourage the development of paper hedging markets, and vice versa.
  • Sixth, the emergence of the US as a supplier would also accelerate these trends. There was already a well-developed and transparent market for natural gas in the US, and a broad and deep hedging market. With US gas able to swing between Asia and Europe and South America depending on supply and demand conditions in these various regions, it was likely to be the marginal source of supply around the world and would hence set price around the world.
  • Moreover, the potential for geographic arbitrages creates short term trading opportunities.

    When pressed about timing, I was reluctant to make a firm forecast because it is always hard to predict when positive feedback mechanisms will take off. But my best guess was in the five year range.

    Those predictions, including the time horizon, are turning out pretty well. There have been a spate of articles recently about the evolution of LNG as a traded commodity, with trading firms like Vitol, Trafigura, and Gunvor, and majors with a trading emphasis like Shell and Total, taking the lead. Here’s a recent example from the FT, and here’s one from Bloomberg. Industry group GIIGNL reports that spot volumes rose from 27 percent of total volumes in 2017 to 32 percent in 2018.

    There are also developments on the contractual front. Last year Trafigura signed a 15 year offtake deal with US exporter Cheniere linked to Henry Hub. In December, Vitol signed a deal with newcomer Tellurian linked to Henry Hub, and last week Tellurian inked heads of agreement with Total for volumes linked to the Platts JKM (Japan-Korea-Marker).* Shell even entered into a deal linked with coal. There was one oil-linked deal signed recently (between NextDecade and Shell), but to give an idea of how things have changed, this met with puzzlement in the industry:

    The pricing mechanism that raised eyebrows this week in Shanghai was NextDecade’s Brent-linked deal with Shell. NextDecade CEO Matt Schatzman said he wanted to sell against Brent because his Rio Grande LNG venture will rely on gas that’s a byproduct of oil drilling in the Permian Basin, where output will likely increase along with oil prices.

    Total CEO Patrick Pouyanne said he didn’t understand that logic.

    “Continuing to price gas linked to oil is somewhat the old world,” Pouyanne said on Wednesday. “I was most surprised to see new contracts linked to Brent, especially from the U.S. Someone will have to explain this to me.”

    I agree! In fact, the NextDecade logic is daft. High oil prices that stimulate oil production will lead to lower gas prices due to the linkage that Schatzman outlines. If you have doubts about that, look at the price of natural gas in the Permian right now–it has been negative, often by $6.00/mmbtu or more. This joint-production aspect will tend to make oil and gas prices less correlated, or even negatively correlated.

    But it’s hard to believe how much the conventional wisdom has changed in 5 years. The whitepaper was released in time for the LNG Asia Summit in Singapore, and I gave a keynote speech at the event to coincide with its release. The speech was in front of the shark tank at the Singapore Aquarium, and from the reception I got I was worried that I might get the same treatment from the audience as Hans Blix did from Kim Jung Il in Team America.

    To say the least, the overwhelming sentiment was that oil links were here to stay, and that any major changes to the industry were decades, rather than a handful of years, away. Fortunately, the sharks went hungry and I’m around to say I told you so.

    I surmise that the main reason that the conventional wisdom was that the old contracting and pricing mechanisms would be sticky was an insufficient appreciation for the nature of liquidity, and how this could induce tipping to a new market organization and new contract and trading norms. These were ideas that I brought from my work in the industrial organization of financial trading markets (“market macrostructure” as I called it), and they were no doubt alien to most people in the LNG industry. Just as ideas about spot trading of oil were alien to most people in the oil industry when Marc Rich and others introduced it in the 1970s.

    Given the self-reinforcing nature of these developments, I believe that the trend will continue, and likely accelerate. Other factors will feed this process. I’ve written in the past about how some traditional contract terms, notably destination clauses, are falling by the wayside due to regulatory pressure in Japan and elsewhere. The number of sources and sinks is increasing, which makes the market thicker and mitigates further temporal specificities. The achievement of scale and greater trading opportunities will encourage investment in infrastructure, notably storage, that facilitates trading. Right now most LNG trading involves only one of the transformations I’ve written about (transformation in space): investment in storage infrastructure will facilitate another (transformation in time)

    It’s been kind of cool (no pun intended, given that LNG is supercooled) to watch this happen in real time. It is particularly interesting to me, as an industrial organization economist, given that many issues that I’ve studied over the years (transactions cost economics, the economics of commodity trading, the nature and dynamics of market liquidity) are all present. I’m sure that the next several years will provide more material for what has already proved to be a fascinating case study in the evolution of contracting and markets.

    *Full disclosure: My elder daughter works for Tellurian, and formerly worked for Cheniere. I have profited from many conversations with her over the last several years. One of my former PhD students is now at Cheniere.

    The Evolution of Corporate Cash

    The Evolution of Corporate Cash

    In another of our Fall 2018 articles, we examine a study published recently in the Review of Financial Studies, where the authors examine, and then attempt to explain, the considerable variation in the cash-to-assets ratios of U.S. public companies over a nearly 100-year period. For example, between 1920 and 1945, the average cash holdings of both small and large U.S. companies tripled.  By 1970, however, the cash levels of both had fallen back to their starting point in the early 1920s.  Then, at the start of the 1980s, the cash policies of small and large companies began to part ways.  Thanks to the very large cash holdings of the wave of companies that went public during the next two decades, the average corporate cash ratio increased sharply from 1980 to 2000—a period when the cash holdings of large, established U.S. companies remained largely unchanged.  But since 2000, it has been the large U.S. companies—many of them multinationals with profits “trapped” overseas—that have experienced the largest increase in cash holdings.

    The authors find especially compelling evidence that the significant increase in average cash holdings from 1980 to 2000 was driven primarily by a “Nasdaq effect” in which a large number of firms went public on the Nasdaq while holding amounts of cash that increased steadily throughout this 20-year period. This Nasdaq effect was most pronounced among unprofitable, largely debt-free, high-growth, and high-volatility firms, most of which operated in the healthcare or high-tech industries. And this trend may well continue in the future, given recent reports of a growing fraction of IPOs by companies that have yet to show profits.

    But along with and apart from this “Nasdaq” effect, the authors also find that for NYSE companies, the sensitivities of company-specific cash holdings to commonly studied variables have been remarkably stable during the past 90 years. The kinds of companies that have operated with high cash-to-assets ratios in recent years—riskier companies with growth opportunities and little if any profits or use of debt—have had large cash holdings in nearly every decade during the last century. And as in the past, relatively low-growth and low-risk public companies producing steady income have continued to operate with lower levels of cash.

    But even with this relative stability of firm-specific cash sensitivities, the authors do not find changes in corporate characteristics helpful in explaining the changes in aggregate cash holdings over time, particularly the large increases during the 1930s and early ’1940s, and the period since 2000. The largest roles in such increases appear to have been played by macroeconomic factors, such as the level of general economic growth and its effect on corporate profitability and investment.

    Nevertheless, in recent times, even after taking these macro and micro factors into account, the authors’ study provides clear evidence that the repatriation tax incentives (that were recently eliminated by the 2018 tax legislation) have played the largest role in the increase in aggregate corporate cash holdings that has taken place since 2000. With the recent elimination of such incentives, the cash holdings of large multinationals are likely to fall toward pre-2000 levels.

    Authored by John R. Graham and Mark T. Leary

    Corporate Short-Termism and How It Happens

    Corporate Short-Termism and How It Happens

    In this excerpt from his forthcoming book, A Cure for Corporate Short-Termism, Greg Milano begins by noting that many corporate management teams “unwittingly foster a culture of short‐termism” that ends up reducing the long‐run value of their companies. Such a culture starts with the process that surrounds quarterly earnings, in which managers seek to “guide” and then beat the analysts’ consensus for EPS. But even if the market seems to deal harshly with companies that “miss” consensus, the author’s own research shows that when viewed over periods of a year or more, it is the changes in earnings and cash flows that drive returns for shareholders, and not management’s consistency in meeting the analysts’ expectations.

    What’s more, this process of managing expectations—which the author calls “sandbagging”—goes on not only between companies and their investors, but also between corporate headquarters and the unit managers in annual budgeting that is often used to set incentive plan targets.

    According to the author, such sandbagging may be “the worst managerial behavior problem facing U.S. public companies.” Measuring managers’ performance against plan as the basis for their bonuses gives them strong incentives to understate the expected profitability and growth of their businesses. And the predictable result is mediocre plans that can be easily beaten—not a prescription for outstanding performance.

    Compounding the problem, many companies these days focus heavily on improving returns on capital or equity, and other efficiency measures, and much less on growth. But as the author emphasizes, encouraging the managers of already high-return businesses to increase or “maximize” their returns is a sure prescription for underinvestment. (After all, if you’re already earning 40% on capital, taking on projects that are expected to earn anything less will reduce your average return—and with it your bonus.)

    The proposed solution—which is presented in detail in later chapters of the book—is a corporate performance measurement and reward system based on a measure of economic profit called “residual cash earnings,” or RCE, which is based on cash earnings less a capital charge on gross investment. Such a measure has the virtue of spreading the NPV out more smoothly over the life of an investment, which allows value-creating investments to drive up the measure much more quickly than with traditional return and economic profit measures. And by tying their managers’ bonuses to, say, annual increases in RCE, such a system can help companies accomplish a number of goals: (1) get more reliable budgets (by eliminating any incentive for sandbagging) from their unit managers; (2) encourage smaller capital requests from low-return businesses, but larger requests from high-return businesses; (3) limit the corporate tendency to succumb to “herding” and “recency bias,” as reflected in massive overinvestment at the tops of business cycles and far too little investment at the bottoms; and (4) create and reinforce a longer-term focus and ownership culture of accountability in which managers throughout the organization participate in and assume responsibility for their decisions and performance.

    Authored by Greg Milano

    Who Are the Short-Termists?

    Who Are the Short-Termists?

    In the second article of our Fall 2018 issue we present an edited version of Wei Jiang’s keynote address at the Financial Management Association’s Annual Conference last October. Wei begins by noting that shareholder turnover in U.S. public companies has increased sharply during the past four decades, rising from a low in the mid-1970s of around 10%—which implies an average holding period of 10 years—to its current level of over 350%, or a holding period of some three or four months.  But this increase in average share turnover in recent decades has also been accompanied by a remarkable growth of long-term investors. 

    In a recent study, the author and two colleagues used quarterly holdings information from Form 13F to identify short-term investors—which they defined as having annualized turnover rates over 100%, implying a holding period of less than a year—and long-term investors—those with a turnover rate below 33%, with holding periods longer than three years.  Defined in this way, the presence of long-term institutional investors in the average public company’s shareholder base has more than doubled since the early 2000s.

    What’s more, in an attempt to determine whether the market encourages corporate short-termism by putting too high a discount rate on—and so undervaluing—earnings or cash flows that are expected to appear in the distant future, the author points to the findings of two studies by others. In the first of the two, an examination of the pricing of a relatively new derivative known as “dividend strips” shows that the implied discount rate for such “incremental” dividends has actually been higher than the rate applied to the long-term residual value, suggesting that the market undervalues near-term cash flows relative to more distant ones. The second of the two cited studies reports that companies with high levels of R&D spending—in other words investments with distant payoffs—are fairly priced in the sense that their future stock returns are comparable to those earned by other companies in the same risk class.

    In response to the claim that shareholder activists force companies to pursue near-term profits at the expense of the corporate future, the author cites her own study (with two colleagues) that examines the stock returns of targeted companies from three years before the announcement of an activist’s taking a position in the stock to three years after. What they find is that the targets significantly underperformed the market and their competitors in the period leading up to the activists’ involvement—and that, after a 5% jump in share prices in response to the announcement, the average performance of the targets was roughly equivalent to their competitors’ during the next three years. And, as if reflecting this 5% net gain, the operating performance of these companies, as measured by ROA, improved significantly during this three-year period.

    To be sure, there is some evidence that activists discourage corporate R&D. But, as the author (and her three co-authors) shows in a study published this past year in the Journal of Financial Economics, although corporate spending on R&D does fall (by an average of $15 million per company) in the year following the appearance of activists, R&D as a percentage of total assets remains unchanged, reflecting the tendency of companies to sell assets; and the smaller R&D function becomes more productive, accounting for 15% increases in both new patents and citations during the next three years.

    Authored by Wei Jiang

    Are U.S. Companies Too Short-Term Oriented? Some Thoughts

    Are U.S. Companies Too Short-Term Oriented? Some Thoughts

    In the first article of our Fall 2018 issue Steve Kaplan notes that today’s widespread criticism of U.S. companies as shortsighted and ever willing to sacrifice their future for near-term profit is by no means new. As the author of this article shows, such charges of short-termism have a long history that goes back at least 40 years. But as he goes on to point out, if these claims were warranted, then the effects we have been warned about all these years would surely have shown up by now.

    But it is difficult to find evidence of such effects. For example, a short-term orientation has not been reflected in any erosion of corporate profitability over time. As the author reports, the ratio of U.S. corporate profits as a percentage of U.S. GDP has not only been on a generally upward trend since the early 1980s, but has never been higher than in the past few years. And corporate spending on R&D has also gone up sharply during this period, from 1.1% of GDP in 1977 to 1.7% in 2016. What’s more, evidence of short-termism has not shown up in either higher amounts of investment, or higher rates of return, by venture capitalists and private equity firms, which are both in a good position to profit from widespread corporate failure to pursue valuable growth opportunities.

    Nor do stock market investors appear to encourage corporate short-termism, given their willingness to fund IPOs of companies with no previous earnings, and to assign high price-earnings multiples to companies, like Amazon and Tesla, whose reported earnings have been modest at best. What’s more, the fact that today’s P/E and CAPE ratios are at relatively high levels suggests that the market continues to expect significant rates of growth by U.S. companies.

    Some critics, to be sure, have argued that the high level of corporate buybacks and other distributions of cash, when combined with today’s near-record corporate cash holdings, provide clear evidence of a widespread failure of companies to invest in their future. But as the author notes, such distributions in fact represent a fairly small fraction—only around 20%—of after-tax corporate net income after infusions of new debt and equity capital are also taken into account.

    Authored by Steve Kaplan

    A review of Buffett’s commentary on accounting, governance, and investing practices: does he “walk the talk”?

    A review of Buffett’s commentary on accounting, governance, and investing practices: does he “walk the talk”?

    In our fifth article Special Issue on Growth and Innovation the co-authors seek to understand Warren Buffett’s investing philosophy, as he is regarded as one of the greatest investors. Unsurprisingly, Buffett has made his opinions on corporate governance, accounting, valuation methodology, and market trends known through the annual reports of Berkshire Hathaway and particularly its Chairman’s Letters.

    Buffett’s extraordinary success alone would make him inherently worthy of scholarly research. His long investment horizon, specific suggestions for improving corporate governance, evident reasoning for his opinions on accounting practice, and generally excellent reputation for integrity make him especially useful to study.

    These three professors studied both Buffett’s publicly expressed opinions and his investment decisions to see how well Buffett’s opinions matched the investments he has made. Additionally, they studied whether Buffett’s investments tended to be made in companies that already shared Buffett’s preferences or whether Buffett’s investment tended to cause companies to change the way they were managed subsequently so that their behavior became better aligned with Buffett’s public views. The findings of Bowen, Rajgopal, and Venkatachalam are a bit mixed.

    As predicted, the companies Berkshire invests in (investees) tend to follow more transparent and timely accounting and disclosure of both good and bad news, tend to have accruals and cash flows in accord, have been more likely to expense stock option costs before being required to do so, are less likely to meet or beat targets, and make conservative assumptions about their pension obligations. On the other hand, Berkshire has invested in companies that are more likely than their peers to flout Buffett’s public advice about using EBITDA and a performance metric, continuing to provide “earnings guidance,” and publishing poorly written and ambiguous annual reports as measured by the “FOG Index.”

    CEOs at Berkshire investees are paid less and their pay is more sensitive to company performance than their peer CEOs. That said, Berkshire investee pay plans do not penalize

    CEOs for poor performance more so than for their peers, do not filter out the effect of marketwide increases in stock prices on CEOs’ compensation, still rely on stock options rather than “straight” stock, are not sensitive to earnings adjusted for the cost of capital, and are as likely as peer companies to boost CEO pay if that CEO’s pay falls in the lower half of his industry peers in the previous year.

    The pattern with members of boards of directors is somewhat similar to the CEOs. While board members of Berkshire investees own more of the investee’s stock than do board members at peer firms, boards are no smaller than average, tend to have fewer outside directors, and greater ethnic and gender diversity than Buffett seems to recommend.
    The multivariate regression analysis shows that investees are consistent with Buffett’s stated investment philosophy on six out of seven characteristics that Buffett prefers. Berkshire investees had higher “owner earnings,” lower volatility of owner earnings, more persistent sales, less competition, lower financial leverage, lower pension and other post-retirement liabilities, and fewer stock splits compared with the average firm in the same industry and year. Berkshire investees also tended to pay dividends more often and were more likely to issue equity when their stock price was greater than its intrinsic value per share.

    Buffett clearly walks the talk on investment practices. However, the results on accounting, compensation, and disclosure practices are less clear cut. Overall, the authors found much evidence that Berkshire investees were already well aligned with Buffett’s investing principles (e.g., high return on equity) before being bought by Berkshire but not so well aligned already in terms of accounting and disclosure practices.

    They found less evidence that these practices changed after Berkshire became a shareholder however. Investee board size and leverage decreased while the frequency of dividend payouts increased, suggesting that Buffett was drawn to certain companies because of the attributes they already had.

    Buffett is well known for a hands-off policy in the operating decisions of Berkshire firms. So, despite Buffett’s commentary suggesting that large investors can improve the business practices of their investees, his passive approach appears to extend to accounting and governance choices as well.

    Although not mutually exclusive, the evidence therefore is more consistent with the “selection” hypothesis than the “influence” hypothesis. Even if Buffett does exert some influence over management after purchasing shares he seems to be relatively passive in doing so—more so than the tone and breadth of his public statements would suggest. We believe it is important to note that Buffett’s passive behavior towards investee management is inconsistent with the belief that large investors have the potential to improve corporate governance.

    Authored by Robert M. Bowen, University of Washington; Shivaram Rajgopal, Columbia Business School; and Mohan Venkatachalam, Duke University

    Financing Urban Revitalization: A Pro-Growth Template

    Financing Urban Revitalization:A Pro-Growth Template

    In our fourth article Special Issue on Growth and Innovation the co-authors recommend American cities adopt a particular property-tax rate cutting strategy. They contrast relatively prosperous San Francisco with impoverished Baltimore. Both cities actually raised property taxes frequently between 1950 and 1975 with roughly the same results—falling population and rising crime. During the same period, many other cities also raised tax rates to make up for lower economic output, thereby encouraging more people and businesses to leave.

    The change in San Francisco’s economic fortunes did not arise out of either a successful crime-fighting program (it had worse crime than Baltimore in 1975) or through the rising prosperity of Silicon Valley forty miles to its south (still too small and far away to make a difference). Rather, the inflection point for San Francisco was in 1978 when a statewide referendum (“Proposition 13”) limited property taxes to 1% of assessed value. San Francisco’s revenue declined by 18% the next year, 1979, but by 1982, its revenue was 66% higher than before Prop 13, despite the lower rates.

    Prop 13 improved cash flows to owners of real property in San Francisco and protected their property rights. Investors bought, built, and improved the city’s residential and commercial capital stock, attracting new residents and creating new job opportunities.

    Politicians are reluctant to try to adopt Prop 13-like measures on their own, however, because the short-term consequences for politicians are painful as several years are required for underlying economic activity to grow enough to offset rate cuts.

    The key is to build a financial bridge before crossing the river through four-steps:

    1. Announce a property tax rate cap that is immediately binding but which would take effect over several years in the future. Rational investors would immediately begin to invest and expand the city’s tax base.
    2. During the transition period, the city should limit its spending to a “maintenance of service” level, while allocating any added revenue to an escrow fund.
    3. The city should supplement this reserve with the proceeds of sales of assets on its balance sheet via sale-and-leaseback contracts (SLBs).
    4. If revenue falls in the short run, cash would be withdrawn from the escrow fund in order to continue to maintain levels of government services at accustomed levels.

    Authored by Steve H. Hanke, The Johns Hopkins University and Stephen J.K. Walters, Loyola University Maryland

    Funding Strategies in a Rising Interest Rate and a Flattening Yield Curve Environment

    Funding Strategies in a Rising Interest Rate and a Flattening Yield Curve Environment

    In our third article Special Issue on Growth and Innovation Niso Abuaf suggests that an optimal corporate funding strategy may be a “barbell” that combines short-term borrowings (to exploit still low short-term rates) with some long-term borrowing to lock in historically low interest rates against the possibility of rising inflation and interest rates. Abuaf shows that a “barbell” funding strategy is on the “efficient frontier” of corporate liability structure, i.e., the curve tracing the lowest cost and lowest standard deviation points. Such strategies consist of a barbell with occasional medium-term borrowings, but with some “rollover” or funding risk attached.

    Once the efficient frontier has been delineated, the chief financial officer can use breakeven analysis to choose the optimal maturity mix. The choice between fixed and floating interest rates will depend upon management’s tolerance for earnings fluctuations resulting from moves in short-term rates.

    While most of the existing literature predicts that a lot of short-term debt leads to early default, Abuaf sees that an upward sloping yield curve can easily make short-term debt cheaper than longterm although it comes at the cost of higher volatility. It follows that in a flatter yield curve environment, longer maturities may be more attractive. If a company’s revenues are highly correlated with short-term rates, it should keep maturities relatively short, however.

    If, as Abuaf thinks most likely, that interest rates increase 100 basis points across the curve, CFOs should lengthen maturities now.

    Authored by Niso Abuaf, Pace University and Samuel A. Ramirez and Co.

    Management’s Key Responsibility

    Management’s Key Responsibility

    In our second article Special Issue on Growth and Innovation Bartley Madden, a leading management consultant and author, follows up after Edmund Phelps’ leading article on innovation and mass flourishing with specific recommendations for business managers.

    Madden identifies a firm’s knowledge-building proficiency as its most important capability in order to survive and prosper over the long term. Even a firm’s competitive advantage and intangible assets are best understood as the result of its ability to build knowledge.

    Along with a firm’s organizational structure, knowledge-building proficiency coordinates and improves work, innovation, and resource allocation.

    Madden is very critical of much of the current academic finance research that, while ostensibly focused what creates “excess shareholder returns” (i.e., economic profit or economic value-added), is actually irrelevant to a fundamental understanding of what creates long-term value.

    Academic studies are usually just statistical factor analyses. Even when economists study individual firms, they usually do so by modeling them simply as production functions: management is assumed to coordinate factors of production to make and sell products until marginal costs equal marginal revenue and profits are maximized. Such a firm is assumed to have clear boundaries and its management tightly controls the work of employees and the accumulation and allocation of its physical assets.

    Instead, Madden proposes a new and more sophisticated concept of the firm to position human capital, in general, and knowledge-building proficiency, in particular, at the center of value creation. In this connection he offers two business exemplars: the American retailer Walmart and the Chinese Haier Group that makes consumer electronics and home appliances.

    Authored by Bartley J. Madden