David Brookfield

Risk and capital budgeting

Capital budgeting in a live environment is crucially influenced by exposure to risk. Argues that while there are many risk analysis techniques that could be used to assist with investment appraisal (for example the incorporation of risk premiums in discount rates, simulation, sensitivity analysis, etc.), it is not often recognized that the most widely used method – net present value (NPV) and nearly all of its variants – will often lead to incorrect conclusions when exposure to risk is not correctly incorporated. When risk is properly accounted for, surprising results emerge in evaluating project viability and sensitivity with respect to risk.

Management styles in the public sector

New research on the role of habits and rules in working practices could have a significant impact on the way management understands the routines subordinate individuals use and how effective change may be brought about. Whilst generally applicable, the benefits of understanding such routines, and how and why they should be encouraged, is highly visible in the public sector where multiple goals are commonplace.

Credit agency regulation and the impact of credit ratings in the international bond market

The use of credit ratings in financial and other legal documents — both in the USA and Europe —, has led to a situation in which the major rating agencies have become (largely unwilling) participants in the legislative process. This situation has become partly formalized in the US (and is being repeated elsewhere in the European Union, Eastern Europe and Latin America) through the creation of officially ‘recognized’ agencies whose ratings now carry the imprimatur of the Securities and Exchange Commission. The purpose of this paper is to contribute to the debate on the necessity for formal legal status to be sustained in the market for bond credit ratings. In this context, the criteria for a credible rating agency are examined and evidence is provided on one element of the criteria which is under-researched: namely, the impact of the ratings in the market place. The influence of rating agencies in international capital markets is assessed through an analysis of the impact of ratings on the yields of bonds, represented by a comprehensive sample of actively traded debt. The sample contains analysis of ratings introductions on both new and seasoned debt and also examines the impact of ratings revisions. It is concluded that official recognition has no market-based role and it is argued that ratings are used by regulators because of the success of the major agencies in performing their market function.

Executive stock options: volatility, managerial decisions and agency costs

Abstract This paper proposes a new rationale for understanding managerial contracts which set-out to induce stock price volatility in the form of granting of executive stock options. First, we suggest that previous research focuses too much on short term volatility effects and offering neither a theoretical or empirical perspective on incentives which might influence long-term behaviour. To address this, we offer a theoretical structure of why managerial incentives might be important in determining the evolution of volatility over the life of an option contract and provide empirical support for our views. Second, we examine the impact of option moneyness on managerial behaviour over time and provide an analysis, with supporting empirical work, of the unintended incentives thereby created. Our approach suggests that volatility-inducing contracts do not work in the intended manner and supports a growing body of work which indicates that option-based remuneration does not incentivise managers to enhance corporate performance. Our evidence is within a UK context, based on a near-population sample size.

The effect of rules, habits and bureaucracies on costing in the UK National Health Service

The widespread adoption and implementation of costing systems in the UK National Health Service (NHS) has been an important part of the response to the structural changes brought about in the health sector over the last 20 years. One key feature of costing systems in this context is to provide a guide by which efficiency and effectiveness may be measured against a background of decision making in a public service environment where the public service provision ethos is important. Re‐assesses the role of costing systems in the NHS in the light of research on rules and habit formation in the decision‐making process. In developing these points further argues that bureaucracies provide an important linkage in marshalling implicit habitual behaviour to multiple‐organisational goals. In so doing, bureaucratic structures represent part of the mechanism which facilitates effective organisational performance. Such performance is made efficient through the use of accounting systems which measure performance and provide signals for resource allocation via quasi‐costs (or the internal quasi‐transfer prices), although the extent of the usefulness of such signals is questioned. In particular, argues that there is no connection between the market, such as it is, and intra‐hospital resource allocations, at least not in a direct manner, nor in any manner in the short term.

Performance Measurement: Focusing on the Key Issue

Examines the nature of performance measurement in the NHS in its relation to the principal objectives of a public health service. Argues that existing measures (bed and theatre utilization, budget deficits, and so on) can give rise to situations which are in conflict with such objectives. Suggests performance measures should reflect the purpose of a public health services. One way this may be achieved is by use of an adjusted or weighted throughout measure which provides an indication of the level of utilization of (largely) fixed resources. Once adopted as a performance measure, throughput efficiency, established in the context of clinical objectives and available resources at unit level gives rise to quite different conclusions as to the effectiveness of existing health care delivery than has traditionally been the case.

Identifying reference companies using the book-to-market ratio: a minimum spanning tree approach

There is substantial evidence to suggest that the book-to-market (BM) ratio is an important factor in explaining stock market returns. Its role has proved difficult to isolate, however, due to statistical problems in its construction and to its observational equivalence to a number of risk and behavioural explanations. In addition, now widely recognised complex behaviour in financial markets has called into question modelling approaches that are limited in their ability to uncover relationships that are possibly masked during financial crises, for example. As one response, our research explores the value of a newly applied technique which examines the topological properties of minimum spanning trees as applied to both the BM ratio and market returns. Our intention is to identify and report investment signals as determined by the BM ratio and to assess the relationships of these signals to returns outcomes. The approach enables highly nonlinear behaviour to be addressed and the relationships we set out to capture to be reported in novel ways. We motivate and evidence a previously unreported role for BM as an investment signal which is effective over varying stock market conditions, including the financial crisis that began in 2008.

New evidence regarding the statistical properties of the FTA500 UK stock market index

A well-known fact regarding the distributional properties of stock market returns is that they are fat-tailed. Evidence is provided in this paper of further interesting properties relating to a simple decomposition of returns.

Investment style positioning of UK unit trusts

We investigate the investment style positioning of UK equity unit trusts (mutual funds) over the 24-year period from 1987 to 2010 and assess if fund manager claims to follow a particular style strategy are evidenced in practice. Generally, UK unit trusts do not, in fact, consistently track declared styles but subject their funds to style switching or rotation. Nor do funds switch to become simple index trackers, as has widely been reported, but exhibit a mix of behaviour that we refer to as ‘market-momentum styling’. Our contribution is to offer a coherent, end-to-end picture of the evolution of investment styles over an economic cycle. In so doing we evidence that fund style positioning is subject to rotation and becomes subordinated to past portfolio performance or style momentum. Even this result is conditional as we go on to demonstrate that style investment is very likely to be driven by broader economic conditions, thereby creating market-momentum styling by default. This is arguably not a style at all and calls into question the intent behind fund ‘strategies’.

Signalling in UK capital markets

Evidence is examined which might provide an underpinning to the effective use of a widely employed chartist technique. In particular, an assessment of correlations over time in the gilt-equity yield ratio (GEYR) is undertaken to determine if the history of movements in the ratio assists in establishing the bounds of GEYR. These correlations help to define turning points in the GEYR and thus support its role as a signalling device used in determining equity strategies. It is argued that only in this way will the use of GEYR be an effective device. The UK tax framework is assessed to determine its impact on the investment behaviour of the largest group of equity investors, namely, pension funds. An evaluation is made of GEYR in the context of it becoming embedded as part of the market/institutional structure and thus enabling a role for long-term chartist techniques, normally regarded as unfeasible if not supported by fundamentals. A portmanteau test is used to analyse the properties of GEYR over time. Repo...