Does Finance Benefit Society?



good evening everybody I'd like to welcome you all to this lecture which is the fifth in my lecture series on how business can better serve society and I think business's responsibility to society should be very evident today we've just recently had the extension of the rebellion movement we had greta thunderbird highlighting two MPs the importance of taking action on climate change she expressed the concerns that businesses have mortgaged the country's future in their pursuit of short-term profits and I'd like to welcome those of you who supported my lecture series right from the very first one have come to every single one but also to welcome those who are here for the first time I believe we also have some guests here as from as far away as Chicago and outside there are transcripts of all the prior lectures so if this is of interest and if you want to see what I covered in the previous four ones you can see the transcripts either outside or on the web but each lecture will be self-contained so don't worry if this is your first one I will make references to the early ones but I I won't rely on what I said previously so what are we talking about today the general lecture series is on business should business companies serve society better I'm going to focus on one particularly controversial element of business which is the financial services sector and that sector is worth 119 billion pounds that was how much the sector was worth in 2017 you might think well that's a massive number but how do I compare this to other things but this 119 billion that is three times as large as an either France or Germany those are also large economies one might argue that they might be even more successful than the UK so why is it does the that the UK has such an outsized financial sector because the resources that we are allocating to that sector could go elsewhere what does citizens welfare depend on might depend on things such as food or clothing or medicines goods that people consume but the financial services sector doesn't produce any goods well clearly we benefit from services as well and one could argue that bank accounts and credit cards they do help us but a large part of the financial services sector might go on things such as mergers and acquisitions share buybacks those are not things that clearly benefit consumers and also this might not just fail to create value for society but it might actively destroy value for society by reallocating resources from elsewhere it might suck the nation's best talent to work in finance rather than these other occupations such as medicine if you just look at the salaries that people earn for an entry-level investment banker starting your job you're charting your career at age 21 you earn 72 thousand pounds on average that is over two and a half times the national median wage and that's with somebody at all stages of their career here just starting out you're earning two hundred and fifty percent of the average man or woman and after ten years that rises to three hundred and twenty nine thousand and even that is a small number we've heard stories and these are not just isolated cases of bankers and traders earning millions of pounds so if some of the nation's top talent is being sucked into finance and away from these arguably more productive industries that is a concern and that's why they will indeed a lot of rebellion and revolt about the current state of the capitalist system and indeed there was a recent study which was referred to in the independent and other newspapers claiming that the UK economy lost out on four point five trillion pounds because of too much finance let me just read verbatim the finance curse sucks talent and investment from other industries costing sixty seven thousand five hundred pounds per person over the course of two decades so this might suggest that your wealth has declined by over twice the median wage because of too much finance but as you might know if you've attended my lectures previously what are there's two themes that I try to draw out from every lecture the first is to be discerning about evidence so we can't take everything that we see at face value it may well be that certain things like this which have large shock value four point five trillion finance is too big they might get a lot of attention because they're so shocking and they also do seem to support what people would like to believe people like to believe the finance sector is too large and maybe the education sector is too small but let's try to critically analyze what actually went into this study one of the things I tried to stress is that we really want to try and draw from the very best peer-reviewed evidence where it's been scrutinized so that we know that the methodologies are very state-of-the-art what they did here is when they're measuring the financial services sector what they only look at in terms of the size of the sector is the amount of private credit which is lending but an important part of the financial services sector is not just lending money but investing in the stock market in particular the pension industry which is really important not just for rich people but for ordinary citizens saving for retirement that is not considered in this number but that's a way which allows ordinary people to share in the benefits of the growing economy by investing in shares through their pension and even if they measure this correctly well what did the study actually do what they looked at was they looked at different countries the size of the financial sector and the size of the overall economy and what they showed is are up to a point the larger the financial sector the larger the economy but as with everything there is an optimal point and once you go past that point when the financial sector becomes too large the economy becomes smaller and the concern here is that the UK is past that optimal point its financial sectors too large but that I do assumes that that optimal point is the same for every country well it might be different because different countries specialize in different industries so maybe the UK doesn't have a comparative advantage in manufacturing or an agriculture but maybe they do have a advantage and say insurance or pension funds and so maybe it does make sense for the UK to have more financial services and also as we know correlation does not imply causation if indeed certain countries are doing worse is that because of a larger financial sector or something else while if we were to look at who are the fastest growing economies in the world today they might be Asian countries does that mean that we should all start speaking Chinese does that mean that the UK economy has lost too much because of too much English being spoken clearly not like there's many other reasons for why Asian economies might be glowing other than the fact that they speak different languages so this is not a conclusion that we can immediately jump to what's interesting is that when you actually read the study they are to the credit of the authors more circumspect they say we should caution that any estimates will always be approximations other approaches could lead to different results but the headlines will never talk about those caveats because it's looking very nice to try and come up with this shocking finding now by saying what I just said this is not to be an apologist for finance I'm going to conclude at the end of the lecture there are many things that can be improved in terms of Finance serving society better but as I've said in fire lectures diagnosis precedes treatment before finding the optimal solution to a problem we need to effectively diagnose it and there are some studies where actually the diagnosis might not be correct so I talked about two themes and all of my lectures one of them is to be discerning about evidence and the second is the difference between the PI growing mentality and the PI splitting mentality what do I mean by this so one concern that people have is well let's say that the amount of resources that we have the amount of talented people the amount of buildings that could be either banks or hospitals that's fixed and so if we compare these two points for those who can't see the actual text the blue represents finance and the orange represents other sectors and so we think well there's only a fixed amount of resources to go around then the large of the financial sector the large of the blue then the smaller the orange what if somebody works as a banker she could not be a pediatrician what you could only do one of those two jobs simle if a building is used to be a bank that building could not also be a hospital and so under the view that there's a fixed amount of resources maybe we should be concerned about a large financial sector because if the pie is fixed it takes from other week other sectors like medicine but the question is is the large financial sector the consequence of pie splitting taking resources away from medicine or education and clothing or is it a product of growing the pie so by the financial sector becoming larger does that allow small businesses to be financed does that allow pensioners to save for retirement I didn't press anything so if you could get great it doesn't allow small businesses to be financed does that allow all the things and is this something which is pion large and the questions is not clear let's look at the evidence there will be evidence for both sides of this debate which is why my position on this is circumspect but why highlight this is that a large financial sector that one one nine billion number might not be at the expense of every everything else but might be as a by-product of serving those other sectors by allowing small businesses to grow and pensioners to invest and indeed there is a lot of research showing that this idea of lending money to companies or financing companies through things like venture capital has substantial effects on a nation's economic growth perhaps one of the most famous and cited papers is by two chicago professors Raghu Rajan who used to be the governor of the Central Bank of India and Luigi Zingales called financial dependence and growth what they looked at was they looked at fast growing industries in different countries and those countries differed by their level of financial development and they found that the same industry grew much faster in countries with a more developed financial sector than those without suggesting that a more developed financial sector does help in terms of helping these fledgling companies to grow this is what leads to an entre Noire with a dream embedding that dream into a vision into a reality and turning that into a company that's what allows a small company to get scale and to grow and then to become something large which might be benefiting large numbers of citizens so there's a lot of research on the benefits of an efficient banking system of a financing helping investment of financing helping growth at a country level and therefore it's not surprising that a lot of government policy is trying to encourage financing particularly for small business in the UK you all probably know about the enterprise investment scheme which are tax efficient ways to invest in Flushing companies so I support through this scheme a bakery which tries to promote disadvantaged women I also support a coffee company new ground coffee which will try to hire ex-convicts so they'll try to rehabilitate them within society the bakery by the way is called luminary which helps disadvantaged women and those are ways in which I can support them through the scheme there's also the Madeline provision in France which does something similar and there's also invest in Germany that tries to encourage the financial sector to fund new companies and some of you will know that the UK government published this industrial strategy white paper where a cornerstone of making the UK more competitive is to allow greater access to financing for these small businesses so if you took that at face value you might think well finance is really good but as I'm trying to stress why there's no nothing is black and white they're shades of grey so just like we can't take this at face value we also shouldn't take these arguments that face from you because even though this is based on really good research showing that providing new financing helps companies and helps countries and help citizens there is one big catch what is this big catch is actually in the UK a huge amount of financing activity is negative what do I mean by this now when we think about financing helping companies we think about companies raising new financing so it could be that a company like uber is considering this right now they're considering going to the markets and raising new funds however actually a lot of the activity is the reverse of that companies actually spend a lot of their money buying back their shares from investors so rather than raising money from investors they're buying back their shares from investors and that's something known as a share buyback and if you're just to look at this graph that will show you of what people are concerned about again for those of you who can't see the text the blue is the amount of share buybacks the pink is the amount of new share issues and the gray here is the pink – the blue so that is how much net share issuance companies are doing within the UK that's how much they're raising versus how much they're buying back and the striking thing about this figure is that in many many years this is negative right other than oh nine and fifteen in every year this seems to be a negative and so that's address but the stock market is not doing its job it's sucking out even more money from companies then it's injecting and therefore it's not surprising at all that people are very concerned about the use of share buybacks within the UK the UK government launched an inquiry into the potential misuse of share buybacks and in the u.s. they're also concerns and what's really interesting is that this is one of the few topics which is united both Democrats and Republicans so senator Rubio who's a Republican has proposed cracking down on share buybacks and senator Elizabeth Warren has also proposed crackdowns she argues that stock buybacks create a sugar high for corporations it boosts prices in the short run but the real way to boost the value of a corporation is to invest in the future and they are not doing that why well what the argument I said to you earlier is finance benefits because I raise money and I use that money to hire workers I use that money to invest but instead I'm if I'm not raising money I'm paying money out then I must be investing less I might be paying for your wages I might be firing people so that's everything in Reverse and this seems to be supported by evidence so professor William mazanik said that 91% of net income goes to buybacks and dividends that left very little for investments in productive capabilities or higher incomes for employees so in order to satisfy these investors the stock market companies are starving their funds their CEOs are starving their companies of funds for investment and that is a big problem well why might I see you want to do that it seems strange that you want to hurt your own company by starving it from in of investment employment why might a CEO do this well let's look at an example let's look at the health insurance company Humana now in 2013 that a pretty good year they earnt 7 dollars and 73 cents per share but 2014 that wasn't such a good year the earnings were seven dollars and 34 cents who's that bad for well that's bad for the shareholders of Humana who remember they're not just nameless faceless capitalists these could be pension funds saving for retirement it could be a university endowment so that's bad for them but it was also bad for this guy this guy was the CEO called Bruce Broussard why was he so unhappy that earnings per share were only 734 because he had a huge bonus target of $7 50 he hid this bonus target he would get a big payday and because the earnings were so low at 7:34 he wasn't getting his payday so what did he try to do well one thing you try to do was manipulate earnings so you want you can do by chain your accounting policies and sort of cooking the books you can change how much revenue you report and this is why people had concerns with say patisserie Valerie more recently is that what they were stating was the case wasn't true so he tried those tricks he changed the accounting policies got it all the way up to seven dollars and forty nine through doing this but not quite they're still not getting his payday so what was the final thing you did it was a share buyback how does a share buyback work well when you're buying back shares the number of shares that are outstanding are lower earnings per share its earnings divided by shares so if there's fewer shares because you've used the company's money to buy them back your earnings per share goes up and that's what happened $7 50 were honey you did exactly the right by bat to get himself a big payday one point six eight million dollars despite performing poorly on the actual thing he should have been focusing on which was providing health insurance it was cooking the books and then buying back shares which got him that money and so what is the general problem here I've alluded to this previously but I want to get everybody on the same page in case this is new to earnings per share is something that managers are often evaluated according to earnings divided by shares and there's potentially good reasons for why this is something that investors and boards and perhaps even employees might use to try to see how is their chief executive doing why is that reasonable what are earrings that's your revenues minus your costs what could a good CEO do well she might boost the revenues here's revenues in a large large font or she might cut unnecessary costs cost some small font and so if you indeed boost your earnings per share by increasing your revenues or cutting some unnecessary costs yeah you should be rewarded for it and that's why Bruce Broussard was given this 7.50 earnings target but there's a catch and the catch is that the other way you can increase your earnings per share as you don't bother out changing the revenues don't bother about cutting costs just reduce the number of shares outstanding by buying back shares and you get this big payday so that's why this could be misused rather than investing and hiring people you use finance not to benefit society that's the title of this lecture you use it to benefit yourself and so what we have here is the share buybacks potentially shrink the PI by using money and using this to payout rather than invest the whole PI shrinks but executives take more of the PI so what I have here is the same PI's before now the blue is what the CEO takes the orange is what society gets and here the CEO is getting more of a smaller pie that was what the 1.6 8 million pounds was so even though the value of the company may have fallen blues didn't care why because he's gotten bonus now let's look at this argument critically because if this was true and if this was true in every single case we should be really concerned with share buybacks we should perhaps prohibit them and outlaw them they're a way of manipulating your earnings in order to get yourself a bonus but remember one of the hallmarks of these lectures is we want to look at large-scale evidence not what happens in one individual case and so what I want to do here is I want to look at many of the concerns that people have about share buybacks and to evaluate them critically and let me stress this is not to be an apologist for share buybacks at the end of the lecture I'm going to acknowledge that they do need to be changed and reformed but again the correct reforms depend on diagnosing them properly and one common concern that people have is that buybacks are a free gift to investors rather than investing within a company you pay them out to shareholders and indeed a prominent newspaper article called this a fifty three billion dollar gift because Trump tax reforms made buybacks easier but it's very important to note that share buybacks are not a gift if I'm a company and I'm engaging in the buyback I'm giving you the shareholders money but in return you're giving up your shares all a share buyback is is somebody selling their shares I'm selling their shares back to the company they're neither gaining or losing yes they have money in their back pocket but they no longer have their shares it's a bit like let's say you've got a mortgage if you've got a mortgage maybe one month you might decide to make an overpayment now the overpayment of your mortgage that you've made is not a free gift to the bank you're not giving the bank a charitable donation here you're giving them money but they've reduced their claim on your home in the future and that's the same with a binder I'm not gonna go through all of these points I wonder as always leave enough time for questions afterwards let's go back to Professor Liu's Onex argument which is 91% of net income goes to buybacks and dividends that left very little for investments in product of capabilities or higher income from in for employees that statement and that evidence is very widely quoted and that seems a smoking gun because of buybacks companies are investing nothing like virtually every penny they're making or 91 pence of every pound goes to be paid out to all shareholders but this statistic makes an extremely basic error because net income or profits that is already calculated after deducting what you've already paid to workers and after deducting what you've invested in many forms such as research and development and advertising through the idea that you're not investing any of this money makes no sense because the investment has already taken place before you've actually calculated your profits is a bit like saying the kids had nothing to eat because their plates are empty right their plates are empty because they've already eaten and that's why they are empty so that's just the same as the argument they're making here but again people don't scrutinize this argument even that makes this very basic mistake because it seems consistent with the popular belief that everything about this is evil now the final point here is perhaps the most nuanced you think well if a company is profitable if it's made a lot of money shouldn't that money go to not just shareholders but stakeholders shouldn't you give the employees a pay rise or maybe invest in reducing your carbon emissions and so on now if accompli successful it's clearly never just out to investors or CEOs your workers worked very hard and this is why I think it's critically important and this has been a theme of all my lectures that stakeholders benefit what do I mean by stakeholders these are every other member of a company other than investors they're the workers that the customers they're the communities there's the suppliers but notice they do benefit workers get wages suppliers get their revenues for their inputs customers they get the product the difference is not that investors get everything and stakeholders get nothing both get stuff but while stakeholders get something which is fixed investors return is risky let me give you an example let's say I owned a house which I don't I live in London I'm not wealthy enough to own a house in London only a small apartment but let's owned a house and I wanted to sell it and before selling it I want to replace the roof so might hire a contractor and then built the Builder and the Builder comes and rebuilds the roof now how much should I pay him or her now one option would be to pay him or her a fixed amount let's say ten thousand pounds now if that was the case he would get the ten thousand pounds regardless of how much I sell my house for and that's kind of fair right because how much I sell my house for depends on how much effort I put into cleaning the house and marketing it it depends on the state of the housing market so the Builder might be perfectly happy taking that ten thousand pounds as fixed now he's clearly being rewarded but he's rewarded in something which is fixed and the same is true for employees within a company so if you're working within a company you will get your salary for how much you've worked now independent of whether the conditions are good or not whether the the toys that you manufactured sell or not you're getting that salary that is something which is fixed no notice that's not the only way that we could do the division now I'd have thought well maybe this new hat this new roof is so fundamental to the sale price of my house that let me not give the Builder ten thousand pounds let me give him or her five thousand pounds plus one hundredth of the sale proceeds so that he or she has now skin in the game and has an incentive to work harder and that's a fair division and that's that something which is alternative which is which was also fine but most companies have chosen to give stakeholders something which is fixed why because it removes risk from them now I don't actually agree with this something that I stress in my second lecture is that we should make sure that workers do benefit when the company does well by giving shares to all employees not just the top management why because if a company does well it's partly down to the workers but notice where the workers share in the benefits of success that depends on whether they are given shares or not that doesn't depend on whether there's a buyback or not okay so this is a question of are you giving your workers and suppliers a fixed reward or a variable reward that's nothing to do with this buyback decision let's look a few are a few other concerns and some of these concerns I will now start to agree with so elizabeth warren said the real value the real way to boost the value of a company is to invest in the future and we always think the investment is good but notice it's a bit more nuanced than that investment only creates value if the benefits of the investment are greater than the cost you might think well a company should produce should invest in a new machine or build a new factory but if it does that it takes resources away which can send you to build a school and so just investing more and more is not always going to be beneficial what matters is is that investment worth the cost of the resources which could be used elsewhere in society and this we've I talked in Prior lectures about examples of say day.you the Korean company which grew in many many areas which were not part of it is expertise and destroyed a lot of value but here's the new ones and here's where I might start to agree with the concerns so some people say this concern if you're sick some CEOs say I am buying back shares because I don't have any good investment ideas right there's no good opportunities for me to invest the money let me buy back the shares some people say well if you're a CEO and you don't have anything better to do then buy back shares you've one out of ideas you're a bad CEO and so I do agree with this to a degree why one thing I've stressed right from the very start from my very first lecture is a new way to think about investments now what finance professors like me sometimes argue and argue wrongly is that in order to make an investment you calculate the costs and you calculate the benefits but are they stress in my very first lecture many of the benefits of an investment cannot be forecast cannot be put into a spreadsheet I in my first lecture talked about Merck which decided to develop a new drug to cure people in western Africa from river blindness now that's that's not something that could ever be good enough spreadsheet why because the African suffering from river blindness were too poor to pay for the drug so if Merck made this profit calculation it would have never invested there's no profit in giving a drug away for free to people in Africa but what I've stressed in my lecture series is that whenever we think about an investment we don't just think about the financial benefit we think about the social benefit and for something like developing this drug to cure blindness there's a massive societal benefit server Dean is the chief executive who thinks that she doesn't have good investment opportunities she might indeed be making the wrong decision why because she might not realize that many investments would have a large social benefit even if they don't have an immediate financial benefit but yet despite that argument despite the fact that I argue that CEO should invest more than they typically do there is still going to be a stopping point right so even if you're the most inspired film director and you think of Racines and extra special effects to put here and there after point in time you've saturated it and any extra scheme would subtract value similarly here even if you are great skier with great ideas to invest in your workers to reduce your pollution and so on there will be a certain stopping point where you've actually done enough and you think that now the best use of my money is to pay it out to shareholders why because what cash elders then do with their money they can invest it elsewhere this title of this lecture series is how business can better serve society so that the lens for any division any decision is not the company but society indeed by certain large companies paying out the surplus funds to investors that allows those investors to finance the fledgling companies of tomorrow why is it that indeed it is quite easy at the moment for the US companies startups to raise money in the stock market it's because some investors are relatively flush with cash due to having received some monies due to by max now let's look at more evidence now some people say stop buybacks create a sugar high for companies it boosts the shut stock price in the short run yet evidence shows that it boosts prices in the long run even more the first study which did this was based in the US but more recently Dayton looking at countries globally finds that this still holds and still holds in the 21st century when the first study was based in the 20th century now you might remember from my second lecture I showed that if you give CEOs these targets of 7.50 CEOs take bad actions to hit the target such as the accounting tricks and such as cutting investments but they actually don't use buybacks to hit the target the humana are example that I gave that is actually the exception not the rule and why is that because by Backson only change your earnings by small amount remember if you go back to the earlier a chart maybe I'm gonna regret her trying to do this right most of what you can do in order to change your earnings is play with your accounts card investment that changed 15 cents buybacks are typically really small so it's very really the case that they are used in order to hit earnings targets so when are they misused they are misused in certain cases one of my own stories finds that when a CEO is about to sell her shares she engages in a buyback to boost the stock price and so then she can sell her shares for more so what's the remedy to this it's to address the root cause of the problem which is that incentives are based on the short term stock price as I showed in the second lecture whenever you are concerned with a short term stock price you do many bad things to inflate it you buy back shares you mess around with your accounts you might cut wages you might cut investment so the big conclusion from my lecture 2 was to give CEO shares which they cannot sell for 5 7 or 10 years let me move to a very different topic in my final 10 minutes away from share buybacks been another controversial feature of financial markets then when I talked about the idea that finance benefit society I talked about primary financial markets this is investors providing new funds to companies for the first time so let's say you want to start a small business I'm giving you financing I'm giving you two cool cash to do this like I'm giving cash to the bakery and to the Coffee Company but actually most of the activity that we see in financial markets occurs in what I call secondary financial markets so here no new shares no new money is going to companies let's say I'm choosing to trade with Sara shares in let's say Vodafone what happens is that I've got my shares and Vodafone I'm selling my shares to Sara and she's giving me money for them no new money goes to Vodafone but we are just trading secondhand shares between us and you might think well that clearly doesn't add value to society yes when I invested in Vodafone to begin with I gave out a phone some money but when I sell my share secondhand to Sarah Vodafone doesn't benefit and if you see all the highly paid people which are earning the salaries that I mentioned earlier most of what they do is they're trading securities that are already issued so people might think well this trading is excessive they take this concern seriously the proposed EU transactions tax suggests that some of this trading may be disastrous and we want to tax it who what I want to stress in my final and segment of this lecture is that even secondary trading even trading secondhand securities can create value for society why let's go back to something I mentioned in my last lecture but let me repeat it for those of you who didn't attend or I don't fully remember what I what the point was so when a moment managers think about do I want to invest for the long run they're concerned about the fact that well maybe the stock market doesn't look at the benefit in the short term let's say I'm a CEO I want to train my workers and invest in them and invest in their personal development and their physical and mental wellness now the stock market might not recognize those benefits immediately and I showed in my first lecture it takes five years for the stock market to fully recognize this as a CEO I might be worried about this because I might be fired before then if my stock point is low but let's say Sarah is a very smart trader when she chooses to trade stocks she doesn't just look at the earnings she actually looks at how well workers have been treated and you might think well isn't this sort of fanciful no this is true right so there is indeed a large fund within the US the Parnassus endeavour fund whose their main investment thesis is to evaluate how well workers are being treated they recognize that people are the most important asset so they don't look at dividends they look at the workers and indeed Morningstar rated them the best large cap fund over the last one year three year five years and ten years in terms of their performance it makes sense to evaluate workers and how well they've been treated when you're choosing which talks about so let's say Sarah comes along and sees that maybe Vodafone is treating its workers really well and this is not reflected in the stock price so Sarah comes and buys our the shares a Vodafone increasing the price and that is really helpful for you as a CEO because if you know that there are informed investors out there who are making their trading decisions based on these long-term factors are you investing in your workers are you promoting diversity are you reducing climate change then as a CEO you're free to make those long-term decisions and because of this secondary trading that's going to be putting bad information in to prices now that's not to say that all trading is good like if you're a trader making your decisions based on short-term earnings that's really bad but what I'm going to end with in a couple of slides time is we want to make sure that the training that we have is based on those long-term decisions but before I get to that I'm going to talk about a new point which I didn't even mention in lecture four which is the idea of learning from the market so here's the idea CEOs make big decisions every day and they've got a lot of information but they also might suffer from groupthink right so they might ask the other team top managers what they think about it they might ask investment bankers to advise them or management consultants but they might be their friends as well and they might really want an outside opinion so let's look at one case in which an outside opinion was useful Carly Fiorina who used to be the CEO of hewlett-packard she considered making a bid for PwC consulting and the rest of the board agreed with this presumably they used investment bankers who agreed with this as well they may be approached to PwC consulting the stop price went down why did the stock price went go down because of these people who are working in the financial services sector trading their shares they realize that this was a bad deal they sold their shares and that drove the stock price down and as a result of that Carly Fiorina said I made a mistake I have listened to you and I realize that this is gonna be a bad deal so I will reverse this and that actually saved millions or billions of dollars being wasted in this bad acquisition so the idea is that this secondary trading by loads and loads of investors millions of investors that goes and affects the price and that's something that a manager can learn from to guide her decisions and this wasn't just an isolated case loosened and Alcatel that was another case of a merger that was stopped because of the stock market reaction what about a cautionary tale of when they were stubbornness like oats and Snapple when the Quaker Oats made the bid for Snapple the stock price went down by 10% because these clever sophisticated traders realized that this was not in the long-term interests cueca did not change its course went ahead with this decision and lost 1.4 billion dollars in this which is one of the worst acquisitions still used in business school case studies of the of how bad acquisitions can be let's look at the evidence I'm not going to go through this in huge detail but someone allowed time for questions but there are some really good papers out there showing that indeed when the market goes down people are more likely to withdraw and stop bad M&A deals they learn from the market there's a large literature which looks at how and managers investment decisions will change compared to the stock price so why is it that people might not be investing in coal nowadays but they might be investing in clean energy because the stock prices of clean energy companies are rising the stock prices of coal companies are going down the stock price is a useful signal of the quality of a company once it it's not just investment decisions maybe my MBA students from London Business School when they decide what career they want to go to afterwards they're gonna look at the ones where the stock price is high because that captures the growth prospects of the industry again we see tobacco perhaps decline in coal declining other sectors rising so what these traders do when they trade is they give a free signal the stock price which you can use in order to evaluate how good an investment opportunity is and indeed there's evidence showing that CEOs will invest more when the stock price is higher unless when the stock price is lower they'll use this as a useful independent guide of their investment opportunities and they're more likely to do this if the stock price is more informative why either traders who are trading I'm not trading on the short-term information but on this long-term factors and so that takes me to my final slide it's to acknowledge there's many parts of finance that do harm Society for example there are times in which they're short selling where you might sell a stock and like and you still vote on an important decision that's something which should be outlawed so short selling huth for those of you who don't know this this is where I have a negative position in a stock I benefit from the stock doing badly but yet I borrow votes from somebody else in order to vote further company to make a bad decision that I believe should be outlawed that harm society other things which harm society are when investors trade on short term earnings not on the long term factors like employee satisfaction that's something I addressed in my last lecture where what we want to make sure is that investors have large stakes why because it means that when they trade they're going to be basing it on these long-term decisions why does Parnassus endeavor Fund look at the employee satisfaction of a company when deciding to trade it's because it only owns a small number of companies and so it has the iddin incentives and the resources to really get into the weeds of every company and to see how well workers have been treated we don't so much what investors who hold 300 companies because if so you have no idea what's going on the only thing that you can look at is profits and dividends because you can find that on Yahoo Finance there's also a lot of concern with finance companies doing really bad things so committing fraud so this was in Wells Fargo where they were just selling products to every come to customers as much as possible regardless of they want or need I have told a people a few lectures ago about the strategy which was called going for great where the CEO made every sales rep sell eight products to every customer even if they didn't need them and why did he call this why did he choose eight because it rhymes with great so that was the scientific rationale for why he was forcing you to sell eight products regardless of whether their customers needed it we also found cases of miss selling of payment protection insurance cases of the writing of subprime loans which I talked about in Prior lectures and all of these things are really serious and so you might think well how I trivialize the issue by spending only one slide on this topic and the rest of my lecture on share buybacks and on trading know why are you spending one lecture on this one slide on this is that we all know that fraud is bad well you didn't need to come here to give up your Wednesday evening to hear me telling you that fraud is bad that's something this huge agreement on why I spent most of the lecture talking about share buybacks and secretary trading is those are much more nuanced and those are cases in which actually the evidence suggests something which might be different from what the public opinion is where's here's something K these are cases in which I fully agree with what everybody says all of these things about and I've suggested solutions to that in my prior lectures so for those of you who are unable to attend them one of them it's a length of the horizon of executive pay as I mentioned earlier why did this case happen in country why were they wrote subprime loans is that the CEO sold these loans then cashed out a hundred and forty million dollars of his own shares so when the loans went delinquent in the financial crisis he didn't care he cashed out so you want to make sure that you hold your loans your pay for a long time and then not part two is how do we address all of these issues is a sense of purpose what is the purpose of a company it is not to make money if your purpose is to make money then you are going to sell eight products even if customers don't want them you're going to miss sell insurance but if your purpose of a company as a bank is to improve consumer welfare and to help people say for their financial future you're going to think really seriously are the products that we are selling genuinely benefiting gust MERS and so that's something I talked about in lecture 1 and finally talked about the idea of improving corporate governance and in lecture three to have challenges from the group thing that we see and to have investors trying to hold companies accountable for purpose it's one thing saying our purpose is to improve financial well-being but it's another thing to put it into practice and so I highlighted the wall of investors and society more generally and making sure that companies do what they actually say so that's all I have for now I'm very happy to take questions and challenges and again as I say in every lecture please do challenge me if you disagree with everything anything that I said I also learn from hearing different viewpoints thank you




Comments
  1. Consider this little bit of the debt market and tell me it's a good thing https://www.bloomberg.com/news/articles/2019-04-24/hsbc-ceo-fink-tell-saudis-future-is-bright-post-khashoggi-furor

  2. Finance is a parasite. Just look at the offshore "banking" industry. Literally trillions of dollars have been kept out of public coffers through tax evasion, causing untold suffering as a result, and it is all directly the "finance" industries fault.

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