Tag: finance

“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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FinLocker provides a secure financial data and analytics platform and works with mortgage lenders to reduce borrower frustrations and lender costs associated in getting a mortgage approved as fast as possible, while increasing certainty for investors. FinLocker accomplishes this by electronically capturing and analyzing borrower data such as employment, income, assets, credit, and other information. Consumers are able to share their financial information without worrying about that information being compromised. FinLocker provides greater certainty to lenders while reducing costs, risk, and potential fraud.

FinLocker has asked the CELect team to determine how it can leverage its technology to aid lenders in areas other than mortgages.

Our team is working with FinLocker to determine which area will provide the best opportunities and make the greatest impact for FinLocker, lenders, and investors. In order to accomplish this, our team will research different types of loans (student loans, auto loans, personal loans, rental, consolidated loans, small business loans, and peer-to-peer lending), and determine which is most attractive. Once we determine which type of loan is most attractive, our team will learn exactly how FinLocker can add value to lenders and investors for those loans.

finlockerOur team is thrilled for the opportunity to work with FinLocker and its experienced team. We are thankful for this real world experience through Washington University in St. Louis’ Center for Experiential Learning and are excited to be a part of FinLocker’s efforts to change the lending landscape.

CELect Team: Mike Manovich, Law; Cole West, BSBA; Tyler Combest, Law; David Allston, MBA

During the McDonnell International Scholars Academy symposium session on “Asset Building for Retirement Security,” we were presented with the examples of the Australian and Singaporean social security systems.

Even though both systems are highly praised, I was surprised to realize that the discussion offered a counter-intuitive dynamic. While Australia was optimistic about the shift towards individual accounts and a lower fiscal burden, the presentation regarding the case of Singapore –a highly praised social security system– focused on the problems of lack of transparency and consistency in the public policies of the country across time. It seemed like there existed some consensus that countries should be moving towards the individual account system (in any of its many flavors), given the current situation of higher longevity and decreasing birth rates.

But there is one key aspect of the discussion and the implementation of this new system that was not emphasized enough. That is, the role of expectations. When presenting a system like this to a country, the public usually cares about one particular variable: How large is my pension going to be?

An Individual Account Pension System sets the final pension as a percentage of the salary each individual received before retirement (called pension replacement rates). In particular, the Australian superannuation system is expected to achieve a replacement rate of 65% by 2050. And this is indeed very promising. But what if it doesn’t?

One of the characteristics of this system, contrary to what happens in a government-funded retirement scheme, is that the true replacement rate will only be revealed after 30-40 years of its introduction (once the first young beneficiaries retire). At that moment, if the initial promise is not met and pensions turn out to be too low, this will cause a great deal of social unrest and put pressure on the fiscal budget (the very situation this system is trying to avoid).

Achieving high replacement rates is intimately tied to a formal and efficient labor market. If people stop contributing to their funds for extensive periods of time (either because they are self-employed, unemployed or work in the informal sector), their accrued wealth will be dramatically diminished.

While admittedly Australia shows low unemployment rates and little difference between male and female rates, this is not the case in many countries, especially in the developing world. Hence, transparency about the inherent risks of this type of pension system, as well as acknowledging that the government will probably have to step up to provide minimum pensions is key. This will anchor expectations and provide a more accurate cost-benefit analysis, which will reduce the likelihood that moving towards this system will turn out to create a future liability.

 Photo by Mary Butkus/WUSTL Photos

Photo by Mary Butkus/WUSTL Photos

Guest Blogger: Rodrigo Moser, McDonnell Scholar and Olin PhD student in Finance.

The McDonnell International Scholars Academy provides the network with which Washington University in St. Louis incubates new ideas and mentors future leaders. Through our partnerships, we lead groundbreaking research projects and prepare our Scholars to be effective leaders in a global community.

Read more from the McDonnell Scholars