Ed deHaan is a professor at Stanford Graduate School of Business. Ed is one of six editors at the Journal of Accounting and Economics and is a former Associate Editor or review board member at Journal of Accounting Research, Management Science, The Accounting Review, and Review of Accounting Studies. Ed primarily teaches financial reporting and analysis at the graduate level. Prior to his current position, Ed was an associate professor at the University of Washington, earned his doctorate from the University of Washington in 2013, and worked in consulting and public accounting. He spoke to SSRN about his recent work on recent consumer credit innovations, the mystery of the missing accountants, and the hidden costs that retail investors often miss…
Q: How did you make the transition from working as an accountant to becoming a researcher?
A: I was an economics major in my undergraduate degree. I graduated in 2001 in the Bay Area during the dot com crash. The only people hiring at that time were accounting firms, so I went into accounting. I did two years, got my CPA and then pivoted into consulting where I heavily relied on my accounting experience to work with organizations, and managing healthcare grants at national levels around the world. Eventually, I decided that I’d like to go back to academia, thinking that I would go into economics. Then I fell across the academic field of accounting. I didn’t realize accounting was a research discipline at first; I did my PhD and I’ve been off to the races ever since.
Q: To get into that research – I was very interested to read your SSRN paper, Buy Now, (Pain?) Later. It’s easy to think of buy-now-pay-later (BNPL) services as a harmless kind of credit, but your research would suggest otherwise…
A: Something that’s at the heart of accounting research is the role of information frictions and their interactions with the corporate and financial sectors, although more and more, it’s moving into spaces like environmental impact and reporting.
We’re also getting increasingly into household finances.
Credit is an amazing thing. Mortgages and credit cards are wonderful, we use them all the time, but there’s a subset of users out there who lack the financial sophistication or education, to be able to use those products within their means. One of the major issues we see in this space is a lack of understanding due to unclear disclosures, or intentionally unclear disclosures, which are obfuscating what the risks and costs of a product are.
In the United States, and in most countries now, certainly in Europe, standard markets such as mortgages and credit cards are very heavily regulated. Even though those disclosures are incredibly difficult to read, at least they’re making attempts to provide the information, same with mutual funds etc. We also have lots of regulation around things like dispute resolution, and fraud protection, and things like that.
BNPL products are a FinTech innovation that identified a hole in the marketplace as there are a significant number of people who are under served by credit cards, in part because the process of getting a credit card, and how to deal with a credit score, is cumbersome. They had a couple of smart insights, they said, “We can profile your credit risk much better using big data than the credit card companies are doing with your loan repayments, and your car payments, etc, we don’t need to rely on these credit scores like the credit card companies do,” which is going to simplify the credit approval process.
They also recognize that there’s a big group of young tech savvy people out there, who are very comfortable shopping on their phones, and they can make it a really great experience for those people. They can link up a quality marketplace in which they can show you products that are very highly attuned to your interests, and essentially provide you on the spot finance. This makes it a very attractive product to young people without established credit, who are unfortunately, also the type of people who tend to overspend on these types of credit.
In our study, we have a first attempt at quantifying what is the on-average impact of BNPL loans. For an average user, quite surprisingly, we find that they start experiencing what we call ‘early indicators of financial distress’.
We certainly expected to find it in the most vulnerable population. You always start with an ‘on average’ effect, and you say, “Okay, now let’s go look at 22-year-olds, now let’s go look at people with low incomes.” We found the affects are bigger when you look in the places you’d most expect to find them, but the effect on average users was a surprising result, and one that I think regulators are now taking very seriously, as they think about designing regulations with Fintech in mind.
Q: It sounds as though you think that BNPL should be regulated in the same way that credit cards are, and they should really contribute to your consumer credit score?
A: Yes. They are subject to regulations, they can’t blatantly lie to you, they can’t steal your money, but they have what we call ‘regulatory arbitrage’ around the sort of rules that were designed for credit cards. It’s quite complicated, but essentially those rules were designed with banks in mind, and BNPL is not a bank, so they get around many of those rules.
I think probably what should happen is that the BNPL companies should report to the credit bureaus. The lack of this type of information right now is problematic because it allows users to do what’s called ‘debt stacking’, which is something we really try to avoid. In the consumer financial marketplace, if you went and maxed out a credit card, you’re going to have a harder time getting the second one, after you’ve maxed out that one, you have a really hard time getting the third one, and that’s because we have visibility across accounts.
With BNPL, because they don’t report to a central agency, there’s no visibility, which means if you’re getting into trouble, you can keep digging that hole deeper and deeper. What we would like to see from a policy perspective, is that we catch that person falling into the hole as quickly as possible and try to help them build their way out of it – the deeper that hole is, the harder it is to get out.
Q: I saw echoes of this in your paper Market Access and Retail Investment Performance, which revealed that having more time to trade may not be a good thing for retail investors. It does seem as though the less trading that retail investors do, the more they make, which is kind of ironic. Were you surprised to see such a clear correlation between smaller time zone trading windows and investor gains?
A: We were quite surprised; as I mentioned in the paper, the SEC in the United States as well as other regulators around the world are considering policies to expand trading hours, which exist in just about every country. This applies for stocks; they don’t exist for crypto, since that doesn’t trade on an exchange.
For some stocks there are already after-market hours where you can trade. That’s not very popular among retail investors yet.
We know from the academic literature that the typical retail investor doesn’t perform as well as they would have if they just held a broad diversified portfolio. For example, if a broad ETF predictably earns *% a year, and stock trading earns maybe only 6% a year on average, then over a lifetime that 2% adds up to huge retirement savings differences.
The risk is if we start making it easier and easier to trade stocks, there will be more potential to underperform by a larger margin. Testing that is incredibly difficult, because we didn’t have any changes in trading hours from a research perspective. As researchers, we’re always looking for variation in the subject of interest, and since we didn’t have any, we used a sort of a quasi-natural experiment around these time zone borders.
And now to your question, were we surprised? Well, we thought we would find something – but it turns out the result is incredibly robust.
Q: So how do you feel about the idea of efficient markets, because based on some of your research it really seems like people should settle down and buy index funds and stop messing with the market. Do you think the retail investor with a laptop and a dream can generate significant returns through skill rather than chance?
A: Certainly not the average retail investor; you think about the population of 330 million US citizens out there, 70 million in the UK, or however many there are. I couldn’t do it. I have a PhD, I have a CPA license and I study this for a living, and I would not pretend to be able to outperform the market. Of course, some can, they’re extremely good at it, and they’re very clever, but the average investor cannot, much in the same way that the average person who walks up to a poker table is going to lose.
Q: That’s quite something: when you look at the financial media ecosystem encouraging people to invest, doesn’t it just seem slightly preposterous if you look at it through a kind of academic lens, in which financial markets seem just like a casino for retail investors to lose their money in?
A: Yes, the amount of money that goes into creating an exciting trading environment for the average person is staggering. In just the same way that the number of resources spent on a casino is staggering. These giant buildings are not cheap, you must assume that they’re making money somehow. So, if you see the platform Robinhood, or you see eToro or a similar trading environment, they’re not doing it for free. You are the product, you are the revenue stream.
I’m not paternalistic: people can do what they want. I think the general policy that we have in most capitalist countries, is, if people are only hurting themselves, they can do what they want. We want people to make good decisions and we try to put up some rails to prevent the worst outcomes. I think a light touch of regulation, just to facilitate the best decision possible, is the regulatory approach that we’ve taken. Preventing someone from doing something is a big deal.
Your question was about efficient markets. I think markets are reasonably efficient, they’re incredibly good at aggregating information from a huge number of sources and coming up with an estimate of what a company or a stock is worth. So, they’re efficient much of the time, but let’s not pretend that the price is always right. The two things are not the same, and it’s in the margins where mispricing can occur, and that tends to be where the retail investors are playing around.
Another thing that we’ve seen very clearly, when I started this career just fifteen years ago, is the mantra that ‘retail investors don’t move prices’, they can trade all they want, all they’re losing is their trading costs, which have been coming down over time. However, if the rise of meme stocks has taught us anything, it’s that retail investors certainly can move prices. They can coordinate new and unprecedented ways of doing things, and they can cause prices to become wildly inefficient with respect to the fundamental values.
Q: If you push that efficient markets theory to its logical absurdity, you end up with someone saying that statistically, you will always produce a Warren Buffett, and so he isn’t really skilled. He isn’t the sage of Omaha. He’s just the guy who flipped the coin, you know, in Tom Stoppard’s Rosencrantz and Guildenstern are Dead and got 92 heads in a row and that’s always a possibility. Which, of course, really defies our intuition, because we see athletes who are very good at the extreme end of the bell curve. Can you put a scientist’s hat on and say that someone like Warren Buffett is a kind of a statistical anomaly? Or, are there just some extraordinary individuals who are super smart and so make all the right choices?
A: It’s a good question. I think even in the heyday of the real hardcore efficient markets’ world, and that was probably seventies, eighties, nineties, Milton Friedman type stuff, people would acknowledge that, yes, occasionally you have a savant who comes along and makes money like Warren Buffett. The average financial manager does not.
There’s an enormous amount of research that’s been done on mutual fund managers. The typical mutual fund earns a little bit of excess return, but then they charge you a fee for it, which pretty much wipes out the entire excess return. And so, do mutual fund managers have skill? Well, the answer is yes, but they’re not actually making an economic profit, no one’s really making an economic profit here, that’s been the prevailing wisdom. I certainly think there are some very clever people out there, I work with some of them who trade and do very well, but it’s a tiny slice of the population.
Q: I was struck by the fact that in both those pieces of research the negative costs and the issues you’ve identified are only a few percent, and therefore hard to spot, but in both cases, they leave the uninformed person very out of pocket in the long run. Do you think that’s the sort of problem that the ordinary investor or consumer needs an academic researcher to spot?
A: Yes, I think that’s exactly right; If you walk into a casino, you put your money down, and you lose all your money at once, you notice that, and hopefully learn from that. I think we saw quite a few people trading during COVID, who did get wiped out and probably did learn that.
The system though – and I hesitate to use inflammatory terms – but think about it like a virus, if a virus immediately kills the host, the virus will be gone quickly, so the virus wants to thrive on the host for a long period of time. I’m not saying the financial sector is a virus, it’s a system we need. But if losses are small and consistent, those small and consistent losses are exactly the sort of underperformance that would be very difficult for the average person to identify. For instance, how do you know that the 8% is less the 9% you really should have gotten? It’s very complicated to make that assessment. Now, you combine that with all of our behavioural biases, and you ask the average person how they do in the slot machines, they will tell you they remember the times they won 20 bucks, buy they don’t remember the many other times when they lost $5. In total, numerous $5 losses add up to a lot more than a $20 win.
Q: We’ve been seeing a lot of interest in new generative AI and large language models such as ChatGPT in the financial space, how do you see these kinds of technologies impacting the work of accountancy and financial professionals?
A: I think we will have to continue to evolve to be relevant, and I think that AI will supplement many of the lower-level tasks that we do. The current versions of GPT, or AI in general, are very good at basic analytic tasks; if you gave it all my papers and said summarize them, it could, and if you asked it to produce a press release for a company in a plain English version, it can do a pretty good job.
Specialized AI is already being used in audit firms and in banks to do risk assessments, and for audit procedures, so we’ll need to evolve, but this isn’t the first time in history this has happened. When Excel was launched, people were worried that it was the end of accountancy, they probably said the same thing about the calculator.
The difference this time is that the technology is much more impressive, and the rollout is much quicker. So, I think the role of labour in the financial and accounting industry will change radically in the next ten years, but I’m also reasonably confident that we will evolve as a profession, along with technology, to find better ways to use our human skills. I don’t think it’s all doom and gloom.
Q: One thing that is a bit doom and gloom in terms of that kind of human capital in the US is the shortage of accountants. A recent piece in Fortune last month claimed the US has a shortfall of 340,000 accountants. They argued that five years of college is a tough ask for a starting salary of $60,000. What do you think is going on there in terms of the employment dynamics around accountancy. In tougher economic conditions you’d think there’d be a flight to safety in a secure profession, but people don’t appear to be making that choice…
A: I recently rejoined Stanford, but I spent most of my career at the University of Washington where we have a large undergraduate accounting program, so this was a daily topic of conversation. As a former CPA myself, this is a topic very close to my heart.
I think we have seen several things happen; the five-year college requirement really did not improve the quality of auditors that were being produced, and it is a material barrier to entry into the field. I was a young college student when the rules were being changed, it made it stricter, and it sent a huge ripple through my program back in 2001. And of course, it’s not improving the quality of accountancy training given that most people pick up their fifth year of college through, you know, doing art classes…
I think the major driver though is that wages haven’t kept up, and why is that?
When I started as a CPA auditor with KPMG in 2002, my starting salary was $50,000, and 20 years later it’s barely increased. Whereas roles in finance and in computing have increased to much larger degrees. Many people in the industry are unwilling to accept that the wages are just too low; they can do many other things trying to convince people to take accounting majors, and focusing on the supply of graduates, but until demand on the employment side increases through wages, we’re just not going to see an increase.
And you mentioned that it’s a stable career: it was for a very long time, that’s why I started. It was the only area hiring during a downturn, and we saw the same thing during the financial crisis. I think there’s enough press around the declining role of bookkeeping tasks and auditing that probably makes people a bit nervous about their career prospects. I think today’s graduates are being snapped up fast, but anecdotally, maybe they’re worried about long term viability.
I also think COVID, at least for now, but maybe not long term, made people reassess their life priorities, and people are living a bit more for the moment, investing less in long-term things like becoming a CPA. The way that audit firm’s work is like a pyramid, you start low and you either leave and have great outside opportunities, like I did, or you work your way up the pyramid, and perhaps people are less willing to do that these days, and maybe for good reasons.
Q: Do you think that the change to more flexible working patterns may have affected the profession after the pandemic? Traditionally accountants needed to come in and work together to close the books…
A: This is a complicated issue that clearly people disagree on. For example, some of my colleagues at Stanford are big proponents of work from home and have research in various contexts that it can be beneficial. My anecdotal experience from academia, but observing practice, is that in the short-term, day to day tasks can certainly be executed from home, and often are executed better, because it is easier to focus at home than when sitting in a conference room with a bunch of other auditors.
What’s missing here are a few key things: one is the training opportunities. In accountancy, in the CPA world, you start as an associate and you learn from the senior associates, who learn from the managers, who learn from the partners, and much of that training is one-on-one, it’s informal, it’s leaning over the desk to chat with somebody, and that is hard to replicate in an online environment. When we feel that there’s a barrier to asking a simple question, we’re less likely to ask.
I think another big thing – again, I’m moving well beyond my research here, but it is a reasonably informed opinion – is that for the average young person, the entry level job at 22, it’s not a fun job. What makes it more pleasant is that hopefully you’re working with cool people who you like, and they’re your friends. So if, for instance, you have to work late one night, at least you’re all in the room together, you end up working for a group of people you care about, you don’t care about the firm, and if you don’t develop those connections, then you don’t have the friendships, you don’t have the rewards and you don’t have the training. You’re not moving up and you probably don’t feel as competent at your job, and I think that would lead to discontent.
So, I think working from home is a challenge, particularly in the creative space. Everybody I talk to who has a creative role, whether it be in programming or in content development, say creativity doesn’t happen by Zoom. There is something magical about being co-located.
Q: Are there some papers that might be fun to highlight for people?
A: There is a paper on Obfuscation in Mutual Funds, the punchline from that paper is that, managers who are selling a high priced mutual fund, create confusion in the marketplace by having unreadable disclosures, and so, what we show is that even among S&P 500 index funds – which are the most standard index fund in the US, there’s 27 of them – they charge fees ranging between two basis points and 500 basis points, that’s like paying $20 versus $5,000 for the same product… Also in that paper, we use some clever methods to show that indeed the funds that are selling these expensive identical S&P 500 index funds, make it hard to understand what they’re selling. They have complicated these structures and created unreadable disclosures and it’s a way of creating confusion in the marketplace, so people just say, “I don’t know, I’m just going to buy one randomly.
There is a paper on Retail Bond Investors and Credit Ratings in which we look at investors in corporate bonds. They are typically considered to be a more sophisticated retail investor. Bonds are not an exciting product, since you’re not going to make windfall gains on bonds, but there are a lot of retail investors who do trade their own bonds, and they treat them like commodities. What we show is that retail bond investors, even these sophisticated ones, make exactly the wrong trading decisions. We clearly identify that, when they go to buy bonds, they go into their broker’s online bond screener, and they say, “Find me double A bonds that have a three-year horizon,” and it gives, for example, 200 options, and they say, “I don’t know how to buy one.”
So, with double A being the credit rating, they are then sorted on the highest yield, and they buy the highest yielding double A bond that’s going to mature in three years. That might seem like a reasonable approach, for example, because choosing the highest yielding product is good advice when choosing something like a savings account. However, because the bond credit ratings are slow, that’s the bond that next month is probably going to get downgraded, and the reason it’s paying a high premium is because the market has already figured this out. The market knows this is a risky bond, they know it’s going to be downgraded, and the institutions want to get rid of it, and the retail investors buy these bonds, and then the bonds systematically downgrade the next month.
So, even these savvy people, who think they’re shopping in clever ways, and at a surface level it sounds like a reasonable approach to shop for a bond, are shopping in the exact way that loses money.
Q: You’ve been using SSRN for a while, so how do you think working papers in general and SSRN in particular fit within the research landscape?
A: I started in 2008, so SSRN was already well established by then, and it was the communication dissemination mechanism for research. It wasn’t long before that, that your only way of learning about research would be in ways such as going to a conference to see working papers presented. But the average conference has six papers and you’d go to two or three a year, so, you’re only seeing about 18 papers that way.
You’d also see papers in print, though by the time it hits a journal in publication, it’s stale. We know journals are stale, so there would be an informal network of people emailing each other, but email didn’t come about until the mid-nineties and it was incredibly inefficient, and so, as a PhD student, SSRN was, and still is, the place I go to look; I still read the daily emails, that’s how I keep up on the latest work.
I think as somebody becomes more senior, their focus becomes narrower, which is natural, so you’re more likely to know of those papers anyway because somebody either emailed it to you, or you reviewed it. I still am surprised when something comes into SSRN, which is exactly in my area, and I have never seen the paper before. I’ve got a folder on my desktop, and I look at it at least three times a week, and that’s still how I stay up to date.