Loyola University Chicago

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Loyola University Chicago

Quinlan School of Business

Risk Management & Corprate Governance Conference 2009

Abstracts Submitted for Review

“Board Risk Oversight, Hedging Intensity, and the Idiosyncratic Risk of U.S. Banks”

Authors: Kathy Fogel, Yingying Shao, and Timothy Yeager

We find positive and significant relations between measures of board control and the intensity of banks' hedging activities.  In addition, larger hedging positions reduce the idiosyncratic risk of bank stocks.  We divide our sample into sub-periods and show a time persistent connection between stronger board oversight and hedging intensity under normal market conditions, the dot-com crash around the year 2001, and the financial crisis around 2008. Our results are consistent with Ferreira and Laux (2007), that stronger corporate control reduces idiosyncratic risk, but we provide a different mechanism, namely, hedging, through which the influence of governance relates to stock price volatility.


“Commercial Paper, Lines of Credit, and the Real Effects of the Financial Crisis of 2008: Firm-Level Evidence from the Manufacturing Industry”

Authors: Pengjie Gao and Hayong Yun

We use firm-level data to examine the interplay between the use of lines of credit and commercial paper, which reveals the real effects of the recent financial crisis on nonfinancial firms.  We find that aggregate commercial paper borrowing declined 15% after the collapse of Lehman Brothers, but the effect was concentrated among firms with high default risk: CP-rated firms with high default risk reduced their commercial paper divided by assets by 91% from the pre-crisis level.  These high default risk firms drew from existing lines of credit to substitute lost borrowing from the commercial paper market.  However, there is no evidence that firms with low default risk drew excessively from their lines of credit and hoarded cash.  The average size of the committed lines of credit scaled by assets decreased immediately after the collapse of Lehman Brothers, but increased after a liquidity injection by the Fed.  Finally, firms with access to liquidity did not change their policies, such as investment and inventory, while firms without liquidity significantly reduced their business activities.  The findings of this paper suggest that lines of credit play critical roles in providing liquidity to firms in times of need as well as screening creditworthy borrowers.


“Coordinating Corporate Investment with Risk Management Policies”

Authors:  Diego Amaya, Geneviève Gauthier, and Thomas-Olivier Léautier

This paper develops a dynamic risk management model that enables to characterize a firm’s optimal risk management strategy. We examine the impact of a multi-period setting on the decisions made by a firm in terms of its capital structure and risk management strategy. The model demonstrates that, when the investment opportunity is independent of the profitability, it is not always optimal to fully hedge.  Moreover, full hedge can be a local minimum. The numerical implementation of the model allows us to assess how changes in the firm’s business environment affect its capital structure and risk management policies.


“Credit Ratings and CEO Risk-Taking Incentives”

Authors:  Yu Flora Kuang and Bo Qin

This study examines the association between credit ratings and top management’s incentives for risk-taking. We measure the risk-taking incentives in two ways: the sensitivity of managerial wealth to the volatility of firm performance (i.e., equity Vega) and the sensitivity of managerial wealth to firm performance (i.e., equity Delta). The former captures managerial direct incentive to pursue risky projects while the latter measures indirectly managerial risk-taking incentive. Using 8,189 firm-year observations from 1992~2006, we find that credit rating agencies incorporate managerial incentives for risk taking into their credit risk assessments. Further, firms having greater concerns about their rating adjust managerial compensation packages to decrease the risk-taking incentives.


“Default Swaps and Director Oversight: Lessons from AIG”

Author:  P.M. Vadusev

Using the recent events at AIG as a case‐study, the paper tests the efficacy of the framework of contemporary corporate governance – namely, the monitoring role assigned to the boards of public corporations and an emphasis on director independence. The article refers to statutory filings, media reports about the company and statements by executives to construct AIG’s business model for credit default swaps. While these publicly available materials provide an overview of the business, it is not possible to draw a clear picture on the implementation of the principle of management by executives and oversight by the directors. The article examines the composition of AIG’s board of directors, and finds constant increases in the number of independent directors. Juxtaposing this trend against the monitoring role of the directors presented in corporate theory, the article questions how far the emphasis on the monitoring function of the directors is suited to the ideal of promoting healthy and responsible governance. Recent theory has mostly neglected another key function of the directors – their role as advisors for the corporate business operations and strategy. It questions how far the independence of directors, which is stressed in the debate on corporate governance, is compatible with a meaningful role in their business advisory function.

Overall, the article identifies significant gaps in the framework of governance in current corporate theory, and advocates:  A more judicious mix of executive and non‐executive directors on boards, better articulation of the role of boards and a greater emphasis on their involvement in business strategy and planning, and development of an effective standard of care for the directors as a principle that informs the governance of business corporations.


“Disclosure 2.0:  Leveraging Technology to Address ‘Complexity’ and Information Failures in the Financial Crisis”

Author:  Erik F. Gerding

This article advocates leveraging advances in computer software, information systems, and the Open Source movement to enhance securities disclosure and remedy some of the information asymmetries that exacerbated the current financial crisis.

This article responds to a critique of mandatory securities disclosure by several legal scholars (Troy Paredes and Steven Schwarcz) that disclosure overloads investors with too much information and fails to help investors analyze the complexity of modern financial instruments and markets. 

However, because the financial crisis stemmed in large measure from information failures, it would be counterproductive to dilute securities disclosure for failing to stop the crisis.  Instead, disclosure must be radically enhanced to enable investors to better analyze: intricate financial instruments, such as asset-backed securities and derivatives; the models used to price these instruments, set risk management policies, and guide trading strategies; and the complex market interactions of these instruments and trading strategies.

Various technologies can revolutionize disclosure including: “tagging” assets that underlay asset-backed securities and derivatives to allow investors to trace which assets affect which financial instruments; access to underlying data that is aggregated in financial statements; “open source” risk models; real-time financial disclosure; and interactive disclosure that allows users to change certain assumptions or accounting methods to see how financial disclosure would change.

Employing these technologies poses certain risks and costs, which this article analyzes.  The article argues that an “open source” approach to technologically enhanced disclosure can mitigate agency costs and advocates experimental testing of disclosure effectiveness.


“Do Ownership Structures Affect the Risk Incentive Provided by Managerial Portfolio Holdings? An Empirical Analysis of the AIM Traded Companies in the UK”

Authors: Helena Pinto and Andrew Marshall

This paper analyses the wealth and risk incentives effect of managerial options and share holdings, on the hedging probability of AIM traded companies in the UK. Contrary to prior literature that estimates the proxies for managerial options’ wealth and risk incentives using the Black and Scholes model, we contribute by considering the specific characteristics of managerial options, including the vesting period, the likelihood that the manager could be fired or leave before the options vest and also the American feature. We also focus our study on small and closely held companies listed in the AIM market in the UK due to their particular ownership and governance structures. Our results show that in such companies the wealth incentive effect provided by managerial options holdings increases the hedging likelihood. We contribute to the literature by finding that the wealth incentive effect provided by managerial share holdings, decreases the hedging likelihood. The latter result is nevertheless, not consistent with treating the incentive variables as endogenous and to redefining our hedging variable as a derivatives usage variable. Further tests show that the incentive effect provided by managerial shareholdings is significantly different if managers are not substantial owners.


“Enhancing The Efficiency Of Board Decision Making: Lessons Learned From The Financial Crisis Of 2008”

Author:  Bernard S. Sharfman

As a result of the financial crisis of 2008, the employment compensation policies and decisions of Wall Street corporate boards have come under close scrutiny.  Specifically, the willingness to approve company-wide compensation plans that resulted in the paying out of billions of dollars in bonuses, even in the face of deteriorating financial and economic conditions, has been a highlight of the controversy.  If only these firms had retained the bulk of these large annual bonuses over the last several years when the financial markets were noticeably in decline, perhaps the economic impact of the current financial crisis would have been less severe.

It is now understood that board approval of compensation policies that are heavily weighted toward large bonuses can encourage the pursuit of fake alpha and that the decisions to pay out huge amounts of company capital in the form of bonuses may primarily be the result of fake alpha being successfully achieved.  In terms of corporate governance, these decisions reveal how opportunistic rent seeking stakeholders can pressure the corporate board into excessively risky decisions that can jeopardize the financial health of the corporation.  The question then becomes whether corporate law needs to be modified to deal with this weakness in corporate governance and if so, how should it be done.  In this article, it is argued that courts should require a public company’s board—a board composed of a majority of presumably independent and disinterested members— to fulfill an enhanced duty in the process of deciding to approve policies or make decisions that on their face implicate both opportunistic rent seeking behavior on the part of one or more company stakeholders and the financial health of the firm.  Such board decisions would necessarily include, among others, those decisions that involve moving massive amounts of cash out of the company and into the pockets of one or more stakeholders (huge company-wide bonuses, large executive management team compensation, large dividend payouts, aggressive stock buybacks, etc.).


“’Enlightened Shareholder Value’: Corporate Governance Beyond the Shareholder-Stakeholder Divide”

Author:  Virginia Harper Ho

The global financial crisis has led to calls for greater corporate accountability and heightened controls over public corporations. As a result, the past year has seen a marked increase in regulatory initiatives that give shareholders a greater voice in corporate affairs. While debate continues to rage in the academy and beyond over the promise and pitfalls of shareholder empowerment, an important undercurrent in the controversy is the potential impact of "shareholder democracy" on corporate stakeholders. 

 This Article considers a vision of the corporation and its purpose that transcends the shareholder-stakeholder divide.  Under this "enlightened shareholder value" approach, which has been introduced statutorily in the United Kingdom and incorporated into the United Nations' Principles for Responsible Investment, attention to financial and non-financial corporate stakeholders, including the environment, employees, and local communities, is seen as a means of generating long-term shareholder value. This Article observes that a similar paradigm is now being advanced in the U.S. by leading institutional investors who identify stakeholder interests as key to long-term financial performance. It then moves beyond prior literature to consider squarely the implications of these developments for the underpinnings of shareholder primacy and the potential direction of ongoing corporate governance reforms.  In so doing, it responds to some of the concerns surrounding corporate stakeholders that have been raised by both proponents and detractors of greater shareholder voice.


“Ethical Mutual Funds: An Experimental Analysis of Investor Behavior”

Authors: Iván Barreda Tarrazona, Juan Carlos Matallín Sáez, and Mª Rosario Balaguer Franch

Mutual funds have grown considerably within the financial system. Investors may be motivated by the financial advantages offered by funds such as those deriving from professional portfolio management. In addition, the social component of some mutual funds, known as socially responsible mutual funds, may also be an investment incentive for some. The aim of the present paper is therefore to analyze investor behavior in response to socially responsible investment alternatives and in particular the role played by the information given to the investor about the SR nature of the investment. To this end, we adopt an analysis based on experimental methodology, where a sample of individuals take investment decisions related to various parameters of information, return combinations, and social responsibility. Two treatments were conducted in which each investor had to decide how to distribute his or her investment budget between two funds, returns on which were uncertain and varied over time. Between the two treatments, we varied the degree of information provided on the socially responsible character (or otherwise) of the investment. The results obtained suggest that although the individuals’ criteria for investment are essentially guided by returns, they invest significantly more in a fund when they know it is socially responsible. Furthermore, the level of social awareness among a substantial group of investors is such that they invest relatively more in ethical funds, even when return differentials are unfavorable. Providing clear statements in the fund information about the SR character of the investment is crucial if the investor is to exert his or her ethical preferences.


“Foreign Banks’ Lending After the Financial Sector Reform in Indonesia: Do Shocks from Home Affect the Currency Mix of Foreign Claims?”

Author: Yuki Masujima

This paper investigates the determinant of growth of foreign bank loans by currency in the Indonesian banking sector, where foreign banks actively disburse loans denominated in foreign and local currency. Due to globalized banking coupled with limited hedging instruments in the Indonesian foreign exchange markets, I hypothesize that foreign banks finance local currency (Indonesian Rupiah) from only local markets including deposits, but they do U.S. dollar from local customers’ deposits as well as their parent banks. Then, I test whether shocks from foreign banks’ parent bank and home country affect their loan growth rates at the bank level in Indonesia. By estimating the impacts on U.S. dollar and Indonesian Rupiah loans separately, I find the evidence that foreign banks reduce Rupiah loans and increase foreign currency ones when the Indonesian stock market is volatile. Moreover, foreign banks’ lending in Rupiah is insensitive to shocks from foreign banks’ parent bank and home country. In contrast, the foreign currency lending is tightly connected to their parent bank and home country during the global financial crisis of 2007-08. Although the currency denomination matters for loan disbursement, the direction of response to time-variant individual bank factors does not depend on the currency denomination within the same types of banks such as state owned banks, private national banks, and foreign banks. The three types of banks differently respond to financial and economic shocks in Indonesia, especially during the crisis. Lessons from the findings are (1) currency denomination of loans is imperative to monitor foreign banks’ response to home and host factors (2) currency denomination is relatively less informative to monitor banks’ response to financial measure of individual banks (3) during a home crisis, it is important to monitor a parent bank’s soundness.


“Formal and Informal Institutions in Asia: A Survey of Asian Corporate Governance”

Author: Andreas Högberg

Comparative literature in corporate governance typically separate between countries with different legal origin, institutions and corporate traditions. However, the importance of informal institutions and their effects on the economic development, firm performance and corporate governance should not be neglected. Informal institutions have been claimed to be of extra importance foremost Asia. This paper comprise of a general discussion on legal origin and formal and informal institutions. This discussion is then connected to recent studies on corporate governance issues in Asia. The results are mixed, but a general picture of corporate governance in Asia is presented. Foremost formal institutions and legislations seem to have their intended effect on the economy in general. However, differences between the countries become clear and the influence of informal institutions seems to differ substantially between the Asian countries. The impact of formal institutions in contrast to informal institutions is important since the economical effects for many of the developing countries in the region may be imperative.


“From Entrepreneurial State to State of Entrepreneurs: Ownership Implications of the Transformation in Mexican Governance Since 1982”

Author:  José G. Vargas-Hernández

This paper has the aim to analyze the ownership implications of the transformation in Mexican governance since 1982. The turning point of the implementation of a new model of development was prompted by the Mexican State financial crisis of 1982, after a period of steady economic growth. The entrepreneurial State since then has been under the attack of new business elite, who are the direct beneficiaries of the massive transfer of public assets and change in ownership from public property to private property. The Mexican State is now captive under the interests of entrepreneurs rule and governance. This paper brings some specific cases related with the change in ownership in the land property, the banking and financial system, the telecom company TELMEX, airlines, etc. The effects of this change in ownership are evident. A weak system of regulatory agencies and mismanagement of privatization programs has ended in private monopolies, low economic growth, uneven social development, political instability, alarming increment of insecurity, social unrest, etc.


“Governance, Performance and Diversification: Evidence from African Microfinance Institutions”

Authors: Thierno Amadou Barry and Ruth Tacneng

In this paper, we analyze the relationship between the performance of microfinance institutions and their organizational, income and fund structure, which includes internal and external governance, and product and service diversification. We particularly investigate three aspects of performance: sustainability, outreach, and portfolio quality or risk. Using a panel of 281 microfinance institutions in 34 African countries from 1996-2008, we find that although non government organizations perform better in terms of depth of outreach and profitability compared to the other institutions, they are not necessarily operationally more self-sufficient. Meanwhile, asset expansion leads to higher number of clients but at the expense of lower depth of outreach. In addition, external governance leads to higher efficiency and productivity but does not necessarily improve portfolio quality. Interestingly, MFIs that focus on loans are found to be less sustainable and have higher risk. Those that offer health and education services however have better portfolio quality than those that do not. These results are further strengthened even when the factor analysis method is employed.


“Identity Theft: The Risks and Challenges of Data Compromise”

Authors: John Winn and Kevin Govern

The loss of private customer data such as Social Security numbers, credit card numbers, birth-dates, and other confidential information to unauthorized third parties presents a daunting set of challenges as well as legal obligations to affected businesses.  Identity theft has been America’s “fastest growing crime” since at least 1989 and although actual cost data is difficult to gauge, various studies estimate direct domestic losses to the US business community at between 56 and 100 billion dollars per year.   These rather staggering figures do not include significant additional tangential costs such as the criminal prosecution and incarceration of offenders. 

Identity theft also directly costs private consumers over $2 billion and 100 million hours of time per annum to resolve in the aftermath of having their identities stolen.   The Privacy Rights Clearinghouse reports over eight million individual victims of identity theft in 2007 alone.   That source also reports at least 900 business-related data breaches in the United States in the United States alone involving the compromise of over 245 million records containing personal information.  

Obviously, given the current risk environment, businesses are obligated to do their utmost to protect systems and ensure customer confidentiality.  Unfortunately, in this same threat environment, careful consideration must also be given to planning and preparation for worst case scenarios.  In the event of a major system compromise, who bears the cost of system restoration or customer reimbursements?  What about negative publicity, loss of goodwill, and lawsuits?  What constitutes minimum due diligence before and after a data-compromise?  What steps should management consider post-breech?  What are the legal consequences to our business, customers and other stake-holders?  Should we purchase cyber-insurance?

Part one of the paper addresses current infrastructure risks and the challenges associated with cyber-insurance underwriting.  Part two attempts to summarize what has become a rather complex legal and regulatory landscape.  Part three addresses due diligence and post-breach best practices that may facilitate the retention of customer goodwill while minimizing business costs and legal liabilities.


“The Implications of the New Governance for Corporate Governance”

Author: John R. Boatright

The scholars who have created the concept of the new governance generally claim, without much explanation or justification, that this development entails or requires some changes in corporate governance.  The aim of this chapter is to examine the question of what implications, if any, the new governance has for corporate governance.  Is the new governance compatible with traditional systems of corporate governance, or are some changes required?  And if some changes are required, what are these changes and, more important, why are they required?  The main conclusion of this examination is that, yes, the new governance has some implications for corporate governance.  However, these implications are due primarily to broader changes in the competitive environment of present-day corporations of which the features cited in the new governance literature are only a relatively small part.  The value of this chapter, then, aside from addressing the question of the implications for corporate governance, is to place the new governance in a larger context and identify some additional forces at work in its development.


“The Multivariate Modeling of the Risky Behavior of Drivers”

Michel Grun-Rehomme and Mériem Maatig

The aim of this study is to find an econometric specification that simultaneously models the risky behavior of drivers. Indeed, the existence of an endogenous bias can mislead us into retaining explanatory variables in a separate equation. The data used for this research were obtained from a questionnaire-based survey of a representative sample of the Paris population with regard to age and gender. We use trivariate probit model to test the existence of causal links between the three risky behaviors of drivers. In this modeling, the characteristics that explain these three behaviors are correlated. In this case, the autonomous estimation of one of the three equations can include an endogenous bias. The individual characteristics of the use of parking sites reserved for disabled persons and alcohol at the wheel, explain also negatively the probability of phoning while driving.


"On the Paradoxical Relation between Group Support and Subsidiary Insolvency in the Insurance Industry"

Author:  George Zanjani

This paper studies the survival outcomes experienced over a 14-year period by a comprehensive sample of group-affiliated U.S. property-casualty insurance companies from 1994. While it is generally assumed that affiliate support enhances the financial strength of a subsidiary within a group, this paper finds that claimants on non-core affiliates (i.e., those with less reinsurance support from and with looser ties to the flagship company) fared better, on average, than claimants on core and flagship subsidiaries.


“Political Spending & Shareholders’ Rights: Why the U.S. Should Adopt the British Model”

Author: Ciara Torres-Spelliscy

American shareholders lack the ability to consent to political spending by corporations.  Indeed, because of gaps between corporate and campaign finance law, U.S. corporations can make political expenditures without giving shareholders any notice of the spending either before or after the fact.  This is problematic because the political interests of the managers who spend the corporate money may diverge from the political interests of shareholders who provided the funding. 

By contrast, British companies must seek permission from shareholders to make political expenditures under the Political Parties, Elections and Referendums Act of 2000 and must report such spending to U.K. shareholders on an annual basis.

Shareholders in U.S. companies have been protected by a century’s worth of election laws which limited the amount of money that could be spent in federal elections by corporations, unions and banks.  Corporations are required to pay for federal political expenditures through corporate political action committees (PACs).

The federal corporate PAC requirement safeguards the interests of shareholders in particular because most investors are unaware of how, when or why corporations make political expenditures.  For example, in states that lack federal-style election rules, corporations may give political donations directly from their corporate treasuries.  (Money in the corporate treasury includes funds from the sale of stocks and products.)  Corporations can spend money on politics without consent from or notice to shareholders.  The shareholder may not know who the corporation supports or may even actively disagree with who the corporation supports. By contrast, if a shareholder chooses to give to a corporate PAC, then the shareholder is fully on notice that the money will be used for a political purpose and there is meaningful consent in the transaction.

The laws that require corporations to pay for political expenditures through corporate PACs are under legal attack in the courts.  Most recently, the Supreme Court heard a rare re-argument in September 2009 in a case called Citizens United.  The topics at re-argument were whether to overrule Austin v. Michigan Chamber of Commerce and McConnell v. Federal Election Commission —two cases which require corporations to conduct political spending through corporate PACs.

As Justice William Brennan wrote in Austin, laws requiring corporations to pay for independent expenditures through corporate PACs, “protect[] dissenting shareholders of business corporations.”  In response to Justice Scalia’s dissent that offended shareholders could simply sell their shares, Justice Brennan went on to explain the difficulties of the mechanics of keeping perpetual tabs on corporate political spending, stating, “shareholders in a large business corporation may find it prohibitively expensive to monitor the activities of the corporation to determine whether it is making expenditures to which they object.”

Most Court watchers predict that the Supreme Court will use Citizens United as an opportunity to expand corporate speech rights.  If the Court overturns Austin and McConnell, this new development in the law would hurt shareholders by allowing corporate managers to use corporate treasury funds to make political expenditures. 

A recent study, “Corporate Political Contributions: Investment or Agency?” by Aggarwal, Meschke, and Wang (2009) found that large corporate political expenditures are linked with lower shareholder value and poor corporate management.  In other words, managers make political donations because they want to, not because giving will necessarily benefit the corporations they manage.  Overruling Austin and/or McConnell will give poor managers even more venues in which to spend shareholders’ investments on political expenses.

By exploring both campaign finance law and corporate law, this paper, “Political Spending & Shareholders’ Rights,” will argue that the U.S. should adopt the British approach to corporate political expenditures.  In the first instance, U.S. corporations should disclose their political spending directly to shareholders and they should give shareholders the opportunity to consent to political spending.  These reforms will improve corporate governance and minimize corporate risk. 

The need for this reform has become heightened with the Supreme Court’s re-argument of Citizens United and the possibility that the ability of managers to spend corporate treasury funds will expanded markedly.  In a world where corporations can spend an unlimited amount corporate treasury funds on federal and state elections, shareholders will need new protections to guard against self-interested political spending by corporate managers.


“The Role of the Interaction Between Information and Behavioral Bias in Explaining Herding”

Authors: Beatriz Fernández, Teresa Garcia-Merino, Rosa Mayoral, Valle Santos, and Eleuterio Vallelado

The current research aims to analyze the interaction between the uncertainty of the financial environment and individuals’ cognitive profile to explain investors’ herding behavior. The authors design and conduct an experiment to observe the behavior of subjects in three settings, each with a different level of information. The results confirm that a dependence relation exists between feeling of uncertainty, investors’ behavioral biases and the herding phenomenon. Moreover, the experiment shows that the determinants of herding—information and behavioral biases—are not mutually independent. Specifically, the presence of high levels of uncertainty favors herding behaviors regardless of inter-individual differences, and only when the level of uncertainty is low are the biases in the individual behavior capable of explaining investors’ herding behavior.


“Stock Repurchase Programs and Corporate Governance: Ethical Issues and Dilemmas”

Author: Richard McGowan, S.J.

Public firms increasingly favor share repurchases over dividend payments as the preferred method of cash dispersion.  There, however, currently exists a dearth of academic literature that focuses on the determinants of share repurchase program size and the ethical considerations that are involved with these stock repurchases.   This paper examines the relevance of each of the prevailing financial and psychological motivations thought to inform share repurchase decisions and seeks to econometrically determine which, if any, of these motives also drive the size of share repurchase programs implemented by U.S. Industrial firms.

Since 1999, more than 4,000 U.S. firms announced share repurchase programs totaling more than $550 billion. This torrid growth in the frequency and size of share repurchase programs shows the rapidly increasing popularity of share repurchases as a means of distributing cash to shareholders.  Much of this growth in popularity of share repurchase programs has come at the expense of more traditional dividend programs.  This is evidenced by the fact that dividend payouts by Industrial firms listed on CompUSA increased by a factor of just over two between 1980 and 2000 from $67.6 billion to $141.7 billion. These findings, in addition to the subsequent conclusions drawn by this paper, convincingly demonstrate that share repurchase programs have become an increasingly important and essential vehicle for U.S. Industrial firms to disperse cash.

There are a myriad reasons hypothesized to motivate corporate managers to repurchase stock.  Topics discussed include: The preferential tax treatment of capital gains versus ordinary income, the ability to adjust leverage and capital structure balances through via a share repurchase, the financial flexibility of share repurchases in comparison to dividend programs, the extent to which executives are compensated with stock options, the information conveyed by share repurchases, the opportunity for firms to profit through the acquisition of undervalued stock, the avoidance of common equity dilution arising from the issuance of compensatory stock options, the volatility of current and expected earnings and cash flows, the prevention of hostile acquisitions, the desire to expropriate value from bondholders, a lack of available positive NPV investment opportunities, and the avoidance of misguided overinvestment by management in negative NPV projects. 

Once the factors have been determined that influence the size of a stock repurchase have been determined, the final section of the paper will examine the ethical implications of these results for corporate governance. For it is the board of directors that has the final say on whether or not a stock repurchase program ought to be initiated. The three major stakeholders in the repurchase decision are the: corporate executives, shareholders, and the employees of the firm.  If  executive compensation happens to be one of the primary factors in determining the size of a stock repurchase, then clearly the board has the responsibility to determine whether or not the corporate executive are merely increasing the share price in the short term in order to sell their stock to cash in on these short term gains. While the shareholders are certainly in a better short position if certain determining factors occur, again, do stock repurchase programs make a stock more attractive in the long run? Does the board have a responsibility to signal to stock holders the long-term viability of a firm? Finally, how does a stock repurchase program affect employees?  If a stock repurchase program is being used to protect a firm from an unwanted suitor, it would seem that employees are better off. But if the stock repurchase program signals that the firm is no longer viable in the long-run clearly its employees are at risk. A corporate board of directors is faced with many conflicting interests as it attempts to evaluate the viability of a stock repurchase program.


“Systematic Scenario Selection: A methodology for selecting a representative grid of shock scenarios from a multivariate elliptical distribution”

Authors: Mark D. Flood and George K. Korenko

We present a quasi-Monte-Carlo algorithm for use in simulation studies and risk management, where elliptical distributions are appropriate (e.g., the multivariate normal and Student’s t). The algorithm selects a systematic mesh (of arbitrary fineness) of shock scenarios that evenly covers an isoprobability ellipsoid in d dimensions. For example, the isoprobability ellipsoid might represent a risk manager’s specific value-at-risk (VaR) probability threshold. The algorithm has linear computational complexity. Choosing scenarios systematically reduces the danger of “blind spots” in a stress test. Extensions are suggested to address the issues of non-monotonic loss functions and financial contagion. We provide tested and commented source code (in Matlab®).


“Tail Dependence of Major U.S. Stocks”

Authors: Long Kang and Simon H. Babbs

We review estimation methods of the tail dependence coefficient (TDC), simulating their finite-sample performance. With our chosen semi-parametric and non-parametric estimators, we estimate TDCs of major U.S. stocks. We have three aims. The first is to establish the “stylized facts” about tail dependence among major U.S. stocks. The second is to compare the “stylized facts” with TDCs implied by a multivariate Student’s t copula model so as to assess its ability of capturing tail dependence patterns of a large set of assets. The third is to explore the accuracy of estimates of VaR and Expected Shortfall when a multivariate Student’s t copula is used to capture tail dependence.


“To Regulate or Un-regulate? The Dichotomy of Chinese and Western Models”

Author: Xiao Huang

After the financial crisis, a larger role of government’s involvement has been called for in market regulation. On the other hand, for China, as a fast-growing economy, the market has been hampered by a high degree of state control and bureaucracy and will inevitably move towards a more liberal one. It appears that there will be an intersection point between the two systems.

Throughout the world, there are two main systems for listing shares. The Chinese one is an approval system. It is prone to administrative influence and complex approval procedures. For example, all IPOs were banned in China since September 2008 to June 2009 to promote stability. Issues such as listing companies’ credit worthiness, the issuance size and time for listing are still largely controlled by the regulator, in particular the China Securities Regulatory Commission (CSRC). Yet most mature markets adopt the registration system. It is largely market-driven, and there is more room for intermediaries and professional institutional investors to play a role during the process.

Such oversight patterns are related to the nature of market. Dispersed ownership in the Anglo-American system has been nurtured by good quality investor protection offered through various legal and market mechanisms. By contrast, Chinese stock market is still essentially speculative and dominated by short-term investment with high turnover ratio. In this situation, state control may be desirable to ensure the quality of issuers.

This paper concerns the equilibrium of the two competing regulatory models. It compares the CSRC to the western supervisory authorities, especially the Securities and Exchange Commission (SEC), in light of self-regulation, public offering system and public enforcement. Then it highlights their potentially changing roles in response to the financial crisis.


“You have been warned! … Really? – Assessment of the Liability of the Service Provider in Case a Warning has been Given to the Client”

Author: J.A. Luzak

A service provider’s duty to warn obligates it to issue a warning when it is  aware or should have been aware of the default in the service it provides, regardless whether the default originated due to its own or someone else’s fault (in circumstances when the duty to warn has been recognized and bound the service provider). What happens if the warning is given but the client does not change his order or instruction to the service provider? E.g. in the construction sector the builder might warn the client that the materials chosen by the designer will not stop water from entering the basement of the client’s new house, but the client does not order other materials. Shall the builder continue the construction process with the materials chosen originally by the client despite knowing that the final product will not fulfill its function properly? May the service provider assume in such a case that the client took upon himself a risk of a faulty construction? What if the client did not consciously decide to take that risk since the warning given by the service provider had been too vague or undermined the seriousness of the problem? What if the client had not understood the warning – if it was too complicated for him to grasp its meaning? Shall the service provider in such a situation try repeating the warning till it is sure that the client understood all the dangers? Shall it refuse to perform the service knowing that the end product will be faulty? Will the service provider be liable for the client if the latter one decides to sue for the faults in the end product? When may the service provider be sure that it performed its service in a risk-free way and will not be held liable?

This article focuses on cases when there was no doubt that the duty to warn bound the service provider – when the service provider recognized that fact and even claimed that it had performed its duty to the client. Due to the service provider’s belief that it had warned the client of the potential default within the service, it does not expect to be held liable for that default. There are still circumstances, however, in which courts found the service provider liable, either on the basis that the warning had not been precise enough or that the service provider should not have limited itself to just giving a warning to its client but should also have acted upon it (e.g. by refusing to provide further service).  The scope of this article is further narrowed down to  defaults appearing in the construction sector and the analysis of English and Dutch case law on this matter (with different rules on liability and different ways of organizing the construction process).

The article will not only describe applicable legal provisions and case law analysis but also contain an analysis of relevant consumer behavior on the matter. When we are talking about the client ignoring the service provider’s warning, two options are possible: the warning has been misunderstood or even not grasped at all by the client or the client made a decision to ignore the warning and take upon himself the risk associated therewith. In both cases it is relevant to take into consideration how consumers make their decisions and what factors may influence that process. Such study may give answers as to how the warnings should be given by the service providers in order to be fully and properly understood by the consumers. On the other hand, if it were possible to distinguish and identify risk-seeking consumers from those who remained ignorant it might help the court to reach a different decision as to the scope of the liability of the service provider who issued a warning to such a group of consumers. In this respect various research on how information is processed by consumers will be analyzed, mainly as to what factors influence the comprehension of the information that service providers provide to the consumers (e.g. time for analyzing information , personal interest in the information, emotions at the time of analyzing information, complexity of the information, source of the information). This analysis should point out these factors that are relevant for consumer decision making and indicate what the strength of that influence is. Based on this analysis, we might be able to conclude how the warning should be conveyed to the consumers in order for it to be easily understood and followed.

Both cognitive and affective skills of the consumers influence the decision making process and various trade-offs are usually made while assessing risks (e.g. quality versus price). It will be presented how as a result of making wrong trade-offs during the decision making process the consumer might end up ignoring the warning of the service provider.

Consumer behavior analysis will serve to illustrate why sometimes the courts find service providers liable even though the service provider had granted a warning to the client. In the modern world the information consumers are provided with is often complex. Consumers are usually not provided with sufficient time to analyze the warnings they receive.  Hiring experts to conduct such an analysis for the consumer is costly and since it is usually not required by law, it is rarely applied in practice. As a result, the service provider, as a professional party in the contractual relationship, should realize that the warning it had issued was very unlikely to fulfill its function. Thus the liability of the service provider even when it granted a warning to the consumer should not come as a surprise.

At the same time, the article intends to point out ways of making the consumer more aware of the risks conveyed with the warning, therefore making it less likely that the consumer will not understand the warning and proceed to ignore it. In such a situation, if the consumer still decides to proceed with the, according to the service provider, dangerous order, the service provider should be released of its liability.


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