Mercers’ School Memorial Professor of Commerce Michael Mainelli

1. Mercers’ School Memorial Professor of CommerceMichael Mainelli Take My Profits, Please! Volatility Reduction and Ethics

2. Outline • Shouldn’t ethics cost? • Shouldn’t ethics pay? • Calculated risks • Valuing shape changers - volatility • Sustainability = Stable? • Measuring the immeasurable benefits of CSR • Societal gains “Get a detailed grip on the big picture.”Chao Kli Ning

3. Shouldn’t Ethics Cost?

4. Shouldn’t Ethics Pay?

5. Calculated Risks

6. Valuing Shape Changers

7. What Is An Option? S = current stock price, say £100 T = time till expiration, 3 months K = option striking price, say £100 C = call premium, £5 or £65?

8. Stable or Wild: Which Is Worth More? • Stable: • almost certainly between £90 and £110 at end of three months • stable = £110 - £100 = £10 • stable = £90 - £100 = -£10 • not a lot of chance to make money • Wild: • anything from £30 to £300 at end of three months • Wild (1) = £30 - £100 = -£70 • Wild (2) = £300 - £100 = £200 • average of Wild (1) and Wild (2) = £65 • Option on Wild worth more than option on Stable

9. Black-Scholes Equation where d1 and d2 are: C = call premium of an option on stock S with duration T S = current stock price, say £100 T = time till expiration, 3 months K = option striking price, say £110 r = risk free interest rate, say 4% s = standard deviation of stock returns, say 20% N = cumulative standard normal distribution

10. Two Cases Priced By Black-Scholes • Stable: • standard deviation 10% • option = £2.51 • Wild • standard deviation 300% • option = £54.90 S = current stock price, say £100 T = time till expiration, 3 months K = option striking price, say £100 r = risk-free interest rate, say 4%

11. 100 Years Of Instability Risk-Return from 1900 to 1999 12 US Shares 10 UK Shares 8 US T-bonds Return 6 French Shares 4 2 US T-bills 0 0 10 20 30 40 Volatility Source http://www.economist.com/displaystory.cfm?story_id=268876

12. Average Premium/Discount to Market by GMO Composite Valuation Top 1000 UK stocks, mcap-weighted quintiles, Dec-69 to Aug-03, 5-year earnings volatility +20% +17.0% +15% +10.0% +10% +5% 0% -2.1% -3.3% -5% -10% -10.9% -15% Low Earnings Volatility Quintile 2 Quintile 3 Quintile 4 High Earnings Volatility Sustainable = Stable? Source: GMO

13. Volatility Loss = Equity Gain • Move perceptions of future profit volatility from 50% to 20% on £10 billion market capitalisation • Estimated gain of 15% on share price from profit volatility reduction • Estimated gain of 10% on share price from share price volatility reduction • Price/earnings ratio of 8 justifies investing up to £125 million for the lower figure (£187.5 million for the higher)

14. Measuring the Immeasurable Benefits of CSR

15. Societal Gains

16. Sustainability Risk Avoidance Reward Enhancement ‘Margin’ Sustainability ‘Stability’ ‘Flexibility’ Volatility Reduction

17. Discussion • Is there anything intrinsically wrong with being ‛good for profit’? • If NGO activism on an issue increases uncertainty for companies, is this rational for the NGO? “Get a big picture grip on the details.”Chao Kli Ning

18. Take My Profits, Please! Thank you!