Book challenge update

At the beginning of this year, I took a break from Twitter (which lasted three months), and set myself a target to read at least 50 books during the calendar year. As things stand now, the number stands at 28, and it’s unlikely that I’ll hit my target, unless I count Berry’s story books in the list.

While I’m not particularly worried about my target, what I am worried about is that the target has made me see books differently. For example, I’m now less liable to abandon books midway – the sunk cost fallacy means that I try harder to finish so that I can add to my annual count. Sometimes I literally flip through the pages of the book looking for interesting things, in an attempt to finish it one way or the other (I did this for Ray Dalio’s Principles and Randall Munroe’s What If, both of which I rated lowly).

Then, the target being in terms of number of books per year means that I get annoyed with long books. Like it’s been nearly a month since I started Jonathan Wilson’s Angels with dirty faces , but I’m still barely 30% of the way there – a figure I know because I’m reading it on my Kindle.

Even worse are large books that I struggle to finish. I spent about a month on Bill Bryson’s At Home, but it’s too verbose and badly written and so I gave it up halfway through. I don’t know if I should put this in my reading challenge. A similar story is with Siddhartha Mukherjee’s The Emperor of All Maladies – this morning, I put it down for maybe the fourth time (I bought it whenever it was first published) after failing to make progress – it’s simply too dry for someone not passionate about the subject.

Oh, and this has been the big insight from this reading challenge – that I read significantly faster on Kindle than I do on physical books. Firstly, it’s easier to carry around. Secondly, I can read in the dark since I got myself a Kindle Paperwhite last year. One of the times when I read from my kindle is in the evening when I’m putting Berry to sleep, and that means I need to read in the dark with a device that doesn’t produce so much light. Then, the ability to control font size and easy page turns means that I progress so much faster – even when I stop to highlight and make notes (a feature I miss dearly when reading physical books; searchable notes are a game changer).

I also find that when I’m reading on Kindle, it’s easier to “put fight” to get through a book that is difficult to read but is insightful. That’s how managed to get through Diana Eck’s India: A Sacred Geography, and that’s the reason I made it a point to buy Jordan Peterson’s book on Kindle – I knew it would be a tough read and I would never be able to get through it if I were to read the physical version.

Finally, the time taken to finish a book follows a bimodal distribution. I either finish off the book in a day or two, or I take a month to finish it. For example, I went to Copenhagen for a holiday in August, and found a copy of Michael Lewis’s The Big Short in my AirBnB. I was there for three days but finished off in that time. On the other hand, 12 rules for life took over a month.

Pertinent Observations Grows Up

Over the weekend, I read Ben Blatt’s Nabokov’s Favourite Word Is Mauve, a simple natural language processing based analysis of hundreds of popular authors and their books. In this, Blatt uses several measures of goodness or badness of writing, and then measures different authors by it.

So he finds, for example, that Danielle Steel opens a lot of her books by talking about the weather, or that Charles Dickens uses a lot of “anaphora” (anyone who remembers the opening of A Tale of Two Cities shouldn’t be surprised by that). He also talks about the use of simple word counts to detect authorship of unknown documents (a separate post will come on that soon).

As someone who has already written a book (albeit nonfiction), I found a lot of this rather interesting, and constantly found myself trying to evaluate myself on the metrics with which Blatt subjected the famous authors to. And one metric that I found especially interesting was the “Flesch-Kincaid grade level“, which is a measure of complexity of language in a work.

It is a fairly simple formula, based on a linear combination of the average number of words per sentence and the average number of syllables per word. The formula goes like this:

Flesch-Kincaid Grade Score

And the result of the formula tells the approximate school grade of a reader who will be able to understand your writing. As you see, it is not a complex formula, and the shorter your sentences and shorter your words (measured in syllables), the simpler your prose is supposed to be.

The simplest works by this metric as mentioned in Blatt’s book are the works of Dr. Seuss, such as The Cat in the Hat or Green Eggs and Spam, on account of the exclusive usage of a small set of words in both books (Dr Seuss wrote the latter as a challenge, not unlike the challenges we would pose each other during “class participation” in business school). These books have a negative grade score, technically indicating that even a nursery kid should be able to read them, but actually meaning they’re simply easy to read.

Since the Flesch Kincaid Grade Score is based on a simple set of parameters (word count, sentence count and syllable count), it was rather simple for me to implement that on the posts from this blog.

I downloaded an XML export of all posts (I took this dump some two or three weeks ago), and then used R, with the Tidytext package to analyse the posts. Word count was most straightforward, using the str_count function in the stringr package (part of the tidyverse). Sentence count was a bit more complicated – there were no ready algorithms. I instead just searched for “sentence enders” (., ?, !, etc. I know the use of . in abbreviations creates problems but I can live with that).

Syllable count was the hardest. Again, there are some packages but it’s incredibly hard to use. Finally after much searching, I came across some code that again approximates this and used it.

Now that the technical stuff is done with, let’s get to the content. This word count, sentence count and syllable count all flow into calculating the Flesch-Kincaid (FK) score, which is the approximate class that one needs to be in to understand the text. Let’s just plot the FK score for all my blog posts (a total of 2341 of them) against time. I’ve added a regression line for good effect.

The trend is pretty clear. Over time, this blog has become more complicated and harder to read. In fact, drawing this graph slightly differently gives another message. This time, instead of a regression line, I’ve drawn a curve showing the trend.

When I started writing in 2004, I was at a 5th standard level. This increased steadily for the first two years (I gained a lot of my steady readership in this time) to get to about 8th standard, and plateaued there for a bit. And then again around 2009-10 there was n increase, as my blog got up to the 10th standard level. It’s pretty much stayed there ever since, apart from a tiny bump up in the end of 2014.

I don’t know if this increase in “complexity” of my blog is a good or a bad thing. On the one hand, it shows growing up. On the other, it’s becoming tougher to read, which has probably coincided with a plateauing (or even a drop) in the readership as well.

Let me know what you think – if you prefer this “grown up style”, or if you want to go back to the more simple writing I started off with.

Tinder taming and Incels and blogging

So Takshashila has launched a new group blog called “Pragati Express”. It’s basically old-style blogging, with lots of links and short posts and not necessarily making a coherent argument – rather than blog posts that try are basically attempts at writing OpEds (like how blog posts in a lot of places have turned out to be).

I’m one of the contributors for this blog, and wrote my first post today. Copy-pasting it here below the fold!

And thinking about it, I’m so glad about this attempt at reviving old-style blogging – I see that the bug of making blogposts coherent and and wannabe-OpEd has bit me as well, and my posts have been getting longer and more serious.

Hopefully  I can bring back the joy into my blogging.

Continue reading “Tinder taming and Incels and blogging”

Bond Market Liquidity and Selection Bias

I’ve long been a fan of Matt Levine’s excellent Money Stuff newsletter. I’ve mentioned this newsletter here several times in the past, and on one such occasion, I got a link back.

One of my favourite sections in Levine’s newsletter is called “people are worried about bond market liquidity”. One reason I got interested in it was that I was writing a book on Liquidity (speaking of which, there’s a formal launch function in Bangalore on the 15th). More importantly, it was rather entertainingly written, and informative as well.

I appreciated the section so much that I ended up calling one of the sections of one of the chapters of my book “people are worried about bond market liquidity”. 

In any case, the Levine has outdone himself several times over in his latest instalment of worries about bond market liquidity. This one is from Friday’s newsletter. I strongly encourage you to read fully the section on people being worried about bond market liquidity.

To summarise, the basic idea is that while people are generally worried about bond market liquidity, a lot of studies about such liquidity by academics and regulators have concluded that bond market liquidity is just fine. This is based on the finding that the bid-ask spread (gap between prices at which a dealer is willing to buy or sell a security) still remains tight, and so liquidity is just fine.

But the problem is that, as Levine beautifully describes the idea, there is a strong case of selection bias. While the bid-ask spread has indeed narrowed, what this data point misses out is that many trades that could have otherwise happened are not happening, and so the data comes from a very biased sample.

Levine does a much better job of describing this than me, but there are two ways in which a banker can facilitate bond trading – by either taking possession of the bonds (in other words, being a “market maker” (PS: I have a chapter on this in my book) ), or by simply helping find a counterparty to the trade, thus acting like a broker (I have a chapter on brokers as well in my book).

A new paper by economists at the Federal Reserve Board confirms that the general finding that bond market liquidity is okay is affected by selection bias. The authors find that spreads are tighter (and sometimes negative) when bankers are playing the role of brokers than when they are playing the role of market makers.

In the very first chapter of my book (dealing with football transfer markets), I had mentioned that the bid-ask spread of a market is a good indicator of market liquidity. That the higher the bid-ask spread, the less liquid a market.

Later on in the book, I’d also mentioned that the money that an intermediary can make is again a function of how inherent the market is.

This story about bond market liquidity puts both these assertions into question. Bond markets see tight bid-ask spreads and bankers make little or no money (as the paper linked to above says, spreads are frequently negative). Based on my book, both of these should indicate that the market is quite liquid.

However, it turns out that both the bid-ask spread and fees made by intermediaries are biased estimates, since they don’t take into account the trades that were not done.

With bankers cutting down on market making activity (see Levine’s post or the paper for more details), there is many a time when a customer will not be able to trade at all since the bankers are unable to find them a counterparty (in the pre Volcker Rule days, bankers would’ve simply stepped in themselves and taken the other side of the trade). In such cases, the effective bid-ask spread is infinity, since the market has disappeared.

Technically this needs to be included while calculating the overall bid-ask spread. How this can actually be achieve is yet another question!

Auctions of distressed assets

Bloomberg Quint reports that several prominent steel makers are in the fray for the troubled Essar Steel’s assets. Interestingly, the list of interested parties includes the promoters of Essar Steel themselves. 

The trouble with selling troubled assets or bankrupt companies is that it is hard to put a value on them. Cash flows and liabilities are uncertain, as is the value of the residual assets that the company can keep at the end of the bankruptcy process. As a result of the uncertainty, both buyers and sellers are likely to slap on a big margin to their price expectations – so that even if they were to end up overpaying (or get underpaid), there is a reasonable margin of error.

Consequently, several auctions for assets of bankrupt companies fail (an auction is always a good mechanism to sell such assets since it brings together several buyers in a competitive process and the seller – usually a court-appointed bankruptcy manager – can extract the maximum possible value). Sellers slap on a big margin of error on their asking price and set a high reserve price. Buyers go conservative in their bids and possibly bid too low.

As we have seen with the attempted auctions of the properties of Vijay Mallya (promoter of the now bankrupt Kingfisher Airlines) and Subroto Roy Sahara (promoter of the eponymous Sahara Group), such auctions regularly fail. It is the uncertainty of the value of assets that dooms the auctions to failure.

What sets apart the Essar Steel bankruptcy process is that while the company might be bankrupt, the promoters (the Ruia brothers) are not. And having run the company (albeit to the ground), they possess valuable information on the value of assets that remain with the company. And in the bankruptcy process, where neither other buyers nor sellers have adequate information, this information can prove invaluable.

When I first saw the report on Essar’s asset sale, I was reminded of the market for footballers that I talk about in my book Between the buyer and the seller. That market, too, suffers from wide bid-ask spreads on account of difficulty in valuation.

Like distressed companies, the market for footballers also sees few buyers and sellers. And what we see there is that deals usually happen at either end of the bid-ask spectrum – if the selling club is more desperate to sell, the deal happens at an absurdly low price, and if the buying club wants the deal more badly, they pay a high price for it.

I’ve recorded a podcast on football markets with Amit Varma, for the Seen and the unseen podcast.

Coming back to distressed companies, it is well known that the seller (usually a consortium of banks or their representatives) wants to sell, and is usually the more desperate party. Consequently, we can expect the deal to happen close to the bid price. A few auctions might fail in case the sellers set their expectations too high (all buyers bid low since value is uncertain), but that will only make the seller more desperate, which will bring down the price at which the deal happens.

So don’t be surprised if the Ruias do manage to buy Essar Steel, and if they manage to do that at a price that seems absurdly low! The price will be low because there are few buyers and sellers and the seller is the more desperate party. And the Ruias will win the auction, because their inside information of the company they used to run will enable them to make a much better bid.

 

Book Release

So my book Between the buyer and the seller is now available on Amazon, in both print and kindle versions. You can go here to buy. Thanks to Amazon’s print on demand service, it’s available worldwide.

It’s been a long time coming. I completed the first draft way back in April 2016. Writing it was no easy task, but was definitely helped by the presence of one awesome coffee shop close to where I was staying in Barcelona.

Having written one draft, I went around finding publishers. It wasn’t a trivial process. In the process, I found out enough about the publishing industry to get a new prologue for the book (I guess that should be part of the Kindle sample).

And then in the course of the backs and forths with the publishers I found a lot of what I’d written to be absolute shit, and so revised the book two times. Then in December last year, the Takshashila Institution decided to publish it.

And then they sent it to some experts for expert opinion. Said opinion came back positive but with some suggestions. So I revised the book yet another time and implemented these suggestions. Then there was the copy editing process and yet another revision. Then the book design (if not anything, doesn’t it at least look good?) and typesetting and stuff. And formatting.

In the meantime, Shashi Tharoor and Bibek Debroy wrote some nice blurbs for the book – they’re printed at the back of the book now. And then some more hoops and procedures and printing and publishing and fighting with Amazon and the book is now out! For you to purchase.

I want to put out a special word of thanks to Anupam Manur, who has effectively “produced” the book, managing the entire process on Takshashila’s behalf. He’s been patient with my periodic abuses, and diligently got work done. The night before his wedding, he was up fixing some stuff on Amazon for the book.

Anyway, enough of my story. Now go buy the book and read it. Let me, and others, know what you think of the book. And spread the word!

Oh, and I want to thank all of you, my patient blog readers, for the encouragement through the last 13 years. It’s your collective effort and support that has made me a better writer, and resulted in this book coming out!

 

The nature of the professional services firm

This is yet another rejected section from my soon-t0-be-published book Between the buyer and the seller


In 2006, having just graduated from business school, I started my career working for a leading management consulting firm. This firm had been one of the most sought after employers for students at my school, and the salary they offered to pay me was among the highest offers for India-based jobs in my school in my year of graduation.

The elation of being paid better than my peers didn’t last too long, though. In what was my second or third week at the firm, I was asked to help a partner prepare a “pitch deck” – a document trying to convince a potential client to hire my firm for a piece of work. A standard feature in any pitch deck is costing, and the cost sheet of the document I was working on told me that the rate my firm was planning to bill its client for my services was a healthy multiple of what I was being paid.

While I left the job a few months later (for reasons that had nothing to do with my pay), I would return to the management consulting industry in 2012. This time, however, I didn’t join a firm – I chose to freelance instead. Once again I had to prepare pitch decks to win businesses, and quote a professional fee as part of it. This time, though, the entire billing went straight to my personal top line, barring some odd administrative expenses.

The idea that firms exist in order to take advantage of saving in transaction costs was first proposed by Ronald Coase in what has come to be a seminal paper in 1937. In “The Nature of the Firm”, Coase writes:?

The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of ‘organising’ production through the price mechanism is that of discovering what the relevant prices are.

In other words, if an employer and employee or two divisions of a firm were to negotiate each time the price of goods or services being exchanged, the cost of such negotiations (the transaction cost) would far outstrip the benefit of using the price mechanism in such a case. Coase’s paper goes on to develop a framework to explain why firms aren’t larger than they were. He says,

Naturally, a point must be reached where the costs of organising an extra transaction within the firm are equal to the costs involved in carrying out the transaction in the open market.

While Coase’s theories have since been widely studied and quoted, and apply to all kinds of firms, it is still worth asking the question as to why professional services firms such as the management consulting firm I used to work for are as ubiquitous as they are. It is also worth asking why such firms manage to charge from their clients fees that are far in excess of what they pay their own employees, thus making a fat spread.

The defining feature of professional services firms is that they are mostly formed by the coming together of a large number of employees all of whom do similar work for an external client. While sometimes some of these employees might work in teams, there is seldom any service in such firms (barring administrative tasks) that are delivered to someone within the firm – most services are delivered to an external client. Examples of such firms include law firms, accounting firms and management consulting firms such as the one I used to work for (it is tempting to include information technology services firms under this banner but they tend to work in larger teams implying a higher contribution from teamwork).

One of my main challenges as a freelance consultant is to manage my so-called “pipeline”. Given that I’m a lone consultant, there is a limit on the amount of work I can take on at any point in time, affecting my marketing. I have had to, on multiple occasions, respectfully decline assignments because I was already tied up delivering another assignment at the same point in time. On the other hand, there have been times (sometimes lasting months together) where I’ve had little billable work, resulting in low revenues for those times.

If I were to form a partnership or join a larger professional services firm (with other professionals similar to me), both my work and my cash flows would be structured quite differently. Given that the firm would have a reasonable number of professionals working together, it would be easier to manage the pipeline – the chances of all professionals being occupied at any point in time is low, and the incoming work could be assigned to one of the free professionals. The same process would also mean that gaps in workflow would be low – if my marketing is going bad, marketing of one of my busy colleagues might result in work I might end up doing.

What is more interesting is the way in which cash flows would change. I would no longer have to wait for the periods when I was doing billable work in order to get paid – my firm would instead pay me a regular salary. On the other hand, when I did win business and get paid, the proceeds would entirely go to my firm. The fees that my firm would charge its clients would be significantly higher than what the firm paid me, like it happened with my employer in 2006.

There would be multiple reasons for this discrepancy in fees, the most straightforward being administrative costs (though that is unlikely to account for too much of the fee gap). There would be a further discount on account of the firm paying me a regular salary while I only worked intermittently. That, too, would be insufficient to explain the difference. Most of the difference would be explained by the economic value that the firm would add by means of its structure.

The problem with being a freelance professional is that times when potential clients might demand your services need not coincide with the times when you are willing to provide such services. Looking at it another way, the amount of services you supply at any point in time might not match the amount of services demanded at that point in time, with deviations going either way (sometimes you might be willing to supply much more than what is demanded, and vice versa).

Freelance professionals have another problem finding clients – as individual professionals, it is hard for them to advertise and let all possible potential clients know about their existence and the kind of services they may provide. Potential clients have the same problem too – when they want a piece of work done by a freelance professional, it is hard for them to identify and contact all possible professionals who might be able and willing to carry out that piece of work. In other words, the market for services of freelance professionals is highly illiquid.

Professional services firms help solve this illiquidity problem through a series of measures. Firstly, they acquire the time of professionals by promising to pay them a regular income. Secondly, as a firm, they are able to advertise and market the services of these professionals to potential clients. When these potential clients respond in the affirmative, the professional services firms sell them the time of professionals that they had earlier acquired.

These activities suggest that professional services firms can be considered to be market makers in the market for professional services. Firstly, they satisfy the conditions for market making – they actually buy and take on to their books the time of the professionals they hire, giving them a virtual “inventory” which they try to sign on. Secondly, they match demand and supply that might occur at different points in time – recruitment of employees occurs asynchronously with the sale of business to clients. In other words, they take both sides of the market – buying employees’ time from employees and selling this employees’ time to clients! Apart from this, firms also use their marketing and promotional activities that their size affords them to attract both employees and clients, thus improving liquidity in the market.

And like good market makers, firms make their money on the spread between what clients pay them and what they pay their employees. Earlier on in this chapter, we had mentioned that market making is risky business thanks to its inventory led model. It is clear to see that professional services firms are also risky operations, given that it is possible that they may either not be able to find professionals to execute on contracts won from clients, or not be able to find enough clients to provide sufficient work for all their employees.

In other words, when a professional joins a professional services firm, the spread they are letting go of (between what clients of their firms pay the firms, and what professionals draw as salaries) can be largely explained in terms of market making fees. It is the same case for a client who has pays a firm much more than what could have been paid had the professional been engaged directly – the extra fees is for the market making services that the firm is providing.

From the point of view of a professional, joining a firm might result in lower average long-term income compared to being freelance, but that more than compensates for the non-monetary volatility of not being able to find business in an otherwise illiquid market. For a potential client of such services also, the premium paid to the firm is a monetisation of the risk of being unable to find a professional in an illiquid market.

You might wonder, then, as to why I continue to be a freelance professional rather than taking a discount for my risks and joining a firm. For the answer, we have to turn back to Coase – I consider the costs of transacting in the open market, including the risk and uncertainty of transactions, far lower than the cost of entering into a long-term transaction with a firm!