Author: SK

Valuing loan deals for football players

Initial reports yesterday regarding Radamel Falcao’s move to Manchester United mentioned a valuation of GBP 6 million for the one year loan, i.e. Manchester United had paid Falcao’s parent club AS Monaco GBP 6 million so that they could borrow Falcao for a year. This evidently didn’t make sense since earlier reports suggested that Falcao had been priced at GBP 55 million for an outright transfer, and has four years remaining on his Monaco contract.

In this morning’s reports, however, the value of the loan deal has been corrected to GBP 16 million, which makes more sense in light of his remaining period of contract, age and outright valuation.

So how do you value a loan deal for a player? To answer that, first of all, how do you value a player? The “value” of a player is essentially the amount of money that the player’s parent club is willing to accept in exchange for foregoing his use for the rest of his contract. Hence, for example, in Falcao’s case, GBP 55M  is the amount that Monaco was willing to accept for foregoing the remaining four years they have him on contract.

Based on this, you might guess that transfer fees are (among other things) a function of the number of years that a player has remaining on his contract with the club – ceteris paribus, the longer the period of contract, the greater is the transfer fee demanded (this is intuitive. You want more compensation for foregoing something for a longer time period than for a shorter time period).

From this point of view, let us now evaluate what it might take to take Falcao on loan for one year. Conceptually it is straightforward. Let us assume that the value Monaco expects to get from having Falcao on their books for a further four years is a small amount less than their asking price of GBP 55M – given they were willing to forego their full rights for that amount, their valuation can be any number below that; we’ll assume it was just below that. Now, all we need to do is to determine how much of this GBP 55M in value will be generated in the first year, how much in the second year and so on. Whatever is the value for the first year is the amount that Monaco will demand for a loan.

Now, loans can be of different kinds. Clubs sometimes lend out their young and promising players so that they can get first team football in a different club – something the parent club would not be able to provide. In such loans, clubs expect the players to come back as better players (Daniel Sturridge’s loan from Chelsea to Bolton is one such example) and thus with a higher valuation. Given this expectations, loan fees are usually zero (or even negative – where the parent club continues to bear part of the loanee’s wages).

Another kind of loan is for a player who is on the books but not particularly wanted for the season. It could happen that player’s wages are more than what the club hopes to get in terms of his contribution on the field (implying a negative valuation for the player). In such cases, it is possible for clubs to loan out the player while still covering part of the player’s salary. In that sense, the loan fee paid by the target club is actually negative (since they are in a sense being paid by the parent club to loan the player out). An example of this kind was Andy Carroll’s loan from Liverpool to West Ham United in the 2012-13 season.

Falcao is currently in the prime of his career (aged 29) and heavily injury prone. Given his age and injury record, he is likely to be a fast depreciating asset. By the time he runs out his contract at Monaco (when he will be 33), he is likely to be not worth anything at all. This means that a lion’s share of the value Monaco can derive out of him would be what they would derive in the next one year. This is the primary reason that Monaco have demanded 30% of the four year fee for one year of loan.

Loaning a player also involves some option valuation – based on his performance on loan his valuation at the end of the loan period can either increase or decrease. At the time of loaning out this is a random variable and we can only work on expectations. The thing with Falcao is that given the stage of his career the probability of him being much improved after a year is small. On the other hand, his brittleness means the probability of him being a lesser player is much larger. This ends up depressing the expected valuation at the end of the loan period and thus pushes up the loan fee. Thinking about it, this should have pushed up Falcao’s loan fee above GBP 16M but another factor – that he has just returned from injury and may not be at peak impact for a couple of months has depressed his wages.

Speaking of option valuation, it is possibly the primary reason why young loan signings to lesser clubs come cheap – the possibility of regular first team football increases significantly the expected valuation of the player at the end of the loan period, and this coupled with the fact that the player is not yet proven (which implies a low “base sale price”) drives the loan valuation close to zero.

Loaning is thus a fairly complex process, but players’ valuations can be done in rather economic terms – based on expected contribution in that time period and option valuation. Loaning can also get bizarre at times – Fernando Torres’s move to Milan, for example, has been classified by Chelsea as a “two year loan”, which is funny given that he has two years remaining on his Chelsea contract. It is likely that the deal has been classified as a loan for accounting purposes so that Chelsea do not write off the GBP 50M they paid for Torres’s rights in 2010 too soon.

In which I thulp the RBI

I’m still so pissed off with the Reserve Bank of India doing a Ramanamurthy that I’ve written a serious editorial in Pragati – the Indian National Interest Review (published by the Takshashila Institution). In this piece I take on measures by the RBI to limit ATM transactions and the thing on two factor authorization.

I claim that both these decisions are economically unsound and there is only possibly a farcical explanation for them:

There is perhaps only one idea (more a conspiracy theory) that possibly explains the above decisions from the RBI. Both these decisions, it might be noticed, help push up the usage of hard currency and decrease the levels of bank deposits. Less bank deposits means less money available for banks to lend out, which means that the cost of borrowing from a bank implicitly goes up. Could it be that the above regulations are a move by the RBI to curtail money supply without necessarily doing the politically tricky task of raising interest rates?

If it is (and it is a very remote possibility), we should commend the RBI for what will then amount to be a sneaky decision

Link

Comparing Airline Pricing across countries

The WSJ reports, based on a survey, that airline prices are cheapest in India (HT: Nitin Pai). They evaluate the cost of flying in terms of cost per 100 km. The usual ridiculous comparisons that go with any such article are present in full here – they compare the per kilometer cost of flying to train and bus fares, and conclude that flying is cheapest (this reminds me of an equally ridiculous report in the Times of India which showed that the cost of India’s Mars mission was less than that of taking a bus in Mumbai).

A few thoughts on this report by the WSJ:

  • Per km is a wrong way at looking at air fares. In most markets (from my experience pricing air tickets and cargo), fares are set based on competition and to fill capacity. Notice that marginal cost of a passenger is really really low, so once a flight is in place airlines will do what they can to maximize their revenues from that.
  • Taking this forward air fares depend on the competition in a particular sector (btw, the way airlines price it, Bangalore-Barcelona is one sector, and the price of that doesn’t depend on the Bangalore-Frankfurt and Frankfurt-Barcelona prices. These are three independent markets and triangle inequality doesn’t necessarily hold. Just FYI). So going by the report, India has a lot more competition compared to other countries in most sectors.
  • Now think of other large countries (you need big area for flights to make sense) and think of their income levels compared to India. Only developed countries and other BRICS come to mind. All of them have a higher willingness to pay than India.
  • Airline prices are thus a function of simple (elastic) demand and (inelastic – flight schedules are announced by “season”) supply. So once in a season we have a lot of flights scheduled, competitive forces push prices down
  • Given that it’s demand and supply that determines airline prices and not costs, in my opinion the airline industry goes through cycles. You have lots of competing airlines. Prices are low and they lose money. In the course of time one or two go out of business or scale down, and that leads to increased prices. Airlines make money for a while, and then looking at the supernormal profits you have new entrants and so on. India right now is going through the phase where you aer getting more investors (Air Asia, Air Costa, Tata-SIA, etc.). That depresses prices. In a year or so I would think someone like SpiceJet will go out of business and that might push fares up for a while.
  • There’s also the seasonality factor – based on regular travel to Bombay over the last two years I’ve found that fares in the monsoon months are half of the fares at any other point in the year. It’s a function of demand, again (Indian seasons don’t exactly tally with international seasons according to which schedules are made, so this results in flawed matching)! Given the timing of the piece it is possible that Indian fares in the monsoon months have been sampled.

 

Charging for parking can solve a lot of problems

Bangalore city has this bizarre policy in that the city doesn’t charge for public parking (barring one or two roads). The ostensible reason was to cut the wings of the so-called “parking mafia”, which had taken over the concessions for operating parking lots through the city. However, not charging for parking means giving away parking for a non-monetary fee (first come first served, for example, or the cost incurred in driving around looking for a place to park). And there are a number of other problems that charging for parking can be solved that the current no parking fee dispensation doesn’t take care of.

  • The lack of parking charges anywhere in the city, including the central business district, means that it is impossible to profitably take your car (without a driver) to such areas. There are non-monetary costs that people pay for parking – cost of time, cost of fuel driving around, cost of paying touts to hold down a parking spot, etc. Now if only these costs can be monetized then it would be a valuable source of revenue to the impoverished city  council
  • Every weekday afternoon the middle of the city gets gridlocked thanks to the presence of four high-profile schools (Bishop Cotton Boys’, Bishop Cotton Girls’, Sacred Hearts and St. Joseph’s Boys) on the same stretch of road. The reason for gridlock is that people double and triple park on the four lane road (albeit with a driver in the car so it’s not strictly “parking”), and this leads to massive jams. Thanks to these schools it is impossible to move from the southern part of the city to the central business district in the afternoons. Now, if we could have dynamically priced parking on these roads, the cost of parking there for picking up kids might be deterrence enough for people to make alternate arrangements (such as school buses) for picking up the kids, and thus decongest the zone. The city has taken several other initiatives (titled “safe route to school”) but the gridlock continues.
  • Thanks to free street parking there is no incentive for people to provide for parking spaces. I live in what is classified by the city as a “mixed zone”. So there are a number of commercial establishments close to where I live. Few of them actually provide parking, leading to major parking chaos around where I live (especially if there is a function at any of the three convention centres located within 100m of my house). The presence of paid street parking can lead to more regulated parking (currently lack of regulation means parking is rather haphazard and blocks gates). It will also create an incentive for the commercial establishments to provision for their own parking spots
  • Establishments (mostly eateries, but some shops too) in the city have responded to the parking problem by providing valets – who will save you the time you would take to find a place to park. This is a rather inefficient solution. What if I have to visit four shops on the same street in an area where parking is difficult, for example?
  • Some buildings in the CBD which have excess parking space let you use their parking space for a fee that is not unreasonable. What we need is more such buildings opening up their parking spaces to public (the “park here only if you have business in my building” paradigm is nonsense). And for that they need to be assured of a reasonable fee. With the city undercutting them at a price of zero they have no real incentive to open up.
  • In the short run, until supply of parking the CBD increases, parking charges can be a good substitute for congestion charge to put a price on people driving into the city. While this will ease out once the supply of parking responds to the demand, in the short run it might work. Though it could be argued that the non-monetary costs of parking are already achieving this objective!

There are many more such reasons I’m sure you can think of. Yet, for close to ten years now the city of Bangalore has steadfastly refused to charge for parking spaces, which is extremely inefficient. Maybe we need MonkeyParking to enter Bangalore. That’s perhaps the only way the municipal authorities will recognize their folly and start monetizing their parking fees.

Ban bathrooms

My grandmother passed away last Sunday. While she was fairly old (late eighties) and her faculties were declining, the immediate cause of her death was a fall in the bathroom. She fell about a month back following which she underwent a hip replacement surgery (at her ripe age). While she responded well to the surgery (an X-ray taken a day before her death shows perfect fit), the fall and the surgery made her considerably weak which probably led to her demise.

Two months back, her sister passed away. While she too was old (not as old as my grandmother, though), her demise too was accelerated by a fall in the bathroom.

One of my grandmother’s brothers has been in hospital for five months now, slipping in and out of coma. He was admitted into hospital following a head injury which happened because, you guessed it right, he fell in the bathroom!

Deaths due to falls in the bathroom are becoming an epidemic now. It is not wise on our part to lose so many of our learned and wise elders due to this trifling presence in our homes. It is important that the government take strong steps to curb this malaise of deaths being caused due to falls in the bathroom.

I have a simple suggestion – ban bathrooms. Once bathrooms have been banned, there will be no place left for old people to fall and die. Banning of bathrooms might be the singular lever that can help push up India’s life expectancy. I expect that the government take steps in this direction quickly.

PS: Past studies have shown that Indians suffer from an acute case of irony deficiency

Marginal and effective tax rates

In a recent blog post, corporate finance and valuation guru Aswath Damodaran (of New York University) has put out data of marginal and effective tax rates in different countries. The point of the post is about the “insanity of the US tax system” and the reason Damodaran presents this data is to show that the US has one of the largest differences between marginal and effective tax rates, and the company it keeps in terms of other countries that have  similar differences is not very worthy.

In this post we analyze the same data, but broadly from an Indian perspective. Where does India stand in terms of its marginal and effective tax rates? Figure 1 has a scatter plot of the marginal and effective tax rates. A few prominent countries have been marked.

marginaleffectivetax

A few pertinent observations:

  • 25% and 30% seem to be the most popular choices of marginal tax rate across countries. Other round figures such as 10, 15 and 20 also see significant representation
  • The highest theoretical marginal tax rate is in the US, followed by Japan. The lowest marginal tax rates (10%) are seen in three countries – Bulgaria, Gibraltar and Qatar (not marked on plot)
  • The countries with lowest effective tax collection are Kazakhstan (at a paltry 2% – compare that to its official marginal tax rate of 20%), Qatar (2.5%) and Cambodia (4%)
  • The countries with most effective tax collection are Norway (51% – compared to marginal 28%), Argentina, Papua New Guinea and Bangladesh! You can draw your own conclusions
  • India is remarkably close to Brazil and Pakistan in terms of its marginal and effective tax rates
  • India’s marginal income tax rate is on the higher side, but effective rate is much lower.
  • The best tax systems need to be effective and efficient – the closer a country is to the red line, the better its tax administration is IMHO

The entire data set is here. You can play around and draw your own conclusions.

Number thirteen

The number of rats I’ve killed in my life has remained constant at twelve for way too long. One of my biggest sources of embarrassment in recent times has been in 2011 when a rat inhabited our home for a full fortnight without me catching it. I’d even chased it around the house one day but it had proved elusive. Considering that that was my first attempt at killing a rat in Pinky’s presence, after having bragged much to her about my previous twelve kills, it was a major disappointment. It was as if my manhood was in question.
I made up for that today by killing number thirteen. This one was rather timid and easy kill. I’d closed the door between the drawing room and back room of my in-laws’ house but the stupid rodent just kept pushing against the door trying to open it. At that moment my mother in law alerted me (I was on a phone call in another room) and in I came and whacked the rat a few times with a broom. It quickly keeled over and I put it in a polythene bag and threw it out.

image

Of course there was considerable groundwork I’d done before this. I’d procured from the mother-in-law a broom and a long stick. I’d closed all the doors and thus restricted the rat to one closed space. I’d tapped around the entire house with the stick trying to scare the rat. And then I moved away to talk on the phone. Groundwork thus laid I proceeded to whack the rodent.

Pinky may not have seen the kill herself but I was on the phone with her as I whacked the rat. Phone in one hand held to the ear. Broom in another whacking the rat dead. Quite I sight I made I imagine!

And while Pinky did not see this kill directly I did one better – Pinky’s mother was there through the entire process (she did her bit by supplying the whacking implements and sacrificing a sweet to lay bait for the rat and most importantly alerting me when the rodent made its stupid move). I feel so glad. I feel like my life has been resurrected. I can finally rest, having made up fit that spectacular failure of 2011.

The rat is dead. Long live the rat!

The RBI does a Ramanamurthy

This is the second time in a few weeks I’m referring to this scene from Ganeshana Maduve. Please watch it first.

To repeat the story:

Ramanamurthy the owner of the “vaTaara” (a kind of apartment that was popular in Bangalore till the 1980s, with lots of small houses in the same compound) wants to whitewash his house. The residents of the vaTaara  demand that if he whitewashes his house he should whitewash the entire vaTaara. After a long and protracted negotiation, Ramanamurthy agrees to their condition – he doesn’t whitewash his house!

It is a similar story with taxi operators in India. Uber (the Ramanamurthy) figured out a way to bypass RBI’s two factor authentication system and offer seamless payment options for their taxi services. Soon other taxi operators like TaxiForSure and Ola started crying foul saying they too wanted their houses painted, i.e. they too wanted to locate payment servers abroad to accept one factor authentication credit cards.

And now RBI, like the rent controller ubiquitous (in mention only) in movies of the late 80s has stepped in and stopped Ramanamurthy from painting his house, too – they’ve barred Uber from charging in US dollars for Indian rides. It would be interesting to see how the market will develop now.

My personal opinion is that RBI’s insistence on two factor authentication is half-assed. They should make every effort possible to increase the number of credit card (or account-to-account) transactions. On one hand it decreases flow of black money but more importantly it means that people will keep more cash within the banking system (rather than as hard cash) which will have a multiplier effect on money available for lending and all that.

It’s fine to have regulations in place such that credit card fraud is minimized but that doesn’t mean cutting credit card transactions altogether! Hopefully the RBI will see the light of day on this one soon.

Alcohol and Shit

I started drinking when I was 21, after I had graduated from IIT. To most, that might sound surprising, but it’s a fact. It wasn’t supposed to be that way – I had initially planned to make my alcohol debut in my last week at IIT, just before the final exams. However, I ended up falling sick and missed the occasion. It would be another two months and entry into another institute of national importance before I finally broke my duck.

There are several reasons that could possibly explain my delay in experimentation with alcohol (you read that right – despite ample opportunity I never even considered experimenting with alcohol at IIT). But thinking back at those days the most compelling one is shit. Yeah, you read that right. I delayed my experimentation with alcohol because I was afraid of what shit it would lead to. Literally.

In the middle of my first night at IIT, I ended up in hospital. Yes, you read that right. The first day had gone alright. My father had accompanied me and helped me set up my third of the room. I had opened a bank account, registered myself at the mess, and after my father left in the evening, went about exploring campus and venturing into other hostels to meet people I know (a cardinal mistake by an IIT “freshie” but somehow I escaped getting caught).

And then in the middle of the night it started. A few trips to the loo later I figured it was time to seek help (it’s not that I wasn’t prepared – my belongings included a sheet of Andial – reputed to put an instant stop to the toughest of shit. But I ended up puking it out that day). I woke up Paddy the Pradeep, who was the only person in my hostel I knew well. He called the institute hospital, which sent an ambulance, and I spent the rest of the night in the hospital, with some shots and on drips. The next morning I was fit enough to be attending the orientation ceremony.

As if this wasn’t enough, shit problems struck again a month down the line, this time during the first round of exams. To make matters worse, the hostel had water problems (always an issue in Chennai). And the institute hospital’s medications wouldn’t seem to help. It was a nightmare.

It was around then that my classmates had settled down in the institute and started experimenting in life. As they began their experimentation I began to notice, and be told stories of, some side effects. If you drank too much you would puke. If you drank too much, the next morning you would have a hangover. And it was only after you shat that the hangover would pass, i was told. It all sounded like so much of a nightmare to me, who was already scarred about any potential stomach problems. There was no way I was going to try something that would give me more shit.

It was after I moved to an institute with reasonably assured water supply that I started my experimentation. Experiments were mostly successful (except for occasional infringements like this and this and this ). Shit wasn’t so much of a problem at all, I realized. The experimentation, though delayed, had ultimately been successful.

It’s of late – perhaps in the last one year – that I’ve noticed a peculiar problem. Whenever I have a few rounds (few can be as few as one) of Vodka or Beer, it results in terrible shit the following day. You get the normal dump right in the morning. But the real bad shit comes out in two installments, usually one after breakfast and one after lunch. It’s really foul-smelling (normally you shouldn’t mind the smell of your own shit or fart, but this is exceptionally bad). It causes great pressure (which means you better stay not far from a toilet). And when it comes out it results in insane pleasure.

One interesting thing is that this happens only when i consume beer or vodka. It never happens with whisky (the kind of alcohol I most often imbibe) – not even with cheap IMFL whisky. With whisky I can drink copious amounts, get drunk, and carry on the next morning like I had fruit juice the previous night. But not with beer or vodka – does anyone have an explanation for this?

You might have guessed that the gritter for this post was certain events last night and this morning. That’s right. At a party last night I didn’t realize that they were serving whisky, too, and went for beer (UB Export Strong – also known as “Yaake Cool Drink”). Having started I had more rounds of it. And after breakfast this morning it’s started acting! If only I’d gone for the whisky!

Using illegal markets as price discovery mechanism

One of the pet projects of my former MLA (former because I moved residence, not because he was voted out) is to set up a formal mechanism for regulating street vendors. He wants to introduce some kind of a medallion for street vendors so that they have legal sanction, and at the same time subject them to health and food safety checks. Considering this is a fairly common practice abroad, and even in some parts of India (like Goa), it is high time something like this is introduced.

Food cart in Miramar, Goa. Notice the bottom portion – it has a license number

The question, however, is how we will price these “medallions”. Price them too high and existing vendors will not want to get into the new regime, and will remain outside regulatory bounds. Price them too low and it can result in missed opportunities and rent seeking (the current situation, where the price is zero, can be seen as a degenerate case of too low a price).

One way to do this would be through an auction. However, one thing we need to preserve is continuity – current existing street vendors need to get a chance to enter the legal fold without too much disturbance from their current business. An auction might see them being priced out and then continue to operate in the illegal framework – which is not an optimal solution.

The solution lies in status quo, and in illegal markets. Given that street vendors currently operate without a license, they are essentially illegal. The way they manage to keep their carts and not get arrested is by paying off a set of public (and private) officials. Perhaps there is the cop who seeks his weekly rent (hafta). Perhaps a municipal officer seeks the same. Maybe a local thug, too.

If you think about this, the sum total of all these payments is essentially the “license fee” that the vendor pays in order to do his business currently. Can we take this as a proxy for the appropriate license fee in a particular location? Can we do an anonymised survey among street vendors (after having classified them into different “areas”) in order to determine the clearing price?

The basic idea is that illegal markets (like that of the “hafta” for being a street vendor) are markets, too, and their price discovery mechanism is as legitimate as those of more legitimate markets. Thus, the price discovered by these illegal markets are a great starting point for regulated pricing!

There is one thing to examine, though – if we price the license at the same “fee” that the vendors are currently paying different rent seekers, will the rent seekers still be able to seek rent? My hypothesis is “no”. The reason rent seekers seek rent is because in its absence there is a “surplus” that the vendors generate which they are willing to share with the rent seekers. If all the rents that are now being collected by illegal rent seekers are subsequently sought by the state, there is no room left for the illegal rent seekers to operate in!

The question is if this framework can be used for eliminating other forms of rent-seeking, too. The answer, sadly, is no. A large number of the rents that are currently being sought are for “public services” which are not supposed to have a fee. I had to get a document from a court recently, and had to pay rents at different points in the chain in order to get it on time. Using this framework, the way to eliminate this would be by increasing the official court fee, but what one must keep in mind is that court services are inelastic – the increase in fee by a few thousand rupees will not deter me from asking for an order. Thus, even if the court fees are increased, nothing prevents the current rent-seekers from continuing to operate.

In other more elastic markets, however, this approach will work, and better be tried.