Economics →
- 24 Mar 2010
- Working Paper Summaries
Fiduciary Duties and Equity-Debtholder Conflicts
Managerial decisions influence the distribution of value between different parties. This can lead to conflicting interests among financial claimants, such as holders of equity and debt. The Credit Lyonnais v. Pathe Communications bankruptcy ruling of 1991 before the Delaware court—a case widely perceived to have created a new obligation for directors of Delaware‐incorporated firms—provides an interesting opportunity to assess whether and how equity-debt conflict affects firm behavior. HBS professor Bo Becker and Stockholm School of Economics professor Per Strömberg outline important changes in behavior after Credit Lyonnais. Key concepts include: The Credit Lyonnais duties are a prime example of how important the Delaware courts are, and how the differences between Delaware corporate law and other jurisdictions can be of significance. After the ruling, behavior changed for Delaware firms in the vicinity of bankruptcy, which enabled them to enter Chapter 11 in a healthier state, thus making bankruptcy resolution easier. Firms in distress sometimes have an incentive to undertake actions that hurt debt and benefit equity. Such behavior leads to indirect costs of financial distress, discouraging leverage and reducing overall firm value. A reduction in such behavior took place after the Credit Lyonnais ruling. Closed for comment; 0 Comments.
- 15 Mar 2010
- HBS Case
Developing Asia’s Largest Slum
In a recent case study, HBS assistant professor Lakshmi Iyer and lecturer John Macomber examine ongoing efforts to forge a public-private mixed development in Dharavi—featured in the film Slumdog Millionaire. But there is a reason this project has languished for years. From the HBS Alumni Bulletin. Closed for comment; 0 Comments.
- 03 Mar 2010
- What Do You Think?
To What Degree Does “Identity” Affect Economic Performance?
Summing up comments to his March column, Jim Heskett says perceptions vary widely on the issue of "identity" and economic performance, particularly as it applies to the U.S. What will it take to turn around negative trends in employee identity? (Forum now closed. Next forum begins April 2.) Closed for comment; 0 Comments.
- 27 Jan 2010
- Working Paper Summaries
Labor Regulations and European Private Equity
Recent theoretical models predict that countries with stricter labor policies will specialize in less innovative activities due to the higher worker turnover frequently associated with rapidly changing sectors. HBS visiting scholar Ant Bozkaya and HBS professor William R. Kerr examine how differences in labor regulations across European countries influence the development of private equity markets, comprised of venture capital and buy-out investors. In so doing, the researchers provide the first empirical evidence for this theoretical prediction at the industry level in the entrepreneurial finance literature. They also make a methodological contribution by demonstrating how jointly modeling the different policies for providing worker insurance delivers more consistent results than their individual relationships would indicate by themselves. Key concepts include: Policy choices regarding the optimal levels and mechanisms of labor market insurance are complex and should consider many economic and non-economic factors. Worker insurance policies favoring labor market expenditures (e.g., unemployment insurance benefits) over employment protection regulations encourage greater private equity entry and larger investment levels. This is true for both domestic investors and U.S.-inbound venture capital investments. This effect is conditional on the level of worker insurance provided, which is of lesser importance for private equity patterns than the policy mechanisms employed. Closed for comment; 0 Comments.
- 25 Jan 2010
- Research & Ideas
A Macroeconomic View of the Current Economy
Concerned or confused by the economic environment? Take some lessons from history and concepts from macroeconomics to get a better understanding of how the economy works. A Q&A with HBS professor David A. Moss, author of A Concise Guide to Macroeconomics: What Managers, Executives, and Students Need to Know. Closed for comment; 0 Comments.
- 19 Jan 2010
- Sharpening Your Skills
Sharpening Your Skills: Managing the Economic Crisis
The economic crisis is tapping the inner reserves of experienced leaders and introducing a new generation of managers to crisis management. These previous WK articles explore leadership, the role of the Board, the emotional needs of managers, and the risk to corporate giving programs. Closed for comment; 0 Comments.
- 23 Dec 2009
- Working Paper Summaries
The Global Agglomeration of Multinational Firms
(Paper formerly titled "The Global Networks of Multinational Firms.") When and why do multinationals group together overseas? Do they agglomerate in the same fashion abroad as they do at home? An answer to these questions is central to the long-standing debate over the consequences of foreign direct investment (FDI). It is critical to understand interdependencies of multinational networks and how multinationals influence one another in their activities at home and overseas. HBS professor Laura Alfaro and George Washington University professor Maggie Chen examine the global network of multinationals and study the significance and causes of multinational agglomeration. Their results provide further evidence of the increasing separation of headquarters services and production activities within multinational firms. The differential specialization of headquarters and subsidiaries leads to distinct patterns of agglomeration. Key concepts include: Recent decades have witnessed an explosion in the activities of multinational corporations, but little is understood about global patterns of multinational agglomeration. Examples of this trend include firms that agglomerated in Silicon Valley and in Detroit now having subsidiaries clustered in Bangalore (termed "the Silicon Valley of India") and in Slovakia ("the Detroit of the East"). A new data set provides detailed location, ownership, and activity information for establishments in more than 100 countries. Multinational subsidiaries with knowledge spillovers, among other factors, tend to agglomerate to one another. The importance of these agglomeration economies is, however, different across headquarters, subsidiary, and employment networks. Many factors play a role in the location decisions of firms, so it may not be possible for a country to duplicate the circumstances that led to agglomeration in other nations. Policymakers need to consider the interdependence of multinational firms when making decisions about FDI. Closed for comment; 0 Comments.
- 16 Dec 2009
- Working Paper Summaries
The End of Chimerica
Economic historians Niall Ferguson and Moritz Schularick of Freie Universität Berlin consider the problem of global imbalances and try to set events in a longer-term perspective. First published in 2009. Closed for comment; 0 Comments.
- 02 Dec 2009
- What Do You Think?
Should Immigration Policies Be More Welcoming to Low-Skilled Workers?
Immigration is a topic that stirs passions globally, judging from the responses to this month's column, says HBS professor Jim Heskett. Readers suggested ways to bring immigration policy into alignment with the reality of what is happening at borders and in workplaces around the world. (Online forum now closed. Next forum begins January 6.) Closed for comment; 0 Comments.
- 01 Dec 2009
- Working Paper Summaries
Modeling a Paradigm Shift: From Producer Innovation to User and Open Collaborative Innovation
We are in the midst of a major paradigm shift: technological trends are causing a change in the way innovation gets done in advanced market economies. In addition to the model of producer-based design—the idea that most important designs for innovations would originate from producers and be supplied to consumers via goods and services that were for sale—two increasingly important models are innovations by single user firms or individuals, and open collaborative innovation projects. Each of these three models represents a different way to organize human effort and investments aimed at generating valuable new innovations. HBS professor Carliss Y. Baldwin and MIT Sloan School of Management professor Eric von Hippel analyze the three models in terms of their technological properties, specifically their design costs and architectures, and their communication requirements. The researchers argue that as design and communication costs decline, single user and open collaborative innovation models will be viable for a steadily wider range of design. These two models will present an increasing challenge to the traditional paradigm of producer-based design—but, when open, they are good for social welfare and should be encouraged by policymakers. Key concepts include: When it is technologically feasible, the transition from closed producer innovation or single user innovation to open single user or open collaborative innovation is desirable in terms of social welfare and is worthy of support by policymakers. Free dissemination of innovation designs is associated with the open model. Open innovation generates innovation without exclusivity or monopoly, and so should improve social welfare, other things being equal. Intellectual property rights grants can be used as the basis for licenses that help keep innovation open as well as closed. Policymakers should seek out and eliminate points of conflict between present intellectual property policies designed to support closed innovation that at the same time inadvertently interfere with open innovation. As design costs fall, many more innovations will originate with single users. Open collaborative innovation projects thrive on low communication costs. Closed for comment; 0 Comments.
- 18 Nov 2009
- Working Paper Summaries
India Transformed? Insights from the Firm Level 1988-2005
Between 1986 and 2005, Indian growth put to rest the concern that there was something about the "nature of India" that made rapid growth difficult. Following broad-ranging reforms in the mid-1980s and early 1990s, the state deregulated entry, both domestic and foreign, in many industries, and also hugely reduced barriers to trade. Laura Alfaro of Harvard Business School and Anusha Chari of the University of North Carolina at Chapel Hill analyze the evolution of India's industrial structure at the firm level following the reforms. Despite the substantial increase in the number of private and foreign firms, the overall pattern that emerges is one of continued incumbent dominance in terms of assets, sales, and profits in both state-owned and traditional private firms. Key concepts include: In sectors dominated by state-owned and traditional private firms before liberalization (with assets, sales, and profits representing 50 percent or higher shares), these firms remain the dominant ownership group following the reforms. Rates of return remain stable over time and show low dispersion across sectors and across ownership groups within sectors. The high levels of state ownership and ownership by traditional private firms in India raise the question of whether existing resources could be allocated more efficiently and whether remaining barriers to competition jeopardize the effectiveness of reform measures that have been put in place. Closed for comment; 0 Comments.
- 10 Nov 2009
- Working Paper Summaries
Endowments, Fiscal Federalism, and the Cost of Capital for States: Evidence from Brazil, 1891-1930
Do endowments matter in determining the cost of capital for a country or state? Endowments, according to Banco de México's André C. Martínez Fritscher and HBS professor Aldo Musacchio, are the conditions that determine what kind of commodities can be produced and exported in a determined geographical region. Studying the determinants of the risk premium of the bonds issued by Brazilian states between 1891 and 1930—a period of extreme decentralization of fiscal revenues and expenditures in Brazil—the researchers find that risk premia are highly correlated with state public revenue per capita. Because these revenues came, to a large extent, from the taxes states levied on commodity exports, the researchers argue that endowments mattered to determine the cost of capital for states. Key concepts include: Between 1891 and 1930, the cost of capital for Brazilian states and the probability of issuing state debt in international capital markets were highly correlated with state revenues per capita. The relationship among endowments and the cost of capital for states or the capacity to issue debt may have led to marked differences in access to capital and in the capacity that states had to spend on public goods. Since differences in expenditures on public goods can lead to market differences in economic development among states, the setup of the 1891 Constitution promoted some of the regional inequality that is still observed today in Brazil. Closed for comment; 0 Comments.
- 05 Nov 2009
- Working Paper Summaries
Medium Term Business Cycles in Developing Countries
At the end of 2007, the U.S. economy entered a recession that, by the first quarter of 2009, had reduced U.S. GDP by 2.2 percent. The Mexican economy was showing no sign of distress until the U.S. recession began. Despite that, Mexican GDP declined by 7.8 percent during the same period. This and similar episodes from other developing countries motivate several questions: Why do shocks to developed economies affect developing countries to such an extent? Does the response of developing economies to shocks that originate in their developed neighbors account for the larger volatility of developing economies? More broadly, what ingredients do macroeconomic models need to incorporate in order to account for the unique features of economic fluctuations in developing economies? To investigate these questions, the researchers developed a two-country asymmetric model to study the business cycle in developing countries. The mechanisms introduced in the model should provide an accurate account of business cycles in other developing countries. Key concepts include: First, U.S. shocks have a larger effect on GDP in Mexico than in the United States. This result is driven by the larger amplitude of fluctuations in Mexican productivity and by the subsequent effects on investment. This finding has important implications for the sources of Mexican volatility. Second, the slow diffusion of technologies to Mexico results in U.S. shocks having more persistent effects on Mexico than in the United States. This result explains the observed lead of U.S. GDP over the medium-term component of Mexican output and the relative price of capital. Third, consumption is no less volatile than output in Mexico. The researchers' model accounts for this stylized fact because a Mexican recession slows down the diffusion of technologies to Mexico, generating a gradual increase in the price of installed capital. As a result, Mexican interest rates increase despite the lower marginal product of capital, and consumption drops precipitously. Closed for comment; 0 Comments.
- 04 Nov 2009
- What Do You Think?
What is the Role of Government Vis-à-Vis Capitalism?
The debate this month boiled down to the extent of government's role in relation to capitalism, says professor Jim Heskett. While some readers argued for a relatively narrow role for government, others disagreed, and commented on the challenges it faces today. (Forum now closed. Next forum begins Dec. 3.) Closed for comment; 0 Comments.
- 28 Oct 2009
- Lessons from the Classroom
HBS Begins Teaching Consumer Finance
Last spring HBS became the first top-ranked U.S. business school to offer a course in consumer finance. Professor Peter Tufano talks about the course and his determination to make consumer finance a broadly accepted academic pursuit. From the HBS Alumni Bulletin. Key concepts include: The household sector in America represents approximately $61 trillion of assets. The course helps students understand consumers and the financial service firms that serve them. Four functions are studied: payments, movements of money from today to tomorrow (savings and investing), movements of money from tomorrow back to today (borrowing), and managing risk. Closed for comment; 0 Comments.
- 22 Oct 2009
- Working Paper Summaries
Strategies to Fight Ad-sponsored Rivals
Many companies choose to finance themselves using ad revenues and offer their products or services—from newspapers to software applications, television programs, and online search—free to consumers. Yet the emergence of ad-sponsored entrants in various industries poses significant threats to the incumbents in these markets whose business models are often based on subscriptions or fees charged to their customers. Faced with the threat from ad-sponsored entrants, incumbents must choose strategies to respond. HBS professor Ramon Casadesus-Masanell and University of Southern California professor Feng Zhu create an analytical framework to establish guidelines for incumbent firms facing these issues. The researchers consider four alternative business models: pure-subscription-based; pure-ad-sponsored; mixed-single-product; and mixed-product-line-extension. Analysis shows that the optimal strategic and tactical choices change dramatically in the presence of an ad-sponsored rival. This is the first study to provide a comprehensive analysis of the competition between a free ad-sponsored entrant and an incumbent that has the option of choosing different business models. Key concepts include: The presence of the ad-sponsored rival puts an upper bound on the number of ads that an incumbent competing through a mixed-product-line-extension can set. When the advertising rate is low, a mixed-product-line-extension model is inferior to the pure-subscription-based model. Even if the incumbent can avoid cannibalization by using a mixed-single-product model, the incumbent may still prefer to use the pure-subscription-based model, since the advertising intensities of the two firms are strategic substitutes. Sometimes the best response of the incumbent to an ad-sponsored entrant is to not change its business model and tactics. This happens only when the optimal business model under both monopoly and duopoly is the pure-subscription-based model, and when the quality difference between the incumbent and the entrant is large. Closed for comment; 0 Comments.
- 08 Oct 2009
- Working Paper Summaries
Clusters of Entrepreneurship
Economic growth is highly correlated with an abundance of small, entrepreneurial firms. This relationship is even stronger looking across industries within cities, and has been taken as evidence for competition spurring technological progress, product cycles where growth is faster at earlier stages, and the importance of entrepreneurship for area success. Any of these interpretations is possible, however, and the only thing that we can be sure of is that entrepreneurial clusters exist in some areas but not in others. This paper first documents systematically some basic facts about average establishment size and new employment growth through entrepreneurship, then analyzes entry and industrial structures at the region and the city levels using the Longitudinal Business Database. Key concepts include: There is a remarkably strong correlation between smaller average firm size and subsequent employment growth due to start-ups. Evidence does not support the view that regional differences in demand for entrepreneurship are responsible for these entrepreneurial clusters. Instead, the evidence suggests that spatial differences in the fixed costs of entrepreneurship and/or in the supply of entrepreneurs best explain cluster formation. Closed for comment; 0 Comments.
- 01 Oct 2009
- Working Paper Summaries
Systemic Risk and the Refinancing Ratchet Effect
During periods of rising house prices, falling interest rates, and increasingly competitive and efficient refinancing markets, cash-out refinancing is like a ratchet, incrementally increasing homeowner debt as real-estate values appreciate without the ability to symmetrically decrease debt by increments as real-estate values decline. This paper suggests that systemic risk in the housing and mortgage markets can arise quite naturally from the confluence of these three apparently salutary economic trends. Using a numerical simulation of the U.S. mortgage market, the researchers show that the ratchet effect is capable of generating the magnitude of losses suffered by mortgage lenders during the financial crisis of 2007-2008. These observations have important implications for risk management practices and regulatory reform. Key concepts include: Consider the hypothetical scenario in which all homeowners decide to refinance and extract cash from any accumulated house equity so that their loan-to-value ratio is kept the same as the one for a new purchaser of that house. Suppose that the refinancing market is so competitive, i.e., refinancing costs are so low and capital is so plentiful, that homeowners can implement this refinancing each month. In this extreme case, during periods of rising home prices and falling interest rates, cash-out refinancing has the same risk effect "as if" all houses had been purchased and their mortgages originated at the peak of the housing market, thereby creating a large systemic risk exposure. Then, when home prices fall, the refinancing ratchet "locks,'' causing a systemic event with widespread correlated defaults and large losses for mortgage lenders. While excessive risk-taking, overly aggressive lending practices, pro-cyclical regulations, and political pressures surely contributed to the recent problems in the U.S. housing market, the simulations show that even if all homeowners, lenders, investors, insurers, rating agencies, regulators, and policymakers behaved rationally, ethically, and with the purest of motives, financial crises can still occur. The fact that the refinancing ratchet effect arises only when three market conditions are simultaneously satisfied demonstrates that the current financial crisis is subtle, and may not be attributable to a single cause. There may be no easy legislative or regulatory solutions: Lower interest rates, higher home prices, and easier access to mortgage loans have appeared separately in various political platforms and government policy objectives over the years. Their role in fostering economic growth makes it virtually impossible to address the refinancing ratchet effect within the current regulatory framework. We need an independent organization devoted solely to the study, measurement, and public notification of systemic risk, not unlike the role that the National Transportation Safety Board plays with respect to airplane crashes, train wrecks, and highway accidents. The subtle and multifaceted nature of the refinancing ratchet effect is just one example of the much broader challenge of defining, measuring, and managing systemic risk in the financial system. Closed for comment; 0 Comments.
- 30 Sep 2009
- Working Paper Summaries
Breakthrough Inventions and Migrating Clusters of Innovation
In just a short period of time the spatial location of invention can shift substantially. The San Francisco Bay Area grew from 5 percent of U.S. domestic patents in 1975-1984 to over 12 percent in 1995-2004, for example, while the share for New York City declined from 12 percent to 7 percent. Smaller cities like Austin, Texas, and Boise, Idaho, seem to have become clusters of innovation overnight. Despite the prevalence of these movements, we know very little about what drives spatial adjustments in U.S. invention, the speed at which these reallocations occur, and their economic consequences. In this paper, HBS professor William R. Kerr investigates whether breakthrough inventions draw subsequent research efforts for a technology to a local area. Evidence strongly supports the conclusion that centers of breakthrough innovations experience subsequent growth in innovation relative to their peer locations. Key concepts include: Breakthrough inventions spur higher subsequent growth in innovation within a local area and technology compared to peer locations that, for example, have the same overall numbers of patents and similar technologies at the time when the breakthrough occurred. The underlying mobility of the workforce is quite important for the speed at which spatial adjustments occur. Immigrants, and particularly new immigration to the United States, can facilitate faster spatial reallocation. Closed for comment; 0 Comments.
Location Strategies for Agglomeration Economies
Locations thick with similar economic activity expose firms to pools of skilled labor, specialized suppliers, and potential inter-firm knowledge spillovers that can provide firms with opportunities for competitive advantage. While certainly attractive, the lure of these agglomeration economies varies. Some firms should be wary of aiding their competitors by co-locating with them, for example, because each "agglomeration economy" differs in how readily competitors can leverage contributions made by others. HBS professor Juan Alcácer and Wilbur Chung of the University of Maryland develop a framework to better understand how firms respond to agglomeration economies. Key concepts include: Firms' location choices balance the perceived risk of aiding competitors with a recognition that some agglomeration economies will be of limited use to others. Firms, on average, place more value on pools of skilled labor and specialized suppliers than on potential knowledge inflows from competitors. The priority placed on labor and suppliers persists even for industries that are more R&D intensive. Economically larger firms are less attracted to industry employment, but more attracted to industry supplier activity. Closed for comment; 0 Comments.