Agency theory and behavioural finance · 2018-03-16 · Investment and behavioural finance 9 Psychology-based explanations of investment behaviour Focus on managerial bias Markets

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University of Stavanger Business Schoolhttp://www.uis.no/MohnTwitter: @Mohnitor

Agency theory and behavioural financeInsights for oil company investment behaviourKlaus Mohn, Professor

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Norwegian Ministry of FinanceOslo, 19 March 2018

Agency theory and behavioural finance

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Insights for oil company investment behaviour

Introduction/backdrop The benchmark model Selected frictions

Agency theory Managerial bias

Three peculiarities Investment and cash flows Dividends and debt Investment and share prices

A note on the outlook

Source: Bøhm, Marit og Klaus Mohn (2017). Agentteori, atferdsfinans og oljeinvesteringer. Samfunnsøkonomen 6/2017.

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Investments: Where it all starts

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Key to resource revenue management

0

50

100

150

200

250

1985 1995 2005 2015

Pipeline transport

Decommisioning

Onshore processing

Producing fields

Field development

Exploration

0

1

2

3

4

5

1970 1980 1990 2000 2010 2020 2030

Yet to find

DiscoveriesUndev. resourcesDeveloped reserves

Produced and sold

Source: Statistics Norway (investment) and the Norwegian Petroleum Directorate (production).

Productionmmboepd

InvestmentNOK bn (nominal)

0

2

4

6

8

10

1970 1980 1990 2000 2010 2020 2030

Cumulated returns

Cumulated transfers

Revenue managementOil fund, NOK trn

The benchmark model

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NPV in a world witout frictions

Markets and prices

Politics and policies

Technology

Drivers of value and risk

Net present value

Cost of capital (CAPM) Required rate of return

T

tt

tii r

CFINPV

1 )1(

fmifi rrErrE )()(


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The benchmark model

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NPV in a world without frictions

Net present value


T

tt

tii r

CFINPV

1 )1(

fmifi rrErrE )()(

RevenuesCapexOpexTariffsExploration

Uncertainty

Flexibility

LicensingDev drilling

Production startPDO

Discovery

Information

Oil investment complexities


The benchmark model

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NPV in a world witout frictions

Net present value


T

tt

tii r

CFINPV

1 )1(

fmifi rrErrE )()(

CAPM assumptions Fully rational, perfect markets Investors optimise risk/return No taxes or transaction costs Endless divisibility of assets Homogeneous expectations Individuals are risk averse Fully diversified investors

No great empirical success


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Irregularities of oil company investment

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Real world behaviour disagrees with benchmark model

Why does investment respond to temporary cash flow fluctuations?

Why are oil companies so concerned with debt and dividends?

Why doesn’t the share price respond positively to investment plans?

Capital expenditureEight major oil companies (USD bn)


Investment in modern theory of finance

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Introducing frictions: Agency theory

Principal and agentsTasks and responsibilities

PRINCIPALe.g., shareholders

AGENTe.g., directors

TASKe.g., managing the company

On behalf of

Employs

To perform

Accountable to

Potential conflicting interests Asymmetric information

Adverse selection Moral hazard

Company valuations Dividend decisions Issuance aversion Capital rationing

Asquith, Paul og David W. Mullins (1986). Equity issues and offering dilution. Journal of Financial Economics 15, 61-89.Jensen, Michael C. (1986). Agency cost of free cash flow, corporate finance, and takeovers. American Economic Review 76 (2), 323-329.Myers, Stewart C. and Nicholas S. Majluf (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics 13, 187-221.Rozeff, Michael S. (1982). Growth, beta and agency costs as determinants of dividend payout ratios. Journal of Financial Research 5 (3), 249-259.Reiss, Peter (1990). Economic and financial determinants of oil and gas exploration activity. In Hubbard, R. Glenn (red.) Asymmetric information, corporate finance, and investment. University of Chicago Press. Stein, Jeremy (2003). Agency, information, and corporate investment. In Constantinides, George M., Harris, Milton og René Stultz (eds) Handbook of the Economics of Finance, utgave 1A (ch 2), Elsevier.Stiglitz, Joseph E. and Andrew Weiss (1981). Credit Rationing in Markets with Imperfect Information. American Economic Review 71 (3), 393-410.

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Investment and behavioural finance

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Psychology-based explanations of investment behaviour

Focus on managerial bias Markets might be efficient

Cognitive biases Over-confidence Miscalibration

Cognitive constraints Simple decision rules Bounded rationality

Baker, M. and J. Würgler (2013). Behavioral Corporate Finance: An updated survey. In Constantinides, George M., Harris, Milton og René Stultz (eds). Handbook of the Economics of Finance, ed 2A (ch 5), Elsevier. Ben-David, Itzhak (2010). Dividend policy decisions. In Baker, H. Kent og John R. Nofsinger (eds.) Behavioral Finance. John Wiley & sons, New Jersey.Ben-David, Itzhak, Graham John R. og Campbell R. Harvey (2013). Managerial Miscalibration. Quarterly Journal of Economics 128 (4), 1547-1584.Bøhm, Marit F. (2017). Oil and gas investments: Agency problems and managerial bias in investment decisions. MSc thesis. University of Stavanger Business School. June 2017.Graham, J. R. and C. R. Harvey (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics 60, 187-243.Krüger, Philipp, Landier, Augustin og David Thesmar (2015). The WACC fallacy: The real effects of using a unique discount rate. Journal of Finance 70 (3), 1253-1285.Malmendier, Ulrike and Geoffrey Tate (2005). CEO overconfidence and corporate investment. The Journal of Finance 60 (6), 2661-2700.Malmendier, Ulrike and Geoffrey Tate (2015). Behavioral CEOs: The role of managerial overconfidence. Journal of Economic Perspectives 29 (4), 37-60.Osmundsen, Petter og Thore Johnsen (2013). Petroleumsbeskatning. Teori og virkelighet. Samfunnsøkonomen 5/2013, 13-21.

0

30

60

90

120

150

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

The great oil price plunge

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Cyclical retreat or structural shift?

Oil price reviewBrent blend, USD/bbl (real)

Shock 1

Shock 2

Shock 3

Source: ThomsonReuters (oil price).

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Headwinds for oil industry and investors

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Oil companies have disappointed their shareholders

Short-term challenge: Profitability

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Returns are eroded by escalating costs and falling oil price

Mixed successGrowth and profitability among major oils (%)

Disappointed shareholders Diverging market views Disputed business model

-10

0

10

20

1990 1993 1996 1999 2002 2005 2008 2011 2014

RoACE Annual production growth

Sources: Deutsche Bank (2013), UBS Warburg (2014),

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Cash flows matter for investment activity

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Oil companies adjust capex plans to oil price fluctations

Cash flow by company and aggregate capex (USD bn)

R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March. Mohn, Klaus (2008). Investment behavior in the international oil and gas industry. PhD Thesis 51. University of Stavanger.Mohn, K. and B. Misund 2009. Investment and uncertainty in the international oil and gas industry. Energy Economics 31 (2), 240-248.Mohn, K. and B. Misund. 2011. Shifting sentiments in oil and gas investments: an application to the oil industry. Applied Financial Economics 21 (7), 469-479.

Cash flow and investmentCross plot (2002-2016)

Oil company cash flow disposition

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Separation of accrual and spending of oil and gas revenues

Statoil cash flow statementFor the calendar year 2015 (NOK bn)

Eight major oils: Cash flow dispositionCash flow, capex, and dividend (USD bn)

Sources: Statoil, ThomsonReuters.

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Dividends and debt as control devices

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Constraint on management flexibility reduces agency costs

Predictable and stable dividends Implicit contract

Erosion of trust Over-confidence Accelerating expenditures Poor returns

Devices of shareholder pressure Reign in management flexibility Directors forced to focus

Dividend paymentsand free cash flow (USD bn)

Ben-David, Itzhak (2010). Dividend policy decisions. I Baker, H. Kent og John R. Nofsinger (red.) Behavioral Finance, John Wiley & sons, New Jersey.Deshmukh, Sanjay, Goel, Anand M. og Keith M. Howe (2013). CEO overconfidence and dividend policy. Journal of Financial Intermediation 22, 440-463.Jensen, Michael C. (1986). Agency cost of free cash flow, corporate finance, and takeovers. American Economic Review 76 (2), 323-329.Modigliani, Franco og Merton Miller (1958). "The cost of capital, corporation finance and the theory of investment". American Economic Review 48 (3), 261-297.Santamarta, Sylvain, Martén, Iván og Esben Hegnsholt (2016). Big Oil’s Road to Reinvention. Report. Boston Consulting Group. Febrary 2016.

Investment plans and investor response

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Share price should be lifted by announcement of investment plans

NPV decision rule Apply CAPM to estimate cost of capital Discount all cash flows Accept if NPV > 0

Investment will add value to company,… … and to shareholders Share price will increase

Source: ThomsonReuters.

Eight major oils: Annual impairmentand the oil price (USD bn/USD per bbl)

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Investment plans and investor response

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Shareholders reward capital discipline and cost restraint

Capex cuts have been rewarded Esp among European companies

Diverging views on valuation Partly due to track record Partly due to market outlook

Variation in agency costs Over time Across companies

Data source: ThomsonReuters.McConnell, John J. og Chris J. Muscarella (1985). Corporate capital expenditure decisions and the market value of the firm. Journal of Financial Economics 14, 399-422.

Announcement of capex plansand share price response (2013-2017, per cent)

Long-term challenge: Growth

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Source: IEA (2014). World Energy Outlook.

Opportunity constrained by access to reserves and demand outlook

Constraints on access and supplyProven oil and gas reserves by global region

Americas13 %

Europe1 %

Asia Oceania0 %

EE/Eurasia8 %

Asia3 %

Middle East48 %

Africa8 %

Latin America19 %

Energy and climate policies Lost ground in transport Shale gale globalisation Markets shift eastward Emerging technologies Shifting OPEC behaviour Access, returns, and risk

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Access, returns and risks

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Scarcity bites: Exploration yields in decline

Big Oil E&A spendingUSD bn

Source: WoodMcKenzie, Wall Street Journal.

Big Oil conventional drill-outAnnual discoveries

Energy and climate policies

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Values and volumes at risk due to rising cost of CO2 emissions

Source: Cust, Jim, Manley, David, and Giorgia Cecchinato (2017). Unburnable wealth of nations. Finance and Development March 2017. International Monetary Fund.

Global CO2 emissions 2010-2035Giga tonnes

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Oil industry response

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Short-term reaction: Speed up production, push policies, buy time

Mohn, Klaus (2017). The gravity of status quo: A review of IEA’s World Energy Outlook. Economics of Energy and Environmental Policy (forthcoming).Muttitt, Greg (2017). Forecasting failure. Why investors should treat oil company energy forecasts with caution. Report for Greenpeace and Oilchange International. March 2017.

The emergence of energy scenariosMajor Oil companies engage

Front-load production More myopic investment behavior Aversion to long-term projects Focus on oil, and esp shale oil

Bend the business framework Community outreach Energy analysis and dialogue Stakeholder engagement

Oil companies and climate risk

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Repositioning, readjustment, diversification

Repositioning Fossil fuel portfolio

Readjustment Focus on CO2 intensity Energy efficiency Cost efficiency New KPIs

Diversification Natural gas Power generation New renewable energy

Bøhm, Marit F. and Klaus Mohn (2017). Agentteori, atferdsfinans og oljeinvesteringer. Samfunnsøkonomen 6/2017, 26-38.Helm, Dieter (2017). Burnout: The end-game for fossil fuels. Yale University Press.Statoil (2017). Statoil’s Climate Roadmap. Creating a low carbon advantage (https://www.statoil.com/content/dam/statoil/image/how-and-why/climate/A5-climate-roadmap.pdf).

The emergence of energy scenariosIEA’s World Energy Outlook 2017

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Agency theory and behavioural finance

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Insights for oil company investment behaviour

Insufficient benchmark model Real-world frictions apply

Agency costs Managerial biases

Mind the gap Cash flow Opportunities


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Agency theory and behavioural finance · 2018-03-16 · Investment and behavioural finance 9 Psychology-based explanations of investment behaviour Focus on managerial bias Markets