Long tradition within HBS
Several manifestations:– Case studies.– Book-length analyses.
Distinction between research and classroom cases.
Initially, apparently a response to lack of theoretical frameworks.
Disappearance elsewhere
Major presence in finance journals prior to 1960.
Virtual disappearance as a finance research (as opposed to teaching) methodology.
Changes in past 15 years:– Clinical section of JFE.– Sloan project at NBER.
Why clinical studies?
Limitations of theoretical frameworks:– Idea generation.– Idea validation.
Can undertake analysis without “data snooping,” introducing biases.
Limitations of case studies
Similar to large sample studies:– Sample selection biases.– Data interpretation biases.• May induce false confidence.
Time and energy.
Elements
Theoretical issues.Justification as to why case is
interesting or representative. Hypotheses to be examined.Evidence regarding hypotheses.
Execution is also important
Linkage to theory:– Need to explicitly frame hypotheses.– Need to highlight why interesting
questions.– Need to acknowledge contrary
evidence.
Use of empirical methodology:– Just because small sample shouldn’t
be sloppy!
The case
Biotechnology company bought call options on its own stock:– Issued stock to investment bank in
exchange.– Anticipated approval of drug by FDA,
leading to jump in stock price:• Would then require funds to buyout R&D
partnership, which options would provide.
Objective of study
Use this case to examine Froot, Scharfstein, and Stein [1993]:– At first glance, very close to their
“cash flow hedging”:• See whether factors predicting use of risk-
management are present.• See whether other explanatory efforts are
at work.
Motivation for case selection
“Near textbook example”:–Much of hedging focuses on providing
insurance in case of disappointments:• E.g., farmer contracting to sell grain at set
price in mid-summer.
– FSS argues that firms should match cash flows with investment opportunities.
– Denote four criteria for when cash flow hedging makes sense.
Motivation for case selection (2)
Explicitly consider the four criteria:– Attractiveness of investment opportunity.– Inability to finance without hedging.
• Somewhat cloudy due to licensing option (accounting rationale).
• Aside from this, Cephalon meets key criteria for hedging.
– External financing costly:• Mixed historical evidence.
– Hedging makes cash available: yes.
Methodology
Review of theoretical literature.Review of public documents.Interviews with management and
analysts.Analysis of securities returns,
option pricing.No release needed.
Authors’ conclusions
In large part, motivation for cash flow hedging corresponds to theory.
But importance of accounting considerations seems difficult to reconcile with theory.
Also, case highlights deadweight costs of hedging as well as risk management:– Both sets of costs poorly understood.
Concerns
Rigorous and well-done analysis:– Linkage to theory.– Analytical tools used.– Open-mindedness of authors.–Willingness to grapple with complexity
of situation.
Concerns (2)
Main limitation is giving a sense of generality of phenomenon under study:– Do other firms do such hedging?– Are accounting-based concerns really
critical everywhere?
To what extent is this a special case with little general applicability?
The case
Investment in Czech media holding company by American entrepreneur (Lauder):– Expropriation by local insider
(Zelezny).• Even though 1% stake!
– Lengthy litigation to recover invested funds.
Objective of study
Law and finance literature:– Focus on institutions…• But typically treat as affecting everyone
equally.
– Also debate between those emphasizing importance of institutions addressing state abuse, private disputes.
Not testing models, but illustrating issues.
Motivation for case selection
Transition economy:– Lots of opportunities for value
extraction.• “Tunneling” phrase originated in Czech
case.
–Media companies a particularly good instance:• Lots of potential private benefits.
Motivation for case selection (2)
Misconceptions:– Often assumed to be closed economy.• In actuality, many points of contact:
– FDI.– International treaties.
– Tunneling seen as hurting minority holders:• Case will illustrate how ownership share
need not matter.
Methodology
Review of theoretical literature.Review of public documents
(especially litigation files).Analysis of securities returns.No release needed.
Authors’ conclusions
Contracts, ownership need not matter:– Zelezny had regulatory support, which
allowed him to extract rents.• A consequence of poorly defined property
rights.
The importance of broader political considerations in resolving dispute:– E.g., Czech desire to join EU.
Media’s private benefits.
Contrast with earlier paper
Critically important topic:– Addressing broad area where
considerable literature.• Also practically critical.
– Careful examination of tangled situation.
–Willingness to suggest where theory has limitations.
Contrast with earlier paper (2)
But less structured analysis:– Not as clear delineation of hypothesis
to be tested.– Less firm foundation in literature.
Overview
Looks at determinants of risk management in gold industry.
Little evidence that value maximization is driver.
Instead, appears management’s ownership is critical.
Gold industry as a research site
~50 public firms in U.S., Canada.Clearly observable price.Active risk management:– Hedging and insurance commonplace.
Extensive disclosure of risk management activities:– Compiled by stock analysts.
Gold industry as a research site (2)Are agency problems particular
severe here?– Numerous small companies.– Propensity of retail investors to hold
natural resource companies.– Loose Canadian securities oversight.
Summary measure
Not examining specific forms of risk management.
Instead create summary measure:– “Delta”=Change in value when small
change in gold price.– “Delta-ounces”=Delta*oz. covered.– “Delta percentage”=Delta-ounces/ total
oz. production in next 3 years. • Only 3 years data; scaling issues.
Summary statistics
Considerable diversity in average level of risk management.
More risk management with:– Greater equity stakes.– Fewer large block-holders–More option holdings (contradictory).– Less exploration (contradictory).
Regression issues
Truncation of dependent variable.Heteroskedasticity:– Especially differing size of firms.
Non-independence of error terms across years (and firms?).
Small sample size:– Precludes “random effects” Tobit.
Regression results
Little evidence of shareholder value maximization, e.g., little impact of:– Direct and indirect mining costs.– Tax loss carry-forwards.– Acquisition activities.• Exploration effect is counter predictions.
Stock, option holdings consistent with Smith and Stulz [1985].– Outside block-holders curb (ABX?)
Addressing concerns
Could results reflect size of management team:– Bigger firms have more insiders and
hence bigger holdings?• Look at holdings per capita.
Maybe % holding by management is better measure of conflicts:–Works less well.
Addressing concerns (2)
In distressed firms, equity may be like an option.
Decision may be driven by CEO, not rest of management.
Management age and tenure may affect risk aversion:– Little evidence, except concerning CFO
tenure.
Concerns
Well-suited research site…– My favorite of the clinical studies.
… but challenges with small sample size:– Can be addressed, at least in part.– Some remaining issues as in other paper.
Evidence consistent with theoretical models of risk management.– But representativeness of industry?