Fraud on the Market theory applied to Analysts

This week, Citigroup agreed to settle its WorldCom class action lawsuit with a huge payment. An article in the WSJ, says Citigroup may have been motivated by an unsual friend-of-the-court brief filed by the SEC in this case. Some quotes from the article:

Citigroup said it settled in part because the Securities and Exchange Commission filed a legal brief in the case saying investors need not show they relied on misrepresentations by analysts to prevail in a suit over flawed research -- because such public statements are reflected in a stock's price. Citigroup had argued this "fraud on the market" doctrine applied only to corporate executives, not analysts... Citigroup and other banks defending shareholder lawsuits involving WorldCom and other alleged corporate frauds had been arguing that because multiple analysts make recommendations, it is difficult to parse exactly what influenced an investor's decision to buy. The SEC's position, if adopted by the courts, would make that argument moot.

The SEC's brief (see PDF or HTML) interprets a 1988 Supreme Court case (Basic v Levinson) to conclude that the fraud-on-the-market theory applies to anyone who disseminates material information that is assumed to be refected in the stock price relied on by investors, and that includes analysts. What's special about this brief from my point is that it makes its case by quoting extensively from published and recent research in finance and accounting research on analysts and analyst forecast. Kudos to my academic colleagues Scott Stickel, Kent Womack, Brad Barbar, N. Jegadeesh, Roby Lehavy, Charles Lee, and other academic colleagues whose work was cited by the SEC in support of its brief. I am surprised, however, that the SEC brief doesn't cite Larry Brown's extensive research on analysts. Larry is by far the most published researcher in this field.

Bala Dharan

US and Indian GDP growth rates - Lots of catching up to do

Yesterday's WSJ has a nice article titled "Is India Shining" by Gurcharan Das. Mr. Das was the former CEO of P&G in India. He made some interesting observations about the growth of the Indian middle class:
- Indian GDP has grown at an average annual 6% real rate for two decades, making it one of the fastest growing major economies in the world over a 23-year period.
- The Indian growth rate of the previous 30 years is double the rate at which the West created its Industrial Revolution.
- India's population growth has slowed down to 1.7%, compared to a historic 2.2% growth rate.
- Almost 170 million Indians have risen out of destitution since 1980 as the poverty ratio has declined to 26%.
- If India's economy continues to grow at this rate for the next few decades, then a majority (mainly in the south, west and northwest) should be middle class by 2025.
- At the current rate Indian per-capita GDP will catch up to the US per-capita GDP by 2066.

I was pleasantly surprised by Mr. Das's forecast that Indian per-capita GDP would catch up with US per-capita GDP by 2066. First of all, it is good news, but it is also depressing since 2066 is too far off for my taste, since I expect to be dead by then :(

I tried to verify where Mr. Das might have got this forecast. According to the CIA Fact Book, the Indian per-capita GDP is $2,600 (actually $500, but this number is adjusted by the CIA for purchasing power parity) and the US per-capital GDP is $37,600.

Also, according to this interesting graph, the US inflation-adjusted per-capita GDP has grown from $13,800 in 1949 to $37,600 now, or an annual growth rate of 2% per year during this period. Assuming it will grow at an annual rate of 1.5% for the next 60-odd years, it will grow to $97,500 in 2066 in today's dollars. For the Indian per-capita GDP to go from $2,600 to $97,500 in the next 64 years, it has to grow at a compounded annual inflation-adjusted growth rate of 5.8%. Let's say the population is growing at 1.5%. Then the overall Indian GDP has to grow at a real annual rate of 7.3% for the next 64 years, to catch up to the US. That does imply a stupendous productivity growth. Assuming an inflation rate of 2-2.5%, it would also translate to a nominal GDP growth rate of 9 to 10% per year. (Im not sure what will happen to purchasing power parity as a result of all this growth, but we will ignore it.)

So, Mr. Das is basically forecasting that India will keep growing at about 9-10% every year for the next six decades. It is an ambitious forecast. Nothing wrong in dreaming big, but one should also note that virtually no corporation has grown at such a high rate for six decades. It will be even rarer for a large country's economy to do so.

Bala Dharan