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.

March 4, 2008

Americans do not generally keep money under their mattresses, but the level of financial sophistication in the country indicates a lot of room for improvement, according to new research. As HBS visiting scholar Annamaria Lusardi writes in "Household Saving Behavior," more effective programs of financial education could help would-be savers and investors access information and learn basic financial concepts to make better decisions around retirement, Social Security benefits, and wealth building. Lusardi's working paper is available for download ($5) from the Social Science Research Network.

What does it mean when a developing country faces a brain drain? A forthcoming article by HBS professor Mihir Desai and colleagues gauges the fiscal impact of talent loss by examining human capital flows from India to the United States during the 1990s. According to the researchers, "the net fiscal loss associated with the U.S. Indian-born resident population ranges from 0.24% to 0.58% of Indian GDP in 2001."

Also up this week: more working papers for download, books, and chapters, as well as cases on advertising, banking, publishing, and more.


Working Papers

Sell Side School Ties


We study the impact of social networks on agents' ability to gather superior information about firms. Exploiting novel data on the educational backgrounds of sell-side equity analysts and senior officers of firms, we test the hypothesis that analysts' school ties to senior officers impart comparative information advantages in the production of analyst research. We find evidence that analysts outperform on their stock recommendations when they have an educational link to the company. A simple portfolio strategy of going long the buy recommendations with school ties and going short buy recommendations without ties earns returns of 5.40% per year. We test whether Regulation FD, targeted at impeding selective disclosure, constrained the use of direct access to senior management. We find a large effect: pre-Reg FD the return premium from school ties was 8.16% per year, while post-Reg FD the return premium was nearly zero and insignificant.

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Bond Supply and Excess Bond Returns


We examine empirically how the maturity structure of government debt affects bond yields and excess returns. Our analysis is based on a theoretical model of preferred habitat in which clienteles with strong preferences for specific maturities trade with arbitrageurs. Consistent with the model, we find that (i) the supply of long- relative to short-term bonds is positively related to the term spread, (ii) supply predicts positively long-term bonds' excess returns even after controlling for the term spread and the Cochrane-Piazzesi factor, (iii) the effects of supply are stronger for longer maturities, and (iv) following periods when arbitrageurs have lost money, both supply and the term spread are stronger predictors of excess returns.

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Household Saving Behavior: The Role of Financial Literacy, Information, and Financial Education Programs


Individuals are increasingly in charge of their own financial security after retirement. But how well-equipped are individuals to make saving decisions; do they possess adequate financial literacy, are they informed about the most important components of saving plans, do they even plan for retirement? This paper shows that financial illiteracy is widespread among the U.S. population and particularly acute among specific demographic groups, such as those with low education, women, African-Americans, and Hispanics. Moreover, close to half of older workers do not know which type of pensions they have and the large majority of workers know little about the rules governing Social Security benefits. Notwithstanding the low levels of literacy that many individuals display, very few rely on the help of experts or financial advisors to make saving and investment decisions. Low literacy and lack of information affect the ability to save and to secure a comfortable retirement; ignorance about basic financial concepts can be linked to lack of retirement planning and lack of wealth. Financial education programs can help improve saving and financial decision-making, but much more can be done to improve the effectiveness of these programs.

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Contract Rights and Risk Aversion: Foreign Banks and the Mexican Economy, 1997-2004


In 1997 Mexico allowed foreign banks unrestricted entry to the market. What impact did foreign mergers and acquisitions have on Mexico's banks? We find that all banks in Mexico have become increasingly risk averse and that foreign banks are even more so. Foreign banks grant less credit, screen loans more intensively, and charge lower interest rate spreads. The cause is Mexico's weak contract rights environment. One would normally associate risk aversion with lower profits. We find, however, that foreign banks are more profitable than domestically owned banks because their market power allows them to charge higher service fees than domestic banks.

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Cases & Course Materials

The Armstrong Investigation

Harvard Business School Case 708-034

In the early 20th century, public outrage at certain life insurance practices led to an investigation in New York State that threatened to curtail growth in the industry. Charles Evans Hughes guided the four-month-long Armstrong Investigation, which made startling revelations and offered a number of controversial recommendations, several of which would forbid the most popular form of life insurance (tontine insurance), limit the growth of life insurers (which included several of the nation's largest financial institutions at the time), and prevent insurance firms from owning the stock of other companies. The New York State legislature approved all of the recommended measures and sent the bill to the Governor for his signature. The life insurance industry objected, however, claiming that some of the new rules would reduce consumer choice and unnecessarily lower returns on company investments.

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The Campaign for Bank Insurance in Antebellum New York

Harvard Business School Case 708-037

The New York State Legislature had come to a standstill in 1829 as lawmakers refused to charter any new banks or recharter any existing banks. Four of New York's forty banks had failed since 1825, and many legislatures believed that a significant change in the banking regime was needed to shore up the state's financial systems. Others, however, feared that a major change in the law was too risky, especially since over three-quarters of the state's banks held charters that were slated to expire over the next four years. On the table was a completely untested proposal to create a mandatory public insurance fund that would back the banknotes and deposits of every state bank. As bank charters throughout New York State rapidly approached expiration, lawmakers faced a tough decision: should they pass the bill and gamble with the untried insurance fund, or should they go seek a more traditional solution to the state's banking woes?

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Envisioning 'Free Banking' in Antebellum New York (A)

Harvard Business School Case 708-038

Banks throughout New York State suspended specie payments (i.e., payments in gold and silver) in May 1837 following the collapse of several state banks and the onset of a nationwide financial panic. Amid the chaos, the upstart Whigs were able to depose the longstanding Republican majority in the state legislature. Responding to citizen anger, as well as perennial calls for more banking capital, the Whigs drafted a novel "free banking" bill, which would override the established bank chartering mechanism and allow any association with sufficient capital the opportunity to open a bank and issue bank notes (a widely accepted form of paper money at the time). The bill also required that every note issued by a New York bank be fully backed by bonds or mortgages. If enacted, the bill seemed likely to encourage the establishment of many new banks. There was no telling what the economic impact of the bill's special bank note provisions would be. Once the bill passed the legislature, Governor Marcy had to decide whether to sign this radical proposal into law.

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iBasis, Inc.

Harvard Business School Case 908-014

No abstract is available at this time.

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Metro International S.A.

Harvard Business School Case 708-429

Explores the business model of Metro International, a company publishing 70 editions of its free newspaper in 20 countries. Metro had been a pioneer in the free newspaper market, fighting incumbent publishers distributing traditional paid-for newspapers. Looks at the decision facing top management of Metro International in 2007 regarding the future strategy of the company. The company had become profitable after years of losses, but other problems had surfaced; competition had increased heavily in many markets and advertising—the free newspaper's only source of income—was quickly shifting from newspapers to the Internet. Spain was a particular case in point. What had Metro International learned from experiences elsewhere on the globe and would they allow the company to make the Spanish unit profitable? What strategy should the Spanish country manager adopt?

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MINI USA: Finding a New Advertising Agency (A)

Harvard Business School Case 508-041

Selling an intangible like advertising services is a difficult task. The first step is to understand how brands buy these services. What are they looking for? What do they need to learn? How do they go about assessing things like creativity, trust, and loyalty? This set of cases puts the students into the roles of the seller (an advertising agency named Butler, Shine, Stern and Partners) and the buyer (MINI USA) and asks them to develop a sales strategy for advertising services. As outlined in the (B) case, the agency developed an intriguing and original approach to assessing the intangibles and students are asked to react to it from a sales perspective and to attempt to generalize the approach to other sales domains.

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MINI USA: Finding a New Advertising Agency (B)

Harvard Business School Supplement 508-042

Supplements the (A) case.

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The South Sea Company (A)

Harvard Business School Case 708-005

In early 1720, the South Sea Company and the Bank of England were competing for the right to issue new shares and to exchange those shares for government bonds that were then in the hands of the public. The British government had already executed two such debt conversions with the South Sea Company. Most individuals who had converted bonds for shares in 1711 and 1719 had seen their South Sea shares appreciate in the meantime, and the government had lowered its debt-servicing costs as a result of these two conversions. The conversion under consideration in 1720, however, would be on a much larger scale. In time, the South Sea Company won the bidding war, and the House of Commons approved its debt conversion plan. Now it was up to the House of Lords to approve or reject the deal.

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World Economic Forum (A)

Harvard Business School Case 708-025

Covers strategy and leadership. World Economic Forum founder Klaus Schwab has created the world's most famous—and exclusive—global business conference, held annually in Davos, Switzerland, and backed by a formidable membership organization that includes many of the world's most prominent firms. He now must consider how to keep the event and the organization vibrant and valuable, as similar new organizations arise and as the challenges of globalization become more difficult. In the aspirational slogan of the Forum, Schwab remains "committed to improving the state of the world," and readers are invited to ponder how he can use the organization he has created to make good on this promise.

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Wall Street's First Panic (A)

Harvard Business School Case 708-002

In the early 1790s, a flood of newly issued public and private securities sparked an investment boom in the nascent United States. In New York, the bustling commercial district along Wall Street emerged as the center of the city's securities trade. One of the many Americans drawn into the frenetic and largely unregulated securities market was William Duer, who ultimately became a major player on the Street. As it turned out, however, Duer's financial dealings proved unsustainable, and his financial collapse helped to bring the securities boom to a halt. Shocked by the widespread devastation wrought by Wall Street's first panic, the New York legislature acted quickly to ban outdoor securities auctions and a popular class of financial instruments known as "time bargains," both of which were thought to have contributed to the boom and bust on Wall Street. Facing public outrage along with the new legal restrictions, New York's top brokers had to decide whether a new system for securities trading was needed and, if so, what it should look like.

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Financial Economics, 2nd ed.


This book seeks to explain finance through its functions rather than its institutions, concentrating on the three pillars of finance: optimization over time, asset valuation, and risk management.

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Greater Good: How Good Marketing Makes for Better Democracy


Marketing has a greater purpose, and marketers, a higher calling, than simply selling more widgets, according to John Quelch and Katherine Jocz. In "Greater Good", the authors contend that marketing performs an essential societal function—and does so democratically. They maintain that people would benefit if the realms of politics and marketing were informed by one another's best principles and practices. Quelch and Jocz lay out the six fundamental characteristics that marketing and democracy share: (1) exchange of value, such as goods, services, and promises, (2) consumption of goods and services, (3) choice in all decisions, (4) free flow of information, (5) active engagement of a majority of individuals, and (6) inclusion of as many people as possible. Without these six traits, both marketing and democracy would fail, and with them, society. Drawing on current and historical examples from economies around the world, this landmark work illuminates marketing's critical role in the development, growth, and governance of societies. It reveals how good marketing practices improve the political process and—in turn—the practice of democracy itself.

Revisiting Rental Housing


Rental housing is increasingly recognized as a vital housing option in the United States. Yet government policies and programs continue to grapple with widespread problems, including affordability, distressed urban neighborhoods, poor-quality housing stock, concentrated poverty, and exposure to health hazards in the home. These challenges can be costly and difficult to address. The time is ripe for fresh, authoritative analysis of this important yet often overlooked sector. In Revisiting Rental Housing, leading housing researchers build on decades of experience, research, and evaluation to inform our understanding of rental housing challenges and what to do about them. The authors look at contributing factors and problems generated by the operation of rental markets and assess whether existing policies and programs have helped and what lessons have been learned. Finally, the authors suggest new directions for housing policy, including the integration of best practices from past lessons into existing programs and innovations for large-scale, long-term market and policy solutions that can get to the root of rental housing challenges.

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Behavioral Frontiers in Choice Modeling


We review the discussion at a workshop whose goal was to achieve a better integration among behavioral, economic, and statistical approaches to choice modeling. The workshop explored how current approaches to the specification, estimation, and application of choice models might be improved to better capture the diversity of processes that are postulated to explain how consumers make choices. Some specific challenges include how to capture and parsimoniously describe heterogeneous mixes of heuristic choice rules, methods for building realistic models of choice, and non-traditional methods for estimating models. An agenda for important future work in these areas is also proposed.

Corporate Tax Avoidance and Firm Value


Do corporate tax avoidance activities advance shareholder interests? This paper tests alternative theories of corporate tax avoidance that yield distinct predictions on the valuation of corporate tax avoidance. Unexplained differences between income reported to capital markets and to tax authorities are used to proxy for tax avoidance activity. These "book-tax" gaps are shown to be larger when firms are alleged to be involved in tax shelters. OLS estimates indicate that the average effect of tax avoidance on firm value is not significantly different from zero but is positive for well-governed firms as predicted by an agency perspective on corporate tax avoidance. An exogenous change in tax regulations that affected the ability of some firms to avoid taxes is used to construct instruments for tax avoidance activity. The IV estimates yield larger overall effects and reinforce the basic result that higher quality firm governance leads to a larger effect of tax avoidance on firm value. The results are robust to a wide variety of tests for alternative explanations. Taken together, the results suggest that the simple view of corporate tax avoidance as a transfer of resources from the state to shareholders is incomplete given the agency problems characterizing shareholder-manager relations.

The Fiscal Impact of the Brain Drain: Indian Emigration to the U.S.


Easing immigration restrictions for the highly skilled in developed countries portend a future of increased human capital outflows from developing countries. The myriad consequences of these developments for developing countries include the direct loss of the fiscal contributions of these highly skilled individuals. This paper analyzes the fiscal impact of this loss of talent for a developing country by examining human capital flows from India to the U.S. The escalation of the emigration of highly skilled professionals from India to the U.S is examined by surveying evidence on the changing nature of the Indian-born in the U.S. during the 1990s. The loss of talent to India during the 1990s was dramatic and highly concentrated amongst the prime-age work force, the highly educated and high earners. In order to estimate the fiscal losses associated with these emigrants, this paper first estimates what these emigrants would have earned in India, and then integrates the resulting counterfactual distributions with details of the Indian fiscal system to estimate fiscal impacts. Two distinct methods to estimate the counterfactual earnings distributions are implemented: a translation of actual U.S. incomes in purchasing power parity terms and an income simulation based on a jointly estimated model of Indian earnings and participation in the workforce. The PPP methods indicate that the foregone income tax revenues associated with the Indian-born residents of the U.S. comprise one-third of current Indian individual income tax receipts. Depending on the method for estimating expenditures saved by the absence of these emigrants, the net fiscal loss associated with the U.S. Indian-born resident population ranges from 0.24% to 0.58% of Indian GDP in 2001.

Seek Strategy the Right Way at the Right Time


Deliberate, emergent, and analogical approaches to finding the best strategy all have their advantages, depending on where an industry is in its life cycle. Be open to the best option at each juncture and wise enough to make the right call.