23/6/21: Covid19 Deaths and Income Inequality

 

An interesting, although intuitively straight forward note on the determinants of Covid19 deaths: https://twitter.com/youyanggu/status/1407418434955005955. 

As Youyang Gu @youyanggu states, "I believe income inequality is the single best predictor of total Covid deaths in the US. Not income, but income *inequality*. The R^2 is surprisingly high: 0.35."

There are some potentially important issues with this analysis (some are explored here: https://github.com/jsill/usstatecovidanalysis/blob/main/usStateCovidAnalysis.pdf), but the conclusion seems to be qualitatively robust. 

11/8/20: ESG Risks, Environment and Consumer Behavior

 

COVID19 ESG impacts: 

• Europe thinks it is getting 'greener'

• The rest of the world is getting decisively not:

What's up with this, people? Wasn't COVID19 pandemic supposed to usher a new 'climate change awareness' era? Or is it all about: "I am doing better things. Everyone else is doing bad things" survey bias thingy?..

14/12/19: Governance and Government Debt

What I am reading this week: a new paper via EFMA, titled "Governance and Government Debt" by João Imaginário and Maria João Guedes, available here: https://efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2019-Azores/papers/EFMA2019_0184_fullpaper.pdf.

The paper looks at "the relationship between Worldwide Governance Indicators [a proxy for governance quality] and Government Debt in 164 countries for the period between 2002 and 2015." Using fixed effects (FE) and generalized method of moments (GMM) models the authors show that "governance quality is negatively and statistically related with government debt. For Low Income countries was found evidence that better governance environment is associated with lower public debt levels."

More specifically, "for a set of 164 countries on a period between 2002 and 2015, ... estimation results for FE model suggest that Control of Corruption (CC) and Voice and Accountability (VA) indexes are negative and statistically significant on influencing government debt. In part, this result confirms our Hypothesis 1 that better governance quality is associated with lower levels of public
debt." But the study also shows that these 'global' effects are predominantly driven by the presence of low income countries in the full sample. The authors find that "the link between good governance quality and government debt reduction is more evident for Low Income countries."

As a caveat, the authors do find that overall higher score in the World Governance Indicators Index (as opposed to specific sub scores) has a negative and statistically significant impact on the levels of government debt, so that overall higher measure of governance quality is associated with lower government debt for the High Income economies. The magnitude of this effect was reasonably large, as well.

20/10/17: Lancet Report on Impact of Pollution

A top-level, comprehensive report compiled by the Lancet Commission details estimates of economic and human costs of pollution worldwide. The full report is available here: http://www.thelancet.com/commissions/pollution-and-health.

Before I summarise some of its main findings, it is worth noting that such an undertaking is, by definition, a difficult one and the one that involves a lot of assumptions, models, estimates and uncertainty around its findings. There will be debates and there will be those who disagree with the report findings. However, two things are clear:

1. Pollution is costly in terms of health, life, quality of human capital (young age development, etc), and economically;
2. Incidences of pollution impacts are bound to be concentrated in the areas where other factors (e.g. poverty, location of extraction industries, etc) are also at play.

Here are the key findings of the report:

• Pollution (in all forms: from water pollution to air pollution to soil contamination, from spills to accidental discharges to regular releases and so on) is linked to 9 million deaths in 2015 with pollution-linked diseases accounting for ca 1 in six deaths worldwide
• By one measure, pollution led to economic damages to the tune of USD 4.6 trillion or roughly 6 percent of global GDP
• In emerging economies, pollution related health and life costs are resulting in a labour productivity decline that accounts for the reduction in potential economic output of around 1-2 percent of GDP annually. And this is only due to productivity declines.
• Map below shows deaths from pollution:

• As the above map indicates, much of the impact of pollution in terms of deaths is concentrated in the emerging economies and Eastern Europe. Three countries with strong presence of extractive industries: Russia, Chile and Australia all have lower pollution-related deaths
• In China, almost 20 percent of all deaths are linked to pollution. And that is hardly the worst record. India and Bangladesh, two major population clusters, have the rates closer to 25 percent
• The likes of Ireland may be faring way better than that, but airborne pollution being the biggest killer, the idea of sticking an outright pollution intensive trash incinerator in the middle of the country largest city is clearly signaling and entirely wrong political agenda

Quoting from the report:

"Pollution is the largest environmental cause of disease and premature death in the world today. Diseases caused by pollution were responsible for an estimated 9 million premature deaths in 2015—16% of all deaths worldwide — three times more deaths than from AIDS, tuberculosis, and malaria combined and 15 times more than from all wars and other forms of violence. In the most severely affected countries, pollution-related disease is responsible for more than one death in four.

Pollution disproportionately kills the poor and the vulnerable. Nearly 92% of pollution-related deaths occur in low-income and middle-income countries and, in countries at every income level, disease caused by pollution is most prevalent among minorities and the marginalised. Children are at high risk of pollution-related disease and even extremely low-dose exposures to pollutants during windows of vulnerability in utero and in early infancy can result in disease, disability, and death in childhood and across their lifespan."

This is a very important report, worth reading.

23/1/17: Regulating for Cybersecurity: A Hacking-Based Mechanism

Our second paper on systemic nature (and regulatory response to) cyber security risks is now available in a working paper format here: Corbet, Shaen and Gurdgiev, Constantin, Regulatory Cybercrime: A Hacking-Based Mechanism to Regulate and Supervise Corporate Cyber Governance? (January 23, 2017): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2904749.

Abstract: This paper examines the impact of cybercrime and hacking events on equity market volatility across publicly traded corporations. The volatility influence of these cybercrime events is shown to be dependent on the number of clients exposed across all sectors and the type of the cyber security breach event, with significantly large volatility effects presented for companies who find themselves exposed to cybercrime in the form of hacking. Evidence is presented to suggest that corporations with large data breaches are punished substantially in the form of stock market volatility and significantly reduced abnormal stock returns. Companies with lower levels of market capitalisation are found to be most susceptible. In an environment where corporate data protection should be paramount, minor breaches appear to be relatively unpunished by the stock market. We also show that there is a growing importance in the contagion channel from cyber security breaches to markets volatility. Overall, our results support the proposition that acting in a controlled capacity from within a ring-fenced incentives system, hackers may in fact provide the appropriate mechanism for discovery and deterrence of weak corporate cyber security practices. This mechanism can help alleviate the systemic weaknesses in the existent mechanisms for cyber security oversight and enforcement.

11/1/17: Mr. Trump's Plan for Addressing Conflicts of Interest is a Fig Leaf of Corporate Governance

Why PEOTUS Donal Trump’s plan to donate hotels profits earned from foreign government payments to the U.S. Treasury is a fig leaf of corporate governance measures?

Photo credit: GettyImages

There are several reasons why a commitment to donate profits arising from foreign governments' payments to his hotels will not reduce, nor even alleviate, business incentives for potential conflict of interest that may arise in the future.

Firstly, donating profits from such activities requires that profits are declared on these activities in the first place. Since profits are declared across the entire business, not on the basis of individual transactions, Mr. Trump can use full extent of tax laws and accounting procedures, including cumulated losses deductions and tax shields on investment, to effectively reduce such denotable profits to nil over the next 4-8 years. 

Secondly, profits are not the most important financial line on which Mr. Trump operates. Mr. Trump operates on the basis of business (net) worth (value of his business) which reflects not so much the declared profits, but rather the earnings generated by his businesses (cash flow basis, e.g. EBITDA) and also reflects earnings over the longer term time horizon (timing factor). 

Now, consider the following hypothetical scenario: suppose Mr. Trump’s hotels receive USD1 million in foreign government’s bookings in 2017. Suppose he earns 10 percent profit margin on these earnings (so we neglect the issue raised in the first argument above). The profit is declared and Mr. Trump donates USD100K to the U.S. Treasury in 2017. The problem is that the 10% profit margin is across the entire group of hotels, not across the individual rooms and services supplied in exchange for the USD1 million foreign Governments' payments. As the result, 10% margin reflects costs and investments undertaken by the whole group. Foreign earnings, therefore, can be used to fund internal investment activities, ammortization and capital replacement costs, hiring costs, new services deployments etc. All of which will increase the value of Mr. Trump's hotels, including hotels that did not collect foreign payments.

In the mean time, Mr. Trump's business earnings did increase in 2017 by USD1 million as the result of the assumed foreign governments' payments. If this increase is viewed as organic or permanent, rather than a one-off windfall, his business value will increase as the result of these 2017 earnings even independent of the aforementioned investment. Why? Because companies are valued on the basis of their cash flow. Not on the basis of declared profits.

Furthermore, foreign governments' paid earnings will increase Mr. Triump's businesses capacity to borrow and raise equity. These increased borrowings and equity raises can further be used to invest in new business capital. This too will enhance business valuations for Mr. Trump.

In simple terms, even after donating his profits, Mr. Trump will be able to still gain substantially from increased revenues paid for by foreign governments. 

Thirdly, there is a host of other implications relating to Mr. Trump’s plan. 

1. It will be hard to account for all payments by ‘foreign governments’ because many such payments can come via private foreign and even domestic companies, foreign organisations and foreign individuals, or for that matter, via domestic agents and agencies acting on behalf of these foreign governments. 
2. How will the donations to Treasury be treated under the U.S. tax laws is material as well. If these are treated as charitable donations, they can be tax deductible, creating a tax shield for Mr. Trump. This tax shield can be extremely valuable, especially if his businesses use foreign-funded earnings to borrow for investment (effectively transferring these payments into future interest-related tax benefits). 
3. Mr. Trump announced today that his companies will not be permitted to make any new foreign deals during his presidency tenure. However, domestic deals will be allowed. The problem is that this does not preclude use of foreign governments’ payments/earnings for the purpose of reinvestment in the U.S. Which cycles us back to the argument that these payments can still be used to enhance Mr. Trump’s business valuations.

In simple terms, Mr. Trump’s plan to prevent conflicts of interest arising does not add up to reducing incentives for conflict of interest. It is a fig leaf of corporate governance.

18/7/16: Gamed Financial Information and Regulation Misfires

A recent interview by the Insights by Stanford Business, titled “In Financial Disclosures, Not All Information Is Equal” (all references are supplied below and all emphasis in quotations is mine) touched upon a pivotal issue of quality of information available from public disclosures by listed companies - the very heart of the market fundamentals.

The interview is with Stanford professor of accounting Iván Marinovic, who states, in the words of the interviewer, that “financial statements are becoming less and less relevant compared to other sources of information, such as analysts and news outlets. ...there is a creeping trend in financial disclosures away from the reliance on verifiable assets and toward more intangible elements of a business’s operations.”

In simple terms, financial information is being gamed. It is being gamed by increasing concentration in disclosures on ‘soft’ information (information that cannot be verified) at the expense of hard information disclosures (information that can be verified). More parodoxically, increasing gaming of information is a result, in part, of increasing requirements to disclose hard information! Boom!

Let's elaborate.

In a recently published (see references below) paper, Marinovic and his co-author, Jeremy Bertomeu define ‘hard’ and ‘soft’ information slightly differently. “The coexistence of hard and soft information is a fundamental characteristic of the measurement process. A disclosure can be soft, in the form of a measure that “can easily be pushed in one direction or another”, or hard, having been subjected to a verification after which “it is difficult to disagree”."

For example, firms asset classes can range "from tangible assets to traded securities which are subject to a formal verification procedure. Forward-looking assets are more difficult to objectively verify and are typically regarded as being soft. For example, the value of many intangibles (e.g., goodwill, patents, and brands) may require unverifiable estimates of future risks.”

The problem is that ‘soft’ information is becoming the focus of corporate reporting because of coincident increase in hard information reporting. And worse, unmentioned in the article, that ‘soft’ information is now also a matter of corporate taxation systems (e.g. Ireland’s ‘Knowledge Development Box’ tax scheme). In other words, gamable metrics are now throughly polluting markets information flows, taxation mechanisms and policy making environment.

Per interview, there is a “tradeoff between reliability and the relevance of the information” that represents “a big dilemma among standard setters, who I think are feeling pressure to change the accounting system in a way that provides more information.”

Which, everyone thinks, is a good thing. But it may be exactly the opposite.

“One of the main results — and it’s a very intuitive one — shows that when markets don’t trust firms, we will tend to see a shift toward financial statements becoming harder and harder. [and] …a firm that proportionally provides more hard information is more likely to manipulate whatever soft information it does provide. In other words, you should be more wary about the soft information of a firm that is providing a lot of hard information.”

Again, best to look at the actual paper to gain better insight into what Marinovic is saying here.

Quoting from the paper: “...a manager who is more likely to misreport is more willing to verify and release hard information, even though issuing hard information reduces her ability to manipulate. To explain this key property of our model, we reiterate that not all information can be made hard. Hence, what managers lose in terms of discretion to over-report the verifiable information, they can gain in credibility for the remaining soft disclosure. Untruthful managers will tend to issue higher soft reports, naturally facing stronger market skepticism. We demonstrate that untruthful managers are always more willing to issue hard information, relative to truthful managers."

Key insight: "...situations in which managers release more hard information are also more likely to feature aggressive soft reports and have a greater likelihood of issuing overstatements.”

As the result, as noted in the interview, “…we should expect huge frauds, huge overstatements precisely in settings or markets where there is a lot of credibility. The markets believe the information because they perceive the environment as credible, which encourages more aggressive manipulations from dishonest managers who know they are trusted. In other words, there is a relationship between the frequency and magnitude of frauds, where a lower frequency should lead to a larger magnitude.”

In other words, when markets are complacent about information disclosed and/or markets have greater trust in the disclosures mandates (high regulation barrier), information can be of lower quality and/or risk of large fraud cases rises. While this is intuitive, the end game here is not as clear cut: heavily regulating information flows might be not necessarily a productive response because markets trust has a significant positive value.

Let’s dip into the original paper once again, for more exposition on this paradox: “We consider the consequence of reducing the amount of discretion in the reporting of any verifiable information. The mandatory disclosure of hard information has the unintended consequence of reducing information about the soft, unverifiable components of firm value. In other words, there is a trade-off between the quality of hard versus soft information. Regulation cannot increase the social provision of one without reducing the other.”

Now, take European banks (U.S. banks face much of the same). Under the unified supervision by the ECB within the European Banking Union framework, banks are required to report increasingly more and more hard information. In Bertomeu-Marinovic model this can result in reduced incidence of smaller fraud cases and increased frequency and magnitude of large fraud cases. Which will compound the systemic risks within the financial sector (small frauds are non-systemic; large ones are). The very disclosure requirement mechanism designed to reduce large fraud cases can mis-fire by producing more systemic cases.

In its core, Jeremy Bertomeu and Ivan Marinovic paper shows that “certain soft disclosures may contain as much information as hard disclosures, and we establish that: (a) exclusive reliance on soft disclosures tends to convey bad news, (b) credibility is greater when unfavorable information is reported and (c) misreporting is more likely when soft information is issued jointly with hard information. We also show that a soft report that is seemingly unbiased in expectation need not indicate truthful reporting.”

So here is a kicker: “We demonstrate that …the aggregation of hard with soft information will turn all information soft.” In other words, soft information tends to fully cancel out hard information, when both types of information are present in the same report.

Now, give this a thought: many sectors today (think ICT et al) are full of soft information reporting and soft metrics targeting. Which, in Bertomeu-Marinovic model renders all information, including hard corporate finance metrics, reported by these sectors effectively soft (non-verifiable). This, in turn, puts into question all pricing frameworks based on corporate finance information whenever they apply to these sectors and companies.



References for the above are:

The Interview with Marinovic can be read here: https://www.gsb.stanford.edu/insights/financial-disclosures-not-all-information-equal.

Peer reviewed publication (gated version) of the paper is here: http://www.gsb.stanford.edu/faculty-research/publications/theory-hard-soft-information

Open source publication is here: Bertomeu, Jeremy and Marinovic, Ivan, A Theory of Hard and Soft Information (March 16, 2015). Accounting Review, Forthcoming; Rock Center for Corporate Governance at Stanford University Working Paper No. 194: http://ssrn.com/abstract=2497613.

21/5/16: Banks Deposit Insurance: Got Candy, Mate?…

Since the end of the [acute phase] Global Financial Crisis, European banking regulators have been pushing forward the idea that crisis response measures required to deal with any future [of course never to be labeled ‘systemic’] banking crises will require a new, strengthened regime based on three pillars of regulatory and balance sheet measures:

• Pillar 1: Harmonized regulatory supervision and oversight over banking institutions (micro-prudential oversight);
• Pillar 2: Stronger capital buffers (in quantity and quality) alongside pre-prescribed ordering of bailable capital (Tier 1, intermediate, and deposits bail-ins), buffered by harmonized depositor insurance schemes (also covered under micro-prudential oversight); and
• Pillar 3: Harmonized risk monitoring and management (macro-prudential oversight)

All of this firms the core idea behind the European System of Financial Supervision. Per EU Parliament (http://www.europarl.europa.eu/atyourservice/en/displayFtu.html?ftuId=FTU_3.2.5.html): “The objectives of the ESFS include developing a common supervisory culture and facilitating a single European financial market.”

Theory aside, the above Pillars are bogus and I have commented on them on this blog and elsewhere. If anything, they represent a singular, infinitely deep confidence trap whereby policymakers, supervisors, banks and banks’ clients are likely to place even more confidence at the hands of the no-wiser regulators and supervisors who cluelessly slept through the 2000-2007 build up of massive banking sector imbalances. And there is plenty of criticism of the architecture and the very philosophical foundations of the ESFS around.

Sugar buzz!...

However, generally, there is at least a strong consensus on desirability of the deposits insurance scheme, a consensus that stretches across all sides of political spectrum. Here’s what the EU has to say about the scheme: “DGSs are closely linked to the recovery and resolution procedure of credit institutions and provide an important safeguard for financial stability.”

But what about the evidence to support this assertion? Why, there is an fresh study with ink still drying on it via NBER (see details below) that looks into that matter.

Per NBER authors: “Economic theories posit that bank liability insurance is designed as serving the public interest by mitigating systemic risk in the banking system through liquidity risk reduction. Political theories see liability insurance as serving the private interests of banks, bank borrowers, and depositors, potentially at the expense of the public interest.” So at the very least, there is a theoretical conflict implied in a general deposit insurance concept. Under the economic theory, deposits insurance is an important driver for risk reduction in the banking system, inducing systemic stability. Under the political theory - it is itself a source of risk and thus can result in a systemic risk amplification.

“Empirical evidence – both historical and contemporary – supports the private-interest approach as liability insurance generally has been associated with increases, rather than decreases, in systemic risk.” Wait, but the EU says deposit insurance will “provide an important safeguard for financial stability”. Maybe the EU knows a trick or two to resolve that empirical regularity?

Unlikely, according to the NBER study: “Exceptions to this rule are rare, and reflect design features that prevent moral hazard and adverse selection. Prudential regulation of insured banks has generally not been a very effective tool in limiting the systemic risk increases associated with liability insurance. This likely reflects purposeful failures in regulation; if liability insurance is motivated by private interests, then there would be little point to removing the subsidies it creates through strict regulation. That same logic explains why more effective policies for addressing systemic risk are not employed in place of liability insurance.”

Aha, EU would have to become apolitical when it comes to banking sector regulation, supervision, policies and incentives, subsidies and markets supports and interventions in order to have a chance (not even a guarantee) the deposits insurance mechanism will work to reduce systemic risk not increase it. Any bets for what chances we have in achieving such depolitization? Yeah, right, nor would I give that anything above 10 percent.

Worse, NBER research argues that “the politics of liability insurance also should not be construed narrowly to encompass only the vested interests of bankers. Indeed, in many countries, it has been installed as a pass-through subsidy targeted to particular classes of bank borrowers.”

So in basic terms, deposit insurance is a subsidy; it is in fact a politically targeted subsidy to favor some borrowers at the expense of the system stability, and it is a perverse incentive for the banks to take on more risk. Back to those three pillars, folks - still think there won’t be any [though shall not call them ‘systemic’] crises with bail-ins and taxpayers’ hits in the GloriEUs Future?…


Full paper: Calomiris, Charles W. and Jaremski, Matthew, “Deposit Insurance: Theories and Facts” (May 2016, NBER Working Paper No. w22223: http://ssrn.com/abstract=2777311)

21/5/16: Voters selection biases and political outcomes

A recent study based on data from Austria looked at the impact of compulsory voting laws on voter quality.

Based on state and national elections data from 1949-2010, the authors “show that compulsory voting laws with weakly enforced fines increase turnout by roughly 10 percentage points. However, we find no evidence that this change in turnout affected government spending patterns (in levels or composition) or electoral outcomes. Individual-level data on turnout and political preferences suggest these results occur because individuals swayed to vote due to compulsory voting are more likely to be non-partisan, have low interest in politics, and be uninformed.”

In other words, it looks like there is a selection bias being triggered by compulsory voting: lower quality of voters enter the process, but due to their lower quality, these voters do not induce a bias away from state quo. Whatever the merit of increasing voter turnouts via compulsory voting requirements may be, it does not appear to bring about more enlightened choices in policies.

Full study is available here: Hoffman, Mitchell and León, Gianmarco and Lombardi, María, “Compulsory Voting, Turnout, and Government Spending: Evidence from Austria” (May 2016, NBER Working Paper No. w22221: http://ssrn.com/abstract=2777309)

So can you 'vote out' stupidity?..