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.

September 29

Getting a handle on systemic risk in the financial system is an increasingly urgent task, as the recent financial crisis illustrates painfully. Yet there are no simple legislative or regulatory answers, according to a new working paper coauthored by HBS professor Robert C. Merton. Merton, a Nobel Prize-winner in the economic sciences (1997), Amir E. Khandani, and Andrew W. Lo suggest that three market conditions underlying our recent crisis are usually perceived as positive—and indeed, get touted in political platforms and policy objectives—but, acting together, create a kind of perfect storm: rising home prices, falling interest rates, and easier access to mortgage loans.

During such periods, Merton et al. write in "Systemic Risk and the Refinancing Ratchet Effect," "cash-out refinancing is like a ratchet, incrementally increasing homeowner leverage as real-estate values appreciate without the ability to symmetrically decrease leverage by increments as real-estate values decline" because property such as a house cannot be subdivided financially.

While warning that the financial crisis cannot be attributed to a single cause, the authors would like to see the establishment of an independent organization (similar to the National Transportation Safety Board) that would monitor systemic risk.

"The subtle and multi-faceted 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," they conclude.

 

Working Papers

Local Dividend Clienteles

Abstract

We exploit demographic variation to identify the effect of dividend demand on firm payout policy. Retail investors tend to hold local stocks and older investors prefer dividend-paying stocks. Together, these tendencies generate geographically varying demand for dividends. Firms headquartered in areas in which seniors constitute a large fraction of the population are more likely to pay dividends, initiate dividends, and have higher dividend yields. However, the fraction of seniors is uncorrelated with share repurchases, investment, or profitability, suggesting that geographic variation in dividend payout is not driven by some unmeasured firm characteristic affecting the ability or willingness to distribute cash to shareholders. We also provide indirect evidence as to why firm managers may cater to the demand for dividends from local seniors. Overall, these results suggest that the composition of a firm's investor base affects corporate policy choices.

Download the paper from NBER ($5): http://papers.nber.org/papers/W15175

Strategies to Fight Ad-sponsored Rivals

Abstract

We analyze the optimal strategy of a high-quality incumbent that faces a low-quality ad-sponsored competitor. In addition to competing through adjustments of tactical variables such as price or advertising intensity, we allow the incumbent to consider changes in its business model. We consider four alternative business models—two pure models (subscription-based and ad-sponsored) and two mixed models that are hybrids of the two pure models. We show that the optimal response to an ad-sponsored rival often entails business model reconfigurations, a phenomenon that we dub "competing through business models." We also find that when there is an ad-sponsored entrant, the incumbent is more likely to prefer to compete through a pure, rather than a mixed, business model because of cannibalization and endogenous vertical differentiation concerns. We discuss how our study helps improve our understanding of notions of strategy, business model, and tactics in the field of strategy.

Download the paper: http://www.hbs.edu/research/pdf/10-026.pdf

Specific Knowledge and Divisional Performance Measurement

Abstract

This paper discusses five common divisional performance measurement methods—cost centers, revenue centers, profit centers, investment centers, and expense centers—while providing a theory that explains when each of these methods is likely to be the most efficient. The central insight of the theory is that each method offers a different way of aligning decision-making authority with valuable "specific knowledge" inside the organization. The theory suggests that cost and revenue centers work best in cases where headquarters has good information about cost and demand functions, product quality, and optimal output mix. Profit centers—defined as business units whose managers have responsibility for overall profits but not the authority to make major capital spending decisions—tend to supplant revenue and cost centers when line managers have a significant informational advantage over headquarters and when there are few interdependencies (or "synergies") between divisions. Investment centers—profit centers in which unit managers are allowed to make major investment decisions—tend to prevail when the activity is capital intensive and when it is difficult for headquarters to identify the value-maximizing investment strategy for the business unit. In evaluating the performance of profit centers, rate-of-return measures like ROA are likely to be effective when unit managers do not have major influence over the level of new investment. But, in the case of investment centers, Economic Value Added, or EVA, is likely to be the most effective single-period measure because it is designed to encourage only value-increasing investment decisions.

Download the paper from SSRN (free registration required): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1475725

Breakthrough Inventions and Migrating Clusters of Innovation

Abstract

We investigate the speed at which clusters of invention for a technology migrate spatially following breakthrough inventions. We identify breakthrough inventions as the top 1% of U.S. inventions for a technology during 1975-1984 in terms of subsequent citations. Patenting growth is significantly higher in cities and technologies where breakthrough inventions occur after 1984 relative to peer locations that do not experience breakthrough inventions. This growth differential in turn depends on the mobility of the technology's labor force, which we model through the extent that technologies depend upon immigrant scientists and engineers. Spatial adjustments are faster for technologies that depend heavily on immigrant inventors. The results qualitatively confirm the mechanism of industry migration proposed in models like Duranton. [Duranton, G., 2007. "Urban Evolutions: The Fast, the Slow, and the Still." American Economic Review 97, 197.221].

Download the paper from SSRN (free registration required): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1471435

Systemic Risk and the Refinancing Ratchet Effect

Abstract

The confluence of three trends in the U.S. residential housing market—rising home prices, declining interest rates, and near-frictionless refinancing opportunities—led to vastly increased systemic risk in the financial system. Individually, each of these trends is benign, but when they occur simultaneously, as they did over the past decade, they impose an unintentional synchronization of homeowner leverage. This synchronization, coupled with the indivisibility of residential real estate that prevents homeowners from deleveraging when property values decline and homeowner equity deteriorates, conspire to create a "ratchet" effect in which homeowner leverage is maintained or increased during good times without the ability to decrease leverage during bad times. If refinancing-facilitated homeowner-equity extraction is sufficiently widespread—as it was during the years leading up to the peak of the U.S. residential real-estate market—the inadvertent coordination of leverage during a market rise implies higher correlation of defaults during a market drop. To measure the systemic impact of this ratchet effect, we simulate the U.S. housing market with and without equity extractions and estimate the losses absorbed by mortgage lenders by valuing the embedded put-option in non-recourse mortgages. Our simulations generate loss estimates of $1.5 trillion from June 2006 to December 2008 under historical market conditions, compared to simulated losses of $280 billion in the absence of equity extractions.

Download the paper: http://www.hbs.edu/research/pdf/10-023.pdf

Policy Bundling to Overcome Loss Aversion: A Method for Improving Legislative Outcomes (revised)

Abstract

Policies that would create net benefits for society but would also involve costs frequently lack the necessary support to be enacted because losses loom larger than gains psychologically. To reduce this harmful consequence of loss aversion, we propose a new type of policy-bundling technique in which related bills that have both costs and benefits are combined. Using a laboratory study, we confirm across a set of four legislative domains that this bundling technique increases support for bills that have both costs and benefits. We also demonstrate that this effect is due to changes in the psychology of decision making, rather than voters' willingness to compromise and support a bill they weakly oppose when that bill is bundled with one they strongly support.

Download the paper: http://www.hbs.edu/research/pdf/09-147.pdf

 

Publications

Commentaries and Cases on the Law of Business Organization

Book Abstract

Updated throughout, the Third Edition of Commentaries and Cases on the Law of Business Organization continues to provide a refreshingly accessible economic analysis perspective. The distinguished team of authors introduces and explains economic concepts in a way that makes this sophisticated book clear and engaging for students.

Publisher's Link: http://www.aspenlawschool.com/books/allen_busorg/

The Story of American Business: From the Pages of the New York Times

Book Abstract

This book sketches some of the most important people and moments in the last 150 years of U.S. business history.

Barriers to Acting in Time on Energy, and Strategies for Overcoming Them

Abstract

Energy policy is on everyone's mind these days. The U.S. presidential campaign focused on energy independence and exploration (drill, baby, drill), climate change, alternative fuels, even nuclear energy. But there is a serious problem endemic to America's energy challenges. Policymakers tend to do just enough to satisfy political demands but not enough to solve the real problems, and they wait too long to act. The resulting policies are overly reactive, enacted once damage is already done, and they are too often incomplete, incoherent, and ineffectual. Given the gravity of current economic, geopolitical, and environmental concerns, this is more unacceptable than ever. This important volume details this problem, making clear the unfortunate results of such short-sighted thinking, and it proposes measures to overcome this counterproductive tendency. All of the contributors to "Acting in Time on Energy Policy" are affiliated with Harvard University and rank among America's pre-eminent energy policy analysts. They tackle important questions as they pertain to specific areas of energy policy: Why are these components of energy policy so important? How would acting in time, i.e., not waiting until politics demands action, make a difference? What should our policy actually be? We need to get energy policy right this time—Gallagher and her colleagues help lead the way.

The Cost Structure, Customer Profitability, and Retention Implications of Self-Service Distribution Channels: Evidence from Customer Behavior in an Online Banking Channel

Abstract

This paper uses the context of online banking to investigate the consequences of employing self-service distribution channels to alter customer interactions with the firm. Using a sample of retail banking customers observed over a 30-month period at a large U.S. bank, we test whether changes in service consumption, cost-to-serve, and customer profitability are associated with the adoption of online banking. We find that customer adoption of online banking is associated with (1) substitution primarily from incrementally more costly self-service delivery channels (ATM and voice response unit); (2) augmentation of service consumption in more costly service delivery channels (branch and call center); (3) a substantial increase in total transaction volume; (4) an increase in estimated average cost-to-serve resulting from the combination of (1) through (3); and (5) a reduction in short-term customer profitability. However, we find that use of the online banking channel is associated with higher customer retention rates over one-, two-, and three-year horizons. The documented relationship between the use of online banking and customer retention remains positive even after controlling for self-selection into the online channel. We also find evidence that future market shares for our sample firm are systematically higher in markets with high contemporaneous utilization rates for the online banking channel. This finding holds even after controlling for contemporaneous market share suggesting it is not simply the result of increased market power leading to the acquisition of online banking customers.

Company Strategy: Business Model Reconfiguration for Innovation and Internationalization

An abstract is unavailable at this time.

Book: http://www.iese.edu/en/files/Competitiveness%20in%20Catalonia%2021.07.09_tcm4-36801.pdf

Siegmund Warburg, the City of London and the Financial Roots of European Integration

Abstract

The process of European economic integration slackened in the 1960s. National markets for goods, most services, and labor were not being integrated because they were not really being liberalized. The exception to this rule was financial services, one of which—the sale of long-term corporate and public sector bonds to relatively wealthy investors—became integrated in a quite novel way in the course of the 1960s. The rise of the so-called 'Eurobond' market was a major breakthrough in the history of European integration, but it was a largely spontaneous result of innovation by private sector actors, led by Siegmund Warburg. In some measure, no doubt, the bankers' primary motive was the profit motive. Yet there is also compelling evidence that Warburg and his associates also had a political agenda. They regarded it not only as a way of making money but also as a potent device for advancing Europe's political integration. In particular, they appreciated that European capital market integration could reinforce the case for British membership of the EEC. The resurrection of London as Europe's principal financial center, even at a time of economic and exchange rate weakness, was a major achievement in its own right. But it was also crucial for the resumption of European integration in the 1970s.

Leadership: The Key to Effective Boards

An abstract is unavailable at this time.

Book: http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470391782.html

 

Cases & Course Materials

Alex Mandl: Life Story of a Recent MBA

Harvard Business School Case 410-040

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410040-PDF-ENG

Ann Gildroy: Life Story of a Recent MBA

Harvard Business School Case 410-037

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410037-PDF-ENG

The Blackstone Group: Merlin Entertainment

Harvard Business School Case 210-014

The Blackstone Group had conducted a roll-up of theme parks and attractions business in Europe. It was considering how to generate liquidity for its investors. Blackstone entered the theme parks and attractions business in Europe by acquiring a majority stake in U.K.-based Merlin Entertainment in 2005. In 2005 and 2006, Merlin Entertainment acquired two other similar businesses, LEGOLAND based in Denmark, and Gardaland based in Italy. At the end of 2006, Blackstone's team was weighing its options for generating liquidity for its investors. The options were to conduct a dividend recapitalization of Merlin Entertainment or to acquire The Tussauds Group. The acquisition, if successful, would result in the second-largest theme parks and attractions business in the world after Disney. The Tussauds Group was owned by another private equity firm, Dubai International Capital (DIC). Blackstone's goal was to make a minimum of 3x on its initial Merlin investment through the dividend recapitalization and at least 5x through the Tussauds acquisition. A third option arose while Blackstone was in negotiation with DIC. This was the opportunity to perform a sale-leaseback of the underlying real estate assets owned by Merlin and Tussauds. Based on the facts and financials provided, it is clear there were tradeoffs between the size of the potential returns for each option, timing, and the risks that have to be managed. What should the Blackstone team do?

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http://cb.hbsp.harvard.edu/cb/product/210014-PDF-ENG

Daniel Salvadori: Life Story of a Recent MBA

Harvard Business School Case 410-041

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410041-PDF-ENG

Jaime Irick: Life Story of a Recent MBA

Harvard Business School Case 410-038

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410038-PDF-ENG

Life Stories of Recent MBAs

Harvard Business School Case 410-026

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410026-PDF-ENG

Life Stories of Recent MBAs: Developing Self-Awareness

Harvard Business School Case 410-030

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Leadership Purpose

Harvard Business School Case 410-034

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410034-PDF-ENG

Life Stories of Recent MBAs: Motivations

Harvard Business School Case 410-031

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Values and Ethical Challenges

Harvard Business School Case 410-029

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Coping with Crucibles

Harvard Business School Case 410-028

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Empowering Others

Harvard Business School Case 410-035

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Leading an Integrated Life

Harvard Business School Case 410-033

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410033-PDF-ENG

Life Stories of Recent MBAs: Losing Their Way

Harvard Business School Case 410-027

An abstract is unavailable at this time.

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Life Stories of Recent MBAs: Relationships and Support Teams

Harvard Business School Case 410-032

An abstract is unavailable at this time.

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Managing Individual Human Capital: Library Resources

Harvard Business School Note 410-046

This technical note provides a list of library resources for researching executives and a bibliography of books on managing one's own career.

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http://cb.hbsp.harvard.edu/cb/product/410046-PDF-ENG

Managing Organizational Human Capital: Library Resources

Harvard Business School Note 410-045

This technical note provides a list of library resources for researching various aspects of managing human capital within organizations.

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http://cb.hbsp.harvard.edu/cb/product/410045-PDF-ENG

Managing Your Own Human Capital: Executive Interview Exercise (2009)

Harvard Business School Note 410-047

This note contains instructions for an exercise in which students interview C-level executives on how they have managed their careers.

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http://cb.hbsp.harvard.edu/cb/product/410047-PDF-ENG

Monica Chi: Life Story of a Recent MBA

Harvard Business School Case 410-036

An abstract is unavailable at this time.

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Sachin Jain: Life Story of a Recent MBA

Harvard Business School Case 410-039

An abstract is unavailable at this time.

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http://cb.hbsp.harvard.edu/cb/product/410039-PDF-ENG

Slanket: Responding to Snuggie's Market Entry

Harvard Business School Case 510-034

How does a pioneer in a new product category deal with the runaway success of a follower? Can search engine marketing and social media help? In 2008 Slanket CEO, Gary Clegg, found that his product, a blanket with sleeves, had been eclipsed by The Snuggie, another sleeved blanket. Snuggie made a brazen entry into the market with a $10 million spend on television infomercials. The Snuggie quickly became a pop culture phenomenon, talked about on popular television programs such as Oprah and The Tonight Show with Jay Leno, and paid mock tribute to on web sites such as YouTube, where hundreds of video parodies could be found. Clegg had been counting on building his Slanket brand. Will the coming of Snuggie mean the end of Slanket?

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http://cb.hbsp.harvard.edu/cb/product/510034-PDF-ENG

Who Broke the Bank of England?

Harvard Business School Case 709-026

In the summer of 1992, hedge fund manager George Soros was contemplating the possibility that the European Exchange Rate Mechanism (ERM) would break down. Designed to pave the way for a full-scale European Monetary Union, the ERM was a system of fixed exchange rates linking together twelve members of the European Union, including Britain, France, Germany, and Italy. However, the impact of German reunification after 1989 had created significant strains within the system. Moreover, financial deregulation and the growth of cross-border flows of "hot" money increased the likelihood that a speculative attack on one or more ERM currencies might succeed. Soros had to decide which currencies to bet against. The Italian lira? The British pound? The French franc? Or all three? The result could determine the success or failure of the project for a single European currency.

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