The share market effects of naming companies after blockchain

This past week in my ECONS101 class, we discussed financial markets. In particular, we discussed the efficient markets hypothesis - the idea that all publicly available information (good and bad) about an asset's future cash flows is already captured in the asset's price (in the strongest form of the efficient markets hypothesis, all private information is also captured in the asset's price). So, it was timely that the Economics Discussion Group discussed this article by Archana Jain (Rochester Institute of Technology) and Chinmay Jain (Ontario Tech University), published in the journal Economics Letters (sorry, I don't see an ungated version). The authors look at the impacts on the share price when a company adds changes its name to include "bitcoin" or "blockchain".

I'd already followed the news about one of these companies in late 2017 - Long Blockchain Corp, formerly Long Island Iced Tea - which has been in the news again recently. Jain and Jain looked at ten such companies, and compared their performance with the performance of other companies that are included in blockchain exchange-traded funds. If there was something important going on with blockchain, you'd expect it to be picked up in the share prices of these other companies as well. Instead, they found that:

...the firms that change their name to include blockchain in it had a negative return of 13.55% from day −14 to day −2. We see an increase in the return of these firms from day 0 to 1 at 34.29%. Over the five-day period from day −2 to day +2, all firms earn a strongly statistically significant abnormal return of 100.89 percent. Over a 30-day (60-day) period from +1 to +30 (+60), all firms earn a 81.47% (72.84%) percent return. However, over a 60-day period from +61 to +120, all firms earn a −56.32 percent return.

In other words, the companies that changed name were not doing well (in terms of share price) in the lead up to their name change. They then saw a massive increase in their share price, up to 30 days after changing name, presumably as investors looking to jump on the cryptocurrency bandwagon bought into the companies. Then the share price started falling back to its original level. In the meantime, it's likely that the original company owners cashed out a big payday, while the stupid investors who failed the due diligence test were left licking their wounds.

Jain and Jain's article is a brief "how-to" guide for making money from a vapourware holding company. Just add the latest buzzword to your company name, and cash out big (but make sure to do so before the SEC figures it out). It's also proof that the efficient markets hypothesis doesn't hold in the short run. Otherwise, investors wouldn't get suckered into this.

Pharmacies and market power

Following on from yesterday's post about market power in the market for diamonds, I was also interested to read this article in The Conversation last week, by Bruce Baer Arnold (University of Canberra), about retail pharmacies in Australia:

In Australia, you are broadly free to operate most retail premises in any location. Three coffee shops might sit side by side, along with two bike shops and a barber’s.

A consequence of the National Health Act 1953 and state and territory law is that pharmacies are different – that’s why you never see two in a row.

Location restrictions state that when pharmacies relocate, they must do so within 10km of the existing site.

The establishment of a new pharmacy must generally be at least 1.5km from an existing operation.

We also have restrictions on ownership. Pharmacies must be operated by a registered pharmacist. A single person or corporation can own no more than five pharmacies. (Though franchising – where individual owners pay for use of a national brand such as Amcal and for services provided by the brand owner – blurs that restriction.)

The current rules seek to ensure most Australians have access to a pharmacy staffed by a highly skilled professional with a pharmacy degree.

By not having too many pharmacies within the same area, and therefore reduced local competition, it increases the likelihood they’ll make enough profit to stay open.

Such restriction is pragmatic, although it discomforts free-market purists who believe fewer rules foster competition through lower prices and better service.

It's interesting to note that New Zealand currently has similar rules to Australia (although the Therapeutic Products and Medicines Bill was initially going to relax the restrictions, it seems from the latest version of the Bill that it won't - see here for more). And it doesn't take a "free-market purist" to see what is going on here. If ownership of pharmacies is restricted to pharmacists, the number of pharmacies each owner can own is limited, and regulations state that pharmacies can't be located close to each other, local competition is lessened and market power is created. Keeping competitors out of your local market is a pretty effective way of gaining and maintaining market power.

Why should consumers care? Among other things, market power for sellers leads to higher prices. We are probably paying more for medicines and other products sold through pharmacies than we would if the market were more competitive. We may also be seeing less innovation in the retail pharmacy sector - why would a pharmacy innovate if they are already making a cosy profit and their market position is protected by law?

The Australian government is worried about the market power that Facebook or Google have, and they are willing to engage in a costly regulatory battle to reduce that market power. Why aren't they worried about the market power that pharmacists have, and willing to lessen the regulatory framework that creates that market power in the first place?

Market power and disruption in the diamond industry

In both of my first-year economics classes, I use De Beers as an example. In ECONS101, it's an example of a firm that has market power. In ECONS102, it's an example of a monopoly firm. In both cases, it's a good example because of barriers to entry - in this case, barriers to entry that arise when a firm is the only owner of a key resource that is necessary to produce the good.

There are few real-world examples of monopolies that arise from a firm being the only owner of a key resource. That's because global competition makes it very difficult for any firm to have sole control over a resource. However, De Beers got close. In the late 1980s, De Beers controlled about 90 percent of the world's diamond supply. They owned the most productive diamond mines in southern Africa, and had supply agreements with the largest diamond producers in other countries like Australia, Canada, and the Soviet Union, who allowed De Beers to handle the wholesaling and distribution of their diamonds (see here for more on this). Controlling such a large proportion of the diamond supply gave De Beers a high degree of market power - they were effectively a monopoly.

De Beers isn't nearly as dominant now, with market share under 40 percent. However, 40 percent market share still conveys a lot of market power. But that market power might be about to fall further, as this article in the New Zealand Herald (republished from the Daily Telegraph) explains:

Diamonds may not be forever after all. The value of the gemstone is set to diminish and they will become common in computer chips, satellites and even medical implants within a decade — if Silicon Valley's avant-garde lab-grown diamond purveyors have their way.

"We want to drive prices down because we think there are going to be many more applications for diamonds at present," says Martin Roscheisen, founder of Diamond Foundry.

His company produces diamonds in a cluster of biotech start-ups. Engineers use proprietary reactors that mimic the extreme pressure and fiery heat that creates plasma that, with the addition of carbon, produces natural diamonds.

Carbon atoms are stacked one by one in a thin layer of diamond atomically and visually identical to gems in Tiffany's. Polishers in Antwerp buff each diamond up to 2000 times to create multiple facets that capture and reflect light. One carat of rough diamond takes "a few weeks" to produce and once polished, prices start north of US$1000 ($1556)...

One of the necessary conditions for monopoly is that your product has no close substitutes. A lab-grown diamond is a very close substitute for a natural diamond. If there are many (and/or close) substitutes available, then the firm's market power is diminished. It isn't all over for De Beers yet, though:

De Beers is limiting supply in the face of trade tensions between the US and China, the two largest markets. The impact of lab diamonds is still only about 1 per cent of the overall market and will rise closer to 3 per cent by 2035, Zimnisky predicts. He is reluctant to say lab-grown diamonds will crush De Beers, saying producers are more likely to focus on hi-tech applications.

So, De Beers probably has years left before lab-grown diamonds really start to cut into their profits. However, one thing is surprising to me. Why isn't De Beers investing in the market for lab-grown diamonds now? You would expect a rent-seeking monopoly like De Beers to recognise the threat and to try to act to prevent it. They could argue that lab-grown diamonds are in some way a poor substitute and should be banned. It seems like they might have tried this already, as the article notes that "US regulators ruled that the definition of a diamond grown in a lab or one chipped from rock as far as 600m below the surface were the same". Since that didn't work, then buying out your competitors might be an alternative option. A purely rhetorical battle like this is going to be pretty ineffective:

Bigger players insist mined diamonds can never be replaced. Nathan Strauss of Tiffany says it will not use lab diamonds, describing mined gems as rare and a "romantic symbol billions of years in the making with an intrinsic value far beyond their chemical make-up".

Some firms don't see disruptive innovation coming, until it's too late (see Kodak, or Nokia, for examples). De Beers probably needs to wake up, and soon, or they may only be a historical example for economics classes in the future.

Gun buybacks and incentives

I was interested to read this article in the New Zealand Herald earlier in the week:

Some New Zealand gun owners are upset they're being compelled to hand over their assault weapons for money. Others believe a government-imposed ban on certain semi-automatics following a March shooting massacre is the best way to combat gun violence.

And The Associated Press has found at least one man may have tried to swindle hundreds of thousands of dollars from the system set up to compensate gun owners...

[Police Deputy Commissioner Mike] Clement said the man showed up at an Auckland buyback event with thousands of magazines seeking to collect hundreds of thousands of dollars in government compensation. A possible flaw in his plan? Clement himself happened to be at the event.

"It's one of those things that didn't look right, didn't feel right," Clement said.

He said police were keeping hold of the magazines and hadn't paid the man any money while they carried out their investigation.

Policy changes create incentives to change behaviour, by changing the costs and/or benefits associated with the behaviour. However, changing the costs and/or benefits can also have unintended consequences (which is something I have blogged about many times before).

In this case, the gun buyback scheme created an incentive to buy cheap gun parts overseas, import them into New Zealand, and then give them to the government as part of the buyback scheme. Any difference between what the gun parts were purchased for overseas (plus the importing costs) and the amount received from the buyback ("between 25 per cent and 95 per cent of the pre-tax price") would be pure profit to the enterprising gun part importer.

The man referred to in the article was doing something that should have been easily anticipated by the government. It's not clear whether his actions were illegal, but they certainly were not within the spirit or the intention of the scheme. That man was caught out, but it makes me wonder: how many others might have already done the same (although perhaps not to the same degree) and gotten away with it?