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.

Nov. 8

Doubling down on risky startups

When the startup market becomes red hot, a cyclical phenomenon, it's believed that venture capitalists are more likely to back sketchy prospects—excess money chasing deals. In the new paper Investment Cycles and Startup Innovation, Ramana Nanda and Matthew Rhodes-Kropf offer a different perspective. What might be happening, they argue, is that VCs are actually more willing to experiment, to invest in riskier firms, with the hopes of winning bigger rewards. "We find that firms that are funded in 'hot' times are more likely to fail but create more value if they succeed. This pattern could arise if in 'hot' times more novel firms are funded. Our results provide a new but intuitive way to think about the differences in project choice across the cycle."

Job loss and private equity buyouts

Critics often argue that private equity buyouts result in significant job losses. But is that the full story? Not really. A new working paper by Steven J. Davis, John Haltiwanger, Ron Jarmin, Josh Lerner, and Javier Miranda reports that though the public-to-private buyouts they studied did cut jobs in 3,200 target firms by an average 6 percent over five years, the loss is actually a loss of less than 1 percent when new jobs created by the target firm and related projects are factored in. "In short," according to Private Equity Employment, "private equity buyouts catalyze the creative destruction process in the labor market, with only a modest net impact on employment. The creative destruction response mainly involves a more rapid reallocation of jobs across establishments within target firms."

The value of time in line

Yogi Berra was once quoted as saying, "The reason no one eats there is because the lines are too long." New research digs into this question by asking how much drive-through diners trade off price for wait time. The research by Gad Allon, Awi Federgruen, and Margaret P. Pierson, explores to what extent waiting-time performance impacts a restaurant's market share and price decisions. The results will be published in the fall 2011 issue of Manufacturing and Service Operations Management, in the article "How Much Is a Reduction of Your Customers' Wait Worth? An Empirical Study of the Fast-Food Drive-Thru Industry Based on Structural Estimation Methods." They report, "Our results confirm the belief expressed by industry experts that in the fast-food drive-thru industry, customers trade off price and waiting time. More interestingly, our estimates indicate that consumers attribute a very high cost to the time they spend waiting."

 

Publications

How Much Is a Reduction of Your Customers' Wait Worth? An Empirical Study of the Fast-Food Drive-Thru Industry Based on Structural Estimation Methods

Abstract

In many service industries, companies compete with each other on the basis of the waiting time their customers experience, along with other strategic instruments such as the price they charge for their service. The objective of this paper is to conduct an empirical study of an important industry to measure to what extent waiting-time performance impacts different firms' market shares and price decisions. We report on a large-scale empirical industrial organization study in which the demand equations for fast-food drive-thru restaurants in Cook County are estimated based on so-called structural estimation methods. Our results confirm the belief expressed by industry experts that in the fast-food drive-thru industry, customers trade off price and waiting time. More interestingly, our estimates indicate that consumers attribute a very high cost to the time they spend waiting.

The Dynamics of Warmth and Competence Judgments, and Their Outcomes in Organizations

Abstract

Two traits-warmth and competence-govern social judgments of individuals and groups, and these judgments shape people's emotions and behaviors. This paper describes the causes and consequences of warmth and competence judgments; how, when, and why they determine significant professional and organizational outcomes, such as hiring, employee evaluation, and allocation of tasks and resources. Warmth and competence represent the central dimensions of group stereotypes, the majority of which are ambivalent-characterizing groups as warm but incompetent (e.g., older people, working mothers) or competent but cold (e.g., model minorities, female leaders), in turn eliciting ambivalent feelings (i.e., pity and envy, respectively) and actions toward members of those groups. However, through nonverbal behaviors that subtly communicate warmth and competence information, people can manage the impressions they make on colleagues, potential employers, and possible investors. Finally, we discuss important directions for future research, such as investigating the causes and consequences of how organizations and industries are evaluated on warmth and competence.

Read the paper: http://www.people.hbs.edu/acuddy/in%20press,%20cuddy,%20glick,%20&%20beninger,%20ROB.pdf

The Surprising Power of Age-Dependent Taxes

Abstract

This article provides a new, empirically driven application of the dynamic Mirrleesian framework by studying a feasible and potentially powerful tax reform: age-dependent labor income taxation. I show analytically how age dependence improves policy on both the intratemporal and intertemporal margins. I use detailed numerical simulations, calibrated with data from the U.S. PSID, to generate robust policy implications: age dependence (1) lowers marginal taxes on average and especially on high-income young workers and (2) lowers average taxes on all young workers relative to older workers when private saving and borrowing are restricted. Finally, I calculate and characterize the welfare gains from age dependence. Despite its simplicity, age dependence generates a welfare gain equal to between 0.6% and 1.5% of aggregate annual consumption, and it captures more than 60% of the gain from reform to the dynamic optimal policy. The gains are due to substantial increases in both efficiency and equity. When age dependence is restricted to be Pareto-improving, the welfare gain is nearly as large.

 

Working Papers

Price Competition under Multinomial Logit Demand Functions with Random Coefficients

Abstract

In this paper, we postulate a general class of price competition models with mixed multinomial logit demand functions under affine cost functions. We first characterize the equilibrium behavior of this class of models in the case where each product in the market is sold by a separate, independent firm, and customers share a common income level. We identify a simple and very broadly satisfied condition under which a Nash equilibrium exists while the set of Nash equilibria coincides with the solutions of the system of first order condition equations, a property of essential importance to empirical studies. This condition specifies that in every market segment, each firm captures less than 50% of the potential customer population when pricing at a level that, under the condition, can be shown to be an upper bound for a rational price choice for the firm irrespective of the prices chosen by its competitors. We show that under a somewhat stronger, but still broadly satisfied version of the above condition, a unique equilibrium exists. We complete the picture, establishing the existence of a Nash equilibrium, indeed a unique Nash equilibrium, for markets with an arbitrary degree of concentration; under sufficiently tight price bounds. We then discuss two extensions of our model: unequal customer income and a continuum of customer types. A discussion of the multi-product case is included in the appendix. The paper concludes with a discussion of implications for structural estimation methods.

Download the paper: http://www.hbs.edu/research/pdf/12-030.pdf

Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge

Abstract

We use the SEC's unexpected announcement on October 4, 2010 that it would significantly delay implementation of its proxy access rule as a natural experiment to measure the value of shareholder proxy access. We find that firms that would have been most vulnerable to proxy access, as measured by institutional ownership and activist institutional ownership in particular, lost value on that day. We also examine intra-day returns and find that the value loss occurred just after the SEC's announcement. Our results are consistent with the view that financial markets placed a positive value on shareholder access, as implemented in the SEC's August 2010 rule.

Download the paper: http://www.hbs.edu/research/pdf/11-052.pdf

Private Equity and Employment

Abstract

Private equity critics claim that leveraged buyouts bring huge job losses. To investigate this claim, we construct and analyze a new dataset that covers U.S. private equity transactions from 1980 to 2005. We track 3,200 target firms and their 150,000 establishments before and after acquisition, comparing outcomes to controls similar in terms of industry, size, age, and prior growth. Relative to controls, employment at target establishments declines 3% over two years post buyout and 6% over five years. The job losses are concentrated among public-to-private buyouts and transactions involving firms in the service and retail sectors. But target firms also create more new jobs at new establishments, and they acquire and divest establishments more rapidly. When we consider these additional adjustment margins, net relative job losses at target firms are less than 1% of initial employment. In contrast, the sum of gross job creation and destruction at target firms exceeds that of controls by 13% of employment over two years. In short, private equity buyouts catalyze the creative destruction process in the labor market, with only a modest net impact on employment. The creative destruction response mainly involves a more rapid reallocation of jobs across establishments within target firms.

Download the paper: http://www.hbs.edu/research/pdf/12-033.pdf

The Impact of Horizontal Mergers and Acquisitions in Price Competition Models

Abstract

The question of what impact mergers and acquisitions have on key equilibrium performance measures is fundamental to our understanding of competitive dynamics in an oligopolistic industry. We address these questions in the context of price competition models with differentiated goods and asymmetric firms allowing for general non-linear demand and cost functions merely assuming that both the pre- and post-merger competition games are supermodular along with two minor technical conditions. We show that, in the absence of cost synergies, post-merger equilibrium prices exceed their pre-merger levels. Moreover, the post-merger equilibrium profit of the merged firms exceeds the aggregate of the premerger equilibrium profits of the merging firms. The equilibrium profit of the non-merging firms increases as well. We establish our results, at first, for settings where each firm in the industry offers a single product; we then generalize them to industries with multi-product firms. We also derive conditions under which cost synergies, by themselves, result in lower equilibrium prices than otherwise observed post-merger and discuss how the combined effect of increased market concentration and cost synergies can be assessed efficiently.

Download the paper: http://www.hbs.edu/research/pdf/12-031.pdf

Investment Cycles and Startup Innovation

Abstract

We find that VC-backed firms receiving their initial investment in hot markets are less likely to IPO but, conditional on going public, are valued higher on the day of their IPO, have more patents, and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is true even for the most experienced VCs. Furthermore, our results suggest that the flood of capital in hot markets also plays a causal role in shifting investments to more novel startups-by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments.

Download the paper: http://www.hbs.edu/research/pdf/12-032.pdf

 

Cases & Course Materials

Patricia Gottesman at Crimson Hexagon

Lena G. Goldberg and Mary Beth Findlay
Harvard Business School Case 312-068

After successful capital raises and significant progress in gaining market acceptance of its tools for analyzing public opinion, Crimson Hexagon's CEO prepares to address the company's investors on the question of exit strategy.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/312068-PDF-ENG

Veracity Worldwide in Syria: Assessing Political Risk in a Volatile Environment

Aldo Musacchio
Harvard Business School Case 712-009

An abstract is unavailable at this time.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/712009-PDF-ENG

Veracity Worldwide: Evaluating FCPA-Related Risks in West Africa

Aldo Musacchio
Harvard Business School Case 712-010

An abstract is unavailable at this time.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/712010-PDF-ENG

Exchange-Traded Funds at Vanguard (B)

Robert C. Pozen and Steven Vickers
Harvard Business School Supplement 311-135

Supplements HBS Case 311-134

Purchase this supplement:
http://cb.hbsp.harvard.edu/cb/product/311135-PDF-ENG

Penn Warranty Corporation

Richard S. Ruback and Royce Yudkoff
Harvard Business School Case 212-007

Penn Warranty Corporation sold warranty contracts to the used-car market. During the recession in 2008/2009 Penn's sales declined by 26% instead of growing by 11% as forecasted. Also, disruptions in financial and insurance markets created a cash shortfall. In the summer of 2009, Penn was facing the likelihood of default and possible foreclosure under its loan agreements. Its lender was refusing to waive covenants unless the company paid down $1 million of its outstanding debt of $7.75 million. The only source for such a refinancing was the equity investors who funded the buyout purchase of the company eighteen months earlier.

Purchase this case:
http://cb.hbsp.harvard.edu/cb/product/212007-PDF-ENG