Course Logistics
Course Admin
• Only electronic materials provided via Moodle:
[Link]
• Instructions about Moodle in the Information Packs sent
this weekend
• Course code: AC210 ; Enrolment key: AC21023
• Course dividend into: Lectures (10am-1pm) and Classes
(afternoons)
• First half taught by me; Second half: Dr Maria Correia
• Two Exams: Mid Exam (27th June); Final Exam (7th July)
Getting Around LSE
• Summer School Office: NatWest Building on Houghton
Street, Monday-Friday 9:30am-5:30pm
[Link]
0.1157116,17z?entry=ttu
• Course changes may only be made in the first two days of
the session, and are arranged through the Summer
School Office
• Welcome Reception: Monday 19th June 5.30pm, Senior
Dining Room, 5th Floor, Old Building (OLD)
Best Practices
• Attendance - Students are expected to attend all lectures
and classes, especially if they hope to do well in the
exams
• Having said that, it is summer time, I get that. My job is to
make sure that those who want to attend are allowed to
have a quality lecture
• There are several pubs around campus; better there than
in the lecture if you do not know what to do with your time.
Choose wisely, I really mean it!
Course Logistics
The End
Investment Banking and Asset
Management: Overview of the Industry
Introduction
Source: Corporate Finance Institute
Introduction
Source: Corporate Finance Institute
Buy Side (Investors): Intro
• Investors have economic recourses (”savings”) and want
to allocate the funds to profitable investment projects to
generate a given risk/return profile.
• In return to their capital, investors get:
• A “ fixed” periodical payment + the principal (bond / loans)
• A “variable” payment (no certainty) + capital gains ( shares )
Buy Side: Trends 2003-2024
Buy Side: Biggest Players
• Black Rock:
one of the world’s leading
providers of investment, advisory
and risk management solutions
from an eight-person start up to
a global company with more
AUM than any other investment
manager
Buy Side: Biggest Hedge Funds
• Citadel:
“Start with an idea. Build it, test it
and refine it. Make it great, then
make it better. Receive fast
feedback from the markets.”
“Our algorithm creates and
analyses statistical themes for
virtually every company and
institution in the world. We combine
over a hundred fundamental inputs,
dozens of valuation models and
trend analyses into a powerful
predictive engine.”
Buy Side: Incentives
The most important driver of
compensation for buy-side
investors is how good their stock
picks are (skill)
Integrity comes second
Introduction
Source: Corporate Finance Institute
Corporations: Intro
• Corporations (Firms) produce goods and services for
consumers to enjoy and for other firms to utilize in their
production processes
• Firms need financing for their projects and thus provide
investment opportunities for investors
• Literally, there are 000s of firms for investors to choose
from: >4,000 stocks only in the US.
Corporations: Intro
• Plenty of choice for investors
• The key question: which of
these represent the best
investments?
• More on firms later
Introduction
Source: Corporate Finance Institute
“Sell side”: Intro
• Sell-side financial analysts play a crucial role as
intermediaries between investors and corporations
• Role: provide investment recommendations and analysis
on companies to assist investors in making informed
investment decisions
• This role entails among others: (i) Research and Analysis;
(ii) Financial Modelling, Valuation and Investment
Recommendations
“Sell side”: Example Report
• You should all leverage-up on the LSE resources
“Sell side”: Largest Players
• JP Morgan:
is a global leader
in financial
services offering
solutions to the
world's most
important
corporations,
governments and
institutions
“Sell side”: Incentives
• Sell-side investment banks make money from trading
commissions and from advisory fees
• How important are the above for EF and SR?
Introduction
The 1st ½ of the
course will focus on
the valuation of
securities (equities)
Particular emphasis
on how to use
accounting
information for
valuation
Accounting
information: Financial
Statements
Source: Corporate Finance Institute
About Me
• Education Background
• PhD in Accounting (Minors: Finance and Econometrics), LBS
• MSc Finance and Economics, LSE
• MSc Accounting and Finance, LSE
• Non-academic Research Experience
• Alpha Consultant, Quantitative Equity Strategies, Citadel Securities
• Academic Advisor, Quantitative Equity Research, Citigroup Securities
• PhD Associate, Quantitative Equity Research, Macquarie Securities
• Research interests: statistical arbitrage and pricing of accounting
information
• My website; My valuation papers
Investment Banking and Asset Management: Overview of the Industry
The End
Why Are Financial Reports Important?
Why Are Financial Reports Important?
• With so many firms choose from, how do
investors decided between the “good” and the
“bad” investments?
• Clearly, investors and firm managers do not
always share the same information. Firm
managers are insiders of the firm and they
may have private information that investors do
not.
• The latter is typically referred to as
asymmetric information between “sellers” and
“buyers”.
• “High quality” firms engage in costly financial
reporting activities to distinguish themselves
from the “bad quality” firms.
• Investors use the information in financial
reports to make better investment decisions.
Why Are Financial Reports Important?
• Accounting provides information
fundamental to informed economic
decision-making.
• Accounting begins with economic activity
and shades of grey.
• Accounting judgements require critical
thinking to create useful information that
can help decision-makers make better
decisions.
• These decisions have consequences for
economic activity and, thus, for
accounting judgements.
• The ultimate benefit of better-informed
decisions is a more prosperous society
for everyone.
Why Are Financial Reports Important?
• This “reality of accounting” diagram stands
in contrast to the “perception of accounting”
diagram on the right-hand side of the figure.
• The latter diagram depicts the focus of
accounting as record-keeping and the
creation of financial reports according to a
set of rules.
• This diagram reflects many individuals’
incorrect perceptions of what accounting
really is.
Why Are Financial Reports Important?
• So, financial reports are important because they provide
information fundamental to informed economic decision-making.
• The International Accounting Standards Board’s (IASB)
Conceptual Framework for Financial Reporting (IASB, 2010) has
elements of this reality. The objective of financial reporting
embraces decision-usefulness when stating that:
“The objective of financial reporting is to provide financial information about
the reporting entity that is useful to existing and potential users in making
decisions about providing resources to the entity.”
Why Are Financial Reports Important?
• Providing information that is useful for
decision-making is the objective of financial
reports but, how the financial reports
actually fulfil their purpose?
• The figure on the right provides some
insights about the usefulness of
accounting information for equity valuation.
• The vertical axis measures the proportion
of stock prices that are explained by
accounting numbers.
• Few highlights are:
• Earnings and book value of equity have
traditionally been the most value-relevant
amounts.
• Intangibles and alternative performance
measures have gained traction recently.
Why Are Financial Reports Important?
• The value relevance of
different financial reporting
amounts varies not only over-
time but also depending on the
type of firm.
• The decrease in the value
relevance of earnings is more
pronounced for new economy
firms than for the traditional
“manufacturing” firms.
Why Are Financial Reports Important?
• The value relevance of
different financial reporting
amounts varies not only over-
time but also depending on the
type of firm.
• The decrease in the value
relevance of earnings is more
pronounced for new economy
firms than for the traditional
“manufacturing” firms.
Why Are Financial Reports Important?
The End
Information in Financial Statements
The Basics
A Users Perspective
• Goal: become educated consumers of, rather than
producers of, accounting information
• How?
Understand financial reports – what’s in them?
Understand how to map individual transactions to their balance
sheet/income statement effects
Accounting Information
Annual/Quarterly report:
• Provided once a year/quarter, within 1-3 months from the
close of the fiscal year/quarter
• Components:
the income statement,
balance sheet,
and cash flow statement,
narrative disclosures.
• How do we qualitatively characterize accounting
information?
Accounting Information
LSE resources or companies Investors’ Relations websites:
let’s look at Microsoft’s 2022 annual report:
Selected financial data, stock price information, issuer
purchases of equity - pp. 8-10
MD&A - pp. 30-44
Main financial statements - pp. 45-51
Notes to accounts – pp. 52-83
Auditor’s report – pp. 84-86
Introduction to Financial Statements
• Balance sheet (BS):
Sets out the financial position of an entity at a given date
ASSETS (i.e. the resources of the entity), LIABILITIES and
OWNER’S EQUITY (i.e. the claims against the resources):
ASSETS = LIABILITIES + EQUITY
• Income statement (IS):
Measures and reports the amount of wealth (profit or loss)
generated over a period
Introduction to Financial Statements
• Cash flow statement (CS):
Provides information on cash flows from operating, investing,
and financing activities
Statement of shareholder’s equity:
Statement that clarifies details in shareholder’s equity (Mostly
redundant from the point of view of our course)
BS, IS and CS are intrinsically related through the Clean
surplus relation: ∆EQUITY= Net Income - dividends
Information in Financial Statements
The End
Accounting Information and Users
Equity Vs Debt Investors
Informational Perspective of Accounting
• Accounting information: facilitates exchange of resources
and contract enforcement.
• This role existed before government-regulated supply of
accounting information.
• Quality and quantity of information: has real effects on
resource allocation and cost of capital.
Informational Perspective of Accounting
• However, not all stakeholders have the same needs: no
single set of accounting rules will completely satisfy all
stakeholders.
• Performance measurement: influential role in shaping the
income statement.
• Balance sheet measurement: reflect stewardship
demands for both debt contracting and management
control purposes.
Equity Investors
• Equity valuation: current cash flows and the amount,
timing, and uncertainty of future cash flows.
• Current performance indicative of future performance:
accounting matters for valuation.
• However, agency problems affect the attributes of
accounting information.
Equity Investors: Ownership Vs Control
• Management’s proclivity to favourably skew reported
performance.
• “Unconditional” conservatism can be attributed to
concerns over verifiability.
• Threshold on verifiability is lowered when information is
adverse: accounting rules are “conditionally”
conservative.
Debt Investors
• Debt holders have a different
pay-off function that equity
holders.
• Debt holders demand
information about:
(i) the value of the firm’s
assets in the event of
liquidation,
(ii) the extent of other claims
on those assets, and
(iii) firm performance.
Debt Investors
• Demand regarding liquidation values: a balance sheet
using conservative accounting.
• Separable and saleable assets net of its economic obligations:
Goodwill?
• Demand regarding firm’s solvency: income statement.
• Debt holders will likely require an independent audit of
the borrowing firm.
Is There a "Best" Reporting System: "Most" Useful?
• Firms’ financial statements trade off the information
needs of different stakeholders.
• One solution: provide different sets of financial
statements to each set of users. Likely to be prohibitively
costly.
• Another solution: single set of general-purpose financial
statements and allow different user groups to tailor (or
adjust) the financial statements to suit their own
purposes.
=>DISCRETION/CHOICE.
Accounting Information and Users
The End