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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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This global mechanism departs from the accumulation of resources through the introduction of a development fund. The mechanism does not only raise the required funds, it also allocates the money from a global perspective of fairness. The process is transparent, and all projects are given an equal chance to get funding. Projects are not only funded, but a follow-up audit makes sure the money allocated is properly used for the purpose in hand.

Within a time frame of five years from inception, the development fund would represent annual funds exceeding the aggregate budget of four of the most representative non-profit organisations worldwide, such as Unicef or the American Red Cross. If, as previously claimed, we assume that the 500 wealthiest individuals devote 10% of their wealth to the fund, total annual profits of the investment strategies would yield $20 billion per annum.

Similarly, let’s consider a national economy like that of Spain, issuing the equivalent of 10% of its GDP in public debt. Spain’s economy has a current public debt level as a percentage of GDP of 44% and a GDP (2004) of roughly $891 billion. The principal of the development fund would accordingly increase by $89 billion and the profits from the 266 Trust and Ethics in Finance investment strategies devoted to development aid would rise by approximately $13 billion if we apply two basic investment strategies.

A virtuous circle Ethical ratings would affect a corporation’s financial status, from the sales figures to the market share, mainly because ethical ratings would have a direct impact on consumer behaviour and the choices made when purchasing products and services. By adapting to a set of ethical constraints a firm could directly or indirectly influence third world economies where the firm or one of its suppliers may conduct operations. This in turn would affect, among others, a poor country’s workforce and its quality of life. Furthermore it would encourage policies that promote the stability of poor countries’ economies, including the fight against money laundering and illegal money transfers.

A development fund, conceived as presented above, would substantially increase the amount of funding available for development aid in third world countries and therefore have a direct influence on the causes of poverty.

Wealth redistribution has enabled modern economic societies of the twentieth and twenty-first centuries to reach a quality of life that would have been unimaginable after the two world wars. The progressive nature of the tax code is certainly something that those who earn most dislike. A wealthy individual would be better off managing that part of his or her wealth on his or her own. The progressivity of the tax code benefits many low-income households to the detriment of a lesser number of higher incomes. This represents the concept of solidarity in countries with established advanced economic systems.

Globalisation cannot serve one goal and deny others. Globalisation is not only about destroying trade barriers to sell internationally. It is also about redistribution from the rich to the poor. And if we think of the world as a common and integrated economic system where everybody is Redefining Capitalism 267 interconnected, there should be income redistribution from the rich to the poor globally, just as there is at a national level.

Susan George makes an interesting remark regarding the allocation of the funds raised through her taxation proposal: “Suppose that international taxation of international transactions, corporate mergers and acquisitions and industrial pollution is accepted; that genuine debt relief is granted and a pool of fresh funds is thereby constituted. Is that the end of the story? The most important part remains to be invented and it concerns managing and using the money. […] Probably the best option would be a new, small UN body made up of personnel chosen from the UN specialised agencies plus a corps of roving auditors. […] After forty-plus years of largely unsatisfactory development aid, we’ve had an opportunity to learn at least one thing: you can’t just hand over funds to a government and hope for the best.” 268 Trust and Ethics in Finance

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Companies may contract investor-relations’ firms (Promoters) to increase investor interest in their securities. These promoters do not disclose their association with the companies and issue positive recommendations. A review of such cases shows that the price of the firm increases for a short period of time. In all of these, the Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) have been taking legal action against the investor-relations’ firms, although only a handful of firms have actually been charged under Section 17(B) of the Securities Act 1934. Event day (the day that these authorities started legal proceedings) returns for the hiring firms are negative and significant. In addition, the firm’s characteristics could help to identify the kind of firms that might hire these promoters. Indeed, smaller firms with free cash flow and higher capital expenditure are more likely to resort to such means. The managers of these firms are concerned about agency problems and try to increase disclosure to reduce the severity of this problem.

270 Trust and Ethics in Finance

Internet and the trading volume





The advent of Internet has made the generation of information inexpensive and its distribution instantaneous. This fact has not been lost on managers: managers of new and small firms spent a lot of time and effort reaching out to the investing public. H. Hong and M. Huang (2005) conjecture that CEOs of these firms might spend as much as 25% of their time on investor relations. Using agencies that specialise in investor relations might reduce the cost of these activities and might enhance their effectiveness. According to D. Deller et al. (1999), the use of Internet as a medium to conduct investor relations is more widespread in the United States of America as compared with the United Kingdom or Germany. B. Barber and T Odean (2001) look at the impact of Internet on investors’ trading behaviour specifically with regard to online trading. They argue that although disintermediation of brokerage houses is a boon for investors, the downside is the loss of advice that the investors were getting from them. P. Wysocki (1998) looks at the impact of message board volume on Yahoo! Message Board on price and trading volume of the underlying stocks. He finds that overnight trading volume is able to predict the trading volume and returns on stocks on next day. W.

Antweiler and M. Frank (2004) look at the posting volume on Yahoo!

and Raging Bull message boards on 45 Dow Jones Industrial Average companies. Their findings pointed out that these messages are good predictors of volatility, and have a statistically significant impact on returns. We can thus conclude from the recent studies that the spread of information via Internet seems to affect the trading volume and price of the stocks.

The “third-party” information provider The importance of this has not been lost on some unscrupulous operators. According to a news item on British Broadcasting When Small Companies Dabble in Disinformation 271 Corporation (BBC) online, some spammers are contacting firms and offering them their services, promising share price increases of up to 250% in a matter of weeks. These firms usually target small investors and small firms.

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Although the motives behind hiring investor-relations specialists might vary from firm to firm, there seems to be a general consensus that 272 Trust and Ethics in Finance the effects will be an increase in price and liquidity. The existing studies do not look at the effect of information emanating from a third party employed by the firm on stock price and liquidity. This third party is required to disclose its affiliation with the hiring firm. However, in the data studied above (Box 1), it failed to do so, and was charged by the Securities and Exchange Commission. In the sample, the quality of information seems credible and trustworthy at first sight. However, the non-disclosure of a relationship between investor-relations’ firms and hiring firms might lead to more severe information asymmetry and less credibility of firm’s information in the long run. It is worth determining if these third parties are able to produce the same results that conventional investor-relations firms produce. This has important implications for credibility of source literature.

Significant but somewhat puzzling findings

Using an event study approach is a good way to look at the impact on price of promotion by investor-relations’ specialists. A market model with value and equally weighed index is used to look at the impact of promotion on the stock price. Promotion or event date is defined as the date on which the Securities and Exchange Commission said that these promoters started promoting the stocks. In those cases where the Securities and Exchange Commission did not specify an exact date, information was collected from Factiva or searched for on the World Wide Web.

The earliest date as the event date was taken into consideration in all cases. The reutilisation of the same firm if the promoter continued promoting the stock over a number of weeks was avoided.

There is evidence of a surge in stock price on the event date. Average Abnormal Returns of 3.05% on the event date are economically and statistically significant at a 1% level of significance. Cumulative Average Abnormal Returns (CAAR) remain positive and significant for fifteen days. This finding indicates that investor relations seem to have an When Small Companies Dabble in Disinformation 273 effect on the stock price of the contracting firms. However, there is a wide dispersion in the abnormal returns within the sample and that needs to be explained. Precision weighted cumulative abnormal returns remain above 5% for the first twelve days and then drop to 4% by the fifteenth day after the event. Nevertheless, they still remain statistically and economically significant.

Looking next at the impact of legal action by the SEC or NASD on stock prices of contracting firms, there is a statistically significant negative effect on the Average Abnormal Returns of these firms on the days that legal action commenced. This effect becomes more pronounced after two days of announcement. The Cumulative Average Abnormal Returns (CAAR) remain negative and statistically and economically significant two days after the event and they remain significant for up to fifteen days. This might be due to the slow spread of information in the security prices. Another possible reason is the fact that legal authorities took action a considerable time after the event. Markets might have learned about the relationship between promoters and contracting firms during this period.

Smaller firms likely to fall into the trap

Looking now at the returns of firms that were being promoted by the same Investor-relations firms, but were not named in Securities and Exchange Commission complaints, it appears that these firms also suffered negative abnormal returns on the dates that the SEC took legal action.

Although, these returns were economically significant, they were not statistically significant. The reason could have been the small number of events. Only 21 such firms with usable data were found.

Subsequently, firms in the sample are being matched with firms from Compustat database on the basis of fiscal year, industry (SIC code) and exchange listed. Using logistic regression is a convenient way to predict what characteristics distinguish the sample firms from the matched 274 Trust and Ethics in Finance firms. Different accounting variables are used such as total assets, Research and Development, Capital expenditure, free cash flow and leverage as some of these characteristics.

Logistic regression analysis indicates that smaller firms are more likely to hire Investor Relations’ specialists. These firms are also more likely to have free cash flow. This supports Jensen’s Hypothesis about the severity of the agency problem. The severity of the agency problem might have induced these firms to hire IR specialists. These firms are also more likely to have higher capital expenditure. They might hire IR specialists to explain the investment opportunities they are facing and the increased capital they are investing.

The existing literature suggests that the motive behind the use of promoters by firms’ managers might be to increase the liquidity of the firms’ securities. This possibility was explored by looking at different measures of the liquidity of the shares of the firms both before and after the event. The daily average trading volume (measured in the number of shares traded) is compared over one year prior to and one year following the event. Paired sample comparison is a means of seeing if promotions increase the number of shares traded on a given day. It appears that there is a significant increase in the trading volume after the event and it lasts for one year. Looking next at the average number of trading days during one year prior to and one year following the event, there is a significant increase in the number of trading days for these firms after the event.

This suggests that there is an increase in the liquidity of the stocks after the event, as suggested by existing literature.

Looking then at the change in ownership of insiders before and after the event, the average insider ownership decreases from 25.93% to 22.30% after the event. The change is statistically significant in paired sample mean comparison at a 5% level of significance. This indicates that increased liquidity might have been the motive behind hiring these promoters. The managers of the firms might then have been able to deWhen Small Companies Dabble in Disinformation 275 crease their stakes in the firm. This might be an important consideration for the managers of young firms. Diversification might have been an important consideration for these managers. However, the sample size for insider ownership is limited to 33 firms.

Spreading true information with dubious means The motive behind spreading information (true or false) might vary from one market participant to another. Rival firms might spread false information about competitors to damage their reputation. Short sellers might spread negative information to drive the stock price of a security down. A recent study by L. Frieder and J. Zittrain (2006) finds that spam works and it earns profits for touters. They suggest numerous regulatory actions to stop the exploitation of investors through this medium. Although studies looking at the impact of information being spread through Internet have enhanced our understanding of this new phenomenon, there has been no attempt to differentiate among those who spread information. Events in which investor relations targeted “buyside investors” to promote the companies that had hired them were looked at. The medium used for promotion varied from Internet to television. However, different methods using Internet were the predominant way of spreading the information. The information being spread was not necessarily false. However, those who spread the information failed to disclose their relationship with the firm. This fact is important for the receiver to judge the credibility of the information and could have an impact on the credibility of the data released. In one of the earliest studies on the credibility of source and information content by C.. Hoveland and W. Weiss (1951), the authors find that subjects were more likely to change their opinion when the information appeared to emanate from a highly credible source as compared to a less credible one.

S.P. Kothari and J.E. Short (2003) look at the impact of disclosure by different sources on stock return volatility and the cost of capital of the 276 Trust and Ethics in Finance firms. They find that positive disclosure by the firm’s management does not impact either of these variables. However negative disclosure by management leads to increased stock return volatility and cost of capital.



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