HBS Working Papers: 2009-2010 - Faculty & Research

HBS Working Papers Collection

2009 - 2010

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Accelerating Innovation In Energy: Insights from Multiple Sectors
No. 10-067
Rebecca M. Henderson and Richard G. Newell
General Management, Strategy
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
A combination of concerns about climate change and energy security has recently led to significant increases in public funding for energy R&D. Some commentators are suggesting that these increases need to be sustained, and are advocating for increases of as much as three or four hundred percent, suggesting that the US needs a "Manhattan project" for energy. Other observers have discussed supporting innovation through a range of additional policy interventions, including tax credits, loan guarantees, IP policy, regulatory mandates, codes and standards. It is critically important that these kinds of interventions be thoughtfully designed since it seems probable that without major advances in energy technology it is unlikely that the world will be able to reduce green house gas emissions rapidly enough to avoid a substantial increase in the risk of significant climate change.

This book hopes to contribute to the public debate in this area by pulling together a group of distinguished economists who have studied the role of public support in generating innovation in other sectors of the economy. Over the last few years relatively few economists have studied energy innovation in any depth, but there has been a substantial investment in understanding the dynamics of innovation in a wide range of other industries, including pharmaceuticals and biotechnology, IT and telecommunications, defense, chemicals and agriculture. We believe that there are valuable lessons in this research for the energy sector.
24 pages

Accountability and Control as Catalysts for Strategic Exploration and Exploitation: Field Study Results
No. 10-051
Robert L. Simons
Accounting and Management
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
This paper reports the collective finding from 102 field studies that look at the relationship between two organization design variables: span of control and span of accountability. Clustering the data yields propositions suggesting that the relationship between these variables may be an important determinant of strategic exploitation and exploration activities.

Data from the field studies suggest that, in accordance with the controllability principle, accountability and control are tightly aligned for exploitation activities. However, this result was found in only a small number of tasks and functions. In the majority of situations, spans of accountability were wider than spans of control. This "Entrepreneurial Gap" is posited to be a result of management's desire for innovation and exploration-and used as a catalyst for changing strategy, creating high levels of customer satisfaction, or motivating people to navigate complex matrix organizations.
Keywords: Ambidextrous Organization, Strategic Exploration and Exploitation, Entrepreneurial Gap, Accountability, Span of Control
35 pages

Agency Revisited
No. 10-082
Ramon Casadesus-Masanell and Daniel F. Spulber
Strategy
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
The article presents a comprehensive overview of the principal-agent model that emphasizes the role of trust in the agency relationship. The analysis demonstrates that the legal remedy for breach of duty can result in a full-information efficient outcome eliminating both moral hazard and adverse selection problems in agency. The legal remedy motivates agents to behave in a trustworthy fashion and principals to place their trust in agents. In contrast to the standard agency model, a complete description of the principal-agent relationship cannot be based on explicit incentives alone but must recognize implicit and exogenous incentives for trust behavior that derive from the legal, social, and market context. These incentives reduce the need to rely on explicit incentives, allowing the principal and agent to reduce transaction costs by using incomplete contracts.
58 pages

The Architecture of Complex Systems: Do Core-periphery Structures Dominate?
No. 10-059
Alan MacCormack, Carliss Y. Baldwin, and John Rusnak
Finance
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
Any complex technological system can be decomposed into a number of subsystems and associated components, some of which are core to system function while others are only peripheral. The dynamics of how such "core-periphery" structures evolve and become embedded in a firm's innovation routines has been shown to be a major factor in predicting survival, especially in turbulent technology-based industries. To date however, there has been little empirical evidence on the propensity with which core-periphery structures are observed in practice, the factors that explain differences in the design of such structures, or the manner in which these structures evolve over time.
We address this gap by analyzing a large number of systems in the software industry. Our sample includes 1,286 software releases taken from 19 distinct applications. We find that 75-80% of systems possess a core-periphery structure. However, the number of components in the core varies widely, even for systems that perform the same function. These differences appear to be associated with different models of development - open, distributed organizations developing systems with smaller cores. We find that core components are often dispersed throughout a system, making their detection and management difficult for a system architect. And we show that systems evolve in different ways - in some, the core is stable, whereas in others, it grows in proportion to the system, challenging the ability of an architect to understand all possible component interactions. Our findings represent a first step in establishing some stylized facts about the structure of real world systems.
37 pages

Assess, Don't Assume, Part I: Etiquette and National Culture in Negotiation
No. 10-048
James K. Sebenius
Negotiation, Organizations & Markets
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
When facing a cross-border negotiation, the standard preparatory assessments-of the parties, their interests, their no-deal options, opportunities for and barriers to creating and claiming value, the most promising sequence and process design, etc.- should be informed and modified by two classes of potentially relevant cross-border factors, the general and the negotiation-specific. Drawing on considerable literature in cross-border and cross-cultural negotiation, this paper develops the first two levels of a four-level prescriptive framework for effectively carrying out such assessments:

Common expectations for surface behavior: etiquette, protocol, and deportment.

Deeper cultural characteristics and their implications for the negotiation process itself.

The bulk of this essay develops these two points but with some strong caveats against stereotyping, overemphasizing national culture, falling prey to potent psychological biases in cross-cultural perception, as well as potentially adapting "past" one's counterpart. [A close companion paper--"Assess, Don't Assume, Part II: Decision Making, Governance, and Political Economy in Negotiation"--elaborates the importance to effective negotiating strategy and tactics of incorporating two less well-studied factors beyond etiquette and deeper cultural characteristics: 3) systematic cross-border differences in decision making, governance, and 4) the broader economic and political context for negotiation as well as salient "comparable" deals.]
22 pages

Assess, Don't Assume, Part II: Negotiating Implications of Cross-Border Differences in Decision Making, Governance, and Political Economy
No. 10-050
James K. Sebenius
Negotiation, Organizations & Markets
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
When facing a negotiation that crosses national borders and/or cultures, the standard preparatory assessments-of the parties, their interests, their no-deal options, opportunities for and barriers to creating and claiming value, the most promising sequence and process design, etc.- should be informed and modified by potentially relevant factors. Drawing on considerable literature in cross-border and cross-cultural negotiation, a two-paper series develops a four-level prescriptive framework for effectively carrying out such assessments. The first paper in this series ("Etiquette and National Culture in Negotiation") described 1) common expectations for surface behavior, and 2) some implications of deeper cultural characteristics for the negotiation process itself, as well as cross-border caveats such as stereotyping and overemphasizing national culture to the exclusion of other factors. The current paper carries this analysis further by systematically analyzing a third and fourth class of factors that often prove critical in cross-border dealmaking:

The decision-making and governance processes that are the targets of influence efforts.

The broader economic and political context for negotiation as well as salient "comparable" deals.

13 pages

Banking Deregulations, Financing Constraints and Firm Entry Size
No. 10-010
William R. Kerr and Ramana Nanda
Entrepreneurial Management
July 2009, revised October 2009
Complete Text (Acrobat PDF Version)

Abstract:
We examine the effect of US branch banking deregulations on the entry size of new firms using micro-data from the US Census Bureau. We find that the average entry size for startups did not change following the deregulations. However, among firms that survived at least four years, a greater proportion of firms entered either at their maximum size or closer to the maximum size in the first year. The magnitude of these effects were small compared to the much larger changes in entry rates of small firms following the reforms. Our results highlight that this large-scale entry at the extensive margin can obscure the more subtle intensive margin effects of changes in financing constraints.
Keywords: entrepreneurship, entry size, financial constraints, banking.
JEL Codes: E44, G21, L26, L43, M13.
13 pages

Banking market concentration and consumer credit constraints: Evidence from the 1983 Survey of Consumer Finances
No. 10-077
Daniel Bergstresser
Finance
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
This paper uses data from the 1983 Survey of Consumer Finances to test the relationship between the banks' market power and households' self-reported levels of credit constraints. The 1983 Survey was the last to identify households' geographic location, making it useful for this analysis. There is evidence that borrowers, and particularly young borrowers, were less credit-constrained in markets where banks enjoyed more market power. Interest rates on consumer borrowing decreased more sharply with age in competitive markets than in concentrated markets. These results are consistent with the Sharpe (1990) and Petersen-Rajan (1995) models of information acquisition in credit markets.
Keywords: Banks, market structure, consumption, credit constraints
JEL Classification: D1; E2; G2; L1
20 pages

Beyond Agency Theory: The Hidden and Heretofore Inaccessible Power of Integrity (PDF file of Keynote Slides)
No. 10-068
Michael C. Jensen and Werner Erhard
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
There is far too much concern today about the conflicts of interest between people; for example, conflicts of interest between agents and owners--historically a favorite topic of Jensen--and not enough attention paid to the damage caused by an individual's conflict of interest with himself or herself. We argue here that a large amount of the damage inflicted on people and organizations is caused by actions of individuals that are not in their own self-interest. That is, people consistently impose costs on their loved ones, friends, associates, partners, employers and the public by actions that are not in their own self interest.

In this talk we focus on the integrity issues that cause huge problems in the lives of most individuals and to every one we come in contact with. These slides draw on the work on a new model of integrity that we have co-authored with Steve Zaffron and is available at:
http://ssrn.com/abstract=920625
http://ssrn.com/abstract=1542759
http://ssrn.com/abstract=1511274

We present a positive model of integrity that, as we distinguish and define integrity, provides powerful access to increased performance for individuals, groups, organizations, and societies. Our model reveals the causal link between integrity and increased performance, quality of life, and value-creation for all entities, and provides access to that causal link. Integrity is thus a factor of production as important as knowledge and technology, yet its major role in productivity and performance has been largely hidden or unnoticed, or even ignored by economists and others.

In summary, we show that defining integrity as honoring one's word (as we have defined honoring one's word): 1) provides an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at both the individual and organizational level, and 2) empowers the three virtue phenomena of morality, ethics and legality.
67 pages

Breakthrough Inventions and Migrating Clusters of Innovation
No. 10-020
William R. Kerr
Entrepreneurial Management
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
We investigate the speed at which clusters of invention for a technology migrate spatially following breakthrough inventions. We identify breakthrough inventions as the top one percent of US inventions for a technology during 1975-1984 in terms of subsequent citations. Patenting growth is significantly higher in cities and technologies where breakthrough inventions occur after 1984 relative to peer locations that do not experience breakthrough inventions. This growth differential in turn depends on the mobility of the technology's labor force, which we model through the extent that technologies depend upon immigrant scientists and engineers. Spatial adjustments are faster for technologies that depend heavily on immigrant inventors. The results qualitatively con.rm the mechanism of industry migration proposed in models like [Duranton, G., 2007. Urban evolutions: The fast, the slow, and the still. American Economic Review 97, 197.221].
JEL Classifications: F2, J4, J6, O3, O4, R1, R3.
Keywords: Agglomeration, Clusters, Entrepreneurship, Invention, Mobility, Reallocation, R&D, Patents, Scientists, Engineers, Immigration.
41 pages

The CHAT Dataset
No. 10-035
Diego A. Comin and Bart Hobijn
Business, Government and the International Economy
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
This note accompanies the Cross-country Historical Adoption of Technology (CHAT) dataset. CHAT is an unbalanced panel dataset with information on the adoption of over 100 technologies in more than 150 countries since 1800. The data is available for download at: http://www.nber.org/data/chat. We discuss the main aim of CHAT, its scope and limitations, as well as several ways in which we have used the data so far and ways to potentially use the data for other research.
Suggested acknowledgment:
If you use the CHAT dataset for your research, please include the following citation: "Our technology measures come from the CHAT data set which is an extension of the data set described in Comin and Hobijn (2004)"
20 pages

Clusters of Entrepreneurship
No. 10-019
Edward L. Glaeser, William R. Kerr, and Giacomo A. M. Ponzetto
Entrepreneurial Management
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
Employment growth is strongly predicted by smaller average establishment size, both across cities and across industries within cities, but there is little consensus on why this relationship exists. Traditional economic explanations emphasize factors that reduce entry costs or raise entrepreneurial returns, thereby increasing net returns and attracting entrepreneurs. A second class of theories hypothesizes that some places are endowed with a greater supply of entrepreneurship. Evidence on sales per worker does not support the higher returns for entrepreneurship rationale. Our evidence suggests that entrepreneurship is higher when fixed costs are lower and when there are more entrepreneurial people.
Keywords: Entrepreneurship, Industrial Organization, Chinitz, Agglomeration, Clusters, Cities.
JEL Codes: J2, L0, L1, L2, L6, O3, R2.
54 pages

Competing Ad Auctions: Multi-homing and Participation Costs
No. 10-055
Itai Ashlagi, Benjamin G. Edelman, and Hoan Soo Lee
Negotiation, Organizations & Markets
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
We model competing auctions for online advertising, with attention to the participation costs that limit advertisers' interest in using small ad platforms. When participation costs are large relative to the volume of traffic an ad platform can offer, an advertiser may forego use of an ad platform that the advertiser otherwise finds profitable. Mergers between ad platforms can increase advertiser welfare if the resulting click-through rate and volume of traffic are sufficiently improved relative to the offerings of the ad auctions when separate. When there is an insufficient improvement, such mergers can harm advertisers.
9 pages

Conceptual Foundations of the Balanced Scorecard
No. 10-074
Robert S. Kaplan
Accounting and Management
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
David Norton and I introduced the Balanced Scorecard in a 1992 Harvard Business Review article (Kaplan & Norton, 1992). The article was based on a multi-company research project to study performance measurement in companies whose intangible assets played a central role in value creation (Nolan Norton Institute, 1991). Norton and I believed that if companies were to improve the management of their intangible assets, they had to integrate the measurement of intangible assets into their management systems.

After publication of the 1992 HBR article, several companies quickly adopted the Balanced Scorecard giving us deeper and broader insights into its power and potential. During the next 15 years, as it was adopted by thousands of private, public, and nonprofit enterprises around the world, we extended and broadened the concept into a management tool for describing, communicating and implementing strategy. This paper describes the roots and motivation for the original Balanced Scorecard article as well as the subsequent innovations that connected it to a larger management literature.
37 pages

Conglomerates and LBO Associations: A Comparison of Organizational Forms
No. 10-024
George P. Baker and Cynthia A. Montgomery
Negotiation, Organizations & Markets, Strategy
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
No Abstract is available at this time
35 pages

The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis
No. 10-086
William R. Kerr, Josh Lerner, and Antoinette Schoar
Entrepreneurial Management, Finance
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
This paper documents the role of angel funding for the growth, survival, and access to follow-on funding of high-growth start-up firms. We use a regression discontinuity approach to control for unobserved heterogeneity between firms that obtain funding and those that do not. This technique exploits that a small change in the collective interest levels of the angels can lead to a discrete change in the probability of funding for otherwise comparable ventures. We first show that angel funding is positively correlated with higher survival, additional fundraising outside the angel group, and faster growth measured through growth in web site traffic. The improvements typically range between 30% and 50%. When using the regression discontinuity approach, we still find a strong, positive effect of angel funding on the survival and growth of ventures, but not on access to additional financing. Overall, the results suggest that the bundle of inputs that angel investors provide have a large and significant impact on the success and survival of start-up ventures.
36 pages

Culture Clash: The Costs and Benefits of Homogeneity
No. 10-003
Eric J. Van den Steen
Strategy
July 2009
Complete Text (Acrobat PDF Version)

Abstract:
This paper develops an economic theory of the costs and benefits of corporate culture — in the sense of shared beliefs and values — in order to study the effects of 'culture clash' in mergers and acquisitions.
I first use a simple analytical framework to show that shared beliefs lead to more delegation, less monitoring, higher utility (or satisfaction), higher execution effort (or motivation), faster coordination, less influence activities, and more communication, but also to less experimentation and less information collection. When two firms that are each internally homogenous but different from each other, merge, the above results translate to specific predictions how the change in homogeneity will affect firm behavior. The paper's predictions can also serve more in general as a test for the theory of culture as homogeneity of beliefs.
38 pages

A Decision-making Perspective to Negotiation: A Review of the Past and a Look into the Future
No. 10-002
Chia-Jung Tsay and Max H. Bazerman
Negotiation, Organizations & Markets
July 2009
Complete Text (Acrobat PDF Version)

Abstract:
Through the decision-analytic approach to negotiations, the past quarter century has seen the development of a better dialog between the descriptive and the prescriptive, as well as a burgeoning interest in the field for both academics and practitioners. Researchers have built upon the work in behavioral decision theory, examining the ways in which negotiators may deviate from rationality. The 1990s brought a renewed interest in social factors, as work on social relationships, egocentrism, attribution and construal processes, and motivated illusions was incorporated into our understanding of negotiations. Several promising areas of research have emerged in recent years, drawing from other disciplines and informing the field of negotiations, including work on the influence of ethics, emotions, intuition, and training.
Keywords: negotiation, bargaining, biases, ethics, affect, intuition, negotiation training
29 pages

The Determinants of Individual Performance and Collective Value in Private-Collective Software Innovation
No. 10-065
Ned Gulley and Karim R. Lakhani
Technology and Operations Management
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
We investigate if the actions by individuals in creating effective new innovations are aligned with the reuse of those innovations by others in a private-collective software development context. This relationship is studied in the setting of eleven "wiki-like" programming contests, where contest submissions are open for reuse by others, each involving more than one hundred contributors and several thousand attempts to generate, over a one-week period, the "best" software solution to a difficult programming challenge. We find that greater amounts of new code and novel recombinations of others' code, in a contest submission, increases both the probability of achieving top rank and the subsequent reuse by others in their own submission (community value). While, increasing use of borrowed code in a submission reduces the probability of achieving top rank, but increases the community value of the submission. Code structures that are more non-conforming to commonly accepted programming conventions similarly increase the probability of generating a top performer, but reduce subsequent reuse by others. Surprisingly, greater code complexity in a submission increases both the odds of generating a top performing entry and its community value. We discuss the implications of these findings in light of the literature on private-collective innovation with an emphasis on the importance of considering both individual and community perspectives as they relate to knowledge creation, reuse and recombination for innovation.
41 pages

The Devil Wears Prada? Effects of Exposure to Luxury Goods on Cognition and Decision Making
No. 10-034
Roy Y.J. Chua and Xi Zou
Organizational Behavior
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
Although the concept of luxury has been widely discussed in social theories and marketing research, relatively little research has directly examined the psychological consequences of exposure to luxury goods. This paper demonstrates that mere exposure to luxury goods increases individuals' propensity to prioritize self-interests over others' interests, influencing the decisions they make. Experiment 1 found that participants primed with luxury goods were more likely than those primed with non-luxury goods to endorse business decisions that benefit themselves but could potentially harm others. Using a word recognition task, Experiment 2 further demonstrates that exposure to luxury is likely to activate self-interest but not necessarily the tendency to harm others. Implications of these findings were discussed.
Keywords: Luxury goods, Cognition, Decision making, Self-interest
16 pages

Does Competition Favor Delegation?
No. 10-009
Christian Alejandro Ruzzier
July 2009
Complete Text (Acrobat PDF Version)

Abstract:
This paper studies the consequences of product-market competition on firms' decisions to delegate more or fewer decision-making responsibilities to managers. By simultaneously addressing the choice of both competitive actions and organizational design, the paper makes an attempt at bringing economic theory and management strategy closer together.
An increase in substitutability between the products of the different firms triggers a different response depending on the size of the firm: larger firms delegate more responsibility, whereas smaller firms centralize decision making. The increase in substitutability also causes some firms to exit the market, which pushes in the direction of reduced managerial autonomy. Stronger competition also leads to less discretion in markets in which the possibilities for product differentiation are important.
For a given number of firms, an increase in market size increases centralization, as the owner of the firm finds it more costly to accept rent seeking by the managers. However, this increase in market size will lead to the entry of more firms, which calls for more decentralized decision making. Under reasonable conditions, the aggregate effect leads to a U-shaped relationship where firms in both small and large markets are characterized by high levels of discretion, while there is less discretion for intermediate market sizes. Finally, a reduction in entry barriers leads unambiguously to an increase in the level of discretion given to the agent, as it results in a larger number of firms entering the market and, for a given market size, in lower concentration or expected firm-level demand, which reduces the value of having control and pushes in the direction of increased autonomy.
Keywords: product-market competition, delegation, authority, oligopoly, firm organization
JEL Codes: D43, L13, L22, M21
28 pages

Does Product Market Competition Lead Firms To Decentralize?
No. 10-052
Nicholas Bloom, Raffaella Sadun, and John Van Reenen
Strategy
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
There is a widespread sense that over the last two decades firms have been decentralizing decisions to employees further down the managerial hierarchy. Economists have developed a range of theories to account for delegation, but there is less empirical evidence, especially across countries. This has limited the ability to understand the phenomenon of decentralization. To address the empirical lacuna we have developed a research program to measure the internal organization of firms - including their decentralization decisions - across a large range of industries and countries. In this paper we investigate whether greater product market competition increases decentralization. For example, tougher competition may make local manager's information more valuable, as delays to decisions become more costly. Since globalization and liberalization have increased the competitiveness of product markets, one explanation for the trend towards decentralization could be increased competition. Of course there are a range of other factors that may also be at play, including human capital, information and communication technology, culture and industrial composition. To tackle these issues we collected detailed information on the internal organization of firms across nations. The few datasets that exist are either from a single industry or (at best) across many firms in a single country . We analyze data on almost 4,000 firms across twelve countries in Europe, North America and Asia. We find that competition does indeed seem to foster greater decentralization.
12 pages

The Economic Crisis and Medical Care Usage
No. 10-079
Annamaria Lusardi, Daniel Schneider, and Peter Tufano
Finance
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
We use a unique, nationally representative cross-national dataset to document the reduction in individuals' usage of routine non-emergency medical care in the midst of the economic crisis. A substantially larger fraction of Americans have reduced medical care than have individuals in Great Britain, Canada, France, and Germany, all countries with universal health care systems. At the national level, reductions in medical care are related to the degree to which individuals must pay for it, and within countries are strongly associated with exogenous shocks to wealth and employment.
24 pages

The End of Chimerica
No. 10-037
Niall Ferguson and Moritz Schularick
Business, Government and the International Economy
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
For the better part of the past decade, the world economy has been dominated by a world economic order that combined Chinese export-led development with US over-consumption. The financial crisis of 2007-2009 likely marks the beginning of the end of the Chimerican relationship. In this paper we look at this era as economic historians, trying to set events in a longer-term perspective. In some ways China's economic model in the decade 1998-2007 was similar to the one adopted by West Germany and Japan after World War II. Trade surpluses with the U.S. played a major role in propelling growth. But there were two key differences. First, the scale of Chinese currency intervention was without precedent, as were the resulting distortions of the world economy. Second, the Chinese have so far resisted the kind of currency appreciation to which West Germany and Japan consented. We conclude that Chimerica cannot persist for much longer in its present form. As in the 1970s, sizeable changes in exchange rates are needed to rebalance the world economy. A continuation of Chimerica at a time of dollar devaluation would give rise to new and dangerous distortions in the global economy.
31 pages

Endowments, Fiscal Federalism, and the Cost of Capital for States: Evidence from Brazil, 1891-1930
No. 10-027
Andre Martínez-Fritscher and Aldo Musacchio
Business, Government and the International Economy
October 2009, revised December 2009
Complete Text (Acrobat PDF Version)

Abstract:
There is a large literature that aims to explain what determines country risk (defined as the difference between the yield of a sovereign's bonds and the risk free rate). In this paper, we contribute to the discussion by arguing that an important explanatory factor is the impact that commodities have on the capacity to pay. We use a newly created data base with state-level fiscal and risk premium data for Brazil states between 1891 and 1930 to show that Brazilian states with natural endowments that allowed them to export commodities that were in high demand (e.g., rubber and coffee) ended up having higher revenues per capita and, thus, lower cost of capital. We also explain that the variation in revenues per capita was both a product of the variation in natural endowments (i.e., the fact that states cannot produce any commodity they want) and a commodity boom that had asymmetric effects among states. These two effects generated variation in revenues per capita at the state level thanks to the extreme form of fiscal decentralization that the Brazilian government adopted in the Constitution of 1891, which gave states the sole right to tax exports. We end by running instrumental variable estimates using indices of export prices for each state to instrument for revenues per capita. Our IV estimates confirm our results that states with commodities that had higher price increases had lower risk premia.
45 pages

Environmental Federalism in the European Union and the United States
No. 10-085
David Vogel, Michael Toffel, Diahanna Post, and Nazli Z. Uludere Aragon
Technology and Operations Management
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
The United States (US) and the European Union (EU) are federal systems in which the responsibility for environmental policy-making is divided or shared between the central government and the (member) states. The attribution of decision-making power has important policy implications. This chapter compares the role of central and local authorities in the US and the EU in formulating environmental regulations in three areas: automotive emissions for health related (criteria) pollutants, packaging waste, and global climate change. Automotive emissions are relatively centralised in both political systems. In the cases of packaging waste and global climate change, regulatory policy-making is shared in the EU, but is primarily the responsibility of local governments in the US. Thus, in some important areas, regulatory policy-making is more centralised in the EU. The most important role local governments play in the regulatory process is to help diffuse stringent local standards through more centralised regulations, a dynamic which has become recently become more important in the EU than in the US.
42 pages

Equity-Debtholder Conflicts and Capital Structure
No. 10-070
Bo Becker and Per Strömberg
Finance
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
We use an important legal event as a natural experiment to examine equity-debt conflicts in the vicinity of financial distress. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors' fiduciary duties in that state. This change limited incentives to take actions favoring equity over debt. We show that, as predicted, this increased the likelihood of equity issues, increased investment, and reduced risk taking. The changes are isolated to indebted firms (where the legal change applied). These reductions in agency costs were followed by an increase in average leverage and a reduction in interest costs. Finally, we can estimate the welfare implications of agency costs, because firm values increased when the rules were introduced. We conclude that equity-bond holder conflicts are economically important, determine capital structure choices, and affect welfare.
JEL Code: G32, G33, L2
30 pages

Estimating the Effects of Large Shareholders Using a Geographic Instrument
No. 10-028
Bo Becker, Henrik Cronqvist, and Rüdiger Fahlenbrach
Finance
October 2009, revised February 2010
Complete Text (Acrobat PDF Version)

Abstract:
Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument - the density of wealthy individuals near a firm's headquarters - for the presence of large, non-managerial individual shareholders in firms. These shareholders have a large impact on firms, controlling for selection effects.
64 pages

The Evolution of Science-Based Business: Innovating How We Innovate
No. 10-062
Gary P. Pisano
Technology and Operations Management
January 2010
Complete Text (Acrobat PDF Version)

33 pages

The Fable of Fisher Body Revisited
No. 10-081
Ramon Casadesus-Masanell and Daniel Spulber
Strategy
March 2010
Complete Text (Acrobat PDF Version)

15 pages

Feeling Good about Giving: The Benefits (and Costs) of Self-Interested Charitable Behavior
No. 10-012
Lalin Anik, Lara B. Aknin, Michael I. Norton, and Elizabeth W. Dunn
Marketing
August 2009
Complete Text (Acrobat PDF Version)

Abstract:
While lay intuitions and pop psychology suggest that helping others leads to higher levels of happiness, the existing evidence only weakly supports this causal claim: Research in psychology, economics, and neuroscience exploring the benefits of charitable giving has been largely correlational, leaving open the question of whether giving causes greater happiness. In this chapter, we have two primary aims. First, we review the evidence linking charitable behavior and happiness. We present research from a variety of samples (adults, children and primates) and methods (correlational and experimental) demonstrating that happier people give more, that giving indeed causes increased happiness, and that these two relationships may operate in a circular fashion. Second, we consider whether advertising these benefits of charitable giving - asking people to give in order to be happy - may have the perverse consequence of decreasing charitable giving, crowding out intrinsic motivations to give by corrupting a purely social act with economic considerations.
23 pages

Financing Constraints and Entrepreneurship
No. 10-013
William R. Kerr and Ramana Nanda
Entrepreneurial Management
August 2009
Complete Text (Acrobat PDF Version)

Abstract:
Abstract is not available at this time
21 pages

From Strategy to Business Models and to Tactics
No. 10-036
Ramon Casadesus-Masanell and Joan Enric Ricart
Strategy
November 2009
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Abstract:
The notion of business model has been used by strategy scholars to refer to "the logic of the firm, the way it operates and how it creates value for its stakeholders." On the surface, this notion appears to be similar to that of strategy. We present a conceptual framework to separate and relate business model and strategy. Business model, we argue, is a reflection of the firm's realized strategy. We find that in simple competitive situations there is a one-to-one mapping between strategy and business model, which makes it difficult to separate the two notions. We show that the concepts of strategy and business model differ when there are important contingencies upon which a well-designed strategy must be based. Our framework also delivers a clear separation between tactics and strategy. This distinction is possible because strategy and business model are different constructs.
45 pages

The Global Networks of Multinational Firms
No. 10-043
Laura Alfaro and Maggie Chen
Business, Government and the International Economy
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
In this paper we characterize the topology of global multinational networks and examine the macro and micro patterns of multinational activity. We construct indices of network density at both pairwise industry and establishment level and measure agglomeration in a global and continuous metric space. These indices exhibit distinct advantages compared to traditional measures of agglomeration including the independence on the level of geographic aggregation. Estimating the indices using a new worldwide establishment dataset, we investigate both the significance and causes of multinational firm co-agglomeration. In contrast to the conventional emphasis of the literature on the role of input-output linkages, we assess the effect of various agglomeration economies. We find that, relative to counterfactuals, multinationals with greater factor-market externalities, knowledge spillovers, and vertical linkages exhibit significant co-agglomeration. The importance of these factors differs across headquarters, subsidiary, and employment networks, but knowledge spillovers and capital-market externalities, two traditionally under-emphasized forces, exert consistently strong effects. Within each macro network, there is a large heterogeneity across subsidiaries. Subsidiaries with greater size and higher productivity attract significantly more agglomeration than their counterfactuals and become the hubs of the network.
59 pages

Going Through the Motions: An Empirical Test of Management Involvement in Process Improvement
No. 10-047
Anita L. Tucker and Sara J. Singer
Technology and Operations Management
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
Managers play a critical role in process improvement. However, research has found that many improvement efforts fail due to insufficient management involvement. Less is known, however, about mechanisms to foster managers' involvement and their impact on organizational climate, which predicts successful outcomes. We addressed this gap with a field experiment suggested by Toyota's problem-solving process. We tested three related process improvement activities: (1) interacting with workers to learn about problems, (2) ensuring that action is taken to address the problems, and (3) communicating about actions taken. Sixty-nine randomly selected hospitals, 20 of which were randomly selected to engage in the three activities for 18-months, participated in the experiment. Survey results showed that identifying problems had a negative impact on organizational climate while taking action had a positive impact. Results suggest that solving problems as they arise (e.g. Toyota's approach) with intense and substantive actions is more productive than gathering information about large numbers of potential problems to solve (e.g. incident reporting systems). Providing feedback about actions taken negatively impacted frontline workers' perceptions. Qualitative results suggest that communication can backfire when managers go through the motions of process improvement activities without making a sincere effort to resolve staff concerns.
Keywords: process improvement, hospitals, Toyota Production System, management, field experiment, safety
35 pages

The Great Leap Forward: The Political Economy of Education in Brazil, 1889-1930
No. 10-075
André Martínez-Fritscher, Aldo Musacchio, and Martina Viarengo
Business, Government and the International Economy
March 2010
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Abstract:
Brazil at the turn of the twentieth century offers an interesting puzzle. Among the large economies in the Americas it had the lowest level of literacy in 1890, but by 1940 the country had surpassed most of its peers in terms of literacy and had done a significant improvement of its education system. All of this happened in spite of the fact that the Constitution of 1891 included a literacy requirement to vote and gave states the responsibility to spend on education. That is to say, Brazilian states had a significant improvement in education levels and a significant increase in expenditures on education per capita despite having institutions that limited political participation for the masses (Lindert, 2004; Engerman, Mariscal and Sokoloff, 2009) and having one of the worst colonial institutional legacies of the Americas (Acemoglu, Johnson, and Robison, 2001; Easterly and Levine, 2003; and Engerman and Sokoloff, 1997, 2002). This paper explains how state governments got the funds to pay for education and examines the incentives that politicians had to spend on education between 1889 to 1930. Our findings are threefold. First, we show that the Constitution of 1891, which decentralized education and allowed states to collect export taxes to finance expenditures, rendered states with higher windfall tax revenues from the export of commodities to spend more on education per capita. Second, we prove that colonial institutions constrained the financing of education, but that nonetheless the net effect of the increase in commodity exports always led to a net increase in education expenditures. Finally, we argue that political competition after 1891 led politicians to spend on education, Since only literate adults could vote, we show that increases in expenditures (and increases in revenues from export taxes) led to increases in the number of voters at the state level.
65 pages

"I read Playboy for the articles": Justifying and rationalizing questionable preferences
No. 10-018
Zoë Chance and Michael I. Norton
Marketing
September 2009
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Abstract:
No abstract is available at this time
23 pages

The Impact of Private Equity Ownership on Portfolio Firms' Corporate Tax Planning
No. 10-004
Brad Badertscher, Sharon P. Katz, and Sonja Olhoft Rego
Accounting and Management
July 2009, revised March 2010
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Abstract:
This study investigates whether private equity (PE) firms influence the tax practices of their portfolio firms. Prior research documents that PE firms create economic value in portfolio firms through effective governance, financial, and operational engineering. Given PE firms' focus on value creation, we examine whether PE firms influence the extent and types of tax avoidance at portfolio firms as an additional source of economic value. We document that PE-backed portfolio firms engage in significantly more nonconforming tax planning and have lower marginal tax rates than other private firms. Moreover, we document that PE-backed portfolio firms pay 14.2 percent less income tax per dollar of pre-tax income than non-PE backed firms, after controlling for NOLs and debt tax shields. We find additional tax savings for PE-backed portfolio firms that are either majority-owned or owned by large PE firms, consistent with PE ownership stake, expertise, and resources serving as important factors in the tax practices of portfolio firms. We infer that PE firms view tax planning as an additional source of economic value in their portfolio firms, where the benefits outweigh any potential reputational costs associated with corporate tax avoidance.
Keywords: Private equity; ownership structure; tax avoidance; tax planning; book-tax differences; cash effective tax rates; marginal tax rates.
58 pages

In Favor of Clear Thinking: Incorporating Moral Rules into a Wise Cost-benefit Analysis
No. 10-001
Max H. Bazerman and Joshua D. Greene
Negotiation, Organizations & Markets
July 2009
Complete Text (Acrobat PDF Version)

Abstract:
Bennis, Medin, and Bartels (2009) have contributed an interesting paper on the comparative benefit of moral rules versus cost-benefit analysis. Many of their specific comments are accurate, useful, and insightful. At the same time, we believe they have misrepresented cost-benefit analysis and have reached a set of conclusions that are misguided and, if adopted wholesale, potentially dangerous. Overall, they offer wise suggestions for making CBA more effective, rather than eliminating CBA as a decision-making tool.
11 pages

India Transformed? Insights from the Firm Level 1988-2005
No. 10-030
Laura Alfaro and Anusha Chari
Business, Government and the International Economy
October 2009
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Abstract:
Using firm-level data this paper analyzes, the transformation of India's economic structure following the implementation of economic reforms. The focus of the study is on publicly-listed and unlisted firms from across a wide spectrum of manufacturing and services industries and ownership structures such as state-owned firms, business groups, private and foreign firms. Detailed balance sheet and ownership information permit an investigation of a range of variables such as sales, profitability, and assets. Here we analyze firm characteristics shown by industry before and after liberalization and investigate how industrial concentration, the number, and size of firms of the ownership type evolved between 1988 and 2005. We find great dynamism displayed by foreign and private firms as reflected in the growth in their numbers, assets, sales and profits. Yet, closer scrutiny reveals no dramatic transformation in the wake of liberalization. The story rather is one of an economy still dominated by the incumbents (state-owned firms) and to a lesser extent, traditional private firms (firms incorporated before 1985). Sectors dominated by state-owned and traditional private firms before 1988-1990, with assets, sales and profits representing shares higher than 50%, generally remained so in 2005. The exception to this broad pattern is the growing importance of new and large private firms in the services sector. Rates of return also have remained stable over time and show low dispersion across sectors and across ownership groups within sectors.
JEL Classification: O12, O14, O19, L10
55 pages

Information Risk and Fair Value: An Examination of Equity Betas and Bid-Ask Spreads
No. 10-008
Edward J. Riedl and George Serafeim
Accounting and Management
July 2009
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Abstract:
Finance theory suggests that information risk—that is, the uncertainty regarding valuation parameters for an underlying asset—is reflected in firms' equity betas and the information asymmetry component of bid-ask spreads. We empirically examine these predictions for a sample of large U.S. banks, exploiting recent mandatory disclosures of financial instruments designated as fair value level 1, 2, and 3, which indicate progressively more illiquid and opaque financial instruments. Consistent with predictions, results reveal that portfolios of level 3 financial assets have higher implied betas and lead to larger bid-ask spreads relative to those designated as level 1 or level 2 assets. Both results are consistent with a higher cost of capital for banks holding more opaque financial assets, as reflected by the level 3 fair value designation.
Keywords: banks, risk, fair value, financial instruments
JEL Codes: G12, G14, G21, M41
43 pages

Input Constraints and the Efficiency of Entry: Lessons from Cardiac Surgery
No. 10-011
David M. Cutler, Robert S. Huckman, and Jonathan T. Kolstad
Technology and Operations Management
August 2009
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Abstract:
Prior studies suggest that, with elastically supplied inputs, free entry may lead to an inefficiently high number of firms in equilibrium. Under input scarcity, however, the welfare loss from free entry is reduced. Further, free entry may increase use of high-quality inputs, as oligopolistic firms underuse these inputs when entry is constrained. We assess these predictions by examining how the 1996 repeal of certificate-of-need (CON) legislation in Pennsylvania affected the market for cardiac surgery in the state. We show that entry led to a redistribution of surgeries to higher-quality surgeons and that this entry was approximately welfare neutral.
43 pages

Insider Trading Preceding Goodwill Impairments
No. 10-007
Karl A. Muller, III, Monica Neamtiu, and Edward J. Riedl
Accounting and Management
July 2009
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Abstract:
We investigate whether insiders strategically sell shares prior to the disclosure of goodwill impairment losses. We provide evidence that insiders of goodwill impairment firms engage in abnormal selling of their shares quarters prior to the announcement of such losses. In addition, of firms recording goodwill impairments, we provide evidence that those firms with insiders selling prior to the announcement of the loss face significantly more negative abnormal returns. Our findings are robust to subsample analysis examining firms reporting goodwill impairments and having low quality information environments (i.e., delayed price discovery). This isolates a setting wherein observed strategic trading behavior more likely reflects insiders' private information regarding goodwill, as opposed to other (non-goodwill related) economic performance. Overall, the results are consistent with corporate insiders being able to profit from their private information relating to a specific financial reporting element, goodwill impairments, prior to its incorporation by the equity market or recognition by the firm's accounting system.
Keywords: Goodwill, impairment, insider trading, SFAS 142
55 pages

Integrity: A Positive Model That Incorporates the Normative Phenomena of Morality, Ethics, and Legality - Abridged
No. 10-061
Werner H. Erhard, Michael C. Jensen, and Steve Zaffron
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
We present a positive model of integrity that, as we distinguish and define integrity, provides powerful access to increased performance for individuals, groups, organizations, and societies. Our model reveals the causal link between integrity and increased performance, in whatever way one chooses to define performance (for example, quality of life, or value-creation for all entities), and provides access to that causal link. Integrity is thus a factor of production as important as knowledge and technology. Yet the major role of integrity in productivity and performance has been largely hidden or unnoticed, or even ignored by economists and others.
The philosophical discourse, and common usage as reflected in dictionary definitions, leave an overlap and confusion among the four phenomena of integrity, morality, ethics, and legality. This overlap and confusion confound the four phenomena so that the efficacy and potential power of each is seriously diminished.
We show that defining integrity as honoring one's word, as we have defined "honoring one's word": 1) provides an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at the individual, organizational and social levels, and 2) empowers the three virtue phenomena of morality, ethics and legality.
We also demonstrate that applying cost-benefit analysis to honoring your word guarantees that you will be untrustworthy.
This paper, intended for use in our leadership course (see http://ssrn.com/abstract=1263835), is an abridged version of our full paper of the same title available at: http://ssrn.com/abstract=920625
This abridged paper is written under the assumption that the reader has read the following 5-page document that lays out the basic structure of our model and analysis. It is available at: http://ssrn.com/abstract=1511274
33 pages

Integrity: Without It Nothing Works
No. 10-042
Michael C. Jensen
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
There is confusion between integrity, morality and ethics. In our much longer paper on the topic (see "Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics and Legality" (available at http://ssrn.com/abstract=920625 )) my co-authors, Werner Erhard and Steve Zaffron and I, distinguish integrity, from morality and ethics in the following way. Integrity in our model is honoring your word. As such integrity is a purely positive phenomenon. It has nothing to do with good vs. bad, right vs. wrong behavior. Like the law of gravity the law of integrity just is, and if you violate the law of integrity as we define it you get hurt just as if you try to violate the law of gravity with no safety device. The personal and organizational benefits of honoring one's word are huge--both for individuals and for organizations--and generally unappreciated.
6 pages

International Differences in the Size and Roles of Corporate Headquarters: An Empirical Examination
No. 10-044
David Collis, David Young, and Michael Goold
Marketing
December 2009
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Abstract:
This paper examines differences in the size and roles of corporate headquarters around the world. Based on a survey of over 600 multibusiness corporations in seven countries (France, Germany, Holland, UK, Japan, US, and Chile) the paper describes the differences among countries, and then applies a model of the factors determining the size of corporate headquarters (Young, Collis, and Goold, 2003) to systematically examine those differences.

The data shows that there are significant differences among countries in the size and role of corporate headquarters, and strongly suggests the existence of a developing country model, a European model, a US model, and a Japanese model of corporate headquarters. Contrary to popular expectations, corporate headquarters in the US are about twice the size of European counterparts. Headquarters there exert a higher level of functional influence and have larger staffs in certain key areas, such as IT and R&D. US managers are generally more satisfied than their European counterparts with their larger more powerful headquarters which suggests that, at least in the US context, large corporate headquarters can create value.

Japanese headquarters, as might have been expected, are substantially larger than elsewhere - a factor of four times larger than in Europe. However, those headquarters are becoming smaller because of dissatisfaction with their performance. It is clear that having headquarters the size of the Japanese firms in the survey is not conducive to value creation.

More specifically, the evidence cannot refute a hypothesis that the slope of the relationship between firm size and the size of corporate headquarters is the same across all countries, but that there are significant differences in the intercept for Chile, the US, Japan, and the European countries. What the data indicates is that at a firm employing 20,000, a European corporate headquarters would on average employ 124 individuals, a US headquarters would have 255 employees, and Japan 467 employees.

The paper also examines differences between countries in the extent to which they perform the two key corporate tasks of control and coordination. The US and Chile chose to be somewhat more interventionist in the traditional tools and processes used to monitor and control business units - setting strategy, budgets, and administering capital budgets. However, there was a significant difference in the degree of influence in operational affairs between countries. The US and Japan exerted far more influence than the other countries over every activity from IT and purchasing, to marketing, R&D and HR issues.

The US was also found to have significantly larger legal, tax, and treasury functions than the common European model, perhaps reflecting a more legalistic institutional structure. Japan also has significantly larger tax, treasury, and corporate management functions, but overall was not that much larger than the common European model.

While the causes of these observed differences cannot be directly determined from the research, suggestions are made that the institutional infrastructure, the size and homogeneity of the domestic market, and cultural factors within countries are important underlying drivers.
36 pages

Investing in Improvement: Strategy and Resource Allocation in Public School Districts
No. 10-057
Stacey M. Childress
General Management
January 2010
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Abstract:
This working paper offers concrete examples of improved productivity and efficiencies at the district level, drawing from the author's experience working with districts and developing such case studies for Harvard Business School. Childress makes the point that given the rarity of the strategic approaches to resource allocation, district leaders need more guidance and tools to help them make better decisions and manage the consequences, particularly when they are under enormous fiscal pressure.
32 pages

Investment Taxation and Portfolio Performance
No. 10-084
Daniel Bergstresser and Jeffrey Pontiff
Finance
March 2010
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Abstract:
Taxes have a first-order impact on portfolio returns. Most research mistakenly assumes that portfolios command similar tax burdens, or that tax burdens are proportional to dividend yields. Portfolio strategies differ in the pace of capital gains realization. We use the federal tax codes from 1926 through 2007 to construct the after-tax returns that individual investors, corporations, and broker-dealers would have generated on a set of benchmark portfolios. For an individual at the 99th income percentile, the effective tax rates on SMB and HML, respectively, are 7 and 15 times greater than the tax rate on the market premium.
51 pages

Labor Regulations and European Private Equity
No. 08-043
Ant Bozkaya and William R. Kerr
Entrepreneurial Management
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
European nations substitute between employment protection regulations and labor market expenditures (e.g., unemployment insurance benefits) for providing worker insurance. Employment regulations more directly tax firms making frequent labor adjustments than other labor insurance mechanisms. Venture capital and private equity investors are especially sensitive to these labor adjustment costs. Nations favoring labor expenditures as the mechanism for providing worker insurance developed stronger private equity markets in high volatility sectors over 1990-2004. These patterns are further evident in US investments into Europe. In this context, policy mechanisms are more important than the overall insurance level provided.
Keywords: employment protection regulations, dismissal costs, unemployment insurance benefits, private equity, venture capital, buy-outs, entrepreneurship.
JEL codes: G24, J21, J65, L26, M13, O31, O32, O52.
37 pages

Local R&D Strategies and Multi-location Firms: The Role of Internal Linkages
No. 10-064
Juan Alcacer and Minyuan Zhao
Strategy
February 2010
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Abstract:
This study looks at the role of firms' internal linkages in highly competitive technology clusters, where much of the world's R&D takes place. The leading players in these clusters are multi-location firms that organize and integrate knowledge across sites worldwide. Strong internal links across locations allow these firms to leverage knowledge for competitive advantage without risking critical knowledge outflow to competitors. We examine whether multi-location firms increase internal ties when they face appropriability risks from direct competitors. Our empirical analysis of the global semiconductor industry shows that when leading firms co-locate with direct market competitors, innovations tend to be quickly internalized, and are more likely to involve collaboration across locations, particularly with inventors from the firm's primary R & D site. Our results suggest that R&D dynamics in clusters are heavily influenced by multi-location firms with innovative links across locations, and that future research on technology innovation in clusters should account for these links.
Keywords: technology clusters, knowledge spillover, internalization, appropriability.
33 pages

Location Strategies for Agglomeration Economies
No. 10-071
Juan Alcácer and Wilbur Chung
Strategy
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
Geographically concentrated industry activity creates pools of skilled labor and specialized suppliers, and increases opportunities for knowledge spillovers. The strategic value of these agglomeration economies may vary by firm, depending upon the relative value of each economy, and upon firm and agglomeration economy traits. To better determine when a firm will be attracted to agglomeration economies, we develop a three-layer framework. The first layer assesses the relative importance of skilled labor, suppliers, and knowledge spillovers. The second layer considers whether firms can benefit from geographic concentration without co-locating. The final layer examines why some firms are more inclined to co-locate than others based upon firm and agglomeration economy traits. We test our framework on the U.S. location choices of new manufacturing entrants between 1985 and 1994 and find that firms are far more attracted to skilled labor and specialized suppliers than they are to potential knowledge spillovers, even in R&D intensive industries. We also find that leading firms will be more attracted to pools of labor, suppliers, and potential knowledge spillovers when their own contributions are less fungible, and cannot be easily leveraged for strategic advantage by proximate competitors.
Keywords: agglomeration economies, location choice, firm strategy
JEL Classifications: R30, R12, L21
38 pages

Management and the Financial Crisis (We have met the enemy and he is us …)
No. 10-033
William A. Sahlman
Entrepreneurial Management
October 2009
Complete Text (Acrobat PDF Version)

Abstract:
The financial crisis of 2008-9 has revealed that our broad model of corporate governance is broken, independent of the shortcomings in the regulatory system. Managers and boards of directors in scores of systemically important firms failed to protect employees, customers, or shareholders, and placed the global financial system at risk. I assert that the root cause of the crisis can be found in five related systems: incentives; risk management and control; accounting; human capital; and culture. The worst firms had lethal combinations of strong incentives, weak control and risk management, flawed internal and external accounting, low skill and/or low integrity people, and corrosive cultures.

Piecemeal attempts to fix elements of corporate governance will fail. The problem, to illustrate, is not just the structure of compensation. Nor will increasing required capital prevent problems at companies with strong incentives and weak controls. I believe that we may need a new kind of external agency for systemically risky firms that would take a holistic look at the five systems to identify weaknesses, make recommendations to managers and boards, and set regulatory policies, including assessing charges for insuring against losses. Without such a comprehensive assessment and improvement plan, boards cannot do their jobs, and the system will remain as subject to calamitous events as it was before the crisis.
36 pages

The Many Faces of Nonprofit Accountability
No. 10-069
Alnoor S. Ebrahim
General Management
February 2010
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Abstract:
What does it mean for a nonprofit organization to be accountable? Nonprofit leaders tend to pay attention to accountability once a problem of trust arises - a scandal in the sector or in their own organization, questions from citizens or donors who want to know if their money is being well spent, or pressure from regulators to demonstrate that they are serving a public purpose and thus merit tax-exempt status. Amid this clamor for accountability, it is tempting to accept the popular view that more accountability is better. But is it feasible, or even desirable, for nonprofit organizations to be accountable to everyone for everything? The challenge for leadership and management is to prioritize among competing accountability demands. This involves deciding both to whom and for what they owe accountability. This paper provides an overview of the accountability pressures facing nonprofit leaders, and examines several mechanisms available to them: disclosures, performance evaluations, self-regulation, participation, and adaptive learning. Nonprofit leaders must adapt any such mechanisms to suit their organization - be it a membership-based organization, a service-delivery nonprofit, or an advocacy network. More crucially, they need to pay greater attention to strategy-driven forms of accountability that can help them to achieve their missions.
33 pages

Matching Firms, Managers, and Incentives
No. 10-073
Oriana Bandiera, Luigi Guiso, Andrea Prat, and Raffaella Sadun
Strategy
March 2010
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Abstract:
We provide evidence on the match between firms, managers, and incentives using a new survey that contains information on managers' risk preferences and human capital, on their compensation schemes, and on the firms they work for. The data is consistent with the equilibrium correlations predicted by a model where firms with different ownership structure and managers with different risk aversion and talent match endogenously through incentive contracts. The model predicts and the data support that, compared to widely-held firms, family firms use contracts that are less sensitive to performance; these contracts attract less talented and more risk averse managers; these managers work less hard, earn less, and display lower job satisfaction.
51 pages

Medium Term Business Cycles in Developing Countries
No. 10-029
Diego Comin, Norman Loayza, Farooq Pasha, and Luis Serven
Business, Government and the International Economy
October 2009
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Abstract:
We build a two country asymmetric DSGE model with two features: (i) a product cycle structure determines the range of intermediate goods used to produce new capital in each country and (ii) there are investment flow adjustment costs in the developing economy. We calibrate the model to match the Mexico-US trade and FDI flows. The model is able to explain (i) why US shocks have a larger effect on Mexico than in the US and hence why the Mexican economy is more volatile than the US; (ii) why US business cycles lead over medium term fluctuations in Mexico and (iii) why Mexican consumption is not less volatile than output.
Keywords: Business Cycles in Developing Countries, Co-movement between Developed and Developing economies, Volatility, Extensive Margin of Trade, Product Life Cycle, FDI.
JEL Classification: E3, O3.
58 pages

Mental Health in the Aftermath of Conflict
No. 10-040
Quy-Toan Do and Lakshmi Iyer
Business, Government and the International Economy
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
We survey the recent literature on the mental health effects of conflict. We highlight the methodological challenges faced in this literature, which include the lack of validated mental health scales in a survey context, the difficulties in measuring individual exposure to conflict, and the issues related to making causal inferences from observed correlations. We illustrate how some of these issues can be overcome in a study of mental health in post-conflict Bosnia and Herzegovina. Mental health is measured using a clinically validated scale; conflict exposure is proxied by administrative data on war casualties instead of being self-reported. We find that there are no significant differences in overall mental health across areas which are affected by ethnic conflict to a greater or lesser degree.
27 pages

The Mirroring Hypothesis: Theory, Evidence and Exceptions
No. 10-058
Lyra Colfer and Carliss Y. Baldwin
Finance
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
The mirroring hypothesis asserts that the organizational patterns of a development project (e.g. communication links, geographic collocation, team and firm co-membership) will correspond to the technical patterns of dependency in the system under development. Thus the hypothesis predicts that developers with few or no organizational linkages will design independent system components, while developers with rich organizational linkages will co-design highly interdependent system components. (The hypothesis claims a correspondence between organizational structure and technical architecture, but allows causality to flow in either direction.)

Scholars in a range of disciplines have argued that mirroring is either a necessary or highly desirable feature in the design of development projects, but empirical research shows that some projects deviate from strict mirroring, seemingly without harmful effects. In this paper, we formally define the mirroring hypothesis, describe its theoretical underpinnings and systematically review the empirical evidence for and against it. Our review includes 129 studies spanning three levels of organization: within a single firm, across firms, and open community-based development. Across these levels, the hypothesis was supported in 69% of the relevant cases, but not supported in 31%. It was most strongly supported within firms, less strongly across firms, and often violated in community-based development settings.

The exceptions in turn were of two types: In four cases, closely collaborating teams within single firms created modular systems comprised of independent components. More surprisingly, in 28 cases, independent and dispersed contributors made highly interdependent contributions to the design of a single technical system (or sub-system). Based on a detailed analysis of the latter 28, we introduce the concept of actionable transparency as a means of achieving coordination without mirroring. Contributors achieve actionable transparency by embedding their design in a centralized system with a shared design language and near-real-time updating, where everyone with an interest in improving the design has the right and the means to act on it. We present examples from practice and then describe the more complex organizational patterns that emerge in lieu of genuine mirroring when actionable transparency allows people to "break the mirror."
47 pages

Mixed Source
No. 10-022
Ramon Casadesus-Masanell and Gastón Llanes
Strategy
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
We study competitive interaction between profit-maximizing firms that sell software and complementary goods or services. In addition to tactical price competition, we allow firms to compete through business model reconfigurations. We consider three business models: the proprietary model (where all software modules offered by the firm are proprietary), the open source model (where all modules are open source), and the mixed source model (where a few modules are open). When a firm opens one of its modules, users can access and improve the source code. At the same time, however, opening a module sets up an open source (free) competitor. This hampers the firm's ability to capture value. We analyze three competitive situations: monopoly, commercial firm vs. non-profit open source project, and duopoly. We show that: (i) firms may become "more closed" in response to competition from an outside open source project; (ii) firms are more likely to open substitute, rather than complementary, modules to existing open source projects; (iii) when the products of two competing firms are similar in quality, firms differentiate through choosing different business models; and (iv) low-quality firms are generally more prone to opening some of their technologies than firms with high-quality products.
Keywords: Open Source, User Innovation, Business Models, Complementarity, Vertical Differentiation, Value Creation, Value Capture
JEL Codes: O31, L17, D43
59 pages

Multinational Strategies and Developing Countries in Historical Perspective
No. 10-076
Geoffrey Jones
Entrepreneurial Management
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
This working paper offers a longitudinal and descriptive analysis of the strategies of multinationals from developed countries in developing countries. The central argument is that strategies were shaped by the trade-off between opportunity and risk. Three broad environmental factors determined the trade-off. The first was the prevailing political economy, including the policies of both host and home governments, and the international legal framework. The second was the market and resources of the host country. The third factor was competition from local firms. The impact of these factors on corporate strategies is explored, as shown in Fig. 1, during the three eras in the modern history of globalization from the nineteenth century until the present day. The performance of specific multinationals depended on the extent to which their internal capabilities enabled them to respond to these external opportunities and threats.
58 pages

Negotiating the Path of Abraham
No. 10-049
Kimberlyn Leary, James K. Sebenius, and Joshua Weiss
Negotiation, Organizations & Markets
December 2009
Complete Text (Acrobat PDF Version)

Abstract:
In the face of daunting barriers, the Abraham Path Initiative envisions uncovering and revitalizing a route of cultural tourism that follows the path of Abraham and his family some 4000 years ago across the Middle East. It begins in the ancient ruins of Harran, in modern-day Turkey, where Abraham first heard the call to "go forth." It passes through some of the world's most revered cultural, historical, and holy sites, ending in the city of Hebron/Al-Khalil at the tomb of Abraham. With Abraham as a venerated patriarchal figure for Islam, Judaism, and Christianity-monotheistic religions whose adherents have so often clashed--the potential unifying power of this conception has attracted a remarkable range of supporters from around the world. From a notion crystallized at Harvard in 2004, this idea has been carefully negotiated into a concrete reality with supporting country organizations in Syria, Turkey, Jordan, Palestine2, and Israel. If completed, it would eventually extend to encompass Abraham's travels to and from Egypt, Iraq, and Saudi Arabia. With the endorsement of the U.N.'s Alliance of Civilizations, over three hundred kilometers of the Path have now been opened to a fast-growing number of travelers ranging from student study groups to Syrian President al-Assad walking a stretch of the path with former U.S. President Jimmy Carter. As it takes fuller shape, the Path variously serves as a catalyst for sustainable tourism and economic development, a platform for the energy and idealism of young people, a beacon for pilgrims and peace-builders, as well as a focus for seemingly endless media inquiries from reporters, documentary film-makers, and writers keen on telling its story to audiences worldwide. This paper provides background on the Path in terms of strategic negotiation, social entrepreneurship, sustainable tourism, and economic development.
42 pages

A New Model of Leadership (PDF File of Keynote Slides)
No. 07-107
Micheal C. Jensen and Allan L. Scherr
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
In this paper we provide a new definition of leadership that gives organizations and individuals access to new power, performance and accomplishment. In our model leadership consists of four critical elements:

The creation of a vision for the future that represents a significant departure from the past, one that requires breakthroughs for its realization.
The creation of a system that facilitates enrollment into and elicits voluntary commitment to the vision by the critical mass of people required to discover and implement the breakthroughs required for realization of the vision.
The creation of a system that ensures both the timely identification of breakdowns (and the dissemination of information about them) that, if unresolved, would prevent the successful realization of the vision.
The creation of a system for managing breakdowns that causes people to voluntarily recommit to the vision and maintain these commitments through to the implementation of the breakthroughs required for the realization of the vision.

36 pages

On the Descriptive Value of Loss Aversion in Decisions under Risk
No. 10-056
Eyal Ert and Ido Erev
January 2010
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Abstract:
Five studies are presented that explore the assertion that losses loom larger than gains. The first two studies reveal equal sensitivity to gains and losses. For example, half of the participants preferred the gamble "1000 with probability 0.5; -1000 otherwise" over "0 with certainty." Studies 3, 4, and 5 address the apparent discrepancy between these results and the evidence for loss aversion documented in previous research. The results reveal that only under very specific conditions does the pattern predicted by the loss aversion assertion emerge. This pattern does not emerge in short experiments or in the first 10 trials of long experiments. Nor does it emerge in long experiments with two-outcome symmetric gambles, or in long experiments with asymmetric multi-outcome gambles. The observed behavior, in these settings, reflects risk neutrality in choice among low-magnitude mixed gambles.
JEL Classification: C91, D01.
37 pages

Opening Up or Shutting Down? The Effects of Multiple Identities on Problem Solving
No. 10-041
Lakshmi Ramarajan
Organizational Behavior
November 2009
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Abstract:
Across three studies, I investigate the distinct effects of multiple identity conflict and enhancement within people on two crucial aspects of resolving problems with others: integrative behavior and openness. The results of two studies support the hypotheses that multiple identity conflict is negatively related to integrative thinking while multiple identity enhancement is positively related to attitudes of openness to others. In a third study, I conducted an interpersonal dyadic negotiation experiment with business school students and found that, as predicted, these effects replicated and extended to integrative outcomes and open behaviors. This research shows that there are both harmful and helpful effects of multiple identities on interpersonal problem solving depending on whether those identities are enhancing or conflicting: multiple identity conflict shuts down integrative thought and behavior and multiple identity enhancement opens us up to other people.
Keywords: multiple identities, identity conflict, identity enhancement, problem solving, integrative complexity, integrative outcomes, openness, conflict management
69 pages

Operational Failures and Problem Solving: An Empirical Study of Incident Reporting
No. 10-017
Julia Adler-Milstein, Sara J. Singer, and Michael W. Toffel
Technology and Operations Management
August 2009
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Abstract:
Operational failures occur in all industries with consequences that range from minor inconveniences to major catastrophes. Many organizations have implemented incident reporting systems to highlight actual and potential operational failures in order to encourage problem solving and prevent subsequent failures. Our study is among the first to develop and empirically test theory regarding which reported operational failures are likely to spur problem solving. We hypothesize that problem solving activities are especially likely to follow reported operational failures that provoke financial and legal liability risks. We also hypothesize that management commitment to problem solving, enacted through managers' communication and engagement practices, can encourage frontline workers to conduct problem solving. We test our hypotheses in the health care context, in which the use of incident reporting systems to highlight operational failures is widespread. Using data on nearly 7,500 reported incidents from a single hospital, we find support for our hypotheses. Our findings suggest that frontline workers' participation in problem solving is motivated by some inherent characteristics of the problems as well as by particular management practices.
43 pages

Optimal Auction Design and Equilibrium Selection in Sponsored Search Auctions
No. 10-054
Benjamin G. Edelman and Michael Schwarz
Negotiation, Organizations & Markets
January 2010
Complete Text (Acrobat PDF Version)

8 pages

Patent policy, patent pools, and the accumulation of claims in sequential innovation
No. 10-005
Gastón Llanes and Stefano Trento
Entrepreneurial Management
July 2009
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Abstract:
We present a dynamic model where the accumulation of patents generates an increasing number of claims on sequential innovation. We study the equilibrium innovation activity under three regimes: patents, no-patents and patent pools. Patent pools increase the probability of innovation with respect to patents, but we also find that: (1) their outcome can be replicated by a licensing scheme in which innovators sell complete patent rights, and (2) they are dynamically unstable. We find that none of the above regimes can reach the first or second best. Finally, we consider patents of finite duration and determine the optimal patent length.
Keywords: Sequential Innovation, Patent Pools, Anticommons
JEL Codes: L13, O31, O34
34 pages

Private Equity and Industry Performance
No. 10-045
Shai Bernstein, Josh Lerner, Morten Sørensen and Per Strömberg
Finance, Entrepreneurial Management
December 2009
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Abstract:
The growth of the private equity industry has spurred concerns about its potential impact on the economy more generally. This analysis looks across nations and industries to assess the impact of private equity on industry performance. Industries where PE funds have invested in the past five years have grown more quickly in terms of productivity and employment. There are few significant differences between industries with limited and high private equity activity. It is hard to find support for claims that economic activity in industries with private equity backing is more exposed to aggregate shocks. The results using lagged private equity investments suggest that the results are not driven by reverse causality. These patterns are not driven solely by common law nations such as the United Kingdom and United States, but also hold in Continental Europe.
40 pages

A Reexamination of Tunneling and Business Groups: New Data and New Methods
No. 10-072
Jordan I. Siegel and Prithwiraj Choudhury
Strategy
February 2010
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Abstract:
The last decade of corporate governance research has been focused in large part on identifying what leads to superior or deficient corporate governance in emerging economies, and we think the conventional wisdom about the economically important topics of tunneling and business groups will need to be significantly questioned and reformulated in light of new findings, data, and methodology presented here. We propose the idea that firms' corporate governance and firms' strategic business activities within an industry are interlinked, and that only by conducting a simultaneous economic analysis of business strategy and corporate governance can scholars fully discern the quality of a firm's governance. We advance this idea by taking a fresh look at one of the most rigorous extant methodologies for detecting "tunneling," or efforts by firms' controlling ownermanagers to take money for themselves at the expense of minority shareholders. We show that efforts to discern which firms have superior or deficient corporate governance in the important emerging economy of India turn critically on whether one does a simultaneous economic analysis of business strategy and corporate governance. We find in contrast to prior views that Indian business groups are not, on average, engaging in tunneling, but are on average exhibiting good corporate governance, especially in light of the markedly different business strategies they typically undertake. Moreover, unlike many past conceptions of business groups from financial economics, sociology, and strategy, we find evidence for a knowledge-based "recombinative capabilities" view of business groups-that such groups have done the most to invest in R&D and other skills necessary to combine inputs in ways that lead to greater added value. Moreover, our finding that Indian business groups have grown larger and more diversified since liberalization and since broad-based corporate governance reforms were implemented, goes expressly against the prediction of prior schools of thought about business groups.
52 pages

Repetition of Interaction and Learning: An Experimental Analysis
No. 10-016
Bradley R. Staats, Francesca Gino, and Gary P. Pisano
Technology and Operations Management
August 2009
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Abstract:
The learning curve is used to investigate how increasing cumulative experience yields improved performance. Experience, however, can take many forms. Building on recent studies on learning in operations, we distinguish between repetition of task (i.e., prior experience with the task) and repetition of interaction (i.e., prior experience with team members). Repetition of interaction may improve learning, since experience working together aids in the identification, transfer, and application of knowledge among members within a group. Additionally, experience need not be constrained to one task. Prior work examining the relationship of multiple tasks (i.e., varied experience) and learning by groups finds inconsistent results. We hypothesize that repetition of interaction may help explain this difference, as familiar teams may be able to use the knowledge gained from the concurrent completion of multiple tasks while unfamiliar teams may not. Using an experimental study we find that while repetition of interaction has no effect on initial performance, it has a persistent effect on learning. By separately examining the repetition of interaction and repetition of task our work offers new insights and direction for the study of learning in operations.
Keywords:Learning, Repetition of interaction, Repetition of task, Team familiarity, Varied experience
34 pages

Specific Knowledge and Divisional Performance Measurement
No. 10-025
Michael C. Jensen and William H. Meckling
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
This paper discusses five common divisional performance measurement methods—cost centers, revenue centers, profit centers, investment centers, and expense centers—while providing a theory that explains when each of these methods is likely to be the most efficient. The central insight of the theory is that each method offers a different way of aligning decision-making authority with valuable "specific knowledge" inside the organization.

The theory suggests that cost and revenue centers work best in cases where headquarters has good information about cost and demand functions, product quality, and optimal output mix. Profit centers—defined as business units whose managers have responsibility for overall profits, but not the authority to make major capital spending decisions—tend to supplant revenue and cost centers when line managers have a significant informational advantage over headquarters and when there are few interdependencies (or "synergies") between divisions. Investment centers—profit centers in which unit managers are allowed to make major investment decisions—tend to prevail when the activity is capital-intensive and when it is difficult for headquarters to identify the value-maximizing investment strategy for the business unit.

In evaluating the performance of profit centers, rate-of-return measures like ROA are likely to be effective when unit managers do not have major influence over the level of new investment. But, in the case of investment centers, Economic Value Added, or EVA, is likely to be the most effective single-period measure because it is designed to encourage only value-increasing investment decisions.
13 pages

State Owned Entity Reform in Absence of Privatization: Reforming Indian National Laboratories and Role of Leadership
No. 10-006
Prithwiraj Choudhury and Tarun Khanna
Strategy
July 2009
Complete Text (Acrobat PDF Version)

Abstract:
The literature on state-owned entity (SOE) reform has been focused on privatization. We however show that even in the absence of property rights, SOEs may significantly improve performance and document 42 Indian state-owned laboratories over 1993-2006 starting from a base of negligible U.S. patents, being granted more patents than all domestic private firms combined. Patent licensing revenue increases from 3% to 15% as a fraction of government budget without negatively affecting publication quality and quantity. This follows incentive policy change and leadership change at labs, an event whose timing is plausibly exogenous being dictated by government employment rules.
32 pages

Stock Price Fragility
No. 10-031
Robin Greenwood and David Thesmar
Finance
October 2009
Complete Text (Acrobat PDF Version)

Abstract:
We investigate the relationship between ownership structure of financial assets and non-fundamental risk. An asset is fragile if its owners collectively have to buy or sell. Such assets are susceptible to non-fundamental price movements. An asset can be fragile because of concentrated ownership, or because its owners face correlated liquidity shocks, ie., they must buy or sell at the same time. Two assets are "co-fragile" if their owners have correlated trading needs, even if the holdings of these owners do not directly overlap. We formalize this idea and apply it to the ownership of US stocks between 1990 and 2007. Consistent with our predictions, fragility strongly predicts future price volatility, and co-fragility predicts cross-stock return comovement.
48 pages

The Strategic Use of Architectural Knowledge by Entrepreneurial Firms
No. 10-063
Carliss Y. Baldwin
Finance
February 2010
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Abstract:
This paper describes how entrepreneurial firms can use superior architectural knowledge of a technical system to gain strategic advantage. The strategy involves, first, identifying "bottlenecks" in the existing system, and then creating a new architecture that isolates the bottlenecks in modules. An entrepreneurial firm with limited financial resources can then focus on supplying superior bottleneck components, and while outsourcing non-bottleneck components. I show that a firm pursuing this strategy will have a higher return on invested capital (ROIC) than competitors with a less modular design. Over time, the focal firm can drive the ROIC of competitors below their cost of capital, causing them to shrink and possibly exit the market. The strategy was used by Sun Microsystems in the 1980s and Dell Computer in the 1990s.
Keywords: architecture, innovation, knowledge, modularity, dynamics, competition, industry evolution
JEL Classification: D23, L22, L23, M11, O31, O34, P13
40 pages

Strategies to Fight Ad-sponsored Rivals
No. 10-026
Ramon Casadesus-Masanell and Feng Zhu
Strategy
September 2009, revised March 2010
Complete Text (Acrobat PDF Version)

Abstract:
We analyze the optimal strategy of a high-quality incumbent that faces a low-quality ad-sponsored competitor. In addition to competing through adjustments of tactical variables such as price or the number of ads a product carries, we allow the incumbent to consider changes in its business model. We consider four alternative business models, a subscription-based model, an ad-sponsored model, a mixed model in which the incumbent offers a product that is both subscription-based and ad-sponsored, and a dual model in which the incumbent offers two products, one based on the ad-sponsored model and the other based on the mixed business model. We show that the optimal response to an ad-sponsored rival often entails business model reconfigurations. We also find that when there is an ad-sponsored entrant, the incumbent is more likely to prefer to compete through the subscription-based or the ad-sponsored model, rather than the mixed or the dual model, because of cannibalization and endogenous vertical differentiation concerns. We discuss how our study helps improve our understanding of notions of strategy, business model, and tactics in the field of strategy.
34 pages

Stretching the Inelastic Rubber: Taxation, Welfare and Lobbies in Amazonia, 1870-1910
No. 10-032
Felipe Tâmega Fernandes
Entrepreneurial Management
October 2009
Complete Text (Acrobat PDF Version)

Abstract:
This paper examines the effect of government intervention via taxation on domestic welfare. A case-study of Brazilian market power on rubber markets during the boom years of 1870-1910 shows that the government generated 1.3% of GDP through an export tax on rubber but that it could have generated 4.7% in total, had the government set the tariff at the optimal level. National, regional and local constraints prevented the government from maximizing regional welfare. In a context of lobbies, government budget maximization may have differed from regional welfare maximization.
Keywords: Rubber, Commodities, Market Power, Optimal Tariff, Welfare, Trade and Brazil.
JEL Codes: F14, H21, L13, L73, and N76.
43 pages

Substitution Patterns of the Random Coefficients Logit
No. 10-053
Thomas J. Steenburgh and Andrew Ainslie
Marketing
January 2010
Complete Text (Acrobat PDF Version)

Abstract:
Previous research suggests that the random coefficients logit is a highly flexible model that overcomes the problems of the homogeneous logit by allowing for differences in tastes across individuals. The purpose of this paper is to show that this is not true. We prove that the random coefficients logit imposes restrictions on individual choice behavior that limit the types of substitution patterns that can be found through empirical analysis, and we raise fundamental questions about when the model can be used to recover individuals' preferences from their observed choices.
Part of the misunderstanding about the random coefficients logit can be attributed to the lack of cross-level inference in previous research. To overcome this deficiency, we design several Monte Carlo experiments to show what the model predicts at both the individual and the population levels. These experiments show that the random coefficients logit leads a researcher to very different conclusions about individuals' tastes depending on how alternatives are presented in the choice set. In turn, these biased parameter estimates affect counterfactual predictions. In one experiment, the market share predictions for a given alternative in a given choice set range between 17% and 83% depending on how the alternatives are displayed both in the data used for estimation and in the counterfactual scenario under consideration. This occurs even though the market shares observed in the data are always about 50% regardless of the display.
41 pages

Systemic Risk and the Refinancing Ratchet Effect
No. 10-023
Amir E. Khandani, Andrew W. Lo, and Robert C. Merton
Finance
September 2009
Complete Text (Acrobat PDF Version)

Abstract:
The confluence of three trends in the U.S. residential housing market—rising home prices, declining interest rates, and near-frictionless refinancing opportunities—led to vastly increased systemic risk in the financial system. Individually, each of these trends is benign, but when they occur simultaneously, as they did over the past decade, they impose an unintentional synchronization of homeowner leverage. This synchronization, coupled with the indivisibility of residential real estate that prevents homeowners from deleveraging when property values decline and homeowner equity deteriorates, conspire to create a "ratchet" effect in which homeowner leverage is maintained or increased during good times without the ability to decrease leverage during bad times. If refinancing-facilitated homeowner-equity extraction is sufficiently widespread-as it was during the years leading up to the peak of the U.S. residential real-estate market-the inadvertent coordination of leverage during a market rise implies higher correlation of defaults during a market drop. To measure the systemic impact of this ratchet effect, we simulate the U.S. housing market with and without equity extractions, and estimate the losses absorbed by mortgage lenders by valuing the embedded put-option in non-recourse mortgages. Our simulations generate loss estimates of $1.5 trillion from June 2006 to December 2008 under historical market conditions, compared to simulated losses of $280 billion in the absence of equity extractions.
Keywords: Systemic Risk; Financial Crisis; Household Finance; Real Estate; Subprime
JEL Codes: G01, G12, G13, G18, G21, E17, E27, E37, E47, R21, R38
68 pages

Modeling a Paradigm Shift: From Producer Innovation to User and Open Collaborative Innovation
No. 10-038
Carliss Y. Baldwin and Eric von Hippel
Finance
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
In this paper we assess the economic viability of innovation by producers relative to two increasingly important alternative models: innovations by single user individuals or firms, and open collaborative innovation projects. We analyze the design costs and architectures and communication costs associated with each model. We conclude that innovation by individual users and also open collaborative innovation increasingly compete with - and may displace - producer innovation in many parts of the economy. We argue that a transition from producer innovation to open single user and open collaborative innovation is desirable in terms of social welfare, and so worthy of support by policymakers.
36 pages

Walking the Talk in Multiparty Bargaining: An Experimental Investigation
No. 10-039
Kathleen L. McGinn, Katherine L. Milkman, and Markus Nöth
Negotiation, Organizations & Markets
November 2009
Complete Text (Acrobat PDF Version)

Abstract:
We study the framing effects of communication in multiparty bargaining. Communication has been shown to be more truthful and revealing than predicted in equilibrium. Because talk is preference-revealing, it may effectively frame bargaining around a logic of fairness or competition, moving parties on a path toward or away from equal-division agreements. These endogenous framing effects may outweigh any overall social utility effects due to the mere presence of communication. In two experiments, we find that non-binding talk of fairness within a three-party, complete-information game leads toward off-equilibrium, equal division payoffs, while non-binding talk focusing on competitive reasoning moves parties away from equal divisions. Our two studies allow us to demonstrate that spontaneous within-game dialogue and manipulated pre-game talk lead to the same results.
Keywords: communication, fairness, bargaining
JEL Codes: C72, C78, D03, D74
28 pages

Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances
No. 10-083
Daniel Bergstresser and John Beshears
Finance
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
We find evidence that households selecting adjustable-rate mortgages (ARMs) during the recent decade were disproportionately those who were less suspicious or who may have had difficulty understanding complicated ARM features that became commonplace prior to the financial crisis.
Keywords: Mortgages, Brokers, Adjustable-Rate Mortgages.
49 pages

Why do firms use non-linear incentive schemes? Experimental evidence on sorting and overconfidence
No. 10-078
Ian Larkin and Stephen Leider
Negotiation, Organizations & Markets
March 2010
Complete Text (Acrobat PDF Version)

Abstract:
Non-linear incentive schemes are commonly used to determine employee pay, despite their distortionary impact. We investigate possible reasons for their widespread use by examining the relationship between convex pay schemes and overconfidence. In a laboratory experiment, subjects chose between a piece rate and a convex pay scheme. We find that overconfident subjects are more likely than others to choose the convex scheme, even when it leads to lower pay. Overconfident subjects also persist in making the mistake despite clear feedback. These results suggest non-linear pay schemes may help companies select and retain overconfident workers, and may reduce the wage bill.
35 pages

Will I Stay or Will I Go? Cooperative and Competitive Effects of Workgroup Sex and Race Composition on Turnover
No. 10-066
Kathleen L. McGinn and Katherine L. Milkman
Negotiation, Organizations & Markets
February 2010
Complete Text (Acrobat PDF Version)

Abstract:
We develop an integrated theory of the social identity mechanisms linking workgroup sex and race composition across levels with individual turnover. Building on social identity research, we theorize that social cohesion (Tyler, 1999; Hogg and Terry, 2000) and social comparison (Festinger, 1954) lead to well-known cooperative effects within subordinate-supervisor pairs of the same sex and race, but potentially competitive effects among demographically similar peers. Analyzing longitudinal human resource data on professionals employed in a large up-or-out knowledge organization, we assess the distinct effects of demographic match with superiors and demographic match with peers on the exit of junior professionals. We find largely cooperative effects of cross-level composition-junior professionals who work in groups with higher proportions of same sex senior professionals are less likely to exit. At the peer level, however, these effects are reversed, and professionals are more likely to leave as the proportions of same sex and race peers within the workgroup increase. The effects hold across demographic groups, but vary by majority/minority status, disproportionately affecting women and underrepresented minorities.
48 pages

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