Cornell Business Review - Fall 2012 by Cornell Business Review

C ornell Business Review FALL 2012 | VOLUME III | ISSUE 1

SOCIAL MEDIA ACQUISITIONS Why an internet giant bought your favorite start-up.

WILL LIBOR REMAIN THE WORLD’S MOST IMPORTANT NUMBER? OUR PERILOUS FISCALCLIFF Too Big to “Fall”

CORNELL’S ENDOWMENTS More than your average portfolio

FINANCIAL REGULATION An Over-Reactive Remedy FEATURED INTERVIEW

insights into the media industry, with

TRACY DOLGIN CEO of YES Network

FALL 2012 Cornell business revieW 1

TABLE OF CONTENTS

C ornell Business Review

FEATURED INTERVIEW

TRACY DOLGIN: CEO of YES Network

19 | AGRICULTURAL

SPECULATION: Mixing Business with Farming, by Annelise Schuepbach

21 | Could SOCIALLY RESPONSIBLE INVESTMENT be the Future of Corporate Social Responsibility? by Judy Ansalem

Thank You To Our Kind Sponsors:

INDUSTRY 26 | SOCIAL MEDIA ACQUISTIONS, by Catherine Chen

The Charles H. Dyson School of Applied Economics and Management

28 | PINTEREST AND TUMBLR, by Catherine Chen

The School of Hotel Administration

30 | ENDOWMENTS: More Than Your Average Portfolio, by Arsham Memarzadeh

The School of Industrial & Labor Relations

32 | APPLE VS. SAMSUNG:

Student Assembly Finance Commission

Innovation or Infringement? by Miguel Hollander-Ho

34 | WHY BIGGER IS

BADDER: Big Data’s Empty Promises for Business, by Grace Gorenstein

INTERNATIONAL GOVERNMENT

finance

06 | OUR PERILOUS FISCAL CLIFF: Too Big to “Fall,” by Oliver Marvin

14 | It looks like LIBOR will

08 | QE3: The Fed’s Last Resort, by Richard Hogan

36 | A DANGEROUS DOMINO EFFECT in the Strait of Hormuz by David Forward

remain the WORLD’S MOST IMPORTANT NUMBER? by Michael Ashton

38 | TREASURES OF THE NORTH, by Sean Patel

16 | FINANCIAL REGULATION: An Over-Reactive Remedy, by 11 | ECB BANKING UNION: Amy Chen Too Much, Too Late? by Zhi-Yen Low 2 cornell business review FALL 2012

40 | CORPORATE PARTY OF

CHINA: Understanding the Role of Government in Chinese Enterprise, by Austin Opatrny

FALL 2012 Cornell business revieW 3

Christopher J. Gray editor in chief managing editor Ji Yung Suh associate editors Amy Chen Austin Opatrny design editor Kristen Hwang BUSINESS MANAGERS Vinay Ramprasad Frank Rizzaro faculty advisor Deborah Streeter Staff Writers Judith Amsalem Michael Ashton Catherine Chen David Forward Grace Gorenstein Miguel Hollander-Ho Zhi-Yen Low Oliver Marvin Arsham Memarzadeh Annelise Schuepbach

BUSINESS TEAM Richard Horgan Catherine Li Sean Patel Aaron Weiner DESIGN TEAM Robert Bland Alexandre Marinier

letter from the editor Explibus acerate doluptatinum aut pellaut atureratur sitatur? Optur? Qui iducitis sant abo. Equia volupta intia cum il maionsequo est, voluptati ut eatio. Et lauta sitaestrum desciet et et venisit volecataqui cuptasperro es dolupta int et estiorit, que ventiunt labor soluptatio ent. Dolupta tiatio. Ut laboria ndianist porehent et as doluptatis quo doloris quam faccae periorum fugiatecus quatibusda comnimo loriand igendipis et quam core et aut lautat unt, sitaten dandaerum verum raescit aquiatendame inctaquas maio inum voluptatem volecat usteceptate nulparum idebitiis vel modi non pariore omniment. Gendaeped quam am, nobisquae officil minulpa ruptia voluptate sum a nullit et es nonsequiaera quiam nis endelliqui aboribus doluptatis et et omnist invel milliquis eum earum rat reperum eatem voloria natempe restotaLaborio. Ut di ipis aute consectatet eum ium none veriatur, testion reprovit pernat que sunt voluptas archi-

cidia culpa cust, consequam nit aut praepro dolorer ecaecabo. Maio conempo remporibus. Ga. Itam, sequi blantem sed que voluptatia que plignisciam venempori aute comnis eos est laccum quate repeles eiciet perae. Nam que voloreptas de re sam facepud iatiae omni ommos aut ad mo con et mi, officia ndelent es con explibu sandionsequi con cus dolenis di ulluptatem quid que re expernatem aut ererferiam sint omniminctur, simpore corecta speris audi optat eri od ma idel moluptatur mi, voloritiates ma prestia dolor sincitiae natur a ne que praturitis sinus maioristiis que none et la et landitatur modia volestio. reperro maxim nonserumquii.

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GOVERNMENT

O U R P E R I LO U S

FISCAL CLIFF TOO

BTIOG

“ FA L

L”

was primarily implemented through two pieces of legislation: The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 and the Budget Control Act of 2011. Unfortunately, the aforementioned legislations yield conflicting economic principles that will dangerously converge come year’s end unless further government action is taken.

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overall bill rises by nearly $3,500. Additionally, those who serve our country can expect a 9.4% cut in defense programs with no further job creation or service programs in place for troops who find themselves affected by the fiscal dilemma. For those looking for a job after college, expect an even more competitive overall market with fewer opportunities for labor accompanied by an unemployment rate that is expected to reach 9.1%. Overall, it is clear that a decision to go off the Fiscal Cliff would lead to a number of

THE ISSUE OF OUR MOUNTING BUDGET DEFICIT IS ONE WE MUST TACKLE OVER THE LONG RUN RATHER THAN OVER NIGHT THROUGH IMPRACTICAL AND AGGRESSIVE POLICY IMPLEMENTATION.

by OLIVER MARVIN

Here at Cornell we are accustomed to our fair share of towering cliffs, but none of these natural wonders can compare in magnitude to the Fiscal Cliff that is facing our nation. Over the past few years, the United States has experienced a period of increased government spending and significant tax cuts in hopes of fueling economic growth. The spirit of such changes

scenario in which spending cuts and tax hikes would occur simultaneously, almost certainly leading to another recession. Many have noted that “plunging off” the Fiscal Cliff would be a much needed, albeit largely unwelcome, wake up call for our nation’s economy due to the shrinkage of our budget deficit that would surely follow. Nevertheless, while trimming nearly half a trillion dollars worth of debt over the course of the year sounds enticing, Americans must evaluate the harm caused by such debt trimming,

Continued inaction would undoubtedly give way to spending cuts and tax hikes, also known as the “Fiscal Cliff”, that would trim our deficit in the long term, but lead to short term recession. What is more concerning is the fact that our nation is in an election year and thus, bipartisanship is inherently at an all-time low. With anxiety mounting in what are already difficult economic times, Americans are faced with the uncertainty that is cast upon us by the impending Fiscal Cliff. Moreover, can we trust that our own government will steer us clear of the ledge? Back in 2010, the Tax Relief Act generously granted a two-year extension to lowered marginal tax rates, a program which we endearingly label “Bush tax cuts.” Coincidentally, the 2011 debt-ceiling crisis led officials in Washington to pass the Budget Control Act, which contains a clause that calls for sequestrations, or widespread cuts in spending, beginning in 2013. As a result, we are faced with a

particularly towards small business owners. By letting Bush-era tax cuts expire in January, President Obama would raise taxes for those earning an annual income of $250,000. In doing so, Congress has estimated that anywhere between 3-50% of small business owners would be hurt by the expiration of Bush tax cuts. On a larger scale, a number of big businesses who choose to file taxes through the individual code will be hurt by these hikes because of their standing as S-corporations. The unsettling implication of our looming Fiscal Cliff has on American business is painfully evident, yet the cliff’s harm extends beyond the offices and into our homes. Over the past decade, our country has operated under a budget deficit that continues to grow at a troublesome rate. Consequently, it is no surprise that officials are searching for the appropriate way to slash our budget deficit. Alas, entrusting the economic vitality of our nation to harsh tax increases and spending cuts is not the answer to our dilemma. Yes, our deficit must be cut but not in the face of a series of events that, according to The Tax Policy Center, will see the average American’s after-tax income fall more than 5% while their

unfortunate events, yet without bipartisan efforts between Democrats and Republicans that seems to be the direction we are headed. In a perfect world, taxes would be minimal, spending would see no limits and Washington D.C. would consist of harmonious government officials. Alas, none of these dreams will ever become reality and there will always be conflict in our nation’s capital. However, as we witnessed with last year’s debt-ceiling crisis, our government has a convenient knack for coming together at the last resort in order to reach a mutually beneficial deal. This apparent aptitude is one that has been missing from our current Fiscal Cliff crisis, where debates over the proper solution have been marred by flawed decisionmaking. What we need now more than ever is a government that will realize the need to vote on right vs. wrong, not Democrat vs. Republican. Can we expect such a change to occur in the midst of a heated Presidential Election? Absolutely not. In fact, both the Obama and Romney campaign’s have seldom discussed the implications of the Fiscal Cliff and the way in which they advocate dealing with such an issue. President Obama has

announced his intention to extend tax cuts only for families earning $250,000 or less, while Mitt Romney believes tax cuts should be extended across the board. Even so, both viewpoints lack the proper substance to tackle the Fiscal Cliff issue, which deals with the issue of sequestration among other things. As the leaders of our country, Washington officials must explore other plans that include either extending Bush-era tax cuts, delaying efforts of sequestration or some combination of the two. Regardless, the issue of our mounting budget deficit is one we must tackle over the long run rather than over night through impractical and aggressive policy implementation. Moving forward, one can only hope that the Fiscal Cliff emerges as a fundamental issue in the current election as it is essential to our nation’s economic well-being. The prospects of foolishly breaching the Fiscal Cliff would affect all of us. Whether you are a student exploring a small business venture or a senior looking forward to a full-time job at a bulge-bracket bank, the prospects for success will become bleaker as economic growth slows down and opportunities dissipate. Instead, we must strive for a stroke of bipartisanship that yields a deal more focused on short-term job growth and employment, while mitigating our budget deficit over the long run. If this cooperation occurs, then we can return to the days where a daunting cliff is more likely to be found high above Cayuga’s Waters than in Washington D.C. Oliver Marvin (oam27@cornell.edu) is a junior at Cornell University majoring in Industrial and Labor Relations.

FALL 2012 Cornell business revieW 7

GOVERNMENT

QE3: The Fed’s Last Resort by RICHARD HORGAN

Most people remotely interested in business have heard about the Fed’s latest attempt to return the sluggish American economy back to its humming, happy self by means of “QE3”. But what is QE3, and why do some believe it will kick-start the economy? QE, which stands for Quantitative Easing, is a mechanism employed by the Federal Reserve Bank meant to lower interest rates by increasing the money supply and purchasing securities from financial in-

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stitutions. With the increase in the money supply and the greater bid for these securities, banks loan at lower rates and interest rates fall. Thus, the aggregate cost of borrowing decreases, facilitating people’s buying of homes, companies’ building of factories, and the general public’s spending on consumer goods. Ideally, this translates into more demand, which in turn translates into companies needing to hire more employees. That’s QE in a nutshell.

There are many risks to printing money to purchase private debt. First and foremost, increasing the money supply could cause elevated levels of inflation. In other words, since the nation’s assets are only worth so much, dividing that worth over more dollars could cause each dollar to become worth less, thus driving up prices. However, the mortgage-backed securities purchased under QE3 are not based on liquid assets, meaning their purchase does not entail as great of an inflation risk as did QE2 or the first round of QE. Furthermore, QE3 may harm people who are living on a fixed income, since the lowered interest rates will reduce the income they receive (interest off of savings) and cause them to spend less. Seniors who depend largely on their savings will be hit hardest. Yet another risk of QE3 is that freed up funds from banks could be used in emerging markets or commodity-based economies rather than lent to US-based borrowers. This would be a capital flight, and the potential effects of this are obvious: new money available to banks is simply moved out of the U.S. and no new jobs are created as the US debt level increases. Two rounds of quantitative easing came before QE3. Have they been successful enough to warrant a third? That depends on your definition of ”successful”. According to the International Monetary Fund, quantitative easing policies undertaken by economically large countries have helped to mitigate systemic risks after the failure of Lehman Brothers. Rounds of QE have also helped to improve market confidence, a leading indicator of economic well-being. It is difficult to establish a direct relationship to tangible outcomes. Former Federal

Reserve Chairman Alan Greenspan felt as though there was little impact on the economy as a whole. Conversely, renowned economist Martin Feldstein felt that the successive rounds of QE led to a rise in the stock market, prompting increasing consumption and a stronger performance of the US economy relative to early 2010. Looking back to late 2010, the S&P 500, a broad U.S. index, was hovering around 1200, and two years later, the S&P has climbed into the mid-1400 level, a marked improvement. Other indicators point that the economy is improving; consumer confidence has been steadily rising and manufacturing data are strong. Furthermore, interest rates have fallen precipitously since the first QE. In November 2008, the 30-year fixed treasury rate was 6.1%, though currently it hovers around 3%.

Whether QE3 will work or not is still deeply in question as are the risks of iT.

The argument that QE didn’t work since unemployment is in the high 7% /low 8% range is a poorly designed one since it assumes that the economy could not have gotten worse than it was in 2008. This assumption is weak since the economy could have continued on a downward spiral into depression. Lastly, due to an increase in the supply of dollars, the value of a single dollar has fallen. This is advantageous to some degree since American exports can better thrive given that they are cheaper relative to those exported from other countries. Higher

exports produces a higher GDP. Whether QE3 will work or not is still deeply in question as are the risks of it. Thus the original intention of the program has worked. Will we see a pick-up in inflation in coming years? It is possible. One question does remain, though. The Fed is an organization supposedly independent of influences from the rest of the federal government. Despite material improvements in the economy, such as stronger manufacturing data, the Fed chose to take part in huge cash injections, indefinitely. The timing of this is suspicious. The 2012 election was only two months away at the time of QE3, an election that Bernanke’s job depended on since Republican nominee Mitt Romney vowed to remove Bernanke if Romney was elected. Could it be that Bernanke influenced the development of QE3 as a way to boost the economy in order to favor President Obama’s reelection, and consequently Bernanke’s job, right before America voted? One would hope that America’s Banker would put the economy before his self-interests. However, nothing is guaranteed and now America’s recovery is burden by $40 billion in additional debt. Richard Horgan (rwh272@cornell. edu) is a junior at Cornell University majoring in Applied Economics and Management.

FALL 2012 Cornell business revieW 9

GOVERNMENT

ECB Banking Union: For over 100 years, the students, faculty, and alumni of the Charles H. Dyson School of Applied Economics and Management have focused on business and economic issues that matter. Food, energy, natural resources, developing economies, international trade, the sustainable management of all types of businesses. Our broad expertise and worldwide connections make the Dyson School uniquely poised to seize the 21st century’s emerging business opportunities and trackle its most significant economic challenges. No wonder the Dyson School’s undergraduate and graduate programs are ranked in the top 10 and our students are in such big demand.

Too Much, Too Late? by ZHI-YEN LOW

LEARN MORE AT DYSON.CORNELL.EDU Warren Hall’s $51 million renovation is under way

FIRST FLOOR LOUNGE

B-25 MAIN LECTURE HALL

10 cornell business review FALL 2012

With bated breath, the whole of Europe is hanging on Mario Draghi’s every word. An August 29th article that the European Central Bank president wrote sent ripples of excitement through European markets as his words, “exceptional measures,” hinted at a bond-buying programme. Suspicions were confirmed on September 6th when Mr Draghi announced that the ECB would resume buying unlimited bonds of debt-stricken countries. Reactions varied, with praises of

acclamation from some parties, but also over explicit objections from the German central bank, the Bundesbank. The German daily, Die Zeit released an article explaining exactly what Mr. Draghi has in mind for the region. He envisions economic and political integration of the Eurozone, which he terms a “historic process of European unification”. Stopping short of suggesting a full-fledged federation, he stresses that a centralization

of all economic policies is not necessary. Instead, he calls for oversight over national budgets because the consequences of misguided fiscal policies within a monetary union are too severe to be self-managed. Because the euro zone is not a nation-state, guaranteeing national competitiveness through cross-regional subsidies while placating all members is not a sustainable option.3 Nations grappling with overflowing debt from the thoughtless profligacy of their politi-

FALL 2012 Cornell business revieW 11

GOVERNMENT

How will the ECB remain independent, assume the unprecedented responsibility of controlling monetary and fiscal policies, all the while maintaining European financial stability? cians cannot continue to be bailed out at the expense of taxpayers in other countries. With regards to financial policy, Draghi calls for stricter controls on banks’ excessive risk-taking and regulatory capture. Regulatory capture occurs when a state regulatory agency initially created to act in public interest, instead advances commercial or special interests of the industry it is responsible for regulating. Draghi asserts that bank resolution frameworks need to be in place to safeguard public finances for the benefit of Euro area taxpayers. Draghi drags out his solution A proposal for a new ECB-directed banking union is now in the pipeline. The new governing body will be entrusted with the heavy responsibility of overseeing the 6,000 odd Eurozone banks. As an offshoot from the ECB, the central banking supervisor will be

able to recapitalize banks directly, essentially providing debt mutualisation in return for more central control.1 According to a European Commission press release, the banking union will be responsible for the authorization of credit institutions, compliance with capital, leverage and liquidity requirements, and the supervision of financial conglomerates.2 It will also have the power to implement pre-emptive intervention measures by requiring remedial action if banks breach or will potentially breach regulatory capital requirements. The implementation of a central supervisor, though arduous and brimming with uncertainty, would be less painful than dealing with a return to marks, lire and francs. Should there be a breakup of the euro, European banks may suffer indelible marks on their history and a fatal loss in confidence. Greece leaving the Eurozone is likely to create turmoil in global markets.

Greek Banks Strain for Cash

Reactions Across the Board Mr Draghi’s European reforms are not without criticism. Bundesbank

Unemployment Soars

Customers make massive withdrawals from banks; ECB freezes lifetime loans.

MAY 18

The Italian and Spanish governments, already steeped in debt, may be immediately plunged into an inability to borrow on decent yields. It is quite possible that a Eurozone rescue fund would have to intervene, starting with Spain, which has already agreed to a €100 billion bailout.9 Other nations, Germany in particular, would need to step in as well as the rescue fund is not big enough to save both Spain and Italy. As such, banking union seems to be the lesser of two evils, but it is not without its conditions. In order for the dormant bondbuying program to proceed, the ECB requires that countries in need of help must ask for it and comply with an agreement monitored by European institutions. Secondly, rescue funds are required to begin buying bonds in the primary market through the temporary European Financial Stability Facility, or the European Stability Mechanism. Mr Draghi stated that the bond-buying program would end when it achieves its objective, or if the country in question breaches its reform agreement.

Eurozone unemployment hits 11%, as employers cut 110,000 jobs from payroll. Spain and Greece suffer most.

MAY 30 Spain Woes Spread to Global Markets

JUN 1

Stocks fall in Europe and Asia; euro slips to two-year low against the dollar; Spain’s borrowing costs spike to six-month highs.

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Plans for coordinated bank rescues in Europe, but wants government leaders to act first.

No Easy Answers But is the ECB really becoming too powerful? Is it straying too much from its traditional role of controlling inflation and interest rates? It is easy to criticize such overtly political measures coming from a supposedly independent central bank. However, after more than two years of repeated failed attempts to alleviate the debt crisis through emergency bailouts and summits, perhaps it is time for the most integrated part of the euro zone to take leadership. Mr Draghi has realized this and as such has stepped up to the plate. Some questions still remain to be answered in the coming months until the targeted date of January 1, 2013 for the inception of the proposed banking union.8 How will the ECB remain independent, assume the unprecedented responsibility of controlling mon-

Investors are disappointed by ECB’s decision to keep rates unchanged.

New Democracy wins parliamentary election, but deep anti-austerity sentiment remains.

JUN 17

ment; Finance Minister Anders Borg asserted that his government would never agree to let his taxpayers bail out “ill-managed” banks elsewhere in Europe.7 In addition, two former ECB chiefs also regard Mr Draghi’s actions as “overstepping the ECB mandate” because his proposal involves financing government debt.5

European Stocks Dive

Greek Election

JUN 6 Europe Unveils Bailout Plan

President Jens Weidmann equivocates the bond purchases to printing unlimited amounts of banknotes, further arguing that monetary policy risks being subjugated by fiscal policy. The intervention purchases cannot safeguard price stability in the euro zone at the expense of monetary policy capability.4 Germany is also skeptical about the union’s ability to govern 6,000 banks. Such arguments suggest competing national interests. According to The Economist’s Charlemagne columnist, some Germans suspect the French of trying to burden the ECB so heavily that it would supervise nothing at all. Meanwhile, the French and other governments think that Germany is lobbying to exclude most of its banks from the new rules. The European ten non-members are watchfully eyeing the unfolding developments, with questions of how they are to meaningfully participate in such a banking union. Britain supports the euro zone integration efforts, but is anxious that the other nations may gang up on it.6 Brussels, on the other hand, is hoping to develop a governing body similar to the American Federal Deposit Insurance Corporation (FDIC). Formidable backlash has erupted from the Swedish govern-

JUN 25 Spain Asks

AUG 2

Spain formally asks for financial aid for its banks from the European Union.

etary and fiscal policies, all the while maintaining European financial stability? Will the ECB be able to probe any bank and have the ability to issue or withdraw banking licences? How will future bailouts be determined and what kind of fiscal backstops will be put in place? The answers lie not only on the shoulders of Mr. Mario Draghi, but also on those of European leaders. Yet the ruminating and hand-wringing can only go on for so long- indecision and inaction in these volatile times will only prolong, if not worsen, Europe’s proliferating despair.

Zhi-Yen Low (zl268@cornell.edu) is a junior at Cornell University majoring in Applied Economics and Management.

“It’s your move,”

Draghi says ECB is prepared to buy government bonds, but political leaders must accept terms.

SEP 6 ECB Outlines BondBuying Program

OCT 4

OCT 21 EU Summit

ECB will buy short-term bonds issued under strict conditions; world markets rally.

European leaders meet at summit to discuss closer Eurozone integration.

FALL 2012 Cornell business revieW 13

FINANCE

It looks like LIBOR will remain the

WOR LD’S MOST I M PORTANT N UM BER by MICHAEL ASHTON

The London Interbank Offered Rate (aka LIBOR) refers to an arcane benchmarking interest rate in quiet existence for 26 years. Its importance however, is that it is tied directly or indirectly to more than $350 trillion dollars of financial instrument derivatives spanning the globe. With some justification therefore, the British Bankers’ Association (BBA), the privately held trade association responsible for maintaining LIBOR’s integrity, has called it “the world’s most important number.

Overview LIBOR is the average interest rate that leading London banks estimate they would be charged if they borrowed funds overnight from another bank. Set daily at 11:00 a.m. London time, it is actually a set of indices with separate rates reported for 15 different maturities, ranging from one to twelve months, in each of 10 currencies. Although four countries – the United States, United Kingdom, Japan, and Canada – account for most of Libor-linked dollars, more

than sixty nations utilize it. Eighteen banks, for example, currently contribute to the fixing of the US Dollar denominated LIBOR. In the United States, many financial contracts reference the threemonth LIBOR rate, which is associated with three-month inter-bank deposits. Both in the U.S., and worldwide, it is also employed in adjustable rate commercial and residential mortgages, fixed term loans, corporate and government interest rate swaps, and commodities contracts. Calculation LIBOR is calculated and published daily (prior to 11:00 a.m.) by Thomson Reuters on behalf of the British Bankers’ Association. First, the BBA surveys a panel of banks with the question; “At what rate could you borrow funds, were you to do so, from inter-bank offers in a reasonable market size?” With answers in hand the highest four and lowest four rate responses are then “trimmed,” with the average of the middle ten becoming that day’s “most important monetary number in the world.” Suggestions of Inefficiency or Manipulation In May 2008 the Wall Street Journal first blew the whistle on possible manipulation of LIBOR by publishing the results of a study which suggested that banks might have intentionally understated their borrowing costs during the run up to 2008 financial crisis. Their motivations

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might have been either to disguise their own increasing borrowing costs or to maximize profitability of loans made to their own customers. Four years later, Barclays became the first bank to be convicted of wrongdoing. It was fined $453 million dollars by UK and USA regulators and had to force resignations of its President and CEO. It also exposed itself to additional suits by victims of its manipulations. More dominoes are sure to follow as a dozen other banks have also acknowledged being under investigation. Solution on the Horizon Meanwhile, a solution to the “LIBOR Scandal,” as it has come to be known, has begun to emerge. In September, in culmination of a months-long study, Martin Wheatley, Managing Director of the U.K.’s Financial Services Authority (FSA), presented a meticulously detailed 92-page report. The two-fold conclusion: 1) the British Banking Association (BBA) had to relinquish sole control of LIBOR setting and 2) the process of calculating the rate had to become objective and verifiable (transparent). Having seen the writing on the wall, the BBA agreed to step aside some days before the report’s presentation. Simultaneously, Wheatley’s American counterpart, Chairman of the Commodity Futures Trading Commission, Gary Gensler, agreed that the LIBOR rate had to go while focusing on standards for a new benchmark. “It is time for a new or revised benchmark—a healthy benchmark anchored in actual, observable market transactions—to restore the confidence of people around the globe,” Mr. Gensler said. “There are no rules requiring controls, firewalls, independent testing, policies and procedures, or a methodology ensuring that submissions are transactionfocused, as the benchmark was originally intended,” he said. Gensler and Wheatley also agreed on a major sticking point: the LIBOR was, at least for now, too big to fail. The global financial structure

“It is time for a new or revised benchmark— a healthy benchmark anchored in actual, observable market transactions.” had become so dependent upon this “benchmark of benchmarks” that it needs to remain in place until another metric can be defined, thoroughly tested, and implemented. LIBOR’s Fate The decision of who will wind up with Libor “is primarily driven by finding someone who can bring integrity and believability back into the system,” Mr. Wheatley explained to the Wall Street Journal. In September, the BBA voted to initiate a bidding process to pave the way for new ownership. Mr. Wheatley has publically stated that he is aware of several interested parties, including large commercial financial data collection agencies. Thomson Reuters Corp., for example, already aggregates LIBOR-related data from par-

ticipating banks and creates reports for the BBA. Another suitor may be Bloomberg LP., which recently suggested that it might also be interested in providing a financial benchmark similar to LIBOR. Meanwhile, there is hope in Great Britain that its own Financial Services Authority will be given authority by the UK government to oversee LIBOR. The group would also be given the power to impose civil and criminal charges upon whatever entity assumes responsibility for the number. In any event, “the world’s most important number” is expected to meet its new owner within the next six months.

Michael Ashton (maa246@cornell. edu) is a senior at Cornell University majoring in Hotel Administration.

FALL 2012 Cornell business revieW 15

FINANCE

FINANCE A Shift in Thought: Refining Regulation Amidst the flurry of regulatory reform, we must focus on refining and simplifying these rules. The Volcker Rule, for example, has good reason to be controversial. As previously described, this rule inhibits proprietary trading in an effort to limit risk-taking by banks. The primary criticism surrounding this piece of legislation are the loopholes involved – for instance, the Volcker Rule does not allow speculative investing but allows hedging, a practice where banks take the opposite position of a trade so that if one part of their portfolios loses money, the hedge will gain some of it back. Hedging by these large financial institutions, however, is in-

FINANCIAL REGULATION An Over-Reactive Remedy by AMY CHEN

Introduction A lot can happen to you in four years. You could graduate high school. You could complete the 161 Things to Do at Cornell. Or, if you’re the banking industry, you could experience an overhaul so drastic and sweeping that the four-years-ago version of you wouldn’t even recognize today’s. In wake of the 2007-2008 financial crisis, America scrambled to steady itself on its feet by turning to increased regulation. Yet what we saw was no historic, singular Glass-Steagall Act. Instead, major regulations emerged at every turn as America attempted to discipline and calm financial markets. From the 2008 Emergency Economic Stabilization Act to Obama’s 2009 Economic Stimulus Plan to the 2010 Dodd–Frank Wall Street Reform and

Consumer Protection Act, it seemed that the “more was better” mentality gripped America as words like regulatory reform and housing bubble became household phrases. Yet this increase in financial regulation has not proven as effective as America has hoped. Investor activity is still cautious, consumer demand sluggish, and banks overwhelmed at best. What we need, then, is not more but rather better, smarter regulation to guide our economy and prepare it for potential future crises. An Overview of Current Regulations At the forefront of recent financial regulation is the over-2000-pagelong Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act essentially strengthens the existing

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regulatory structure by creating and reorganizing federal agencies, increasing supervision of institutions with “systemic risk,” promoting transparency within the financial industry, among other goals. Embedded within the Dodd-Frank Act is the controversial Volcker Rule, which bans banks from speculative investments using their own deposits, also known as proprietary trading. Other recent regulations include Basal III, which increases minimum capital requirements for banks, as well as stricter merger regulation, which prohibits mergers of financial institutions if the combined firm would exceed 10 percent market share of all financial companies in the United States.

normal levels of risk-taking should not be punished; excess should. credibly complex, and often the line between speculative trading (banned by the Volcker Rule) and hedging is blurred since banks can simply frame any speculative trade as a hedge. In addition, the Volcker Rule’s focus on minimizing trading risks is restrictive: risk is an integral part of finance. The Volcker Rule is therefore not only regulating ineffectively and ambiguously, but also bogging down practices central to the livelihood of the financial industry. To improve, we should consider refining the Volcker Rule by 1) closing the aforementioned loopholes, which would show the banking industry that America understands and is serious about the regulations in place, and 2) re-evaluating its take on risk – normal levels of risk-taking should not be punished; excess should. A Shift in Focus: Simplifying Regulation Equally important as refinement is simplification. Insofar as complex regulation has stifled growth in our economy, we witness both obvious and nonobvious costs. The obvious costs

include the costs of administering and complying with these new piles of regulations, such as reporting requirements, constant testing, and integration within operational workflows. This takes away resources from other areas of the industry. Nonobvious costs reference the fact that it is nearly impossible to account for every potential risky circumstance in the rules and models we have created. As Bank of England Executive Director of Financial Stability

crises. This increased awareness means that regulations are proactive rather than over-reactive. By identifying the root of the problem and putting more efficient regulations in place, we set our momentum forward in our quest to improve and advance coming out of the crisis. We must remain cognizant of the fact that complex rules may hinder our ability to effectively regulate as well as stunt our economy’s growth. A lengthy

the goal of simplification should be to educate both regulators and consumers about the financial industry. Andrew Haldane notes, “Since Basel II allowed banks to use internal risk management models for calculating [risk], capital regulation is now performed by models that potentially include millions of parameters that must be estimated.” Such parameters can only be estimated using a limited sample size, which is not adequate in estimating these extraordinarily complex models. To be certain, the goal of simplification should be to educate both regulators and consumers about the financial industry. Regulators must understand what they are supposed to be regulating; consumers must understand what they are signing up for. What we need are thus clearer descriptions of financial products so that both regulators and consumers are aware of possible implications. As such, we must shift our focus from regulating anything we can get our hands on to educating Main Street about Wall Street. The ensuing increase in communication, understanding, and transparency between the two Streets may arguably prove to be more effective than rampant regulation – and that is where refinement and simplification come into play.

list of rules also prevents us from remaining flexible: we must be able to adapt our financial systems to changing times and detailed rules will only limit us in our potential to expand. As such, regulation should bend and mold the financial industry – shaping circumstances into ways we see fit – rather than micromanage every aspect of it. Thus, while the current regulations are noble and well-intentioned, it is imperative that we improve upon their structure and modify their purposes, for in the ever-changing landscape of the financial industry, change is indeed the only constant. Smarter, simpler regulation will provide regulators and consumers with a clearer understanding of financial products to help them make informed decisions, as well as effectively target problems – all without compromising market efficiency and America’s competitive position in the global market. Amy Chen (ac732@cornell.edu) is a junior at Cornell University majoring in Economics.

Conclusion Clarification, simplicity, and polish all serve the purpose of successful regulation. In this way, regulators learn to recognize the structures of the problem – a necessary step in detecting future

FALL 2012 Cornell business revieW 17

FINANCE

Agricultural Speculation Mixing Business with Farming by ANNELISE SCHUEPBACH

We have stepped into an age in which each cob of corn and each coffee bean are indistinguishable from each other−a time where markets have redefined the trade of environmental products. Financial speculation is defined as “high-risk” transactions that hope to gain short-term returns from a fluctuating market value, and although “high-risk” and “short-term returns” do not necessarily paint the most positive picture of this tool, financial speculation supports many different markets in essential ways. By taking on risk that other financial parties may not be willing to absorb, speculators bring liquidity into the market, and if successful they are rewarded for the risk they take on. Agricultural products and livestock became a target for speculation over two decades ago via the Goldman Sachs Commodity Index (GSCI)- a

18 cornell business review FALL 2012

quantifiable measure of productivity for 24 raw materials around the world that opened up the financial sector to global investments in consumable products. The supposed effects of this index range from the global food shortages that occurred in 2007 and 2008, to the support for the industrial food system that provides small and midscale farmers access to global crop markets. Proponents of the Commodity Index stand behind the belief that commoditizing the Earth’s products is essential to the evolution of our growing population and global economy. In light of unpredictable climate conditions in past years, some farmers have become fearful that they will not be able to effectively plan for their harvests, and their profits could suffer as a result. The CI has given rise to set market prices and allowed

FALL 2012 Cornell business revieW 19

FINANCE

Could Index Chart for SPGSCI

700.00

600.00

2012 Feb

Mar

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transnational agriculture conglomerates such as Cargill the ability to contract with small farmers and agree to take all that they produce, connecting farmers to a major market. In addition, the process of bringing liquidity and interest into agricultural markets has allowed the private sector to have a better understanding of what is happening with the environment and our natural resources, which may prove useful in detecting problems or crop failures early on. Arguably the largest benefit can be seen in the protection that the CI brings to the international commodity markets, in that it provides a resistance to price volatility within individual countries by having a flood of available cheap commodities to supplement any shortages. For example, Australia had an extremely small corn harvest this year; however, they were able to tap into the international supply and mitigate their losses with a commodity priced lower than their available stock. However, any widespread system will be subject to substantial criticism. In the case of the Index, there are a few clear risks that opponents have

Aug

Sep

Oct

Nov

Dec

500.00

targeted. If you were to look at traditional agriculture markets, a buy-sell transaction was made though the pairing of farmers with the speculators that would provide the liquidity and accept the risk that farmers could not bear. The CI is a buy-only tool, which poses a risk to the tried-andtrue soundness of the original trade model. Private sector intervention has enabled a system of pricing that allows agricultural companies to purchase crops at an extremely low priceone that is too low for farmers who would like to grow commodity crops but do not have access to the necessary technology or buyer. Global com-

The future of the economy and environment are two of the most pressing challenges facing our generation.

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munities have witnessed the effects that the flood of money into the agricultural sector has created. The “food bubble” of the mid 2000s exemplified that prices can skyrocket as a result of speculation: many staple crops such as hard red spring, a wheat variety, saw price increases of well over 50% in a very short span despite small changes in production. It is clear that the commoditization of agricultural products and natural resources plays an integral role in the modern economy. Though the effects of the GSCI (now called the S&P GSCI) are widely contested, the one fact that cannot be debated is that it needs to be effectively managed so that we can ensure stable food prices in the future. The future of the economy and environment are two of the most pressing challenges facing our generation. In order to ensure a sustainable world for our children as we wrestle with issues of population growth, global climate change, and political unrest in an extremely globalized society, we will need to manage our current financial tools to ensure that they are evolving as continuously as we are. Annelise Schuepbach (as934@cornell.edu) is a sophomore at Cornell University majoring in International Agriculture and Rural Development.

socially responsible investment be the future of

Corporate Social Responsibility? by JUDY AMSALEM For over a decade, socially responsible investment, or SRI, has been growing at an increasingly rapid rate. Since 2005 alone, SRI assets have increased by over 34%, compared to a 3% increase in overall professionally managed assets. This growth is perhaps best illustrated by looking at “socially screened” mutual funds, which comprise the largest share of SRI. In 2003 socially screened mutual funds included $151 billion under management. By 2010 that number had climbed to $316.1 billion amongst approximately 250 different funds. All in all, the $3.07 trillion of assets invested under SRI principles in the US marketplace comprise one out of every eight dollars invested, compared to one out of every nine dollars in 2003. But what does this mean for the broader marketplace? Does this growing investment strat-

egy have the ability to go beyond impacting a small group of companies and usher in a larger trend of corporate social responsibility (CSR) in the marketplace, as many hope? There are three ways SRI could potentially accelerate the expansion of CSR as part of corporate culture. If SRI finds shares in responsible corporations more desirable and makes them more highly sought after, then rising share prices and a lowered cost of capital could give firms an advantage over their less-responsible competitors. Unfortunately, this is not only unlikely, but fundamentally flawed. It is unlikely because a significant portion (some models say up to 25%) of a company’s shares would have to be bought or sold concurrently for share prices to be affected. Even if all SRI vehicles directed

WHAT IS SOCIALLY RESPONSIBLE INVESTMENT? Socially responsible investment (SRI) is investment that considers some measure of the social responsibility of the recipient in the decision to invest. By controlling the flow of capital, often using positive or negative screens to select eligible recipients of investment, socially responsible investment promotes some degree of corporate social responsibility (CSR) alongside a desire for competitive financial returns. Socially responsible investors will also sometimes take active roles dialoguing with companies on CSR issues and filing or co-filing shareholder resolutions on topics of concern. Finally, a specific approach to SRI called “community investing” directs capital to communities underserved by traditional financial services institutions.

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FINANCE

their purchasing powers towards the same corporations at the same time, a change of this scale seems unlikely. Yet even if this did happen, it is the nature of the market to flatten out differences in price. In other words, if socially responsible investors avoid purchasing shares in a firm that does not meet their criteria, other investors will see the cheaper shares as a buying opportunity. And if SRI favored a firm and ran up the share prices, other investors would likely view the securities as overvalued and sell them, lowering the share price once again. Of course, even if SRI does not change share prices immediately, it still contributes to promoting CSR by investing in a supposedly more “responsible” subset of companies. Secondly, shareholder participation promotes CSR in corporate policy from the inside. Shareholders have certain rights, such as communicating with managers, submitting shareholder resolutions, voting on proxies and attending annual meetings. These serve as incentives for shareholders to keep, or even to purchase, shares in offending companies in order to pressure the management for change from the inside. Activist shareholder campaigns have been successful in the past, and examples of corporations who changed their corporate practices after repeated pressure from shareholders include Wal-Mart, Home Depot, Staples, Gillette and Reebok, among many others. This method is certainly successful in individual cases, but a preemptive change among non-targeted firms would require that these firms perceive a significant risk of having their policies targeted, which in turn would have a negative impact on their bottom line. While this leads to precautionary improvements in some cases, it is most often the case only for bigger companies in highly visible industries. Finally, a common argument for the ability of SRI to usher in an era of more widespread CSR is that if a large proportion of investments are decided according to social criteria, there will be an incentive for firms to change their policies to gain access to that capital. But as big as SRI has gotten, it is still not large enough to deprive compa-

FEATURE

POSITIVE VS. NEGATIVE SCREENING Screening is the process of selecting companies to invest in based on their social and/ or environmental performance. SRI vehicles use positive and negative screens to determine who is eligible to receive their funding. Positive screening, also called affirmative screening, is a proactive method of selecting companies that are leaders in environmental protection, labor rights, product design or

nies who cannot meet its criteria from finding investors elsewhere. This shortcoming is exacerbated by the fact that screens are rarely very comprehensive. An investor can employ only one screen and still be considered an SRI firm. For example, with a negative screen as basic and common as refusing to invest in tobacco companies, an investment fund can be considered a socially responsible investor. But it’s easy to see how if many or even most investors are not employing more rigid screens than this, they are not making their pool of capital particularly hard to access for the average company (who is not involved in the production of tobacco products or weapons). Even these two industries, whose companies are often the first to be denied funding through SRI policies, still finds investors and manages to survive. The bottom line is not that SRI is bad, or even ineffective, but that at this point it is not likely to lead to a larger trend of corporate social responsibility in the marketplace. Like consumers, investors have difficulty identifying more or less virtuous firms, so SRI funds are an inefficient mechanism for investors to “vote their values” in the marketplace if they expect to see rapid changes. But SRI does have very real positive effects for some of the firms it targets - though screening does not always necessarily single out the greenest or most responsible for funding, it does get funding to companies that are at least conscien-

22 cornell business review FALL 2012

employee treatment. Negative, or avoidance screening, consists of excluding companies that manufacture objectionable products, such as weapons or tobacco products.

tious of corporate responsibility goals, if not completely compliant. SRI has not yet reached the limits of what it can do. Right now a major limiting factor is that there is no universal, reliable way of reporting corporate social responsibility. If and when there is a way, locating responsible companies for funding will mean a lot more, and less responsible companies will have an incentive to change their policies to gain access to SRI funding. This scenario is also contingent on the pool of SRI assets continuing to grow, and this growth seems very likely to continue into the future. SRI is in its starting phase, and while it might not cause a large trend towards CSR in the national or global marketplace today, with the right changes and continued growth, there’s no reason to rule out the possibility that it will do so tomorrow. Judy Amsalem (jma262@cornell.edu) is a senior at Cornell University majoring in Natural Resources.

TRACY DOLGIN. INSIGHTS INTO THE MEDIA INDUSTRY

Tracy Dolgin ’81 is a Cornell University alumnus from the college of Industrial and Labor Relations. As the CEO and President of YES Network, a position he has held since 2004, he is responsible for all operations of the most-watched regional sports television network in the country. Prior to joining YES Network, Tracy served as an Executive Vice President of Marketing at both Fox Broadcasting Corporation and Fox Sports, Senior Vice President of Marketing at HBO Video, President of FOX Sports Net and a Managing Director and Co-Head of Houlihan Lokey’s Media, Sports and Entertainment practice.

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FEATURE

there. It was a really great experience and helped round out my portfolio as the CEO of an independent company vs. running a division of a multi-national company. CBR: How did the ILR school help facilitate your career in the sports and entertainment industry?

Cornell Business Review: You have been in the sports and media business since very early in your career. How did you decide that such a competitive industry was right for you? Tracy Dolgin: I get asked that question quite a bit. Students think that by working in the TV business, their jobs will be better since it is a field they are passionate about. I tell them they are wrong because there are other, more important questions to ask, such as, “Is this a good training ground? Am I going to learn to be the best at what I do? Is the culture good? Is it a meritocracy?” Some students want to know whether I had a plan, and for that I respond that I never had a plan. I graduated from Cornell, went to Stanford Business School and then worked at General Foods in packaged goods. I figured out that real-life experience could not be taught from a text book. From General Foods, I got hired at HBO into its home video division through a bit of good fortune. It was not part of some amazing plan. It was a happenstance call from a Cornellian, Frank O’Connell, who eventually

became my mentor. When you go into a job, you want to be the best at what you do. You want to learn from the best and brightest. You want to learn the best practices. That is how you succeed. CBR: Before joining YES Network, you had served as a Managing Director and Co-head of Houlihan Lokey’s Media, Sports and Entertainment practice. Can you describe how this type of position at an investment bank differs from an executive position in the entertainment industry? TD: It’s very interesting. I was at FOX for over a decade, running various divisions, and wanted to do something entrepreneurial. A group of friends and I started an investment bank from the position of operators who knew how to run media companies. We thought we would be able to do better deals from the perspective of an operator, but there was only one problem. We didn’t know how to do investment banking. We were operators. Houlihan Lokey bought us out, and I started as a Senior Partner

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TD: There are two things that, combined, make up 100% of the value of a media company. First, intellectual capital, which in our case is the rights to the New York Yankees and Brooklyn Nets, and the production of their games. The second thing is human capital. Take both of these and maximize them. Both are pieces that make successful businesses. All of the things I learned in ILR, whether it was collective bargaining or organizational behavior, had a maximizing effect. It has helped me every step of the way. CBR: In your experience, what qualities differentiate individuals who rise quickly up the corporate ladder? TD: The media business is different from most businesses. Most businesses are meritocracies. Media

The YES Network, the most-watched regional sports network in the country the past nine years, features the 27-time World Champion New York Yankees and the Brooklyn Nets. YES, which has earned 235 Emmy Award nominations and 55 Emmy Awards since launch, also televises original biography, interview and magazine programs, in addition to college sports.

businesses -- not YES, since I pattern it after a meritocracy -- seem to be a bit more political. It’s a lot of luck and circumstance combined with skill and organizational savvy. The skills or circumstances that make you successful in a non-meritocracy are very unpredictable. Finding the right mentor can help, but there really is no correct answer. CBR: Many students dream about being in the sports and media industry, but are often afraid to follow through because of the limited opportunities. What advice do you have for these students? TD: Rethink what you have been thinking, especially earlier in your

company that is in second place or one that is not important. It’s a bit risky to go that way if you are not at the top. CBR: Reflecting on your career, what have been your most notable achievements? TD: Balancing work and family. You have to keep it all in perspective. In the sports and media business, most jobs are not nine-to-five jobs. There is a lot of travel and work on nights and weekends. My wife raised three wonderful kids, two of whom are at Cornell, in spite of the fact that my value add in that department was somewhat limited because of what I chose to do. Balance is what you

Also, it’s not about making the same mistake over and over again. I have made many mistakes, but I can count on one hand making the same mistake twice. I rarely do that. CBR: How would you recommend students at Cornell develop their leadership and communication skills while at school before entry to the workplace? TD: Well, it’s good to take challenging classes, join clubs, and run organizations. All of that helps. But it is a fantasy to believe that anything you learn in the classroom in school adds up to helping you on the job. All of these things open up doors, but there is no substitute for experience.

IT DOESN’T MATTER WHAT YOU HAVE DONE OVER THE LAST 5 YEARS, 5 MONTHS, 5 MINUTES.

IT’S ABOUT WHAT YOU ARE GOING TO DO NEXT. career. Go to a place that is a teaching environment. What you do is going to influence your happiness more so than the product you are working with. Upon graduation from Cornell, I didn’t have the plan to do what I am doing now. Be less concerned about the product and then later, when you have the skills, you can bring important skills to the media business and have a differential advantage. CBR: What advice can you offer students, specifically entrepreneurs, about succeeding in niche markets? TD: You have to make sure that, within your niche, you are the best, the most important. You have to have the best product. It’s better to be in second or third place at a big, broad company with market power and leverage than it is to be at a niche

should look for in life. Look for that right balance of career achievement and spending time with family and friends. CBR: Looking back, what are some mistakes you may have made? What did you learn from them? TD: Well, I started an investment bank, and I had no skills in that area. That was a significant mistake. I have made other mistakes in my career, figuring out what things worked and what things didn’t. The difference between someone who is successful and someone who is not successful is NOT that the successful ones make fewer mistakes. If you find people who have not made any mistakes, they tend not to be successful, since they do not take chances.

CBR: What do you believe is the most valuable piece of advice a student can receive starting out of college? TD: It would be to relax. Young people seem to think that every decision they make is going to affect the rest of their lives. It doesn’t matter what you have done over the last 5 years, 5 months, 5 minutes. It’s about what you are going to do next. That is the most important decision. Everyone is so tense – they want the right job, the right place, the right this, the right that. It will all work out – it always does for good, smart people.

FALL 2012 Cornell business revieW 25

INDUSTRY

Social Media Acquisitions

by CATHERINE CHEN

An internet giant has bought your favorite start-up. Here’s why. Internet industry players have recently gone on start-up shopping sprees. The last few months have marked much activity in the landscape of social media, particularly involving Google and Facebook. On July 31, 2012, Google acquired Wildfire Interactive, a social media marketing service that lets brands serve marketing and ad campaigns on Facebook, Google+, Twitter, Pinterest, YouTube and LinkedIn, for $350 million. In a similar instance, Facebook acquired mobile photo sharing application Instagram on September 6, 2012 for $1.01 billion. This is indicative of an

overarching trend of larger technology firms acquiring social mediabased start-ups to address the increasing importance of social media. Wildfire and Instagram are similar in their path of formation and acquisition as successful startups with remarkably rapid growth. Wildfire, based in Redwood City, California, was founded in 2008 by Victoria Ransom and Alain Chuard. It won a $250,000 first prize from the Facebook Fund (the social network’s investment vehicle) an equity investment of another $100,000 from Facebook in 2009, and raked in a total of $4.1 million dollars of funding. It has since grown to 400 employees

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and serves 16,000 customers including 30 of the world’s 50 most valuable brands, and was acquired by Google only four years after its founding. San Francisco-based Instagram, founded in 2010 by Kevin Systrom and Mike Krieger, grew to a team of 12 members with more than 5 billion photos shared. Currently, over 30 million people have downloaded the mobile application; when the Android application was released early April, it attracted more than 1 million downloads in just 12 hours. Though completely profitless, Instagram was acquired by Facebook a mere two years after its inception, a remarkable feat even in Silicon Valley standards.

These purchases were not made without strategic calculation. With its acquisition of Wildfire, Google targets social media marketing and seeks to capture a bigger portion of advertising budgets devoted to reaching consumers who interact over the Web. According to eMarketer Inc, worldwide social network ad revenues are expected to reach more than $8 billion this year, a significant increase from $5.54 billion last year. With the acquisition of Wildfire, Google is entering a fast-growing ad sales market dominated by Facebook, which sells ads on its own web pages yet includes opportunity for companies such as Wildfire to “facilitate ad sales” on Facebook and other social sites. Not only goes Google gain revenue from this acquisition; the internet giant also gains access to valuable data regarding user behavior and user-brand interaction on social sites, making Wildfire a smart purchase. The reasoning behind Facebook’s acquisition of Instagram follows a similar trajectory but is different in nature; revenue generation is not the primary motivator of the deal. Though like Google’s motivation to purchase Wildfire, Facebook has the possibility to use the Instagram platform to generate advertising revenue through sponsored photos, this benefit is secondary. Instead, Facebook looked to quell a potential competitor in mobile photo sharing. Since Instagram so successfully built a “social platform of shared experiences” that has been described as “built upon emotion”, it has a dedicated community of users. With this acquisition, Facebook can also tap into this user base and at the same time quell the potential competition that Instagram may have posed. Neither acquired company has seen much change in structure since their respective acquisition, giving

credence to the idea that acquired companies, especially their products, stay regrettably stagnant after being bought by a larger entity. Though now a Google entity, Wildfire promises there will be “no disruption or immediate change” to its service; it will continue providing its original services based on Facebook and other social media platforms. What will be most interesting to monitor will be Facebook’s reaction to the acquisition. Google is put in the peculiar position of being able to profit from a competitor’s successes, putting Google and Facebook in close combat. Likewise, Instagram has seen little change; the only two possible functionalities that may be added include a Facebook

It is no doubt that the social media landscape is shaping up and shifting to become a vital, dynamic field worthy of notice.

login to the service as well as a simplified way of bulk importing Instagram photos onto Facebook. Facebook has promised to run Instagram independently. Interesting to note is the fact that Google and Facebook are allowing their acquired start-ups to operate as mini-independent entities, which puts the two internet giants in a peculiar position. Given the interconnectivity of social media platforms, Google and Facebook are able to profit from each other’s successes yet remain constant competitors.

It is no doubt that the social media landscape is shaping up and shifting to become a vital, dynamic field worthy of notice; it is prevalent enough that internet giants such as Google and Facebook (though the latter is already the de-facto leader of social) have taken notice and are scrambling to get a solid footing in the space. These two companies are not alone in their social media start-up shopping sprees; within the past year, Salesforce has acquired Buddy Media, Microsoft has acquired Yammer, and Oracle has acquired Virtue and Involver. The recent movement towards a social media-based based internet is vital not only in terms of generating revenue, but also in terms of ensuring that users stay engaged and boosting the longevity of the large company’s current product. As smaller social media start-ups are acquired by industry giants, their products and goals are re-aligned to suit the purpose of the purchasing company. As for whether how Google and Facebook will choose to wield their new acquisitions? Only time will tell. Catherine Chen (ckc63@cornell.edu) is a sophomore at Cornell University majoring in Applied Economics and Management.

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INDUSTRY

PINTEREST & TUMBLR by CATHERINE CHEN

In recent times, curation-based social media sites have been explosively popular. Two such examples: Tumblr, a microblogging platform, has skyrocketed to 50 million blogs and 20 billion posts as of April 2012; Pinterest, a pinboard-style social sharing website, has gained a user base of 20 million as of July 2012. Why is content curation especially relevant in this time and age, why has it achieved sudden widespread popularity, and what does this mean regarding the profitability of such sites? Turns out there’s psychology behind the widespread nature of curation. Platforms like Tumblr and Pinterest essentially function as what the New York Times terms as “longing machines”. In a paper titled “What Is It We Are Longing For” published in The Journal of Research in Personality, these “life longings” are broken down into essential categories. When we curate material, we are addressing aspects of our lives that are either incomplete or imperfect. Curation ties into our fantasies of

an idealized, utopian future and involves comparisons of our life to the lives of successful others. This isn’t a new phenomenon; we have been “collecting beautiful things and using them as a way to express ourselves to the world” all along. Sites like Tumblr and Pinterest just make the process simpler, easier and more streamlined. What is interesting to note is the effect that the psychology factor has on the longevity of these social media sites. Revenue generation translates to longevity, and content-curation sites are attempting to monetize. To illustrate, Pinterest is making money by adjusting and tracking links attached to user-generated pins as well as working with affiliated networks that help companies monetize their sites. Tumblr is experimenting with monetizing through advertisements, offering “highlighted posts” and “pinned posts” for a small fee, allowing users to make their posts stand out in the dashboard. Tumblr is also offering advertisements through “Tumblr Spotlight” and “Tumblr

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Radar”, but with a steep price point of $25,000. A noticeable trend is that both Tumblr and Pinterest make their revenue generation unconscious and integrated into the features of the sites. Users are not being charged to use the curation sites; revenue comes from third party companies that would like to understand the psychology behind Tumblr and Pinterest’s user base and reach out to the users. This “innocent” monetization helps users retain a generally distraction-free emotional experience on these curation-based sites and allows external companies to easily reach a target demographic. The standpoint of content curation platforms like Tumblr and Pinterest is unique, and addresses the deeper psychological longing of idealized futures. In the end, curation sites like Pinterest and Tumblr have their benefits; they allow users to take part in their human inclination to curate, generate revenue, and allow external companies to easily reach its user base. Catherine Chen (ckc63@cornell.edu) is a sophomore at Cornell University majoring in Applied Economics and Management.

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INDUSTRY

ENDOWMENTS More Than Your Average Portfolio by ARSHAM MEMARZADEH

stream portfolio managers expect to terminate funds or open new funds in a given period – clearly distinct from the nearly infinite horizon of endowments. Another discrepancy lies in the asset allocation process of endowments. It is traditional for endowments to invest across six or seven asset classes, whereas even the most audacious managers limit themselves to two asset classes. The ability to invest across several asset classes is provided by the everlasting presence of endowments. It is commonly accepted that diversification is the only “free lunch” left in the implacable world of investing. By definition, diversification provides higher returns for any given level of risk. Colleges recognize this advantage and act accordingly. Cornell, for instance, dissipates their endowment across eleven different asset classes. After the endowment’s board of trustees and investment team determine asset allocation targets, the analysts endeavor to locate the most promising managers. Proper manager selection is the key determinant of success. A university’s manager selection is analogous to an equity manager’s stock selection. There are thousands of portfolio managers to select from, and an endowment’s investment team

Long Term Investments Total MV

Cornell is one of the sixty-two American schools with an endowment that falls in the billions, currently valued at $5.3 billion. To put this into context, some refer to the endowments of peer institutions like Harvard’s, valued at $30.7 billion, or Brown, valued at $2.6 billion. Many, including university administrators, find it difficult to usefully compare these numbers. While it may be glamorous to financially outperform a rival university, it serves no purpose to the endowment’s long-term goal of advancing the academic opportunities available to its own students. These comparisons are not useful to Cornell’s investment team, as all endowments are idiosyn-

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5-year annualized

FYTD

1 Yr

3 Yr

5 Yr

10 Yr

St Dev

LTI

5.9%

1.9%

3.7%

13.7%

2.5%

6.9%

9.8%

Benchmark

3.3%

1.7%

3.3%

12.3%

3.1%

5.0%

14.3%

Relative

2.6%

0.2%

0.4%

1.4%

−0.6%

1.9%

must decipher a method to decide managers that offer promising returns at low risk. Cornell, with returns that have been undeniably attractive over the past several years, seems to have mastered this art. They boast threeyear rolling returns of 13.7%, compared to benchmark returns of 12.3%. Even more impressive (on a relative basis) is their ten-year rolling returns of 6.9% compared to the benchmark’s 5.0% returns. The investment team interminably refines Cornell’s investment strategy. Each analyst specializes in a specific asset class and is required to boast a broad skill set pertaining to their area. For instance, CIO’s Director of Long-Only Equity and Natural Resources, Cody Danks-Burke, judges managers’ investment strategies and has to pick the superior approach. But within long-only equity falls managers that specialize in several products ranging from various markets (domes-

Current & Target Asset Allocations cratic and investment strategies are tailored to particular endowments. Endowments share the common purpose of sustaining their college for an infinite time period. A college’s mission doesn’t simply cater to the advancement and education of the current youth; their intent more closely resonates with the permanent nature of a university. An endowment must ensure that the school can, without falter, educate its students year after year. Such a horizon presents a notable investment advantage for investment teams. They are able to favor long-term returns over liquidity, which in turn provides the opportunity for higher returns. Conversely, main-

$5,351.7 m QTD

MV ($m) The average size of a large-scale hedge fund manages less than $1.8 billion – Cornell boasts an endowment nearly three times that size. Colleges around the world boast multi-billion dollar valuations with little information revealing their purpose or how they have been accumulated. Admittedly, I couldn’t answer any questions revolving around an endowment until my summer internship at the Cornell Investment Office (CIO) – the university arm that is directly responsible for our endowment. My experience at the CIO exposed me to the unique nature of endowments: the endowment fund’s infinite projection, and allocation in all asset classes.

(March 31, 2012)

(June 30, 2012) Current Allocation

Long Term Target

Domestic Equity

548.1

10.4%

11.0%

Non-US Developed

181.8

3.5%

4.0%

Emerging Mkts Equity

377.6

7.2%

10.0%

Hedged Equity

341.2

6.5%

5.0%

Private Equity

1065.0

20.3%

15.0%

Real Estate

655.0

12.5%

12.0%

Resource Related

574.7

10.9%

13.0%

Core Fixed Income

183.6

3.5%

4.0%

Marketable Alternatives

421.0

8.0%

10.0%

Special Opportunities

325.6

6.2%

6.0%

Enhanced Fixed Income

434.6

8.3%

10.0%

Cash

147.3

2.8%

0.0%

5255.5

100.0%

tic, developed, emerging, frontier, etc.) to different market capitalizations (small, medium, large). The investment team conducts thorough research on the world’s top performing managers to deduce the specific funds that will ensure highest returns for our portfolio. An analyst’s traditional investment recommendation is constructed through a sound understanding of global markets and several manager interviews coupled with research in relevant markets, manager holdings, and fund performance. Cornell demonstrates that superior, calculated asset allocation along with a scrutinizing portfolio manager selection process can assure appealing returns. Endowments are inherently unique. Their infinite presence alone separates them from most other funds. As a result of precise asset allocation and unmatched manager selection, Cornell has developed an investment strategy that has proven itself to consistently outperform benchmarks. Surely this brief review of endowments leaves the average readers more perplexed than they had been prior to reading it. Easy fix – pursue an internship at the Cornell Investment Office and learn all about the backbone that sustains our awesome school. Arsham Memarzadeh (am2342@cornell. edu) is a senior at Cornell University majoring in Industrial Labor Relations.

FALL 2012 Cornell business revieW 31

INDUSTRY

APPLE vs. SAMSUNG Innovation or Infringement? by MIGUEL HOLLANDER-HO

In one of the biggest patent lawsuits in history, Apple Inc. sued Samsung Electronics Co. for $2.525 billion over infringements of various Apple patents. While the suit was filed in April 2011,

Samsung and Apple began arguments on July 30th 2012. On August 24, 2012, a jury in San Jose, California awarded Apple $1.05 billion in damages for intellectual property used by Samsung, specifically in its Samsung Galaxy series.

32 cornell business review FALL 2012

Apple went on to claim $2.5 billion in damages for the various utility and design patent infringements by Samsung. These damages were based on both alleged lost profits – derived from Samsung’s sales – and a royalty on the rest of sales from Samsung’s infringing products. The jury based its decision off a Supreme Court decision from 1871, Gorham Co. v. White, which held that infringement of a design patent occurs “if, in the eye of an ordinary observer, giving such attention as a purchaser usually gives, two designs are substantially the same, if the resemblance is such as to deceive such an observer, inducing him to purchase one supposing it to be the other, the first one patented is infringed by the other.” This Supreme Court decision was used for various earlier patent court battles and played an important role in the decision made by the San Jose jury. An International Affair The lawsuits between Samsung and Apple were not limited to the United States. Samsung and Apple have filed suit against each other in various countries, making this battle one of global proportions. Samsung won a patent case against Apple in Japan, while South Korean courts determined that Samsung and Apple were in breach of each others’ patents. Interestingly enough, according to the Wall Street Journal, Apple’s victory “was seen by some in South Korea as a win for the team with home-field advantage.” In other words, the court in the United States may have sided with Apple due to Apple being an American company and Samsung being a foreign company. A Strain in the Relationship? Shortly after the U.S. court’s decision in favor of Apple was made, Apple reduced its orders for Samsung memory chips used in the iPhone. Thus, the court decision may put a strain on the relationship between Samsung and Apple, even though;

Samsung continues to be the sole supplier of the microchips that power the iPhone and iPad. Because Apple tends to focus on innovation and the creation of the best overall experience for their users, it allows them to outsource microchip production to Samsung. However, as the reduction of orders already shows, Apple may be looking for a new supplier of microchips. Apple has also filed for additional damages from Samsung numbering $707 million. “Apple wants a $400 million damage award for design infringement by Samsung, $135 million for willful infringement of utility patents, $121 million in supplemental damages and $50 million preadjustment interest on damages through Dec.31,” Reuters reported. Along with the additional damages, Apple is also calling for a ban on 26 Samsung phones and three tablets. In turn, Samsung has asked for a new trial, which would enable “adequate time and even-handed treatment of the parties” because Samsung does not believe they were given adequate time to prepare for a case of such complexity and magnitude.

if its biggest competitor is eliminated, will Apple have the drive to continue its current rate of innovation?

20 million units worldwide since September 6, 2012, making it the iPhone 5’s largest competitor. If the Samsung Galaxy S III is removed from the market, the iPhone 5 will lose its biggest competitor. Much of the innovation seen in the iPhone 5 has come from Apple’s strive to beat all of its competitors. Thus, if its biggest competitor is eliminated, will Apple have the drive to continue its current rate of innovation? The New York Times writes, “Consumers could end up with some welcome diversity in phone and tablet design — or they may be stuck with devices that manufacturers have clumsily revamped to avoid crossing Apple.” Because Apple has been able to patent much of their design and utility innovations, companies like Samsung may become unnecessarily cautious in avoiding any similarity with Apple products. Essentially, this court battle could force companies like Samsung to come up with their own breakthrough innovations, instead of riding on the coattails of Apple’s success. This court decision could challenge companies like Samsung to compete with Apple instead of trying to keep up with them. The question is, will companies like Samsung be able to come up with new innovations and shine, or will their cautiousness of Apple’s patents stall their innovation?

Miguel Hollander (mfh53@cornell.edu) is a junior at Cornell University majoring in Applied Economics and Management.

Consequences for the Industry This court case could have a huge impact on patent law, especially in the technology sector. One of the main reasons for the rapid advancement of technology in the 21st century was the ability for people to take existing technologies and improve upon them. An interesting issue arises from this case: will the court’s decision limit the speed of innovation? Currently, the Samsung Galaxy S III has sold over

FALL 2012 Cornell business revieW 33

INDUSTRY

Why is

BIGGER

BADDER.

Big Data’s Empty Promises For Business by GRACE GORENSTEIN

Since the recent financial crisis, the subject of executive compensation has captivated millions of Americans. Regulations in the Dodd-Frank Act have called for increased transparency, while Occupy Wall Street protestors have called for a radical overhaul of how executives are rewarded. Meanwhile, few outside of the academic world have focused on how executives are compensated rather than how much they are paid. Managers are rarely paid a flat cash sum each year. Instead, executive compensation packages are often comprised of salaries, bonuses, and stock options that are tied to shareholder performance. These figures are still colossal compared to those of the average worker. However, the real focus of regulations and outrage

Big Data, despite its perceived potential good, has a dark side.

ought to be directed at the exorbitant paychecks given to executives that oversee poor shareholder returns. In order to diagnose this problem, scholars across the world have conducted studies analyzing the relationship between executive compensation and shareholder wealth. Looking at the depth and detail of any one of these studies could convince a reader that there is a visible and predictable link. Yet many inconsistencies remain. A study by one research team may reveal a positive correlation between compensation and shareholder value, while a report from an equally reputable group of experts may reveal a striking nega-

34 cornell business review FALL 2012

tive connection. These studies have highlighted important trends in executive compensation, but have also shown there is no definite evidence that proves executive compensation is tied to shareholder wealth one way or the other. Perhaps this lack of a definite relationship simply shows there is a middle ground that can be reached. Attempting to find an exact statistical formula for the perfect level of compensation would be impossible and unnecessary, since each company is different. However, there are a variety of regulatory and market-based mechanisms available to control agency costs, and as an investor, it

is important to understand what can stitute, wisely suggests that pay packmotivate a company’s management ages should be flexible by “giving a to boost your return. CEO more stock and less cash after The managerial labor market and company shares plummet, restoring an executive’s career concerns can the CEO’s incentives to boost the longhelp align management’s incentives term share price.” While bonuses can with those of stockholders. Executives be effective, they are often given out may be penalized for poor perfor- annually and do not always reflect the mance, which may lead to a fall in the executive’s performance. At the end company’s stock price. Many executives of larger corpo“The focus of Big Data on rations seek coveted board financial markets has not seats in the future, but if they lose shareholders’ money increased our understandand are voted out of one ing of how our complex company, it is unlikely they and global economies will be welcomed at other companies. From a regulawork. Being able to tory standpoint, stock and identify variables does not bond rating agencies play a lead to an understanding significant role. If managers are mismanaging finances of them.” and accumulating debt, stock and bond rating agencies will raise the cost of running the of 2011, for example, Goldman Sachs corporation by raising interest rates, CEO Lloyd Blankfein was awarded a which in turn may decrease both the $7.2 billion bonus, even though his stock’s value and the manager’s like- company’s stock price fell 46% that lihood of keeping his job. year. Restricted stock thus incentiviz In terms of pay structure, re- es the manager to grow the company stricted stock— stock that has specific over an extended period rather than limitations and is often restricted make decisions that artificially push from being sold until a certain length up the stock price in the short term. of time has passed— may be an ef- By becoming a long-term investor, fective way of tying compensation the manager will see that his comto company performance. Prevent- pensation is more closely tied to the ing executives from selling company wealth of shareholders. stock until several years down the This leads to the central quesroad provides a powerful incentive tion of the financial crisis. Does to think in long-term views. Dr. Alex more money for executives mean Edmans, a research associate at the more problems for shareholders? Economic Corporate Governance in- Not necessarily. At first glance, it is

easy to understand how many observers believe in the affirmative. It is no secret that the majority of corporate executives attain a level of prosperity and privilege that many Americans will never reach. To these onlookers pulling themselves out of recession, executive compensation looks shockingly high. And from a shareholder perspective, there is not much transparency into the mind of someone running your company. In some cases, these people are right, for there are certainly highly paid CEOs who put their own interests before shareholder value. But the answer is not simply to restrict how much executives are given. Instead, the goal should be for companies to construct executive compensation plans that align management’s incentives with shareholders’ interests. This will compel an executive to not only think like a shareholder with a vested interest, but to run his company like one too.

Grace Gorenstein (geg62@cornell. edu) is a sophomore at Cornell University majoring in Economics and History.

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INTERNATIONAL

A Dangerous Domino Effect in the Strait of Hormuz by DAVID FORWARD This time last year, many Americans had probably never heard of the Strait of Hormuz. Yet as tensions with Iran have escalated over recent months, the strait has become a focal point of economic and political study around the world. The Strait of Hormuz is a narrow strip of water between Iran and Oman through which nearly 20% of the global oil supply passes each day. Due to its location and its small two-mile wide shipping lane, the Energy Information Administration has identified the Strait of Hormuz as the most important oil chokepoint in the world. As the Western World has recently tightened economic sanctions on Iran due to its nuclear program, Iran has responded by threatening to shut down the Strait of Hormuz. Such a decision could have a dangerous domino effect, hurting consumers and businesses alike. Indeed, even the possibility of closing

36 cornell business review FALL 2012

the strait has caused the price of crude oil to jump in recent months. Yet there remain severe economic, political, and military consequences to closing the strait. So how can a small strip of water 6,000 miles away affect you, the average American consumer? Most analysts agree that Iran’s decision to close the Strait of Hormuz would have damaging economic effects on both the U.S. and the global economy, for the supply shock resulting from blocking a fifth of the world’s oil would cause gas prices to skyrocket. John Felmy, chief economist at the American Petroleum Institute, suggests that 84% of the price of gasoline is directly tied to the price of crude oil. Energy analysts estimate that the price of oil could spike as high as $170 per barrel, causing U.S. gas prices to rise above $5 a gallon. Paying more at the pump takes discretionary income away from consumers,

which in turn lowers demand and hurts the economy as a whole. According to the Center for Naval Analysis, a conflict in the strait would not only cause higher gas prices and unemployment; it would also lower U.S. Gross Domestic Product while raising inflation. This domino effect would be similar internationally, as countries like China and India import more than 15 percent of their oil from Iran. For a fragile global economy, even a short-term supply shock could have long-term consequences. A shutdown of the Strait of Hormuz would also increase operating costs for businesses. The airline and automobile industries would be hit hardest, as higher oil prices make traveling more expensive and increase the cost of producing parts like tires. On the one hand, renewable energy companies would benefit as consumers seek cheaper sources of energy. In general, though, higher oil prices will translate into greater transportation and packaging costs, which negatively affects almost all industries. And while nearly half of crude oil is eventually converted into gasoline, petroleum is also used to make everyday products like CDs, athletic shoes, deodorants, tires, and adhesives. Oil is quite literally the glue that thousands of businesses rely on, and if oil prices skyrocket due to tensions between the West and Iran, increased costs for these businesses will translate into higher prices facing consumers and a more vulnerable economy. While the global costs of closing the Strait of Hormuz are unsettling, the costs to Iran’s own economy would

perhaps be even more destructive. Iran generates 65 percent of its revenue from oil exports, almost all of which pass through the strait. Sanctions are already weakening Iran’s financial resources, and while closing the strait may send a message to the West, it would do so at the expense of Iran’s own economy. Iranians are already beginning to feel the effects of the sanctions, and as a country whose history is rich in revolution, Iran’s leaders would be wise to weigh the domestic consequences of closing the strait. The political implications of a possible closing of the strait are just as important as the economic repercussions. In preparation for Iran’s blocking of the strait, many countries are working together to prevent disruptions in the global oil supply. Even China and India, who have been active trade partners with Iran, have started to wean themselves off Iranian oil. India is building up a two-week reserve, while China has cut down its Iranian oil imports by 50 percent over the past year. Meanwhile, Saudi Arabia, the world’s largest oil producer and exporter, has agreed to step in and supply the European Union should any shortfalls in oil from Iran occur. From a political standpoint, Iran risks alienating itself from many of its former partners as those countries seek alternative ways to protect their own economies and prevent higher energy costs. This risk of isolation can be realized from a military perspective as well. While Iran’s top Naval commander recently remarked that closing the strait would be “easier than drinking a glass

of water,” U.S. officials appear to feel the same way about reopening the channel. U.S. Naval Commander Rodney Mills asserts, “There is consensus among the analysts that the U.S. military would ultimately prevail over Iranian forces if Iran sought to close the strait.” The costs of military intervention, political isolation, and economic debilitation could arguably be as high for Iran as are the costs of rising oil prices for consumers and businesses in the United States. Many analysts expect Iran to use the Strait of Hormuz as a bargaining chip to dissuade further sanctions rather than initiate a costly global conflict. Iran’s leaders are likely aware that the only viable alternative oil supply routes, the Fujairah Pipeline in the Indian Ocean and the Petroline in Saudi Arabia, are too small and underdeveloped to replace the 17 million barrels of oil that flow through the Strait of Hormuz each day. Iran is the world’s fifth largest oil exporter, and if it closes the strait, it will have significantly weakened its ability to negotiate sanctions. However, Iran’s regime is unpredictable. If it does close the strait, or even if uncertainty continues to mount, then a domino effect could test the fortitude of the global economy. This domino effect may begin with a simple reduction in oil supply and higher oil prices, but may quickly lead to substantial energy costs, higher prices facing consumers, less demand, lower stock prices, and a weakened overall economy. As a stillfragile nation, the United States may be one of the first to see these effects. Thus, if tensions ultimately heighten along with oil prices, then the two milewide strip of water bordering Iran could end up knocking the rest of the world back into recession, a result no country desires to see.

David Forward (dcf62@cornell.edu) is a junior at Cornell University majoring in Economics and Government.

FALL 2012 Cornell business revieW 37

INTERNATIONAL

treasures of the north by SEAN PATEL For centuries the Arctic has persisted as a silent giant, largely untouched by the global expansion of trade and development. Although the region houses some of the largest glaciers and rivers on Earth, it plays host to a motley crew of scientists, fishermen, and anthropologists. For the general population, this region has flown under the radar.

The US Geological Survey has estimated that 30% of the world’s undiscovered reserves of natural gas, and 13% of its undiscovered oil lie in the Arctic.

However, this trend is quickly shifting, and interest in exploring the opportunities in the Artic is expanding. The attention of the public is quickly turning to this area. The reason for this recent shift in world focus is global warming. Since 1951, the Arctic has warmed roughly twice as much as the global average- may want to briefly explain the function behind this, as many people are not familiar with the magnified effects of climate change on the poles. The temperature of Greenland has risen over 1.5oC, as compared to a 0.7o global increase. Global climate change is not a new issue in media coverage, but for the first time the global community is witnessing novel parties express economic and political interest in the emerging wealth of the world’s commons. The US Geological Survey has estimated that 30% of the world’s

38 cornell business review FALL 2012

undiscovered reserves of natural gas, and 13% of its undiscovered oil lie in the Arctic. It also contains coal, iron, uranium, gold, copper, rare earths, gemstones and fish. For the resourcehungry East Asian countries like China, Japan, and South Korea, this represents a huge economic opportunity. That is not all the melting Arctic has to offer. The long dreamed of North-East Passage above Russia will soon become navigable for a few months each summer. The passage cuts the voyage from Shanghai to Hamburg by more than 4,000 miles. This can become even shorter when the ice across the North Pole begins to melt. Although the political and economic impact of arctic opportunities is still subject to speculation and uncertainty, many parties have already taken great interest in exploring the

potential for claiming stake in a newly available resource pool.[With all of these opportunities, many parties have already taken great interest in the area]. China has greatly ramped up its research spending. It has established a research station in the Svalbard archipelago, and built the Xue Long, the first Chinese vessel to travel the North-East Passage. Additionally, government officials frequently visit nations adjacent to the Arctic Circle in search of support and partnership. Denmark, Sweden, and Iceland this summer, offering lucrative trade deals to gain favorable relations. Of course, China isn’t the only country interested in the region. Japan, Singapore, and South Korea have all applied for observer status on the Arctic Council, which is a loose international body of eight Arctic nations that develops policy for the region. They are all the while promoting the “inherited wealth of humankind” in regards to the riches of the Arctic. All of these countries are extremely hungry for natural resources, and the Arctic is a huge opportunity for all of them. In addition to governmental entities, private sector parties have worked to position themselves at a vantage point during this critical strategic period. With a green light from the Environmental Protection Agency, Shell plans to move into the Arctic off the Alaskan coast this fall. Exxon and BP are also planning to make moves into the Arctic quite soon, and Gazprom and Rosneft have

already started drilling in Russia. Despite apparent competition for territorial acquisition and land control in the arctic, areal division of the Arctic is relatively unambiguous. . The Law of the Sea Convention, established by the United Nations in 1984, grants certain set areas of the Arctic sea floor to the five circumpolar nations – Canada, the U.S., Russia, Norway, and Denmark. Each country owns the land 370 kilometres out from its shoreline, and an additional 278 kilometres out from any area scientifically proven to be continental shelf. This scientific designation of continental shelf has been the cause of many disputes over the area. Although much of the territory is clear cut, there are some very controversial areas as well. The Lomonosov Ridge, for example, is an oceanic ridge extending 2,000 kilometers across the Arctic Ocean from Russia to Canada. While Russia claims the ridge, Canada and Denmark have been con-

testing ownership for decades. The melting of the Arctic is not necessarily all good news. Niche habitats, such as meltwater pools are dwindling and some highly specialized Arctic species will likely become extinct as their habitats disappear. High-Arctic species, including the polar bear, are struggling and may become extinct due to the melting. Melting glaciers will affect sea levels drastically. Greenland’s ice cap is losing an estimated 200 giga-tons of ice a year. The Arctic’s smaller ice caps and glaciers together are losing a similar amount. The Intergovernmental Panel on Climate Change has predicted a sea-level rise of up to 59cm during this century due to the ice loss. The melting of this ice may also begin to disrupt the circulation of the global oceans. This could hamper the ocean’s natural ability to bring warm tropical water to the higher latitudes and cold polar water back down to the equator, which would have dramatic effects for natural temperature moderation throughout the world. Finally, the thawing Arctic permafrost could release vast quantities of carbon dioxide and methane into the atmosphere. This alone could lead to a temperature increase of 5°C over a few thousand years. The pros and cons for the melting Arctic are clear. Whether the world is better off because of the impending situation is much less so. Regardless, the events that will occur over the next few years in the Arctic can no longer be avoided. The world must learn to embrace this melting, for better or for worse, and must learn to responsibly take advantage of the opportunities that it has to offer. Sean Patel (srp98@cornell.edu) is a junior at Cornell University majoring in Applied Economics and Management.

FALL 2012 Cornell business revieW 39

INTERNATIONAL

INTERNATIONAL the state as the majority shareholder, and control 53% of the Chinese lending market. For contrast, the top four banks in the United States only control 35%. The Chinese Communist Party (and thus Chinese government) has used these banks to finance the expansion of other SOEs, as well as to finance various state projects. The 2009 stimulus program, valued at $600 billion, coincided with a marked increase in lending by state banks. The majority of this lending went to other SOEs, causing the creation of the phrase “Guojin Mintui,” meaning “the state advances and private companies retreat.” In general, the largest Chinese banks lend only to large companies – small and medium sized enterprises are

left to fend for themselves, often turning to unregistered sources of funding such as loan sharks or family lending networks. These sources frequently charge high interest rates in comparison to those offered by legitimate banks (there are only about 100 in China, a nation of 1.3 billion). This high financial burden limits the success of a sector responsible for 70% of Chinese employment, 65% of the patents filed each year and 60% of exports. The sector only receives 20% of China’s financial resources. If China hopes to facilitate the growth of more globally competitive companies (such as Haier and Lenovo), it must make it easier for the so-called “bamboo entrepreneurs” to access capital. Premier Wen

Jiabao recognized this in April, when he called for the “breakup of the bank monopoly.” As his term is ending within a year, it will remain up to the new leadership to effectively address this challenge. Austin Opatrny (abo27@cornell.edu) is a junior at Cornell University majoring in Economics and Asian Studies.

Five Largest Chinese Companies by Revenue

Corporate Party of China

Company Sinopec

Understanding the Role of Government in Chinese Enterprise by AUSTIN OPATRNY On October 8th, the United States House Intelligence Committee released a report claiming that two major Chinese manufacturers of telecommunications equipment, Huawei and ZTE, had design elements that would facilitate the dissemination of sensitive information from the United States into China. The leadership and motives of Huawei and ZTE (the first and fifth largest manufacturer of telecommunication equipment, respectively) were called into question because of the established links between them and the Chinese government. The founder and current president of Huawei, Ren Zhengfei, worked in the information-technology unit of the People’s Liberation Army. This interconnectedness is not, however, a unique feature of the two companies. Instead, the largest corporations in China are frequently padded with well-connected political figures, and the influence of the Chinese Communist Party is felt in all corners of the economy. This trend of

interconnected relations with the government has been accelerating, rather than decelerating, as China’s economy matures. If China hopes to develop an economy that encourages innovation, this could be one its greatest liabilities. State-owned enterprises (SOEs) make up more than 40% of China’s nonagricultural GDP. This has caused problems for the international expansion of Chinese corporations – Aluminum Corporation of China, a state-owned enterprise, saw its 2009 bid to acquire a $19.5 billion share in Australian-British mining conglomerate Rio Tinto scuttled partially because of concern over potential loss of sovereignty over resources. CNOOC, a state-run oil company, is currently seeking approval from the Canadian government for the $15.1 billion acquisition of Nexen, an energy company specializing in oil and gas, particularly oil sands. Politicians have been discussing what the “net benefit to Canada” will be – the government own-

40 cornell business review FALL 2012

Connection to Government

$375,214 in Revenues $9,452.9 in Profits 1,021,979 Employees

Chinese Communist Party’s Organization Department appoints board of directors.

Headquarters in Beijing. 5th largest world company 326.5 million barrels of oil production in 2012

China National Petroleum

ership of CNOOC has clearly influenced political discourse. Even corporations not directly controlled by the Chinese government have seen foreign acquisition efforts stymied by worries about Chinese hegemony and economic ascendency. China Minsheng Bank, one of the first commercial banks in China not controlled by the government, attempted in 2009 to acquire a controlling stake in struggling United Commercial Bank, based in San Francisco and catering to the overseas-Chinese community. This deal was not approved by the Fed, who stated that “Chinese authorities are working hard to meet the standards that would permit them to buy banks in the US, but these things take time.” Domestically, SOEs have shaped the course of Chinese economic development, especially in regards to finance. The “Big Four” Chinese banks (Bank of China, China Construction Bank, Industrial and Commercial Bank of China, Agricultural Bank of China) all have

Company Info ($M)

$352,338.0 in Revenues $16,317.0 in Profits 1,668,072 Employees Headquarters in Beijing. 6th largest world company Produces 73% of China’s natural gas

State Grid

$259,141.8 in Revenues $5,678.1 in Profits 1,583,000 Employees

75.84% of shares owned by the Chinese government, via a company administered by State-Owned Assets Commission.

Chinese Communist Party’s Organization Department appoints board of directors. Chairman is member of Chinese Central Committee. Entirely owned by Chinese government. Chairman is member of Chinese Central Committee, spent previous career in state power administration bureaus.

Headquarters in Beijing. Entirely owned by Chinese government. Transmits power to 90% of China, or 1.1 billion people. 7th largest company in the world.

Industrial & Commercial Bank of China

$109,039.6 in Revenues $32,314.1 in Profits 408,859 Employees Headquarters in Beijing. $2,458,987.7 in assets. 54th largest company in the world.

China Construction Bank

$89,648.2 in Revenues $26,108.6 in Profits 329,438 Employees Headquarters in Beijing. $1,951,356 in assets. 77th largest company in the world.

More than 70% owned by two state-controlled entities – Ministry of Finance of China and Central Huijin Investment Ltd., wholly owned by China Investment Corporation Chairman is a member of the Chinese Central Committee Chairman is former President of the Chengdu branch of the People’s Bank of China, as well as State Administration of Foreign Exchange. 57% owned by Central Huijin Investment Ltd, wholly owned by China Investment Corporation

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last look: world news update

Contributors: Oliver Marvin, Miguel Hollander-Ho, Austin Opatrny, Zhi-Yen Low

EGYPTIAN PRESIDENT GIVES HIMSELF BROAD POWERS

POTENTIAL SEC CHARGES AGAINST SAC CAPITAL After receiving a warning from the Securities and Exchange Commission, renowned fund manager Steven A. Cohen and his $14 billion firm SAC Capital Advisors have begun to prepare for insider-trading charges in a case that could shake Wall Street. In a 20-minute conference call, Cohen notified top SAC executives that the company had been served a “Wells notice” from the SEC. The notice implies that charges against SAC are likely as prosecutors continue to gauge whether they can build a successful criminal case against the firm. This notice

Tensions have mounted in Egypt over President Morsi’s decision to grant himself near-absolute power. The new declaration freed Morsi from judicial oversight. With no parliament currently in place, many said longtime dictator Hosni Mubarak had simply been substituted for another. Waves of protestors poured into the streets of Cairo after the decree. This came following a seven-article declaration, one of which stated that Morsi’s laws

comes less than a week after prosecutors charged a former SAC employee with running a very complex, yet successful, insider trading scheme. With an annual return of 30 percent since it’s inception, the immense success of Steve Cohen and SAC has long prompted rumors of possible insider trading. It will be interesting to see whether this notorious reputation finally catches up to Mr. Cohen and his fund.

E.U. U.S.A.

and decrees “are final and binding and cannot be appealed by any way or to any entity.” However, Morsi’s office insists that the powers are only temporary until a draft of their new substitution is submitted. Morsi insists that he did not infringe upon the authority of the country’s top judges. As protests mount in Egypt, it will be important to monitor the country as they continue to attempt to set up a democracy.

China Egypt

US TREASURY DECLINES TO LABEL CHINA ‘CURRENCY MANIPULATOR’

EUROPEAN UNION BRUSSELS SUMMIT INCONCLUSIVE European Union leaders ended their two day summit in Brussels with no concrete agreements on a common budget for the next seven years. Leaders were split between countries that stand to gain from EU finances, and countries that pay to keep the poorer nations of the 27-nation bloc afloat. European Council Chief Herman Van Rompuy hinted at a possibility of a deal in the beginning of next year, but the outlook remains grim. The bleak economic

conditions throughout the region have only helped to fuel discontent in the U.K. and the Netherlands about budget funding. These countries are becoming increasingly reluctant to foot the bill for spending when their own countries are weathering strict budgets. Mr. Van Rompuy maintained the original European Commission budget of 1.025 trillion euros and upheld the spending ceiling of 973 billion euros. The failure to agree on a budget just days after talks

42 cornell business review FALL 2012

failed between finance ministers of the 17 euro zone nations on conditions for releasing a new tranche of bailout funds to Greece cast foreboding doubts over the union’s decisionmaking process. Should leaders fail to reach agreement on a budget by the end of the year, the 2013 budget could be rolled over into 2014 on a month by month basis, which may jeopardize long term projects.

The US Treasury department declined to name China a currency manipulator in its November 26 th semi-annual currency report to Congress. Although the report conceded that the yuan “remains significantly unvervalued,” the Treasury cited reduced intervention and “steps to liberalize controls on capital movement in order to move to a more

flexible exchange-rate regime” as reasons against citing China as a manipulator. Anti-China US politicians were angered by the report, which “all but admits China’s currency is being manipulated, but stops short of saying so explicitly,” according to NY Senator Chuck Schumer. By failing to designate China a currency manipulator, the US denies itself the opportunity to pursue punitive sanctions against China. This is a desired outcome for many US corporations such as Apple Inc. and Wynn Resorts, which benefit substantially from their access to the Chinese market and want to maintain a harmonious relationship between the two countries. Chinese Central Bank Governor Zhou Xiaochuan said that full convertibility of the yuan will be China’s next step. This will hopefully further appease international critics.

FALL 2012 Cornell business revieW 43