Sunday, March 22, 2009

Theory of Shareholder Value Equivalence

Economics is replete with Equivalence theories. The plethora of paradoxes in economic theory and more so in practice is invitation enough for one more such theory.

Ricardian Equivalence theory posits that the impact of taxes and sovereign debts on aggregate demand, interest rates etc. is identical. Like any economic hypothesis, Ricardian equivalence also is based on many convenient assumptions including the existence of inter-generational altruism. This may be a far-fetched assumption in view of the present day absence of even intragenerational altruism. But then, this is the way economic theories are built up.

Modigliani and Miller have argued that costs of equity and debt are identical. Leveraging therefore does not result in any cost advantage. However, inconvenient facts like tax implications queer the pitch.

Say's Law emphasises that supply creates its own demand. Hence, supply cannot exceed demand. It is intuitive that demand creates supply. So, demand cannot exceed supply. Ergo the supply - demand equivalence. As an aside, quantitative easing forced on central banks by global economic turmoil is an opportunity to test whether supply of even such a tempting product like money creates its own demand. Evidence so far is not encouraging.

Recently, Jack Welch derided the concept of shareholder value maximisation as a strategy. He observed that this is only an objective and not a strategy. Let us now see if shareholder value is a function of corporate action at all. Is shareholder value driven by corporate behaviour? In the absence of any empirical evidence to the contrary, it is logical to hypothesise that given a set of comparable alternative courses of action for a corporate, the choice of any particular option will not apriori guarantee any better impact on shareholder value than the exercise of any other comparable course of action. I venture to float this as the Theory of Shareholder Value Equivalence.

Saturday, March 21, 2009

Looking for meaning in the meaningless: catch 22

Two hypotheses readily come to one's mind. One, PSUs concentrate their attention where they can catch their victims more easily. Therefore, their focussed targets are those who have been "gullible twice over".

The second and the more persuasive hypothesis is that the higher average age of IIT-IIM combos makes them cognitively more receptive to public sector culture. Theoretical support for this hypothesis is seen in Prof. Timothy Salthouse's recent discovery that old age starts at 22. (Actually, the Professor says that cognitive capacity is at its best at 22 years of age, plateaus for some time and there is a noticeable decline from 27). Average age of an IITian is 21 at graduation. Average age of a non-engineer at graduation from IIM is also 21. Typical age of an IIT cum IIM graduate is 23 when he / she passes out of IIM. At 23, if Timothy Salthouse is right, a person's cognitive ability is likely to have started declining. Does it make public sector a better place to work in for such alumni?

Timothy Salthouse is unlikely to be proved wrong anytime soon because any challenge from persons on the wrong side of 22 is likely to be dismissed as a sinister response from the cognitively - challenged.

Looking for meaning in the meaningless

How attractive is public sector as an employer to IIT / IIM / IIT cum IIM graduates? 6 % of IIT graduates (who have not "done time" in IIM) occupy public sector jobs. Only 5 % of IIM graduates (who have not come via IIT) have chosen public sector careers. 8% of IIT cum IIM graduates are into public sector.

Reading these statistics, one would have expected less than 6 % among IIT cum IIM graduates would be interested in PSU career. How come 8 % are so interested?

It is tempting to dismiss the survey findings as lacking in credibility on account of low sample size, non-randomness of sample, biasses of surveyors etc. But, assuming that the survey findings reflect reality (possibly the weirdest assumption), what could be the reasons for increased preference for public sector placement among IIT cum IIM graduates compared to IIT and IIM standalones? We will explore in the next blog.

Sunday, March 15, 2009

Managerial turnaround

When the turnaround in the economy is nowhere in sight, managers do a turnaround. Jack Welch confesses that shareholder value is stupid as a strategy.Jeff Immelt says that even dogs could manage the business in the nineties (Jack Welch pretends not to understand). Ayn Randish Alan Greenspan discovers merit in nationalisation. it is good that the economic crisis has made business leaders less hubristic and more receptive to divergent views.

Monday, March 09, 2009

Economic crisis and interest rates

It is obvious that we are in the midst of an economic crisis. Though some economists are apprehensive that the situation will deteriorate further and we will drift into depression akin to the Great Depression (1929-33), most analysts are less pessimistic and are of the view that the problem is only a recession in some economies like the US and the UK and a slowdown in countries like India and China.

Whatever be the diagnosis, the ailment calls for urgent remedial steps. Recession is theoretically defined as fall in Gross Domestic Product or National Income in two consecutive quarters. Recession may be either cyclical or structural. Economies undergo expansion and contraction alternately. If cyclical contraction is severe and prolongs over a minimum of two quarters, it leads to cyclical recession. On the other hand, if misallocation of resources among various competing sectors in the economy results in recession, we call it as structural recession. Misguided economic policies culminate in asset bubbles causing mispricing of assets like real estate,stocks and shares and commodities.

If we look at the origin of the present global economic meltdown, it all started with the drastic fall in real estate prices in America. Market prices of houses in America were earlier recording vertiginous rise year after year because of cheap availability of credit. Continual increase in house prices resulted in positive "wealth effect" stimulating even higher growth in overall consumption demand. Economy was growing on the unsustainable combination of low savings and high consumption which was typical of American culture. When the house price bubble burst, consumption demand was adversely affected and the hunky-dory days came to an end.

Whereas opinion is divided on whether the recession is cyclical or structural, the intensity and recalcitrance of sluggishness in demand indicate that it is a hybrid of the two. Therefore, urgent fiscal and monetary measures are desperately needed to reflate the economy. It is in this background that governments and central banking authorities in various countries are implementing different stimulus packages and an accommodative monetary policy. Ironically, many economists who had traditionally placed 'market mechanism' on a high pedestal and abhorred nationalisation of any kind are now advocating a crucial role for the state to revive the moribund economy. They are even recommending nationalisation of banks to rescue the battered banks and the effete economy. How times have changed !

As RBI has eloquently observed, "Even as policy responses across countries are broadly similar, their precise design,quantum,sequencing and timing have varied".One common policy measure adopted by all countries so far has been to reduce interest rates.It is hoped that the fall in interest rates will encourage borrowings for scaling up production in the real sector and for purchase of houses,cars etc.If more liquidity is released in the economy, consumption also will increase.Thus, supply as well as demand for goods will spiral up, buttressing the economy in the process.Fed rates have been reduced to as low as 0.25% in the US. RBI has pruned the repo rate (the interest rate at which commercial banks can borrow from RBI by pledging G-Secs) from 9% to 5.5% in the space of just one quarter.Though there has been persistent demand from industry to reduce rates further, RBI has wisely refrained from effecting more cuts atleast for the present, while releasing the third quarter review of Monetary Policy recently.

What are the factors to be considered before scaling down interest rates? Interest rates impact various economic indicators like supply and demand for goods and services, exchange value of the rupee, savings culture and inflation prospects. From April 2008 to January 2009, rupee has depreciated against the US Dollar, Japanese Yen and Euro.It has marginally appreciated against Pound Sterling.The rupee underwent precipitous depreciation during February and has worryingly breached the psychological Rs.50 to a Dollar.Further reduction in interest rates in India will only exacerbate the weakness of the rupee.

The risk perception about an emerging economy like India is heightened during the present critical times.Any further dip in rupee interest rates will disincentivise forex inflows.It will also have an adverse impact on public's propensity to save.RBI's cautious approach in this delicate area merits appreciation.Inflation based on Consumer Price Index continues to cause concern and does not warrant any further drop in interest rates.

Sunday, March 08, 2009

Economic crisis and interest rates

It is obvious that we are in the midst of an economic crisis. Though some economists are apprehensive that the situation will deteriorate further and we will drift into depression akin to the Great Depression (1929-33), most analysts are less pessimistic and are of the view that the problem is only a recession in some economies like the US and the UK and a slowdown in countries like India and China.

Whatever be the diagnosis, the ailment calls for urgent remedial steps. Recession is theoretically defined as fall in Gross Domestic Product or National Income in two consecutive quarters. Recession may be either cyclical or structural. Economies undergo expansion and contraction alternately. If cyclical contraction is severe and prolongs over a minimum of two quarters, it leads to cyclical recession. On the other hand, if misallocation of resources among various competing sectors in the economy results in recession, we call it as structural recession. Misguided economic policies culminate in asset bubbles causing mispricing of assets like real estate,stocks and shares and commodities.

If we look at the origin of the present global economic meltdown, it all started with the drastic fall in real estate prices in America. Market prices of houses in America were earlier recording vertiginous rise year after year because of cheap availability of credit. Continual increase in house prices resulted in positive "wealth effect" stimulating even higher growth in overall consumption demand. Economy was growing on the unsustainable combination of low savings and high consumption which was typical of American culture. When the house price bubble burst, consumption demand was adversely affected and the hunky-dory days came to an end.

Whereas opinion is divided on whether the recession is cyclical or structural, the intensity and recalcitrance of sluggishness in demand indicate that it is a hybrid of the two. Therefore, urgent fiscal and monetary measures are desperately needed to reflate the economy. It is in this background that governments and central banking authorities in various countries are implementing different stimulus packages and an accommodative monetary policy. Ironically, many economists who had traditionally placed 'market mechanism' on a high pedestal and abhorred nationalisation of any kind are now advocating a crucial role for the state to revive the moribund economy. They are even recommending nationalisation of banks to rescue the battered banks and the effete economy. How times have changed !

As RBI has eloquently observed, "Even as policy responses across countries are broadly similar, their precise design,quantum,sequencing and timing have varied".One common policy measure adopted by all countries so far has been to reduce interest rates.It is hoped that the fall in interest rates will encourage borrowings for scaling up production in the real sector and for purchase of houses,cars etc.If more liquidity is released in the economy, consumption also will increase.Thus, supply as well as demand for goods will spiral up, buttressing the economy in the process.Fed rates have been reduced to as low as 0.25% in the US. RBI has pruned the repo rate (the interest rate at which commercial banks can borrow from RBI by pledging G-Secs) from 9% to 5.5% in the space of just one quarter.Though there has been persistent demand from industry to reduce rates further, RBI has wisely refrained from effecting more cuts atleast for the present, while releasing the third quarter review of Monetary Policy recently.

What are the factors to be considered before scaling down interest rates? Interest rates impact various economic indicators like supply and demand for goods and services, exchange value of the rupee, savings culture and inflation prospects. From April 2008 to January 2009, rupee has depreciated against the US Dollar, Japanese Yen and Euro.It has marginally appreciated against Pound Sterling.The rupee underwent precipitous depreciation during February and has worryingly breached the psychological Rs.50 to a Dollar.Further reduction in interest rates in India will only exacerbate the weakness of the rupee.

The risk perception about an emerging economy like

Sunday, March 01, 2009

(Danny) Boyle's Law

In film world, P/V is a constant.P=Praise and V=Vilification. No wonder therefore that Slumdog Millionaire is pilloried and eulogised in proportionate measure. After the Oscar Award, Salman Rushdie sighed that the movie piles impossibility over impossibility. Since when was cinema expected to reflect reality? Incidentally, will the sequel be "Palacedog Pauper"?