May 2005

Cold-Calling Van Horne

by Kathleen O'Toole

Four former students turn the tables on the venerable finance professor.

Salespeople trade tales about cold-calling customers, but at the Business School, students and alums reminisce about the moments when their hearts stopped because of “cold calls” from Professor James Van Horne.

The A. P. Giannini Professor of Banking and Finance is legendary for his classroom-quizzing techniques, which somehow strike both fear and respect into the students who volunteer for his elective courses. Now in his 40th year at the Business School, Van Horne crafts tough questions about interest rates and finance for corporations, nonprofits, and governments. He also demands tough answers of himself. During a lecture to alumni last fall, for example, he challenged the conventional wisdom that says it’s good for the Federal Reserve Board to signal its intentions on interest rates. Van Horne argues that the policy gives us a false sense of certainty.

Recently, the School’s most fabled inquisitor consented to have the tables turned. At the suggestion of an alumnus, this magazine invited four alums to cold-call Van Horne on anything they desired. Here is an edited transcript of that laughter-filled discussion last October, which Van Horne, in his usual disciplined style, promptly ended at the appointed time.

TONY LEVITAN, MBA ’93: When I first learned that you were coming into your 40th year at the Business School, I started to think about what the Van Horne legacy meant to me. If there is a legacy, what do you think it’s going to be?

JAMES VAN HORNE: I would hope it would be that students developed a better way of organizing managerial problems in a framework to reach decisions, that they understand market dynamics and imperfections in the markets that create opportunity, and that they think of things in an ethical way.

It’s important for students to have some institutional background, to know what’s happening currently in the marketplace, and to be aware of trends. More important, however, is an analytical framework to analyze a corporation and the dynamic process of funds flowing through a balance sheet. In the case of other types of markets, what’s the equilibrium process that’s driving things? What’s the market for corporate control? Students should be able to systematically lay out a framework, a means for looking at this and other things, with respect to operating performance, valuation, and driving forces.

STEPHANIE TWOMEY, MBA ’83: You once were quoted as saying students had changed—they were brighter but less intellectually curious than your earlier students. I’m curious how you see the state of the students these days.

VAN HORNE: Students still are quite stimulating to me, and they are challenging. The data suggests they are spending less time on academic affairs than they did 20 years ago. In a quasi-seminar type of course that I teach, we used to have lively discussions of academic journal articles. About 8 or 10 years ago, that no longer was possible. Certainly there were students who were intellectually curious who could engage in those conversations, but the majority of the class was not, and consequently I changed the format of my teaching.

VICKI RUPP, MBA ’84: When I went back to Minneapolis after business school, I revived the Business School alumni group there. You were one of the first speakers. It was a very snowy winter in Minneapolis and when I tramped over to the First Bank Building and looked at the assembled crowd, I remember being awestruck because half to two-thirds of the financial movers and shakers in Minneapolis were in that room. After you talked, they beat a path up to you. When you have so many alumni who stay in touch with you, what kinds of things do they want to talk about?

VAN HORNE: Sometimes it’s just social chit-chat about what they are doing. Some former students run ideas by me, particularly things that are new in financing. I’ve had probably 8,000 students, so I don’t keep up with all by any stretch of the imagination. However, I have interaction with several hundred a year. It’s been a good and stimulating interchange.

ROELOF BOTHA, MBA ’00: I want to ask a more technical question. The first time I ever heard of the Green Shoe was in your introductory corporate finance class. You alluded to this as the underwriters’ over-allotment option in a public offering, originating with the Green Shoe Co. Recently we’ve seen some companies, including Google, which was one of Sequoia Capital’s investments, wanting to embrace an open IPO process and not wanting to use the traditional underwriting process, which seems to put a lot of power in the underwriters’ hands. The Green Shoe, in my mind, is a more expensive part of going public than people appreciate. I am curious whether you would counsel a technology company going public to embrace an open IPO or an auction-based process for setting its price. In addition, should the company also avoid the Green Shoe, which really puts the company’s interests at odds with those of the underwriters, because underwriters can capture profits from IPO share price “pops”?

VAN HORNE: You have a lot of questions embraced in that one. The notion of the Green Shoe basically is one where the underwriters say they want to be able to satisfy the demand of certain institutional investors and need to have the ability to go short and hence use the Green Shoe in order to get shares to cover their short position. Secondly, the option may have value to the underwriter apart from this. I don’t think for technology companies it makes a whole lot of sense. On the notion of an auction IPO, Google had to make some concessions moving a little more toward an underwritten deal, but the number of companies with that investment allure is small, and obviously the underwriters are opposed to an auction. What do you think?

BOTHA: I encourage anything that’s an open process, having gone through the experience of taking a company public and having the bankers renegotiate terms at the last minute before going public. At that juncture, the pressure is so high to complete the IPO, that you are forced to just take what the bankers give you.

VAN HORNE: You weren’t in that position with PayPal, were you?

BOTHA: We were. When we initially tried to go public a couple of frivolous lawsuits hit, and we had to postpone the offering by a week. That changed the banks’ bargaining position, and we went from being 20 times oversubscribed to 8 times oversubscribed. They forced us to lower our IPO price, and our shares traded up 50 percent on the first day. Because of the Green Shoe, the banks reaped significant profits! They insisted on a Green Shoe [laughing] because it’s “standard practice.”

VAN HORNE: You have to take your hats off to Google and others that have challenged the modus operandi.

TWOMEY: In 1987, right after the stock market crash, you were quoted with respect to hedging. You said we can hedge all day long in financial services and finance, but for some reason we just can never get our hands on basis risk. Is that an enduring situation today?

VAN HORNE: In financial markets, you cannot necessarily trade off all types of assets against each other and avoid systemic risk that’s going to affect all financial asset categories. In what was then called portfolio insurance, the hedges that were in place could not be effectively reversed because prices were dropping so rapidly during that day that there was no liquidity. So there was enormous basis risk. Basis risk is when the spot market instrument and the offsetting hedge-market instrument have different movements in the marketplace. In this case it was a liquidity issue that just simply drove some of those values dramatically apart.

Do I think something of that sort will repeat itself? I doubt it, unless there was some episodic event that triggered it. There is still a lot of discussion on what happened in the 1987 stock market crash. Merton Miller, a Nobel Laureate now deceased, had various theories on it. There was the avalanche theory, where you have many little snowflakes and finally one snowflake starts an avalanche. But there were statements by the secretary of the Treasury and by the head of the Fed that, perhaps, could have triggered it. Once it started, the momentum, the avalanche, just kept going well beyond what most people would have considered reasonable.

RUPP: What do you hope students take away from the finance program and from the MBA Program as a whole?

VAN HORNE: I like to force students to stand up and be accountable, make a decision. Oftentimes in our courses we have tons of analysis and talk about issues and never reach a decision.

LEVITAN: [laughing] Having experienced that, I’m getting a sense of déjà vu. I did get a lot of finance from your class, but I also got something different, and I think it goes to your approach in class and your belief in the cold call. I remember vividly, as many people probably do, my Van Horne Cold Call, which taught me a lot. There was the financial part but there was also the interactive part, the character part as a business leader, which I still think about when I interact with people. So, as a nonfinancial guy, am I seeing more in the cold call because I couldn’t experience the financial part as well as you would have liked? Or is there another intent behind it as well?

VAN HORNE: There are many intents, and I suspect I’ve gotten somewhat better at it over the years. The purpose is to have everybody prepared and engaged in the course, and to hold them accountable. As you know, I allow people to give me notes at the beginning of class and I don’t call on them, but when I call on people, I expect them to be prepared. I try not to be mean and embarrass people, and I’ve gotten a little better at that. The better a student is, the more I will push. To other students I’ll throw softer balls and try to effectively encourage them.

LEVITAN: Mine was a Nerf ball. [laughter]

RUPP: As was mine. [laughter]

VAN HORNE: I realize some students do not like my teaching style. They find it intimidating. That’s not my purpose, but nonetheless I understand their concerns. Hopefully they’ll realize that and not take the course. That’s the advantage of teaching elective courses.

LEVITAN: For me, there was a combination of a coaching moment—of “I expect a lot from you”—and a kick in the butt, saying “You can do more,” and that’s the part that I take with me.

VAN HORNE: I now walk around the classroom a lot more. At times, I lecture from the back of the class. I also call on people behind my back whom I’m not looking at.

TWOMEY: That’s exciting!

LEVITAN: Yeah! [laughter]

VAN HORNE: Students get used to that. I’ll be walking up the steps toward the back lecturing and I’ll call on some poor student in the front row. It’s unnerving.

RUPP: Gives more meaning to guard your back. [laughter]

BOTHA: I’m curious. What do you think enables you to pull that off so well?

VAN HORNE: I don’t know that I pull it off that well. When I came here I was blessed with some really great, hard-nosed teachers. They extracted their pound of flesh every class, and they were just wonderful teachers. So cold-calling was a tradition here. I tried to refine it and know its limitations, because you can offend some students, and that’s not my intent.

BOTHA: For me, it’s the entire package of your teaching that makes the cold-calling effective. Part of what I experienced was a feeling of not wanting to let you down with my answer because I had so much respect for you as a teacher. You’re demanding but endearing; you’re a mentor but a teacher who expects the student to have an answer.

VAN HORNE: Well, I take teaching seriously. With some students who struggle with the course, I spend a lot of time. I have open office hours; I see students whenever they come in. I also spend a lot of time formulating a course by going through journal articles and cases and preparing for each class. I think that one thing that students do not forgive, and they should not, is a professor that’s not well prepared and well organized. Moreover, I have a genuine interest—most of my colleagues do as well—in students. I enjoy the students; I enjoy teaching here. It is really a thrill and a privilege to be in the classroom at Stanford Business School.

RUPP: The last question of my final exam in your course began “If pigs could fly…” and then you asked us to develop a financial instrument of our own. Well, if pigs could fly, what courses should the GSB be offering current students? Along with that, what kind of refreshers should the GSB offer alumni? A number of us who graduated 20 years ago are now on nonprofit or corporate boards where we’re playing a financial role. In many cases that really wasn’t our function in our careers.

VAN HORNE: We’re offering a lot of courses to current students. It’s hard for me to imagine too many more that we should be offering. In regard to nonprofits, I’m teaching a new course in the spring quarter on government and nonprofit financing. Our public management students seem to want a course of that sort. In our Center for Social Innovation, we are offering executive education and continuing education programs in that regard. I think the center has done a good job of outreach to bring management skills to nonprofit organizations in particular.

TWOMEY: What do you think the MBA core curriculum ought to look like?

VAN HORNE: I’ve had fairly strong views. The dean’s office and the faculty have not agreed with me, but it’s evolving in that direction. My view is that the first quarter should include five courses of foundation areas, much as we have now, and then we should go to distribution requirements of two or more courses in various areas giving first-year students more freedom in the second and third quarters. I think the dean’s office, Dean Kreps in particular, is moving in that direction. The core changes over time slowly, and there is a sizable group of faculty that think that the core is very important and some that think the core should be even larger, in the sense of occupying virtually the entire first year. I certainly don’t agree with that.

BOTHA: Have you seen student interest in finance courses change? When I was here in ’99-2000, interest seemed to wane when everybody was trying to drop out of school and start the next dot-com company.

VAN HORNE: You bet! [laughs] The classes of ’99 and 2000 shied away from analytical finance and accounting courses. A fixed-income course I taught, which, I think, was called Money and Capital Markets when you took it, was in a classroom that holds 60. The first year I was running 60 or close to 60 students. The next year, 1999, it went down to 49 students, and the next year to 30 students, and then the next year it was back up to 55 or 60 students. In ’99-2000, it was particularly difficult for finance professors to talk about how you value a company—I mean, most of the principles of valuation we couldn’t apply.

LEVITAN: They were too busy looking two quarters forward, price-to-earnings valuation on an IPO. Right?

BOTHA: Price to sales. [laughter]

LEVITAN: Oh right, sorry. Price to possible sales.

VAN HORNE: People would say that five years out, this will be our market share. There is huge uncertainty around it, and no sales yet, but we will assume a total market of X and a market share of Y. Then, an enterprise-to-sales ratio is applied to get a value. Seemingly, some stocks were worth the moon.

LEVITAN: There’s so much irresponsibility around valuation in the venture community—I’m speaking like a true entrepreneur! [laughter] Do you feel any attachment to that, given that these are people who’ve come through the GSB and you would think maybe they’d know better?

VAN HORNE: Without naming names, at times I’m moderately embarrassed. I don’t teach venture capital per se. I follow it to a limited extent. I know people that are in this business.

Were dumb things done in ’99-2000? Of course. The problem with ’99-2000, in my judgment, is that you had a paradigm shift. There’s no question that this paradigm shift had real economic value, but you don’t know with a paradigm shift how big the pot of gold will be at the end of the rainbow. It was imagined to be far larger than it proved to be. Still, it was an amazing change and revelation.

Having said ’99-2000 student interests were unusual, I should add that a longer, more secular trend is that other areas of the School have built up, some dramatically. Finance used to be the largest area in the school faculty-wise and, arguably, had the most interesting and best courses. I’m talking about 25 years ago. Now, the menu available to students is far greater and consequently the enrollments in finance courses on a percentage basis have declined. I’m not saying we’re suffering, but certainly you can’t add a lot of excellent faculty and imaginative offerings in other areas without affecting some of our enrollments.

RUPP: When I think of the influence you’ve had on the classmates I know, this idea of integrity and responsibility comes through. We were here in the early ’80s. How is the school addressing the issues of integrity and responsibility in the aftermath of some of the meltdowns we saw in the last few years?

VAN HORNE: Certainly they’re used as examples. There’s a fine line between trying to emphasize it and not overdoing it. Students aren’t interested in being sermonized to. By exploring some of these issues, with Enron and things of that sort, we can inculcate a better feeling of right and wrong. In one of my classes, I lecture on financial ethics. The problem is there are various shades of gray; those shades are very difficult to differentiate as to what is ethical behavior and what really isn’t. So I try to give some feel for that. There are manipulations that go on in financial markets that are embarrassing. I’m unwilling to give accolades to people in tax arbitrage and other endeavors who do things that, while not necessarily illegal, are pushing up against the legal boundary and are clearly, in my judgment, not morally or ethically right. So I’m at odds, particularly in finance, with some people that push the limits that I think should not be pushed. Some happen to fall over the line and it’s no longer a case of them just being morally accountable. It’s really a case of them being legally accountable. We have a lot of cases of greed that are disturbing.

LEVITAN: Professor, I’ve spent four years teaching as a lecturer at Berkeley. It went from being absolutely thrilling to pretty fun to OK to boring. Partly it was because they didn’t set up a framework where it was in the best interest to evolve the curriculum. At 40 years, how do you stay fresh beyond the things that you have already talked about?

VAN HORNE: There are two things. The students are different every year. They have different personalities, and I find them stimulating. Second, the field I’m in is constantly changing and I am genuinely interested in following the trends by reading systematically. Also, you’re only as good as your last class. Students are interested in the here and now, so you can’t rest on your notes of five years ago and expect them to be interested. They’ve got to be stimulated. It’s not sufficient that some person they knew—their father or grandfather—took my course. [laughter from the group]

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The four alums who interviewed Professor Van Horne are:

Roelof Botha, MBA ’00, a venture capitalist with Sequoia Capital in Menlo Park. He previously was chief financial officer of PayPal Inc.

Tony Levitan, MBA ’93, founder of Clip-on Pro LLC, a golf product company in Palo Alto. Previously, he cofounded Egreetings Network, an early Internet company.

Vicki Rupp, MBA ’84, vice president of purchasing for the Americas at American Express until she retired in 2001 and moved to Kentfield, Calif. Before attending business school, she taught middle-school math in a suburb of Minneapolis.

Stephanie Twomey, MBA ’83, vice president of the Private Client Group at Merrill Lynch & Co. Inc. in Menlo Park.

 James Van Horne has taught finance to more than 8,000 students since he joined the Business School faculty in 1965 after earning a doctorate from Northwestern. He is shown above (from top) in 1966, 1978, and 1985.

Besides his teaching, he is best known for his work on the theory and behavior of interest rates, corporate finance, budgeting decisions, and the valuation of market instruments. He has authored five widely used textbooks, and served in the U.S. Treasury and as dean of academic affairs at the Business School.