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Daily Bamboo Innovator Insight (Investing Process, Research): Thursday 13 Nov 2014 – Michael Mauboussin: Attributes of a Good Investment Process

Investing Process

Michael Mauboussin: Attributes of a Good Investment Process: ValueWalk, PPT

Legendary Finance Professor Ben Graham Revealed The Problem With Earnings Announcements Decades Ago: BusinessInsider

Asset Management: A Systematic Approach to Factor Investing: Amazon

Buffett Said He Paid a Lot. $15 Billion Later, BNSF Is a Cash Machine. ‘He Stole It’: Bloomberg

Research

Does Culture Matter for Development? SSRN

Acquisition Decisions of Zero-Leverage Firms: SSRN

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Governing Misvalued Firms

Governing Misvalued Firms

Dalida Kadyrzhanova, Matthew Rhodes-Kropf

NBER Working Paper No. 19799
Issued in January 2014
Equity overvaluation is thought to create the potential for managerial misbehavior, while monitoring and corporate governance curb misbehavior. We combine these two insights from the literatures on misvaluation and governance to ask ‘when does governance matter?’ Examining firms with standard long-run measures of corporate governance as they are shocked by plausible misvaluation, we provide consistent evidence that firm performance is impacted by governance when firms become overvalued – overvaluation causes weaker performance in poorly governed firms. Our findings imply that firm oversight is important during market booms, just when stock prices suggest all is well.

Powerful Independent Directors

Powerful Independent Directors

Kathy Fogel, Liping Ma, Randall Morck

NBER Working Paper No. 19809
Issued in January 2014
Shareholder valuations are economically and statistically positively correlated with more powerful independent directors, their power gauged by social network power centrality measures. Sudden deaths of powerful independent directors significantly reduce shareholder value, consistent with independent director power “causing” higher shareholder value. Further empirical tests associate more powerful independent directors with fewer value-destroying M&A bids, more high-powered CEO compensation and accountability for poor performance, and less earnings management. We posit that more powerful independent directors can better detect and counter managerial missteps because of their better access to information, their greater credibility in challenging errant top managers, or both.

Local Government Financing Platforms in China: A Fortune or Misfortune?

Local Government Financing Platforms in China: A Fortune or Misfortune?

Yinqiu Lu International Monetary Fund

Tao Sun 

International Monetary Fund (IMF)
December 2013
IMF Working Paper No. 13/243

Abstract: 
China’s rapid credit expansion in 2009–10 brought local government financing platforms (LGFPs) into the spotlight. This paper discusses their function, reasons behind their recent expansion, and risks they are posing to the financial sector, local governments, and sovereign balance sheet. This paper argues that LGFPs were a fortune for China in the past, but would turn out to be a misfortune if the causes of the rapid expansion of LGFPs are not addressed promptly. In this context, the paper proposes ways to avoid misfortune by: acknowledging and addressing the revenue and expenditure mismatches at the local government level; establishing a comprehensive framework to regulate and supervise local government budgets; ensuring the sustainability of the financial resources obtained from the sale of land use rights; and developing local government bond markets and promoting financial reforms.

Bad Corporate Marriages: Waking Up in Bed the Morning After

Bad Corporate Marriages: Waking Up in Bed the Morning After

Ye Cai Santa Clara University – Leavey School of Business

Hersh Shefrin Santa Clara University – Leavey School of Business; National Bureau of Economic Research (NBER)

December 27, 2013

Abstract: 
This paper examines corporate risk taking behavior in the wake of unsuccessful merger activities. We find that relative to other firms, firms that made bad acquisitions take both more systematic risk and more idiosyncratic risk. Moreover, higher risk is associated with greater value destruction and stronger corporate governance. The increased risk can be traced to increased cash flow volatility, increased leverage, decreased asset liquidity, more investment in R&D, and more equity-based executive compensation. These findings are in line with the behavioral approach suggesting that in the domain of losses, decision makers generally become more tolerant of risk.

Corporate Disclosure of Material Information: The Evolution—and the Need to Evolve Again

Corporate Disclosure of Material Information: The Evolution—and the Need to Evolve Again

Jean Rogers1, Robert Herz2

Article first published online: 23 DEC 2013

Journal of Applied Corporate Finance

Volume 25Issue 3pages 50–55, Summer 2013

This article by the former chairman of the FASB and the founder and executive director of the new Sustainability Accounting Standards Board (SASB) presents the rationale for and mission of the SASB. As the authors point out, both the Securities and Exchange Commission, which was created in 1934, and the Financial Accounting Standards Board, set up in 1973, emerged during times of low investor confidence to restore trust in the capital markets. And the institutional changes brought about by the creation of both the SEC and the FASB succeeded in eliciting new information for investors and in raising the standards by which such information was reported.

How to Create Value Without Earnings: The Case of Amazon

Josh Tarasoff1, John McCormack2

Article first published online: 23 DEC 2013

Journal of Applied Corporate Finance

Volume 25Issue 3pages 39–43, Summer 2013

Investors and commentators often equate GAAP accounting metrics, especially earnings per share, with financial success. The reality, however, is that there is no simple, linear relationship between GAAP earnings and intrinsic value, which is defined as the present value of expected future cash flows. And adjustments of GAAP metrics, though admittedly subjective, are often required to understand the economic reality of a business.

http://Amazon.com Inc. provides a case study that throws into sharp relief the need to look beyond GAAP in order to analyze underlying fundamentals and value. In this paper, the authors argue that Amazon has done a superb job of building shareholder wealth, all the while reporting low and declining operating and net income margins. The article provides a framework for thinking about Amazon’s underlying profitability that is based on the concept of return on capital in relation to the cost of capital, and shows how that profitability has been masked by GAAP accounting. The authors demonstrate that the company is now investing very large amounts of capital with the expectation of earning rates of return well above its cost of capital. And their analysis suggests that if such investment can continue over the long term, Amazon’s current market value of $140 billion can be readily justified.

But as the authors go on to argue, we now live in a different world, one in which the management of environmental, social, and governance issues is increasingly viewed as critical to the long-run value creation of companies. And because today’s corporate reporting fails to account in a systematic way for material non-financial issues, it’s time once again for the capital markets to evolve. The SASB aims to meet this need by creating sustainability accounting standards for use by public companies in disclosing a minimum set of material sustainability impacts for companies in over 80 different industries. As part of a natural evolution in disclosure, the SASB aims to achieve the same goal the SEC and FASB started with: to protect investors and the public.

Is Sell-Side Research More Valuable in Bad Times?

Is Sell-Side Research More Valuable in Bad Times?

Roger K. Loh, René M. Stulz

NBER Working Paper No. 19778
Issued in January 2014
In bad times, uncertainty is high, so that investors find it more difficult to assess the prospects of the firms they invest in. Learning models suggest that in such times investors should, everything else equal, value informative signals such as analyst forecasts and recommendations more than in good times. However, the higher uncertainty in bad times and career concerns stemming from troubled employers may make the task of analysts harder, so that analyst output is noisier and hence less valuable in bad times. Consequently, whether analyst forecasts and recommendations are more valuable during bad times is an empirical matter. We examine a large sample of analyst output from 1983 to 2011. We find that analysts work harder in bad times, but their earnings forecasts accuracy is worse and that they disagree more. Despite more inaccurate earnings forecasts, revisions to earnings forecasts and stock recommendations have a more influential stock-price impact during bad times as predicted by a learning model.

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