Tag Archives: Finance

Why the Internet did not kill RadioShack

See the original article posted on Fortune Insider here>>

Although the electronics retailer is the latest victim in the rise of e-commerce, several other missteps led to its demise.

We’ve seen the downfall of many bricks and mortar stores over the last decade, including Borders, Circuit City, and most recently, RadioShack — to name just a few. As e-commerce continues to rise, it’s seemingly becoming more difficult for traditional stores to stay in business.

It’s true that online shopping has significantly grown over the last 10 years. Even in the last year, we’ve seen a noticeable uptick. According to the U.S. Census, total e-commerce sales for 2014 in the U.S. were estimated at $304.9 billion, which is a 15.4% increase from 2013. However, plenty of bricks and mortar stores are still healthy. Is it fair to blame e-commerce for every store closing and bankruptcy?

As a U.S. bankruptcy judge on Tuesday said he would approve a plan by the electronics retailer to sell 1,740 of its stores to the Standard General hedge fund and exit bankruptcy, it’s worth taking a closer look at why RadioShack failed. E-commerce wasn’t the only culprit. One big mistake involved poor strategic decisions over its financials. Feeling undervalued, the retailer bought back $400 million in stock in 2010 when its net profit was $206 million. It did something similar in 2011 when its net profit had declined to $72 million and it did another buy back for $113 million. In the end, it spent more than $500 million trying to push up the stock price.

However, the company didn’t make enough money to finance the buy back and had to borrow money, which increased its debt-to- value ratio and left RadioShack vulnerable to a declining profits. Rather than buying back so much of the stock and taking on debt, it should have accepted the valuation, closed a few inefficient stores and avoided bankruptcy.

Another significant mistake was its decision to change its product market strategy. In prior years, RadioShack was known as the place to go for hard-to-find parts and components needed to build things. It also had knowledgeable staff who could help customers with high-level customer service. Customers were willing to pay higher prices because of this additional value. After all, there is a difference between getting helpful information in person and trying to explain an issue via the phone, an online chat, or a Google search.

When RadioShack changed its business model to sell finished products like laptops and phones, it lost that competitive edge. Customers could get those finished products from many other retailers and e-commerce sites at lower prices. And a higher-level of customer service wasn’t needed for those products.

While it’s too late for RadioShack, its demise offers some important takeaways for other bricks and mortar stores:

Find a competitive edge. If you offer a unique product, like RadioShack did with selling specialty components, don’t disregard that strength.

Be aware of price sensitivities. A big challenge for bricks and mortar stores is that they have to pay for overhead whereas online retailers don’t, allowing them to charge lower prices. Customers are more likely to price shop for larger and more expensive items, especially ones readily available online like phones and tablets. They tend to be less price sensitive about small and specific goods like the components previously sold by RadioShack.

Focus on customer experience. A big draw for RadioShack was its knowledgeable staff. When it moved to selling finished products, the need for that staff — and consumer willingness to pay higher prices — disappeared. Many people still value talking to a real person.

Looking ahead, it won’t be smooth sailing for traditional stores. But it won’t be all doom and gloom either if they can learn from the mistakes of retailers like RadioShack.

Andrey Malenko is the Jon D. Gruber Career Development Assistant Professor of Finance at the MIT Sloan School of Management.

Evidence of the Financial Accelerator using Corn Fields

The role of financial frictions in amplifying and propagating economic shocks has received significant attention in explaining fluctuations over the business cycle. Financial frictions introduce a wedge between the cost of external finance and the opportunity cost of internal funds. This implies that the strength of firms’ balance sheets will affect the manner in which their investment activity reacts to economic shocks. Current firm investment affects future balance sheet strength, creating a dynamic feedback loop that propagates economic shocks over time. Theoretical models of this so-called “financial accelerator” have played an important role in the literature (e.g. Bernanke and Gertler (1989); Kiyotaki and Moore (1997); Shleifer and Vishny (1992), Bernanke (2007)).

In spite of their importance, empirically testing financial accelerator models has proven to be difficult. While a vast literature exists examining the presence of financial frictions, these frictions serve only as a necessary ingredient for financial accelerator models. See, for example, Lamont (1997), Rauh (2006), Hennessy and Whited (2007) and Kaplan and Zingales (1997), Hubbard and Kashyap (1992), and Rajan and Ramcharan (2012). The essence of financial accelerator models—namely, the role that financial frictions play in propagating economic shocks—remains understudied empirically. There are at least three reasons why this is the case. First, it is difficult to measure exogenous shocks that affect firm productivity. Second, measuring firm productivity, in and of itself, is quite challenging. Indeed, standard productivity measures, such as TFP, are often residuals of regressions relating (mismeasured) outputs and inputs. Finally, it is difficult to obtain clean measures of collateral values, which often play an important role in financial accelerator models.

In a recent project we test the central predictions of financial accelerator models by focusing on a novel setting – the agricultural sector in Iowa. This sector provides a natural environment, rich in data, to examine how shocks to productivity are propagated, both during normal times as well as during crises. As a source of identification, we use exogenous shocks to productivity arising from variation in weather. To analyze productivity, and relate it to productivity shocks as well as measures of financial constraints, we exploit the rich data available on farm crop yields. Finally, focusing on the agricultural sector provides us with a measure of collateral values: land is a main source of collateral for farms and data on land prices are readily available.

We find that the effect of weather shocks is indeed persistent: past weather-driven shocks to productivity affect both current farm yields as well as current land values, up to two years following the shock. We also find these effects are weaker for counties with higher per-capita income. Consistent with the importance of financial frictions in accelerator models, our results show that the sensitivity of farm yields and land values to past weather shocks increases during the 1980s farm debt crisis. The effect is economically substantial, with the sensitivity of yields to past shocks increasing during the debt crisis by a factor of more than three. The result highlight how temporary shocks to productivity can have long lasting effects.

Rajkamal Iyer is an Associate Professor of Finance at MIT Sloan School of Management.

Contributors to this post include Nittai Bergman,  Associate Professor of  Finance at MIT Sloan and Richard Thakor, a doctoral student at MIT Sloan.

Tackling the challenges of governments as financial institutions

From the MIT Sloan Newsroom:

Governments not only regulate the private financial marketplace, they also own and operate some of the world’s largest financial institutions. Government agencies make trillions of dollars of loans, insure large and complex risks, and design new financial products. Yet their leaders often lack the analytical support and rigorous financial training of their peers in the private sector, and transparency is often lacking.


The MIT Center for Finance and Policy officially launched this month to address those gaps, along with other challenges facing financial policy makers.

“This is a big unmet need,” said Professor Deborah Lucas, director of the center. “To have an academic center devoted to the broad swath of government financial policies that have such an enormous effect on the allocation of capital and risk in the world economy.”

“What we want to do is to promote research that policymakers, practitioners, and informed citizens can turn to as an objective source of information when they’re thinking about these policy issues. That information often isn’t available now,” she said.

Research endeavors so far include, among others: the production of a world atlas of government financial institutions, an effort helmed by Lucas to catalog, compare, and evaluate governments’ financial involvement worldwide; a project led by Professor Andrew Lo to develop a dashboard that measures systemic financial risk; a study of the effects of algorithmic and high frequency trading, led by Professor Andrei Kirilenko; and a study of policies on retirement finance led by MIT Sloan professor and Nobel laureate Robert Merton.

Lo, Kirilenko, and Merton are all co-directors of the center.

Along with the research work, Lucas said there is also an educational mission for the center. In many cases, the center’s leaders say, financial problems could have been avoided, mitigated, or at least predicted had public sector workers had an education on par with that received by many private sector finance professionals.

“The idea is to provide the people who are working on finance within a government context with the same skillset as their peers in private industry,” Lucas said. “One reason you see a lack of finance education is because it’s tended to be a rather expensive education. And people going into the public sector may not even realize that finance is what they will need to know.”

At MIT Sloan, work at the center has already led to the creation of Kirilenko’s new course—Core Values, Regulation, and Compliance—as well as a student club on financial markets and policy.

The center began sponsoring events in October 2013, but officially launched Sept. 12-13 with the inaugural MIT Center for Finance and Policy Conference in Cambridge, Mass. More than 120 people attended the invite-only event, which featured discussions on the cost of government credit support, the costs of single-family mortgage insurance, and contagion in financial markets. Peter Fisher, senior director at BlackRock Investment Institute and a former undersecretary at the U.S. Department of the Treasury, gave a keynote talk.

The conference also included a panel discussion on improving government financial institutions, which addressed the need for government agencies to improve how they manage credit portfolios and monitor program risk levels over time. Panel members also discussed ways to raise red flags when there are problems in government credit programs.

The outlook was not entirely dire. “The move toward embracing risk management concepts across the federal government has been impressive in recent years,” said Doug Criscitello, a managing director at Chicago-based audit, tax, and advisory firm Grant Thornton and the former CFO of the U.S. Department of Housing and Urban Development. “We’ve seen the rise of independent risk management offices … that are housed outside the credit extension department.”

Lucas said she believes MIT’s depth in finance, economics, policy, and systems thinking make it the ideal place to study governments as the world’s largest and most complex financial institutions.

“I think an important reason that more academics haven’t taken on these issues—despite their importance—is that they are extremely complex,” she said. “Making progress takes a big investment in understanding institutions and laws and motivations. The problems are inherently interdisciplinary. And MIT is this great institution in terms of having the horsepower and energy to go after it and say ‘We can hit this question from a lot of different dimensions.’”