Managing by commitments

What makes a great manager great? Despite differences in their personal attributes, successful managers all excel in the making, honoring, and remaking of commitments. Managerial commitments take many forms, from capital investments to personnel decisions to public statements, but each exerts both immediate and enduring influence on a company. A leader's commitments shape a business's identity, define its strengths and weaknesses, establish its opportunities and limitations, and set its direction. Executives can all too easily forget that commitments are extraordinarily powerful. Caught up in the present, managers often take actions that, while beneficial in the near term, impose lasting constraints on their operations and organizations. When market or competitive conditions change, they can find themselves unable to respond effectively. Managers who understand the nature and power of their commitments can wield them more effectively throughout a company's life cycle. Entrepreneurs can avoid taking actions that imprint a new venture with a dysfunctional character. Managers in established enterprises can buttress past commitments that retain their currency and learn to recognize when commitments have become roadblocks to needed changes. The manager can then replace those roadblocks with new, rejuvenating commitments. That doesn't mean you should try to anticipate all the long-run consequences of every commitment--and it certainly doesn't mean you should shy away from making commitments. But it does mean that before making important decisions about, say, operating processes or partnerships, you should always ask yourself: Is this a process or relationship that we can live with in the future? Am I locking us into a course that we'll come to regret?     

The Future of Private Equity

A distinguished University of Chicago financial economist and longtime observer of private equity markets responds to questions like the following:

• ? With a track record that now stretches in some cases almost 30 years, what have private equity firms accomplished? What effects have they had on the performance of the companies they invest in, and have they been good for the economy?
• ? How will highly leveraged PE portfolio companies fare during the current downturn, especially with over $400 billion of loans coming due in the next three to five years?
• ? With PE firms now sitting on an estimated $500 billion in capital and leveraged loan markets shut down, are the firms now contemplating new kinds of investment that require less debt?
• ? If and when the industry makes a comeback, do you expect any major changes that might allow us to avoid another boom‐and‐bust cycle? Have the PE firms or their investors made any obvious mistakes that contribute to such cycles, and are they now showing any signs of having learned from those mistakes?

Despite the current problems, the operating capabilities of the best PE firms, together with their ability to manage high leverage and the increased receptiveness of public company CEOs and boards to PE investments, have all helped establish private equity as “a permanent asset class.” Although many of the deals done in 2006 and 2007 were probably overpriced, the “cov‐lite” deal structures, deferred repayments of principal, and larger coverage ratios have afforded more room for reworking troubled deals. As a result of that flexibility, and of the kinds of companies that get taken private in leveraged deals in the first place, most troubled PE portfolio companies should end up being restructured efficiently, thereby limiting the damage to the overall economy. Part of the restructuring process involves the use of the PE industry's huge stockpile of capital to purchase distressed debt and inject new equity into troubled deals (in many cases, their own). At the same time the PE firms have been working hard to rescue their own deals, some have been taking significant minority positions in public companies, while gaining some measure of control. Finally, to limit overpriced and overlev‐eraged deals in the future, and so avoid the boom‐and‐bust cycle that appears to have become a predictable part of the industry, the discussion explores the possibility that the limited partners and debt providers that supply most of the capital for PE investments will insist on larger commitments of equity by sponsors to their own funds and individual deals.     

Financial Planning and Investor Communications at GE (With a Look at Why We Ended Earnings Guidance)*

In this edited version of a talk given at a conference of accounting academics and corporate practitioners, the Vice Chairman and Chief Financial Officer of General Electric describes the company's internal budgeting and financial planning process, and how the information generated by this process is communicated to investors. The company's business model—the common thread running through all its different businesses—is to make large investments in technology that make possible the firm's equipment sales, which in turn provide the basis for a profitable long-term services business. The main role of the company's internal analysis and planning process is to help management allocate capital in a way that produces long-run growth in revenues and earnings but, most important, a competitive return on investor capital. Another major aim of the company's planning process is to help management identify and manage major risks that could interfere with management's ability to carry out its strategic investments and goals. The company's focus on risk management is both reflected in, and facilitated by, a forecasting process that puts less emphasis on the accuracy of “point estimates” and pays greater attention to the range and distribution of possible outcomes. “What we really care about,” as the author says, “is the quality of the thinking and the dialogue among our managers that takes place around the forecasting process.” And it is the output of these internal processes, and “the quality of the thinking and dialogue” behind it, that are “the essence of what the company is trying to communicate to analysts and investors.” Instead of holding up quarterly earnings targets—a practice the company ended in 2008—management's communications with investors are intended to create “a continuous flow of information and feedback about the ongoing performance, investment opportunities, and risks confronting the firm.” In the author's words, “Ending the firm's longstanding practice of holding up earnings target s to the Street, and then trying to meet them, helped us rid ourselves of needless pressures and burdens… that can get in the way of managing for long-run growth and profitability.”     

Moral Hazard and Optimal Subsidiary Structure for Financial Institutions

Banks and related financial institutions often have two separate subsidiaries that make loans of similar type but differing risk, for example, a bank and a finance company, or a “good bank/bad bank” structure. Such “bipartite” structures may prevent risk shifting, in which banks misuse their flexibility in choosing and monitoring loans to exploit their debt holders. By “insulating” safer loans from riskier loans, a bipartite structure reduces risk‐shifting incentives in the safer subsidiary. Bipartite structures are more likely to dominate unitary structures as the downside from riskier loans is higher or as expected profits from the efficient loan mix are lower.     

Life Sciences Roundtable: Strategy and Financing

In light of the challenges facing the pharmaceutical industry, a distinguished group of pharma executives and strategic and financial advisers discusses the following corporate decisions:

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The end of corporate imperialism

As they search for growth, multinational corporations will have no choice but to compete in the big emerging markets of China, India, Indonesia, and Brazil. But while it is still common to question how such corporations will change life in those markets, Western executives would be smart to turn the question around and ask how multinationals themselves will be transformed by these markets. To be successful, MNCs will have to rethink every element of their business models, the authors assert in this seminal HBR article from 1998. During the first wave of market entry in the 1980s, multinationals operated with what might be termed an imperialist mind-set, assuming that the emerging markets would merely be new markets for their old products. But this mind-set limited their success: What is truly big and emerging in countries like China and India is a new consumer base comprising hundreds of millions of people. To tap into this huge opportunity, MNCs need to ask themselves five basic questions: Who is in the emerging middle class in these countries? How do the distribution networks operate? What mix of local and global leadership do you need to foster business opportunities? Should you adopt a consistent strategy for all of your business units within one country? Should you take on local partners? The transformation that multinational corporations must undergo is not cosmetic--simply developing greater sensitivity to local cultures will not do the trick, the authors say. To compete in the big emerging markets, multinationals must reconfigure their resources, rethink their cost structures, redesign their product development processes, and challenge their assumptions about who their top-level managers should be.     

A dynamic theory of multiple borrowing

Multiple borrowing—when borrower obtains overlapping loans from multiple lenders—is a common phenomenon in many credit markets. We build a tractable, dynamic model of multiple borrowing and show that, because overlapping creditors can impose default externalities on each other, expanding financial access by introducing more lenders can backfire. Capital allocation is distorted away from the most productive uses. Entrepreneurs choose inefficient endeavors with low returns to scale. These problems are exacerbated when investments become more pledgeable or when borrowers have access to more lenders, explaining why increased access to finance does not always improve outcomes.     

Deregulation,technological change,and the business-lending performance of large and small banks

According to DeYoung et al. [Journal of Financial Services Research, 2004] deregulation and technological change has divided the US banking industry into two primary size-based groups: very large banks, specializing in the use of “hard” information to make standardized loans and smaller banks, specializing in the use of “soft” information and relationship development to make non-standardized loans. We evaluate business-lending performance for small and large banks over the 1993–2001 period. Small business lending by small banks is characterized by relationship development and non-standardized loans. Consistent with DeYoung et al.'s model, we find that, after controlling for market concentration, cost of funds, and a variety of other factors that might influence yields, smaller banks perform better than larger banks in the small business lending market. However, larger banks appear to have the advantage in credit card lending, a market characterized by impersonal relationships and standardized loans. Interestingly, we find evidence that larger banks have been making inroads in the market for the smallest business loans, a result consistent with the use of credit scoring by large banks to make very small business loans [Berger et al., Journal of Money, Credit, and Banking, 2004].     

中国影子银行的经济学分析:定义、构成和规模测算

2008年国际金融危机以后,中国金融体系发生的重大变化之一是影子银行的较快发展,其规模迅速膨胀,交易结构日趋复杂,各类市场主体都牵涉其中。这些变化吸引了政策制订者和学术界的广泛关注。本文给出了中国影子银行的功能性定义,即依赖于银行信用、从事银行业务、但又没接受严格的银行业监管的金融业务,具体指传统的银行表内贷款和债券投资以外的,具备完整的信用转换、期限转换和流动性转换功能的金融业务。本文逐项分析影子银行业务,详细总结各类型业务的交易结构、业务主体、业务实质、资金来源、法律基础、资产负债表表示,准确测算了2002年至今影子银行总量和资产负债表结构月度数据。只从资产负债表的负债端着手加总,既完整地涵盖了影子银行的全部业务,得到其宏观总量,又剔除了重复计算。本文测算数据为后续研究打下了基础。     

Corporate Portfolio Management Roundtable

The dean of a top ten business school, the chair of a large investment management firm, two corporate M&A leaders, a CFO, a leading M&A investment banker, and a corporate finance advisor discuss the following questions:

• ? What are today's best practices in corporate portfolio management? What roles should be played by boards, senior managers, and business unit leaders?
• ? What are the typical barriers to successful implementation and how can they be overcome?
• ? Should portfolio management be linked to financial policies such as decisions on capital structure, dividends, and share repurchase?
• ? How should all of the above be disclosed to the investor community?

After acknowledging the considerable challenges to optimal portfolio management in public companies, the panelists offer suggestions that include:

• ? Companies should establish an independent group that functions like a “SWAT team” to support portfolio management. Such groups would be given access to (or produce themselves) business‐unit level data on economic returns and capital employed, and develop an “outside‐in” view of each business's standalone valuation.
• ? Boards should consider using their annual strategy “off‐sites” to explore all possible alternatives for driving share‐holder value, including organic growth, divestitures and acquisitions, as well as changes in dividends, share repurchases, and capital structure.
• ? Performance measurement and compensation frameworks need to be revamped to encourage line managers to think more like investors, not only seeking value‐creating growth but also making divestitures at the right time. CEOs and CFOs should take the lead in developing a shared value creation model that clearly articulates how capital will be allocated.

     

How SmithKline Beecham makes better resource-allocation decisions

Major resource-allocation decisions are never easy. For a pharmaceuticals company like SmithKline Beecham, the problem is this: How do you make good decisions in a high-risk, technically complex business when the information you need to make those decisions comes largely from the project champions who are competing against one another for resources? In 1993, the company experimented with ways of depoliticizing the process and improving the quality of decision making. In most resource-allocation processes, project advocates develop a single plan of action and present it as the only viable approach. In SB's new process, the company found an effective way to get around the all-or-nothing thinking that only reinforces the project-champion culture. Project teams were required--and helped--to create meaningful alternatives to current development plans. What would they do with more money? With less? With none at all? In another important departure from common practice, SB separated the discussion of project alternatives from their financial evaluations. In doing so, SB was able to avoid the premature evaluations that kill both creativity and the opportunity to improve decision making. The new process at SB has allowed the organization to spend less time arguing about how to value its R&D projects and more time figuring out how to make them more valuable. In the end, the company learned that by tackling the soft issues around resource allocation--such as information quality, credibility, and trust--it had also addressed the hard ones: how much to invest and where to invest it.     

希望中国继续购买欧洲债券

“我希望中国也能像其他国家一样,继续向我们购买债券。”——克劳斯·雷格林 欧元区已经走出谷底。这当然要部分归功于“欧元区救火队长”——欧洲稳定机制（ESM）总裁兼欧洲金融稳定机构（EFSF）首席执行官克劳斯·雷格林（Klaus Regling）。     

BANK OF AMERICA ROUNDTABLE ON THE LINK BETWEEN CAPITAL STRUCTURE AND SHAREHOLDER VALUE

A number of popular business magazines have recently run cover stories describing the “return of leverage.” Although full of interesting details about individual leveraged deals and the investment bankers who put them together, they are largely silent on several issues of economic importance: Why is this happening now? What are the most important benefits as well as costs of debt financing? Is there such a thing as a value-maximizing, or “optimal,” capital structure for public corporations? No financial economist has thought and written as much about corporate capital structure and its relationship to shareholder value and corporate governance as Harvard professor Michael Jensen. The first economist to see the value-adding potential of LBOs in the 1980s, he was also the first to identify the source of the problems with the late-'80s deals. In this roundtable discussion, Professor Jensen explores the “real” effects of corporate financial policies on managerial decision-making and shareholder value with a distinguished group of corporate executives and financial advisors.     

The Role of Private Equity in Life Sciences

In a roundtable published in this journal a year ago, there was a clear consensus that the R&D function in big pharma was inefficient and in need of major restructuring, possibly through increased investments by venture capital and private equity firms. In this discussion, an accomplished group of industry practitioners begins by looking at the prospects for both venture capital and private equity to play meaningful roles in financing early- and mid-stage drug development. In so doing, they explore questions like the following:

• • Are there ways for big pharma and biotech to reduce “science risk” and make R&D funding more profitable and attractive to venture capital and private equity—and perhaps even hedge funds?
• • What roles do you see for specialty PE firms like Symphony Capital and Paul Capital, which are now bundling mid-stage development assets and securitizing royalties?

Then the panelists turn to the broader life sciences industry and consider the outlook for leveraged private equity transactions involving marketed products, late-stage development, and services. Here they consider issues like the following:

• • Will PE be attracted to less-R&D-intensive activities like medtech and generics?
• • Have the recent consolidation through mergers and reorganization of big pharma into decentralized business units created opportunities for carve-outs of certain businesses?

For big pharma and life sciences companies in general, the answers to such questions point to greater specialization and focus achieved partly through strategic alliances with venture capital, private equity, and even hedge funds, and involving marketed products and services as well as early-stage drug development.     

Simple rules for making alliances work

Corporate alliances are growing in number--by about 25% a year--and account for up to a third of revenues and value at many companies. Yet some 60% to 70% of them fail. What is going wrong? Because alliances involve interdependence between companies that may be competitors and may also have vastly different operating styles and cultures, they demand more care and handling than other business arrangements, say Hughes and Weiss, management consultants at Vantage Partners. The authors have developed five principles--based on their two decades of work with alliances -to complement the conventional advice on alliance management: (1) Focus less on defining the business plan and more on how you and your partner will work together. (2) Develop metrics pegged not only to alliance goals but also to performance in working toward them. (3) Instead of trying to eliminate differences, leverage them to create value. (4) Go beyond formal systems and structures to enable and encourage collaborative behavior. (5) Be as diligent in managing your internal stakeholders as you are in managing the relationship with your partner. Companies that have adopted these principles have radically improved their alliance success rate. Schering-Plough, for example, engages in a systematic "alliance relationship launch": four to six weeks of meetings at which the partners explore potential challenges, examine key differences and develop shared protocols for managing them, and establish mechanisms for day-to-day decision making. Blue Cross and Blue Shield of Florida measures the quality of alliance progress through regular surveys of both its own staff and its partners'. These companies have learned that the conventional advice is not so much wrong as incomplete. The five simple rules can help fill in the blanks.     

HOW DO CFOs MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS?

This paper summarizes the findings of the authors' recent survey of 392 CFOs about the current practice of corporate finance, with main focus on the areas of capital budgeting and capital structure. The findings of the survey are predictable in some respects but surprising in others. For example, although the discounted cash flow method taught in our business schools is much more widely used as a project evaluation method than it was ten or 20 years ago, the popularity of the payback method continues despite shortcomings that have been pointed out for years. In setting capital structure policy, CFOs appear to place less emphasis on formal leverage targets that reflect the trade‐off between the costs and benefits of debt than on “informal” criteria such as credit ratings and financial flexibility. And despite the efforts of academics to demonstrate that EPS dilution per se should be irrelevant to stock valuation, avoiding dilution of EPS was the most cited reason for companies reluctance to issue equity. But despite such apparent contradictions between theory and practice, finance theory does seem to be gaining ground. For example, large companies were much more likely than their smaller counterparts to use DCF and NPV techniques, while small firms still tended to rely heavily on the payback criterion. And a majority of the CFOs of the large companies said they had “strict” or “somewhat strict” target debt ratios, whereas only a third of small firms claimed to have such targets. What does the future hold? On the one hand, the authors suggest that we are likely to see greater corporate acceptance of certain aspects of financial theory, including the use of real options techniques for evaluating corporate investments. But we are also likely to see further modifications and refinements of the theory, particularly with respect to smaller companies that have limited access to capital markets.     

中国农户融资选择意愿研究——来自10省2万家农户借贷调查的证据

农村金融研究核心议题之一是农户融资行为特征问题。农户在自身积累、民间融资、正规金融机构融资等多种融资来源选择中,哪些因素影响着农户融资选择行为?同时,农户融资选择是否存在一定的融资次序?本研究应用2007年人民银行委托国家统计局在全国10省区调查获得的2万份调查问卷数据,进行了系统地实证研究。实证研究表明:(1)中国农户外出务工获得非农收入对农户借贷具有很强的替代性;(2)民间互助性借贷对正规金融机构贷款具有较强的替代性,而东部和中部相对发达地区对民间互助性借贷意愿更为强烈;(3)中国农户融资显著偏向内源融资,这集中反映了中国农户借贷行为具有道义小农假说的特点;同时,农户对商业性金融和互助性金融两种外源融资之间选择并不存在显著差异,两者之间存在选择的替代均衡。     

Investment,consumption, and hedging under incomplete markets

Entrepreneurs often face undiversifiable idiosyncratic risks from their business investments. We extend the standard real options approach to an incomplete markets environment and analyze the joint decisions of business investments, consumption/savings, and portfolio selection. For a lump-sum investment payoff and an agent with a sufficiently strong precautionary savings motive, an increase in volatility can accelerate investment, contrary to the standard real options analysis. When the agent can trade the market portfolio to partially hedge against investment risk, the systematic volatility is compensated via the standard CAPM argument, and the idiosyncratic volatility generates a private equity premium. Finally, when the investment payoff is a series of flows, the agent's idiosyncratic risk exposure alters both the implied option value and the implied project value, causing a reversal of the results in the lump-sum payoff case.     

The effect of TARP on the propagation of real estate shocks: Evidence from geographically diversified banks

This study examines the effect of TARP on the propagation of real estate shocks via geographically diversified banks in the U.S. I find that TARP money provided for banks exposed to distressed areas (i.e., “affected” banks) was positively associated with small business loan originations in “non-distressed” areas (i.e., counties with smaller real estate shocks), mitigating the shock transmission. In addition, the bailout funds facilitated “affected” banks’ faster return to their pre-crisis level of franchise value. Overall, the marginal benefit of TARP funds seems to have been greater for “affected” TARP banks. I conclude that this policy helped “affected” banks cleanse/strengthen their balance sheets and recapitalize, which paved the way for increased lending.     

Bootstrap finance: the art of start-ups

Entrepreneurship is more popular than ever: courses are full, policymakers emphasize new ventures, managers yearn to go off on their own. Would-be founders often misplace their energies, however. Believing in a "big money" model of entrepreneurship, they spend a lot of time trying to attract investors instead of using wits and hustle to get their ideas off the ground. A study of 100 of the 1989 Inc. "500" list of fastest growing U.S. start-ups attests to the value of bootstrapping. In fact, what it takes to start a business often conflicts with what venture capitalists require. Investors prefer solid plans, well-defined markets, and track records. Entrepreneurs are heavy on energy and enthusiasm but may be short on credentials. They thrive in rapidly changing environments where uncertain prospects may scare off established companies. Rolling with the punches is often more important than formal plans. Striving to adhere to investors' criteria can diminish the flexibility--the try-it, fix-it approach--an entrepreneur needs to make a new venture work. Seven principles are basic for successful start-ups: get operational fast; look for quick break-even, cash-generating projects; offer high-value products or services that can sustain direct personal selling; don't try to hire the crack team; keep growth in check; focus on cash; and cultivate banks early. Growth and change are the start-up's natural environment. But change is also the reward for success: just as ventures grow, their founders usually have to take a fresh look at everything again: roles, organization, even the very policies that got the business up and running.