Intellectual Capital

From the Fall 2015 edition of Vanderbilt Business

As members of one of the nation’s top research universities, Owen faculty always have something interesting on their minds. Here’s a portion of what two faculty members are currently considering.

Richard Willis

IntCapWillis166x422Who: Richard Willis, the Anne Marie and Thomas B. Walker Jr. Professor of Accounting. The West Texas native joined the Owen faculty in 2006. Willis earned his MBA from the Fuqua School of Business at Duke University in 1992 and his Ph.D. from the University of Chicago in 1998. He was an associate professor of accounting at the Freeman School of Business at Tulane University before coming to Vanderbilt. He has also held teaching positions at the Kellogg School of Management at Northwestern University and the Fuqua School, where he was awarded the Daimler-Chrysler Award for excellence in teaching.

Prior to his academic career, Willis was a marketing research analyst for Warner-Lambert Company (later acquired by Johnson & Johnson), where he worked on many popular oral care brands, and at E. & J. Gallo Winery, where he helped launch the Bartles & Jaymes wine cooler.

What he’s researching: Willis has extensive experience in accounting and financial reporting and a distinguished body of scholarly research in premier accounting and finance journals. Willis conducts what’s known as empirical financial accounting research. That means he studies questions that are addressable through data that’s either present in financial statements or disclosed by security analysts. Vanderbilt has a group of faculty working in this area, which is one of the reasons that Willis was attracted to Owen.

Lately, Willis has become more politically minded. Willis and colleagues are currently studying elections in more than 30 countries to see how companies alter their tax strategy in response to political uncertainty. They are examining how companies around the globe avoid paying taxes in anticipation of upcoming national elections.

Their hypothesis is that in the face of political uncertainty, companies may respond to that uncertainty by avoiding taxes to the fullest extent possible. The research team defines political uncertainty as general uncertainty about upcoming government and regulatory policies that might be altered as a result of a change in an incumbent government. Preliminary research suggests that companies will hold on to more of their cash whenever possible until after the election, when the uncertainty is resolved.

The way these companies behave in the run-up to an election is similar to how everyday consumers behave during an economic downturn. When the economy tanked in 2008, consumers were uncertain about their future finances, so they saved more cash because they weren’t sure what was going to happen.

“When that anxiety about the future manifests itself, a natural response is to hold on to more cash because you don’t know what’s coming next,” Willis says.

Why it’s important: It matters to companies. In this case, with political uncertainty as an example, if the tax rate was going to drop after the election, then a company would want to defer paying taxes today—to the fullest extent possible—in expectation that they could pay lower taxes in the future after the tax rate was decreased.

Companies look to avoid paying taxes through various tax deference strategies, such as tax shelters in offshore countries. In another scenario, if a company is running money through that tax shelter today, but expects that laws might soon change to make tax shelters illegal in that country, then the company might try to maximize the use of the shelter today.

The U.S. corporate tax rate is the highest corporate tax rate in the world, so American companies are desperate to lower their tax burden and will try various strategies to do so. Understanding how companies are responding to global political uncertainty through their tax deference strategy could help economists better predict future responses to elections.

Nicholas Crain

Who: Assistant Professor of Finance Nicholas Crain came to Vanderbilt in 2013 after earning his Ph.D. in finance from the McCombs School of Business at the University of Texas at Austin. His dissertation examined the effect of career concerns on the pattern of investments selected by venture capital fund managers. He was also awarded runner-up in the 2012 Coller Ph.D. prize given by the London Business School for the best paper relating to private equity and/or venture capital fields. Prior to graduate school, Crain served as associate professor of naval science at the University of Idaho and as a division officer in the U.S. Navy aboard the USS Augusta, a nuclear-powered submarine.

IntCapCain220x420What he’s researching: Crain’s research is about investment decisions and what affects performance in venture capital and private equity funds. To be a venture capitalist, he says, you have to raise new money periodically. Investors may commit capital, often between $30­‑$150 million, to be spent over five years. As this commitment winds down, you have to go out and raise more money, facing scrutiny on your past performance.

According to Crain, this practice actually discourages risk taking. His research has shown that venture capital companies want to hit singles and doubles before trying to hit home runs. Convince investors that you have talent, he says, then start swinging for the fences. That’s the pattern seen in Crain’s data. Early investments for venture capitalists tend to have a lower variance in outcomes than later investments. The venture capitalists who do poorly with initial investments tend to keep making safer bets. Those who appear certain to raise new money are the ones who make risky investments with higher reward potential.

Lately, Crain is interested in how newly available data will affect private equity in venture capital. Progress in quantitative analysis in the private equity and venture capital field has been slow because it is difficult to get data on these private transactions. That’s starting to change. Just in the last few years, the data that’s accessible to researchers has improved and now it is at the point where Crain can use it in his research. Soon, the data will be at the point where people in the venture capital industry can use it to help make decisions about their investments. Why is the investment data from venture capital and private equity firms more accessible now? More demand and improved technology, Crain says. Several companies are collecting the data and have invested the money needed to do a good job of assembling a clean database. The alternative asset industry has grown large enough for that investment to make sense.

Why it’s important:  Better and more accessible data could lead to better insights into how investment performance is related to agency problems or corporate finance theory, which Crain studies. Practitioners will be able to get better insight into how well a fund manager performs.

“Looking at their fund level returns, it’s hard to discern whether they’re awfully good or awfully lucky,” Crain says.

Being able to see a little bit more about their performance on a granular level will reveal, for example, if a successful fund return came from one home run investment or a series of consistently successful investments. Such an analysis would lead to a systemic benchmarking across firms.

“With the demand for venture capital transparency, along with the information technology’s ability to gather data easier, we will see improved benchmarking start to show up and be the basis for a lot of really interesting research sooner rather than later,” Crain says.