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HBS Working Papers: 2006-2007

All HBS Working Papers are copyrighted by their authors. For permission to reproduce or to request a copy, contact an author directly.

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We assess the effects of opening physical retail stores on direct-to-consumer channel sales. Our data come from a leading U.S. retailer which opened four new stores over several years in different retail trading areas. We hypothesize two effects, cannibalization and complementarity, and conjecture that the magnitude of these effects may change over time and may differ between the catalog and online channels. We find that opening retail stores cannibalizes sales in the catalog channel in the short term, but produces complementary effects in both the catalog and the online channels in the long term; the complementary effects, which are magnified in the online channel, more than overcome the initial losses in the catalog channel. Customer analysis suggests that opening retail stores paves the way for higher rates of customer acquisition and higher rates of repeat purchasing among existing customers in the direct channels in the long term. Our results are based on intervention analysis with a treatment/control group design. We achieve greater balance between the groups by matching zip codes in the treatment and control regions; these procedures have been developed by scholars in other fields to approximate datasets that would have resulted from random experimentation.
45 pages

In this paper, we seek to use quantitative models to help appreciate the behavioral processes associated with successful cross-functional and cross-firm alignment in supply/demand planning. We model the interaction between a sales and a manufacturing function within a firm, or between an upstream and downstream firm. We claim that misalignment is costly both to the involved functions/firms and to the rest of the organization or supply chain, and focus the paper on studying the circumstances under which alignment will or will not happen. Using game theory, we find that, although misaligned economic incentives can play a role in explaining misalignment of planning behaviors, there is another important issue to consider: in our setting, the key factor that determines whether two functions or firms can align their planning is how much each party knows about the other's beliefs about demand. Thus, in this paper's setting, improved communication can induce alignment even if no economic incentives are changed. While consistent with the predominant view in organizational behavior (OB), this is a fundamental departure from the extant operations management (OM) literature.
40 pages

How do organizations survive in the face of change? Underlying this question is a rich debate about whether organizations can adapt-and if so how. One perspective, organizational ecology, presents evidence suggesting that most organizations are largely inert and ultimately fail. A second perspective argues that some firms do learn and adapt to shifting environmental contexts. Recently, this latter view has coalesced around two themes. The first, based on research in strategy suggests that dynamic capabilities, the ability of a firm to reconfigure assets and existing capabilities, explains long-term competitive advantage. The second, based on organizational design, argues that ambidexterity, the ability of a firm to simultaneously explore and exploit, enables a firm to adapt over time. In this paper we review and integrate these comparatively new research streams and identify a set of propositions that suggest how ambidexterity acts as a dynamic capability. We suggest that efficiency and innovation need not be strategic tradeoffs and highlight the substantive role of senior teams in building dynamic capabilities.
62 pages

Architectural Innovation and Dynamic Competition: The Smaller "Footprint" Strategy
No. 07-014
Carliss Y. Baldwin, Kim B. Clark
Finance
August 2006
Complete Text (Acrobat PDF Version)

We describe a dynamic strategy that can be employed by firms capable of architectural innovation. The strategy involves using knowledge of the bottlenecks in an architecture together with the modular operator “splitting” to shrink the “footprint” of the firm’s inhouse activities. Modules not in the footprint are outsourced—module boundaries are redrawn and interfaces designed for this purpose. The result is an invested capital advantage, which can be used to drive the returns of competitors below their cost of capital. We explain how this strategy works and model its impact on competition through successive stages of industry evolution. We then show how this strategy was used by Sun Microsystems against Apollo Computer in the 1980s and by Dell against Compaq and other personal computer makers in the 1990s
54 pages

This paper examines the licensing of intellectual property in exchange for royalties that depend on the self-report of the licensee. The self-reporting aspect of the problem gives rise to demand for auditing by the licensor. We characterize the optimal royalty contract, accounting system choice by the licensee, and audit strategy choice by the licensor. We show when the owner prefers to license the property in exchange for a royalty and when it prefers to use the property directly. We also show that the internal control provisions of section 404 of Sarbanes-Oxley make royalty arrangements based on self-reporting more attractive.
32 pages

We present a model of bandwidth allocation in a stylized peer-to-peer file sharing network with s peers (sharers) who share files and download from each other and f peers (freeriders) who download from sharers but do not contribute files. Assuming that upload bandwidth is scarcer than download bandwidth and efficient allocation, we compute the expected bandwidth obtained by each peer. We show that (i) while the exact formula is complex, s/(s + f) is a good approximation and (ii) sharers (freeriders) obtain bandwidth larger (smaller) than s/(s+f). The paper constitutes a first step towards a general analytical foundation for scarce resource allocation in peer-to-peer file sharing networks.
23 pages

18 pages

This paper explores time variation in bond risk, as measured by the covariation of bond returns with stock returns and with consumption growth, and in the volatility of bond returns. A robust stylized fact in empirical finance is that the spread between the yield on long-term bonds and short-term bonds forecasts positively future excess returns on bonds at varying horizons, and that the short-term nominal interest rate forecasts positively stock return volatility and exchange rate volatility. This paper presents evidence that movements in both the short-term nominal interest rate and the yield spread are positively related to changes in subsequent realized bond risk and bond return volatility. The yield spread appears to proxy for business conditions, while the short rate appears to proxy for inflation and economic uncertainty. A decomposition of bond betas into a real cash flow risk component, and a discount rate risk component shows that yield spreads have offsetting effects in each component. A widening yield spread is correlated with reduced cash-flow (or inflationary) risk for bonds, but it is also correlated with larger discount rate risk for bonds. The short rate forecasts only the discount rate component of bond beta.
56 pages

In this paper, we examine the motivations of large information technology ("IT") vendors, to invest in open source software ("OSS"). What drives companies with large, proprietary software portfolios to invest hundreds of millions of dollars in OSS? We approach this question by grouping a sample of OSS projects into clusters and examining vendors' motivations for each cluster. We find one cluster has received almost no investment. Contributions to projects in this cluster are confined to the voluntary effort of the vendors' employees, and vendors are likely altruistically motivated. By contrast, the other cluster has received over 99% of vendor investments. Here, vendors are more likely economically motivated to invest in OSS projects that can serve as a complementary asset to vendors' core, proprietary businesses.
31 pages

The controversy over whether and how much to charge for health products in the developing world rests, in part, on whether higher prices can increase use. We test this hypothesis in a field experiment in Zambia using door-to-door marketing of a home water purification solution. Our methodology separates the screening effect of prices (charging more changes the mix of buyers) from the psychological effect of prices (charging more stimulates greater use for a given buyer). We find that higher prices screen out those who use the product less. The amount paid does not have a psychological effect on use, but there is some evidence that the act of paying increases use. We use our data to estimate an economic model of product use, simulate counterfactuals, and develop tentative implications for pricing policy.
61 pages

Capturing Benefits from Tomorrow’s Technology in Today’s Products: The Effect of Absorptive Capacity
No. 07-009
Daniel Snow
Technology and Operations Management
July 2006
Complete Text (Acrobat PDF Version)

In this paper, I propose and examine a specific means by which firm R&D experience may be helping firms to improve their current-technology products: Firms that conduct future-technology R&D may be better at adapting components from related future technologies for use in their current-technology products. I use patent data to test whether automobile carburetor suppliers with higher levels of future-technology R&D activity are better at adapting components from related future technologies for use in carburetors.
29 pages

Cartels and Competition: Neither Markets nor Hierarchies
No. 07-011
Jeffrey Fear
Business, Government, and International Economy
August 2006
Complete Text (Acrobat PDF Version)

This article provides an overview on the rise and fall of cartels since the late 19th century when the modern cartel movement properly arrived with the rise of big business based on scale and scope. The general narrative about cartels may not be a story of rise and fall, but rise, boom, collapse, revitalization, gradual decline, and then criminalization. Yet, until the 1980s, the global story of big business must be told in conjunction with cartels rather than without them. They affected technological development, corporate strategy, and organizational change. Viewing cartels only as a "conspiracy against the public" short-circuits many important questions and obscures the great variations in objectives, type, and services provided by cartels.
32 pages

Coerced Confessions: Self-Policing in the Shadow of the Regulator
No. 07-020
Jodi L. Short and Michael W. Toffel
Technology and Operations Management
September 2006, 4th revision June 2007
Complete Text (Acrobat PDF Version)

As part of a recent trend toward more cooperative relations between regulators and industry, novel government programs are encouraging firms to monitor their own regulatory compliance and voluntarily report their own violations. In this study, we examine how regulatory enforcement activities influence organizations' decisions to self-police. We created a comprehensive dataset for the "Audit Policy," a United States Environmental Protection Agency (U.S. EPA) program that encourages companies to self-disclose violations of environmental laws and regulations in exchange for reduced sanctions. We find that facilities are more likely to self-disclose if they were recently subjected to one of several different enforcement measures and if they were provided with immunity from prosecution for self-disclosed violations.
41 pages

Corporate Governance and Networks: Bankers in the Corporate Networks of Brazil, Mexico, and the United States circa 1910
No. 07-008
Aldo Musacchio
Business, Government, and International Economy
July 2006
Complete Text (Acrobat PDF Version)

How does the development of financial markets change the interaction between banks and corporations? This paper compares the importance of interlocking boards of directors between corporations and banks in Brazil, Mexico and the United States circa 1909. The hypothesis tested is that the development of financial markets and the institutions that accompany it (e.g. financial disclosure rules, investor protections, etc) allows corporations to rely less on connections to banks. There are two specific hypotheses tested in this work. First, given the development of disclosure and corporate governance standards in Brazil, I expect bankers to have been less central than in Mexico and, perhaps, the United States. Second, I test if the availability of financing alternatives, like a well developed bond market in Brazil, reduced the average importance of corporate connections to commercial banks compared to Mexico. I test these hypotheses using network analysis and a simple multivariate regression that explains bank connections. I use comparable business directories to create databases with names of directors and financial information for all major corporations in Mexico and Brazil in 1909. The findings show that using different centrality measures, connections between banks and corporations were less important in Brazil than in Mexico and the United States. Also, in Brazil, the availability of bonds as a way to obtain financing allowed corporations to have a lower average number of connections to banks when compared to their Mexican counterparts. In Mexico, foreign companies, which had access to financial markets abroad, had also lower average connections with banks. I conclude by arguing that even though the Brazil, Mexico and the U.S. had very different network structures, rapid industrial growth was achieved by these three countries. In Mexico, a strong and dense network replaced for some of the institutions that promoted financial development and growth in Brazil.
42 pages

Organizational design affects performance via coupled search processes. At low frequency, managers search for appropriate organizational designs. At higher frequency, managers use designs to search for high-performing operational choices. The two searches are coupled: organizational design molds the choice among operational alternatives, and performance feedback from operational choices shapes design. Our simulation model shows how coupled search processes can dramatically obscure the true impact of design on performance, confounding empirical research. We identify research strategies for tackling this difficulty; discuss populationlevel advantages of coupled search processes; and highlight implications for analogous coupled search processes that shape networks, cognition, and capabilities.
48 pages

Cross Functional Alignment in Supply Chain Planning: A Case Study of Sales & Operations Planning
No. 07-001
Rogelio Oliva and Noel Watson
Technology and Operations Management
July 2006, revised October 2006
Complete Text (Acrobat PDF Version)

In 2002, Leitax, a niche consumer electronics company, suffered serious supply chain planning mishaps due to poor cross-functional integration in the supply/demand planning activities. The poor integration resulted from organizational differentiation among the functions and an unsophisticated approach to integration. In response to the planning mishaps, the organization introduced significant changes, which we examine in this case study. After highlighting the constituent responsibilities, structures, and processes, we recognize a system, as opposed to a list of mechanisms, as responsible for cross-functional integration. Operationalizing integration as functional alignment with generated plans, we find collaborative engagement of the functions to be a consistent process feature and operational norm encouraged and maintained by integrators. In particular, the information processing nature of the sales and operations planning (S&OP) process introduced at Leitax is argued effective as a result of this collaborative engagement. We argue that this collaborative engagement positively influences alignment even in the absence of an overall reduction in the level of differentiation exhibited by an organization, which stands in contrast to academic structural recommendations for changes in incentives for achieving integration. Examining a systemic tradeoff consciously acknowledged by the organization, we further argue that alignment encouraged by this collaborative engagement can be more important than achieving, superior performance along such dimensions as speed or accuracy in individual information processing steps of the S&OP process, a tradeoff which to our knowledge has not been highlighted in the supply chain management literature.
30 pages

The Balanced Scorecard offers a previously unrecognized benefit: a new way of looking at the traditional organizational structure of cost and profit centers. Every unit, by contributing to effective strategy execution, has the opportunity to support and create profit. This capability has important implications for specifying objectives and evaluating the performance of all organizational units.
9 pages

   We study how US branch-banking deregulations affected the entry and exit of firms in the non-financial sector using establishment-level data from the US Census Bureau's Longitudinal Business Database. The comprehensive micro-data allow us to study how the entry rate, the distribution of entry sizes, and survival rates for firms responded to changes in banking competition. We also distinguish the relative effect of the policy reforms on the entry of startups versus facility expansions by existing firms. We find that the deregulations reduced financing constraints, particularly among small startups, and improved ex ante allocative efficiency across the entire firm-size distribution. However, the US deregulations also led to a dramatic increase in 'churning' at the lower end of the size distribution, where new startups fail within the first three years following entry. This churning emphasizes a new mechanism through which financial sector reforms impact product markets. It is not exclusively better ex ante allocation of capital to qualified projects that causes creative destruction; rather banking deregulations can also 'democratize' entry by allowing many more startups to be founded. The vast majority of these new entrants fail along the way, but a few survive ex post to displace incumbents.
41 pages

Ratings of corporations' environmental activities and capabilities influence billions of dollars of "socially responsible" investments as well as some consumers, activists, and potential employees. In one of the first studies to assess these ratings, we examine how well the most widely used ratings-those of Kinder, Lydenberg, Domini Research & Analytics (KLD)-provide transparency about past and likely future environmental performance. We find KLD "concern" ratings to be fairly good summaries of past environmental performance. In addition, firms with more KLD concerns have slightly, but statistically significantly, more pollution and regulatory compliance violations in later years. KLD environmental strengths, in contrast, do not accurately predict pollution levels or compliance violations. Moreover, we find evidence that KLD's ratings are not optimally using publicly available data. We discuss the implications of our findings for advocates and opponents of corporate social responsibility as well as for studies that relate social responsibility ratings to financial performance.
51 pages

Theory predicts that mandated employment protections may reduce productivity by distorting production choices. Firms facing (non-Coasean) worker dismissal costs will curtail hiring below efficient levels and retain unproductive workers, both of which should affect productivity. These theoretical predictions have rarely been tested. We use the adoption of wrongful-discharge protections by U.S. state courts over the last three decades to evaluate the link between dismissal costs and productivity. Drawing on establishment-level data from the Annual Survey of Manufacturers and the Longitudinal Business Database, our estimates suggest that wrongful- discharge protections reduce employment flows and firm entry rates. Moreover, analysis of plant-level data provides evidence of capital deepening and a decline in total factor productivity following the introduction of wrongful-discharge protections. This last result is potentially quite important, suggesting that mandated employment protections reduce productive efficiency as theory would suggest. However, our analysis also presents some puzzles including, most significantly, evidence of strong employment growth following adoption of dismissal protections. In light of these puzzles, we read our findings as suggestive but tentative.
48 pages

Abstract is not available
42 pages

The central insight of asset pricing is that a security's value depends on both its distribution of payoffs across economic states and state prices. In fixed income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default is likely to occur. Such investors are likely to be attracted to securities whose payoffs resemble those of economic catastrophe bonds-bonds that default only under severe economic conditions. We show that many structured finance instruments can be characterized as economic catastrophe bonds, but offer far less compensation than alternatives with comparable payoff profiles. We argue that this difference arises from the willingness of rating agencies to certify structured products with a low default likelihood as "safe" and from a large supply of investors who view them as such
44 pages

This paper uses concepts from the theory of the firm and MIS research to argue that some types of information technology (IT) will be deployed only within hierarchical governance structures. This argument introduces a contingency into the 'electronic markets hypothesis,’ which holds that greater use of IT is unidirectionally associated with reduced use of hierarchies. We revisit the assumption that interfirm IT is never a relationship-specific asset. While many types of interfirm IT are highly redirectable others are not, and become relationship-specific assets once configured for a particular context; these assets are referred to here as enterprise information technologies. Because complete contracts over IT assets are not possible, relationship specificity is an important consideration; scholarship on the theory of the firm yields a consistent prescription that when assets are relationship specific and contracts incomplete, the single decision-making authority of a hierarchy is optimal. The paper therefore argues that when enterprise IT is required, so is an electronic hierarchy: a collaboration in which one member has all required decision rights over jointly used IT. This contingent theory yields three hypotheses, which are tested using data gathered from firms in Italian industrial districts. Because of this paper’s focus on governance rather than price-setting, electronic hierarchies are contrasted not with electronic markets, but instead with electronic heterarchies.
56 pages

The purpose of this paper is to detect the presence of sophisticated economic motives behind individual concerns for privacy. Recent theories of privacy demands in commercial contexts have assumed an economically aware and sophisticated consumer, capable of evaluating the indirect consequences of information transmission. We present evidence, from a large-scale experiment evoking a realistic context, that privacy concerns are indeed sensitive to the indirect consequences of information transmission.
10 pages

Entrepreneurship and Business History: Renewing the Research Agenda
No. 07-007
Geoffrey Jones and R. Daniel Wadhwani
Entrepreneurial Management
July 2006
Complete Text (Acrobat PDF Version)

During the 1940s and 1950s business historians pioneered the study of entrepreneurship. The interdisciplinary Center for Research on Entrepreneurial History, based at Harvard Business School which included Joseph Schumpeter and Alfred Chandler, and its journal Explorations in Entrepreneurial History were key institutional drivers of the research agenda. However the study of entrepreneurship ran into formidable methodological roadblocks, and attention shifted to the corporation, leaving the study of entrepreneurship fragmented and marginal. Nevertheless business historians have made significant contributions to the study of entrepreneurship through their diverse coverage of countries, regions and industries, and – in contrast to much management research over the past two decades - through exploring how the economic, social, organizational, and institutional context matters to evaluating entrepreneurship. This working paper suggests that there are now exciting opportunities for renewing the research agenda on entrepreneurship, building on the strong roots already in place, and benefiting from engaging with advances made in the study of entrepreneurial behavior and cognition. There are opportunities for advancing understanding on the historical role of culture and values on entrepreneurial behavior, using more careful methodologies than in the past, and seeking to specify more exactly how important culture is relative to other variables. There are also major opportunities to complement research on the role of institutions in economic growth by exploring the precise relationship between institutions and entrepreneurs.
50 pages

Designers often seek modular architectures to better accommodate expected changes and to enable parallel development. However, we lack a formal theory and model of modularity and software evolution, which can be used for description, prediction, and prescription. According to Baldwin and Clark's theory, modular architectures add value to system designs by creating options to improve the system by substituting or experimenting on individual modules. In this paper, we evaluate their theory by looking at the design evolution of two software product platforms through the modeling lens of design structure matrices (DSMs) and design rule theory. Our analysis shows that DSM models and options theory can explain how real-world modularization activities in one case allowed for different rates of evolution in different software modules and in another case conferred distinct strategic advantages on a firm (by permitting substitution of an at-risk software module without substantial change to the rest of the system). The experiment supports our hypothesis that these formal models and theory can account for important aspects of software design evolution in large-scale systems
11 pages

Governments are known for procrastinating when it comes to resolving painful policy problems. Whatever the political motives for waiting to decide, procrastination distorts economic decisions relative to what would arise with early policy resolution. In so doing, they engender excess burden. This paper posits, calibrates, and simulates a life cycle model with earnings, lifespan, investment return, and future policy uncertainty. It then measures the excess burden from delayed resolution of policy uncertainty. The first uncertain policy we consider concerns the level of future Social Security benefits. Specifically, we examine how an agent would respond to learning in advance whether she will experience a major Social Security benefit cut starting at age 65. We show that having to wait to learn materially affects consumption, saving, and portfolio decisions. It also reduces welfare. Indeed, we show that the excess burden of government indecision can, in this instance, range as large as 0.6 percent of the agent's economic resources. This is a significant distortion in of itself. It's also significant when compared to other distortions measured in the literature. The second uncertain policy we consider concerns marginal tax rates. We obtain similar results once we adjust for the impact of tax rates on income.
49 pages

Decision researchers have long been interested in behaviors that deviate from rational choice. Of these, the compromise effect has received considerable attention, with it repeatedly shown that the probability of choosing an item increases when that item is a middling, as opposed to extreme, alternative in a choice set. The term extremeness avoidance has been used to describe the reason underlying this phenomenon. In this research, we argue that extremeness avoidance behavior depends on assortment type, with consumers displaying extremeness avoidance for alignable assortments, but systematically and predictably displaying extremeness seeking for non-alignable assortments. Across three studies, we show the extremeness seeking effect, contrast it with extremeness avoidance, and explore its underlying cause.
40 pages

Most of what organizational scholars know about new industry emergence and entrepreneurship in new industries comes from studies of completely new industries that were born out of technological innovations. We know far less about the emergence of non-technologybased industries and about the legitimacy-seeking activities of entrepreneurs in an industry that is transported from one part of the world to another, making it novel only in a new, limited geographic region. In this exploratory and inductive study of the emergence and evolution of the Indian high-end fashion industry and the actions of entrepreneurs in the early days of this industry, I seek to redress these shortcomings of prior organizational research. Based on a series of interviews with designers and individuals associated with the industry, I find that although legitimacy-seeking is an important activity for pioneering entrepreneurs, they are unconsciously aided by other actors who are acting out of self-interest rather than from a desire to actively help these entrepreneurs. Furthermore, entrepreneurs are aided by the fact that the industry is not new to the world, due to which they can adapt and adopt institutional practices already legitimized by counterpart industries in other parts of the world. The paper builds on existing community ecology and social movement perspectives on industry emergence and evolution and adds new dimensions to both, and thus has implications for organizational theory.
41 pages

We report on a field study demonstrating systematic differences between the preferences people anticipate they will have over a series of options in the future and their subsequent revealed preferences over those options. Using a novel panel data set, we analyze the film rental and return patterns of a sample of online DVD rental customers over a period of four months. We predict and find that people are more likely to rent DVDs in one order and return them in the reverse order when should DVDs (e.g., documentaries) are rented before want DVDs (e.g., action films). This effect is sizeable in magnitude, with a 2% increase in the probability of a reversal in preferences (from a baseline rate of 12%) ensuing if the first of two sequentially rented movies has more should and fewer want characteristics than the second film. Similarly, we also predict and find that should DVDs are held significantly longer than want DVDs within-customer. Finally, we find that as the same customers gain more experience with online DVD rentals, their "dynamic inconsistency" is attenuated. We interpret our results as evidence that myopia has a meaningful impact on decisions in the field and that people learn about their myopia with experience, allowing them to curb its influence.
34 pages

We investigate, using a unique firm level dataset of nearly 20 million firms in 80 countries, whether differences in the allocation of resources across heterogeneous plants are a significant determinant of cross-country differences in income per worker. Using a monopolistic competitive firm framework to derive our benchmark calibration, we find that the model over-explains income variance. We further explore whether the results are driven by sample biases, calibration assumptions, or modeling choice. We find the same results prevail even in sub-samples in which the data are more reliable, and when we vary the calibration assumptions. This suggests the need for more complex modeling structures. Despite these acknowledged shortcomings, our results suggest that misallocation of resources is a crucial determinant of income dispersion.
25 pages

Kim Clark occupies a unique place in management scholarship. As a member of the Technology and Operations Management unit of Harvard Business School, he participated in several major research initiatives during the 1980s and early 1990s, before becoming Dean of the School in 1995. And even as Dean, he continued to pursue research until 2005, when he left Harvard to become President of Brigham Young University—Idaho. In this paper, we describe Clark’s research and discuss his contributions to management and economics. We look at three distinct bodies of work. In the first, Clark (in conjunction with Robert Hayes and Steven Wheelwright) argued that the abandonment by U.S. managers of manufacturing as a strategic function exposed U.S. companies to Japanese competition. In the second research stream, conducted with Wheelwright, Bruce Chew, Takahiro Fujimoto, Kent Bowen and Marco Iansiti, Clark made the case that product development could be managed in new ways that would lead to significant competitive advantage for firms. Finally, in work conducted with Abernathy, Rebecca Henderson and Carliss Baldwin, Clark placed product and process designs at the center of his explanation of how innovation determines the structure and evolution of industries.
54 pages

Many companies have successfully used outsourcing to lower costs. But, unless the company's efforts are unusually good, true competitive advantage is fleeting when competitors begin outsourcing and achieve similar results. To build sustainable competitive advantage, leading companies are now using an advanced form of outsourcing, called global collaboration, to drive new revenue, quicken time-to-market, and increase innovation. Global collaboration impacts their top as well as bottom lines. But effectively adopting this approach requires adjustments to traditional outsourcing strategy, organization and processes.

In a recent research project, we interviewed managers from 45 projects in over 20 firms to understand the practices that differentiated those firms that reported greater success with the use of collaboration. We found that the competencies required for achieving top-line growth through global partners are different than the competencies required to be successful in reducing costs via outsourcing. Yet, many companies continue to manage global collaboration projects in the same ways they managed cost-reduction projects and thus do not obtain the full value from these projects. Our work led us to propose several frameworks for how firms should think about their collaboration efforts (reported in a separate working paper) as well as to codify a set of organizational "best practices" that were common to companies who reported greater success in the use of collaboration (reported in this paper).
20 pages

People often experience tension over certain choices (e.g., they should reduce their gas consumption or increase their savings, but they do not want to). Some posit that this tension arises from the competing interests of a deliberative "should" self and an affective "want" self. We show that people are more likely to select choices that serve the should self (should-choices) when the choices will be implemented in the distant rather than the near future. This "future lock-in" is demonstrated in four experiments for should-choices involving donation, public policy, and self-improvement. Additionally, we show that future lock-in can arise without changing the structure of a should-choice, but by just changing people's temporal focus. Finally, we provide evidence that the should self operates at a higher construal level (abstract, superordinate) than the want self, and that this difference in construal partly underlies future lock-in.
63 pages

This paper considers the risk management problem of an investor who holds a diversified portfolio of global equities or bonds and chooses long or short positions in currencies to manage the risk of the total portfolio. Over the period 1975-2005, we find that a risk-minimizing global equity investor should short the Australian dollar, Canadian dollar, Japanese yen, and British pound but should hold long positions in the US dollar, the euro, and the Swiss franc. The resulting currency position tends to rise in value when equity markets fall. This strategy works well for investment horizons of one month to one year. In the past 15 years the risk-minimizing demand for the dollar appears to have weakened slightly, while demands for the euro and Swiss franc have strengthened. These changes may reflect the growing role for the euro as a reserve currency in the international financial system. The risk-minimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the US dollar. Risk-reducing currencies have had lower average returns during our sample period, but the difference in average returns is smaller than would be implied by the global CAPM given the historical equity premium.
74 pages

In this paper we distinguish different "qualities" of FDI to re-examine the relationship between FDI and growth. We use 'quality' to mean the effect of a unit of FDI on economic growth. However, this is difficult to establish because it is a function of many different country and project characteristics which are often hard to measure. Hence, we differentiate "quality FDI" in several different ways. First, we look at the possibility that the effects of FDI differ by sector. Second, we differentiate FDI based on objective qualitative industry characteristics including the average skill intensity and reliance on external capital. Third, we use a new dataset on industry-level targeting to analyze quality FDI based on the subjective preferences expressed by the receiving countries themselves. Finally, we use a two-stage least squares methodology to control for measurement error and endogeneity. Exploiting a new comprehensive industry level data set of 29 countries between 1985 and 2000, we find that the growth effects of FDI increase when we account for the quality of FDI.
43 pages

How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages
No. 07-013
Laura Alfaro, Areendam Chanda, Sebnem Kalemli-Ozcan, and Selin Sayek
Business, Government and International Economy
August 2006
Complete Text (Acrobat PDF Version)

The empirical literature finds mixed evidence on the existence of positive productivity externalities in the host country generated by foreign multinational companies. We propose a mechanism that emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. In a small open economy, final goods production is carried out by foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate products. To operate a firm in the intermediate goods sector, entrepreneurs must develop a new variety of intermediate good, a task that requires upfront capital investments. The more developed the local financial markets, the easier it is for credit constrained entrepreneurs to start their own firms. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration exercises indicate that a) holding the extent of foreign presence constant, financially well-developed economies experience growth rates that are almost twice those of economies with poor financial markets, b) increases in the share of FDI or the relative productivity of the foreign firm leads to higher additional growth in financially developed economies compared to those observed in financially under-developed ones, and c) other local conditions such as market structure and human capital are also important for the effect of FDI on economic growth.
56 pages

We use oil price fluctuations to construct a new instrument to test the impact of transfers from wealthy OPEC nations to their poorer Muslim allies. The instrument identifies plausibly exogenous variation in foreign aid. We investigate how aid is spent by tracking its short-run effect on aggregate demand, the national accounts, and the balance of payments. We find that much aid is consumed, primarily in the form of imported non-capital goods. Some aid is invested and aid has a positive, though statistically imprecise, effect on growth. Aid has no effect on the financial account but leads to unaccounted capital flight.
47 pages

How do decisions made for tomorrow or two days in advance differ from decisions made for several days in the future? We use novel panel data from an online grocer to address this question. In general, we find that as the delay between order completion and delivery increases, grocery customers spend less, order a higher percentage of "should" items (e.g., vegetables), and order a lower percentage of "want" items (e.g., ice cream) controlling for customer fixed effects. However, orders placed by a customer for delivery tomorrow versus two days in the future do not show this want/should pattern, and we briefly discuss survey results suggesting a potential explanation for this.
36 pages

26 pages

This study considers organizational artifacts as triggers of procedural justice expectations, showing the effects of one artifact – an organizational wait queue – on perceived procedural justice. Queue designs that violated consistency or suggested bias were perceived as less procedurally just than those that implied consistency and lack of bias. Information about the bias implied by a queue improved perceived procedural justice. The analysis suggests organizational artifacts to be "secondary contract makers" and informs the study of procedural justice by suggesting a new source of inferences about and precursors to perceived justice. The study offers implications for the management of queues as well as other artifacts.
31 pages

As numerous papers have argued, sales, inventory, and gross margin for a retailer are interrelated. We construct a simultaneous equation model to establish these interrelationships at a firm level. Using publicly available financial data we estimate the six causal effects among sales, inventory, and gross margin. Our results show that sales, inventory, and gross margin are mutually endogenous. In particular, we provide new evidence of the impact of inventory on sales and the interrelationship between gross margin and inventory. We also estimate the effects of exogenous explanatory variables such as store growth, proportion of new inventory, capital investment per store, selling expenditure, and index of consumer sentiment on sales, inventory, and gross margin. We show that our model can be used to benchmark retailers’ performance in sales, inventory, and gross margin simultaneously. Finally, we show that our model can be used to generate sales forecasts even when sales were managed using inventory and gross margin. In numerical tests, sales forecasts from our model are more accurate than forecasts from time-series models that ignore inventory and price as well as forecasts from financial analysts.
32 pages

This paper details the construction of a firm-year panel dataset combining the NBER Patent Dataset with the Industry R&D Survey conducted by the Census Bureau and National Science Foundation. The developed platform offers an unprecedented view of the R&D-to-patenting innovation process and a close analysis of the strengths and limitations of the Industry R&D Survey. The files are linked through a name-matching algorithm customized for uniting the firm names to which patents are assigned with the firm names in Census Bureau’s SSEL business registry. Through the Census Bureau’s file structure, this R&D platform can be linked to the operating performances of each firm’s establishments, further facilitating innovation-to-productivity studies.
29 pages

This study addresses the paradox of embedded human agency, or the contradiction between actors’ agency and institutional determinism. It helps to resolve this paradox by considering the enabling role of actors’ social position. Adopting a relational view of human agency, I model the impact of their social position on the likelihood that actors will initiate changes that diverge from the existing institutions. I test this model using data from 93 change projects conducted by clinical managers at the National Health Service in the United Kingdom. My findings suggest that social position is an important enabling condition for divergent organizational change, and is a determinant as well of the type of divergent organizational change an actor may undertake.
65 pages

Many recent studies highlight the need to rethink the way we manage innovation. Traditional approaches, based on the assumption that the creation and pursuit of new ideas is best accomplished by a centralized and collocated R&D team, are rapidly becoming outdated. Instead, innovations are increasingly brought to the market by networks of firms, selected for their unique capabilities, and operating in a coordinated manner. This new model demands that firms develop different skills, in particular, the ability to collaborate with partners to achieve superior innovation performance. Yet despite this need, there is little guidance on how to develop or deploy this ability.

This article describes the results of a study to understand the strategies and practices used by firms that achieve greater success in their collaborative innovation efforts. We found many firms mistakenly applied an "outsourcing" mindset to collaboration efforts which, in turn, led to three critical errors: First, they focused solely on lower costs, failing to consider the broader strategic role of collaboration. Second, they didn't organize effectively for collaboration, believing that innovation could be managed much like production and partners treated like "suppliers." And third, they didn't invest in building collaborative capabilities, assuming that their existing people and processes were already equipped for the challenge. Successful firms, by contrast, developed an explicit strategy for collaboration and made organizational changes to aid performance in these efforts. Ultimately, these actions allowed them to identify and exploit new business opportunities. In sum, collaboration is becoming a new and important source of competitive advantage. We propose several frameworks to help firms develop and exploit this new ability.
23 pages

Organizational Responses to Environmental Demands: Opening the Black Box (previously "Institutional Pressures and Environmental Strategies")
No. 07-022
Magali A. Delmas and Michael W. Toffel
Technology and Operations Management
October 2006, revised June 2007, January 2008
Complete Text (Acrobat PDF Version)

This paper combines new and old institutionalism to explain differences in organizational strategies. We propose that differences in the influence of corporate departments lead their facilities to prioritize different external pressures and thus adopt different management practices. Specifically, we argue that external constituents-including customers, regulators, legislators, local communities, and environmental activist organizations-who interact with influential corporate departments are more likely to affect facility managers' decisions. As a result, managers of facilities that are subjected to comparable institutional pressures adopt distinct sets of management practices that appease different external constituents. We test our framework in the context of the adoption of environmental management practices using an original survey and archival data obtained for nearly 500 facilities. We find support for these hypotheses.
56 pages

International Financial Integration and Entrepreneurial Firm Dynamics (previously "International Financial Integration and Entrepreneurship")
No. 07-012
Laura Alfaro and Andrew Charlton
Business, Government, and International Economy
August 2006, revised March 2007
Complete Text (Acrobat PDF Version)

We explore the relation between international financial integration and the level of entrepreneurial activity in a country. We use a unique firm level data set of approximately 24 million firms in nearly 100 countries in 2004 and 1999, which enables us to present both cross-country and industry level evidence. We establish robust cross-country correlations between increased international financial integration and the activity of entrepreneurs using various proxies for entrepreneurial activity such as entry, size, and skewness of the firm-size distribution and de jure and de facto measures of international capital integration. We then explore causal channels through which foreign capital may encourage entrepreneurship. We find evidence that entrepreneurial activity in industries which are more reliant on external finance is disproportionately affected by international financial integration, suggesting that foreign capital may improve access to capital either directly or through improved domestic financial intermediation. Second we find that entrepreneurial activity is higher in industries which have a large share of foreign firms or in vertically linked industries.
51 pages

No abstract
31 pages

The Judgment-Decision Paradox in Experience-based Decisions and the Contingent Recency Effect
No. 07-003
Greg Barron, Ido Erev, and Eldad Yechiam
Negotiation, Organizations, and Markets
July 2006
Complete Text HBS Only (Acrobat PDF Version)

The current paper explores a judgment-decision paradox in experience-based decisions: the finding that rare events are overweighted in probability judgments but are underweighted in repeated decisions under uncertainty. Two laboratory studies examine both decisions and probability assessments within the same paradigm. The results reveal overweighting and negative recency in probability assessments but underweighting and positive recency in choices. At the same time, there remains an overall consistency between choices and assessments. A third study validates the results in a field study. The results show that, after a negative rare-event (i.e. a suicide bombing) people believe the risk to have decreased (negative recency) but are more cautious (positive recency).
28 pages

27 pages

Learning and Equilibrium As Useful Approximations: Accuracy of Prediction on Randomly Selected Constant Sum Games
No. 07-004
Ido Erev , Alvin E. Roth, Robert L. Slonim, and Greg Barron
Negotiation, Organizations, and Markets
July 2006
Complete Text HBS Only (Acrobat PDF Version)

There is a good deal of miscommunication between and among experimenters and theorists, and psychologists and economists, about how to evaluate a theory that can be rejected by sufficient data, but may nevertheless be a useful approximation. A standard experimental design reports whether a general theory can be rejected on an informative test case. This paper, in contrast, reports an experiment designed to meaningfully pose the question: "how good an approximation does a theory provide on average." Even on the simplest class of two-person constant sum games there is mixed evidence on this question, and resulting controversy (dating from the 1950’s in psychology and continuing through the 1990’s in economics). We consider a random sample of 2x2 constant sum games to determine how close on average are the equilibrium predictions to observed play in repeated play of a game against a fixed opponent. We also compare the predictions of several models of learning and related models. We find that equilibrium becomes a better predictor of observed play as the players become more experienced, but that simple models of learning predict more accurately, over the 500 periods of repeated play that we observe. We also discuss how the predictive value of a theory can be measured in terms of how many pairs of experimental subjects you would have to observe playing a previously unexamined game before the mean of the experimental observations would provide a better prediction than the theory about the behavior of a new pair of subjects playing this game. We call this latter quantity the model’s Equivalent Number of Observations (ENO), and explore its properties.
29 pages

Theories abound on the potential macroeconomic impact of AIDS in Africa, yet there have been surprisingly few empirical studies to test the mixed theoretical predictions. In this paper, we examine the impact of the AIDS epidemic on African nations through 2002 using the male circumcision rate to identify plausibly exogenous variation in HIV prevalence. Medical researchers have found significant evidence that male circumcision can reduce the risk of contracting HIV. We find that national male circumcision rates for African countries are both a strong predictor of HIV/AIDS prevalence and uncorrelated with other determinants of economic outcomes. Two-stage least squares regressions do not support the hypotheses that AIDS has had any measurable impact on economic growth, savings, or fertility behavior in African nations. However we do find weak evidence that AIDS has lead to a slow-down in education gains, as measured by youth literacy, and a rise in poverty, as measured by malnutrition.
57 pages

Manage Resource Allocation to Craft Strategy
No. 07-018
Joseph L. Bower and Clark G. Gilbert
General Management
September 2006
Complete Text (Acrobat PDF Version)

Research from a set of studies conducted over 35 years shows that actual strategy rather than words on paper at corporate is crafted step by step as company resources are committed to policies, programs, people, and facilities. In turn the process of allocating resources is distributed across all levels of the company. Those activities go on simultaneously. As a consequence, the way in which the structure divides up responsibility and the way the processes of the organization distribute information have vital consequences. Senior managers often have less control over their strategy than they think while middle managers and operating managers can have a much greater role on strategy than is generally recognized either those managers or by top management: But the complexity of the resource allocation process only increases the need for leadership at the top. This requires a more complete understanding of the processes of the company from a strategic perspective. That understanding implies that systems cannot substitute for management in the resource allocation process.
10 pages

To date, little research has been done on managing the organizational and political dimensions of generating and improving forecasts in corporate settings. We examine the implementation of a supply chain planning process at a consumer electronics company, concentrating on the forecasting approach around which the process revolves. Our analysis focuses on the forecasting process and how it mediates and accommodates the functional biases that can impair the forecast accuracy. We categorize the sources of functional bias into intentional, driven by misalignment of incentives and the disposition of power within the organization, and unintentional, resulting from informational and procedural blind spots. We show that the forecasting process, together with the supporting mechanisms of information exchange and elicitation of assumptions, is capable of managing the potential political conflict and the informational and procedural shortcomings. We also show that the creation of an independent group responsible for managing the forecasting process, an approach that we distinguish from generating forecasts directly, can stabilize the political dimension sufficiently to enable process improvement to be steered. Finally, we find that while a coordination system-the relevant processes, roles and responsibilities, and structure-can be designed to address existing individual and functional biases in the organization, the new coordination system will in turn generate new individual and functional biases. The introduced framework of functional biases (whether those biases are intentional or not), the analysis of the political dimension of the forecasting process, and the idea of a coordination system are new constructs to better understand the interface between operations management and other functions.
36 pages

We use an economic model to study the optimal management of know-how, defined here as employee-generated information about the performance of specific solutions to problems that may or will recur in the future. We derive three main results. First, information about successes is typically more useful than information about failures, since successful methods can be replicated while failures can only be avoided. This supports firms' focus on 'best practice'. Second, recording mediocre know- how can actually be counter-productive, since such mediocre know-how may inefficiently reduce employees' incentives to experiment. This is a strong-form competency trap. Third, the firms that gain most from a formal knowledge system are also the ones that should be most selective when encoding information (i.e., the ones that are most at risk from the competency trap); namely, large firms that repeatedly face problems about which there is little general knowledge and that have high turnover among their employees. Beyond these main principles, we also show that it may be optimal to disseminate know-how on a plant-level but not on a firm-level, and that storing back-up solutions is most valuable at medium levels of environmental change.
22 pages

In a platform-mediated network, users rely on a common platform, provided by one or more intermediaries, that encompasses infrastructure and rules required by users to transact with each other. A fundamental design decision for firms that aspire to develop platform-mediated networks is whether to preserve proprietary control or share their platform with rivals. A proprietary platform has a single provider that solely controls its technology, for example, Federal Express, Apple Macintosh, or Google. With a shared platform, such as Visa, DVD, or Linux, multiple firms collaborate in developing the platform's technology then compete in offering users different but compatible versions of the platform. This article examines factors that favor proprietary versus shared models when designing new platforms then explains how management challenges differ for proprietary and shared platform during subsequent life-cycle stages: network mobilization and platform maturity.
28 pages

Since the dawn of broadcasting, and especially in the past decade, Americans have turned their attention from local to more distant sources of news and entertainment. While the integration of media markets will raise the private welfare of many consumers, critics of a globalized information and entertainment industry claim that transnational media undermine civic engagement, transforming locally engaged citizens into viewers consuming programming from distant sources. In response to such concerns, many regulatory agencies, including the Federal Communication Commission in the United States, curtail the integration of media markets to promote “localism.” To find the right balance between the private benefits of integrated markets and the public value of civic engagement, evidence on the size of the positive spillovers from local media is needed. To date, such evidence is scant. In this paper, we exploit the rapid growth of Hispanic communities in the United States to test whether the presence of local television news affects local civic behavior. Spanish-language local television news programming was available in 25 US metro areas in 2002, up from only 14 areas in 1994. Our estimates indicate that Hispanic voter turnout increased by 5 to 10 percentage points, relative to non-Hispanic voter turnout, in markets where local Spanish-language television news became available. We conclude that the tradeoff between integrated media markets and civic engagement is real. The results of this study provide a basis for the continued pursuit of regulatory policies that promote localism.
22 pages

This paper provides a first pass at clarifying the economic tradeoffs between two polar strategies for market intermediation: the "merchant" mode, in which the intermediary buys from sellers and resells to buyers; and the "two-sided platform" mode, under which the intermediary enables affiliated sellers to sell directly to affiliated buyers. The merchant mode yields higher profits than the two-sided platform mode when the chicken-and-egg problem due to indirect network effects for the two-sided platform mode is more severe and when the degree of complementarity/substitutability among sellers' products is higher. Conversely, the platform mode is preferred when seller investment incentives are important or when there is asymmetric information regarding seller product quality. We discuss these tradeoffs in the context of several prominent digital intermediaries.
19 pages

Multi-sided platforms (MSPs), which bring together two or more interdependent groups of customers, have recently risen to economic and business prominence in many industries. This paper first lays out a simple micro-founded framework which aims to organize academic and managerial thinking about MSPs. It argues that any MSP performs one or both among two fundamental functions: reducing search costs and reducing shared transaction costs among its multiple sides. Using a variety of illustrations, the framework is then used to formulate general principles driving MSP design and expansion strategies: choosing the relevant platform "sides", deciding which fundamental activities to perform and trading off depth against scope of MSP functions.
26 pages

The high cost of international economic and financial crises highlights the need for a comprehensive framework to assess the robustness of national economic and financial systems. This paper proposes a new comprehensive approach to measure, analyze, and manage macroeconomic risk based on the theory and practice of modern contingent claims analysis (CCA). We illustrate how to use the CCA approach to model and measure sectoral and national risk exposures, and analyze policies to offset their potentially harmful effects. This new framework provides economic balance sheets for inter-linked sectors and a risk accounting framework for an economy. CCA provides a natural framework for analysis of mismatches between an entity's assets and liabilities, such as currency and maturity mismatches on balance sheets. Policies or actions that reduce these mismatches will help reduce risk and vulnerability. It also provides a new framework for sovereign capital structure analysis. It is useful for assessing vulnerability, policy analysis, risk management, investment analysis, and design of risk control strategies. Both public and private sector participants can benefit from pursuing ways to facilitate more efficient macro risk accounting, improve price and volatility discovery, and expand international risk intermediation activities.
46 pages

Several scholars have documented the positive consequences of job-hopping by inventors, including knowledge spillovers and agglomeration and the concentration of spinoffs. This work investigates a possible antecedent of inventor mobility: regional variation in the enforcement of postemployment noncompete covenants. While previous research on non-competes has been largely focused on California and Silicon Valley, we exploit Michigan's inadvertent reversal of its noncompete enforcement legislation as a natural experiment to investigate the impact of noncompetes on mobility. Using the U.S. patent database and a differences-in-differences approach between inventors in states that did not enforce and did not change enforcement of non-compete laws, we find that relative mobility decreased by 34% in Michigan after the state reversed its policies. Moreover, this effect was amplified 14% for "star" inventors and 17% for "specialist" inventors.
33 pages

        A century ago, everyone thought time and distance were well defined physical concepts. But neither proved absolute. Instead, measures/reports of time and distance were found to depend on one's reference point, specifically one's direction and speed of travel, making our apparent physical reality, in Einstein's words, "merely an illusion."
        Like time and distance, standard fiscal measures, including deficits, taxes, and transfer payments, depend on one's reference point/reporting procedure/language/labels. As such, they too represent numbers in search of concepts that provide the illusion of meaning where none exists.
        This paper, dedicated to our dear friend, David Bradford, provides a general proof that standard and routinely used fiscal measures, including the deficit, taxes, and transfer payments, are economically ill-defined. Instead these measures reflect the arbitrary labeling of underlying fiscal conditions. Analyses based on these and derivative measures, such as disposable income, private assets, and personal saving, represent exercises in linguistics, not economics.
18 pages

We present a simple formal model to address the question: When is open innovation superior to integrated innovation? Our model has firms with limited visibility that either control all aspects of product innovation (integrated innovation) or open their designs to components developed by other players (open innovation). We show that the desirability of each development method depends on the complexity of product development. With low complexity, both approaches fare similarly. As complexity grows, open innovation becomes increasingly attractive. When complexity is very large, integrated innovation tends to deliver better returns. We show that an open innovation strategy allows the firm to discover combinations of product features that would be hard to envision under integration. Open innovation, however, confines the ability of the firm to establish the product’s technological trajectory. The resolution of the trade-off between discovery and confinement determines the best approach to innovation.
22 pages

Optimal Reserve Management and Sovereign Debt
No. 07-010
Laura Alfaro and Fabio Kanczuk
Business, Government, and International Economy
August 2006
Complete Text (Acrobat PDF Version)

Most models currently used to determine optimal foreign reserve holdings take the level of internat