[Economic literacy and superannuation investment decision-making]

By

Financial literacy and superannuation investment

Introduction

In a tournament, players compete for prizes where their effort and their share of the prizes depends upon their ranking: relative performance matters. Tournament contracts can be viewed as attempts to address the principal-agent problem that exists when the principal does not have full information about the ability of the agent(s). Initial empirical testing of tournament models focused on sporting tournaments in golf and tennis, for example, Ehrenberg and Bognanno (1990), Orszag (1994). While these studies attempted to assess whether tournament compensation schemes actually elicited effort responses, other researchers began examining the incentive effects of tournaments on risk-taking as well as effort responses, in the sporting, corporate management and funds management fields.

Three basic observations are helpful in understanding the funds application of the tournament model. First, investment funds usually receive compensation in the form of a fee that is a fixed percentage of funds under management. An incentive therefore exists to pursue those strategies that will maximize funds under management. Second, findings by Ippolito (1992), Capon, Fitzsimons, and Prince (1996) and others give support to the widely held view that the crucial factor influencing choice of fund by retail investors is past investment performance. This finding gives strong support to the interpretation of the funds flow-investment performance relationship as an implicit incentive contract. Third, researchers such as (Sirri and Tufano, 1992) and (Sirri and Tufano, 1998) found that while those funds which recorded the highest performance during a period attracted the largest increases in funds under management, those funds which had performed poorly were not penalized by proportionate outflows of funds under management, indicating an asymmetric structure to the investment performance-funds flow relationship.

 

Financial literacy and superannuation investment

Firms should invest in proposals that generate maximum value for the company and its shareholders. Financial managers and CEO's should invest in a project that is worth more than the cost of the project. The chosen project should be the one that results in a higher Net Present Value (NPV), which is the difference between the project's value and the cost. This paper will discuss capital budgeting for Silicon Arts, Inc (SAI) and the inherent risks associated with the investment decision-making. Additionally, valuation techniques for the internal and external investment strategies will be discussed.

Capital Budgeting

The financial analyst at SAI was provided with two capital investment proposals that were prepared by a task force set up by company Chairman, Hal Eichner. The investment goal was to increase market share and keep pace with technology. SAI is a 4-year-old start-up firm generating 70% of sales in North America, 20% sales in Europe, and 10% of sales generated in Southeast Asia. SAI has growth plans and wants to pursue introducing new product lines. The firm's sales turnover is $180 million from manufacturing digital imaging integrated circuits that are used in digital cameras, DVD players, computers, and medical and scientific instruments (Scenario, 2008). The analyst evaluated two mutually exclusive capital investment proposals and made recommendations to the CFO, Kathy Lane, ...