First Look

First Look summarizes new working papers, case studies, and publications produced by Harvard Business School faculty. Readers receive early knowledge of cutting-edge ideas before they enter the mainstream of business practice. For complete details on faculty research, see our Working Papers section.

October 31, 2006

As national economies become more intertwined with world markets, they have also become more vulnerable to volatilities in global markets for credit, currencies, commodities, and other assets. To help policymakers, credit analysts, and investors measure, analyze, and manage macroeconomic risk, a new method is proposed in the working paper "A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy." The approach is based on the theory and practice of modern contingent claims analysis, and its authors include Harvard Business School professor and Nobel Prize winner Robert C. Merton.

Also this week, publications on running a family business and a case study looking behind Warner Bros.' agreement to make BitTorrent its first authorized peer-to-peer film distributor.

 

Working Papers

How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages

Abstract

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

Download working paper: http://papers.nber.org/papers/W12522

A New Framework for Analyzing and Managing Macrofinancial Risks of an Economy

Abstract

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

Download working paper: http://www.hbs.edu/research/pdf/07-026.pdf

 

Cases & Course Materials

C. R. Smith and the Birth of American Airlines

Harvard Business School Case 406-082

Presents an overview of the path that C. R. Smith pursued to build American Airlines into one of the largest airlines in the world in the 20th century. Over the course of his 30-year tenure as president of American Airlines, Smith deployed a three-pronged strategy—technology standardization, safety, and customer service—to build his business. Covers the first 50 years of American Airlines' history, beginning with its role as an industry consolidator in the late 1920s. Smith's strategic and operational choices in building American Airlines played a significant role in the overall growth of the airline industry in the United States. Explores the interaction between the growth of a company and an overall industry.

Purchase this case:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=406082

Fundamentals of Family Business System Governance

Harvard Business School Note 807-019

Reviews the purposes and ingredients in the governance (or steering) of a family business system. Explores at a high level the governance of the family business, its owners, and the family. Focuses on how these governance structures, processes, plans, and agreements interact.

Purchase this note:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=807019

Governance of the Family Business

Harvard Business School Note 807-022

Reviews the ways to achieve governance of the family business. Points out the importance of plans (e.g., strategic plans), statements (e.g., mission statements), policies, rules, and agreements to the governance process. Discusses the roles of three structures in family business governance: the top management team, the family employee council, and the board of directors.

Purchase this note:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=807022

Trolltech A.S.—(Norway)—The Cenapio Project

Harvard Business School Case 806-090

Describes the creation of an open source software venture in Norway, Australia, and the United States that lands a strategic OEM deal with a leading Japanese manufacturer of embedded devices (PDAs in this instance). Details the evolution of the two companies' relationship and the differences in mindset and culture—Norwegian/Japanese as well as small venture/big venture and software company/hardware company. There are also conflicts with a U.S. software venture that is serving as the general contractor for the project. The co-founders must decide how to deal with certain requests by the Japanese partner.

Purchase this case:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=806090

Warner Bros. Embraces BitTorrent

Harvard Business School Case 807-012

Involves the copyright issues associated with Bram Cohen's revolutionary program BitTorrent, which makes it possible to transfer very large files, such as movies, at a high speed over the Internet. The program, which is available for free over the Internet, is used for peer-to-peer sharing of movies and music and for the legitimate distribution of licensed software, including games. Discusses Warner Bros.' online distribution strategy as well as the negotiations between BitTorrent and the Movie Picture Association of America and Warner Bros. that ultimately led to Warner Bros.' agreement to make BitTorrent its first authorized peer-to-peer film distributor.

Purchase this case:
http://www.hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=807012

 

Publications

Forging Global Accountabilities: Participation, Pluralism, and Public Ethics

Abstract

This edited volume contributes analytical depth to the diverse debates on accountability in modern organizations. It explores the nature, forms and impacts of accountability efforts in civil society organizations, public and inter-governmental agencies, and private corporations. Contributors draw from a range of disciplines, including political science, public administration, civil society studies, anthropology, organizational sociology, business, and social and critical theory. In so doing, they demonstrate the inadequacy of modern rationalist prescriptions for establishing accountability standards and for monitoring them. The authors show how accountability frameworks attached to principal-agent logics and applied universally across cultures typically fail to achieve their objectives. Accountability is a socially constructed means of control used by the weak as well as the powerful. The chapters in this volume provide evidence of its highly contested and power-laden nature. By relying on a diverse range of empirical experience and case studies—from the local to the global, and from wealthy industrialized countries of the "North" to poorer nations of the "South"—this book underscores the importance of grounding accountability procedures and standards in the divergent cultural, social, and political settings in which they operate. It offers a critique of universalizing and technocratic notions of accountability, thus providing a "second-generation" perspective on accountability that is interpretive and culturally embedded.

How Does Accountability Affect Mission? The Case of a Nonprofit Serving Immigrants and Refugees

Abstract

This paper examines accountability processes in a nonprofit organization serving immigrants and refugees, with special attention to their impacts on mission-based activities. The research finds that upward accountability requirements of donors do not necessarily yield improved mission achievement, and practitioners thus have to navigate a complex environment of pressures. More intriguingly, we identify a series of strategies used by nonprofit executives and staff to manage the tensions between upward accountability and mission: a prioritization of lateral accountability, staff empowerment through organizational slack, and a tight coupling of evaluation with job tasks. The findings suggest that funders and nonprofits might gain more from investing in internal grantee capacities for lateral communication and coordination than by soliciting more detailed reporting.

Rich versus King: The Entrepreneur's Dilemma

Abstract

The two major motivations to start a new venture are the profit motive and the control motive. This paper examines how entrepreneurs' choices that increase their potential financial gains (i.e., achieve the profit motive) should conflict with their ability to achieve the control motive. In particular, it focuses on how attracting the external resources required to build value can conflict with entrepreneurs' abilities to keep control of their ventures at the CEO and board levels. It explores whether this tension exists both at the level of the individual entrepreneur's financial gains and at the level of the overall venture's value, and also whether entrepreneurs can avoid the tradeoff by building more human capital before founding the venture and by retaining more co-founders as the venture grows. It tests its hypotheses on a unique dataset of 457 private technology ventures, and finds strong support for each of its core propositions. Implications include the need for entrepreneurs to understand the small probability of achieving both the profit and control motives, and to examine their core motivation and proactively plan their strategic choices to achieve that motivation.

Stewards, Agents, and the Founder Discount: Executive Compensation in New Ventures

Abstract

Agency theory suggests that the interests of opportunistic, self-interested agents conflict with those of principals. Stewardship theory suggests instead that executives' interests are aligned with company interests and that executives are thus more intrinsically motivated than agency theory implies. This study develops hypotheses regarding the psychological and situational factors that affect the applicability of each theory to executive compensation. I tested hypotheses using a unique data set of 1,238 executives from 528 private companies. Results suggest significant differences between founder-stewards and nonfounder agents that diminish with company growth, and significant effects of equity ownership and outside rounds of financing.