Finance

Finance is a featured research topic at Harvard Business School.

Our intellectual roots are based in a long line of scholars from Robert Merton whose collaborative work on risk management and option pricing won him the Nobel Prize in Economics in 1997, to John Lintner who co-created the Capital Asset Pricing Model and made significant contributions to dividend policy, and Gordon Donaldson whose work helped shape the field of corporate finance. We strive to understand how managers and firms make value-enhancing decisions; and how financial institutions, markets, and instruments contribute to this process. Our approach to research is distinguished by its unique combination of theory, empirical analysis, mathematical modeling, and field observations at companies.

Featured Works

Working Paper | 2016
Playing Favorites: How Firms Prevent the Revelation of Bad News
Lauren Cohen, Dong Lou and Christopher J. Malloy
We explore a subtle but important mechanism through which firms can control information flow to the markets. We find that firms that “cast” their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 149 basis points per month, or almost 18 percent per year. We find similar evidence in an international sample of earnings call transcripts from the UK, Canada, France, and Japan. Firms with higher discretionary accruals, firms that barely meet/exceed earnings expectations, and firms (and their executives) that are about to issue equity, sell shares, and exercise options, are all significantly more likely to cast their earnings calls.
Keywords: Information; Strategy; Ethics;

Citation:
Cohen, Lauren, Dong Lou, and Christopher J. Malloy. "Playing Favorites: How Firms Prevent the Revelation of Bad News." Working Paper, October 2016. (Winner of 2014 Crowell Memorial Prize For the best paper on quantitative investing, PanAgora Asset Management, Inc. 2014.) View Details
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Article | American Economic Review: Papers and Proceedings | May 2014
Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment
Shawn A. Cole, Daniel Stein and Jeremy Tobacman
This paper estimates how experimentally-manipulated experiences with a novel financial product, rainfall index insurance, affect subsequent insurance demand. Using a seven-year panel, we develop three main findings. First, recent experience matters for demand, consistent with overinference from small samples. Second, spillovers also matter, in the sense that the recent payout experience of village co-residents affects insurance demand about as much as one's own recent payout experience. Third, the spillover effect decays as time passes while the effect of one's own experience does not. We discuss implications of this analysis for commercial sustainability of this complicated but promising risk management technology.

Citation:
Cole, Shawn A., Daniel Stein, and Jeremy Tobacman. "Dynamics of Demand for Index Insurance: Evidence from a Long-Run Field Experiment." American Economic Review: Papers and Proceedings 104, no. 5 (May 2014): 284–290. View Details
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Article | Review of Financial Studies | 2014
Expectations of Returns and Expected Returns
Robin Greenwood and Andrei Shleifer
We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.
Keywords: Performance Expectations; Investment Return;

Citation:
Greenwood, Robin, and Andrei Shleifer. "Expectations of Returns and Expected Returns." Review of Financial Studies 27, no. 3 (March 2014): 714–746. (Internet Appendix Here.) View Details
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Article | Journal of Financial Economics | August 2014
Mortgage Convexity
Samuel G. Hanson
Most home mortgages in the United States are fixed-rate loans with an embedded prepayment option. When long-term rates decline, the effective duration of mortgage-backed securities (MBS) falls due to heightened refinancing expectations. I show that these changes in MBS duration function as large-scale shocks to the quantity of interest rate risk that must be borne by professional bond investors. I develop a simple model in which the risk tolerance of bond investors is limited in the short run, so these fluctuations in MBS duration generate significant variation in bond risk premia. Specifically, bond risk premia are high when aggregate MBS duration is high. The model offers an explanation for why long-term rates could appear to be excessively sensitive to movements in short rates and explains how changes in MBS duration act as a positive-feedback mechanism that amplifies interest rate volatility. I find strong support for these predictions in the time series of US government bond returns.
Keywords: Mortgages; Interest Rates; Volatility;

Citation:
Hanson, Samuel G. "Mortgage Convexity." Journal of Financial Economics 113, no. 2 (August 2014): 270–299. (Internet Appendix Here.) View Details
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Working Paper | 2014
Financial Repression in the European Sovereign Debt Crisis
Bo Becker and Victoria Ivashina
By the end of 2013, the share of government debt held by the domestic banking sectors of Eurozone countries was more than twice its 2007 level. We show that this type of increasing reliance on the domestic banking sector for absorbing government bonds generates a crowding out of corporate lending. For a given domestic firm, new debt is less likely to be a loan—i.e., the loan supply contracts—when local banks have purchased more domestic sovereign debt and when that debt is risky (as measured by CDS spreads). These effects are most pronounced in the period following the second Greek bailout in early 2010.
Keywords: Credit Cycles; Sovereign debt; Financial Repression; Sovereign Finance; Greece;

Citation:
Becker, Bo, and Victoria Ivashina. "Financial Repression in the European Sovereign Debt Crisis." Working Paper, April 2014. View Details
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Recent Publications

Case | HBS Case Collection | September 2020
Eaton Corporation: Portfolio Transformation and The Cost of Capital
Benjamin C. Esty, E. Scott Mayfield and Daniel Fisher
In 2000, Eaton Corporation was a broadly diversified industrial conglomerate. But its strategy was evolving and its focus was narrowing around “power management” and more recently on “intelligent power,” the use of digitally enabled products and services designed to enhance efficiency and reliability. To implement this transition, Eaton had acquired more than 70 companies and divested another 50. Such active portfolio management required Eaton to regularly assess the prospects of each business unit—the profit and growth potential—and to explore opportunities to enhance its capabilities through acquisitions. In January 2020, Eaton got an offer from Danfoss, a Danish conglomerate, to buy its hydraulics business for $3.3 billion. Recently appointed CEO Craig Arnold must decide whether this deal makes sense strategically and financially. In particular, he must decide if $3.3 billion is a fair price for the firm’s hydraulics business.
Keywords: Mergers and Acquisitions; Business Conglomerates; Business Divisions; Cost of Capital; Corporate Finance; Value; Valuation; Industrial Products Industry; United States; Denmark; Republic of Ireland;

Citation:
Esty, Benjamin C., E. Scott Mayfield, and Daniel Fisher. "Eaton Corporation: Portfolio Transformation and The Cost of Capital." Harvard Business School Case 221-006, September 2020. View Details
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Article | Foundations and Trends® in Accounting | 2020
Research on Corporate Sustainability: Review and Directions for Future Research
Jody Grewal and George Serafeim
We review the literature on corporate sustainability and provide directions for future research. Our review focuses on three actions: measuring, managing and communicating corporate sustainability performance. Measurement is the least developed of the three and represents promising opportunities for research. Compelling evidence now exists on the role of management control systems, investor pressure and mandated disclosure in improving corporate sustainability outcomes. Research has moved beyond weighing the importance of all sustainability issues equally, with recent studies drawing distinctions between the financial materiality of different sustainability issues. Collectively, this new line of inquiry suggests that improving performance on material sustainability metrics is related to improved financial performance, helping to resolve four decades of inconclusive evidence on the relation between sustainability and financial outcomes. Finally, we review research on how disclosure mediums, accounting standards, information monitors and intermediaries shape the communication of sustainability performance. We conclude with a call for research on how to measure performance in the 21st century when corporate purpose extends beyond shareholder value maximization.
Keywords: sustainability; sustainability reporting; Sustainability Management; nonfinancial disclosure; nonfinancial information; nonfinancial performance; materiality; ESG; ESG (environmental, social, governance) performance; ESG (environmental, social, governance) performance; ESG disclosure; ESG disclosure metrics; ESG ratings; ESG reporting; inequality; corporate social responsibility; Accounting; Finance; Management; Strategy; Environmental Sustainability; Climate Change; Diversity; Equality and Inequality; Corporate Disclosure; Measurement and Metrics; Corporate Governance; Corporate Accountability; Corporate Social Responsibility and Impact;

Citation:
Grewal, Jody, and George Serafeim. "Research on Corporate Sustainability: Review and Directions for Future Research." Foundations and Trends® in Accounting 14, no. 2 (2020): 73–127. View Details
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Article | Studies in Comparative International Development | September 2020
The Rise of the Investor State: State Capital in the Chinese Economy
Meg Rithmire and Hao Chen
The nature and extent of the role of the Chinese state in the economy is fundamental to many empirical and theoretical debates about that country’s political economy. We document and explain the rise of a novel form of intervention on the part of the Chinese state: the expansion of state capital beyond ownership of state firms. We argue that state investment as a mode of state intervention in the economy is conceptually distinct from both “state capitalism” and the “developmental state” in its introduction of new agents to distribute state capital to firms and new mechanisms through which states, especially authoritarian ones, monitor and influence business actors. We document the growth of the investor state in several ways. Case studies of three high-profile shareholding firms in China demonstrate that state capital can be deployed strategically, for example to respond to financial crisis or facilitate industrial upgrading, but also generates moral hazard, resulting in corruption and resource misallocation, and international alarm about the intentions of Chinese firms. We further compare the rise of state shareholding firms in China to similar phenomena in Brazil and Malaysia, concluding that the practice has both economic and political logics.
Keywords: China's political economy; state shareholding; state-business relations; State capitalism; China's financial system; Economy; Business and Government Relations; Finance; System; China;

Citation:
Rithmire, Meg, and Hao Chen. "The Rise of the Investor State: State Capital in the Chinese Economy." Studies in Comparative International Development 55, no. 3 (September 2020): 257–277. View Details
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Working Paper | HBS Working Paper Series | 2020
State and Local Government Employment in the COVID-19 Crisis
Daniel Green and Erik Loualiche
Local governments are facing large losses in revenues and increased expenditures because of the COVID-19 crisis. We document a causal relationship between fiscal pressures induced by COVID-19 and the layoffs of state and local government workers. States that depend more on sales tax as a source of revenue laid off significantly more workers than other states. The CARES Act's provision of $150 billion in aid to state and local governments reduced the fiscal pressures they faced. Exploiting a kink in the formula for allocation of funding across states, we estimate a state and local government employment multiplier for federal aid—each dollar of federal aid was used by states to support 31 cents of payrolls. State rainy day fund balances limit the sensitivity of employment to both revenue shocks, revealing that balanced budget requirements for state and local governments increase the procyclicality of public service provision.
Keywords: local government; municipal finance; public finance; fiscal capacity; fiscal policy; Health Pandemics; Governance; Finance; Public Sector; Budgets and Budgeting; Employment;

Citation:
Green, Daniel, and Erik Loualiche. "State and Local Government Employment in the COVID-19 Crisis." Harvard Business School Working Paper, No. 21-023, August 2020. View Details
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Case | HBS Case Collection | August 2020
PayPal: The Next Chapter
Michael Porter, Mark Kramer and Annelena Lobb
Can a social purpose and stakeholder capitalism confer a powerful competitive advantage in the age of COVID-19? For PayPal, the answer is yes. After spinning off from eBay in a 2015 IPO, the company declared its purpose as "democratizing financial services" by ensuring that low-income consumers and small businesses can efficiently and inexpensively manage their money. The company fully lives into this purpose, sending employees out into communities to experience firsthand the indignities and high fees imposed on the unbanked, dramatically lowering the cost of international remittances, enabling small businesses to access working capital without credit checks, and facilitating cross-border purchases for small merchants. The company takes the welfare of each stakeholder group seriously: achieving racial and gender pay equity, raising hourly worker pay and benefits to ensure a living wage, and building a diverse and inclusive culture; working closely with regulators and law enforcement to unearth signs of sex trafficking and terrorism; aggressively removing hate-group transactions; providing $4 billion in credit to hundreds of thousands of small businesses that would never have qualified for bank loans, especially those owned by women and people of color. Together these actions have built a high degree of trust that creates a competitive moat in the otherwise commodity business of online payments. During the pandemic, the company was able to get stimulus funds to individuals and small businesses far faster and less expensively than banks or the SBA, and committed $500 million to investments in black-owned businesses. In the 5 years since its IPO, despite intense competition from major banks and credit card companies, Google, Apple, and countless VC-backed fintech players, the company has more than doubled its users, increased profits and boosted the stock price 500%.
Keywords: Mission and Purpose; Finance; Business and Stakeholder Relations; Social Entrepreneurship; Competitive Advantage; Financial Services Industry;

Citation:
Porter, Michael, Mark Kramer, and Annelena Lobb. "PayPal: The Next Chapter." Harvard Business School Case 721-378, August 2020. View Details
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Working Paper | HBS Working Paper Series | 2020
Conflicting Interests and the Effect of Fiduciary Duty—Evidence from Variable Annuities
Mark Egan, Shan Ge and Johnny Tang
We examine the drivers of variable annuity sales and the impact of a proposed regulatory change. Variable annuities are popular retirement products with over $2 trillion in assets in the United States. Insurers typically pay brokers a commission for selling variable annuities that ranges from 0% to over 10% of investors' premium payments. Brokers earn higher commissions for selling inferior annuities, in terms of higher expenses and more ex-post complaints. Our results indicate that variable annuity sales are roughly six times more sensitive to brokers' financial interests than investors'. To help limit conflicts of interest, the Department of Labor proposed a rule in 2016 that would hold brokers to a fiduciary standard when dealing with retirement accounts. We find that after the proposed fiduciary rule, the sales of high-expense variable annuities fell by 52% as sales became more sensitive to expenses and insurers increased the relative availability of low-expense products. Based on our structural model estimates, investor welfare improved as a result of the fiduciary rule under conservative assumptions.
Keywords: variable annuity; Brokers; conflict of interests; Fiduciary Duty; Finance; Investment; Insurance; Financial Services Industry; Insurance Industry; United States;

Citation:
Egan, Mark, Shan Ge, and Johnny Tang. "Conflicting Interests and the Effect of Fiduciary Duty—Evidence from Variable Annuities." Harvard Business School Working Paper, No. 21-018, August 2020. (Revised August 2020. NBER Working Paper Series, No. 27577, July 2020; SSRN Working Paper Series, July 2020) View Details
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Case | HBS Case Collection | July 2020 (Revised August 2020)
Pricing at Netflix
Elie Ofek, Marco Bertini, Oded Koenigsberg and Amy Klopfenstein
Since its launch in 1998 as “the Amazon.com of DVDs,” Netflix had evolved from a DVD rental company to a video streaming platform and producer of original films and television shows. As the company matured, it regularly increased prices and adjusted its product offerings while continuing to add new subscribers. However, between late 2019 and mid-2020, competition within the streaming industry intensified with the launch of new entrants such as Disney+, Apple TV+, and HBO Max, jeopardizing Netflix’s position as the industry leader. In spite of the heightened competition in the streaming industry, some analysts and customer willingness-to-pay surveys suggested that Netflix had the opportunity to implement another rate hike in the near future. By May 2020, Netflix must decide whether to increase prices again, or whether it should consider a different pricing model altogether.
Keywords: pricing; Marketing; Marketing Strategy; Entertainment; Film Entertainment; Television Entertainment; Finance; Price; Strategy; Competition; Competitive Strategy; Business Strategy; Adaptation; Technology; Internet; Online Technology; Technology Platform; Customers; Customer Satisfaction; Customer Value and Value Chain; Entertainment and Recreation Industry; North and Central America; United States;

Citation:
Ofek, Elie, Marco Bertini, Oded Koenigsberg, and Amy Klopfenstein. "Pricing at Netflix." Harvard Business School Case 521-004, July 2020. (Revised August 2020.) View Details
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Case | HBS Case Collection | July 2020
Amanda and Kristen: Mented Cosmetics
Steven Rogers, Jeffrey J. Bussgang and Alterrell Mills
The co-founders (Black HBS alumnae) of an e-commerce beauty startup explore the unmet needs within the beauty industry. This case study examines the entrepreneurial opportunities that come from identifying an underserved market, specifically within the Black community and the best startup financing approach to pursue those opportunities. Students learn approaches to product ideation/innovation, marketing strategies for the social media age and launching a startup for a targeted audience. Students learn to analyze macro and micro economic data of an industry, synthesize consumer demographics and purchase behavior data, and create projected unit economics as well as pro forma financial documents to determine the potential economic opportunity that is unmet in a market and the requisite fundraising to launch a new business. At the time of the case, Mented co-founders went on to become the 15th and 16th African-American women to raise over $1 million in startup funding.
Keywords: Brands and Branding; Competition; Customers; Disruption; Disruptive Innovation; Distribution Channels; Entrepreneurship; Finance; Macroeconomics; Marketing; Marketing Channels; Marketing Communications; Marketing Strategy; Mission and Purpose; Organizational Culture; Product Design; Product Development; Product Positioning; Sales; Social Issues; Social Marketing; Business Startups; Strategic Planning; Strategy; Supply Chain Management; Venture Capital; Advertising Industry; Public Relations Industry; Chemical Industry; Beauty and Cosmetics Industry; Manufacturing Industry; Retail Industry; North and Central America; United States; New York (city, NY); New York (state, US);

Citation:
Rogers, Steven, Jeffrey J. Bussgang, and Alterrell Mills. "Amanda and Kristen: Mented Cosmetics." Harvard Business School Case 321-002, July 2020. View Details
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Case | HBS Case Collection | June 2020
Accounting for Leases at American Airlines (B)
Jonas Heese, Gerardo Pérez Cavazos and Julia Kelley
This is a supplement to the “Accounting for Leases at American Airlines (A)” case. The (B) case describes American Airlines’ financial results for the first quarter of 2020, as well as the continuing effects of coronavirus on the airline industry.
Keywords: Accounting; Financial Reporting; Financial Statements; Finance; Governance; Corporate Accountability; Corporate Governance; Governing Rules, Regulations, and Reforms; Governing and Advisory Boards; Health Pandemics; Accounting Industry; Air Transportation Industry; North and Central America; United States;

Citation:
Heese, Jonas, Gerardo Pérez Cavazos, and Julia Kelley. "Accounting for Leases at American Airlines (B)." Harvard Business School Case 120-113, June 2020. View Details
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Case | HBS Case Collection | June 2020 (Revised July 2020)
Accounting for Leases at American Airlines (A)
Jonas Heese, Gerardo Pérez Cavazos and Julia Kelley
In March 2020, as coronavirus reduced demand for air travel, an analyst was forecasting American Airlines’ (American’s) first quarter financial results. To develop a forecast, she needed to familiarize herself with Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842),” passed four years earlier by the Financial Accounting Standards Board. ASU 2016-02 required companies to disclose all leases on their balance sheets, but it made an exception for leases with variable payments, allowing companies to leave such leases off-balance sheet. The Wall Street Journal estimated that more than 50% of American’s leases remained off-balance sheet due to the exclusion of variable leases. Should American and other companies be allowed to leave variable lease payments off-balance sheet? How did the decision to leave these payments off-balance sheet affect companies’ risk profiles and valuations?
Keywords: Accounting; Financial Reporting; Financial Statements; Finance; Governance; Corporate Accountability; Corporate Governance; Governing Rules, Regulations, and Reforms; Governing and Advisory Boards; Leasing; Accounting Industry; Air Transportation Industry; North and Central America; United States;

Citation:
Heese, Jonas, Gerardo Pérez Cavazos, and Julia Kelley. "Accounting for Leases at American Airlines (A)." Harvard Business School Case 120-069, June 2020. (Revised July 2020.) View Details
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