Author Archives: MIT Sloan Finance Group

Unlocking the modern financial system

Leading MIT Sloan finance faculty share research, ideas with alumni in London

Professor Robert Merton speaks at the MIT Sloan Finance Forum: Financial System 2.0

The financial system is evolving and businesses and regulators need to move quickly to keep pace with the speed of change. That was a key lesson at Financial System 2.0, a special event held in London on June 13 as part of the MIT Sloan Finance Forum series.

Some 200 alumni and friends of the School attended the event, which saw MIT Sloan’s leading academics meet with experts from across the finance industry to discuss the state of the world’s financial markets and how to shape what comes next.

Highlights of the day included:

Professor Stewart Myers look at management incentives and corporate governance. Myers discussed ways to build a functional balance between shareholder remuneration and good company management, including the idea of levying a transaction cost on shareholder intervention.

Professor Andrew Lo’s examination of how financial markets can be harnessed to help cure cancer. Lo explained that a typical cancer drug development program could cost  $200 million, with a success rate of 5 percent. However, instead of investing in one program, it might be possible to invest in 150 different ones, with diversification offering investors more than a 99 percent chance of at least two successes and a higher return on investment. The reduced level of risk resulting from diversification would allow managers of a “cancer megafund” to issue approximately $16.7 billion of debt immediately, Lo said.

“Instead of declaring war on cancer, we should put a price on its head,” said Lo.

A frank discussion, chaired by Financial Times commentator Gillian Tett, on hedge funds and how they are evolving to respond to the shifting financial landscape.

An overview of MIT Sloan’s intensive, one-year Master of Finance program. Launched in 2008, during the financial crisis, the program was developed to put highly-trained graduates to work in the financial sector. MIT Sloan’s goal is to create the next generation of global finance leaders, with a deep understanding of the profession’s potential contributions to society. Graduation data demonstrates that it is succeeding: although the finance sector has seen a general decline in interest, the number of graduates from MIT Sloan’s Master of Finance program continues to grow.

Professor Antoinette Schoar’s demonstration of how to apply insights from behavioral finance in order to mitigate credit risk, particularly in emerging markets. Schoar explained that in many emerging market countries, small businesses regularly pay late and go into default. Behavioral economics suggests small businesses and individuals in emerging economies slip into default through lack of attention to the repayment cycle, said Schoar.

Professor Andrei Kirilenko’s discussion of market evolutions and high-frequency trading. Kirilenko asked whether high-frequency trading is essentially beneficial or “legalized front­running.” He showed that a survey of market participants concluded that high frequency trading had been the cause of the May 2010 “Flash Crash” that saw the Dow Jones Industrial Average dip 9 percent only to rebound a few minutes later.

But Kirilenko shared research showing that high-frequency trading had not caused the crash.

“We should not look at high-frequency trading as being ‘good’ or ‘evil,’” Kirilenko said. “It is more productive to think of it as a trade-off between beneficial and detrimental effects.”

Kirilenko also discussed the new MIT Sloan Center for Finance and Policy, which will serve as a hub for financial analysis of public policy issues and a collaborative platform to stimulate cooperation between government, the private sector, and academia.

Professor Robert Merton’s demonstration of the role connectedness plays in the global financial markets. Merton warned that there is a need to improve integration between the different parts of government with responsibility for managing fiscal policy and promoting stability.


View videos from this event here

MIT Sloan, friends celebrate life of Nobel laureate Franco Modigliani


Stewart Myers, Robert Merton, and James Poterba

The late Franco Modigliani, who won the 1985 Nobel Memorial Prize in Economic Sciences, was celebrated April 9 for his many contributions to the field of economics and his lasting legacy at MIT, where he taught for more than four decades.

Fellow economists, former students, Boston-area professionals, and family gathered at the MIT Faculty Club for the two-hour long “A Celebration in Honor of Franco Modigliani” to delve into the academic giant’s work in economics and finance and to share stories about the man whose infectious enthusiasm affected so many.

“It’s very hard to believe Franco passed away almost a decade ago,” said Stewart C. Myers, professor of finance at MIT Sloan. “I remember him so vividly I can expect him to walk through that door. And if he did, I think he’d have the same combination of energy and happiness about the field of economics, ideas about economics, and absent-minded generosity he was famous for.”

Modigliani won the Nobel Prize for his pioneering analysis of savings and financial markets. He taught at MIT from 1962 until his death in 2003. Nobel laureate and MIT Sloan professor Robert Merton said Modigliani’s work remains relevant.

“There’s no question his work has a long shelf life,” said Merton. “In 2013, it’s still cutting edge.”

A lasting impact on economic foundations

Franco Modigliani

Merton, speaking on the panel “The Life and Times of Franco Modigliani,” said that before Modigliani’s Life Cycle theory, economists tried to explain how people save and consume by looking at a single year in a person’s life.

Modigliani’s insight was that people plan their consumption and savings over a lifetime in order to spend in retirement.

“He believed most people believe a standard of living in work or retirement should be similar—they don’t want to live on dog food and dine on crystal in retirement, or the reverse,” Merton said.

Modigliani’s work led to the commonly used income-replacement ratio. It remains relevant in today’s MIT Sloan classrooms.

MIT economics professor James Poterba compared Modigliani to Isaac Newton—someone whose work formed the building blocks studied in today’s classrooms.

“Franco’s work is timeless,” Poterba said. “The issues he worked on are the big questions. They are as important today as when he wrote his papers.”

Poterba said Modigliani’s work on monetary theory and stabilization in 1944 “clarified for the rest of the world…sometimes you couldn’t influence the macro economy any more by pushing on interest rates.”

Modigliani also built, along with economist Albert Ando, a large-scale model of the U.S. economy to test the impact of monetary policy.

“We learned enormous amounts about individual sectors of the economy,” Poterba said. “No part of the economy was safe from Franco’s microscope. It was tremendously influential.”

Modigliani was also a pioneer in behavioral economics, currently a hot field of study. In the early 1980s he believed the stock market was underpriced because people weren’t choosing to account for high inflation. As a result, he cautioned investors to hold stocks for a long time so their value could rebound.

Myers said Modigliani left his fingerprints on the way corporate finance is studied and practiced. In 1958, he and economist Merton Miller devised the Modigliani-Miller theorem, which says a corporation’s value is unaffected by whether it is financed by debt or equity.

“It moved corporate finance from the Dark Ages to the Renaissance,” Myers said.

Today, bank regulators want lenders to have greater debt to equity ratios. Bankers oppose this, saying that would hurt their corporations. Myers believes Modigliani would conclude that’s wrong—the theorem says the amount of debt and equity shouldn’t affect the value of a corporation.

“Modigliani would say that’s a freshman-level mistake,” Myers said. “Informed corporate finance always starts with Modigliani-Miller.”

Fervent inquiry into pressing problems

Born in Italy in 1918, Modigliani was always interested in Italian and European economics, long after he and his wife, Serena Calabi, immigrated to the United States in 1939.

A second panel, “The Fate of the Euro,” considered how Modigliani would react to the financial crisis affecting Europe and Italy today.

Panelist Francesco Giavazzi, a professor of economics at Bocconi University in Milan and a regular visiting professor at MIT, noted that in 1998 Modigliani predicted a crisis if wages and labor costs fell out of line.

“You see Franco was right,” Giavazzi said. “Prices did go out of line and the issue today is how to bring these prices back in line with each other.”

Modigliani’s granddaughter, Leah Modigliani, said her grandfather would have liked an opportunity to fix today’s euro crisis. In fact, he never stopped trying to solve the world’s economic problems. She remembered a trip to the beach with a childhood friend that was cut short when her grandfather suddenly had an idea to save Social Security.

“My friend asked, ‘What is your grandfather talking about?’ Well, he has an idea to save the U.S. Social Security system,” Modigliani recalled. “And he would in fact write a letter to The New York Times, and by the time I got home he’d have gotten (Federal Reserve Chairman Alan) Greenspan on the phone to discuss his ideas.”

“He said these things about trying to make the world a better place,” Modigliani added. “His ideas were contagious.”

Beyond his lasting imprint on the study of economics, Modigliani left an impression on many people around MIT.

Serenella Sferza, co-director of the MIT-Italy program, said Modigliani was among the faculty who advised her on establishing the program, which now sends 50 students to Italy annually. Like other panelists, she said she learned that all doors in Italy opened to Modigliani.

But as an MIT student, Sferza studied political science and not economics.

“I envied fellow Italians doing their PhD in economics,” Sferza said. “They had better fellowships, shorter dissertations, and they had Franco Modigliani, who was a magnate, full of authority, good humor, and generosity.”

The Celebration in Honor of Franco Modigliani was held as part of the 2013 Year of Italian Culture in the United States, and Pioneer Investments’ U.S. Colloquia Series.

MIT Sloan Private Equity Symposium addresses the need for new markets

Private equity firms must expand beyond their traditional geographic interests and industry expertise to be successful, Bain Capital’s Steve Pagliuca told a gathering of industry professionals at the 10th Annual MIT Sloan Private Equity Symposium on April 5.

Steve Pagliuca

“The successful players are going to have a huge value-added focus,” said Pagliuca. “You’re going to have to have a global reach, deeper expertise, and the ability to find and evaluate the best deals in the market.”

Pagliuca, managing director of the global investment firm and co-owner of the Boston Celtics, was the closing keynote speaker at the symposium, headlined, “Growth Beyond Traditional Markets.” It was held at the MIT Media Lab.

Pagliuca explained that private equity firms need to search for new markets now that tough economic times are reducing returns investors can expect from U.S. and European investments.

He noted that Chinese leaders “wake up every day” looking for ways to put capital to work to lift their people out of poverty. India’s government is working to become friendly to investment. And Brazil and Latin America are “very exciting places these days,” with strong natural resources.

As those countries grow, Pagliuca said, businesses need capital and expertise to grow, creating opportunities for private equity firms.

Global presence isn’t enough. Private equity firms must have deep knowledge of many industries to “grow and transform and build” businesses in those regions. For instance, Bain has energy, health care, retail, industrial, and high technology divisions. It also offers companies every level of capital—venture, debt, and private equity.

Pagliuca, a member of the nonpartisan Campaign to Fix the Debt, said that the federal government must do more to control the national debt, which he called a drag on the economy and private equity investment.

The national debt could be cut in 15 years by raising taxes and cutting spending by .3 percent annually, Pagliuca said.

MIT Sloan students organized the symposium, which was attended by approximately 250 private equity and venture capital industry leaders and students. Students selected the theme and the panels on creating middle market operational value, energy, health care in Latin America, technology, and finance.

Phil Canfield, managing director of Chicago private equity firm GTCR, and Gary Loveman, CEO of Caesars Entertainment Corp., also gave keynote addresses.

“This is a great example of action learning—working an event outside the classroom, finding it relevant to the industry you aspire to work in, and gaining management experience,” said Mike Reynolds, MBA ’14, one of the organizers of the symposium.

The symposium was sponsored by Choate Hall & Stewart LLP, Ernst & Young, Mekko Graphics, and Pitchbook.