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Risk and returns for private equity and venture capital funds

The early success of some well-known private equity and venture capital funds has led to their rapid growth. According to research from Narasimhan Jegadeesh, the Dean’s Distinguished Chair in Finance, Roman Kraussl (U of Luxembourg), and Joshua M. Pollet (U of Illinois), investors should carefully evaluate the future risk and return potential of this asset class and avoid investing primarily because of past successes. Some private equity indices compiled by the industry suggest that these funds offer bigger returns than the public equity market, but prior academic studies offer mixed evidence on performance. Jegadeesh and his coauthors devised a new approach to determine the actual risk and returns by using market prices of funds that primarily invest in unlisted PE and VC funds listed on several European stock exchanges. This approach has a distinct advantage because it uses publicly available market prices rather than self-reported data, which were previously used in other academic studies. Their findings indicate that unlisted PE and VC funds as an asset class are unlikely to yield extraordinary returns as suggested by some self-reported data. They may even yield about the same return as the stock market but are illiquid. Source:

Misreporting in securitized loans

Nonagency mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) derived from MBSs and their role in the recent financial and housing crisis remain a subject of discussion. An MBS is an asset-backed security secured by a mortgage or grouping of mortgages. Non-agency MBSs are not guaranteed by any government-sponsored organization, such as Freddie Mac or Fannie Mae, or the federal government. According to research from Gonzalo Maturana, assistant professor of finance, and John Griffin (U of Texas), the complexity of these structured products made it difficult to learn the true value of the underlying assets. They analyzed “apparent fraud among securitized nonagency loans, looking at unreported second liens, owner occupancy misreporting, and appraisal overstatements.” The study data comes from Lewtan’s ABSNet Loan and HomeVal data sets, along with DataQuick’s Assessor and History files, for the time period between January 2002 and December 2011. The researchers discovered that “48% of loans exhibited at least one indicator of misrepresentation.” The level of misreporting was similar for low- and full-documentation loans. Also, loans with a misreporting were 51% more likely to be delinquent. Maturana and Griffin’s research points to apparent fraud by loan originators and MBS underwriters, and it also suggest that MBS underwriting banks were aware of some of the MBS representations at issuance. Source:

CFOs & earnings misrepresentation

The quality of a company’s earnings is determined by controllable factors, such as internal controls and corporate governance, and noncontrollable factors, such as industry and economic conditions. But CFOs also have considerable influence over the communication and presentation of those earnings. In a new research study, Ilia Dichev, Goizueta Foundation Chair, professor of accounting, and coauthors John Graham (Duke U), Campbell R. Harvey (Duke U), and Shiva Rajgopal (Columbia U) note that discretion in accounting methods allows CFOs to misrepresent earnings. CFOs are motivated to misrepresent earnings in order to increase stock price and meet earnings targets, as well as boost their own compensation and career profile. The authors conducted a survey of 375 CFOs to explore their definition of earnings quality and ways to determine earnings misrepresentation. The authors concluded that “in any given period, a remarkable 20% of companies intentionally distort earnings, even while adhering to GAAP (generally accepted accounting principles).” The study found a number of red flags for earnings misrepresentation, including “a lack of correspondence between GAAP earnings and cash flows from operations, and unexplained deviations from peer and industry norms.” Source:

Mobile advertising and crowded locations

As marketers look for new ways to target consumers on their smartphones, they are capitalizing on the ability to use location for mobile advertising. Today, retailers send mobile coupons and alert shoppers to sale items as they roam the aisles of the store. New research from Michelle Andrews, assistant professor of marketing, and coauthors Zheng Fang (Sichuan U), Anindya Ghose (NYU), and Xueming Luo (Temple U), investigates the impact of another type of location on mobile ad effectiveness. The authors studied real-time data from one of the world’s largest telecom providers, compiling responses to mobile advertising by 14,972 mobile phone users on crowded and noncrowded subway trains. Surprisingly, commuters in packed subway trains were twice as likely to respond to and make a purchase from a mobile ad than travelers in less crowded subway trains. The researchers write, “A plausible explanation is mobile immersion: As increased crowding invades one’s physical space, people adaptively turn inwards and become more susceptible to mobile ads.” The research indicates that “hyper-contextual mobile advertising” needs to be a bigger consideration for marketers looking to improve their mobile advertising. Source:

Synergies between product placements and TV ads

As television watchers get inundated with commercials, the temptation to flip the channel grows. In the hopes of better connecting with consumers, advertisers are increasing their efforts to get product placements directly into TV shows. In a research study, David Schweidel, Goizueta Term Chair, Caldwell Research Fellow, and associate professor of marketing, and coauthors Natasha Zhang Foutz (U of Virginia) and Robin J. Tanner (U of Wisconsin) took a look at how the synergy between product placements and traditional commercials can keep viewers from flipping past the ad. The trio found that by simply putting a product in a television show and then immediately following it up with a commercial featuring the same product, viewers were more likely to stay tuned to the commercial. “The audience loss during the ad decreases by 5%,” they note. The effect was intensified when differing products from the same brand were shown in a program and then in a commercial immediately following the TV show. They write, “This indicates a positive synergy between the two activities that can reduce audience decline by more than 10%.” When products of different brands were featured in a television program and in a subsequent commercial, audience loss increased. Source:

Integrating knowledge in outsourced software development

Despite the prevalence of using outside vendors to handle a company’s software development, little is known about the best way to effectively share the knowledge critical to a project’s success among the client and vendor software team members. In research from Anandhi Bharadwaj, professor of information systems & operations management (ISOM) and Goizueta Term Chair in ISOM, and coauthor Nikhil Mehta (U of Northern Iowa), the duo determined that knowledge integration on outsourced projects is further complicated by the uncertainty often inherent in software development. Bharadwaj and Mehta analyzed 139 vendor development teams taken from sixteen Indian software companies for their research. The authors found that the manner in which software teams share and protect the information resources they have impacts the knowledge integration ability of the team. Since software teams operate under conditions of resource scarcity and dependence, team leaders need to ensure that their software development teams have not only the requisite technical skills but also the ability to import needed skills and knowledge from external sources and share it effectively within the team. An important implication of Bharadwaj and Mehta’s research is that organizations should develop holistic performance appraisal policies that assess software developers for both intergroup and within-group activities. Source:

Investor conferences and analyst advantage

In a research paper, T. Clifton Green, associate professor of finance and doctoral area coordinator, and coauthors Russell Jame 10PhD (U of Kentucky), Stanimir Markov (Southern Methodist U), and Musa Subasi (U of Maryland) focused their investigation on broker-hosted investor conferences to determine their impact on investor research. They studied 68,194 presentations by 4,394 companies at 2,749 investor conferences led by 107 brokerages for the period January 2004 to December 2010. According to the data, Green and his coauthors concluded that brokerage research analysts were more likely to provide better research for firms that participated at their conferences. Conference-hosting brokers were more likely to provide “more informative stock recommendations and more accurate earnings forecasts” than non-hosts. They discovered that firms participating in “broker-hosted investor conferences have a closer relation with the hosting analyst than with non-hosts, resulting in more private interactions (e.g., more company visits and meetings with management) and a continual flow of value-relevant information throughout the sample period.” Source:

Increased trading activity and declining returns

Improved trading technologies are changing the markets, facilitating the boom in algorithmic trading and the growth of hedge funds. Liquidity and trading volume continue to hit record levels. In a research study, Tarun Chordia, R. Howard Dobbs Professor of Finance, and coauthors Avanidhar Subrahmanyam (UCLA) and Tong Qing (Singapore Management U) analyzed whether or not increased liquidity and the trading activity of hedge funds has had an impact on financial market anomalies. Anomalies are return patterns that are inconsistent with the basic risk-return paradigm of finance. Increased arbitrage is a possible factor in attenuating the impact of anomalies, including momentum, reversals, accruals, etc. To find the link, Chordia and his coauthors studied proxies for arbitrage trading, including “the impact of the decline in the tick size due to decimalization and the impact of hedge fund assets under management, short interest, and share turnover.” The researchers referenced a wide sampling of equity market anomalies for more than three decades to show that increased liquidity and hedge fund trading activity did ultimately result in the decrease of the “economic and statistical significance of these anomalies.” Source:

Why negotiations fail

For business leaders engaged in negotiations, it’s essential to constantly analyze and revisit their negotiation strategy to avoid many of the errors typically made in the process. In the Handbook of Conflict Management Research, Erika Hall, assistant professor of organization & management, and coauthors Brian Lucas (U of Chicago) and Leigh Thompson (Northwestern U) offer a window into negotiation methods and some of the mistakes negotiators make along the way. The trio discovered and defined three specific errors that occur in negotiations, including what they label as domain myopia, the self-preoccupation effect, and the script hijack effect. Domain myopia is described as the “tendency for negotiators to fail to see meaningful parallels across negotiation situations that might appear different on the surface, but have meaningful underlying similarities.” Hall and her coauthors also describe the self-preoccupation effect, where negotiators let their emotions win the day and subsequently lose perspective. The third scenario that they define is the script hijack effect, which they describe as “the tendency for negotiators to feel compelled to follow a script, often based on stereotypes.” According to the authors, the problems they document apply across a variety of industries. Source:

Repo transactions and bank risk

In a research study from Edward Owens, assistant professor of accounting, and Joanna Shuang Wu (U of Rochester), the authors examine bank reporting of short-term borrowings in the repo market. Repo borrowings, otherwise known as sale and repurchase agreements, are essentially collateralized loans known for their short-term nature. The authors note that repo borrowings are typically associated with risky trading behavior, especially due to their opaque nature and role in the recent financial crisis. Owens and Wu found that current financial reporting requirements for banks might not adequately capture a full accounting of the risks associated with a bank’s repo liabilities. Specifically, end-of-quarter balance sheets may not correctly show the risk levels from repo borrowings exhibited throughout the quarter. The researchers analyzed quarter-end deviations in bank repo borrowings to better study the risk they represent. The primary research sample for the study was pulled from “13,548 bank-quarter observations across 573 unique publicly traded bank holding companies.” The authors attribute some of the deviation to what is termed “window dressing,” a step banks might take “to temporarily reduce the reported level of repo borrowings around quarter-end reporting dates.” Expected fluctuations in bank depositor and borrower activity around the end of the quarter did factor into the deviation as well. Source: