Tag: finance

Performance-based pay plans for corporate executives are becoming more popular as stockholder activists and board members demand more accountability. Gopalan, tells Nicklaus,”that’s a big step forward from the days when insider-dominated boards often handed out discretionary bonuses based on little more than a desire to keep the big boss happy.” Gopalan also notes that the executive labor market has become more competitive.

Link to article: “It was a good year for St. Louis CEOs, but not for all of them”

In another column, Nicklaus predicts executive pay could become a hot political issue in 2018. A new rule under the Dodd-Frank Act goes into effect next year that requires “companies to compare their chief executive’s pay to that of an average worker.”

Professor Gopalan says the ratio doesn’t have much merit. “It will give political fodder to politicians who don’t like corporations, but I don’t think it’s an economically meaningful number to focus on,” he says.

Link to article: “Pay ratio will be hot political issue next year”

With pension payouts skyrocketing, tax credits expiring and the inability to pay operating expenses, Puerto Rico filed for bankruptcy protection May 3. The U.S. territory owes an estimated $73 billion to assorted creditors, including Wall Street firms. This makes the bankruptcy the largest-ever American municipal debt restructuring in history.

A senior lecturer in finance at Washington University in St. Louis’s Olin Business School says the situation should serve as a dire wake-up call to the municipal bond market.


“Earlier this year, when the bankruptcy of the fictitious town of Sanidcott became the subject of the hit Showtime series ‘Billions’, I knew we had reached a new low point in the municipal bond market,” said Rich Ryffel, who advised governments, corporations and more about financing and capital structure in his 30-year career in investment banking and asset management. “So common had the once-unheard of notion of municipal bankruptcy become, that it would now be understandable to the television audience and fodder worthy of acting out on the small screen. Well, now the folks in Puerto Rico have given us an even better subject.  Reminiscent of CSI Las Vegas, CSI Miami, CSI Whatever, we now have – Municipal Bankruptcy: Puerto Rico.

“Puerto Rico has become the U.S. municipal bond market’s own little Greece, seeking from the courts what it could not find the will nor the way to do on its own; change its profligate ways and pay its creditors.  Its move to the courts lowers the recovery floor in its negotiations with creditors and gives it remedies heretofore unavailable… . Years of preferential tax and trade treatment failed to create an island economic paradise, so after seeking new assistance from Congress last year, Puerto Rico is now adding itself to the list of those expecting others to suffer the hangover after they they enjoy the bender; think Greece, Argentina, Wall Street.  Where does this end?”

Ryffel says the long-held assumption that governments could repay their debt has eroded, and that’s changed the playing field for lenders.

“Not that long ago, the municipal bond market used two standards when considering whether to open the lending tap to borrowers — one’s ability to pay and one’s willingness to pay,” Ryffel said. “The first threshold was fairly easy to assess. The second was always more difficult to gauge — being more qualitative in nature — but it was assumed that governments would only borrow what was needed to provide essential public services and would take all necessary means to repay its obligations. Default, let alone bankruptcy, was a remote thought.

“Now, however, we see with growing and concerning frequency borrowers treating repayment as optional, as the redemption provision in their bonds themselves. The problem is that the markets depend on this second lending standard and as it erodes, the availability of municipal credit will both shrink and become more expensive for all market participants.”

The Puerto Rico bankruptcy dwarves that of Detroit, which was previously the U.S.’s largest municipal bankruptcy. The city filed for Chapter 9 protection in 2013, with $18 billion in debt. While studies are underway to assess the impact of Detroit’s financial woes, Ryffel says the Puerto Rico situation could send even more shockwaves, not just because of the amount owed, but also for the way it could change laws allowing massive debt forgiveness.

“Puerto Rico may have even larger impacts on the market because they have not only moved to the Doomsday scenario, they successfully had law changed to allow them to do so,” Ryffel said. “In essence, they not only started the markets down the slippery slope, they had a slippery slope built for them.

“To be fair, Puerto Rico is only doing what they need to do to protect their citizens, and they have used every tool available to them. One can’t blame their leadership for that.  While there may not be enough money to go around, there is plenty of blame to go around.  Healthy portions of it go to prior administrations which borrowed without a plan to repay and which borrowed to pay operating expenses rather than invest in the future. Still too, blame must also go to the municipal bond markets, which for years knew of Puerto Rico’s increasing lack of ability to pay, yet still lent it money.”

Guest blogger: Erika Ebsworth-Goold, WashU’s The Source


“Right now, I think the increase in CEO pay is more stock market driven than profit driven,” said Radhakrishnan Gopalan, Olin associate professor in finance told NBC News in response to a new study from the Wall St. Journal on CEO compensation.

“The stock market is rising in anticipation of future growth in profits,” Gopalan said. “The stock awards, which are basically what’s driving the growth in CEO pay, are mostly a motivator for future performance.”

This kind of forward-looking optimism is typical of a stock-heavy incentive structure, but some warn this can be an imperfect way of measuring performance, since bull market gains aren’t matched proportionately with bear market losses.

Unfortunately, they never retrench,” Gopalan said. “That link is weaker on the down side.”

Link to NBC story here.

Watch video about related research on CEO compensation from Prof. Gopalan and Prof. Todd Milbourn that won the Olin Award in 2016.

Todd Gormley, Associate Professor of Finance, comments on OpenInvest, a new fintech venture that focuses on “ethical investing,” and uses algorithms to determine which firms to invest in.

“The key idea is you’re just trying to get the return of a wide set of firms without trying to pick which ones you think are going to perform better,” says Professor Todd Gormley from the Olin Business School at Washington University, St. Louis. Passive funds, like the portfolios built by OpenInvest algorithms, are the “new normal” because they’re less expensive for investors, and there’s no real evidence that actively managed funds actually do any better, Gormley continues.

Link to article “This Man’s Algorithms will Manage Your Money — With a Conscience” published Jan 19, 2017 on Ozy.

Prof. Gormley

Prof. Gormley

Professor Gormley’s most recent research has analyzed the impact of passive institutional investors on both firms’ governance structures and the strategic choices of outside activists.

Link to his faculty page.




Video, above: Professor Panos Kouvelis, Emerson Distinguished Professor of Operations and Manufacturing Management and Director of The Boeing Center for Supply Chain Innovation at Washington University speaks about his research on managing commodity price volatility in the supply chain in the latest Boeing Center digital production.

When commodity prices are stable, firms usually agree upon fixed wholesale price contracts, quantity discounts, buybacks and even some revenue-sharing schemes. But in volatile commodity price environments, annual price volatility can be as high as 60%, resulting in the need for escalation clauses and adjustable contracts. High volatility may even create situations where vulnerable suppliers fail to meet contractual obligations.

The focus of the new research is to find ways to better manage risks for such environments through using the right contracts and when it is appropriate to use financial hedges. One example of contracts often advocated for in such cases is the pass-through, or index contract, which is used to describe how the supplier will pass some of the increased material costs down to the buyer. These contracts can be effective as long as the downstream buyer is “big” enough to absorb the risk or has financially hedged such risks appropriately.

Pass-through contracts have not been viewed favorably by the corporate finance community. For example, environments of perfect markets with no financial frictions can be dominated by the so-called “coordinating contracts,” such as revenue-sharing or two-part tariff contracts.  Coordinating contracts achieve “first best” (i.e., the same profit as a single firm owning and running the whole supply chain), and with appropriate setting of their parameters, can coordinate the commodity risks for short lead-time environments.

Long lead-time environments create the need for appropriate penalty structures on top of such contracts, a feature not mentioned in the current literature, but elucidated in Kouvelis’ research.  However, in an environment of financing frictions (e.g., firms have limited working capital and need to borrow to execute their supply chain transactions), the coordinating contracts might be ineffective in the handling of financing costs.

In many cases, a pass-through contract with a downstream buyer that hedges commodity risks can be more effective. These situations are common when under capitalized suppliers with good margins contract with larger buyers in high volatility price environments, such as the auto, appliance, and aerospace manufacturing settings.

To learn more, read the abstract from Prof. Kouvelis’ paper below, or download the paper HERE.

Paper title: “The Role of Pass-Through Contracts in Environments with Volatile Input Prices and Frictions”
Authors: Panos Kouvelis, Danko Turcic (Olin), Wenhui Zhao, Shanghai Jiao Tong University (SJTU) – Antai College of Economics and Management

We model a bilateral supply chain with stochastic demand, stochastic input costs, production lead times, and working capital constraints. The supply chain participants contract as follows: Either they use the pass-through contract under which the upstream supplier passes her entire commodity input cost onto the downstream assembler, or they use an appropriately adapted revenue sharing contract under which the firms split both the production costs and the operating revenues. In the absence of financing needs for either firm, the pass-through contract is dominated by the revenue sharing contract – even if downstream buyer hedges all input costs. However, when working capital limitations drive financing needs in the chain, the financial frictions break the coordinating nature of the revenue sharing contract, and the created double marginalization inefficiencies and financing costs for firms with differential working capital and financing needs weaken the profit performance of the contract. Pass-through contracts do dominate revenue sharing ones when there are low (or no) working capital suppliers. Hedging behavior can be justified even in the absence of financing frictions for pass-through contracts, and it only involves the buyer. Hedging behavior in revenue sharing contracts happens when financing is needed, and either firms both hedge, or neither hedges, all commodity purchases in the supply chain. Double marginalization inefficiencies versus financing costs are the main factors in determining the effectiveness of the contracts, with financing cost dominated environments favoring the pass-through contract.

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