Category: Finance

An Eclipse of the Public Markets?

Eclipse of the Public Corporation or Eclipse of the Public Markets?

In our Winter 30.1 issue of the Journal of Applied Finance our first article looks back at Michael Jensen’s 1989 article “The Eclipse of the Public Corporation.” The authors find some of his predictions have been borne out but other important ones, not. Jensen concluded that the publicly held corporation was in decline and had outlived its usefulness in many sectors. He argued that agency costs made public corporations an inefficient form of organization and that new private organizational forms promoted by private equity firms would likely replace the public firm.

The number of public firms in the U.S. has declined significantly but there are still many hugely profitable and successful public companies. U.S. public markets are still well-suited for firms with mostly tangible assets. So, what we are really witnessing is an eclipse not of public corporations, but of the public markets as the place where young firms with mostly intangible capital seek their funding.

This is especially true when the usefulness of the intangible assets has yet to be proven. Sometimes the market is extremely optimistic about some intangible assets, but otherwise firms with unproven intangible assets may be better off funding themselves privately. This evolution has a downside: investors limited to public markets are cut off from investing in high intangible-asset firms. Additionally, as fewer firms remain publicly listed, fewer firms will be transparent to society.

By authors Craig Doidge, University of Toronto, Kathleen M. Kahle, University of Arizona, G. Andrew Karolyi, Cornell University, and René M. Stulz of Ohio State University.

See Wiley’s Online Library to access the full text of this article.

The Trendsetter: Where a California Pension Plan Sees Opportunity Now

The Trendsetter: Where a California Pension Plan Sees Opportunity Now

Chris Ailman was a SASB panelist in our Spring 2017 issue of The Journal of Applied Corporate Finance. He gives his investment outlook and elaborates on what ESG means to him in an article in Barron’s entitled The Trendsetter: Christopher Ailman of CalSTRS.

See Wiley’s Online Library to access the full text of our SASB roundtable.

How can companies address environmental and social problems while earning rates of return high enough to attract the capital to sustain themselves?

Sustainability and Shareholder Value

The JACF, with the support of the High Meadows Foundation, has just published the fourth (read the complete issue here) in what has become an annual series of issues devoted to the corporate “sustainability” question: how can companies address environmental and social problems while still earning high enough rates of return to attract the capital necessary to sustain themselves?

Our first sustainability issue featured corporate initiatives and investments designed to protect the environment while preserving—or, in some cases, even increasing—value for shareholders. The main focus of the second in our series was large influential investors and the growing role of “ESG” (environmental, social, and governance) criteria in their decision-making. That issue emphasized that public companies could find long-term “partners” among a small but distinguished group of “value-based” investors who have made ESG analysis a critical part of their stock valuation process.

Our third sustainability issue explained how companies could find such investors and persuade them to buy their shares. Most of the suggestions involved “integrated reporting,” a relatively new form of investor communication but one recently adopted by as widely admired a company as GE. Integrated reporting differs from the “sustainability reports” that provide exhaustive accounts of all corporate environmental and social activities. Integrated reporting instead aims to provide, within and as part of a company’s traditional financial statements, detailed accounts of only their “material” environmental and social risks—the ones that are capable of having significant effects on profitability and value.

And that brings us to the focus of this, our fourth, sustainability issue: the critical importance of identifying material corporate ESG exposures and of communicating to the capital markets both the plans to manage such exposures and their expected effects on corporate strategy and value. In our lead article, Harvard Business School’s George Serafeim and Chris Pinney, President of the High Meadows Institute, dispel a number of “myths” about ESG investing. The most prevalent, and misleading, of these myths is that ESG investors must settle for below-market returns. In reality, investors who have incorporated “material” ESG risks and opportunities into their decision-making have earned returns that are if anything higher than those earned by conventional portfolios, while exhibiting lower risk. Also in this issue, Jean Rogers, CEO of the Sustainability Accounting Standards Board, (SASB) and co-author (and former FASB head) Bob Herz discuss the practical import of SASB’s success in identifying and providing standards for corporate reporting on material ESG exposures in 79 different industries. But that success does not keep Bob Eccles and Tim Youmans of Harvard Business School from arguing that determinations of materiality are important “exercises of judgment” that should not be left to the SASB or to corporate managements. They should instead be viewed as the responsibility of corporate boards, which are urged to issue a one-page Statement of Significant Audiences and Materiality each year that explains their determinations of which exposures are material, and what the companies plan to do about them.

When we come to do our fifth sustainability issue a year from now, it will be interesting to see how many corporate boards have chosen to take this step. But even if the answer is none, the corporate share of mind for the concept of “materiality” should have increased significantly.

– Don Chew

The Rise of the Reluctant Activist

Tactics of Activist Investors

This morning’s Wall Street Journal features an article (“Don’t Make Me Do This: Rise of the Reluctant Activist”, February 19, 2016) on how many investors are adopting, even if reluctantly, the tactic of activist investors. Referring to a technology-oriented hedge fund manager:

Investor Jeffrey Osher sat on his holdings in prepaid-debit-card issuer Green Dot Corp. for three years before he lost his patience.

In December, after a string of disappointing earnings reports that left the company’s shares down sharply, the hedge-fund manager met with the board and asked directors to fire founder and Chief Executive Steven Streit, according to people familiar with the meeting. When the board refused, Mr. Osher’s Harvest Capital Strategies LLC did something it had never done before: It publicly threatened to run a campaign to oust the company’s directors.

Those moves put Mr. Osher into a newly emerging class of shareholders: Typically passive investors who are adopting, sometimes reluctantly, the tactics of activists (emphasis added).

This phenomenon was discussed at length in the Roundtable on Activist Investing published in the JACF’s Summer 2015 issue. Participants including professors from Harvard Law and Business Schools, senior decision-makers from leading hedge funds, and corporate managers with experience dealing with activist investors.

To read more and to download the issue Click here.

When to Hedge?

Hindsight is 20/20

Institutional hedging programs seem to be discussed more intensely and at higher levels of negatively affected organizations only after some major price change has taken place.

Paradoxically, price levels that seem very rewarding in hindsight rarely seemed worth protecting before the adverse price move.

For example, a January 22 article in the Financial Times “Russia considers hedging part of oil its revenues” reports that

Russia is looking at hedging a portion of its oil revenues in the future, highlighting how the collapse in prices has upended Moscow’s economic plans.

The Russian finance ministry will this year prepare the technical infrastructure necessary to implement an oil hedging programme like that of Mexico, Maxim Oreshkin, deputy finance minister, said on Friday.

The Russians are now reacting to a sharp drop in the price of its major export, crude oil. The benchmark Brent crude oil fell from over $110/barrel in mid-2014 to less than $30 recently.

As the FT story indicates, some other producers such as Mexico have long established hedging programs involving put options.

Russia has limited choices

The University of Houston’s Craig Pirrong (a regular contributor to the JACF) comments on the FT story at his blog and outlines the limited choices available to the Russians at this very late date. Craig thinks that put options, rather than swaps, are the way for Russia to go but, even this choice is complicated by the cash Russia would need now to have to pay for the puts.

Read the whole thing.

Bund for Glory, or It’s a Long Way to Tip a Market

In the Fall 2015 issue of the JACF we published a revised version of an article by Craig Pirrong called “Bund for Glory, or It’s a Long Way to Tip a Market.”

The technical details not included in this version of his article, can be found in his previous version, via the attached pdf, pages 10-28.

Bund for Glory, or It’s a Long Way to Tip a Market

To see an index of articles from the past 5 years, click here for a complete pdf.

The JACF is published by Wiley.

Where Have All the Public Companies Gone?

The U.S. Listing Gap

The number of public companies in the US has declined significantly since the late 1990s. This is the subject of a working paper, The US Listing Gap by Craig Doidge (Toronto), George Karolyi (Cornell) and René Stulz (Ohio State). While recognizing that Sarbanes-Oxley has increased the costs of being a public company in the US, they still find the extent of the decline in the US numbers to be “puzzling.”

Marc Hodak, a reader and contributor to the JACF, agrees that the numbers of public companies have declined sharply but thinks the cause is fairly evident. On his blog, he says,

Well, it’s not puzzling if you use a more realistic model of what would be driving those results. The model I have used for over a decade is quite simple:

A company will choose to be public when the benefits of being a public company exceed its costs, otherwise it will not join, or will exit, the public sphere.

The way it exits is of secondary importance.

His entire post is worth reading.

Marc addressed some of the costs of being a public company on the US in The Growing Executive Compensation Advantage Of Private Versus Public Companies in the Winter 2014 issue of the JACF, (Volume 26 Number 1).

Icahn’s Major Gains Come from Positions Held 7-10 Year or Longer

Icahn Says all of His Major Gains Have Come from Long-term Positions

In addition to Stanley Druckenmiller, Andrew Ross Sorkin interviewed legendary activist investor Carl Icahn at the Dealbook conference this week.

Sorkin asked Icahn whether activist investors contributed to managerial short-termism. The conventional wisdom is that investors like Icahn take major positions in certain companies, enjoy a jump in the share price from the surrounding publicity, and then sell off those shares after management has been forced to take actions not in the long-term interest of the firm.

Icahn replied that description simply wasn’t accurate. Far from reaping profits from short-term positions, Icahn said all of his major gains have come from positions held for 7-10 years or even longer. Mentioning specific companies he has held, Icahn described how he has interacted with managers at various companies in which he has been a shareholder. Shareholdings he continues to maintain include the following (with years held):

    ACF (31 years)
    American Railcar Industries (23 years)
    Federal Mogul (14 years)
    PFC Metals (17 years)
    Viskase (14 years)
    XO Communications (14 years)
    Vector Group (13 years)
    American Casino (11 years)
    National Energy (11 years)
    WestPoint Home (11 years)

The link to the interview is here.

For an explanation of how and why Carl Icahn became an activist investor, read The Icahn Manifesto by Tobias Carlisle in the Fall 2014 issue of the JACF (Volume 26 Number 4). For a broad discussion of corporate capital allocation issues, see Capital Deployment Roundtable: A Discussion of Corporate Investment and Payout Policy with Paul Clancy, Michael Mauboussin, John Briscoe, Scott Ostfeld, Paul Hilal, Greg Milano, John McCormack and Don Chew in the same issue.

Druckenmiller Says Earnings per Share Don’t Count

NYT Dealbook interviews Stanley Druckenmiller

On Tuesday of this week, the New York Times-sponsored Dealbook conference featured a particularly fascinating interview by columnist Andrew Ross Sorkin with well-known hedge fund manager Stanley Druckenmiller. Druckenmiller’s remarks dealt with several important issues the JACF has addressed over recent years.

On the subject of whether meeting Wall Street earnings expectations was a good thing—and “missing” earnings was a bad thing, Druckenmiller expressed great admiration for Amazon but not for IBM:

…the last 19 quarters, Amazon has missed their quarterly earnings nine times. They don’t give a damn…IBM has missed three quarters since 2006. They really care about their quarterly earnings.
[IBM] are under major attack from Amazon, Palantir, all these companies out there are eating away…Their R&D has shrunk in absolute terms and as a percentage of their sales.”
Oh yeah, I love Amazon because they’re investing in their future.

Druckenmiller said the same holds for Netflix:

“Same thing. I only heard 30 seconds of [Netflix CEO Reed Hastings]… but he said, ‘If you manage for quarterly earnings, you’re dead.’ Then somebody on CNBC says, ‘Well, it’s easy for him to say with a stock price like that.’ Well, why do you think he has a stock price like that? Because he thought about the long term and not cared about quarterly earnings and all this short-termism the whole time.”

It is unfortunate that so many business people seem to find Druckenmiller’s well-founded opinions surprising.

For a more formal and extensive treatment of exactly this topic, please read Three Common Misconceptions About Markets (or Why Earnings Smoothing, Guidance, and Concern About Meeting Consensus Estimates are Likely to Be Counterproductive) from our Summer 2013 issue, by Tim Koller, Bin Jiang, and Rishi Raj.

Some of the same ideas were expressed earlier in the JACF and actually put into practice at General Electric. See Financial Planning and Investor Communications at GE (With a Look at Why We Ended Earnings Guidance) by GE’s then CFO Keith Sherin in our Fall 2010 issue.