1. “New Learning” Barnard’s Inn Hall Holborn London EC1N 2HH Tel: +44 (0)20 7831 0575 Fax: +44 (0)20 7831 5208 Email : enquiries@gresham.ac.uk www.gresham.ac.uk © Gresham College 2005 Mercers’ School Memorial Professor of Commerce Michael Mainelli Take My Profits, Please! Volatility Reduction and Ethics

2. www.gresham.ac.uk © Gresham College 2005 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. www.gresham.ac.uk © Gresham College 2005 Shouldn’t Ethics Cost?

4. www.gresham.ac.uk © Gresham College 2005 Shouldn’t Ethics Pay?

5. www.gresham.ac.uk © Gresham College 2005 Calculated Risks

6. www.gresham.ac.uk © Gresham College 2005 Valuing Shape Changers

7. www.gresham.ac.uk © Gresham College 2005 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. www.gresham.ac.uk © Gresham College 2005 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. www.gresham.ac.uk © Gresham College 2005 Black-Scholes Equation where d 1 and d 2 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. www.gresham.ac.uk © Gresham College 2005 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. www.gresham.ac.uk © Gresham College 2005 100 Years Of Instability Source http://www.economist.com/displaystory.cfm?story_id=268876 Risk-Return from 1900 to 1999 US Shares UK Shares French Shares US T-bonds US T-bills 0 2 4 6 8 10 12 010203040 Volatility Return

12. www.gresham.ac.uk © Gresham College 2005 Sustainable = Stable? 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 +17.0% +10.0% -3.3% -10.9% -2.1% -15% -10% -5% 0% +5% +10% +15% +20% Low Earnings VolatilityQuintile 2Quintile 3Quintile 4High Earnings Volatility Source: GMO

13. www.gresham.ac.uk © Gresham College 2005 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. www.gresham.ac.uk © Gresham College 2005 Measuring the Immeasurable Benefits of CSR

15. www.gresham.ac.uk © Gresham College 2005 Societal Gains

16. www.gresham.ac.uk © Gresham College 2005 Sustainability Volatility Reduction Reward Enhancement Risk Avoidance ‘Margin’ ‘Stability’ ‘Flexibility’ Sustainability

17. www.gresham.ac.uk © Gresham College 2005 Discussion 1. Is there anything intrinsically wrong with being ‛good for profit’? 2. 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. www.gresham.ac.uk © Gresham College 2005 Take My Profits, Please! Thank you!

19. www.gresham.ac.uk © Gresham College 2005