2007 Vol. 1

China's Markets

Pansy Yang, Ph.D.
Executive Director of the Fink Center for Finance & Investments

In the wake of the largest single-day drop in the Chinese stock market over the past decade, it may be worthwhile to take a moment and contemplate the history and outlook for China's financial markets.

What is the role of China's equity market in global markets? What are the implications, if any, of the recent turbulence for China's future economy? The popular press reports that some market players believe that China's ripple effect across international stock markets proves its key role in the world economy, but "many analysts say such sentiment is premature. China's stock market, they say, traditionally has had a low correlation with its economy, much less the global one." ("As Asian Markets Reel, Shanghai Still Surprises," WSJ, 3/1/2007.)

This issue of the CFI Bulletin features articles on China's equity market. They explore its rapid recent growth and challenges that remain to be overcome.

The academic perspective in this issue is contributed by James Tong, UCLA political science professor and former Director of UCLA's Center for East Asian Studies. He is a leading China expert, has served as a World Bank consultant on fiscal policy in China and has testified at the US Congressional Executive Committee on China.

Donald Straszheim, Vice Chairman of ROTH Capital Partners, shares his insights from an industry perspective. His expertise relates to China's evolving role in the global economy including its likely impact on companies and industries in America and elsewhere. Don is recognized as one of Wall Street's top economic and financial market experts.>>PLEASE SEND YOUR COMMENTS

In Theory ...
China's Financial Markets

James Tong
Associate Professor, Political Science, UCLA

The clout of China's financial markets can be seen in both the boom and gloom it brings to global finance. On the one hand, the further opening of its banking, securities, insurance, and fund-management sectors in recent years have generated historic opportunities and handsome fees for international investors. On the other, the 9.1% slide of its stock market on February 27 has led to a worldwide sell-off, resulting in a single-day loss of $800 billion in the U.S. stock market, and negative signs in all 21 of the national stock indexes listed in the Wall Street Journal.>>READ PAPER

In Practice ...
Are China's Equity Markets Infectious?

Donald H. Straszheim
Vice Chairman, Roth Capital Partners

On February 27, 2007, China's domestic equity markets in Shanghai and Shenzhen plunged by roughly 9%, breaking an impressive 18-month bull market that had increasingly turned into a mania. Equity markets around the world plunged in response. For the first time, developments in China's equity markets have shocked equity markets around the world, reflecting the fact that in recent years China has gone from being interesting to being important. But as jolting as this decline was, China's one-day 9% decline is not likely the start of something bigger. Equity markets in China are not yet of sufficient size or significance to materially alter China's strong economic growth trajectory. Neither recession nor major economic slowdown in China is in sight. Furthermore, despite the instantaneous contagion, investors will eventually conclude that developments in China's equity markets are not a reliable guide to equity markets around the world. >>READ PAPER

Events at CFI

March 12, 2007
R.O.I. '07
Panel discussion featuring Larry Fink ('76), Stephen Schwarzman and Maria Bartiromo presented by the UCLA Anderson Center for Finance & Investments. The Museum of Television and Radio, New York City.

May 2, 2007
Distinguished Speaker: David Windreich ('83)

David WindreichDavid Windreich has been a Managing Member of Och-Ziff Management since its inception. Prior to joining the Management Company Mr. Windreich was a Vice President in the Equity Derivatives Department at Goldman Sachs. Mr. Windreich became Vice President in 1988, and began his career with Goldman Sachs in 1983. Mr. Windreich holds both a BA in Economics and MBA in Finance from UCLA Anderson.

May 3, 2007
Distinguished Speaker: Karlheinz Muhr ('85)
Karlheinz MuhrKarlheinz Muhr is a Managing Director of Credit Suisse in the Asset Management Division and Head of Credit Suisse Volaris Volatility Management, based in New York. He is also a member of the Chairman's Board of Credit Suisse. Karlheinz was co-founder and Chairman of Volaris prior to its acquisition by Credit Suisse First Boston. He holds a Master's Degree from Vienna's University for Business and Economics and an MBA from UCLA Anderson.

May 4, 2007
Alternative Assets Conference
Academic and industry perspectives on hedge funds, private equity, real estate, commodities and venture capital. UCLA Anderson, Gold Hall. Schedule of events.

CFI Working Paper

"Superstar CEOs: Why to be Thankful if You're Not on the Cover of Time"

Is there nowhere to go but down after you become a superstar? According to a recent paper by finance professors Ulrike Malmendier (U.C. Berkeley) and Geoffrey Tate (UCLA), downhill appears to be the destiny of firms whose CEOs are "superstars" ? those who have won high-profile awards from the business press or other prominent organizations. The paper investigates the performance of CEOs who are superstars and finds that their companies subsequently underperform, both in terms of stock returns and accounting profits over the one to three years following the award.

CEO performance

Is it possible, though, that we are simply observing mean reversion as opposed to real underperformance? Previous academic papers (DeBondt and Thaler, 1985; Fama and French, 1988 among others) document mean reversion in portfolios of stocks with extreme performance over the past three to five years. In other words, past winners become losers, and vice-versa. Hence, it is plausible that this well-documented pattern of returns is what accounts for the underperformance of firms following CEO awards.

To test for this, the authors construct a control sample of "predicted award winners" ? firms similar to the award winners at the time of each award but ones in which the CEO did not win an award. The matching sample is formed by running a logit regression of CEO awards on firm and CEO characteristics, including size, book-to-market, and prior returns. The long run performance of actual award winners is then compared to that of the "predicted award winners." If the long-run performance of award winners is due to mean reversion, then there should be little difference across the two samples.

The results? Using data drawn from a variety of publications, including Business Week, Forbes, Time/CNN, amongst others, the authors first document that cumulative abnormal returns (CARs) following a CEO award are significantly negative over the three year window beginning five days after publication of the award. The sample period is 1975-2002.

Furthermore, they find that the additional underperformance of award winners relative to their control sample, is both significant and robust, providing evidence for underperformance beyond the effects of mean reversion.

As it turns out, award-winning CEOs are more likely to write books and their memoirs as well as sit on more boards of other firms than in years prior to winning an award. This is documented in a section of the paper entitled, "Distraction." Thus, part of the underperformance may be due to the new opportunities available to the CEO with newfound superstardom. These opportunities, while exciting, may distract him from the business of maximizing shareholder value.

While tournaments may be an effective way to extract maximal effort from executives, they do not appear to be the best mechanism for ensuring high performance after widespread recognition, such as winning a prestigious award. A question remains whether any such mechanism exists, or if human nature prevents any successful design.

As Mark Twain said, "?a man is a human being, and that is enough for me; he can't be any worse." - P. Yang

>>Read the paper, "Superstar CEOs" by Ulrike Malmendier and Geoffrey Tate (PDF)


Distinguished Speakers

January 18
Joan PaydenJoan Payden, CFA, is the President and CEO of Payden & Rygel, the global investment management firm that she founded in 1983. At Payden & Rygel, Joan has overseen the firm's international expansion and its growth to more than $50 billion in assets under management. In 1992, the firm launched Payden & Rygel Investment Group, a family of mutual funds, of which she is Chairman and CEO. Prior to founding Payden & Rygel, Joan was managing director of West Coast operations for Scudder, Stevens & Clark as a national partner of the firm.

January 23
Larry FinkLaurence D. Fink is the Chairman and CEO of BlackRock, an investment management firm that has in excess of $1.2 trillion under management. He is Chairman of BlackRock's Executive and Management Committees, as well as Chairman of the Board of Nomura BlackRock Asset Management, BlackRock's joint venture in Japan, and several of BlackRock's alternative investment vehicles. Prior to founding BlackRock in 1988, Larry was a member of the Management Committee and a Managing Director of The First Boston Corporation.

January 24
Robert ArnottRobert Arnott, founder and CEO of Research Affiliates, established the firm in 2002 as a research-intensive asset management firm. Over $20 billion in assets are managed using investment strategies developed by Research Affiliates. A widely published financial thinker, Rob has been a frequent contributor to leading financial journals and books, including the Financial Analysts Journal, the Journal of Portfolio Management, the Harvard Business Review, amongst other respected journals. Rob is Editor Emeritus at the Financial Analysts Journal and former chairman of First Quadrant, LP, where he developed quantitative asset management products. He also served as global equity strategist at Salomon Brothers (now part of Citigroup), the president of TSA Capital Management (now part of Analytic), and as a vice president at The Boston Company (now PanAgora).

February 7
Ed WedbushEdward Wedbush is the CEO of Wedbush Morgan Securities. Ed was fresh out of college when he and partner Robert Werner each pooled $5,000 to open the first office of Wedbush & Co. on Crenshaw Boulevard in 1957. A half century later, Wedbush Morgan Securities is worth more than $200 million and ranks as one of the top correspondent clearing services in the United States, executing trades for hundreds of small broker-dealers. At 73, Ed still gets to the office every day at 5:45a.m. and spends several hours on the firm's trading floor, gauging the market in front of a bank of computer monitors. His interest in stocks began when he made his first investment at the age of 17.

CFI Dissertation Fellowship

YuZhao Zhang is the recipient of the CFI 2006-2007 dissertation fellowship. The dissertation fellowship is awarded each year to an outstanding doctoral student performing interesting and relevant research. Before joining the doctoral program in finance at UCLA Anderson, YuZhao completed his master's degree in mathematical finance at the New York University Courant Institute. His current research interests include the information efficiency of financial markets and the behavior of institutional investors. One of his recent working papers focuses on the relative information efficiency of the stock market and the derivatives market, a subject that has been long debated among researchers and practitioners. Using data from the U.K., he and co-authors Rossen Valkanov and Pradeep Yadav find that information in the options market leads the underlying FTSE 100 index for up to three days. More specifically, they can predict the FTSE 100 index for up to three days using American options' early exercise premium. Their evidence supports Black's (1975) famous conjecture that informed investors prefer to trade on their superior information in the options market rather than in the underlying asset market. Download the paper (PDF).

Finance Seminars
Please click here for details.

October 6
Hanno Lustig, UCLA

January 17
Alex Edmans, MIT

January 22
Adair Morse, Michigan

January 26
Bruce Carlin, Duke

January 31
Dimitris Papanikolaou, MIT

February 7
Hui Chen, University of Chicago

February 9
Nikolai Roussanov, University of Chicago

February 16
Christopher Malloy, London Business School

March 2
Ning Zhu, UC Davis

March 23
Pete Kyle, University of Maryland

April 6
Massimo Massa, INSEAD

April 27
Todd Milbourn, Washington University

May 11
Xavier Gabaix, MIT

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