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 | HBS Working Paper Series | 2018
Macroeconomic Drivers of Bond and Equity Risks
John Y. Campbell, Carolin E. Pflueger and Luis M. Viceira
Our new model of consumption-based habit formation preferences generates loglinear, homoscedastic macroeconomic dynamics and time-varying risk premia on bonds and stocks. Consumers' first-order condition for the real risk-free interest rate takes the form of an exactly loglinear consumption Euler equation, commonly assumed in New Keynesian models. Estimating the model separately for 1979–2001 and 2001–2011 explains why the exposure of U.S. Treasury bonds to the stock market changed from positive to negative. A change in the comovement between inflation and the output gap explains changing bond risks but only when risk premia change endogenously as predicted by the model.
Keywords: Risk and Uncertainty; Bonds; Central Banking; System Shocks; Policy; Macroeconomics;

Citation:
Campbell, John Y., Carolin E. Pflueger, and Luis M. Viceira. "Macroeconomic Drivers of Bond and Equity Risks." Harvard Business School Working Paper, No. 14-031, September 2013. (Revised August 2018.) View Details
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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 | January 2019
Analytical Space: The Next Frontier?
Thomas R. Eisenmann, Jeffrey J. Bussgang and David Lane
With one satellite aloft and in the midst of beta testing in late 2018, Analytical Space founders Justin Oliveira and Dan Nevius turned to critical questions about the pioneering startup’s go-to-market, pricing, and business development strategy. Analytical Space aimed to build and operate a constellation of inexpensive satellites that would receive and relay to the ground data gathered by orbiting Earth observation satellites, thereby speeding and increasing the amount of data their operators could collect and sell to clients in the multi-billion market for information on crops, weather, and other observable changes on Earth. The cofounders now needed to select the best initial customers, validate demand for their unique data relay service, and establish pricing that would both spur adoption and impress investors ahead of their next financing round.
Keywords: pricing decisions; demand validation; revenue model; business development; space tech; satellites; earth observation; remote sensing; Business Startups; Emerging Markets; Growth and Development Strategy; Finance; Selection and Staffing; Business Strategy; Aerospace Industry;

Citation:
Eisenmann, Thomas R., Jeffrey J. Bussgang, and David Lane. "Analytical Space: The Next Frontier?" Harvard Business School Case 819-089, January 2019. View Details
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Case | HBS Case Collection | December 2018
R/GA: Corporate Venture Studio vs. Accelerator
Andy Wu, Grant Son and Aastha Thakar
New approach to accelerating the development of innovation through corporate venturing by creating partnerships between startup venture and established corporations through the launch of the Global Sports Venture Studios created by R/GA Ventures and the Los Angeles Dodgers.
Keywords: entrepreneurship; start-ups; entrepreneurial finance; Corporate Venture Capital; incubators; accelerators; Startup financing; innovation; partnerships; Ecosystems; Entrepreneurship; Business Startups; Finance; Venture Capital; Partners and Partnerships; Innovation and Invention; Sports Industry; Technology Industry; Entertainment and Recreation Industry; United States; New York (city, NY); Los Angeles;

Citation:
Wu, Andy, Grant Son, and Aastha Thakar. "R/GA: Corporate Venture Studio vs. Accelerator." Harvard Business School Case 719-414, December 2018. View Details
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Working Paper | HBS Working Paper Series | 2018
The Creation and Evolution of Entrepreneurial Public Markets
Shai Bernstein, Abhishek Dev and Josh Lerner
This paper explores the creation and evolution of new stock exchanges around the world geared towards entrepreneurial companies, known as second-tier exchanges. Using hand-collected novel data, we document the proliferation of these new stock exchanges that were created in a large number of countries, attracted a significant volume of global IPOs, were introduced fairly cyclically, and had lower listing requirements when compared to first-tier stock exchanges. We find that increases in demand for entrepreneurial capital—as proxied for by patenting, IPOs, and stock market valuations—led to a higher likelihood of the introduction of second-tier exchanges. We find no evidence that new second-tier exchanges diverted the existing flow of IPOs from established stock exchanges. Shareholder protection strongly predicted exchange success, even in countries with high levels of venture capital activity, patenting, and financial market development. Second-tier exchanges in countries with better shareholder protection allowed younger, less profitable, but faster-growing companies to raise more capital. These results highlight the importance of institutions in enabling the provision of entrepreneurial capital to young companies.
Keywords: entrepreneurial finance; stock exchanges; Entrepreneurship; Finance; Initial Public Offering; Capital;

Citation:
Bernstein, Shai, Abhishek Dev, and Josh Lerner. "The Creation and Evolution of Entrepreneurial Public Markets." Harvard Business School Working Paper, No. 19-061, December 2018. View Details
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Case | HBS Case Collection | December 2018
Bata versus Relaxo—Analyzing Performance
Suraj Srinivasan, Iris Leung and Quinn Pitcher
Set in 2016, Bata India versus Relaxo—Analyzing Performance compares the strategies and financial performance of two Indian footwear companies. Bata India had long been the market leader in footwear in India, but its leading market position was being challenged by Relaxo, a relatively young, upstart company. The case is framed from the perspective of an emerging markets financial analyst presented with the financial statements and operational data for both companies. The analyst has to compare and contrast the performance of the two companies based on financial ratios. Students can apply the traditional DuPont decomposition framework to drill down into the business model of the two companies. The case then allows students to use the modified (also known as additive or alternate) DuPont approach with the goal of systematically understanding the differences that arise from operating performance, leverage, and the effect of large cash holdings (in Bata). In doing so, students learn the components of the traditional and modified DuPont frameworks and how to analyze financial statements to better understand how firm performance can arise from operating and financing decisions. The traditional DuPont framework provides for a methodical evaluation of performance for each business, but it has its limits: it does not separate operating assets and liabilities from financing assets and liabilities. When the financing components are separated and reclassified using the modified DuPont framework, students can clearly observe the crucial role that financing activities vis-à-vis operating activities can have in amplifying performance.
Keywords: Finance; Strategy; Operations; Performance Evaluation; Financial Statements; Analysis; Apparel and Accessories Industry;

Citation:
Srinivasan, Suraj, Iris Leung, and Quinn Pitcher. "Bata versus Relaxo—Analyzing Performance." Harvard Business School Case 119-050, December 2018. View Details
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Article | Harvard Business Review (website)
The Hidden Costs of Initial Coin Offerings
Jeffrey J. Bussgang and Ramana Nanda
In recent years, much has been written about how the Blockchain is poised to transform traditional industries such as banking, real estate, and healthcare. More recently, it has gained attention as a way to finance new ventures, through what is known as an Initial Coin Offering (ICO). Less noticed, though, is ICOs appear almost antithetical to the standard approach to financing a risky venture. Structured experimentation, popularized by Eric Ries' The Lean Startup, has been widely embraced as the gold standard for how to approach the commercialization of radical new ideas. From Boston to Beijing to Bangalore, entrepreneurs and investors rattle off the importance of designing focused experiments to test hypotheses in a capital-efficient fashion in order to achieve product-market fit. But ICOs substantially limit the benefits associated with such staged experimentation, for three reasons.
Keywords: Initial Coin Offerings; Business Ventures; Entrepreneurship; Finance;

Citation:
Bussgang, Jeffrey J., and Ramana Nanda. "The Hidden Costs of Initial Coin Offerings." Harvard Business Review (website) (November 7, 2018). View Details
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Working Paper | HBS Working Paper Series | 2018
Arbitration with Uninformed Consumers
Mark Egan, Gregor Matvos and Amit Seru
We examine whether firms have an informational advantage in selecting arbitrators in consumer arbitration as well as the impact of the arbitrator selection process on outcomes. We collect data containing roughly 9,000 arbitration cases in securities arbitration. Securities disputes present a good laboratory: the selection mechanism is similar to other major arbitration forums; arbitration is mandatory for all disputes, eliminating selection concerns; and the parties choose arbitrators from a randomly generated list. We first document that some arbitrators are systematically industry friendly while others are consumer friendly. Firms appear to utilize this information in the arbitrator selection process. Despite a randomly generated list of potential arbitrators, industry friendly arbitrators are 40% more likely to be selected than their consumer friendly counterparts. Better informed firms and consumers choose more favorable arbitrators. We develop and calibrate a model of arbitrator selection in which, like the current process, both the informed firms and uninformed consumers have control over the selection process. Arbitrators compete against each other for the attention of claimants and respondents. The model allows us to interpret our empirical facts in equilibrium and to quantify the effects of changes to the current arbitrator selection process on consumer outcomes. Competition between arbitrators exacerbates the informational advantage of firms in equilibrium resulting in all arbitrators slanting towards being industry friendly. Evidence suggests that limiting the respondents' and claimants' inputs over the arbitrator selection process could significantly improve outcomes for consumers.
Keywords: Arbitration; Financial Advisers; Financial Advisors; Brokers; consumer finance; Financial Misconduct; Personal Finance; Conflict and Resolution; Information; Fairness;

Citation:
Egan, Mark, Gregor Matvos, and Amit Seru. "Arbitration with Uninformed Consumers." Harvard Business School Working Paper, No. 19-046, October 2018. (NBER Working Paper Series, No. 25150, October 2018.) View Details
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Working Paper | HBS Working Paper Series | 2018
When Harry Fired Sally: The Double Standard in Punishing Misconduct
Mark Egan, Gregor Matvos and Amit Seru
We examine gender differences in misconduct punishment in the financial advisory industry. We find evidence of a "gender punishment gap": following an incident of misconduct, female advisers are 20% more likely to lose their jobs and 30% less likely to find new jobs relative to male advisers. Females face harsher outcomes despite engaging in misconduct that is 20% less costly and having a substantially lower propensity towards repeat offenses. The gender punishment gap in hiring and firing dissipates at firms with a greater percentage of female managers at the firm or local branch level. The gender punishment gap is not driven by gender differences in occupation (type of job, firm, market, or financial products handled), productivity, misconduct, or recidivism. We extend our analysis to explore the differential treatment of ethnic minorities and find similar patterns of "in-group" tolerance. Our evidence is inconsistent with a simple Bayesian model and suggests instead that managers are more forgiving of missteps among members of their own gender/ethnic group.
Keywords: Financial Advisers; Brokers; Gender Discrimination; consumer finance; Financial Misconduct and Fraud; FINRA; Financial Institutions; Employees; Crime and Corruption; Gender; Prejudice and Bias; Outcome or Result; Personal Finance; Financial Services Industry;

Citation:
Egan, Mark, Gregor Matvos, and Amit Seru. "When Harry Fired Sally: The Double Standard in Punishing Misconduct." Harvard Business School Working Paper, No. 19-047, October 2018. (Revise and Resubmit, Journal of Political Economy. NBER Working Paper Series, No. 23242, March 2017) View Details
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Case | HBS Case Collection | October 2018
African Bank Investments Limited (A)
Lynn S. Paine and Will Hurwitz
Less than a year after joining the board of African Bank Investments Limited (ABIL), the newest director finds himself in difficult discussions with other directors about removing the struggling company’s CEO. The case is set in South Africa in mid-2014 as shares in ABIL, which traded on the Johannesburg Stock Exchange, are declining precipitously. The case describes ABIL’s origins and evolution, including the acquisition and growth of its wholly owned subsidiary African Bank, a provider of unsecured loans to help individuals pay for expenses such as vehicle repairs, home renovations, funeral costs, medical bills, and education. As ABIL’s profits rose and share price soared, it became the darling of analysts. However, when the South African economy turned sour, customers started defaulting on their loans, and ABIL and African Bank began to struggle. As ABIL’s stock price dropped, the management team faced difficult questions about the company’s lending practices, risk management processes, and plans to turn the business around. By 2014, the situation was grim, and pressure mounted from shareholders and market regulators for the board to take action. The case details the history of unsecured lending in South Africa, describes the regulatory, social, and legal contexts for the company and its business model, and explores the company’s unique corporate structure and executive and director dynamics.
Keywords: Ethics; Personal Finance; Corporate Accountability; Governing and Advisory Boards; Corporate Governance; Crisis Management; Insurance; Leadership; Management; Risk Management; Banking Industry; Financial Services Industry; Insurance Industry; Africa; South Africa;

Citation:
Paine, Lynn S., and Will Hurwitz. "African Bank Investments Limited (A)." Harvard Business School Case 319-052, October 2018. View Details
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Book | 2018
Varieties of Green Business: Industries, Nations and Time
G. Jones
Published at a time of ever-increasing warnings that the pace of climate change and other environmental changes risk making the Earth unsustainable within our own lifetimes, this book looks at the past of green business to identify lessons for the future. It provides rich new evidence and insights on green business as it examines its variation between industries and nations over time. It shows the deep historical origins of endeavors to create for-profit businesses that were more responsible and sustainable as well as how these strategies have faced constraints, trade-offs, and challenges of legitimacy. The industries covered range from sustainable finance and solar energy to organic food and wine, ecotourism, and outdoor clothing. Strategies pursued range from incremental shifts towards sustainability to abandoning for-profit business entirely and re-wilding and conserving millions of acres of lands in Latin America. The book's distinctiveness lies in the use of original empirical data and the willingness to engage with both successful and unsuccessful cases. The wide geographical coverage includes not only the United States and Europe but also less studied settings, including Chile, Costa Rica, New Zealand, and Japan. The book serves as a warning against facile beliefs in the potential of win/win solutions as business tries to reduce its environmental impact or even save the planet. The lesson of history is that making business sustainable is a hard journey, littered with system-wide roadblocks, but it is a journey that is possible and one that is urgently needed.
Keywords: Green Business; sustainability; business history; eco-tourism; organic wine; organic food; waste management; sustainable finance; Ethics; Finance; History; Entrepreneurship; Accommodations Industry; Agriculture and Agribusiness Industry; Banking Industry; Energy Industry; Food and Beverage Industry; Green Technology Industry; Tourism Industry; Europe; Asia; Latin America; North and Central America; New Zealand;

Citation:
Jones, G. Varieties of Green Business: Industries, Nations and Time. Northamption, MA: Edward Elgar Publishing, 2018. View Details
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Article | Academy of Management Journal | March 2016
The Role of Investor Gut Feel in Managing Complexity and Extreme Risk
Laura Huang
Securing financial resources from investors is a key challenge for many early stage entrepreneurial ventures. Given the inherent uncertainty surrounding a decision to invest in these ventures, prior research has found that experienced investors rely heavily on their investor gut feel—dynamic expertise-based emotion-cognitions specific to the entrepreneurship context. In this paper, I inductively find that rather than based on rapid, nonconscious impulse, as much of prior literature would suggest, what investors call their "gut feel" is an elaborate "intuiting process." This process serves a distinct purpose: it emboldens investors to make investments that would otherwise be considered overly risky and likely to lead to failure. In the theoretical model I present, I delineate how investors are guided by a predisposed stance on risk and uncertainty, which dictates the approach investors take towards managing the complexity of an investment opportunity—and how they cognitively and emotionally reframe investment risk into a compelling narrative that transcends avoidance behavior and leads investors to invest. These findings expand our overall understanding of the complex ways in which investors contend with the risks and uncertainties in entrepreneurial finance.
Keywords: angel investors; gut feel; intuition; Entrepreneurship; Finance; Risk and Uncertainty; Complexity; Decision Making;

Citation:
Huang, Laura. "The Role of Investor Gut Feel in Managing Complexity and Extreme Risk." Academy of Management Journal 61, no. 5 (October 2018): 1821–1847. View Details
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