Commodity price exposure and ownership clienteles

1
Commodity price exposure and ownership clienteles

• Phil Davies, Bernadette Minton and
• Cathy Schrand
• First draft October 2007

2
Research question

• Do investor stock holdings reveal a preference
  for commodity price exposure?
• Main analysis
• OWNERSHIP f (EXPOSURE, CONTROLS)
• Exposure proxies are market-based factor-price
  betas (gold/OG)
• Three proxies for ownership
• All investors Proxy for ownership is share
  turnover
• Institutions Proxy for ownership is number of
  investors (LNUMGR)
• Individuals Proxy for ownership is number of
  sector fund managers
• Cross-sectional analysis based on
• Source of the exposure
• Type of institutional investor
• By fiduciary standards Banks, Insurance
  Companies, Mutual Funds, Investment Advisors,
  Pensions/Endowments
• By monitoring incentives Dedicated owners,
  quasi-indexers, transient investors
• Performance of the underlying commodity

3
Motivation

• First step to answer the question that we
  ultimately want to examine
• Do firms incorporate investor preferences into
  their exposure decisions?
• f(x) traditional explanations for optimal
  risk management
• Hedging reduces financial distress by reducing
  internal capital volatility
• Hedging reduces expected taxes when tax schedule
  convex
• Hedging reduces agency (contracting) costs by
  reducing earnings/stock price volatility

4
Motivation, continued

• We consider ownership O(x) as a potential
  factor in hedging decision
• b represents liquidity benefits of ownership
• Assume b is non-zero
• In this paper, we address the partial equilibrium
  question
• Is ownership a function of exposure?
• That is Is O(x) non-zero
• Unique prediction Investors are attracted to an
  unhedged firm

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Analogous corporate decisions

• Dividends
• Owners have cash flow preferences
• Various costly activities that generate
  attention/visibility
• Listing decisions
• Owners exhibit home bias
• Direct advertising
• We dont make the products you use, we make the
  products you use better.
• IR departments/costly communication
• All of the above types of studies cite Merton
  (1987)
• An interesting example Otherwise negative NPV
  projects
• In 2000, management determined that the Company
  should position itself in high-profile natural
  gas projects in an effort to attract capital and
  as a result of increasing demand for natural
  gas.
•  
• Imperial Petroleum Inc. 10-K

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Why do we examine exposure?

• Inherent interest in firms hedging decisions
• Pure play firms are an unexplained phenomenon
• Plausible arguments for why exposure might
  attract ownership
• Anecdotal evidence
• GOLDCORP We want to make mining attractive not
  just to investors who invest in the mining
  industry, but to investors who are looking for
  investments across the whole market. So what is
  the ultimate gold stock? Low risk superior
  assets very profitable business leverage to
  gold a strong board and management group and
  excellent growth prospects. We are North American
  based, we have no debt, we are not hedged, a
  quarter billion dollars in cash at the end of the
  first half.
• NEWMONT MINING Newmont wears its unwillingness
  to hedge its production like a badge of honour.
  When people buy a gold stock, they want the
  exposure to the commodity If you're selling
  forward, you run the risk of capping your upside.
  And the shareholder is likely to say, 'Why did I
  pay a premium for a company that's limited its
  upside?' At Newmont, our hedge, if you will, is
  our low cost".

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Investor preferences for exposure

• Commodities are a unique asset class
• Higher returns than stocks or bonds
• Offer diversification opportunities
• Commodity returns tend to be negatively
  correlated with stock market returns.
• Commodities may be a hedge for inflation
  (Gorton/Rouenhorst, 2005 Kat/Oomen, 2007)
• So why not invest in commodities (spot market or
  derivatives)?
• Impractical
• Fiduciary standards

8
Investor preferences for exposure,
contd

• Exposure is correlated with transparency
• We conjecture that unhedged firms are more
  transparent because hedged firms are
• More diversified
• Use derivatives
• Evidence that institutions are attracted to
  transparency

9
Main analysis

• OWNERSHIP f (EXPOSURE, CONTROLS)
• Three proxies for ownership
• All investors Proxy for ownership is share
  turnover
• Institutions Proxy for ownership is number of
  investors (LNUMGR)
• Individuals Proxy for ownership is number of
  sector fund investors

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Exposure measures
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Control variables
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Table 2Share turnover regressed on exposure
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Table 3LNUMGR regressed on exposure
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Cross-sectional analysis

• Source of the exposure
• Diversification
• Derivatives
• Type of institutional investor
• By fiduciary standards Banks, Insurance
  Companies, Mutual Funds, Investment Advisors,
  Pensions/Endowments
• By monitoring incentives Dedicated owners,
  quasi-indexers, transient investors
• Performance of the underlying commodity

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Table 4. Univariate comparisonDerivatives use
and diversification
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Table 5 Turnover results
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Table 6 Classified by fiduciary standards
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Table 6 Classified by monitoring incentives
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Table 7 Conditional on performance
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Summary

• Main analysis General preference for unhedged
  stocks
• Cross-sectional analysis
• No difference as a function of source of exposure
• Investment cos./advisors gt banks, insurance cos.,
  pensions
• No variation across dedicated owners,
  quasi-indexers, transient investors
• Consistent with unique asst hypothesis, not
  transparency
• Currently planned extensions/improvements
• Inclusion in stock market indices
• Should hold in all industries (Fama-French
  industry groups)