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.

June 30

When U.S. venture capital firms cluster in three metropolitan areas—San Francisco, New York, and Boston—does it help their investments further afield? While the phenomenon of clustering is documented in economic literature as long ago as 1920, and local VC-backed firms benefit from proximity to such venture capital centers, new research suggests that the clustering of VC firms helps non-local investments as well.

"This finding is counterintuitive, since venture capitalists might be expected to be the most involved and add the most value to the geographically closest companies," write Henry Chen, Anna Kovner, and HBS professors Paul Gompers and Josh Lerner in "Buy Local? The Geography of Successful and Unsuccessful Venture Capital Expansion" [PDF]. "We observe this outperformance of non-local companies in both early- and late-stage investments. […] One potential explanation of this higher return to non-local deals is that venture capitalists have a higher hurdle rate (i.e., require a higher expected rate of return) for investments that have a higher monitoring cost." Their findings should interest policymakers who want to attract venture capital to new areas.

In the July-August issue of Harvard Business Review, HBS faculty consider a worst-case scenario of financial free fall ("The Descent of Finance" by Niall Ferguson) and the worrisome impact on future U.S. innovation as manufacturing is outsourced ("Restoring American Competitiveness" by Gary P. Pisano and Willy C. Shih).

 

Working Papers

Wellsprings of Creation: How Perturbation Sustains Exploration in Mature Organizations (revised)

Abstract

Organizations struggle to balance simultaneous imperatives to exploit and explore, yet theorists differ as to whether exploitation undermines or enhances exploration. The debate reflects a gap—the missing theoretical mechanism by which organizations break free of old routines and discover new ones. We propose that the missing link is perturbation—novel stimuli that disrupt the execution of specialized routines. Perturbation creates opportunities for organizations to invoke exploratory, general-purpose problem-solving routines. In mature organizations, exogenous perturbations become increasingly scarce to the point that exploration is stifled and inertia sets in. We theorize that mature organizations can sustain exploration by deliberately inducing perturbations in their own processes. Our theory yields testable hypotheses about the relationships between exploitation, perturbation, and exploration. We provide illustrations from the Toyota Motor Company to show how deliberate perturbation enables efficient exploration in the midst of intense exploitation.

Download the paper: http://www.hbs.edu/research/pdf/09-011.pdf

Understanding Inflation-Indexed Bond Markets

Abstract

This paper explores the history of inflation-indexed bond markets in the U.S. and the U.K. It documents a massive decline in long-term real interest rates from the 1990s until 2008, followed by a sudden spike in these rates during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation-indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing going forward, even though they have offered high returns over the past decade.

Download the paper from SSRN ($5): http://papers.nber.org/papers/w15014

Buy Local? The Geography of Successful and Unsuccessful Venture Capital Expansion

Abstract

We document geographic concentration by both venture capital firms and venture capital-financed companies in three cities-San Francisco, Boston, and New York. We find that firms open new satellite offices based on the success rate of venture capital-backed investments in an area. Geography is also significantly related to outcomes. Venture capital firms based in locales that are venture capital centers outperform, regardless of the stage of the investment. Ironically, this outperformance arises from outsized performance outside of the venture capital firms' office locations, including in peripheral locations. Outperformance of non-local investments suggests that policy makers in regions without local venture capitalists might want to mitigate costs associated with established venture capitalists investing in their geographies rather than encouraging the establishment of new venture capital firms.

Download the paper: http://www.hbs.edu/research/pdf/09-143.pdf

Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act

Abstract

This paper analyzes the impact on firm behavior of the Homeland Investment Act of 2004, which provided a one-time tax holiday for the repatriation of foreign earnings by U.S. multinationals. The analysis controls for endogeneity and omitted variable bias by using instruments that identify the firms likely to receive the largest tax benefits from the holiday. Repatriations did not lead to an increase in domestic investment, employment or R@amp;D—even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed. The results have important implications for understanding the impact of U.S. corporate tax policy on multinational firms.

Download the paper from SSRN ($5): http://papers.nber.org/papers/w15023

Variation in Experience and Team Familiarity: Evidence from Indian Software Services

Abstract

In settings ranging from product development to service delivery, fluid teams of individuals with different sets of experience are tasked with projects that are critical to their organization's success. Although building teams from individuals with different prior experience is increasingly necessary, prior work examining the relationship between experience and performance fails to find a consistent effect of variation in experience on performance. The problem is that variation in experience improves a team's information processing capacity and knowledge base but also creates coordination challenges. We hypothesize that team familiarity—team members' prior experience working with one another—is one mechanism that helps teams leverage the potential benefits of variation in team member experience by alleviating coordination problems that such variation may create. We use several years of detailed project- and individual-level data from an Indian software services firm, Wipro Technologies, to examine the effects of team familiarity and variation in experience on multiple measures of performance for software development projects. In most cases, we do not find evidence of a significant main effect for variation in experience on performance. However, when we examine the interaction of team familiarity and variation in experience, we see a complementary effect on measures of delivery performance (i.e., a project being delivered on time and on budget). In team familiarity, our paper identifies one mechanism for capturing the performance benefits of variation in experience and provides insight into how the broader management of experience accumulation affects team performance.

Download the paper: http://www.hbs.edu/research/pdf/09-145.pdf

Measuring and Understanding Hierarchy as an Architectural Element in Industry Sectors

Abstract

Hierarchy is a generic structure in which levels are asymmetrically ordered. In an industry setting, classic supply chains display strict hierarchy, whereas clusters of firms have linkages going in many different directions. Previous theory has often assumed the existence of the hierarchical relationships among firms, and empirical work has focused on a single level of an industry or bilateral relationships. However, quantitative evidence on the deep hierarchy in large industrial sectors is lacking. In this paper, we develop metrics and methods to define and measure the degree of hierarchy in transactional relationships among firms and apply the methods to two large industrial sectors in Japan: automotive and electronics. We compiled the networks of firms connected by transactional relationships. Our empirical analysis shows that the automotive sector exhibits a higher degree of hierarchy than the electronics sector. We further analyze the differences in hierarchy using a simulation model based on transaction breadth and transaction specificity. The empirical measurement and model analysis together indicate that it is the low transaction specificity that drives down the degree of hierarchy in the electronics sector. Differences in transaction patterns in turn may result from the differences in the power level of underlying technologies, which affect product specificity and asset specificity. Thus, the degree of hierarchy in an industry sector may be traced back to fundamental properties of the underlying technologies.

Download the paper: http://www.hbs.edu/research/pdf/09-144.pdf

Unraveling Results from Comparable Demand and Supply: An Experimental Investigation

Abstract

Markets sometimes unravel, with offers becoming inefficiently early. Often this is attributed to competition arising from an imbalance of demand and supply, typically excess demand for workers. However this presents a puzzle, since unraveling can only occur when firms are willing to make early offers and workers are willing to accept them. We present a model and experiment in which workers' quality becomes known only in the late part of the market. However, in equilibrium, matching can occur (inefficiently) early only when there is comparable demand and supply: a surplus of applicants, but a shortage of high quality applicants.

Download the paper from SSRN ($5): http://papers.nber.org/papers/W15006

 

Publications

Preferential Treatment: The New Face of Protectionism?

Abstract

Free trade agreements have increased dramatically over the past decade. This forethought considers how they present global executives with thorny strategic and operational decisions, a piece of which has to do with China's entry into the FTA scene.

Implicit Affect in Organizations

Abstract

Our goal is to integrate the construct of implicit affect—affective processes activated or processed outside of conscious awareness that influence ongoing thought, behavior, and conscious emotional experience—into the field of organizational behavior. We begin by offering a definition and review of implicit processes, including implicit cognition, motivation, and affect. We then draw upon recent empirical research in psychology and neuroscience to make the case for a three-category framework of implicit affect: (1) implicit sources of affect, (2) implicit experiencing of affect, and (3) implicit regulation of affect. To demonstrate the use of this framework in organizational scholarship, we present illustrative examples from organizational behavior research that represent each category. Given the limited amount of research in the organizational domain, we focus on demonstrating how an implicit affect perspective might alter or extend theoretical perspectives about a variety of organizational phenomena. We then discuss methodological options and challenges for studying implicit affect within the organizational domain. In sum, we provide a theoretical and methodological roadmap as well as a call for action for understanding the role of implicit affective processes in organizational behavior.

The Descent of Finance

Abstract

What if the current recession turns out to be like the Great Depression of 1929-1933? Four years from now, the United States might find itself with a still-shrinking economy, half as many banks as in 2009, a third as many hedge funds, and retail banking resembling a public utility. The federal debt could be at $20 trillion, the top income tax rate at 45%, and the S&P 500 at 418. Ferguson, a professor at Harvard University and Harvard Business School, imagines that to be the worst-case scenario. The Breakdown, as Ferguson calls it, would alter the international economic order too, with China's GDP rising to half that of the U.S. by 2013 and the IMF's Special Drawing Rights replacing the dollar as the international reserve currency. Ferguson analyzes the roots of the crisis as well as the measures taken by the Obama administration to tackle it. He goes on to describe the impact on the global economy and points out that the slowdown is hurting other nations more than the United States, thereby building a powerful case for a somewhat more sanguine view of America's future. In a better-case 2013, he posits, the Federal Reserve's policies have produced neither inflation nor deflation, a remarkable number of new banks have appeared, the top income tax rate is 35%, and the S&P 500 stands at 976. Because the world has become more dangerous as well as poorer, everyone looks to the United States to continue acting as a global policeman—and the greenback is still the world's currency of choice.

The Agglomeration of U.S. Ethnic Inventors

Abstract

The ethnic composition of U.S. inventors is undergoing a significant transfor ation—with deep impacts for the overall agglomeration of U.S. innovation. This study applies an ethnic-name database to individual U.S. patent records to explore these trends in greater detail. The contributions of Chinese and Indian scientists and engineers to U.S. technology formation increased dramatically in the 1990s. At the same time, these ethnic inventors became more spatially concentrated across U.S. cities. The combination of these two factors helped stop and reverse long-term declines in overall inventor agglomeration evident in the 1970s and 1980s. The heightened ethnic agglomeration is particularly evident in industry patents for high-tech sectors, and similar trends are not found in institutions constrained from agglomerating (e.g., universities and government).

Download the paper from SSRN ($5): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1162226

Restoring American Competitiveness

Abstract

For decades, U.S. companies have been outsourcing manufacturing in the belief that it held no competitive advantage. That's been a disaster, maintain Harvard professors Pisano and Shih, because today's low-value manufacturing operations hold the seeds of tomorrow's innovative new products. What those companies have been ceding is the country's industrial commons—that is, the collective operational capabilities that underpin new product and process development in the U.S. industrial sector. As a result, America has lost not only the ability to develop and manufacture high-tech products like televisions, memory chips, and laptops but also the expertise to produce emerging hot products like the Kindle e-reader, high-end servers, solar panels, and the batteries that will power the next generation of automobiles. To rebuild the commons and restore its wealth-generating machine will require government and industry in the U.S. to make two drastic changes: First, the government must change the way it supports basic and applied scientific research to promote the broad collaboration with business and academia needed to tackle society's big problems. Second, corporate management practices and governance structures must be overhauled so they no longer exaggerate the payoffs and discount the dangers of outsourcing production and cutting investments in R&D. Restoring the ability of enterprises to develop and manufacture high-tech products in America is the only way the country can hope to pay down its enormous deficits and raise its citizens' standard of living.

 

Cases & Course Materials

Financial Networks and Informal Banking in China: From Pawnshops to Private Equity

Harvard Business School Note 809-111

Provides an analysis of why informal financial networks and institutions still play an extremely important role in China's economy in the 21st century. Although China has emerged as one of the fastest growing economies in the world, it still suffers from a weak financial system dominated by state-controlled banks and severely limited access to capital for private entrepreneurs and consumers. The case shows how the political climate, economic regulatory environment, and social attitudes towards lending practices have shaped the approach to and structure of financing private enterprises over time. It also addresses the response of the Chinese government to the resilient curb market in the context of the economic reforms and policy changes for the banking and financial sector.

Purchase this note:
http://hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=809111

KenCall—Can Nik Nesbitt's Venture Succeed in Kenya?

Harvard Business School Case 809-114

Nik Nesbitt is preparing a presentation of his Kenyan contact center startup to a group of angel investors visiting for the first time. The task has given him cause for some soul searching: has it been worth it to battle the impoverished infrastructure and inappropriate government regulations to launch this venture?

Purchase this case:
http://hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=809114

TOTO: The Bottom Line

Harvard Business School Case 809-064

TOTO, the leading manufacturer of toilets in Japan, is struggling to penetrate the U.S. market with its premier bidet-toilets, which are present in 63% of homes in Japan. The case examines the behavioral, cultural, and institutional barriers that TOTO faces in gaining adoption of an innovation. It also explores the role of product categorization in driving consumer behavior—in contrast to the U.S., toilets in Japan are considered a high-tech consumer electronic device. Finally, the role of organizational identity and culture is examined. The creation of the bidet-toilet category in Japan was a defining accomplishment for TOTO, and this history has created a strong commitment to promoting it in the U.S. But given that TOTO has been highly successful selling regular high-end toilets in the U.S., is this commitment to the bidet-toilet appropriate?

Purchase this case:
http://hbsp.harvard.edu/b01/en/common/item_detail.jhtml?id=809064