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 30

They are not called "angel" financiers for nothing. In a new study, scholars William Kerr, Josh Lerner, and Antoinette Schoar find that angel funding is positively correlated with "higher survival, additional fundraising outside the angel group, and faster growth measured through growth in Web site traffic. The improvements typically range between 30 percent and 50 percent." Read their working paper, "The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis."

Do people use health care differently in countries where service is nationalized? The working paper "The Economic Crisis and Medical Care Usage" finds that Americans seek less routine non-emergency medical care in the middle of an economic crisis than do citizens of countries such as Great Britain and Canada, where universal health care is provided. "At the national level, reductions in medical care are related to the degree to which individuals must pay for it, and within countries are strongly associated with exogenous shocks to wealth and employment," according to researchers Annamaria Lusardi, Daniel Schneider, and Peter Tufano.

Among cases this week, "Sheikh Mohammed and the Making of 'Dubai, Inc.'" explores how Sheikh Mohammed bin Rashid Al Maktoum transformed Dubai from a tiny coastal village into a world-class city, famous for the world's tallest building and economic promise.

 

Publications

The Coexistence of Overestimation and Underweighting of Rare Events and the Contingent Recency Effect

Abstract

Previous research demonstrates overestimation of rare events in judgment tasks and underweighting of rare events in decisions from experience. The current paper presents three laboratory experiments and a field study that explore this pattern. The results suggest that the overestimation and underweighting pattern can emerge in parallel. Part of the difference between the two tendencies can be explained as a product of a contingent recency effect: although the estimations reflect negative recency, choice behavior reflects positive recency. A similar pattern is observed in the field study: immediately following an aversive rare-event (i.e., a suicide bombing), people believe the risk decreases (negative recency) but at the same time exhibit more cautious behavior (positive recency). The rest of the difference is consistent with two well established mechanisms: judgment error and the use of small samples in choice. Implications for the two-stage choice model are discussed.

The Role of Experience in the Gambler's Fallacy

Abstract

Recent papers have demonstrated that the way people acquire information about a decision problem, by experience or by abstract description, can affect their behavior. We examined the role of experience over time in the emergence of the Gambler's Fallacy in binary prediction tasks. Theories of the Gambler's Fallacy and models of binary prediction suggest that recency bias, elicited by experience over time, may play a significant role. An experiment compared a condition where participants sequentially predicted the colored outcomes of a virtual roulette wheel spin with a condition where the wheel's past outcomes were presented all at once. In a third condition, outcomes were presented sequentially in an automatic fashion without intervening predictions. Subjects were yoked so that the same history of outcomes was observed in all conditions. The results revealed the Gambler's Fallacy when outcomes were experienced (with or without predictions). However, the Gambler's Fallacy was attenuated when the same outcomes were presented all at once. Observing the Gambler's Fallacy in the third condition suggests that the presentation of information over time is a significant antecedent of the bias. A second experiment demonstrated that, while the bias can emerge with an all-at-once presentation that makes recent outcomes salient (Burns & Corpus, 2004), the bias did not emerge when the presentation did not draw attention to recent outcomes.

Fixing Health Care on the Front Lines

An abstract is unavailable at this time.

Read the preview: http://hbr.org/2010/04/fixing-health-care-on-the-front-lines/ar/1

Happiness Adaptation to Income beyond "Basic Needs"

Abstract

We test for whether, once "basic needs" are satisfied, there is happiness adaptation to further gains in income using three data sets. Individual German Panel Data from 1985 to 2000, and data on the well-being of over 600,000 people in a panel of European countries from 1975 to 2002, shows different patterns of adaptation to income across the rich and poor. We find evidence that for wealthy Germans, and for the rich half of European nations, higher levels of per capita income don't buy greater happiness. The reason appears to be adaptation. However even for the rich half of European nations such habituation may take over five years so the happiness gains that they experience, while not permanent, can still be relatively long-lasting. Finally we study a cross section of nations in 2005 from the World Gallup Poll and find that the past 45 years of economic growth (from 1960 to 2005) in the rich half of nations has not brought happiness gains above those that were already in place once the 1960s standard of living had been achieved. However in the poorest half of nations we cannot reject the null hypothesis that the happiness gains they have experienced from the past 45 years of growth have been the same as the gains that they experienced from growth prior to the 1960s.

Central Banks Maximize Happiness? Happiness, Contentment and other Emotions for Central Banks

An abstract is unavailable at this time.

Download chapter: http://www.bos.frb.org/economic/conf/BehavioralPolicy2007/chapter6.pdf

File Sharing and Copyright

An abstract is unavailable at this time.

Book: http://www.nber.org/books/lern09-1

 

Working Papers

International Financial Integration and Entrepreneurial Firm Dynamics

Abstract

We explore the relation between international financial integration and the level of entrepreneurial activity in a country. We use a unique firm-level data set in a broad sample of developed and developing countries, which enables us to present both cross-country and industry-level evidence. We find a positive robust correlation between de jure and de facto measures of international financial integration and proxies for entrepreneurial activity such as entry, size, and skewness of the firm-size distribution. We then explore potential channels through which foreign capital may encourage entrepreneurship. We find that entrepreneurial activity is higher in industries that have a large share of foreign firms in vertically linked industries. Second, we find that entrepreneurial activity in industries that are more reliant on external finance is disproportionately affected by international financial integration.

Download the paper: http://www.hbs.edu/research/pdf/07-012.pdf

Nominal versus Indexed Debt: A Quantitative Horse Race

Abstract

The main arguments in favor of and against nominal and indexed debt are the incentive to default through inflation versus hedging against unforeseen shocks. We model and calibrate these arguments to assess their quantitative importance. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and contingent-debt service. Our framework also recognizes that contingent debt can be associated with incentive problems and lack of commitment. Thus, the benefits of unexpected inflation are tempered by higher interest rates. We obtain that costs from inflation more than offset the benefits from reducing tax distortions. We further discuss sustainability of nominal debt in developing (volatile) countries.

Download the paper: http://www.hbs.edu/research/pdf/05-053.pdf

The Price of Capital: Evidence from Trade Data

Abstract

We use highly disaggregated data on trade in capital goods to study differences in the price of capital across countries. This strategy is motivated by the fact that most countries import the bulk of machinery equipment from a small number of industrialized countries. We find the price of imported capital goods to be negatively and significantly correlated with the income of the importing country. We cross check our results in number of ways. Our results, which differ from findings using Penn World Tables data, caution against discounting a role for the higher price of capital goods in explaining the higher relative price of capital to consumption goods observed in poor countries.

Download the paper: http://www.hbs.edu/research/pdf/07-073.pdf

The Impact of Private Equity Ownership on Portfolio Firms' Corporate Tax Planning

Abstract

This study investigates whether private equity (PE) firms influence the tax practices of their portfolio firms. Prior research documents that PE firms create economic value in portfolio firms through effective governance, financial, and operational engineering. Given PE firms' focus on value creation, we examine whether PE firms influence the extent and types of tax avoidance at portfolio firms as an additional source of economic value. We document that PE-backed portfolio firms engage in significantly more nonconforming tax planning and have lower marginal tax rates than other private firms. Moreover, we document that PE-backed portfolio firms pay 14.2% less income tax per dollar of pre-tax income than non-PE backed firms, after controlling for NOLs and debt tax shields. We find additional tax savings for PE-backed portfolio firms that are either majority-owned or owned by large PE firms, consistent with PE ownership stake, expertise, and resources serving as important factors in the tax practices of portfolio firms. We infer that PE firms view tax planning as an additional source of economic value in their portfolio firms, where the benefits outweigh any potential reputational costs associated with corporate tax avoidance.

Download the paper: http://www.hbs.edu/research/pdf/10-004.pdf

Investment Taxation and Portfolio Performance

Abstract

Taxes have a first-order impact on portfolio returns. Most research mistakenly assumes that portfolios command similar tax burdens, or that tax burdens are proportional to dividend yields. Portfolio strategies differ in the pace of capital gains realization. We use the federal tax codes from 1926 through 2007 to construct the after-tax returns that individual investors, corporations, and broker-dealers would have generated on a set of benchmark portfolios. For an individual at the 99th income percentile, the effective tax rates on SMB and HML, respectively, are 7 and 15 times greater than the tax rate on the market premium.

Download the paper: http://www.hbs.edu/research/pdf/10-084.pdf

Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances

Abstract

We find evidence that households selecting adjustable-rate mortgages (ARMs) during the recent decade were disproportionately those who were less suspicious or who may have had difficulty understanding complicated ARM features that became commonplace prior to the financial crisis.

Download the paper: http://www.hbs.edu/research/pdf/10-083.pdf

The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis

Abstract

This paper documents the role of angel funding for the growth, survival, and access to follow-on funding of high-growth start-up firms. We use a regression discontinuity approach to control for unobserved heterogeneity between firms that obtain funding and those that do not. This technique exploits that a small change in the collective interest levels of the angels can lead to a discrete change in the probability of funding for otherwise comparable ventures. We first show that angel funding is positively correlated with higher survival, additional fundraising outside the angel group, and faster growth measured through growth in Web site traffic. The improvements typically range between 30% and 50%. When using the regression discontinuity approach, we still find a strong, positive effect of angel funding on the survival and growth of ventures but not on access to additional financing. Overall, the results suggest that the bundle of inputs that angel investors provide have a large and significant impact on the success and survival of start-up ventures.

Download the paper: http://www.hbs.edu/research/pdf/10-086.pdf

The Economic Crisis and Medical Care Usage

Abstract

We use a unique, nationally representative cross-national dataset to document the reduction in individuals' usage of routine non-emergency medical care in the midst of the economic crisis. A substantially larger fraction of Americans have reduced medical care than have individuals in Great Britain, Canada, France, and Germany, all countries with universal health care systems. At the national level, reductions in medical care are related to the degree to which individuals must pay for it, and within countries are strongly associated with exogenous shocks to wealth and employment.

Download the paper: http://www.hbs.edu/research/pdf/10-079.pdf

Environmental Federalism in the European Union and the United States

Abstract

The United States (U.S.) and the European Union (EU) are federal systems in which the responsibility for environmental policy-making is divided or shared between the central government and the (member) states. The attribution of decision-making power has important policy implications. This chapter compares the role of central and local authorities in the U.S. and the EU in formulating environmental regulations in three areas: automotive emissions for health related (criteria) pollutants, packaging waste, and global climate change. Automotive emissions are relatively centralised in both political systems. In the cases of packaging waste and global climate change, regulatory policy-making is shared in the EU, but is primarily the responsibility of local governments in the U.S. Thus, in some important areas, regulatory policy-making is more centralised in the EU. The most important role local governments play in the regulatory process is to help diffuse stringent local standards through more centralised regulations, a dynamic that has recently become more important in the EU than in the U.S.

Download the paper: http://www.hbs.edu/research/pdf/10-085.pdf

 

Cases & Course Materials

Google Inc. (Abridged)

Benjamin Edelman and Thomas Eisenmann
Harvard Business School Case 910-032

Describes Google's history, business model, governance structure, corporate culture, and processes for managing innovation. Reviews Google's recent strategic initiatives and the threats it poses to Yahoo, Microsoft, and others. Asks what Google should do next. One option is to stay focused on the company's core competence, i.e., developing superior search solutions and monetizing them through targeted advertising. Another option is to branch into new arenas, for example, build Google into a portal like Yahoo or MSN; extend Google's role in e-commerce beyond search to encompass a more active role as an intermediary (like eBay) facilitating transactions; or challenge Microsoft's position on the PC desktop by developing software to compete with Office and Windows.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/910032-PDF-ENG

The EC Rains on Oracle/Sun

Lena G. Goldberg
Harvard Business School Case 310-086

Oracle's proposed acquisition of Sun was on a fast track until the EC's antitrust concerns about open-source MySQL ignited a transatlantic war of words delaying the deal. Sun's performance suffered and its customers were approached by competitors while regulatory objections were debated and tensions rose between U.S. and EC regulators.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/310086-PDF-ENG

Managing Drugs on the Forefront of Personalized Medicine: The Erbitux and Vectibix Story

Richard G. Hamermesh, Raju Kucherlapati, and Rachel Gordon
Harvard Business School Case 810-066

In May 2007, Amgen Inc. (Amgen) received disappointing news from the European Medicines Agency (EMEA) that its drug Vectibix, developed to fight metastatic colorectal cancer, had been rejected. This was especially surprising news given that a similar rival drug had received approval several years prior. Moreover, Vectibix had also received Food and Drug Administration approval in 2006. During additional trials, Amgen has learned that the Vectibix is only effective with the 60% of the population that has a specific gene marker. Given this development, what should Amgen's strategy around Vectibix be both in Europe and the United States?

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/810066-PDF-ENG

Sheikh Mohammed and the Making of 'Dubai, Inc.'

Anthony J. Mayo, Nitin Nohria, Umaimah Mendhro, and Johnathan Cromwell
Harvard Business School Case 410-063

Sheikh Mohammed bin Rashid Al Maktoum has converted Dubai from a sleepy little coastal village into a world-class city, famous for its ambition, drive, and economic promise. He is the founder, part-owner, and visionary behind companies such as Emirates Airlines, a UAE-based airline serving over 100 destinations; Nakheel, the property developer that built a trilogy of man-made islands; and DP World, a leader in international marine terminal operations. Despite being surrounded by political instability in the Middle East, Sheikh Mohammed pursued capitalism and embraced Western culture while maintaining safety for millions of annual tourists. By 2010, Dubai had the world's tallest building, the most expensive hotel, and the largest shopping mall. But rapid development did not come without difficulties. While hundreds of thousands immigrated to help build the metropolis, labor conditions suffered and some local Emirati felt like they lost aspects of their cultural identity. Growth was rapid, infrastructure was weak, and the real estate bubble grew as the financial crisis loomed. To produce economic, social, and cultural prosperity for the people of Dubai, Sheikh Mohammed had to balance his role as a business leader and a political ruler.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/410063-PDF-ENG

SIPEF: Biological Assets at Fair Value under IAS 41

Edward J. Riedl and Kristin Meyer
Harvard Business School Case 110-026

This case examines fair value accounting under lAS 41 for a European-listed agricultural firm. Students identify the firm's core operations, distinguishing the IFRS treatment for three distinct assets: land, agricultural assets that reside on the land, and inventory harvested from the land. They also analyze key reporting decisions relating to the agricultural assets, which create frictions such that market value and book value do not converge despite the application of fair value for the majority of the firm's assets. The case also highlights how fair value accounting affects key valuation inputs such as earnings and the implications for abnormal-earnings based valuation.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/110026-PDF-ENG