Associate Professors Lauren H. Cohen and Christopher J. Malloy study how social connections affect important decisions and, ultimately, how those connections help shape the economy. Their research shows that it's possible to make better stock picks simply by knowing whether two industry players went to the same college or university. What's more, knowing whether two congressional members share an alma mater can help predict the outcome of pending legislation on the Senate floor.
While financial innovation is often praised as a positive force for societal growth, it also takes much of the blame for the recent global financial crisis. In this paper, Harvard Business School professors Josh Lerner and Peter Tufano explore financial innovation and discuss how it differs from other types of innovation.
Published in 2010
The valuation of forecasted cash flows can be an inaccurate process, especially when the forecasts are created by optimists who neglect to consider worst-case scenarios. In this paper, Harvard Business School professor Richard S. Ruback has developed methods of valuating forecasted cash flow when the predictions are biased upward.
Harvard Business School professors Robert Steven Kaplan, David A. Moss, Robert C. Pozen, Clayton S. Rose and Luis M. Viceira share their perspectives on the Dodd-Frank Wall Street Reform and Consumer Protection Act, slated to be signed this week by U.S. President Barack Obama.
Summing Up: The word profit provoked a wide range of issues and emotions among respondents, says Jim Heskett. It also launched debates, and many readers argued for measures of success other than profit. (Online forum has closed; next forum opens August 5.)
Bank lending falls in economic recessions. In particular, it shrank considerably during the recent economic downturn. Does such cyclicality of bank lending reflect a decline in banks' willingness to lend (the "loan supply" effect) or reduced demand for loans from firms (the "loan demand" effect)? The considerable attention that is given to banks' financial health by the Federal Reserve, Congress, and other branches of government is only warranted if the answer is supply.
Focusing on U.S. firms that raised new debt financing between 1990 and 2009, HBS professors Bo Becker and Victoria Ivashina demonstrate that many large U.S. firms turn to the bond market when banks are in poor financial health. When times are better, the same firms get bank loans. Becker and Ivashina argue that the substitution between bonds and loans at the firm-level is a good economic proxy for the bank credit supply.
Does the combination of banking and private equity investing endow banks with superior information that allows them to identify good prospects and garner superior returns? Or does the combination bestow banks with an unfair ability to expand their balance sheets, capturing benefits within the bank at the expense of the overall market and ultimately the taxpayers? INSEAD's Lily Fang and Harvard Business School professors Victoria Ivashina and Josh Lerner examined nearly 8,000 unique private equity transactions between 1978 and 2009, looking in depth at the nature of the private equity investors, the structure of the investments, and the performance of the firms. Collectively, findings suggest that there are risks in combining banking and private equity investing. The results are consistent with many of the worries about these transactions articulated by policymakers.
Family firms dominate economic activity in most countries, and are significantly different from other companies in their behavior, structural characteristics, and performance. But what explains the significant variation in the prevalence and value of family firms around the world? The two leading explanations are legal investor protection and institutional development, but cross-country studies are unable to rule out the alternative explanation that cultural norms are what account for these differences. In contrast, China provides an excellent laboratory for addressing this question because it offers great variation in institutional efficiency across regions, yet the country as a whole shares cultural and social norms together with a common legal and regulatory framework. In this paper, HBS professor Belén Villalonga and coauthors study ownership data from a sample of nearly 1,500 publicly listed firms on the Chinese stock market. They conclude that institutional development plays a critical role in the prevalence and value of family firms, and that the differences observed across regions are not attributable to cultural factors.
The impact of financial analysts on capital market efficiency has been much debated in academia and in practice. A large body of academic research finds that analysts act as important information intermediaries who contribute to the overall efficiency of capital markets. Other research, however, has identified contexts in which the value of analyst coverage may be relatively more limited, such as when analysts face possible conflicts of interest, or when the company or situation they are presented with is especially complex. Still other research questions the informativeness of analyst recommendations in light of regulatory changes. In this paper, HBS doctoral graduate Emilie Rose Feldman and professors Stuart C. Gilson and Belén Villalonga examine 1,793 analyst reports written at the time of corporate spinoffs to determine how much value analysts create as information intermediaries in this setting. Spinoffs provide an interesting context for this purpose because the degree of information asymmetry between corporate insiders and investors is especially high. The paper is one of the first to provide very fine-grained detail on the quantity and types of analyses included in analyst reports.
The global financial crisis of 2008-2009 has led academics and practitioners to question many widely held beliefs about business and economics. One such belief relates to the value of corporate diversification. Popular views about diversification have swung like a pendulum over the past half-century, from a generally positive view in the 1960s and 1970s, when many large conglomerates were formed, to a generally negative view in the 1980s and early 1990s, when many such conglomerates were dismantled or at least fell out of the stock market's favor. In 2009, in the wake of the global financial crisis, a new view seems to be emerging that conglomerates are ready for a comeback. In this paper, HBS doctoral candidate Venkat Kuppuswamy and professor Belén Villalonga examine whether and why conglomerates have become more valuable during the 2008-2009 financial crisis. They find that they have, and that the increase does not simply reflect changes in investor perceptions but real differences in corporate finance and investment.
What is the impact of corporate ownership on corporate diversification and on the efficiency of firms' internal capital markets? Corporate governance and internal capital markets are two topics closely intertwined in theoretical research; for example, agency problems—which corporate governance mechanisms seek to mitigate in a variety of ways—are at the heart of every theory of inefficient internal capital markets. Yet surprisingly few empirical studies have looked into the actual link between corporate governance and internal capital markets. This paper by University of Amsterdam professor Zacharias Sautner and HBS professor Belén Villalonga seeks to fill the gap by taking advantage of a natural experiment provided by a tax change in Germany in 2002. The researchers provide direct evidence of the effect of governance structures on how markets work, as well as new evidence about the benefits and costs of ownership concentration.
Under what circumstances do firms access capital markets when the potential for agency costs is high? The prevailing view holds that controlling shareholders sell shares to outsiders only when internal capital is inadequate to fund attractive investment opportunities. While the role of market efficiency in corporate finance has attracted considerable research attention, the interaction of stock market mispricing with agency problems is not well understood. HBS doctoral graduate Sergey Chernenko and professors C. Fritz Foley and Robin Greenwood propose a new explanation—based on stock market mispricing—for why firms with a controlling shareholder raise outside equity, even when firms cannot commit not to expropriate minority shareholders.
The global economic crisis has taken a historic toll on national economies and household finances around the world. What is the impact of such large shocks on individuals and their behavior, especially on their willingness to seek routine medical care? In this research, Annamaria Lusardi of Dartmouth College, Daniel Schneider of Princeton University, and Peter Tufano of Harvard Business School find strong evidence that the economic crisis—manifested in job and wealth losses—has led to large reductions in the use of routine medical care. Specifically, more than a quarter of Americans reported reducing their use of such care, as did between 5 and 12 percent of Canadian, French, German, and British respondents.
Managerial decisions influence the distribution of value between different parties. This can lead to conflicting interests among financial claimants, such as holders of equity and debt. The Credit Lyonnais v. Pathe Communications bankruptcy ruling of 1991 before the Delaware court—a case widely perceived to have created a new obligation for directors of Delaware‐incorporated firms—provides an interesting opportunity to assess whether and how equity-debt conflict affects firm behavior. HBS professor Bo Becker and Stockholm School of Economics professor Per Strömberg outline important changes in behavior after Credit Lyonnais.
Recent theoretical models predict that countries with stricter labor policies will specialize in less innovative activities due to the higher worker turnover frequently associated with rapidly changing sectors. HBS visiting scholar Ant Bozkaya and HBS professor William R. Kerr examine how differences in labor regulations across European countries influence the development of private equity markets, comprised of venture capital and buy-out investors. In so doing, the researchers provide the first empirical evidence for this theoretical prediction at the industry level in the entrepreneurial finance literature. They also make a methodological contribution by demonstrating how jointly modeling the different policies for providing worker insurance delivers more consistent results than their individual relationships would indicate by themselves.
In response to the global financial crisis that began in 2007, governments worldwide are rethinking their approach to regulating financial institutions. Among the financial institutions that have fallen under the gaze of regulators have been private equity (PE) funds. There are many open questions regarding the economic impact of PE funds, many of which cannot be definitively answered until the aftermath of the buyout boom of the mid-2000s can be fully assessed. HBS professor Josh Lerner and coauthors address one of these open questions, by examining the impact of PE investments across 20 industries in 26 major nations between 1991 and 2007. In particular, they look at the relationship between the presence of PE investments and the growth rates of productivity, employment, and capital formation.
Published in 2009
Are large shareholders good monitors of management? A public firm's shareholders have extensive legal control rights in the corporation, but in practice much of this control is delegated to managers. In companies with small, dispersed shareholders, owners may find it costly to coordinate and exercise monitoring and control, leaving management with considerable discretion. Large shareholders, however—by concentrating a block of shares in the hands of a single decision-maker—may play a beneficial role in facilitating effective owner control. Yet large shareholders are not without their costs. HBS professor Bo Becker and coauthors develop and test a framework to quantify the impact of large owners (individual non-managerial blockholders, not mutual funds or other institutions) on several key aspects of firm behavior. They show that such shareholders play an important role for corporate governance in sizable U.S. public firms, and can affect several firm policies.
Does the composition of ownership of a financial asset influence future returns and risk? Previous economic research has documented significant price effects of investor demand in numerous settings, including retail demand for options, investor demand for bonds, and mutual funds' flow-driven demand for stocks. This paper provides a methodology to identify assets that are vulnerable to such investor demand shocks. The central idea is that assets are risky if the current owners of the asset face correlated liquidity shocks—i.e., they buy and sell at the same time. We call assets with a high concentration of owners who trade in the same direction "fragile." A related concept is "co-fragility." Two assets are "co-fragile" if their owners have correlated trading needs, even if the holdings of these owners do not directly overlap. The authors build measures of fragility for U.S. stocks between 1990 and 2007. Consistent with their predictions, more fragile stocks are more volatile, and two co-fragile stocks exhibit high correlations among their stock returns.
Performance measurement is one of the critical factors that determine how individuals in an organization behave. It includes subjective as well as objective assessments of the performance of both individuals and subunits of an organization such as divisions or departments. Besides the choice of the performance measures themselves, performance evaluation involves the process of attaching value weights to the different measures to represent the importance of achievement on each dimension. This paper examines five common divisional performance measurement methods: cost centers, revenue centers, profit centers, investment centers, and expense centers. The authors furnish the outlines of a theory that attempts to explain when each of these five methods is likely to be the most efficient.
During periods of rising house prices, falling interest rates, and increasingly competitive and efficient refinancing markets, cash-out refinancing is like a ratchet, incrementally increasing homeowner debt as real-estate values appreciate without the ability to symmetrically decrease debt by increments as real-estate values decline. This paper suggests that systemic risk in the housing and mortgage markets can arise quite naturally from the confluence of these three apparently salutary economic trends. Using a numerical simulation of the U.S. mortgage market, the researchers show that the ratchet effect is capable of generating the magnitude of losses suffered by mortgage lenders during the financial crisis of 2007-2008. These observations have important implications for risk management practices and regulatory reform.
Financing constraints are one of the biggest concerns impacting potential entrepreneurs around the world. Given the important role that entrepreneurship is believed to play in the process of economic growth, alleviating financing constraints for would-be entrepreneurs is also an important goal for policymakers worldwide. In this paper HBS professors William R. Kerr and Ramana Nanda review two major streams of research examining the relevance of financing constraints for entrepreneurship. They then introduce a framework that provides a unified perspective on these research streams, thereby highlighting some important areas for future research and policy analysis in entrepreneurial finance.
How do financing constraints on new start-ups affect the initial size of these new firms? Since bank debt comprises the majority of U.S. firm borrowings, new ventures are especially sensitive to local bank conditions due to their limited options for external finance. Liberalization in the banking sector can thus have important effects on entrepreneurship in product markets. As HBS professors William Kerr and Ramana Nanda explain, the 1970s through the mid-1990s was a period of significant liberalization in the ability of banks to establish branches and to expand across state borders, either through new branches or through acquisitions. Using a database of annual employment data for every U.S. establishment from 1976 onward, Kerr and Nanda examine how U.S. branch banking deregulations impacted the entry size of new start-ups in the non-financial sector. This paper is closely related to their prior work examining how the deregulations impacted the rates of startup entry and exit in the non-financial sector.
The notion of levying higher taxes on tall people—an idea offered largely tongue in cheek—presents an ideal way to highlight the shortcomings of current tax policy and how to make it better. Harvard Business School professor Matthew C. Weinzierl looks at modern trends in taxation.
What is the role of fair values in the current economic crisis? The interplay between information risk—that is, uncertainty regarding valuation parameters for an underlying asset—and the reporting of financial instruments at fair value has been a subject of high-level policy debate. Finance theory suggests that information risk is reflected in firms' equity betas and the information asymmetry component of bid-ask spreads. HBS professor Edward Riedl and doctoral candidate George Serafeim test predictions for a sample of large U.S. banks, exploiting recent mandatory disclosures of financial instruments designated as fair value level 1, 2, and 3, which indicate progressively more illiquid and opaque financial instruments. Overall, banks with higher exposures to level 3 financial assets have both higher equity betas and higher bid-ask spreads. Both results are consistent with higher levels of information risk, and thus cost of capital, for these firms.
Competition usually creates better products and services. But when competition increased among credit rating agencies, the result was less accurate ratings, according to a study by HBS professor Bo Becker and finance professor Todd Milbourn of Washington University in St Louis. In our Q&A, Becker discusses why users of ratings should exercise a little caution.
Although private firms are important components of the U.S. economy, their tax practices remains largely unknown due to the lack of publicly available financial information. In recent years, private equity (PE) firms have been broadly criticized based on the substantial tax benefits enjoyed by their owners and managers. Editorials have inflamed public opinion by accusing PE firm owners and managers as having excessively low tax rates, and pointing out that the substantial wealth generated by PE firms can "pay for sophisticated tax planning," including the use of offshore investment companies based in tax havens. More generally, critics contend that PE firms aggressively manage their tax liabilities and those of their portfolio companies. This study investigates the latter contention. In particular, the authors look at whether private companies that are majority-owned by PE firms ("majority PE-backed firms") engage in more tax avoidance than other publicly traded and privately held firms. This may be the first study to compare the tax practices of firms with different private ownership structures.
Are developments in the theory of taxation improving tax policies around the world? The optimal design of a tax system is a topic that has long fascinated economic theorists and flummoxed economic policymakers. This paper explores the interplay between tax theory and tax policy. It identifies key lessons policymakers might take from the academic literature on how taxes ought to be designed, and it discusses the extent to which these lessons are reflected in actual tax policy. The authors find that there has been considerable change in the theory and practice of taxation over the past several decades—although the two paths have been far from parallel. Overall, tax policy has moved in the directions suggested by theory along a few dimensions, even though the recommendations of theory along these dimensions are not always definitive.
A tax on height follows inexorably from a well-established empirical regularity and the standard approach to the optimal design of tax policy. Many readers of this paper, however, will not so quickly embrace the idea of levying higher taxes on tall taxpayers. Indeed, when first hearing the proposal, most people either recoil from it or are amused by it. That reaction is precisely what makes tax policy so intriguing, according to N. Gregory Mankiw of Harvard University and Matthew Weinzierl of HBS. This paper addresses a classic problem: the optimal redistribution of income. A Utilitarian social planner would like to transfer resources from high-ability individuals to low-ability individuals, but is constrained by the fact that he cannot directly observe ability. Taxing height helps the planner achieve redistribution efficiently because height, the data show, is an indicator of income-earning ability. Although readers might take this paper in one of two ways—some seeing it as a small, quirky contribution aimed to clarify the literature on optimal income taxation, others as a broader effort to challenge the entire literature—the authors' results raise a fundamental question about the framework for optimal taxation for which William Vickrey and James Mirrlees won the 1996 Nobel Prize in Economics and which remains a centerpiece of modern public finance.
Do insiders strategically sell their stock holdings prior to the accounting disclosure of goodwill impairment losses? While a number of recent studies provide evidence of insider trading prior to the announcement of earnings performance measures, a remaining puzzle is what types of information aggregated into reported earnings constitute the source of insiders' private information. This study provides evidence of a specific reporting item, goodwill impairments, about which insiders are able to strategically trade before its full discovery by the equity market and its recognition within the financial statements. Goodwill impairments represent likely sources of information for insiders to trade on for two reasons. First, they tend to be economically large, averaging 11.9 percent of the market value of equity during the sample period of 2002-2007. Second, managers likely have material private information regarding future cash flow estimates through their internal budgeting processes; and managers' private information advantage may be relatively long-lived due to goodwill impairment testing rules that may delay the accounting recognition of economic goodwill impairments.
Insurance markets are growing rapidly in developing countries. Despite the promise of these markets, however, adoption to date has been relatively slow. Yet households often remain exposed to movements in local weather; regional house prices; prices of commodities like rice, heating oil, and gasoline; and local, regional, and national income fluctuations. In many cases, financial contracts simply do not exist to hedge these exposures, and when contracts do exist their use is not widespread. Why don't financial markets develop to help households hedge these risks? Why don't more households participate when formal markets are available? HBS professor Shawn Cole and coauthors attempt to shed light on these questions by studying participation in rural India in a rainfall risk-management product that provides a payoff based on monsoon rainfall. The results suggest that it may take a significant amount of time—and substantial marketing efforts—to increase adoption of risk-management tools at the household level.
Why is there apparently limited demand for financial services in emerging markets? On the one hand, low-income individuals may not want formal services when informal savings, credit, and insurance markets function reasonably well, and the benefits of formal financial market participation may not exceed the costs. On the other hand, limited financial literacy could be the barrier: If people are not familiar or comfortable with products, they will not demand them. These two views carry significantly different implications for the development of financial markets around the world, and would suggest quite different policy decisions by governments and international organizations seeking to promote "financial deepening." HBS professor Shawn Cole and coauthors found that financial literacy education has no effect on the probability of opening a bank savings account for the full population, although it does significantly increase the probability among those with low initial levels of financial literacy and low levels of education. In contrast, modest financial subsidies significantly increase the share of households that open a bank savings account within the subsequent two months.
Although 99 percent of the companies operating in the United States are private, according to the American Institute of Certified Public Accountants, their accounting practices remain largely unknown due mainly to the lack of publicly available financial statements. In this study, HBS professor Sharon P. Katz used a unique database of firms with privately held equity and publicly held debt to examine how two different ownership structures-private equity sponsorship and non-private equity sponsorship-affect firms' financial reporting practices, financial performance, and stock returns in the years preceding and following the initial public offering (IPO).
The quality of accounting information is influenced by an array of factors, most of which stem from the demand for such information for use in contractual arrangements and from the incentives and opportunities of management to manage the reported numbers. Both the demand for quality accounting information for contractual purposes and management incentives to adjust the reported earnings are likely to be influenced by whether the equity of the company is privately held or publicly traded. This study examines the differential earnings quality of private equity and public equity firms in order to shed light on how public ownership of equity affects the quality of firms' earnings. The research highlights how the presence of public equity investors affects management's reporting behavior.
This paper examines the politics of corporate governance at the world's largest appropriations committee, the World Bank's Board of Executive Directors, and exposes a weakness in the design of the World Bank's decision-making structure. Any large public organization faces a challenge of representation and management. Since all decisions cannot be made by all members, founders often grant a more nimble body with decision-making powers. But representatives on the decision-making body may face a temptation to govern in the interests of their own wallet or narrow constituency rather than in the interests of the larger body. In 2008, the Bank's two primary component institutions—the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA)—committed nearly $25 billion in loans and grants through some 300 development projects around the globe. Where did it go? By exploring the political dynamics and corporate governance of an international appropriations committee, we not only learn about international organizations but also the nature of the international system itself.
The role of sovereign wealth funds (SWFs) in the global financial system has been increasingly recognized in recent years, and many reports suggest that SWFs are often employed to further the geopolitical and strategic economic interests of their governments. The resources controlled by these funds—estimated to be $3.5 trillion in 2008—have grown sharply over the past decade. Projections, while inherently tentative due to the uncertainties about the future path of economic growth and commodity prices, suggest that they will be increasingly important actors in the years to come. Despite this significant and growing role, financial economists have devoted remarkably little attention to these funds. The lack of scrutiny must be largely attributed to the deliberately low profile adopted by many SWFs, which makes systematic analysis challenging. Bernstein, Lerner, and Schoar analyze how SWFs vary in their investment styles and performance across various geographies and governance structures. Taken as a whole, results suggest that high levels of home investments by SWFs, particularly those with the active involvement of political leaders, are associated with trend chasing and worse performance.
Can patterns of corporate net stock issuance help identify times when particular characteristics, such as industry, size, or book-to-market ratio, are mispriced? The authors of this study argue that differences between the characteristics of issuers and repurchasers can shed light on characteristic related stock returns. Consider the case in which analysts were interested in forecasting the returns of Google. The standard approach would be to collect Google's characteristics (e.g., large, technology, non-dividend paying, etc) and associate these characteristics with an average return in the cross-section. The authors argue that if other stocks with these characteristics are issuing stock, this bodes poorly for Google's future returns, even if Google is itself not issuing. This research by HBS professor Robin Greenwood and Harvard doctoral student Samuel Hanson has implications for studying the stock market performance of seasoned equity offerings (SEOs), initial public offerings (IPOs), and recent acquirers.
Are nominal government bonds risky investments that investors must be rewarded to hold? Or are they safe investments, whose price movements are either inconsequential or even beneficial to investors as hedges against other risks? U.S. Treasury bonds have performed well as hedges during the financial crisis of 2008, but the opposite was true in the late 1970's and early 1980's. John Y. Campbell, a Visiting Scholar at HBS, Harvard Ph.D. candidate Adi Sunderam, and HBS professor Luis M. Viceira explore such changes over time in the risks of nominal government bonds.
Professor David Moss says we need ongoing federal regulation of the few "systemically significant" institutions whose demise could threaten financial stability.
How did the process of securitization transform trillions of dollars of risky assets into securities that many considered to be a safe bet? HBS professors Joshua D. Coval and Erik Stafford, with Princeton colleague Jakub Jurek, authors of a new paper, have ideas.
Published in 2008
The past 10 years have seen a profound change in the conditions under which financial innovations are pursued. Because patents fundamentally alter the way in which innovations can be used, assessing the impact of patenting is critical to understanding the future of financial innovation. Litigation is crucial to delineating the boundaries of patent awards, and this paper examines the litigation of such financial patents to gain insights into the future of financial innovation. This paper seeks to understand the litigation of financial innovations, an area where patents have only recently been granted.
The depth of the global financial crisis is becoming clearer day by day, says HBS professor Jim Heskett. Respondents to this month's column offered creative solutions, and by and large resisted the temptation to venture into the realm of ideology. (Online forum now closed.)
University endowments are important and interesting institutions both in the investing community and society at large. They play a role in maintaining the academic excellence of many universities that rely heavily on income from their endowments. In contrast, poor finances can undermine a school's ability to provide academic services altogether. Endowments have also received much attention recently for their superior investment returns compared with other institutional investors. In this study, the authors document the trends in college and university endowment returns and investments in the United States between 1992 and 2005.
This paper acknowledges the wide range of solutions to the problem of low family savings. Families, and of particular interest to the authors, low-income families, save for a wide variety of purposes, including identifiable reasons such as education and retirement and others that are more broad, like rainy days or emergencies. Given societal pressures to consume, and given the diversity among people, it is unlikely that there is a single solution to the savings problem. Yet a number of programs described by Tufano and Schneider have great promise in supporting household savings. Tufano and Schneider discuss each program from the perspectives of would-be savers as well as from that of other key stakeholders.
Saving money doesn't need to be so difficult. According to HBS professor Peter Tufano, "The most interesting ideas—indeed the oldest—try to make savings a fun or satisfying experience." As Tufano describes in this Q&A, different solutions appeal to different people. Here's what government policy, the private sector, and nonprofits can do.
School connections are an important yet underexplored way in which private information is revealed in prices in financial markets. As HBS professor Lauren H. Cohen and colleagues discovered, school ties between equity analysts and top management of public companies led analysts to earn returns of up to 5.4 percent on their stock recommendations. Cohen explains more in our Q&A.
Certain agents play key roles in revealing information into securities markets. In the equities market, security analysts are among the most important. A large part of an analyst's job (perhaps the majority) is to research, produce, and disclose reports forecasting aspects of companies' future prospects, and to translate their forecasts into stock recommendations. Therefore, isolating how, or from whom, analysts obtain the information they use to produce their recommendations is important. Do analysts gain comparative information advantages through their social networks—specifically, their educational ties with senior officers and board members of firms that they cover? This paper investigates ties between sell-side analysts and management of public firms, and the subsequent performance of their stock recommendations.
How does information flow in security markets, and how do investors receive information? In the context of information flow, social networks allow a piece of information to flow along a network often in predictable paths. HBS professors Lauren Cohen and Christopher Malloy, along with University of Chicago colleague Andrea Frazzini, studied a type of dissemination through social networks tied to educational institutions, examining the information flow between mutual fund portfolio managers and senior officers of publicly traded companies. They then tested predictions on the portfolio allocations and returns earned by mutual fund managers on securities within and outside their networks.
Retirement assets make up a large and growing percentage of the mutual fund universe. In 2004, nearly 40 percent of all mutual fund assets were held by defined contribution plans and individual retirement accounts. This percentage is steadily increasing largely because these retirement accounts represent the majority of new flows into non-money market mutual funds. With such a large and growing percentage of their assets coming from retirement accounts, mutual funds are likely to be interested in securing these big clients. This paper examines a new channel through which mutual fund families can attract assets: by becoming a 401(k) plan's trustee. HBS professor Lauren Cohen and colleague Breno Schmidt provide evidence consistent with the trustee relationship affecting families' portfolio choice decisions. These portfolio decisions, however, have the potential to be in conflict with the fiduciary responsibility mutual funds have for their investors, and can impose potentially large costs.
Entrepreneurs are, on average, significantly wealthier than people who work in paid employment. Research shows that entrepreneurs comprise fewer than 9 percent of households in the United States but they hold 38 percent of household assets and 39 percent of the total net worth. This relationship between personal wealth and entrepreneurship has long been seen as evidence of market failure, meaning that talented but less wealthy individuals are precluded from entrepreneurship because they don't have sufficient wealth to finance their new ventures. Nanda studied how changes in the cost of external finance affected the characteristics and likelihood of individuals becoming entrepreneurs. He finds that market failure accounts for only a small fraction of the relationship between personal wealth and entrepreneurship in advanced economies such as the U.S.
Published in 2007
Summing Up. Professor Jim Heskett considers his reader's comments on the growing imbalance between what John Bogle terms managerial capitalism and owners' capitalism.
One of the enduring puzzles for researchers on FDI has been the role and importance of "horizontal" and "vertical" FDI. Horizontal FDI tends to mean locating production closer to customers and avoiding trade costs. Vertical FDI, on the other hand, represents firms' attempts to take advantage of cross-border factor cost differences. A central challenge for study has been the absence of firm-level data to distinguish properly among the types of and motivations for FDI. Alfaro and Charlton analyzed a new dataset, and in this paper present the first detailed characterization of the location, ownership, and activity of global multinational subsidiaries.
This paper documents the existence of considerable variation over time in the covariance or correlation of Treasury bond returns with stock returns and with consumption growth. There are times in which bonds appear to be safe assets, while at other times they appear to be highly risky assets. The paper finds that time variation in bond risk is systematic and positively related to the level and the slope of the yield curve. These are factors that proxy for inflation and general economic uncertainty, inflation risk, and the risk premium on bonds.
Are hedge funds better than large institutional investors at identifying undervalued companies, locating potential acquirers for them, and removing opposition to a takeover?
Are they best equipped to monitor management? While blockholding by large institutional investors—pension funds and mutual fund investment companies—is widespread, there is virtually no evidence that these institutional shareholders are effective monitors of management or that their presence in the capital structure increases firm value. When institutional blockholders make formal demands on management, there is no evidence of their success. This working paper outlines the advantages and limits of hedge funds to manage these tasks. Greenwood and Schor's characterization differs markedly from previous work on investor activism, which tends to attribute high announcement returns to improvements in operational performance.
Pooling economic assets into large portfolios and tranching them into sequential cash-flow claims has become a big business, generating record profits for both the Wall Street originators and the agencies that rate these securities. This paper by business economics doctoral student Jakub Jurek and HBS professors Joshua Coval and Erik Stafford investigates the pricing and risks of instruments created as a result of recent structured finance activities. It demonstrates that senior collateralized debt obligation (CDO) tranches have significantly different systematic risk exposures than their credit rating-matched, single-name counterparts, and should therefore command different risk premia.
Understanding the effect of foreign direct investment is important for two main reasons: It informs foreign investment policy, and it has implications for the effect of rapidly growing investment flows on the process of economic development. While academics tend to treat foreign direct investment as a homogenous capital flow, policymakers maintain that some FDI projects are better than others. In fact, national policies toward FDI seek to attract some types of FDI while regulating other types, reflecting a belief among policymakers that FDI projects differ greatly in terms of the national benefits to be derived from them. Policymakers from Dublin to Beijing, for instance, have implemented complex FDI regimes in order to influence the nature of FDI projects attracted to their shores. Using a dataset on 29 countries, Alfaro and Charlton distinguished different qualities of FDI in order to examine the various links between types of FDI and growth.
The flat tax is an idea that's burst to life in post-communist Eastern and Central Europe, especially in Slovakia. But is the rest of the world ready? A new Harvard Business School case on Slovakia's complex experience highlights many hurdles elsewhere, as HBS professor Laura Alfaro, Europe Research Center Director Vincent Dessain, and Research Assistant Ane Damgaard Jensen explain in this Q&A.
Real estate continues to defy revert-to-the-mean gravity to deliver handsome returns to investors. Professor Arthur I. Segel looks at the latest developments in the field and also considers several warning clouds that could darken the picture.
Published in 2006
The vulnerability of a national economy to volatility in the global markets for credit, currencies, commodities, and other assets has become a central concern of policymakers, credit analysts, and investors everywhere. This paper describes a new framework for analyzing a country's exposure to macroeconomic risks based on the theory and practice of contingent claims analysis. (A contingent claim is any financial asset for which future payoff depends on the value of another asset.) In this framework, the sectors of a national economy are viewed as interconnected portfolios of assets, liabilities, and guarantees that can be analyzed like puts and calls. The framework makes it transparent how risks are transferred across sectors, and how they can accumulate in the balance sheet of the public sector and ultimately lead to a default by the government.
Researchers and participants in the market for securities have long been interested in the costs of transacting and the notion of liquidity as a performance measure of market structure. In real world capital markets, investors and corporations generally do not expect to transact at fundamental value. Rather, market participants face some degree of illiquidity, where they must sacrifice price, trade size, or speed of execution, forcing them to transact at prices away from fundamental value. The exact price of liquidity, however, is unknown. This paper develops an option-based model of the price of liquidity via the pricing of limit orders.
Adam Smith is best known for The Wealth of Nations, but professor Nava Ashraf believes another of his works, The Theory of Moral Sentiments, presaged contemporary behavioral economics.
Published in 2005
Corporations have turned tax obligations into profit centers, bringing into question the whole rationale for business taxes in the first place. Professor
Mihir A. Desai discusses problems with the modern corporate tax structure and suggests possible remedies.
Published in 2004
Microfinance is not a magic ticket out of poverty, but it can help both the loan receiver as well as the loan giver, says Harvard Business School’s Michael Chu.
Published in 2003
Gyaana means "knowledge" in Sanskrit—a fitting name for a business that aims to fight the 50 percent dropout rate in India by offering microfinance loans to families.
Published in 2002
It's a crucial question: How can this country's poor build up their assets and jump out of the spiral of poverty? The challenge is to create asset-building programs that go beyond savings, expanding into other financial services with higher return rates and greater opportunities, with a big assist from technology, argues Harvard Business School professor Peter Tufano.
Published in 2001
Is there a relationship between a company's social performance and its financial performance? HBS associate professor Joshua D. Margolis and University of Michigan colleague James P. Walsh make the connection in their latest working paper. PLUS: Margolis Q&A.
In this Harvard Business Review article, Professor Joseph L. Bower shares some of the results of his year-long study of M&A activity sponsored by HBS. Discover how five distinct merger and acquisition strategies scenarios play out—and his recommendations for success.
Published in 2000
Technology is bringing about vast changes in worldwide financial markets, generating improvements in efficiency, speed and economies of scale. But as technological change continues to occur, attention must also be paid to changes in the role that regulation plays, said industry leaders in a panel on "Technology and the Future of the Financial Markets."
Stock options dominate the pay of top executives today, but are often poorly understood both by those who grant them and those who receive them. In this excerpt from an article in the Harvard Business Review, HBS Professor Brian J. Hall describes three types of stock option plans and the incentives and risks they entail.
Published in 1999
