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.
December 18, 2007
The world's financial institutions are increasingly intrigued by the possibilities and potential of risk management, given the market volatility all around us. This week sees a new article by Anette Mikes, a postdoctoral fellow at Harvard Business School, who studies evolving directions in risk management and the emerging roles of senior risk officers, particularly the chief risk officer, or CRO. Her article "Beyond Compliance: The Maturation of CROs and Other Senior Risk Executives" describes how CROs play an ever greater role in areas such as governance, capital allocation, data management, internal reporting, and group-level budgeting and planning.
Also this week, a look at how emotions are affected by macroeconomic fluctuations, and a paper for purchase ($5) on the success rate—high—of top analysts who become entrepreneurs. First Look will return in the new year!
Happiness, Contentment and Other Emotions for Central Banks
|Authors:||Rafael Di Tella and Robert MacCulloch|
We show that data on satisfaction with life from over 600,000 Europeans are negatively correlated with the unemployment rate and the inflation rate. Our preferred interpretation is that this shows that emotions are affected by macroeconomic fluctuations. Contentment is, at a minimum, one of the important emotions that central banks should focus on. More ambitiously, contentment might be considered one of the components of utility. The results may help central banks understand the tradeoffs that the public is willing to accept in terms of unemployment for inflation, at least in terms of keeping the average level of one particular emotion (contentment) constant. An alternative use of these data is to study the particular channels through which macroeconomics affects emotions. Finally, work in economics on the design of monetary policy makes several assumptions (e.g., a representative agent, a summary measure of emotions akin to utility exists and that individuals only care about income and leisure) that can be used to interpret our results as weights in a social loss function.
Purchase the paper from SSRN.com ($5): http://papers.nber.org/papers/w13622
New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability
|Authors:||Dale F. Gray, Robert C. Merton, and Zvi Bodie|
This paper proposes a new approach to improve the way central banks can analyze and manage the financial risks of a national economy. It is based on the modern theory and practice of contingent claims analysis (CCA), which is successfully used today at the level of individual banks by managers, investors, and regulators. The basic analytical tool is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise's assets and liabilities to external "shocks." At the national level, the sectors of an economy are viewed as interconnected portfolios of assets, liabilities, and guarantees—some explicit and others implicit. Traditional approaches have difficulty analyzing how risks can accumulate gradually and then suddenly erupt in a full-blown crisis. The CCA approach is well-suited to capturing such "non-linearities" and to quantifying the effects of asset-liability mismatches within and across institutions. Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk.
Purchase the paper from SSRN.com ($5): http://papers.nber.org/papers/w13607
Does Individual Performance Affect Entrepreneurial Mobility? Empirical Evidence from the Financial Analysis Market
|Authors:||Boris Groysberg, Ashish Nanda, and M. Julia Prats|
Our paper contributes to the studies on the relationship between workers' human capital and their decision to become self-employed as well as their probability to survive as entrepreneurs. Analysis from a panel data set of research analysts in investment banks over 1988-1996 reveals that star analysts are more likely than non-star analysts to become entrepreneurs. Furthermore, we find that ventures started by star analysts have a higher probability of survival than ventures established by non-star analysts. Extending traditional theories of entrepreneurship and labor mobility, our results also suggest that drivers of turnover vary by destination: (a) turnover to entrepreneurship and (b) other turnover. In contrast to turnover to entrepreneurship, star analysts are less likely to move to other firms than non-star analysts.
Purchase the paper from SSRN.com ($5): http://papers.nber.org/papers/w13633
The Impact of Component Modularity on Design Evolution: Evidence from the Software Industry
|Authors:||Alan MacCormack, John Rusnak, and Carliss Baldwin|
Much academic work asserts a relationship between the design of a complex system and the manner in which this system evolves over time. In particular, designs which are modular in nature are argued to be more "evolvable," in that these designs facilitate making future adaptations, the nature of which do not have to be specified in advance. In essence, modularity creates "option value" with respect to new and improved designs, which is particularly important when a system must meet uncertain future demands. Despite the conceptual appeal of this research, empirical work exploring the relationship between modularity and evolution has had limited success. Three major challenges persist: first, it is difficult to measure modularity in a robust and repeatable fashion; second, modularity is a property of individual components, not systems as a whole, hence we must examine these dynamics at the microstructure level; and third, evolution is a temporal phenomenon, in that the conditions at time t affect the nature of the design at time t+1, hence exploring this phenomenon requires longitudinal data. In this paper, we tackle these challenges by analyzing the evolution of a successful commercial software product over its entire lifetime, comprising six major "releases." In particular, we develop measures of modularity at the component level, and use these to predict patterns of evolution between successive versions of the design. We find that modularity has a strong and unambiguous impact on design evolution. Specifically, we show that i) tightly-coupled components are "harder to kill," in that they have a greater likelihood of survival in subsequent versions of a design; ii) tightly-coupled components are "harder to maintain," in that they experience more surprise changes to their dependency relationships that are not associated with new functionality; and iii) tightly-coupled components are "harder to augment," in that the mix of new components added in each version is significantly more modular than the legacy design.
Download the paper: http://www.hbs.edu/research/pdf/08-038.pdf
Cases & Course Materials
Food Security and The Church of Jesus Christ of Latter-day Saints
Harvard Business School Case 508-002
The Mormon Church focuses on self-reliance and being prepared for emergencies. Part of their program encourages each member of the Church to have a reserve food supply on hand at all times. Given U.S. and global food stock levels, is the Church program a good model for the country?
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Credit Reporting, Relationship Banking, and Loan Repayment
|Authors:||Martin Brown and Christian Zehnder|
|Periodical:||Journal of Money, Credit and Banking 38, no. 8 (December 2007)|
How does information sharing between lenders affect borrowers' repayment behavior? We show—in a laboratory credit market—that information sharing increases repayment rates, as borrowers anticipate that a good credit record improves their access to credit. This incentive effect of information sharing is substantial when repayment is not third party enforceable and lending is dominated by one-shot transactions. If, however, repeat interaction between borrowers and lenders is feasible, the incentive effect of credit reporting is negligible, as bilateral banking relationships discipline borrowers. Information sharing nevertheless affects market outcome by weakening lenders' ability to extract rents from relationships.
Was sind Cluster? Antworten aus der Wissenschaft
|Author:||Christian H.M. Ketels|
|Publication:||In Treibhäuser der Innovation, 20-29. Essen, Germany: Stifterverband für die Deutsche Wissenschaft, 2007|
No abstract is currently available for this book chapter.
Analyzing the Evolution of Large-Scale Software Systems Using Design Structure Matrices and Design Rule Theory: Two Exploratory Cases.
|Authors:||Matthew J. LaMantia, Yuanfang Cai, Alan MacCormack, and John Rusnak|
|Publication:||Proceedings of the 7th Working IEEE/IFIP Conference on Software Architecture (WICSA7), forthcoming|
Designers often seek modular architectures to better accommodate expected changes and to enable parallel development. However, we lack a formal theory and model of modularity and software evolution, which can be used for description, prediction, and prescription. According to Baldwin and Clark's theory, modular architectures add value to system designs by creating options to improve the system by substituting or experimenting on individual modules. In this paper, we evaluate their theory by looking at the design evolution of two software product platforms through the modeling lens of design structure matrices (DSMs) and design rule theory. Our analysis shows that DSM models and options theory can explain how real-world modularization activities in one case allowed for different rates of evolution in different software modules and in another case conferred distinct strategic advantages on a firm (by permitting substitution of an at-risk software module without substantial change to the rest of the system). The experiment supports our hypothesis that these formal models and theory can account for important aspects of software design evolution in large-scale systems.
Learning the Fine Art of Collaboration
|Authors:||Alan MacCormack and Theodore Forbath|
|Periodical:||Forethought. Harvard Business Review (forthcoming): 10-11|
Innovations are increasingly brought to the market by networks of firms, selected for their unique capabilities and operating in a coordinated manner. This collaborative model demands that firms develop different skills, yet despite this need, there is little guidance on how to develop these abilities. Based on a recent study, this article describes the main factor differentiating those firms who excel at collaboration from those who struggle—the ability to learn how to collaborate. We describe the four areas in which firms must invest to get better at learning: People, Process, Platforms and Programs.
Beyond Compliance: The Maturation of CROs and Other Senior Risk Executives
|Periodical:||GARP Risk Review, no. 39 (November-December 2007): 12-18|
Senior risk management executives—particularly the chief risk officer—have assumed greater responsibilities in recent years. Whereas CROs were once considered compliance specialists, most now wield board-level power and are heavily involved in areas like governance, capital allocation, data management, internal reporting and group-level budgeting and planning. What's more, other significant roles—such as the so-called group risk controller—have emerged in support of the CRO. Anette Mikes and David Townsend analyze the results of comprehensive interviews they performed with senior risk officers.
Prudence in Bargaining: The Effect of Uncertainty on Bargaining Outcomes
|Periodical:||Games and Economic Behavior (forthcoming)|
We investigate the outcome of bargaining when a player's pay-off from agreement is risky. We find that a risk-averse player typically increases his equilibrium receipts when his pay-off is made risky. This is because the presence of risk makes individuals behave "more patiently" in bargaining. Strong analogies are drawn to the precautionary saving literature. We show that the effect of risk on receipts can be sufficiently strong that a decreasingly risk-averse player may be better off receiving a risky pay-off than a certain pay-off.