Free Cash Flow (FCF), Economic Value Added (EVATM), and Net Present Value (NPV):A Reconciliation of Variations of Discounted-Cash-Flow (DCF) Valuation

1. Abstract
§ The paper assist the user of DCF methods by clearly setting forth the relationship of free-cash-flow (FCF) and economic value added (EVATM) concept to each other and to the more traditional applications of DCF thinking such as NPV
§ The equivalence between EVA and NPV, approaches:
i. Links the problems of security valuation, enterprise valuation, and investment project selection
ii. Relates to more directly use of standard financial accounting information
§ FCF approach → focuses on the periodic total cash flows obtained by deducting total net investment and adding net debt issuance to net operating cash flow
§ EVA(TM) approach → requires defining the periodic total investment in the firm
§ FCF and EVA(TM) are equivalent to NPV

2. Introduction
§ The use of DCF method for investment decision making and valuation is well entrenched in finance theory and practices
§ Modern literature has broadened application of DCF techniques → capital budgeting and security valuation problems
§ Free cash flow → security valuation
§ Economic value added → managerial performance evaluation

3. Cash Flow
a. The cash budget identity
i. Consider the single period cash budget identity
ii. The components are operating revenues and cost, net security issuance, interest payments, dividend payments, taxes paid, and net investment.
iii. Investment maybe divided into working capital and long-term investment
iv. In practice, use of accounting information for economic analysis requires a number of adjustments to bring the accounting numbers into conformity with economic reality
v. Sources = Uses
Rt + ∆Bt = Ot + Intt + Divt + Taxest + ∆It + ∆WCt

b. Dividends
i. Divt = (Net profit after tax + depreciation) – total net investment + net debt issuance

c. Divisions of cash flow among investors
i. Cash flow to equity (CFE is equivalent to our expression for dividend
ii. Proponents of the FCFE method emphasize that FCFE is dividends that could be paid to shareholders
iii. The difference between FCFE and dividends paid in given year maybe characterized as investment in “excess marketable securities” and its omission from consideration is moot so long as such investments have zero NPV
iv. Cash flow to debt holders in period t, CFDt:
CFDt = Intt - ∆Bt = interest paymentst – net debt issuance

d. Taxes
i. Consider the total-taxes-paid component of cash flow to equity
ii. It is being equal to the tax on operating income before interest – the tax-shield benefits provided by interest payments
iii. Taxest = tax with no debt financing – interst-tax-shield benefits

e. Free cash flow to the firm
i. Free cash flow to the firm → cash flow to equity + cash flow to debt holders – interest-tax-shield benefits from the cash flow to debt holders
ii. We can express that
© CFFt = after tax operating profit from equivalent unlevered firm + depreciation – totaol net investment

4. Valuation
i. Three basic business contexts:
© Project valuation (capital budgeting)
© Security valuation
© Firm valuation
ii. Purpose → demonstrate the conceptual consistency in valuation methodology among the various computational techniques employed in the three valuation contexts

a. Equity valuation by the dividend discount approach
i.

b. Equity valuation by the free-cash-flow-to-equity approach
i.

c. Debt valuation
i.

d. Total firm valuation
i. Total firm value:
ii. To express free cash flow to the firm, firm value can be described in terms of NOPAT, depreciation, and total net investment

e. Project valuation
i.

f. Economic profit (EP) and economic value added (EVATM)
i. The concept of EP boils down to a simple restatement of total firm valuation that “reallocates” investment expenditures from the periods in which they are made to periods over which their resulting benefits occur.
ii. In the EVA(TM) approach to EP →the reallocation assigns to each period an “EVA(TM) depreciation” component representing the “usage” of a portion of the cost of the firm, plus a “capital charge” representing the opportunity cost of the remaining net investment in the firm
iii. The computation of EP:
EPt = (NOPATt + difference between tax depreciation and EVA(TM) depreciation – capital charges on EVA(TM) operating assets / economic profitt

5. Measurement Issues
§ Another important use of valuation concepts requiring use of accounting information is determination of managerial compensation
§ Spirit of managerial compensation arrangement → to reward manager to increase shareholders value → measurement of changes in firm value is critical
§ With the free cash flow model, income must be adjusted for the fact that GAAP involve reliance on both the realization and matching principles

a. Derivation of operating cash flow from accounting profit
i. The dividend discount and free cash flow to equity models adjust accounting profits by starting with NPAT, then adding depreciation and net debt issuance, and subtracting total net investment

b. Derivation of economic profit from accounting profit
i. It is not only concerned with reconciliation of accounting profit and cash flow, but also focuses on issues defining the capital investment in the firm

6. Conclusions
a. Free cash flow, economic value added, and net present value approaches to valuation and decision-making are equivalent
b. Linkage among the problems of security valuation, enterprise valuation, and investment project selection, and by doing so in a manner that relates directly to the use of standard financial accounting information
c. Net operating profit after tax (NOPAT) → adding after tax interest payments to net profit after taxes
d. FCF approach → focuses in periodic total cash flow obtained by deducting total net investment and adding net debt issuance to net operating cash flow
e. EVA(TM) approach → requires defining the periodic total investment in the firm

Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value

1. Content
§ How to incorporate expectations into the corporation’s decision processes to enhance shareholder value
§ EBM → A revolutionary new performance metric that links performance standards, performance measurement, and the achievement of performance
§ The literature on investment management pays little attention to shareholder value → from the perspective of the relationship between corporate managers' behavior and investors' expectations
§ Corporate finance research → sidesteps the issue of how management actions affect investor expectations and stock price discovery
§ Beating expectations drives shareholder value
§ expectations into fundamental management behavior
i. Difficult → because it requires corporate managers to adopt an unaccustomed mindset and focus
§ The Author:
i. Tom Copeland is a distinguished financial scholar who has moved to consulting
ii. Aaron Dolgoff is an associate principal of consulting firm CRA International
§ Managing based on beating expectations through a systematic decision process is the best way to increase shareholder value

2. Sections
a. Measuring performance with expectations
i. Expectations-based management (EBM) → determining which management approach is most correlated with increases in shareholder value → EBM
ii. EBM's underlying intuition is almost too simple:
© Managers must beat the expectations embedded in stock prices → create value
© Achieving what analysts already predict about the company will not create value
b. Managerial implications of expectations-based performance
i. the authors argue that expectations count
ii. The corporate manager's job is to identify investors' most important expectations and systematically include them in all aspects of company behavior
iii. EBM is not a simple lesson but a way of thinking that must be translated into action throughout the company
iv. Example:
© how a company should evaluate a new investment proposal
o The projected return on investment must exceed not only the cost of capital but also investors' expectations for returns on existing projects
v. Copeland and Dolgoff argue that managers need to reverse-engineer the value of the company to determine what the market thinks returns should be
vi. Market's expected return is the hurdle rate that must be met, not for a given quarter but over multiple periods
vii. Clarifying a company's actions to exceed market expectations is the key role of management
viii. Top management has to be driven to beat expectations, rather than rewarded for rising stock prices that merely reflect a general market increase
c. The expectations-based model from viewpoints other than management's

Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value (Journal)

Abstract
Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value, by Tom Copeland and Aaron Dolgoff, is reviewed.

Full Text
Copyright CFA Institute Mar/Apr 2007

Reviewed by Mark S. Rzepczynski.

This unique book provides practical advice on how to incorporate expectations into the corporalion's decision processes to enhance shareholder value. Surprisingly, the literature on investment management pays little attention to shareholder value from the perspective of the relationship between corporate managers' behavior and investors' expectations. Similarly, corporate finance research often sidesteps the issue of how management actions affect investor expectations and stock price discovery.

Anyone dealing with Wall Street understands that beating expectations drives shareholder value. Even so, embedding this message in corporate managers' behavior is difficult. Incorporating expectations into fundamental management behavior, beyond guidance on quarterly earnings, is particularly problematic because it requires corporate managers to adopt an unaccustomed mindset and focus.

Although, integrating investor expectations with management behavior is a tall order, the authors of Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value prove more than up to the challenge. Tom Copeland is a distinguished financial scholar who has moved to consulting, and Aaron Dolgoff is an associate principal of consulting firm CRA International. Their premise in this book is that managing based on beating expectations through a systematic decision process is the best way to increase shareholder value.

Copeland and Dolgoff divide the book into three major parts:
1. measuring performance with expectations,
2. managerial implications of expectations-based performance, and
3. the expectations-based model from viewpoints other than management's.

The first section of the book examines the validity of expectations-based management (EBM) through the simple test of determining which management approach is most correlated with increases in shareholder value. The authors test several well-known value-creation alternatives-top-line growth, earnings (bottom-line growth), the top-line and bottom-line growth combination, return on investment capital, and the spread between return on capital and the cost of capital. None of these can explain variance in shareholder return as well as the expectations-based approach. This powerful research was previously published in a leading accounting journal, but the authors have expanded it here to provide clear descriptions of the alternative approaches.

EBM's underlying intuition is almost too simple: To create value, managers must beat the expectations embedded in stock prices. Merely achieving what analysts already predict about the company will not create value. The challenge is determining how EBM can be incorporated into everyday operating behavior.

In the second main section of the book, the authors argue that expectations count. This claim is backed by clear research and good examples of how expectations can be incorporated into decisions. The corporate manager's job is to identify investors' most important expectations and systematically include them in all aspects of company behavior. Copeland and Dolgoff argue that EBM is not a simple lesson but a way of thinking that must be translated into action throughout the company.

For example, the authors explain how a company should evaluate a new investment proposal. The projected return on investment must exceed not only the cost of capital but also investors' expectations for returns on existing projects. This section of the book contains a helpful discussion of the relevance of weighted average cost of capital and the need to adjust it to incorporate expectations. All budget processes, say the authors, need to be consistent with the EBM approach.

Copeland and Dolgoff argue that managers need to reverse-engineer the value of the company to determine what the market thinks returns should be. The market's expected return is the hurdle rate that must be met, not for a given quarter but over multiple periods. The stock price and analysts' views signal the market's expectations. Management has to send a signal indicating what the company is doing to match or exceed expectations-not in a given quarter but from a longer-term perspective. Clarifying a company's actions to exceed market expectations is the key role of management.

A chapter on investor relations explains how to reduce noise in signaling what is happening inside the company. The authors also contend that expectations can become truly operational only if a clear set of incentives motivates all managers. Top management has to be driven to beat expectations, rather than rewarded for rising stock prices that merely reflect a general market increase.

The third section, which deals with other points of view, further examines investor relations from the investor's perspective. This section also contains a discussion of public policy issues associated with the information that investors receive about the company's behavior. The book ends with a persuasive summary argument for the authors' approach.

Copeland and Dolgoff follow the consulting profession's time-honored custom of writing about their key strategic theories. The result, however, is much more than marketing material for new business. Their book offers a well-reasoned framework for embedding expectations in the budget and management process. In addition, it is refreshingly free of consulting platitudes. The authors make a compelling case, which they present in a clear and forceful manner.

In summary, Outperform with ExpectationsBased Management is a practical handbook for managers who have a solid grounding in the paradigm of rational expectations and efficiency as well as the basics of corporate finance. At the same time, it is a highly useful book for investment analysts. It provides clarity for managers on using expectations and gives investment analysts a framework for evaluating the actions of management.

-M.S.R.

Trying Free Cash Flows to Market Valuations

1. Introduction
§ In a companion piece to his article in the last issue*, Robert Howell turns his attention to the importance of free cash flow in determining valuations
§ Fixing Financial Statements:
i. Traditional format → must be redesign → useful for:
Meaningful financial analysis
Decision making
Value creation
§ Objective of business → increase real shareholders value → increase NPV
§ Financial statement → put more emphasis on the free cash flows

2. Relating Free Cash Flows to Market Values
§ A firm market value → reflects the collective judgment of the shareholders’ expectation of its future cash flow
i. If the expected cash flow:
Constant → market value constant
Better → market value rise
Worse → market value erode
§ Assume a firm has positive cash flow $100 million → assume it is perpetuity
i. A perpetuity valuation model → capitalize → annuity stream using the firm’s cost of capital as discount rate
ii. Free cash flow $100 million divided by yields 0.1 → NPV $1 billion
iii. This $1 billion is equal to entity value → represent the NPV for a stream of $100 million
iv. Debt s have to be subtracted from firm’s entity value → determine how much value accrues to the equity shareholders / equity value
v. If:
Market value > equity value → market expect free cash flow to improve
Market value < equity value → market expect free cash flow to erode § Perpetuating negative cash flow → negative value § We may start with the firm’s market value → multiply by firm’s cost of capital → to calculate free cash flow would be required to justify market price i. Dot-com company with $10 billion and estimated cost of capital → $1.5 billion in free cash flow § Management should regularly undertake those process to their own firm § Invertors should do the same to each infestation

3. Managing for Free Cash Flows and Shareholder Value Creation
§ Management’s fundamental responsibility → increase shareholders value
i. Requires increasing the NPV of the future stream of cash flow
§ Three ways to do it:
i. Increase cash earnings by growing the business
Growth improve free cash flows → has to take into account additional investment in working capital and capital expenditures required to support the growth
Cost management → spending more to increase cash earnings and free cash flows
Good cost management may means:
o Spending to develop new products or support customers
o Finding ways to take costs out of products without effecting their perceived value
o Reducing administrative cost

ii. Reduce investments
Means managing working capital and fixed and other assets more tightly
That might mean:
o Collecting receivables more quickly → Dell
o Turning inventories faster → Toyota
o Getting out under fixed assets via outsourcing → Nike
o Focusing more attention on intangible asset performance

iii. Financial management
It has two primary elements:
o Managing the mix of capital to minimize the firm’s weighted average cost of capital
a. Means increasing the proportion of debt capital that is less expensive than equity capital
o Using free cash flow → increase the company’s future value
a. Many mature company pays dividend
b. Shareholders must pay taxes of the dividend
§ Most business have variety of products and products group
§ Each product’s life cycle, positioning, competitive strength, and investments requirements influences its cash flow pattern and value-creating contribution
§ The ultimate financial management challenge is to use free cash flows to invest in new business opportunities that build shareholder value

4. Xerox Corp. Profits vs. Cash Flows
§ Xerox Corp. provides a classic example of how potentially misleading accounting profits can be
i. Year 1998 is excellent year → EPS were up to 16 %, income were up to 17 %
ii. After annual report was released, Xerox stocks climbed to nearly $64 per share
§ Bad news in 1999:
i. Softness in its significant Brazilian market
ii. A profit warning for the third quarter that stunned Wall Street
iii. Another warning and large earning shortfall for the fourth quarter
§ Speculation emerge → Xerox might file for bankruptcy
i. Stock fell to $5 per share
ii. Lost more than 90 % of its value
§ Revenues were up in 1998; margins before restructuring were better and profits would have been up slightly.
i. Revenues dropped in 1999, but profit held up
ii. The market expected more → the market valuation slid
§ In three year period, Xerox burned close to $2 billion in cash before interest payments and dividend distributions
§ In three year period, reported earnings aggregated more than $3 billion, cash flows were more than negative $5 billion
§ In early April, it agreed to restate earnings for four year period and pay a $10 million fine to the security and the exchange commission
§ What Xerox did was attribute more of its leasing transactions to current revenues and profits than it should have

5. Metrics to Monitor Free Cash Flows and Value Creation
§ Traditional financial statement analysis has focused on measure:
i. Profitability focused on “return on assets” and “return on equity”
ii. Risk measures focused on “liquidity” and “solvency”
§ ROA suffers on two counts
i. The return numerator of net operating profit after taxes (NOPAT) is suspect because of the many deficiencies of accrual-based earnings
§ ROE measures fail for same reasons
§ Return on invested capital (ROIC) → NOPAT divided by the investments in the business-working capital property, plant and equipment and intangible assets
§ To create shareholders value → ROIC must exceed the firm’s WACC.
§ To use ROE, the equity base must be the market value
i. Market based ROE > estimated shareholder cost of capital → the firm is creating value for shareholders
§ The classic liquidity measures focused on the relationship of current assets to current liabilities
i. More is better is deficient on the last two counts:
It fails to recognize the flow characteristics of working capital
Having fewer resources tied up in working capital is better in that it reduces the amount of cash required to support growth and improves ROIC
§ Solvency measures are the times-interest earned ratio and various debt-to-capital ratios

6. Summary
§ Free cash flow have to be the focus of major financial statement overhaul
§ Free cash flow may be directly related to current market valuations to determine if the current free cash flows support current market values

Peer Pressure

1. Introduction
§ Stock Valuation and portfolio construction → two core activities → active equity investment managers
§ Portfolio construction → studied from the point of view of:
i. efficient diversification of risk
ii. individual stock of return
iii. return standard deviations and return correlations
§ Portfolio construction → rank on Market Cap → as value, blended, or growth
§ Investment strategies → value stocks as opposed to Growth stocks
§ Academics used portfolio constructions concerns the universe of stocks considered
§ Testing for the effectiveness of contrarians portfolio strategies:
i. Academics sort over universe of all listed stocks → defined by market capitalization
ii. Practitioners generally focused on narrow group of firms drawn from the same industry
§ One level → test → peer group perspective actually improves upon assessments of relative values
i. Examine the usefulness of → book-to-market, cash flow-to-market, earnings-to-market ratios → explaining the cross-section of observed individual stock values
ii. Estimate how quickly individual firm value ratios correct themselves back toward the peer group median
iii. specifically highlight industry effects on portfolio design and returns to contrarians strategies

2. Literature Review
§ Lie & Lie
i. Apply the multiples-based firm valuation model in a peer group setting → determined by SIC groupings
ii. Examine the explanatory power of both assets-based multiples → in company valuations → enterprise value and equity value
§ Dremen and Lufkin
i. Analyze returns to contrarian strategies → using relative-value rankings and compare them to returns from corresponding rankings

3. Data and Peer Group Construction
§ Kim and Ritter → bankers use valuation via median peer group characteristic multiples → prospective IPO
§ Typical investment banker’s peer group definitions → useful multiple-based valuation analysis
§ Median multiple level → differ significantly across industry peer groups at any given time

4. Using Characteristic Multiples to Value Stocks
§ Lie and Lie (2002) → presuming → forming industry peer groups improves valuation precision
§ Industry-based median ration approach → significantly reduces stock pricing error ↔ aggregated single median ratio approach
§ Current median multiple for industry peer group → used as a forecast of the fair multiple → soon-to-be-listed firms
§ Relative stock valuations within a peer group appear sticky at the one-year horizon
i. Currently observed differences in individual firm book-to-market ratios appear → to reflect firm-specific factors → that tend to persist

5. Ranking Produce Excess Returns in Hedge Portfolios
§ Generic contrarians strategies → constructed based on relative value ranking across the full universe of firms
§ Create a second net return series → Rich stock return minus Cheap stock return
§ Net return series → return on quasi-arbitrage strategy → purchases the portfolio of the cheapest stocks & sell the richest stocks
§ Average return on the industry-neutral version → could be higher / lower → depend on:
i. valuation ratio used
ii. The particular forward period considered
§ Identification appropriate peer group → crucial first step in the company valuation process

6. Result from Deciles Portfolios
§ Our two key equal-weighted portfolios → created by drawing:
i. The cheapest stocks in each industry
ii. The richest stocks in each industry
§ This hedge portfolio has no net exposure to industry effects
§ Average net of return → between these richest and the cheapest portfolio equals zero

7. Conclusion
§ Peer pressure is a term describing the pressure exerted by a peer group in encouraging a person to change their attitude, behavior and/or morals, to conform to
§ Two types of peer pressure:
i. Positive peer pressure → tries to help a company change
ii. Negative peer pressure → tries change a company
§ Contrarian Strategy → approach based on the idea that the market will eventually rediscover out-of-favor stocks and bring the high-flyers back down
§ It looks for medium to large cap stocks with low price / earnings ratios and a potentially strong financial condition

It’s Time to Take a Closer Look at Dividends

Abstract
§ Yields from dividend-paying stocks → very attractive in today's market environment
§ The highest dividend yields tend to come from companies in the utilities, telecommunications services and financial sectors.
o Organization → information technology and health care → not to provide significant dividends.
§ Stock valuations elevated around the world
o investors concerned about equity market volatility

Content
§ Many plan members are still skittish about investing in equities
o Result → holding disproportionate amounts of fixed income
o Dividend-paying stocks → encourage investors to participate in equity market → acquire sufficient growth
§ Successful long-term investors → see a company's ability to distribute dividends consistently → indicator that the business is well run
o Others → dividend-paying stocks → outperform other equities when markets are flat or sinking
o Dividend income → the biggest driver of equity market returns
§ TSX index → grown by a factor of 11 over the past five decades
o TSX Total Return Index → adds by a factor of more than 50 over the same time period
o strong performance has tended to come with lower volatility in recent periods

Attractive Outlooks
§ Yields from dividend-paying stocks → very attractive → today's market environment
o outlook for dividend-paying stocks appears positive
o With:
i. corporate earnings momentum losing steam
ii. stock valuations elevated around the world
iii. investors concerned about equity market volatility
more investors will turn to the reliable returns of dividends

It's time to take a closer look at dividends (journal)

Abstract

Yields from dividend-paying stocks are very attractive in today's market environment, with the average yield of the top 10 yielding equities on the TSX having overtaken yields for five-year Government of Canada bonds. The highest dividend yields tend to come from companies in the utilities, telecommunications services and financial sectors, while industries that are typically associated with growth-such as information technology and health care-tend not to provide significant dividends.
Looking ahead, the outlook for dividend-paying stocks appears positive. With corporate earnings momentum losing steam, stock valuations elevated around the world, and investors concerned about equity market volatility, it's likely that more and more investors will turn to the reliable returns of dividends. Rising interest rates in the United States and other countries may also be an impediment to stock market capital appreciation-leaving dividends to pick up an even greater share of equity performance.

Full Text
Copyright Rogers Publishing Limited Dec 2004

Many plan members are still skittish about investing in equities and, as a result, are holding disproportionate amounts of fixed income and cash in their portfolios. Dividend-paying stocks may be the way to encourage investors to participate in equity market returns again, and acquire sufficient growth in their plan to sustain their lifestyle in retirement.
Successful long-term investors have understood the potential of dividend-paying stocks for some time. Many see a company's ability to distribute dividends consistently, year after year, as an indicator that the business is well run. Others are reassured by the fact that dividend-paying stocks, as a class, tend to outperform other equities when markets are flat or sinking.
And while these investments tend to be perceived as relatively conservative equity vehicles, they pack a performance punch. It may surprise your plan members to learn that dividend income has, in fact, been the biggest driver of equity market returns. Over the past 50 years, capital appreciation has contributed just 40% to TSX performance. The compound return from reinvested dividends is responsible for 60% of those results.
As a consequence, the TSX Index (which tracks only capital appreciation) has grown by a factor of 11 over the past five decades-but the TSX Total Return Index (which combines capital appreciation, reinvested dividends and buybacks) has ballooned by a factor of more than 50 over the same time period (see chart).
Meanwhile, this strong performance has tended to come with lower volatility in recent periods. A research paper published by CIBC World Markets illustrated that dividend-paying stocks outperformed low dividend growth stocks during the full five years ended mid-2003, with much less variability in yearly results.

* ATTRACTIVE OUTLOOK

Yields from dividend-paying stocks are very attractive in today's market environment, with the average yield of the top 10 yielding equities on the TSX having overtaken yields for five-year Government of Canada bonds. The highest dividend yields tend to come from companies in the utilities, telecommunications services and financial sectors, while industries that are typically associated with growth-such as information technology and health care-tend not to provide significant dividends.
Looking ahead, the outlook for dividend-paying stocks appears positive. With corporate earnings momentum losing steam, stock valuations elevated around the world, and investors concerned about equity market volatility, it's likely that more and more investors will turn to the reliable returns of dividends. Rising interest rates in the United States and other countries may also be an impediment to stock market capital appreciation-leaving dividends to pick up an even greater share of equity performance.
Offering your plan members the opportunity to invest in dividend-paying stocks gives them access to a steady income stream, relatively stable returns during down markets, and the potential for capital appreciation. That may be just the incentive they need to move some of their fixed income and cash off the sidelines and participate once again in the growth possibilities of equities.

Will You Adopt Quality Financial Reporting?

1. Preface
§ Company is presently “playing around with the scorecard”
i. Embracing the Quality Financial Reporting (QFR)
ii. Start representing as much useful public information as possible
§ Those ways → promises low capital cost → higher security prices → because its more than likely that the capital markets respond to inadequate reporting by bidding stock prices down

2. The traditional reporting model
§ Traditional reporting strategies → Capital markets depend totally on managers to provide public information for their use
§ No standardize Generally Accepted Accounting Principles (GAAP) → compromised
§ Report → too long → managers resisted to initiate new requirements
§ Political pressure → severely compromised standards
§ TQM → The goal is to build good customer relationship and keep working as good as possible
§ Adopt QFR → Build better relationship with capital markets by providing the best financial statement

3. Solving the problem
§ Capital markets have needs and desires for financial information that are not addressed by traditional public reports
§ Balance sheet → perceived as irrelevant
§ Footnotes seem to frustrate analysts the most → capital markets cannot understand them → they do not contain adequate information
§ Three negative outcomes of complying with GAAP:
i. Lack of useful information in financial statements → cause market to pursue other investment opportunities → securities’ lower prices and higher capital cost
ii. Markets decide that the company’s investment potential is great → people may invest after:
1. Taking into consideration the resulting high degree of uncertainty
2. Insisting on higher expected rate of return
→ doesn’t advance the stockholders’ interests
iii. Sophisticated investors and credits will turn elsewhere → market want to discover information that no one else know
§ Managers provide additional public information:
i. Less uncertainty would exist
ii. The analyst’ extra effort and the redundant cost of finding that information would be avoided
iii. Information would be more reliable
§ Uncertainty means more risk to investors → demand higher return

4. Quality financial reporting-A superior strategy
Adopting QFR has positive effects for essentially everyone
§ Managers
i. Having access to cheaper capital
ii. Earn more income and enjoy payoffs from appreciated stock options and other incentives
§ Stockholders
i. Greater demand for their shares
ii. A rate of return that’s appropriate for their real risk
§ Investors and creditors
i. They can evaluate investment opportunities with more emphasis on their financial merits
ii. Less concern for risk created by incomplete information
§ The economy operates more productively
i. The capital markets can establish security prices more efficiently
Two groups will lose when QFR is practiced:
§ People who has somehow fooled the market
§ People who successfully cheat the markets with illegal insider information

5. The high road
Get started with QFL
§ Doing what FASB recommended instead doing what it has permitted
i. Managers usually do not use preferred method → they think that footnote will not improve their securities’ prices
ii. QFR suggest → Markets usually penalized stockholders with lower security prices even management reports larger earnings on the income statement
§ Engage tough auditors and do what they say instead of picking cheap and easy auditors who do what managers say
§ Branch out into new areas based on your own market research and common sense as to what helps statement readers make better decisions

6. Objection and Are you ready?
§ QFR → higher preparation costs created by additional reporting and auditing efforts
§ Respond:
i. The cost of them is still less than the benefit to financial statement users of:
o Minimizing the cost of providing the data by having the firms doing it at once
o Having the firms as the source of information
o Making available an additional source of information that confirms or denies other sources
§ Resisting QFR because of preparation costs seems to be very shortsighted
§ It must flow from the efforts

Risk of property defaults growing; [USA 2ND EDITION]

Abstract
"For (recent) loans coming to maturity this year . . . it will be very difficult to acquire refinancing," said Sam Chandan, chief economist at Reis, a property re-search company.
Signs of growing stress also exist in the UK commercial property sector. Tomorrow, UK group British Land is expected to announce a sharp write-down in the value of its commercial property. The Bank of England highlighted its unease in its recent quarterly bulletin, noting that "commercial property prices fell sharply" in recent months, and "returns on commercial property slowed significantly".

Full Text
(Copyright Financial Times Ltd. 2008. All rights reserved.)
By DANIEL PIMLOTT and GILLIAN TETT
There is a growing risk of defaults on loans on commercial property this year, in a trend that could knock down real estate values and create more jitters in the credit world, analysts and bankers warn.
US property companies that took out big short-term loans to finance acquisitions in the past couple of years at low-interest rates are now struggling to refinance this debt, as banks curb lending and commercial property prices fall.
In recent days, Harry Macklowe, the New York developer, has failed to refinance Dollars 5.8bn in short-term loans he used to buy seven Manhattan office towers from Equity Office Properties last February. Deutsche Bank, which arranged the loan, has taken control of the buildings and will put them up for sale, a person familiar with the matter said.
Analysts warn of a pattern that could spread. US commercial property prices have fallen 10 per cent in some markets since August, after rising more than 90 per cent since 2001, according to Real Capital Analytics.
"For (recent) loans coming to maturity this year . . . it will be very difficult to acquire refinancing," said Sam Chandan, chief economist at Reis, a property re-search company.
Signs of growing stress also exist in the UK commercial property sector. Tomorrow, UK group British Land is expected to announce a sharp writedown in the value of its commercial property. The Bank of England highlighted its unease in its recent quarterly bulletin, noting that "commercial property prices fell sharply" in recent months, and "returns on commercial property slowed significantly".
Most analysts think the scale of problems building in the commercial property sector is far smaller than in the subprime loans market. However, if the sector produces tangible losses this year, this will be deeply unwelcome for banks and investors in commercial mortgage-backed securities
One area of concern revolves around property companies that have taken out floating rate loans in the past couple of years.
This year Dollars 22bn out of a total Dollars 38bn in outstanding floating rate CMBS is coming due, according to Wachovia Capital Markets data, of which Dollars 2bn faces the greatest risk of default because it has a final maturity this year with no option to extend.

Market Efficiency versus Behavioral Finance

1. Discussion
§ Prof. Burton G. Malkiel → stock prices follow a random walk → cannot be systematically predicted by professionals
§ Markets are efficient → rationally and accurately reflect all publicly available information
§ EMH → Efficient Market Hypothesis
§ Very tight relationship between economic activity ↔ quantity of money
§ Market may get things wrong but 90% efficient
§ Advise from individual and institutional investors:
a. Buy and hold a broad-based, low-cost index fund
§ Index funds → active mutual funds underperforms a low-cost index mutual fund
§ Index funds → safer → lower cost than stocks → more stable

2. Are Stocks Prices Predictable? And Has EMH Survived the Bubble?
§ You can’t make and loose money in the market → you may lose transaction cost but you can’t lose money in the market
§ Campbell-Shiller → P/E multiples → P/E multiples above average → future market returns will be terrible
§ Malkiel → A buy and hold strategy, even without rebalancing, does better than Campbell-Shiller to move between bonds and stocks
§ Rebalancing → keep risk in control
§ When returns going to be high or low → not enough to do an investors any good → nobody can predict when the market will turn
§ Investors are part of the wind → they want to get out before the bubble pops
§ The worse get better ↔ the best get worse

3. How Does the EMH Account for Trading Volume?
§ If the market were efficient → people wouldn’t be doing all trading that they do → waste time and money
§ Trading is driven by rebalancing or liquidity needs
§ EMH → allow for variation:
a. Private information
b. Heterogeneity of opinion
§ Two reasons for excessive trading:
a. Overconfidence → Investors think they know something
b. Perverse incentives
§ Small investors consistently lose money
§ Invest in opposite of market not always profitable

4. Rationality and Arbitrage
§ Markets are sufficiently efficient → it’s not going to last very long
§ Strongest evidence that markets are very efficient is that you don’t see professionals making excess returns
§ We want to see pattern in the data → sometimes real pattern cannot be found → only appearance of the pattern
§ 10 % of the investors were rational → sufficient for market efficiency
§ Index fund is always fully invested → that’s the only way to track the index → index fund takes the full hit when the market is going down

5. Investor Choice and Public Policy
§ Indexing bonds is stronger than stocks because bonds are essentially a commodity product
§ Too much choices → investors confuse → wrong actions
§ There isn’t any persistence in performance

6. How do The Experts Invest Their Money?
§ Some people “play” in stock markets because it is fun
§ Some people really count the risk and the return

Risk of Property Defaults Growing

1. Abstract
§ It will be very difficult to acquire refinancing
§ Signs of growing stress also exist in the UK commercial property sector
§ Commercial property prices fell sharply and returns on commercial property slowed significantly

2. Contents
§ There is a growing risk of defaults on loans on commercial property
§ US property companies’ → took out big short-term loans to finance acquisitions low-interest rates are now struggling to refinance this debt, as banks curb lending and commercial property prices fall.
§ Analysts warn of a pattern that could spread:
i. US commercial property prices have fallen 10 per cent in some markets → after rising more than 90 per cent since 2001
ii. UK group British Land is expected to announce a sharp writedown in the value of its commercial property
§ Most analysts think the scale of problems building in the commercial property sector is far smaller than in the subprime loans market
§ This sector produces tangible losses this year → this will be deeply unwelcome for banks and investors in commercial mortgage-backed securities

Understanding Risk and Return, the CAPM, and the Fama-French Three-Factor Model

1. Risk and Return
a. The General Concept
§ Higher expected returns require taking higher risk
§ Uncertainty ↑ - return required to justify the risk ↑ - investors’ willingness to invest ↓
§ Investor willing to sacrifice some return to reduce the risk
b. Volatility as a Proxy for Risk
§ Widely accepted measure of risk (standard deviation of risk)
§ Amount of asset’s varies through successive time period
§ Greater volatility → future values of volatile assets span a much wider range
c. Diversification and Systematic Risk
§ Individual stock’s volatility in and of itself
§ Holding two stocks → won’t experience extreme
§ Assets do not move in lock step with one another → volatility can be reduced without reducing expected returns
§ Volatility reduced by the addition of more assets to a portfolio → unsystematic risk
d. Beta as a measure of Systematic Risk
§ Systematic risk → measured by the degree to which its returns vary relative to those of the overall market
§ Beta → measure of the risk contribution of an individual security to a well diversified portfolio
§ Determining Beta → average the individual securities betas, weighted by the market capitalization of each security

2. CAPM
a. Key Assumptions Drive the Formulation of the Model
§ CAPM → quantify the relationship between the beta of an asset and its corresponding expected return
§ Assumptions:
1. Investors care only about expected returns and volatility
2. Investors have homogeneous beliefs about the risk/reward tradeoffs in the market
3. Only a risk factor is common to a broad-based market portfolio
§ If securities’ beta is known, it is possible to calculate expected returns
b. Logic of The Model: Developing Intuition
§ Consider assets has no volatility, no risk, its return do not vary with the market → Beta = 0, expected return = risk-free rate
§ Consider assets that has Beta = 1 → E(rA) = E(rM)
§ Consider assets that has Beta > 1, expect this asset to earn more return as compensation of this extra risk
§ CAPM → E(rA) = rf + ßA(E(rM) – rf)
c. The CAPM as a Tool to Evaluate Fund Managers
§ Active fund managers select stocks in portfolio based on research and informed opinions
§ Realized return > predicted return on CAPM → adding value
§ Realized return < predicted return on CAPM → just collecting fees, no investment value
§ Managers to increase expected returns → invest in positions that embody greater systematic risk
§ Difference between realized return and predicted retun on CAPM is excess return (ά)
§ ά positive, managers’ work is good
d. Regression Analysis: A Tool for Employing the CAPM
§ We need three time series of data:
1. Returns for the stocks whose beta we are calculating for a significant period of time
2. Returns on the overall market index in the same period
3. Risk free returns for the same period
§ rA = rf + ßA(rM – rf) + ά
§ We can regress the excess market return ↔excess portfolio return
e. Critique of the CAPM
§ Several key criticms:
1. CAPM true predict power is questionable
a. R2 measure only 0.85, which the maximum is 1
b. 15% of the variation is still unexplainable
2. The simplicity of CAPM’s assumption of a single risk factor explaining expected returns is still questionable
§ The predictive and explanatory power of the CAPM is bound by the structure of the model
f. Additional Factors Increase Predictive Power
§ Risk factors facing companies today: market risk, bankruptcy risk, currency risk, etc
§ Model with more than one risk give more descriptive and predictive model

3. Fama and French and Three Factor Model
a. Size and Value Factors Create Additional Explanatory Power
§ Value and size → most significant factors (besides market risks) → explaining the realized returns of publicity traded stocks

§ Two factors to represent these risks:
1. SMB to address size risk
2. HML to address value risk
b. The SMB and HML Factors
§ SMB Factor: Accounting for the Size Premium
1. Small Minus Big → measure the additional return investors have historically received by investing in stocks of companies with relatively small market capitalization
2. Average return for the smallest 30% of stocks minus average return of the largest 30% of stocks in that month
3. Positive SMB → small caps stocks outperformed large caps stocks
§ HML Factor
1. High Minus Low → measure the value premium provided to investors for investing in companies with high book-to-market values (B/M)
2. Average return for the 50% of stocks with the highest B/M ratio minus average return of 50% of stocks with the lowest B/M ratio
3. Positive HML → value stocks outperformed growth stocks
c. Interpretations of the Factors
§ SMB and HML factors first drew attention and continue to be the most commonly used simply
§ For SMB → small companies logically should be expected to be more sensitive to many risk factors → undiversified nature
§ For HML → companies need to reach a minimum size in order to execute an Initial public Offering
d. Constructing the Three Factor Model
§ Fama French Three Factor Model → describes the expected return on an asset as a result of its relationship to three risk factors: market risk, size risk, and value risk
§ rA = rf + ßA(rM – rf) + sASMB + hAHML
e. SMB and HML Provide Added descriptive Dimensions for Riskiness
§ Primary implications → investors can choose to weight their portfolios such that they have greater or lesser exposure to each risk factors → can target more precisely different levels of expected returns
f. Categorizing Funds with the Three Factor Model
§ Compelling feature → it provides a way to categorize mutual funds by the size and value risks to which its portfolio is exposed as a result of assets held
§ Two main benefits:
1. Classifying funds into style buckets
a. Compare managers → placing them in broad buckets based on the style of asset allocation they choose
b. The Morningstar (the biggest resource for mutual fund) classification of fund is often different with what the fund claims as its official strategy
2. Specifying risk factor exposure informs investor choice
a. Investors can effectively choose the amount to which they are exposed to each risk factor when investing in particular funds
g. Multivariate Regression and Evaluating Managers with the Three Factor Model
· Five time series needed:
1. Return for the stock whose beta we are calculating for a significant period of time
2. Returns on the overall market index for the same period
3. Risk free returns for the same period
4. Calculated SMB and HML for each months
§ rA – rf = ά + ßA(rM – rf) +sASMB + hAHML
§ Positive measure of alpha → the mutual fund manager is adding value to the portfolio
§ Benefits of regression with Three factor model:
1. Explain much more of the variation observed in realized returns → R2 ≥0.95
2. It exposes the fact that the positive alpha observed in CAPM regression model merely a result of exposure to either HML or SMB factors, rather than actual manager performance
h. Fund Evaluation in Practice (1) – Legg Mason (CAPM)
§ Legg Mason Value Prim fund returned 27.3% > market only 21.6
§ Evaluate funds manager: ά = 0.46%, ß = 0.93
§ CAPM only consider one-dimensional market risk → the realized returns must come from either the fund’s exposure to market risk, or the value added by the manager
§ Manager was able to add 46 basis points to the fund’s return on the monthly basis or about 5.5% per year above the return expected from a portfolio with beta of .93
T-statistic associated with alpha is 2.37, means that achieving returns without skill would be extremely unlikely probabilistic
i. Fund Evaluation in Practice (2) – Legg Mason Revisited (Three Factor Model)
§ Coefficient results: ά = 0.22, ß = 0.99, sA = 0.36, hA = 0.22
§ Manager was only able to add 22 basis points on a monthly basis
§ The high return associated with the fund’s exposure to size and value risk rather than the skill of the manager

Stakeholders, Governance, and the Russian Enterprise Dilemma

1. Introduction
Russian problems
§ Continuing lack of investment and restructuring in the corporate sector
o Russian’s firms output, profitability, and cost efficiency is very low
o Domestic investment in Russian fall
o Russian receive the least foreign direct investment
§ “Virtual” Economy
o Wages left unpaid, fiscal obligations unfulfilled, barter based transaction
o Lack of credible investor protection

“Why the construction of the institutional apparatus required to ensure payments and investor protection in Russian has proved to be such an intractable problem for so long, despite the country’s having received the best available advice and millions of dollars in foreign aid.

2. What happens when manager are owners
No external monitoring should be needed in an enterprise wholly owned by those who:
§ Initiate and implement decision
§ Provide the financing
§ Bear the residual risks

Problem of corporate Governance in Russia
§ Not limited in protecting minority shareholders ↔ insufficient incentives
o Owner-managers → with the short time horizon → expected gain from increasing firm’s value and share application less than what they can obtain by stripping asset
o Maximizing value → reasonable objective → if that value can be analyzed through the sale of the ownership rights in enterprises
o Owners have been more inclined to withdraw cash (illegally)

3. Regional governments exert influence
§ Regional governments → exert a strong influence → key enterprises (whether they have been formally privatized
§ Cash-flow diversion → taxable revenues reduce → regional governments collect revenues and control it

4. Barter and arrears as tools of control
Barter → nonpayment and non cash settlement
§ Preferential tax treatment
§ “discount” on utility bills
§ preferences in public procurement

5. Need for selective ownership transformation
Three critical problems in relying upon bankruptcy procedures to initiate ownership transformation:
§ Creditor coordination is difficult to sustain
§ The capacity of the judicial system is limited
§ Bankruptcy is disruptive

Any transaction aimed at restructuring ownership must apply with two requirements:
§ Acquired equity must be simultaneously sold to external investors
§ Resulting shareholdings must be sold in a way that involves some degree of competition among prospective investors

Dilemmas on ownership mechanism
§ Simultaneous conversion of debt to shares and the sale of the resulting shares can be accomplished only if there is only a priori investor interest in the share purchase
§ If the investor interest is needed before a conversion can take place, this will preclude a competitive auction

Ownership transformation would accomplish three necessary reforms:
§ It would transfer a cash payment to the regional authorities
§ It would allow coalitions of outside investors to dilute the ownership of insiders
§ It followed up with a coherent program of supporting social reforms

Objection
§ Ownership transformation is an easy exit for managers, but it is not
§ Ownership transformation would be applied only to steps debt

Japanese Patent Law Favors Employed Inventors

1. Abstract
Nichia in 1999 and filed his first lawsuit claiming ownership to the patent
§ Japanese courts → Pre existing agreement between Nichia and the inventor → transfer his patent rights if any invention to the company
§ Nakamura, the former employee, was still eligible a reward

2. Content

Many American companies have subsidiaries in countries whose patent laws favor employed inventors
§ An inventor's corporate salary is considered fair compensation for any inventions created during a term of employment, and also in Japan
§ Japanese Court → prevent → bonus → deemed unreasonable → profit by employer

In January 2005, Nichia settled its dispute with Shuji Nakamura over a patent for blue light-emitting diodes
§ Nakamura → awarded 20 billion yen ($190 million) by the Tokyo District Court in January 2004
§ Received a 20,000 yen bonus (less than $200) from Nichia when the firm filed for a patent in 1990
§ No clear-cut provisions in its employment agreements regarding ownership of patent rights

Nakamura left Nichia in 1999 and filed his first lawsuit claiming ownership to the patent
§ Seeking "reasonable" compensation for his transfer of patent rights
§ The inventor won this round of litigation and was awarded 20 billion yen
§ Nichia subsequently appealed

Japanese companies have since lobbied the legislature to modify Japan's patent law
§ amount of reasonable remuneration → calculated based on agreements between companies and individual employees ↔ on court decisions or court-imposed formula

American inventor compensation laws
§ Employers are not required to give employee-inventors fair compensation for the value of their inventions beyond their salary
§ When an employee resides abroad, however, U.S. patent law may not apply

American companies with overseas subsidiaries should take steps to prevent foreign employee-inventor disputes
§ Firms should create clear rules regarding patent ownership and a system to provide for fair remuneration for inventions created by their employees
§ Firms should make an honest effort to fairly evaluate an invention's worth and compensate employees accordingly, documenting how the assessment was performed

Japanese Patent Law Favors Employed Inventors (Journal)

Abstract
[Shuji Nakamura] left Nichia in 1999 and filed his first lawsuit claiming ownership to the patent. In September 2002, the Japanese courts held that there was a pre-existing agreement between Nichia and the inventor that he would transfer his patent rights to any inventions to the company. However, the court held that Nakamura was still eligible for a reward under Article 35. Nakamura filed suit again, this time seeking "reasonable" compensation for his transfer of patent rights.

Full Text
Copyright American Institute of Chemical Engineers May 2005
Many American companies have subsidiaries in countries whose patent laws favor employed inventors. The recent ending to a long-running dispute between Nichia Corp., a closely held Japanese chemical company, and a former employee, Shuji Nakamura, dramatically illustrates a major difference between U.S. and other national patent law systems with regard to employed inventors.
In January 2005, Nichia settled its dispute with Shuji Nakamura over a patent for blue light-emitting diodes, the last of the three LED types necessary to enable the creation of all other colors in display panels, green and red LEDs having been discovered years earlier. Nakamura was originally awarded 20 billion yen ($190 million) by the Tokyo District Court in January 2004. The final settlement of 843 million yen ($8 million), which was mediated by the Tokyo High Court, is the largest ever in Japan as compensation for an invention by a corporate employee. Nakamura initially received a 20,000 yen bonus (less than $200) from Nichia when the firm filed for a patent in 1990.
In the U.S., an inventor's corporate salary is considered fair compensation for any inventions created during a term of employment. Many companies offer a nominal bonus as an incentive.
In Japan, companies have also awarded nominal bonuses for patents obtained during employment. However, the Japanese courts have ruled that Patent Law Article 35 voids any provision in an employment agreement if the compensation originally given is later deemed "unreasonable" in light of the profits obtained by the employer.
When Nichia filed for a patent, it claimed that it had no clear-cut provisions in its employment agreements regarding ownership of patent rights. In the eight years following the device's commercialization, Nichia's annual sales revenues rose from just over $190 million to more than $760 million, of which about 60% was attributed to blue LED products.
Nakamura left Nichia in 1999 and filed his first lawsuit claiming ownership to the patent. In September 2002, the Japanese courts held that there was a pre-existing agreement between Nichia and the inventor that he would transfer his patent rights to any inventions to the company. However, the court held that Nakamura was still eligible for a reward under Article 35. Nakamura filed suit again, this time seeking "reasonable" compensation for his transfer of patent rights. The inventor won this round of litigation and was awarded 20 billion yen, a ruling that Nichia subsequently appealed. Because of the high costs associated with maintaining the appeal, Nakamura settled the case.
Japanese companies have since lobbied the legislature to modify Japan's patent law so that the amount of reasonable remuneration is calculated based on agreements between companies and individual employees rather than on court decisions or court-imposed formulae. Amendments to Article 35 are currently under consideration and are expected to become effective in April 2005; however, they maintain the "reasonable remuneration" standard, thereby forcing companies to handle this issue with continued uncertainty.
American patent law differs greatly from the law in Japan and other countries with inventor compensation laws. Employers are not required to give employee-inventors fair compensation for the value of their inventions beyond their salary. Generally, state common law governs how inventors are compensated.
Absent an agreement, employers own the inventive output of employees who are hired to invent. If a non-R&D employee invents something closely related to the employee's duties or uses the firm's resources, the firm and employee share rights to the invention. If the employee invents something unrelated to his or her duties or without the employer's resources, the employee typically owns the invention outright. Employers can generally acquire ownership rights to inventions made under the latter two scenarios through pre-invention assignment agreements.
Eight states (CA, DE, IL, KS, MN, NC, UT and WA) have enacted "Freedom to Create" statutes. These laws preclude enforcement of any provision in an employment contract that purports to give an employer ownership of an invention that was developed entirely on the employee's own time, using none of the employer's resources.
When an employee resides abroad, however, U.S. patent law may not apply. Thus, American companies with overseas subsidiaries should take steps to prevent foreign employee-inventor disputes.
First, they should create clear rules regarding patent ownership and a system to provide for fair remuneration for inventions created by their employees. New employees should be given these rules and asked to sign an acknowledgment stating that they are aware of the rules and waive any rights to ownership to any invention that is related to the company's business and/or developed on company time using company resources
Firms should make an honest effort to fairly evaluate an invention's worth and compensate employees accordingly, documenting how the assessment was performed. This will help prevent future disputes and demonstrate good faith if a dispute should arise.

Discussion of Separation of Ownership from Control and Acquiring Firm Performance: the case of Family ownership in Canada

1. The Theoretical Background
Announcement of mergers and acquisitions
§ Not wealth creating → transfer wealth from shareholder of bidder to target
§ Do pay for both sides
§ Not all mergers and acquisitions give long term negative return
Ben-Amar and Andre
§ Relating ownership structure → performance of bidders on announcement date
§ Review detailing cost and benefits of ownership
§ In Canada, Firms are closely-held mostly by families
§ Family ownership mitigates the agency conflicts as families are long-term investors and they are concerned with the wealth transfer to the next generation

2. The Data and the Methodology
Ben-Amar and Andre
§ 327 mergers ands acquisition announcements → by 232 Canadian → 1998-2002
§ Only completed mergers → acquisitions of majority interest
→ sample selection bias as non-completed mergers
§ The announcement dates are subject to a confounding event that may effect their methodology

3. Empirical Evidence
Boom (1998 to March 2000) ─ Bear (April to 2002)
Family Controlled Firms
§ Smaller
§ Average board size is 8.92 (median 8.0) → smaller
§ Domestically listed company (for general) → smaller
§ Rely on internal financing to finance their acquisitions
§ Faster return

Non-family Controlled Firms
§ Bigger
§ Average board size is 10.06 (median 9.0)
§ Cross-listed company (for general) → bigger
§ Less likely to use cash to finance acquisition → issue equity and bond
§ Slower return

Risk of Business

Company type : Manufacture Company
Company name: Maesindo Indonesia .ltd

Information
This company produces some goods that use papers and plastics as the raw materials. Its products such as skull-cap (peci), polybag (plastic bags), catoon, etc. This company actually is a big company but it is not really well-known because it is operated in a small village in Bantul, we usually call it Kasongan. This company also has not become a multinational company yet.

Risk of That Business
Risk from inside
1. Production Delay
In manufacturing company, there should be orders from customers. Customers usually give some time limitation to the factory to produce thing that they need. If the factory agrees to fulfill the customers’ needs, the factory should be able to produce the order on time, it means no late. The risk that they might face is production delay. This risk can be happen; first, because of the machine. Factory always use some machine in producing their products. There must be some people that watch the condition and the work of the machine.
Even there are some people those are given a responsibility to the machine, there could be something broken in the machine that is slipped to be watched by those people; Second, human errors can be happen in that kind of factory. In the factory, even there are some machine used, there should be people that do the job that cannot be done by the machine. More people do that job, more chance also for the broken products there. Those two reasons are things that I found in the factory that can make a production delay.
2. Defective Products
As what I have mentioned above, there must be human errors in the production process. In a production process, for example if the customer needs 5000 pieces of the products, the factory will produce more than 5000 pieces. It is used to cover the defective products that could be there. I think it is not efficient because the cost that they spend will be higher than it used to be. It seems like the factory cannot control that defective products and cannot move away from that risk. I think this risk is controllable. It is depend on the people inside the company itself.
This risk (defective products) could be happen because of the machine also. For example in Maesindo Indonesia, there is a big machine that draws some color picture to the skull-cap. What really happen in the factory is the machine is not always does a good job. Sometimes the color that printed by the machine is not good. There are some white dots in the color. It is counted as defective product. Those are risks that could be faced by the manufacturing company from inside of the company.

Risk from outside
Basically I can say that risks from outside the company are uncontrollable but the company can do something to minimize the risks. There are many risks that come from outside the company, such as earthquake, ships drowning, flood, car crash, customers’ denial, incomplete papers, etc. Those risks seem like they cannot be happen or they are very difficult to be happen, but I think those risks might be faced by the manufacturing company.
For example ships drowning. That risk can be happen uncontrollable. Even the manufacturing company has designed everything well, if the wind is very strong suddenly in the shipment process, the ship could be drowning and the company will loose everything. Another example is flood. A view times ago, there is flood happen in Ngawi. If the company’s truck need to pass through Ngawi to deliver the products to Bali, that will make a delay arriving products for the customers. When the products arrived, the customers do not want to accept the products or they just want to pay half of the payment. This risk sound impossible, but is happen in Maesindo Indonesia. Those are the risks that the manufacture company might face from outside the company.