Finance

295 Results

 

A Playbook for Small-Business Job Creation

Karen Mills left her post as SBA Administrator for a joint fellowship at Harvard to tackle a question she's faced her whole career: How can the United States drive innovation and turn it into jobs? Open for comment; 1 Comment posted.

Opting Out of Good Governance

New disclosure rules of the Security and Exchange Commission (SEC) require that foreign firms listed on US exchanges articulate more clearly their compliance with exchange requirements. In this paper the authors study the extent to which cross-listed firms opt out of corporate governance rules, analyzing which firms opt out of US exchange requirements and the consequences of doing so. Opting out is quite common, with 80.2 percent of cross-listed firms opting out of at least one exchange corporate governance requirement. Firms that opt out appear to adopt weaker governance practices and have fewer independent directors. The decision to opt out appears to reflect the relative costs and benefits of this governance choice. The costs of complying are likely to be higher for insiders who might enjoy certain private benefits when following weak governance practices allowed in their home country. The benefits of complying are likely to be higher for firms that are attempting to raise capital and grow. Consistent with this tradeoff, the data show that firms based in countries with weak corporate governance are less likely to comply, and those that are based in such countries and are expanding and issuing equity are more likely to comply. Opting out of US exchange requirements also has consequences for how the market values cash holdings. For firms from countries with weak governance requirements, cash within the firm is worth significantly less if the firm opts out of more US exchange requirements. Overall, the paper provides insight about the costs and benefits of complying with stringent governance rules and also sheds light on the effect of governance requirements on valuation. Read More

The Use of Broker Votes to Reward Brokerage Firms’ and Their Analysts’ Research Activities

Broker votes are one of the most pervasive yet least understood reporting practices on Wall Street. The votes are essentially ratings of the value of brokers' investment research services. These ratings are produced by institutional investors (the "buy side") and solicited by broker dealers (the "sell side"). Little research to date, however, has examined the determinants of broker votes, their consequences, and their economic function. In this paper the authors use data gathered from a mid-sized investment bank for the years 2004 to 2007 in order to study how broker votes are related to institutional investors' commission payments and analysts' client services and compensation. Results overall suggest that broker votes help to facilitate implicit contractual relationships between sell-side brokers, their affiliated analysts, and their buy-side clients. Broker votes are neither mere popularity contests nor a simple reflection of trading in analysts' covered stocks. Instead, they appear to be a key component of the investment research industry's contracting technology, acting as the nexus for a set of relationships between sell-side brokers, their affiliated analysts, and their buy-side clients. The findings thus deepen our understanding of how information is exchanged on Wall Street and help to explain why the practice of collecting and aggregating client votes—a costly internal reporting procedure—has stood the test of time and has been replicated across countless sell-side research departments. Read More

Counting Up the Effects of Sarbanes-Oxley

More than a decade after its inception, the effects of Sarbanes-Oxley seem, if anything, beneficial, say Harvard's Suraj Srinivasan and John C. Coates. Why then do so many critics remain? Open for comment; 5 Comments posted.

When Will the Next Dot.com Bubble Burst?

Summing Up: Is that the sound of a dot.com bubble bursting? Could be, but is that a bad thing?, ask Jim Heskett's readers. Open for comment; 13 Comments posted.

Consequences to Directors of Shareholder Activism

Activism by hedge fund and other investors to improve governance and performance of companies has become a significant phenomenon in recent years. In this paper the authors examine a number of career consequences for directors when firms are subject to activist shareholder interventions. Examining 1,868 activism events—all publicly disclosed shareholder activism from 2004 to 2012 conducted by hedge funds or other major shareholders—the authors find that directors exit the board at a higher rate when their firms are targeted by activists. Even directors not specifically targeted by dissident shareholders are also likely to leave the board, as are directors at firms targeted by activism with no board-related demands, let alone a formal proxy fight. Overall, whether departure is voluntary, optimal, or otherwise, the evidence suggests that activism is associated with career consequences for directors. Read More

Integrated Reporting and Investor Clientele

As a relatively new phenomenon in the world of corporate reporting, integrated reporting (IR) has gained traction across both the corporate and investor community in the last 10 years. A recent pilot program of the International Integrated Reporting Council, for example, included more than 100 large multinational companies supported by an investor network with more than 40 members. Although IR has the potential to fundamentally change corporate reporting, we still know relatively little about its causes and consequences. Proponents of IR argue that the attraction of long-term investors is a benefit of adopting IR. While anecdotal evidence has suggested the presence of a link, no empirical evidence to date has been provided to establish such a relation. In this paper, the author examines how the practice of IR affects the investor base of the firm. Specifically, analyzing data on more than 1,000 firms between 2002 and 2010, he finds that firms practicing IR have a more long-term investor base and fewer transient investors. In addition, evidence supports a causal mechanism from IR to the investor base of a firm. Investor activism on sustainability issues is shown to be effective in improving IR, but such investor-induced changes in IR do not affect the composition of the investor base. Overall, the paper contributes to emerging scholarship that seeks to understand the causes and consequences of sustainability and integrated reporting. It also contributes to studies examining how companies cater to different types of investors. Read More

Companies Detangle from Legacy Pensions

Although new defined benefit plans are rare, many firms must still fund commitments to retirees. Luis M. Viceira looks at the pension landscape and the recent emergence of insurance companies as potential saviors. Open for comment; 4 Comments posted.

HBS Cases: What Warren Buffett Saw in Newspapers

When Warren Buffett made a bid for troubled Media General's newspapers, analysts wondered whether the legendary investor had lost his fastball. Hardly, as Benjamin Esty's case reveals. Open for comment; 3 Comments posted.

Companies Choreograph Earnings Calls to Hide Bad News

Data from thousands of Wall Street earnings conference calls suggests that many companies hide bad performance news by calling only on positive analysts, according to new research by Lauren Cohen and Christopher Malloy. Open for comment; 3 Comments posted.

Is Top-Down Resource Allocation on the Rise?

Summing Up Respondents to this month's column provided Jim Heskett possible explanations for greater reliance on top-down resource allocation processes while arguing that a blend of influences from the top and bottom of an organization are still important for best results. Closed for comment; 14 Comments posted.

The Real Cost of Bribery

George Serafeim finds that the biggest problem with corporate bribery isn't its effect on a firm's reputation or the regulatory headaches it causes. Rather, bribery's most significant impact is its negative effect on employee morale. Closed for comment; 22 Comments posted.

Do Measures of Financial Constraints Measure Financial Constraints?

A core question in corporate finance is how financial constraints affect firm behavior. To answer this question we need a way to identify constrained firms with reasonable accuracy. Since the financial constraints that a firm faces are not directly observable, scholars have tended to rely on indirect proxies-such as having a credit rating or paying dividends-or on one of three popular indices based on linear combinations of observable firm characteristics such as size, age, or leverage (the Kaplan-Zingales, Whited-Wu, and Hadlock-Pierce indices). In this paper the authors ask: How well do these measures of financial constraints identify firms that are plausibly financially constrained? The short answer is: not well at all. The authors develop three different tests that show that public firms classified as constrained have no trouble raising debt when their demand for debt increases, are unaffected by changes in the supply of bank loans, and engage in paying out the proceeds of equity issues to their shareholders ("equity recycling"). Results imply that popular measures of financial constraints tend to identify as constrained subsets of firms that differ from the general firm population of public firms on a number of dimensions, but not in their ability to raise external funding. Importantly, the tests developed by the authors can be used to systematically test the extent to which any measure of financial constraints does capture constraints. Read More

Missing the Wave in Ship Transport

Despite a repeating boom-bust cycle in the shipping industry, owners seem to make the same investment mistakes over time. Can other cyclical industries learn the lessons of the high seas? Research by Robin Greenwood and Samuel G. Hanson. Open for comment; 1 Comment posted.

Monetary Policy Drivers of Bond and Equity Risks

Given the importance of nominal bonds in investment portfolios, and in the design and execution of fiscal and monetary policy, financial economists and macroeconomists need to understand the determinants of nominal bond risks. This is particularly challenging because the risk characteristics of nominal bonds are not stable over time. In this paper the authors ask how monetary policy has contributed to these changes in bond risks. They propose a model that integrates the building blocks of a New Keynesian model into an asset pricing framework in which risk and consequently risk premia can vary in response to macroeconomic conditions. The model is calibrated to US data between 1960 and 2011, a period in which macroeconomic conditions, monetary policy, and bond risks have experienced significant changes. Findings show that two elements of monetary policy have been especially important drivers of bond risks during the last half century. First, a strong reaction of monetary policy to inflation shocks increases both the beta of nominal bonds and the volatility of nominal bond returns. Positive inflation shocks depress bond prices, while the increase in the Fed funds rate depresses output and stock prices. Second, an accommodating monetary policy that smooths nominal interest rates over time implies that positive shocks to long-term target inflation cause real interest rates to fall, driving up output and equity prices, and nominal long-term interest rates to increase, decreasing bond prices. The paper shows empirical evidence that the Fed monetary policy followed an anti-inflationary stance after 1979, but it has moved to a more accommodating, nominal interest rate smoothing policy since the mid 1990's. Consistent with the predictions of the model, the first period corresponds to a period of average positive Treasury-bond beta and stock-bond correlation, and the second period to a period of average negative bond beta and stock-bond correlation. Overall, results imply that it is particularly important to take account of changing risk premia. Read More

The Disintermediation of Financial Markets: Direct Investing in Private Equity

As numerous news stories document, interest on the part of institutional investors in undertaking direct investments—and thus bypassing intermediaries—appears to have increased substantially. More generally, the impact of financial intermediation has also been a subject of considerable examination in the corporate finance literature. On the one hand, these middlemen should be able to overcome transaction cost and information problems; on the other, they may be prone to agency conflicts that affect their performance. In this paper, the authors focus on private equity, a setting in which disintermediation has become increasingly common. Private equity might appear to be a textbook case where the benefits from financial intermediation—in this case, specialized funds—would be substantial: not only are the transaction costs associated with structuring these investments large, but substantial information asymmetries surround the selection, monitoring, and nurturing of the investments, giving rise to potential information advantages for specialized investors. Using proprietary data covering 392 deals by a set of institutions, both co-investments and direct investments, between 1991 and 2011, the authors find a sharp contrast between the performance of solo deals and that of coinvestment deals. Outperformance of solo direct investments is due in part to their ability to exploit information advantages by investing locally and in settings where information problems are not too great, as well as to their relative outperformance during market peaks. The underperformance of coinvestments appears to be associated with the higher risk of deals available for coinvestments. Read More

X-CAPM: An Extrapolative Capital Asset Pricing Model

Many investors assume that stock prices will continue rising after they have previously risen, and will continue falling after they have previous fallen. This evidence, however, does not mesh with the predictions of many of the models used to account for other facts about aggregate stock market prices. Indeed, in most traditional models, expected returns are low when stock prices are high: in these models, stock prices are high when investors are less risk averse or perceive less risk. In this paper, the authors present a new model of aggregate stock market prices which attempts to both incorporate expectations held by a significant subset of investors, and address the evidence that other models have sought to explain. The authors' model captures many features of actual returns and prices. Importantly, however, it is also consistent with survey evidence on investor expectations. This suggests that the survey evidence is consistent with the facts about prices and returns and may be the key to understanding them. Read More

Waves in Ship Prices and Investment

Dry bulk shipping is a highly volatile and cyclical industry in which earnings, investment, and returns on capital appear in waves. In this paper, the authors develop a model of industry capacity dynamics in which industry participants have trouble forecasting demand accurately and fail to fully anticipate the effect that endogenous supply responses will have on earnings. The authors estimate the model using data on earnings, secondhand prices, and investment in the dry bulk shipping industry between 1976 and 2011. Findings show that returns to owning and operating a ship are predictable and closely related to industry-wide investment in capacity. High current ship earnings are associated with higher ship prices and higher industry investment, but predict low future returns on capital. Conversely, high levels of ship demolitions-a measure of industry disinvestment-forecast high returns. Read More

Accountability of Independent Directors-Evidence from Firms Subject to Securities Litigation

Shareholders have two publicly visible means for holding directors accountable: They can sue directors and they can vote against director re-election. This paper examines accountability of independent directors when firms experience litigation for corporate financial fraud. Analyzing a sample of securities class-action lawsuits from 1996 to 2010, the authors present a fuller picture of the mechanisms that shareholders have to hold directors accountable and which directors they hold accountable. Results overall provide an empirical estimate of the extent of accountability that independent directors bear for corporate problems that lead to securities class-action litigation. These findings are useful for independent directors to assess the extent of risk they face from litigation, shareholder voting, and departure from boards of sued firms. While the percentage of named directors is small compared with the overall population of directors, individual directors can weigh their risk differently. From a policy perspective, the findings provide insight on the role that investors play in holding directors accountable for corporate performance. Read More

Crowdfunding a Poor Investment?

Crowdfunding promises to democratize funding of startups. But is that necessarily a good thing? Entrepreneurial finance experts Josh Lerner, Ramana Nanda, and Michael J. Roberts on the promises and problems with the newest method for funding small businesses. Closed for comment; 12 Comments posted.

Measurement Errors of Expected Returns Proxies and the Implied Cost of Capital

In accounting and finance the implied cost of equity capital (ICC)—defined as the internal rate of return that equates the current stock price to discounted expected future dividends—is an increasingly popular class of proxies for the expected rate of equity returns. Though ICCs are intuitively appealing and have the potential to help researchers better understand the cross-sectional variation in expected returns, much remain unknown about the sources of their measurement errors and how to correct for them; thus their use in regression settings should be interpreted with caution. This paper studies the measurement errors properties of GLS, a popular implementation of ICCs developed by Gebhardt, Lee, and Swaminathan (2001). The paper finds that ICCs can have persistent measurement errors that are associated with firms' risk or growth characteristics, and thus produce spurious results in regression settings. It also finds that ICC measurement errors are driven by not only analyst forecast biases but also functional form assumptions, suggesting that correcting for the former alone is unlikely to fully resolve these measurement-error issues. Together, these findings emphasize the importance of complementing ICC regressions with realized returns to establish robust inferences on expected returns. Read More

Do Strict Capital Requirements Raise the Cost of Capital? Banking Regulation and the Low Risk Anomaly

The instability of banks in the financial crisis of 2008 has stoked the enduring debate about optimal capital requirements. One of the central concerns has long been the possibility that capital requirements affect banks' overall cost of capital, and therefore lending rates and economic activity. In this paper, the authors estimate how leverage affects the risk and cost of bank equity and the overall cost of capital in practice. They are especially motivated by the potential interaction of capital requirements and the "low risk anomaly" within the stock market: That is, while stocks have on average earned higher returns than less risky asset classes like corporate bonds, which in turn have earned more than Treasury bonds, it is less appreciated that the basic risk-return relationship within the stock market has historically been flat-if not inverted. Using a large sample of historical US data, the authors find that the low risk anomaly within banks may represent an unrecognized and possibly substantial downside of heightened capital requirements. However, despite the fact that tightened capital requirements may considerably increase the cost of capital and lending rates, with adverse implications for investment and growth, such requirements may well remain desirable when all other private and social benefits and costs are tallied up. Read More

Faculty Symposium Showcases Breadth of Research

Faculty present their latest research on the human tendency toward dishonesty, the use of crowdsourcing to solve major scientific problems, and the impact of private equity investments. Open for comment; 3 Comments posted.

Improving Store Liquidation

Store liquidation, defined as the time-constrained divestment of retail stores through an in-store sale of inventory, is a critical aspect of the retail industry for both defunct and going concerns. Store liquidation is important for firms and investors, affecting everything from retailer performance to how retailers are financed and how investors are compensated. Further, store liquidation is fundamental to innovation in the retail sector, since extracting value from defunct stores and firms is a key step in the process of creative destruction. In this paper, the authors introduce methods for increasing the efficiency of store liquidations operated by retail asset disposition firms, and they thus extend management science techniques to a consequential problem that has not yet been addressed by the literature. These methods were developed through a collaboration with GBG, a prominent liquidator, during the liquidation of over $3B of inventory. Read More

The Auditing Oligopoly and Lobbying on Accounting Standards

The US auditing industry has been characterized as an oligopoly, which has successively tightened from eight key players to four over the last 25 years. This tightening is likely to change the incentives of the surviving big auditors, with implications for their role in our market economy. Motivated by the economic and public policy implications of the tightening audit oligopoly, the authors of this paper investigate the changing relation between the big firms and accounting standards. Accounting standards are a key input in the audit process and, through their effects on financial reporting, can impact capital allocation decisions in the economy. Results show that the big auditors are more likely to identify decreased reliability in proposed standards as the auditing oligopoly has tightened: This suggests that big auditors perceive higher litigation and political costs from the increased visibility that accompanies tighter oligopoly. The findings are also consistent with tighter oligopoly decreasing competition among the surviving firms to satisfy client preferences in accounting standards. The findings do not support the concern that tightening oligopoly has rendered the surviving big firms "too big to fail." Read More

How Chapter 11 Saved the US Economy

In a relatively short time, much of the corporate debt that defaulted during the US financial crisis has been managed down and corporate profits have rebounded. Stuart C. Gilson reviews the power of Chapter 11 bankruptcy Closed for comment; 5 Comments posted.

Big Deal: Reflections on the Megamerger of American and US Airways

The proposed marriage between American Airlines and US Airways would create the nation's largest airline. Professors Rosabeth Moss Kanter and Stuart Gilson reflect on a megamerger. Open for comment; 0 Comments posted.

Expectations of Returns and Expected Returns

Much of modern asset pricing seeks to explain changes in stock market valuations using theories of investors' time-varying required returns. Although researchers have achieved considerable progress in developing proxies for expected returns, an important but often overlooked test of these theories is whether investors' expectations line up with these proxies. This paper shows that they do not. Read More

Are the Big Four Audit Firms Too Big to Fail?

Although the number of audit firms has decreased over the past few decades, concerns that the "Big Four" survivors have become too big to fail may be a stretch. Research by professor Karthik Ramanna and colleagues suggests instead that audit firms are more concerned about taking risks. Open for comment; 13 Comments posted.

Dollar Funding and the Lending Behavior of Global Banks

A striking fact about international financial markets is the large share of dollar-denominated intermediation done by non-US banks. The large footprint of global banks in dollar funding and lending markets raises several important questions. This paper takes the presence of global banks in dollar loan markets as a given, and explores the consequences of this arrangement for cyclical variation in credit supply across countries. In particular, the authors show how shocks to the ability of a foreign bank to raise dollar funding translate into changes in its lending behavior, both in the US and in its home market. Overall, the authors identify a channel through which shocks outside the US can affect the ability of American firms to borrow. Although dollar lending by foreign banks increases the supply of credit to US firms during normal times, it may also prove to be a more fragile source of funding that transmits overseas shocks to the US economy. Read More

Boardroom Centrality and Firm Performance

Economists and sociologists have long studied the influence of social networks on labor markets, political outcomes, and information diffusion. These networks serve as a conduit for interpersonal and inter-organizational support, influence, and information flow. This paper studies the boardroom network formed by shared directorates and examines the implications of having well-connected boards, finding that firms with the best-connected boards on average earn substantially higher future excess returns and other advantages. Read More

Cost of Capital Dynamics Implied by Firm Fundamentals

Despite ample evidence that expected returns are time varying, there has been relatively little empirical research on estimating the dynamics of firm-level expected returns. Capturing the dynamics of firm-level expected returns is important, because it allows for a better understanding of firm risk over time and can inform investors in tailoring their portfolios to match their desired investment horizons. Findings show that cost of capital is time varying and highly persistent. The authors also demonstrate that the model produces empirical proxies of expected returns that can predict future stock returns up to three years into the future and sorts portfolio returns with near monotonicity. Aside from its practical contributions, this paper adds to a budding finance and accounting literature that studies the properties of expected return dynamics. Read More

Vulnerable Banks

Since the beginning of the US financial crisis in 2007, regulators in the United States and Europe have been frustrated by the difficulty in identifying the risk exposures at the largest and most levered financial institutions. Yet, at the time, it was unclear how such data might have been used to make the financial system safer. This paper is an attempt to show simple ways in which this information can be used to understand how deleveraging scenarios could play out. To do so the authors develop and test a model to analyze financial sector stability under different configurations of leverage and risk exposure across banks. They then apply the model to the largest financial institutions in Europe, focusing on banks' exposure to sovereign bonds and using the model to evaluate a number of policy proposals to reduce systemic risk. When analyzing the European banks in 2011, they show how a policy of targeted equity injections, if distributed appropriately across the most systemic banks, can significantly reduce systemic risk. The approach in this paper fits into, and contributes to, a growing literature on systemic risk. Read More

Funding the Design of Livable Cities

As a burgeoning global population migrates to the world's urban centers, it's crucial to design livable cities that function with scarce natural resources. John Macomber discusses the critical connection between real estate financing and innovative design in the built environment. Open for comment; 4 Comments posted.

Securities Litigation Risk for Foreign Companies Listed in the US

In the US, securities class action litigation provides investors with a mechanism to hold companies and managers accountable for violations of securities laws. This study examines the incidence of securities class action litigation against foreign companies listed in the US and the mechanism driving the litigation risk. Looking at more than 2,000 securities class action lawsuits between 1996 and 2010, the authors find that significant litigation risk does exist for foreign issuers, but at rates considerably lower than for US companies. The authors also identify potential factors in lower litigation rates: 1) transaction costs and 2) the lower rate of trigger events such as accounting restatements, missing management forecasts, or sharp drops in stock prices that are needed in a lawsuit context to allege intentional and wrong prior disclosures on the part of managers. This suggests that while the effective enforcement of securities laws is constrained by transaction costs, availability of high quality information (that reveals potential misconduct) can contribute to a well-functioning litigation market for foreign firms listed in the US. Read More

Admitting Mistakes: Home Country Effect on the Reliability of Restatement Reporting

The authors study restatements by foreign firms listed in the US, compare the extent of restatements by the foreign firms to that of domestic US firms, and examine the role of home country characteristics on the likelihood of the foreign firms restating their financials. When foreign firms list in the US, they become subject to the same accounting rules and regulations as US firms. However, results suggest that foreign firms listed in the US restate significantly less than comparable US firms. This difference is not because the foreign firms have superior accounting quality but because of opportunistic avoidance of issuing a restatement. The difference is driven primarily by firms originating from countries with weaker institutions. Overall, findings imply that restatements are a less accurate measure of the extent of reporting problems in an international setting compared to US domestic firms. Read More

Causes and Consequences of Linguistic Complexity in Non-US Firm Conference Calls

Does the form in which financial information is presented have consequences for the capital markets? The authors examine the level of linguistic complexity of more than 11,000 conference call transcripts from non-US firms between 2002 and 2010. Findings show that the linguistic complexity of calls varies with country-level factors such as language barriers, but also with firm characteristics. Firms with more linguistic complexity in their conference calls show less trading volume and price movement following the information releases. Overall, these results may be useful to foreign firms that wish to communicate with investors globally. Analysts and investors around the world may also find the results helpful since they might be able to push managers to speak in a less complex manner. This study is the first to analyze conference calls in a cross-country setting. Read More

Stop Talking About the Weather and Do Something: Three Ways to Finance Sustainable Cities

How do we ensure that our cities are resilient in the face of inevitable future weather events like Hurricane Sandy? John Macomber offers three ways that the private sector can take action. Open for comment; 6 Comments posted.

What Wall Street Doesn’t Understand About International Trade

Firms that correlate their international trading activity with the local ethnic community significantly outperform those that don't, according to new research by Lauren H. Cohen, Christopher J. Malloy, and Umit G. Gurun. Closed for comment; 4 Comments posted.

Want People to Save More? Send a Text

What's the most effective way to encourage people to save their money? The answer lies in a combination of peer pressure and text messages, according to new research by Assistant Professor Dina D. Pomeranz. Open for comment; 6 Comments posted.

Book Excerpt: “The Architecture of Innovation”

In his new book, The Architecture of Innovation, Josh Lerner explores flaws in how corporations fund R&D. This excerpt discusses the corporate venturing model and how incentive schemes make it successful. Open for comment; 1 Comment posted.

Funding Innovation: Is Your Firm Doing it Wrong?

Many companies are at a loss about how to fund innovation successfully. In his new book, The Architecture of Innovation, Professor Josh Lerner starts with this advice: get the incentives right. Open for comment; 4 Comments posted.

Why Public Companies Underinvest in the Future

Private companies are much more focused on the long term when making deals than their publicly owned counterparts. Which side has the right idea? New research from Assistant Professor Joan Farre-Mensa and colleagues. Open for comment; 3 Comments posted.

Liability Structure in Small-Scale Finance: Evidence from a Natural Experiment

Microfinance has exploded in popularity and coverage in recent years, particularly in meeting the large unmet demand for finance. But what is the optimal loan contract structure? This paper examines the relative merits of joint and individual liability contracts by analyzing the effect of contract structure on a group of borrowers who are willing to borrow with either individual or group liability. Findings show that group liability structure significantly improves repayment rates. Overall, these results provide the first credible evidence that group liability contracts improve upon individual liability, particularly in ensuring repayment and increasing savings discipline among clients. Read More

FIN Around the World: The Contribution of Financing Activity to Profitability

A basic premise of financial economics is that financial markets aid the flow of capital to its best use. In a frictionless world, every firm's return on equity (ROE) would equal the firm's cost of equity capital. However, numerous frictions at the firm and country level cause return on equity to vary considerably within and across countries. In this paper, the authors study one prominent friction―the availability of domestic credit from banks―and investigate how differences in the availability of domestic credit across countries influences the resulting leverage, spread, and the net financing contribution to firms' return on equity. Results show that the influence of domestic credit in a country, the rate that trade credit and financial credit substitute for each other, and how operating performance flows through to the financial performance, all depend critically on the relative size of the firm in its home economy. Read More

Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers

Recent research presents convincing evidence that incentives rewarding loan origination may cause severe agency problems and increase credit risk, either by inducing lax screening standards or by tempting loan officers to game approval cutoffs even when such cutoffs are based on hard information. Yet to date there has been no evidence on whether performance-based compensation can remedy these problems. In this paper, the authors analyze the underwriting process of small-business loans in an emerging market, using a series of experiments with experienced loan officers from commercial banks. Comparing three commonly implemented classes of incentive schemes, they find a strong and economically significant impact of monetary incentives on screening effort, risk-assessment, and the profitability of originated loans. The experiments in this paper represent the first step of an ambitious agenda to fully understand the loan underwriting process. Read More

The Acquirers

Associate Professor Matthew Rhodes-Kropf sets out to discover why public companies dominate some M&A waves while private equity firms win others. Open for comment; 3 Comments posted.

Financial vs. Strategic Buyers

What drives either financial or strategic buyers to have a more dominant position in mergers and acquisitions activity at different points in time? The question of competition matters not only because the economic magnitude of this activity is so large, but also because the balance of power between financial vs. strategic acquirers changes the ownership structure of assets and alters the incentives and governance mechanisms that surround the economic engine of our economy. This paper explores how the possibility of misvalued debt markets can both fuel merger activity and alter the balance between PE and strategic buyers. The authors use an approach based on a model of private equity (PE) and strategic merger activity in which all players in the model make value-maximizing decisions conditional on their information. Findings suggest that the possibility of misvalued debt may have important impacts on both firms and investors, on who buys whom, and for default levels in the economy. Read More

Book Excerpt: ’The Future of Boards’

In an excerpt from The Future of Boards, Professor Jay Lorsch discusses why directors are newly questioning their roles. Closed for comment; 0 Comments posted.

The Future of Boards

In The Future of Boards: Meeting the Governance Challenges of the Twenty-First Century, Professor Jay Lorsch brings together experts to examine the state of boards today, what lies ahead, and what needs to change. Open for comment; 3 Comments posted.

Trade Credit and Taxes

Economists have extensively analyzed the effects of taxation on many aspects of corporate financial policy, including borrowing and dividend distributions. But the effects of corporate income taxes on trade credit practices have been much less understood. Research by Mihir A. Desai, C. Fritz Foley, and James R. Hines, Jr. develops the idea that trade credit allows firms to reallocate capital in response to tax differences. Using detailed data on the foreign affiliates of US multinational firms, the authors are able to observe affiliates of the same firm operating in different countries and therefore facing different corporate income tax rates. Taken together, the findings illustrate that firms use trade credit to reallocate capital from low-tax jurisdictions to high tax jurisdictions to capitalize on tax-induced differences in pretax marginal products of capital. Their actions imply that tax rate differences across countries significantly affect capital allocation within firms, depressing investment levels in high tax jurisdictions and introducing differences between the productivity of capital deployed in different locations. Read More

Reaching for Yield in the Bond Market

"Reaching for yield"—investors' propensity to buy high yield assets without regard for risk—has been identified as one of the core factors contributing to the buildup of credit that preceded the financial crisis. Despite this potential importance, however, the way in which reaching for yield works and where it occurs is not well understood. Professors Bo Becker and Victoria Ivashina examine reaching for yield in the corporate bond market by looking among insurance companies, the largest institutional investor in this arena. Findings suggest that reaching for yield may limit the effectiveness of capital regulation to a time-varying and unpredictable extent. Reaching for yield may also allow regulated entities to become riskier than regulators and legislators intend, and may impose distortions on the corporate credit supply. Read More

Creating a Venture Ecosystem in Brazil: FINEP’s INOVAR Project

Since the mid-1990s, several groups in Brazil have been working on developing an indigenous venture capital ecosystem, largely to stimulate the establishment of innovative companies and help them gain access to capital. In 2000, the Brazilian government's Agency for Innovation (Financiadora de Estudos e Projectos, or FINEP), with support from the Multilateral Investment Fund (MIF), unveiled INOVAR, a program to address these needs. In the 12 years since INOVAR's debut, the program has had two iterations and has been recognized as a role model for government efforts to stimulate a VC ecosystem. In this paper, Ann Leamon and Josh Lerner present a brief background on private equity in both Latin America and Brazil, then explore the genesis of INOVAR (Innovation), the details of the program, and its results. They conclude with challenges to be addressed. Read More

Is a VC Partnership Greater Than the Sum of Its Partners?

Venture capital investments are an important engine of innovation and economic growth, but extremely risky from an individual investor's point of view. Furthermore, there are large differences in fund performance between top quartile and bottom quartile venture capital funds. The ability to consistently produce top performing investments implies that there is something unique and time-invariant about venture capital firms. But to what extent are the important attributes of performance a part of the firm's organizational capital or embodied in the human capital of the people inside the firm? Michael Ewens and Matthew Rhodes-Kropf find that the partner is extremely important. Additionally, results suggest that venture capital partnerships are not much more than the sum of their partners. Partners are often significantly different from each other, but "good" firms are those with a group of better partners. Thus, firms that have maintained high performance across many funds may have simply been able to retain high quality partners rather than actually provide those partners with much in the way of fundamental help. Read More

The High Risks of Short-Term Management

A new study looks at the risks for companies and investors who are attracted to short-term results. Research by Harvard Business School's Francois Brochet, Maria Loumioti, and George Serafeim. Closed for comment; 4 Comments posted.

The Stock Selection and Performance of Buy-Side Analysts

Important differences between buy- and sell-side analysts are likely to affect their behavior and performance. While considerable research during the last twenty years has focused on the performance of sell-side analysts (that is, analysts who work for brokerage firms, investment banks, and independent research firms), much less is known about buy-side analysts (analysts for institutional investors such as mutual funds, pension funds, and hedge funds). This paper examines buy recommendation performance for analysts at a large, buy-side firm relative to analysts at sell-side firms throughout the period of mid-1997 to 2004. The researchers find evidence of differences in the stocks recommended by the buy- and sell-side analysts. The buy-side firm analysts recommended stocks with stock return volatility roughly half that of the average sell-side analyst, and market capitalizations almost seven times larger. These findings indicate that portfolio managers (buy-side analysts' clients) prefer that buy-side analysts cover less volatile and more liquid stocks. The study also finds that the buy-side firm analysts' stock recommendations are less optimistic than their sell-side counterparts, consistent with buy-side analysts facing fewer conflicts of interest. This and future studies may help sell-side and buy-side executives to allocate their financial and human resources more strategically. Read More

Causes and Consequences of Firm Disclosures of Anticorruption Efforts

Academic research on corruption has typically focused on its macro causes and consequences. While the country level is certainly important to understand, it is at the firm level where many questions remain unanswered. This study examines 480 of the world's largest companies, using ratings by Transparency International of firms' public disclosures of strategy, policies, and management systems for combatting corruption. Professors Paul Healy and George Serafeim find that firm disclosures are related to enforcement and monitoring costs, such as home country enforcement, US listing, big four auditors, and prior enforcement actions. Disclosures also reflect industry and country corruption risks. Meanwhile the financial implications of fighting disclosure are more nuanced. Read More

Private Meetings of Public Companies Thwart Disclosure Rules

Despite a federal regulation, executives at public firms still spend a great deal of time in private powwows with hedge fund managers. Eugene F. Soltes and David H. Solomon suggest that such meetings give these investors unfair advantage. Closed for comment; 5 Comments posted.

Are There Too Many Safe Securities? Securitization and the Incentives for Information Production

Markets for near-riskless securities have suffered numerous shutdowns in the last 40 years, with the recent financial crisis the most prominent example. This suggests that instability could be a general characteristic of such markets, not just a one-time problem associated with the subprime mortgage crisis. Professors Samuel G. Hanson and Adi Sunderam argue that the infrastructure and organization of professional investors are in part determined by the menu of securities offered by originators. Since robust infrastructure is a public good to originators, it may be underprovided in the private market equilibrium. The individually rational decisions of originators may lead to an infrastructure that is overly prone to disruptions in bad times. Policies regulating originator capital structure decisions may help create a more robust infrastructure. Closed for comment; 0 Comments posted.

What Impedes Oil and Gas Companies’ Transparency?

Oil and gas companies face asset expropriations and corruption by foreign governments in many of the countries where they operate. In addition, most of these companies operate in multiple host countries. What determines their disclosure of business activities and hence transparency? Paul Healy, Venkat Kuppuswamy, and George Serafeim examine three forms of disclosure costs that oil and gas managers could potentially consider. Both the US government and the European Union are currently considering laws that would require oil and gas companies to disclose information about operations in host countries. Read More

The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance

Robert G. Eccles, Ioannis Ioannou, and George Serafeim compared a matched sample of 180 companies, 90 of which they classify as High Sustainability firms and 90 as Low Sustainability firms, in order to examine issues of governance, culture, and performance. Findings for an 18-year period show that High Sustainability firms dramatically outperformed the Low Sustainability ones in terms of both stock market and accounting measures. However, the results suggest that this outperformance occurs only in the long term. Managers and investors who are hoping to gain a competitive advantage in the short term are unlikely to succeed by embedding sustainability in their organization's strategy. Overall, the authors argue that High Sustainability company policies reflect the underlying culture of the organization, where environmental and social performance, in addition to financial performance, are important, but these policies also forge a strong culture by making explicit the values and beliefs that underlie the mission of the organization. Read More

The Cost of Capital for Alternative Investments

An accurate assessment of the cost of capital is fundamental to the efficient allocation of capital throughout the economy. Alternative investments are investments made by sophisticated individual and institutional investors in private investment companies like hedge funds and private equity funds. These investments are frequently combined with financial leverage to bear risks that may be unappealing to the typical investor or that require flexibility that public investment funds may not provide. Often there is a real possibility of a complete loss of invested capital. For this paper, Jakub W. Jurek and Erik Stafford study the required rate of return for a risk-averse investor allocating capital to alternative investments. They argue that the risks borne by hedge fund investors are likely to be positive net supply risks that are unappealing to average investors, such that they may earn a premium relative to traditional assets. Read More

Market Competition, Government Efficiency, and Profitability Around the World

Understanding whether and how corporate profitability mean reverts across countries is important for valuation purposes. This research by Paul M. Healy, George Serafeim, Suraj Srinivasan, and Gwen Yu suggests that firm performance persistence varies systematically. Country product, capital, and to a lesser extent labor market competition all affect the rate of mean reversion of corporate profits. Corporate profitability exhibits faster mean reversion in countries with more competitive factor markets. In contrast, government efficiency decreases the speed of mean reversion, but only when the level of market competition is held constant. The findings are useful to practitioners and scholars interested in understanding how country factors affect corporate profitability. Read More

Doing What the Parents Want? The Effect of the Local Information Environment on the Investment Decisions of Multinational Corporations

As firms increase the scale of their global operations, monitoring operations across borders becomes increasingly challenging. Transparency in the external information environment can help multinational corporations monitor foreign subsidiaries and resolve internal agency problems. In this paper, researchers Nemit O. Shroff, Rodrigo S. Verdi, and Gwen Yu find that foreign subsidiaries located in country-industries with more transparent information environments are better able to translate local growth opportunities into investments. Read More

Doomsday Coming for Catastrophic Risk Insurers?

Insurance "reinsurers" underwrite much of the catastrophic risk insurance taken out to protect against huge disasters natural and man-made. Problem is, says Professor Kenneth A. Froot, reinsurers themselves are in danger of failing from a major catastrophic event. Open for comment; 5 Comments posted.

Decoding Insider Information and Other Secrets of Old School Chums

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. Open for comment; 1 Comment posted.

The Globalization of Corporate Environmental Disclosure: Accountability or Greenwashing?

Between 2005 and 2008, the world saw a dramatic increase in corporate environmental reporting. Yet this transition toward greater transparency and accountability has occurred unevenly across countries and industries. Findings by professors Christopher Marquis and Michael W. Toffel provide the first systematic evidence of how the global environmental movement affects corporations' environmental management practices. Firms' use of symbolic compliance strategies, for instance, is affected by specific corporate characteristics and by institutional context. This study contributes to a larger body of research on the effects of global social movements and environmental reporting. Read More

Non-Audit Services and Financial Reporting Quality: Evidence from 1978-1980

What are the costs and benefits of auditors providing non-audit services? In this paper, the authors investigate whether high non-audit services (NAS) fees relative to audit fees are associated with poor quality financial reporting. Associate Professor Suraj Srinivasan and colleagues look specifically at a sample of S&P 500 firms during the years 1978-80. The authors thus provide an early history analysis of a long-standing regulatory concern that NAS fees create an economic dependence that causes the auditor to acquiesce to the client's wishes in financial reporting, reducing the quality of the audit. This concern led the Sarbanes-Oxley Act to prohibit auditors from providing most consulting services. The authors find that, contrary to regulatory concerns, NAS are associated with better quality financial reporting: lower earnings management and higher earnings informativeness. Conclusions rely on the specific institutional features of the years 1978-80. Read More

The International Politics of IFRS Harmonization

Contrary to its staid image in popular culture, accounting has reigned at the forefront of globalization over the last decade. As of 2010, about 100 countries, including all of the world's major economies, either have adopted a common set of accounting principles known as International Financial Reporting Standards, have initiated an IFRS harmonization program, or have in place a national strategy to respond to IFRS. In fact, the proliferation of IFRS worldwide is one of the most important developments in corporate governance today. Through a series of case studies on Canada, China, and India, Assistant Professor Karthik Ramanna analyzes key similarities and differences in the international political dynamics that contribute to countries' responses to IFRS. His framework helps explain and predict countries' decisions on IFRS harmonization, as well as the potential structure and impact of IFRS in the future. Read More

Corporate Social Responsibility and Access to Finance

Corporate social responsibility may benefit society, but does it benefit the corporation? Indeed it does, according to a new study that shows how CSR can make it easier for firms to secure financing for new projects. Research was conducted by George Serafeim and Beiting Cheng of Harvard Business School and Ioannis Ioannou of the London Business School. Read More

Poultry in Motion: A Study of International Trade Finance Practices

When engaging in international trade, exporters must decide which financing terms to use in their transactions. Should they ask the importers to pay for goods before they are loaded for shipment, ask them to pay after the goods have arrived at their destination, or should they use some form of bank intermediation like a letter of credit? In this paper, Pol AntrÓs and C. Fritz Foley investigate this question by analyzing detailed data on the activities of a single US-based firm that exports frozen and refrigerated food products, primarily poultry. The data cover roughly $7 billion in sales to more than 140 countries over the 1996-2009 period and contain comprehensive information on the financing terms used in each transaction. Read More

The First Deal: The Division of Founder Equity in New Ventures

When starting a company, entrepreneurs must decide how to divide shares among the founders. The simplest way is to split the shares equally, which is what one third of startups decide to do. But that may not be the fairest or most effective way—especially in cases where some founders are doing more for the company than others. In this paper, Thomas F. Hellman (University of British Columbia) and Noam Wasserman (Harvard Business School) examine when and whether teams are likely to divide shares equally among all the founders, and explore whether such an equity split is good for the company. Read More

Accounting for Crises

A key endeavor of modern economic theory is to understand the causes of panics. This paper shows empirically that currency investors are more likely to get spooked unnecessarily when they have too much information. This finding accords well with global games models, which argue that self-fulfilling panics—i.e., panics unrelated to fundamentals—are more likely to occur when the quality of public information available to investors is very high. Research was conducted by Venky Nagar (University of Michigan) and Gwen Yu (Harvard). Read More

Leading and Lagging Countries in Contributing to a Sustainable Society

To determine the extent to which corporate and investor behavior is changing to contribute to a more sustainable society, researchers Robert Eccles and George Serafeim analyzed data involving over 2,000 companies in 23 countries. One result: a ranking of countries based on the degree to which their companies integrate environmental and social discussions and metrics in their financial disclosures. Open for comment; 11 Comments posted.

Mandatory IFRS Adoption and Financial Statement Comparability

In the past decade, many countries have adopted International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board, which has impelled economists to examine the benefits of the standards. This paper discusses how IFRS adoption affects financial reporting comparability—that is, the properties of financial statements that allow users to identify similarities or differences between the economics of different reporting entities over any given period of time. Research was conducted by Francois Brochet and Edward J. Riedl of Harvard Business School, and Alan Jagolinzer of the University of Colorado at Boulder. Read More

Building a Better Board

While corporate board members take their jobs more seriously than ever, they are not necessarily as helpful or effective as they could be, says HBS senior lecturer Stephen Kaufman. He recently sat down with HBS Working Knowledge to discuss what he considers to be the biggest practical issues facing boards today. Closed for comment; 11 Comments posted.

Top Executive Background and Financial Reporting Choice: The Case of Goodwill Impairment

In the management literature, some theories hold that corporate actions and strategic choices can be partially predicted by knowing the functional background of executives. The authors provide evidence on how CEOs and CFOs who were former investment bankers, auditors, and private equity/venture capital executives managed decisions around goodwill impairments (essentially goodwill charge-offs)—a complex accounting choice involving a high degree of managerial discretion. Research by HBS professor Francois Brochet and doctoral candidate Kyle Welch. Read More

The Consequences of Financial Innovation: A Counterfactual Research Agenda

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. Read More

Accounting Scholarship That Advances Professional Knowledge and Practice

Accounting scholars generally do a fine job of analyzing how we process accounting data, but they ought to spend more time looking at how that data is produced, says Harvard Business School professor Robert S. Kaplan. In this paper—in response to a newly minted professor who sought his advice—Kaplan reminds young scholars that accounting is more of a professional discipline than an academic subject. To that end, he advises them not just to teach their students the common body of accounting knowledge, but also to advance that body of knowledge by bridging the gap between scholarship and practice. Read More

What’s Government’s Role in Regulating Home Purchase Financing?

The Obama administration recently proposed housing finance reforms to wind down Fannie Mae and Freddie Mac and bring private capital back to the mortgage markets. HBS professor David Scharfstein and doctoral student Adi Sunderam put forth a proposal to replace Fannie and Freddie and ensure a more stable supply of housing finance. Read More

A Behavioral Model of Demandable Deposits and Its Implications for Financial Regulation

Depositors are overconfident of their chances of recovering demandable deposits in a bank run. In a recent research paper, professor Julio J. Rotemberg reviews various government regulations available to be imposed on financial institutions—minimum capital levels, asset requirements, deposit insurance, and compulsory clawbacks—to understand how much they can help protect investors. Read More

Leviathan as a Minority Shareholder: A Study of Equity Purchases by the Brazilian National Development Bank (BNDES), 1995-2003

There is a trend in many developing countries toward governments buying minority stakes in private companies. While there has been ample discussion on the wisdom of such actions, little has been said about how governments can make such interventions work better. This paper aims to fill that void, using data from the Brazilian National Development Bank (BNDES). Research was conducted by Sergio G. Lazzarini of the Insper Institute of Education and Research, and Aldo Musacchio of Harvard Business School. Read More

Lawful but Corrupt: Gaming and the Problem of Institutional Corruption in the Private Sector

In the business world, "gaming" refers to the act of subverting the intent of rules or laws without technically breaking them--a skillful if unsavory way to achieve private gain. Harvard Business School professor emeritus Malcolm S. Salter explores how gaming the system can lead to institutional corruption, citing examples from Enron and early efforts by some banks to game the implementation of the Dodd-Frank financial reform act. Read More

A Brief Postwar History of US Consumer Finance

The growth of the consumer finance sector after World War II provided a bevy of new financial options for Americans. These options led to a "do-it-yourself" approach to consumer finance, and an increase in household risk taking. In this paper, Harvard Business School professors Gunnar Trumbull and Peter Tufano, along with former HBS research associate Andrea Ryan, discuss the major themes that dominated the expansive postwar sector, including some of the factors that set the stage for the recent subprime mortgage crisis. Read More

Activist Board Members Increase Firm’s Market Value

Board members nominated by activist investors presumably have one primary goal: change the status quo. Does that agenda create or diminish value of the firm in the eyes of shareholders? New evidence offered by Harvard Business School professors Bo Becker, Daniel B. Bergstresser, and Guhan Subramanian suggests financial markets value a new approach. Open for comment; 3 Comments posted.

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

In August 2010, the Security and Exchange Commission announced a highly anticipated rule that would make it easier for investors to nominate new board members and get rid of existing ones. It allowed shareholders to have their board candidates included in the company's proxy materials--if those shareholders had owned at least 3 percent of the firm's shares for at least the prior three years. On October 4, the SEC unexpectedly and indefinitely postponed the implementation of that rule, pending the outcome of a lawsuit aimed at overturning it. This paper gauges the significance of the proxy access rule by measuring whether certain firms gained or lost market value on news of the delay. Research was conducted by Harvard Business School professors Bo Becker, Daniel Bergstresser, and Guhan Subramanian. Read More

HBS Faculty on 2010’s Biggest Business Developments

Three Harvard Business School professors—former Medtronic chairman and CEO Bill George, economist and entrepreneurship expert William Sahlman, and innovation and strategy authority Rosabeth Moss Kanter—offer their thoughts on the most significant business and economic developments of 2010. Read More

Tax US Companies to Spur Spending

With traditional monetary and fiscal policy instruments to stimulate the economy seemingly exhausted, professor Mihir Desai offers a radical proposal: Use taxes to motivate corporations to spend a trillion dollars in cash. Open for comment; 9 Comments posted.

Decoding Inside Information

Price setters and regulators face a difficult challenge in trying to understand the stock trading activity of corporate insiders, especially when it comes to figuring out whether the activity is a good indicator of the firm's financial future. This National Bureau of Economic Research paper discusses how to distinguish "routine" trades (which predict virtually no information about a firm's financial future) from "opportunistic" trades (which contain a great deal of predictive power). Research was conducted by Harvard Business School professors Lauren Cohen and Christopher Malloy and Lukasz Pomorski of the University of Toronto. Read More

Towards an Understanding of the Role of Standard Setters in Standard Setting

Accounting standards promulgated by the Financial Accounting Standards Board (FASB) play an important role in the development and maintenance of capital markets worldwide, so it is important to understand how these standards come to be. Prior research has focused on the effect of corporate lobbying on the development of FASB standards, but has largely overlooked the role of the FASB members themselves. Looking at these individuals between 1973 and 2007, Harvard Business School doctoral candidate Abigail M. Allen and professor Karthik Ramanna examine how board members' professional experience, length of service on the board, and political leanings influenced accounting standards. Read More

Reversing the Null: Regulation, Deregulation, and the Power of Ideas

Who's to blame for the recent financial crisis? To some extent, the fault lies with scholars of economics, according to professor David Moss. In this paper, he argues that an academic focus on government failure in the second half of the 20th century led to the general idea that less was always more when it came to regulation--which, in part, contributed to the crisis. To that end, he calls for a fundamental shift in academic research on the government's role in the economy. Read More

Valuation When Cash Flow Forecasts Are Biased

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. Read More

The Landscape of Integrated Reporting: An E-Book

An e-book written by participants of a recent HBS workshop on integrated reporting is now available. HBS Dean Nitin Nohria offers a forward. Read More

Payout Taxes and the Allocation of Investment

The corporate payout that shareholders periodically receive--dividends or repurchases of shares--is subject to taxation in many countries. Such taxes make it cheaper to finance investment out of retained earnings than from equity issues. Using tax data from 25 countries over a 19-year period, this paper discusses whether these taxes have a direct effect on investor behavior, and to what extent. Research was conducted by Bo Becker of Harvard Business School, Marcus Jacob of the European Business School, and Martin Jacob of the Otto Beisheim School of Management. Read More

GM’s IPO: Back to the Future

General Motors reaches a milestone this week as it presents an initial public offering. HBS faculty discuss issues facing the automaker's revival. Read More

Network Effects in Countries’ Adoption of IFRS

Between 2003 and 2008, 75 countries adopted, to various degrees, International Financial Reporting Standards (IFRS) developed by the International Accounting Standards Board. More countries, including the United States and China, are currently engaged in convergence projects. Researchers Karthik Ramanna (Harvard Business School) and Ewa Sletten (MIT Sloan School of Management) report on the role that perceived network benefits play in convincing some countries to shift from local accounting standards to IFRS. Read More

One Report: Integrated Reporting for a Sustainable Strategy

What a company externally reports shapes how it behaves internally. The key question is, "What should companies report?" Read More

How Did Increased Competition Affect Credit Ratings?

When Fitch Ratings took on Standard & Poor's and Moody's as an alternative credit rating agency in the 1990s, there was a general assumption that the increased competition would lead to higher-quality corporate debt ratings from the incumbents. In fact, their ratings quality declined during the 10-year study period, according to Harvard Business School's Bo Becker and Washington University's Todd Milbourn. One possible cause: competition weakens reputational incentives that drive ratings quality. Read More

HBS Workshop Encourages Corporate Reporting on Environmental and Social Sustainability

The concept of integrated reporting could help mend the lack of trust between business and the public, Harvard Business School Dean Nitin Nohria tells attendees at a seminal workshop. Closed for comment; 7 Comments posted.

Financing Risk and Bubbles of Innovation

While start-up firms are key to any technological revolution, they also run a high risk of failure. To that end, investors often provide limited capital in several careful stages, gaining confidence in a firm before doling out another round of funding. However, these investors still face the possibility that other investors won't provide follow-on funding, even when the firm's prospects remain sound. That's a big risk for individual investors who can't afford to fund a new firm all by themselves, and whose investment will flounder if others don't invest, too. Research by HBS professors Ramana Nanda and Matthew Rhodes-Kropf explores why future investors may not fund the project at its next stage even if the fundamentals of the project have not changed. Read More

Venture Capital’s Disconnect with Clean Tech

Clean-tech start-ups depend on patience and public policy to thrive—the Internet models for VC funding don't apply. That's why Harvard Business School professor Joseph Lassiter is making an unusual recommendation to his entrepreneurship students: Spend a few years serving time in a government job. Closed for comment; 18 Comments posted.

A Comparative-Advantage Approach to Government Debt Maturity

Can the government do anything to discourage short-term borrowing by the private sector? HBS Professor Robin Greenwood, Harvard University and Harvard Business School PhD candidate Samuel Hanson, and Harvard University Professor Jeremy C. Stein suggest the government could actively influence the corporate sector's borrowing decisions by shifting its own financing between T-bills and bonds. Read More

How Government can Discourage Private Sector Reliance on Short-Term Debt

Financial institutions have relied increasingly and excessively on short-term financing--putting the overall system at risk. Should government step in? Harvard researchers Robin Greenwood, Samuel Hanson, and Jeremy C. Stein propose a "comparative advantage approach" that allows government to actively influence the corporate sector's borrowing decisions. Read More

Crashes and Collateralized Lending

This paper presents a framework for understanding the contribution of systematic crash risk to the cost of capital for a variety of different types of securities. The framework isolates the systematic crash risk exposure of different collateral types (equities, corporate bonds, and CDO tranches), and provides a simple mechanism for allocating the cost of bearing this risk between a financing intermediary and investor. Research was conducted by Jakub W. Jurek (Bendheim Center for Finance, Princeton University) and Erik Stafford (Harvard Business School). Read More

Does Mandatory IFRS Adoption Improve the Information Environment?

Created by the International Accounting Standards Board, the International Financial Reporting Standards (IFRS) comprise several principles designed to help public companies increase transparency in their financial reports. But are they worth the hefty compliance costs associated with them? This paper investigates whether adopting the IFRS improves the information environment for firms in which the standards are legally required. Research was conducted by Joanne Horton at the London School of Economics, George Serafeim at Harvard Business School, and Ioanna Serafeim at the Greek Capital Market Commission. Read More

The Impact of Corporate Social Responsibility on Investment Recommendations

Security analysts are increasingly awarding more favorable ratings to firms with corporate socially responsible (CSR) strategies, according to this paper by Ioannis Ioannou and HBS professor George Serafeim. Their work explores how CSR strategies can affect value creation in public equity markets through analyst recommendations. Read More

HBS Faculty Debate Financial Reform Legislation

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. Read More

Is Profit as a “Direct Goal” Overrated?

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.) Closed for comment; 84 Comments posted.

Cyclicality of Credit Supply: Firm Level Evidence

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. Read More

“An Unfair Advantage”? Combining Banking with Private Equity Investing

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. Read More

The Role of Institutional Development in the Prevalence and Value of Family Firms

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 BelÚn 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. Read More

When Do Analysts Add Value? Evidence from Corporate Spinoffs

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 BelÚn 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. Read More

Does Diversification Create Value in the Presence of External Financing Constraints? Evidence from the 2008-2009 Financial Crisis

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 BelÚn 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. Read More

Corporate Governance and Internal Capital Markets

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 BelÚn 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. Read More

Agency Costs, Mispricing, and Ownership Structure

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. Read More

What Brazil Teaches About Investor Protection

When Brazil entered the 20th century, its companies were a model of transparency and offered investor protections that government did not. Can our financial regulators learn a lesson from history? HBS professor Aldo Musacchio shares insights from his new book. Read More

Just Say No to Wall Street: Putting A Stop to the Earnings Game

Over the last decade, companies have struggled to meet analysts' expectations. Analysts have challenged the companies they covered to reach for unprecedented earnings growth, and executives have often acquiesced to analysts' increasingly unrealistic projections, adopting them as a basis for setting goals for their organizations. As Monitor Group cofounder Joseph Fuller and HBS professor emeritus Michael C. Jensen write, improving future relations between Main Street and Wall Street and putting an end to the destructive "earnings game" between analysts and executives will require a new approach to disclosure based on a few simple rules of engagement. (This article originally appeared in the Journal of Applied Corporate Finance in the Winter 2002 issue.) Read More

The Consequences of Entrepreneurial Finance: A Regression Discontinuity Analysis

What difference do angel investors make for the success and growth of new ventures? William R. Kerr and Josh Lerner of HBS and Antoinette Schoar of MIT provide fresh evidence to address this crucial question in entrepreneurial finance, quantifying the positive impact that angel investors make to the companies they fund. Angel investors as research subjects have received much less attention than venture capitalists, even though some estimates suggest that these investors are as significant a force for high-potential start-up investments as venture capitalists, and are even more significant as investors elsewhere. This study demonstrates the importance of angel investments to the success and survival of entrepreneurial firms. It also offers an empirical foothold for analyzing many other important questions in entrepreneurial finance. Read More

The Economic Crisis and Medical Care Usage

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. Read More

Fiduciary Duties and Equity-Debtholder Conflicts

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 Str÷mberg outline important changes in behavior after Credit Lyonnais. Read More

Accountability and Control as Catalysts for Strategic Exploration and Exploitation: Field Study Results

The need for organizations to both exploit current resources and explore new opportunities is a central and long-standing theme in the literature of organizations. The challenge, of course, is that these two imperatives require very different structures and skills. Exploitation demands a focus on efficiency and effectiveness in executing preset plans and procedures. Exploration requires the ability to step outside these routines by emphasizing experimentation, creativity, and novelty. In this study, HBS professor Robert L. Simons focuses on the relationship between two organization design variables—span of control and span of accountability. Using data from 102 field studies, he illustrates how these variables can be manipulated by managers to tilt the balance toward either exploration or exploitation in response to different tasks, different organizational contexts, and changing competitive environments. Read More

Labor Regulations and European Private Equity

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. Read More

A Macroeconomic View of the Current Economy

Concerned or confused by the economic environment? Take some lessons from history and concepts from macroeconomics to get a better understanding of how the economy works. A Q&A with HBS professor David A. Moss, author of A Concise Guide to Macroeconomics: What Managers, Executives, and Students Need to Know. Read More

Private Equity and Industry Performance

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. Read More

Good Banks, Bad Banks, and Government’s Role as Fixer

Government action to stem collapse of the U.S. financial system was certainly warranted, agrees professor Robert Pozen. But results include less competition and increased risk to taxpayers. A Q&A from the HBS Alumni Bulletin and book excerpt from Too Big to Save? Read More

Shareholders Need a Say on Pay

"Say on pay" legislation now under debate Washington D.C. can be a useful tool for shareholders to strengthen the link between CEO pay and performance when it comes to golden parachutes, says Harvard Business School professor Fabrizio Ferri. Here's a look at how the collective involvement of multiple stakeholders could shape the future of executive compensation. Read More

Estimating the Effects of Large Shareholders Using a Geographic Instrument

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. Read More

Stock Price Fragility

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. Read More

Specific Knowledge and Divisional Performance Measurement

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. Read More

Systemic Risk and the Refinancing Ratchet Effect

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. Read More

Financing Constraints and Entrepreneurship

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. Read More

Banking Deregulations, Financing Constraints and Firm Entry Size

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. Read More

The Height Tax, and Other New Ways to Think about Taxation

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. Read More

Information Risk and Fair Value: An Examination of Equity Betas and Bid-Ask Spreads

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. Read More

Why Competition May Not Improve Credit Rating Agencies

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. Read More

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

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. Read More

Optimal Taxation in Theory and Practice

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. Read More

The Optimal Taxation of Height: A Case Study of Utilitarian Income Redistribution

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. Read More

Insider Trading Preceding Goodwill Impairments

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. Read More

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

From Silicon Valley to Herzliya, Israel, venture capital firms are concentrated in very few locations. More than half of the 1,000 venture capital offices listed in Pratt's Guide to Private Equity and Venture Capital Sources are located in just three metropolitan areas: San Francisco, Boston, and New York. More than 49 percent of the U.S.-based companies financed by venture capital firms are located in these three cities. This paper examines the location decisions of venture capital firms and the impact that venture capital firm geography has on investments and outcomes. Findings are informative both to researchers in economic geography and to policymakers who seek to attract venture capital. Read More

Reputation and Competition: Evidence from the Credit Rating Industry

Credit ratings are a key aspect of the financial system. The quality of these ratings is certainly sustained in part by the reputational concerns of rating agencies, whose paying customers have no inherent interest in the quality of ratings. Competition in this industry has been increasing, and there have been calls for yet more competition. Whether competition will reduce quality or improve it is not yet clear. HBS professor Bo Becker and Washington University in St. Louis professor Todd Milbourn test these conflicting predictions in the ratings industry. Their evidence is more or less consistent with a reduction in credit rating quality as Fitch increased its market presence. Their empirical findings suggest that the system will work better when competition is not too severe. These results have potential policy implications. Read More

Why Do Countries Adopt International Financial Reporting Standards?

Why do some countries adopt the European Union (EU)-based International Financial Reporting Standards (IFRS) when others do not? To expand our understanding of the determinants and consequences of IFRS adoption on a global sample, HBS professor Karthik Ramanna and MIT Sloan School of Management coauthor Ewa Sletten studied variations over time in the decision to adopt these standards in more than a hundred non-EU countries. Understanding countries' adoption decisions can provide insights into the benefits and costs of IFRS adoption. Read More

Elections and Discretionary Accruals: Evidence from 2004

How does the political process affect accounting? During the 2004 U.S. congressional elections, outsourcing of American jobs was a major campaign issue. Because outsourcing is assumed to be net profitable, the use of income-decreasing accruals would enable donor firms to deflect public scrutiny of both the firm and the political candidate over outsourcing. HBS professor Karthik Ramanna and MIT Sloan School professor Sugata Roychowdhury examine the accrual choices made by outsourcing firms with links to U.S. congressional candidates during the 2004 elections, and specifically test for income-decreasing discretionary accruals. Evidence is consistent with firms using earnings management to reduce both direct political costs and the costs associated with causing embarrassment to affiliated political candidates. Read More

Can a Continuously-Liquidating Tontine (or Mutual Inheritance Fund) Succeed where Immediate Annuities Have Floundered?

The changeover from defined benefit to defined contributions retirement plans in the United States has created a vast group of individuals that faces (or will face) the difficult problem of using a lump sum of assets to provide consumption for a relatively long but uncertain number of years. Up to this point, however, consumers appear not to have embraced annuitization. HBS professor Julio J. Rotemberg suggests an alternative instrument that, like immediate annuities, provides longevity insurance and postpones income until old age. In the proposed Mutual Inheritance Fund (MIF), a pool is formed by having individuals of a particular age buy shares in a mutual fund. The income from the underlying assets in the mutual fund is reinvested in the fund so that the value of the shares in an individual's name (and possibly also the number of these shares) grows over time. The basic idea behind the MIF is that the shares of pool members who die are liquidated, and the proceeds are then distributed in cash to the remaining members in proportion to the number of mutual fund shares that are currently in their name. Read More

Barriers to Household Risk Management: Evidence from India

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. Read More

Money or Knowledge? What Drives Demand for Financial Services in Emerging Markets?

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. Read More

An Ounce of Prevention: The Power of Public Risk Management in Stabilizing the Financial System

The present financial crisis should remind us that private financial institutions and markets cannot always be counted upon to manage risk optimally on their own. Almost everyone now recognizes that the government has a critical role to play—as the lender, insurer, and spender of last resort—in times of crisis. But effective public risk management is also needed in normal times to protect consumers and investors and to help prevent financial crises from starting in the first place. According to HBS professor David Moss, the biggest threat to our financial system today is posed not by commercial banks (as in 1933), but rather by systemically significant institutions (outside of commercial banking) that have the potential to trigger financial avalanches. The threat posed by these financial institutions is only compounded by the unprecedented federal guarantees introduced in response to the current crisis and the pervasive moral hazard they spawn. Under the system that Moss proposes, no financial institution would be too big to fail. Read More

Earnings Quality and Ownership Structure: The Role of Private Equity Sponsors

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). Read More

Female Empowerment: Impact of a Commitment Savings Product in the Philippines

Does access to personal savings increase female decision-making power in the household? The answer could be important for policymakers looking to increase female empowerment. HBS professor Nava Ashraf and colleagues developed a commitment savings product called a SEED (Save, Earn, Enjoy Deposits) account with a small, rural bank in the Philippines. The SEED account requires that clients commit not to withdraw funds that are in the account until they reach a goal date or amount, but it does not explicitly commit the client to continue depositing funds after opening the account. This working paper examines the impact of the commitment savings product on both self-reported decision-making processes within the household and the subsequent household allocation of resources. Read More

Does Public Ownership of Equity Improve Earnings Quality?

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. Read More

Corporate Misgovernance at the World Bank

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. Read More

The Investment Strategies of Sovereign Wealth Funds

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. Read More

Gray Markets and Multinational Transfer Pricing

Gray market goods are brand-name products that are initially sold into a designated market but then resold through unofficial channels into a different market. Gray markets can arise when transaction and search costs are low enough to allow products to "leak" from one market segment back into another. Examples of industries with active gray markets include pharmaceuticals, automobiles, and electronics. Understandably, reactions to gray market encroachment are mixed. On the one hand, consumer advocates and governments have applauded the increasing role that gray markets have played in improving competition for domestic goods. On the other hand, multinationals have decried the increasing role of gray markets in the economy, with an estimated $40 billion in cannibalized sales resulting from gray markets in the information technology sector alone. This study investigates the optimal price of a multinational's internal transfers and the consequences of regulations mandating arm's-length transfer pricing. Read More

The Economics of Structured Finance

This paper investigates the spectacular rise and fall of structured finance. HBS professor Joshua Coval, Princeton professor Jakub Jurek, and HBS professor Erik Stafford begin by examining how the structured finance machinery works. They construct simple examples of collateralized debt obligations (CDOs) that show how pooling and tranching a collection of assets permits credit enhancement of the senior claims. They then explore the challenge faced by rating agencies, examining, in particular, the parameter and modeling assumptions that are required to arrive at accurate ratings of structured finance products. They conclude with an assessment of what went wrong and the relative importance of rating agency errors, investor credulity, and perverse incentives and suspect behavior on the part of issuers, rating agencies, and borrowers. Read More

Securing Jobs or the New Protectionism? Taxing the Overseas Activities of Multinational Firms

Popular imagination often links two significant economic developments: the rapid escalation of the foreign activities of American multinational firms over the last 15 years, and rising levels of economic insecurity, particularly among workers in certain sectors. The presumed linkages between these phenomena have led many to call for a reconsideration of the tax treatment of foreign investment. Increasing the tax burden on outbound investment by American multinational firms, it is claimed, offers the promise of alleviating domestic employment losses and insecurity while also raising considerable revenue. HBS professor Mihir A. Desai looks beneath the trends, examining the economic determinants of outbound investment decisions and synthesizing what is known about the relationship between domestic and foreign activities. Read More

Catering to Characteristics

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. Read More

Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds

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. Read More

Podcast: Preventing Future Financial Failures

Professor David Moss says we need ongoing federal regulation of the few "systemically significant" institutions whose demise could threaten financial stability. Read More

Fear of Rejection? Tiered Certification and Transparency

The sub-prime crisis has thrown a harsh spotlight on the practices of securities underwriters, which provided too many complex securities that proved to ultimately have little value. Certifiers such as rating agencies, journals, standard setting bodies, and providers of standardized tests play an increasingly important role in the market economies. Yet as scrutiny of rating agencies in the aftermath of the sub-prime crisis has shown, these organizations have complex incentive structures and may adopt problematic approaches. On an explicit level, all major rating agencies follow a well-defined process, whose end product is the publication of a rating based on an objective analysis. But firms have been historically able to get rating agencies not to disclose ratings that displease them. HBS professor Josh Lerner and colleagues examined when certifiers might adopt more complex rating schemes, rather than the simple pass-fail scheme, and highlight that such nuanced schemes are more likely when the costs of such ratings are lower. In addition, these schemes are more common when sellers are less averse to the revelation of information about their quality, and more impatient. Read More

Risky Business with Structured Finance

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. Read More

Smart Money: The Effect of Education, Cognitive Ability, and Financial Literacy on Financial Market Participation

(Previously titled "If You Are So Smart, Why Aren't You Rich? The Effects of Education, Financial Literacy and Cognitive Ability on Financial Market Participation.") Individuals face an increasingly complex menu of financial product choices. The shift from defined benefit to defined contribution pension plans, and the growing importance of private retirement accounts, require individuals to choose the amount they save, as well as the mix of assets in which they invest. Yet, participation in financial markets is far from universal in the United States. Moreover, researchers have only a limited understanding of what factors cause participation. Cole and Shastry use a very large dataset new to the literature in order to study the important determinants of financial market participation. They find that higher levels of education and cognitive ability cause increased participation—however, financial literacy education does not. Read More

Market Reaction to the Adoption of IFRS in Europe

How do investors in European firms react to a change in financial reporting? Prior to 2005, most European firms applied domestic accounting standards. The adoption of International Financial Reporting Standards (IFRS) would result in the application of a common set of financial reporting standards within Europe, and between Europe and the many other countries that require or permit application of IFRS. However, modification of IFRS by European regulators would result in European standards differing from those used in other countries, thereby eliminating some potential convergence benefits. This study investigates the equity market reaction to 16 events associated with the adoption of IFRS in Europe. Overall, the researchers' findings are consistent with investors expecting the benefits associated with IFRS adoption in Europe to exceed the expected costs. Read More

Can Housing and Credit be “Nudged” Back to Health?

Did human frailty cause this crisis? Several thinkers have come forward with a suggestion for improvements to fiscal policy that are based on fostering better decisions while preserving consumer choice, says HBS professor Jim Heskett. What should be done? What do you think? (Online forum now closed. Next forum begins January 7.) Closed for comment; 38 Comments posted.

The Litigation of Financial Innovations

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. Read More

Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items

Do managers' presentation decisions within their financial statements reflect informational motivations (that is, revealing the underlying economics of the firm) or opportunistic motivations (that is, attempts to bias perceptions of firm performance)? The authors examine managers' choices to present special items (such as write-offs and restructuring charges) separately on the income statement rather than aggregated in other line items with disclosure only in the footnotes. Prior research suggests that managers engage in opportunistic reporting in other presentation decisions, and that managers' presentation decisions on the financial statement affects users' judgments. The distinction also matters because current changes in reporting standards are likely to increase the occurrence of "nonrecurring" type charges similar to special items, such as fair value changes. Read More

Consequences of Voluntary and Mandatory Fair Value Accounting: Evidence Surrounding IFRS Adoption in the EU Real Estate Industry

The required adoption of International Financial Reporting Standards (IFRS) in the European Union, effective January 1, 2005, resulted in a number of significant changes in how firms report their financial results. Mandatory IFRS adoption has been criticized for both the flexibility afforded under the standards and the encroachment of the fair value paradigm. Specifically, common accounting standards alone may not be sufficient to provide the benefits of common accounting practices. This paper examines the causes and consequences of different forms of fair value disclosures for tangible long-lived assets. Insights may assist standard setters and users in understanding the factors influencing firms' current and future accounting choices, and may also interest U.S. standard setters and managers of the almost 250 publicly traded U.S. real estate firms. Read More

Workout vs. Bailout: Should Government Take Advantage of the Buffett Effect?

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.) Closed for comment; 50 Comments posted.

Financial Crisis Caution Urged by Faculty Panel

Dean Jay O. Light and a group of Harvard Business School faculty explored the origins and possible outcomes of the U.S. financial crisis at a recent "Turmoil on the Street" panel. Read More

New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability

This paper proposes a set of leading indicators of macrofinancial distress that can be helpful to policymakers and regulators in preparing for, mitigating, and maybe even preventing a credit crisis. These early-warning indicators of crisis are based on modern contingent claims analysis (CCA), which are successfully used today at the level of individual banks by managers, investors, and regulators. The authors' ultimate objective is to provide new tools to help governments and central banks manage financial sector risks. Read More

Secrets of the Academy: The Drivers of University Endowment Success

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. Read More

HBS Cases: Walking Away from a $3 Billion Deal

Managers of the ABRY Fund V were so successful they had investors waiting to pour in an additional $3 billion. But to invest that much would require trade-offs that could jeopardize the chemistry that made the fund successful in the first place. Take the money or walk away? From HBS Bulletin. Read More

Why the U.S. Should Encourage FDI

American financial executives are courting foreign direct investors, particularly sovereign wealth funds, for new investments. Should these investments draw increased scrutiny from U.S. regulators? Harvard Business School professor Mihir Desai argues that most of these deals work out in America's best financial interest. Read More

Rethinking Retirement Planning

Many of us are relying on defined contribution plans to help fund retirement. But Harvard Business School professor Robert C. Merton believes today's plans are not sustainable. So what's next? A new way to look at the problem. Read More

Using Financial Innovation to Support Savers: From Coercion to Excitement

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. Read More

Innovative Ways to Encourage Personal Savings

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. Read More

Accounting Information as Political Currency

The study of accounting and the political process has long been viewed through the political cost hypothesis, the basic premise of which is that firms manage earnings in order to extract first-order benefits (or avoid first-order costs) from regulators. This paper develops and tests a distinct, yet likely, complementary hypothesis: Firms manage reported earnings in order to supply first-order benefits to regulators. Focusing on Democratic and Republican candidates in congressional races in 2004, Ramanna and Roychowdhury test whether the management of accounting information is in some circumstances akin to a political contribution from firms to politicians: in other words, whether accounting information can be used as political currency. The authors predict and find that identified corporate donors to candidates in closely watched races in 2004 managed information related to outsourcing, a hot-button issue in those races. Read More

Testing Strategy with Multiple Performance Measures Evidence from a Balanced Scorecard at Store24

To what extent do balanced scorecards provide useful information for testing and validating an organization's strategy? Numerous case studies of balanced scorecard implementations document their use in translating organizational strategies to objectives and measures, communicating strategic objectives to employees, evaluating the performance of business units, and aligning the incentives of employees across business units and functions. There has been comparatively little research, however, on the potential learning and feedback role of balanced scorecards. Analyzing balanced scorecard data from Store24—a privately held convenience store retailer in New England—during the implementation of an innovative but ultimately unsuccessful strategy, this study investigates whether, when, and how information about problems with the firm's strategy was captured in the multiple performance measures of its balanced scorecard. Read More

Connecting School Ties and Stock Recommendations

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. Read More

Accounting Information as Political Currency

Corporate donors that gave at least $10,000 to closely watched races in the U.S. congressional elections of 2004 were more likely to understate their earnings, say Harvard Business School's Karthik Ramanna and MIT colleague Sugata Roychowdhury. Such "downward earnings management" may have functioned as a political contribution. In this Q&A, Ramanna explains how accounting and politics influence each other. Read More

Organizational Design and Control across Multiple Markets: The Case of Franchising in the Convenience Store Industry

Chain organizations operate units that are typically dispersed across different types of markets, and thus serve significantly different customer bases. Such "market-type dispersion" is likely to compromise the headquarters' ability to control its stores for two reasons: Relative differences in local conditions make it difficult to monitor a store manager's behavior, and a chain with wide-ranging customer bases will have a harder time serving its customers and will need to rely more heavily on store managers' ability to adapt to local needs. This study identifies market-type dispersion as a factor that is systematically related to firms' organizational design choices. The results may help managers and consultants who deal with control challenges related to a chain's geographic expansion into different markets. Read More

Venture Capital

Professor Josh Lerner provides a summary report on the recently held HBS Centennial colloquium on venture capital. Read More

Bank Accounting Standards in Mexico: A Layman’s Guide to Changes 10 Years after the 1995 Bank Crisis

Mexico was the first emerging market compelled to reformulate the financial reporting of its banks as a result of a financial crisis. In the last decade, Mexico has undergone a process of internationalization of its banking industry. Today, more than 80 percent of the equity of Mexican banks belongs to internationally active bank corporations. This internationalization demands more transparent regulation, including standardized accounting rules and better disclosure of information. The case of Mexico can therefore serve as an example of the relevance of these changes, as well as of their scope and limitations. This paper attempts to clarify the nature and structure of the new accounting standards, and explains how they have affected financial statements and their interpretation. Read More

The Gap in the U.S. Treasury Recommendations

U.S. Treasury recommendations for strengthening the regulation of the financial system are a good start but fall short, says Harvard Business School professor emeritus Dwight B. Crane. Here's his suggestion for bringing regulation into the 21st century. Read More

The Matchmaker of the Modern Economy

In the wake of World War II, Georges Doriot helped found the world's first public venture capital firm, American Research and Development. Doriot (1899–1987) was also a professor at Harvard Business School for 40 years. Our book excerpt from Creative Capital: Georges Doriot and the Birth of Venture Capital (HBS Press) describes how ARD first came to "marry" investors and innovators. Read More

The Debate over Taxing Foreign Profits

Corporate tax policy has suddenly become a hot topic in the U.S., including the issue of whether current tax laws encourage American firms to outsource jobs to other countries. Harvard Business School professor Mihir Desai makes a case for exempting foreign profit from taxes if proper safeguards are put in place. Read More

Bridge Building in Venture Capital-Backed Acquisitions

The acquisition of new capabilities through the purchase of small venture capital-backed start-ups is a strategy that has been employed by many large technology firms including Cisco, Microsoft, Google, and EMC. Young venture capital-backed companies, for their part, often develop innovative technologies that can be exploited by existing technology companies. The value inherent in these start-ups is typically tied up in the intellectual property or human capital that has been developed during the early stages of the company's life. The opportunity to acquire valuable intangible assets, however, is balanced by the difficulty in assessing the value of the underlying assets. Unlike purchasing companies with substantial operating profits and a long track record of sales, the ability to fully assess the prospects of intangible assets is subject to substantial asymmetric information and uncertainty. This paper explores mechanisms for limiting the asymmetric information that potentially plagues the acquisition of young venture capital-backed companies. The results also shed light on the value that venture capitalists add to their portfolio companies as well as to companies in their venture capital network. Read More

Sell Side School Ties

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. Read More

Long-Run Stockholder Consumption Risk and Asset Returns

The long-run consumption risk of households that hold financial assets is particularly relevant for asset pricing. The fact that stockholders are more sensitive to aggregate consumption movements helps explain why the consumption risk of stockholders delivers lower risk aversion estimates. Understanding further why consumption growth, particularly that of stockholders, responds slowly to news in asset returns will improve finance scholars' understanding of what drives these long-run relations. HBS professor Malloy and his coauthors examine more disaggregated measures of long-run consumption risks across stockholders and non-stockholders, and provide new evidence on the long-run properties of consumption growth and its importance for asset pricing. Read More

Consumer Demand for Prize-Linked Savings: A Preliminary Analysis

Prize-linked savings (PLS) products are savings vehicles that may appeal to people with little savings and little interest in traditional savings products. PLS products offer savers a return in the form of the chance to earn large prizes, rather than in more traditional forms of interest or dividend income or capital appreciation. The probability of winning is typically determined by account balances, and the aggregate prize pool can be set to deliver market returns to all savers. Prize-linked assets are offered in over twenty countries around the world—including the U.K., Sweden, South Africa, and many Latin American and Middle Eastern countries—but are not available in the United States, where state laws and federal regulations make the offering of prize-linked programs problematic. This working paper provides a first look into demand for a PLS product in the United States. Read More

Laws vs. Contracts: Legal Origins, Shareholder Protections, and Ownership Concentration in Brazil, 1890-1950

The early development of large multidivisional corporations in Latin America required much more than capable managers, new technologies, and large markets. Behind such corporations was a market for capital in which entrepreneurs had to attract investors to buy either debt or equity. This paper examines the investor protections included in corporate bylaws that enabled corporations in Brazil to attract investors in large numbers, thus generating a relatively low concentration of ownership and control in large firms before 1910. The case of Brazil is particularly interesting because, in Latin America before World War I, it boasted the second-largest equity market and largest number of traded companies. As HBS professor Aldo Musacchio shows, the considerable variation of investor protections over time at the country level, and even at the company level, urges cautions against notions about the persistency of institutions, especially of legal traditions. Read More

The Small World of Investing: Board Connections and Mutual Fund Returns

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. Read More

Attracting Flows by Attracting Big Clients: Conflicts of Interest and Mutual Fund Portfolio Choice

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. Read More

Cost of External Finance and Selection into Entrepreneurship

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. Read More

A House Divided: Investment or Shelter?

For decades Americans viewed their homes as a safe harbor, a place to put down roots. But the last decade saw the rise of housing as an investment opportunity. What comes next? asks Harvard Business School professor Nicolas P. Retsinas, director of Harvard's Joint Center for Housing Studies. Read More

Has Managerial Capitalism Peaked?

Summing Up. Professor Jim Heskett considers his reader's comments on the growing imbalance between what John Bogle terms managerial capitalism and owners' capitalism. Closed for comment; 30 Comments posted.

Intra-Industry Foreign Direct Investment

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. Read More

Evidence on the Effects of Unverifiable Fair-Value Accounting

Since the late 1990s, the Financial Accounting Standards Board (FASB) has pressed for the use of fair values in accounting. When such fair values are based on verifiable market prices, they are less likely to be managed. However, in some FASB standards, fair values are based on managers' or appraisers' unverifiable subjective estimates. Agency theory suggests that managers will take advantage of this unverifiability to manage financial reports in order to extract rents. This paper considers a recent FASB standard known as SFAS 142, which relies on unverifiable fair-value estimates when accounting for acquired goodwill. The goal of the research is to see whether firms are using this standard to manage their financial reports. Read More

Building Sandcastles: The Subprime Adventure

The early days of the subprime industry seemed to fulfill a market need—and millions of renters became homeowners as a result. But rapidly escalating home prices masked cracks in the subprime foundation. HBS professor Nicolas P. Retsinas, who is also director of Harvard University's Joint Center for Housing Studies, lays out what went wrong and why. Read More

Bond Risk, Bond Return Volatility, and the Term Structure of Interest Rates

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. Read More

Global Currency Hedging

This article is forthcoming in the Journal of Finance. How much should investors hedge the currency exposure implicit in their international portfolios? Using a long sample of foreign exchange rates, stock returns, and bond returns that spans the period between 1975 and 2005, this paper studies the correlation of currency excess returns with stock returns and bond returns. These correlations suggest the existence of a typology of currencies. First, the euro, the Swiss franc, and a portfolio simultaneously long U.S. dollars and short Canadian dollars are negatively correlated with world equity markets and in this sense are "safe" or "reserve" currencies. Second, the Japanese yen and the British pound appear to be only mildly correlated with global equity markets. Third, the currencies of commodity producing countries such as Australia and Canada are positively correlated with world equity markets. These results suggest that investors can minimize their equity risk by not hedging their exposure to reserve currencies, and by hedging or overhedging their exposure to all other currencies. The paper shows that such a currency hedging policy dominates other popular hedging policies such as no hedging, full hedging, or partial, uniform hedging across all currencies. All currencies are uncorrelated or only mildly correlated with bonds, suggesting that international bond investors should fully hedge their currency exposures. Read More

The Hedge Fund as Activist

Do hedge funds improve management of the companies they invest in? A new study by Harvard Business School professor Robin Greenwood and coauthor Michael Schor argues that, in fact, hedge funds create shareholder value through anticipation of change, not necessarily delivering it. Read More

Hedge Fund Investor Activism and Takeovers

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. Read More

3 Steps to Reduce Financial System Risk

By using complex derivative products, banks are better able to manage risk. But this "credit risk transfer" technology is transferring risk to a new set of investors inexperienced in this arena and posing exposure problems for the international financial system as a whole, argues Harvard Business School professor Mohamed El-Erian. Here's how to fix the problem. Read More

Economic Catastrophe Bonds

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. Read More

Contracting in the Self-reporting Economy

Intellectual property can be used by its owner directly, licensed to a third party for a fixed royalty, or licensed to a third party for a variable royalty. The variable royalty arrangement depends on self-reporting by the licensee, which in turn induces demand for auditing by the licensor. This research studies a setting with the following features: a production cost advantage on the part of the outside party that creates gains from licensing; a limited liability constraint that prevents the licensee from owing more royalties than the gross profits of licensing the intellectual property and prevents the licensor from capturing all of the economic surplus via a fixed royalty agreement; and accounting and auditing costs that reduce the benefits of a variable royalty agreement. Read More

Leveling the Executive Options Playing Field

Harvard Business School professor Mihir A. Desai recently presented testimony to a U.S. Senate subcommittee looking at the subject of executive stock options. His theme: A "dual-reporting system" makes it difficult for investors and tax authorities to learn the real numbers. Read More

Behavioral Finance—Benefiting from Irrational Investors

Do investors really behave rationally? Behavioral finance researchers Malcolm Baker and Joshua Coval don't think humans are such cold calculators. One proof: Individual and even institutional investors often give in to inertia and hold on to shares in unwanted stock. And therein lays opportunity for investment managers and firms. Read More

Growth and the Quality of Foreign Direct Investment: Is All FDI Equal?

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. Read More

All Eyes on Slovakia’s Flat Tax

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. Read More

Adding Time to Activity-Based Costing

Determining a company's true costs and profitability has always been difficult, although advancements such as activity-based costing (ABC) have helped. In a new book, Professor Robert Kaplan and Acorn Systems' Steven Anderson offer a simplified system based on time-driven ABC that leverages existing enterprise resource planning systems. Read More

What’s Behind China’s Wild Stock Ride?

Podcast: The recent one-day plunge of 9 percent in China's stock markets has continued to weigh heavily on other markets around the world. What caused the fall? Are more ups and downs to come? Professor Li Jin discusses the unique characteristics that drive Chinese stocks. Read More

Government’s Misguided Probe of Private Equity

The U.S Department of Justice has begun an inquiry into potentially anti-competitive behavior on the part of leading private equity firms. Professor Josh Lerner looks to history to underscore why this move carries the prospect of damaging what is actually an incredibly competitive industry that creates much value. Read More

The New Real Estate

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. Read More

Inexperienced Investors and Market Bubbles

The evidence isn't conclusive, but new research from Harvard Business School suggests younger fund managers may have contributed to the tech stock bubble. Professor Robin Greenwood discusses the research paper, "Inexperienced Investors and Bubbles," and what mutual fund investors should keep in mind. Read More

Helping Low-Income Families Save More

Marketers are quite efficient at targeting potential customers when they have money—that is, at tax-refund time. Professor Peter Tufano thinks tax time could also be perfect for helping low-income families save more. Read More

“UpTick” Brings Wall Street Pressure to Students

Money managers work in a stressful, competitive pressure cooker that's hard to appreciate from the safety of a business management classroom. That's why HBS professors Joshua Coval and Erik Stafford invented upTick—a market simulation program that has students sweating and strategizing as they recreate classic market scenarios. Read More

The Business Press Is a Watchdog that Bites

When financial fraud is at stake, the press is a watchdog that bites more often than we think, says HBS professor Gregory S. Miller, an expert in financial communication. Many times, the press is on the case long before analysts or even the SEC. In this Q&A he describes what he learned and what managers should keep in mind. Read More

What’s Behind the Private Equity Boom?

Podcast: On just one day in November, $52 billion worth of private equity deals were announced, and more than $200 billion worth of deals have been agreed to so far in 2006. The deals include such major names as Qantas ($8.7 billion), Hertz ($15 billion), and Clear Channel ($ 18.7 billion). Are public markets being eclipsed? Are investors and employees being victimized? Professor Josh Lerner looks at historical trends and current deals to put it all in perspective. Read More

Investors Hurt by Dual-Track Tax Reporting

What corporations report in profit to the IRS and what they report to shareholders are often two different numbers—sometimes wildly so. That's why the IRS and Securities and Exchange Commission are proposing that companies publicly report taxes paid—and Professor Mihir Desai thinks this is only a first step. Read More

The Money Connection—Understanding VC Networks

Venture capital firms often consider investments in companies located far away or in unfamiliar industries. How do they spot these opportunities and also reduce risk? It's the power of networks, says Harvard Business School professor Toby Stuart—and understanding how they work in VC is just now starting to be understood. Read More

Rich or Royal: What Do Founders Want?

It's a fundamental tension many entrepreneurs face, the conflict between wanting to become rich and wanting to keep control of their new company. Few can have both. Professor Noam Wasserman discusses his research into the motivations of entrepreneurs and the people who invest in them. Read More

A New Framework for Analyzing and Managing Macrofinancial Risks of An Economy

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. Read More

Fixing Executive Options: The Veil of Ignorance

Who says you can't rewrite history? Dozens of companies have been caught in the practice of backdating options for top executives. But this is only part of the problem with C-level compensation packages, which often motivate top executives to act in their own best interests rather than those of shareholders. Professors Mihir Desai and Joshua Margolis turn to philosopher John Rawls for a solution: Reward the execs, but don't give them the details. Read More

Pricing Liquidity: The Quantity Structure of Immediacy Prices

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. Read More

The Success of Reverse Leveraged Buyouts

RLBOs have a bad rap, but Josh Lerner says the reputation is not deserved. Studying almost 500 private equity-led IPOs over a 22-year period, Lerner and co-researcher Jerry Cao conclude that reverse leveraged buyouts in general outperformed other IPOs and the market as a whole. Quick flips, however, are another story. Read More

Optimal Value and Growth Tilts in Long-Horizon Portfolios

Long-term investors look for portfolio strategies that optimally trade off risk and reward, not in the immediate future, but over the long term. It is unrealistic to expect long-term investors to adopt an "invest and forget" strategy, but creating a portfolio strategy that adjusts asset allocations in response to changing risk premia, interest rates, and expected inflation remains a challenge in finance. Jurek and Viceira have devised a solution method that aims at a practical implementation of dynamic portfolio choice models with realistically complex investment opportunity sets. They have applied their method to study the role of value stocks and growth stocks in the portfolios of long-term investors, and have found that long-term investors might want to tilt their portfolios away from value stocks despite the fact that the average return on value stocks is larger than the average return on growth stocks (the so-called "value premium"). Their findings provide support for the idea that the superior performance of value stocks might reflect simply that they are riskier than growth stocks at long horizons. Read More

Corporate Governance and Networks: Bankers in the Corporate Networks of Brazil, Mexico, and the United States circa 1910

Brazil today looks like a typical case in which business groups and close relations between companies and banks play an important role to overcome information and monitoring problems. This was not always the case. To study how the development of financial markets can change the interaction between banks and corporations, Musacchio compared the importance of interlocking boards of directors between corporations and banks in Brazil, Mexico, and the United States at the turn of the twentieth century. This paper and previous research support Musacchio's hypothesis that financial markets in Brazil were sustained by an institutional framework that protected investors, enforced credit contracts, and promoted regular financial disclosure of company accounts. The development of bond and stock markets, and the relatively good corporate governance practices in Brazil before 1930, made connections with bankers less necessary. Read More

Reinventing the Dowdy Savings Bond

Families with low and moderate incomes have difficulty saving money—many can't even open bank accounts. To help these families plan for the future, professor Peter Tufano proposes minor changes to the U.S. savings bonds program. Read More

What Companies Lose from Forced Disclosure

Increased corporate financial reporting may benefit many parties, but not necessarily the companies themselves. New research from Harvard Business School professor Romana Autrey and coauthors looks at the relationship between executive performance and public disclosure. Read More

The Competitive Advantage of Global Finance

Relatively few multinational companies truly understand or take advantage of international finance. Professor Mihir A. Desai tackles the subject in a new book, International Finance: A Casebook. Here’s a Q&A. Read More

Unlocking Your Investment Capital

By reassessing risk exposure, many companies can create more equity capacity to fund investments, says Harvard Business School professor Robert C. Merton. Just don't leave it up to the Finance Department. Read More

The Trouble Behind Livedoor

When Livedoor CEO Takafumi Horie was arrested last month, it shook the economic underpinnings of Japan. Professor Robin Greenwood discusses what went wrong with one of that country's most-watched Internet companies. Read More

Should CEOs of Public Companies Offer Earnings Guidance?

A small but growing chorus of public company CEOs is deciding not to provide quarterly earnings guidance. Is this a good or bad development for shareholders, investors, analysts, the marketplace, and the company’s short- and long-term health? Closed for comment; 17 Comments posted.

Financial Reporting Goes Global

Globalization is the key issue in determining the future of financial accounting, says professor Gregory S. Miller. And as more countries consider adopting an international accounting standard, India is positioned to be a strong leader. Read More

Adam Smith, Behavioral Economist?

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. Read More

Rebuilding Commercial Real Estate

The commercial real estate business is awash with money and opportunity. Is this the calm before the bubble pops? Read More

VCs Survey Post-Bubble Opportunities

At the annual Cyberposium conference held at Harvard Business School, venture capitalists pondered what makes for winners and losers in the new VC landscape. Read More

The Best Place for Retirement Funds

Turns out location, location, location isn’t just about real estate. Professor Daniel Bergstresser discusses his research on optimal asset location strategies. Read More

Reinventing Savings Bonds

At one point in American history, savings bonds were an important tool families used to build assets and get ahead. While times have changed, this function of savings bonds may be even more important now, especially for the 41 million low- and moderate-income American households. Tufano and Schneider lay out a case for why savings bonds should be reimagined to help millions of Americans build assets now. Read More

Time to Rethink the Corporate Tax System?

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. Read More

Float Manipulation and Stock Prices

When a firm reduces the number of shares available to trade, so-called float manipulation, the price of the stock is often driven up. The author uses a series of 2,000 stock split events in Japan as an experiment to understand the consequences of float manipulation for stock prices. The conclusion: Stock prices are raised significantly when there are differing opinions about the value of shares, investors are unable to sell short, and the number of outstanding shares is reduced. Read More

Four VCs on Evaluating Opportunities

Four venture capitalists explain to Harvard Business School professor Mike Roberts and senior research associate Lauren Barley how they evaluate potential investments. Read More

A Cross-Sectional Analysis of the Excess Comovement of Stock Returns

This paper develops cross-sectional predictions from a model in which the excess comovement of stock returns comes from correlated demand shocks. The model is tested on 298 Nikkei index stocks and 1,458 non-index stocks for the years 1993 through 2003. The study finds that controlling for index membership, index overweighting is a significant determinant of the comovement of returns with index returns. Read More

The VC Quandary: Too Much Money

The VC money "overhang" continues as investors compete to get into a small number of deals each year. How do smart venture firms approach the challenge? A report from the 11th Annual Venture Capital & Private Equity Conference. Read More

Rethinking Activity-Based Costing

Activity-based accounting looks great in the classroom, but too often fails in the field. In this Harvard Business Review excerpt, HBS professor Robert S. Kaplan along with Steven R. Anderson suggest a way around the obstacles. Read More

Public Pension Reform: Does Mexico Have the Answer?

Mexico may have found a formula for avoiding most of the misfortunes that could arise when individuals invest their own funds. What's the right way to support an aging workforce? And why is it that a concept—life-long security—that should bring comfort to all of us is so distasteful to address in public? Closed for comment; 10 Comments posted.

Professors Introduce Valuation Software

HBS professors Krishna Palepu and Paul Healy have developed a business analysis and valuation software program, which is being sold to the public. Here is why investors and executives should take a look. Read More

The Bias of Wall Street Analysts

Historically, stock analysts’ recommendations have been swayed by business relationships between the analyst’s employer and the target company, says Professor Mark Bradshaw. Have recent SEC reforms helped? Read More

Cash and the Woman-Owned Business

Female entrepreneurs often lack start-up cash. This excerpt from the book Clearing the Hurdles, co-authored by HBS professor Myra M. Hart, explains what women can do about it. Read More

Real Estate: The Most Imperfect Asset

Real estate is the largest asset class in the world—and also the most imperfect, says Harvard Business School professor Arthur Segel. He discusses trends toward institutionalization, environmentalism, and globalization. Read More

New Challenges for Long-Term Investors

Risk-reward. Rising interest rates. Stocks or bonds. The long-term investor has lots to ponder when setting asset allocation strategy, says HBS professor Luis M. Viceira. And the answers might not come with "conventional wisdom." Read More

For Greater Transparency, Is Section 404 an Effective Response?

Section 404 of the Sarbanes-Oxley Act requires that managers certify the integrity of their internal controls for financial reporting. In the end, are shareholders getting their money’s worth? Are more costly amendments to come? Closed for comment; 15 Comments posted.

Analyst Disagreement, Forecast Bias and Stock Returns

It is well documented that financial analysts' opinions are reflected in stock prices. The problem: Analysts often operate under incentives that are inconsistent with telling the truth. Retail investors, who tend to be less sophisticated, may fail to make proper adjustments for the more nuanced of the resulting biases, some of which might be reflected in market prices. To study the scope of market efficiency, Scherbina studied analysts' incentives, resulting forecast biases, and their potential impact on market prices. Read More

Microfinance: A Way Out for the Poor

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. Read More

The Big Money for Big Projects

This isn't your father's venture capital. Amusement parks, satellite networks, oil fields, toll roads: HBS Professor Benjamin Esty studies financing of large projects. Q&A Read More

When Reputation Trumps Regulation

Foreign firms cross-listing on U.S. exchanges are learning that their biggest appeal to potential investors lies in a strong reputation. An interview with HBS professor Jordan Siegel. Read More

European Private Equity—Still a Teenager?

If the private equity industry has a life cycle, these are the teenage years for Europe, according to panelists at the conference session on European private equity. Read More

Is This the Twilight Era for the Managed Mutual Fund?

Once a "safe bet," mutual funds are facing a rocky future as investment managers come under fire for such mismanagement as arbitrage trading. These alleged double dealings will end up costing investors a bundle in the long run. Are we witnessing mutual funds' swan song? Closed for comment; 11 Comments posted.

Can Investors Have Too Much Accounting Transparency?

The earnings of all publicly owned organizations may soon take a hit as the organizations comply with various provisions of the Sarbanes-Oxley Act and new FASB rules. Are these and perhaps other "cures" to the corporate scandals really worth the cost to investors? Closed for comment; 12 Comments posted.

Time-Driven Activity-Based Costing

Activity-based costing (ABC) has become popular in business writing and management circles. (An example of an activity would be process customer complaints.) However, calculating baselines for activities, developing the model, and retesting the model once it is implemented is time-consuming and costly. Kaplan and Anderson developed improvements in the process through what they call time-driven ABC. Time-driven ABC decreases the amount of data needed, and only requires estimates of two things: (1) the practical capacity of committed resources and their cost, and (2) unit times for performing transactional activities. Read More

The Problem with Hedge Funds

Hedge funds are the New Big Thing—and that’s bad for the average investor, says professor D. Quinn Mills. An excerpt from Wheel, Deal, and Steal. Read More

A Bold Proposal for Investment Reform

Do the markets need an investor's union? Should company audits be overseen by stock exchanges? If you want to restore investor confidence, think radical reforms, say professors Paul Healy and Krishna Palepu. Read More

Why Budgeting Kills Your Company

Why doesn’t the budget process work? Read what experts say about not only changing your budgeting process, but whether your company should dispense with budgets entirely. Read More

Surveying the VC Landscape

In an e-mail Q&A, HBS professor Josh Lerner discusses issues including transparency and private equity, buyout firms, Sarbanes-Oxley, and the role of VC on innovation. Read More

Expensing Options Won’t Hurt High Tech

Will expensing stock options harm the competitiveness of start-ups? Not likely, say Zvi Bodie, Robert S. Kaplan, and Robert C. Merton in this Harvard Business Review excerpt. Read More

Business Plan Winner Targets India Dropouts

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. Read More

Are Conditions Right for the Next Accounting Scandal?

Will risk-averse corporate audit committees' natural tendencies to engage the biggest accounting firms insure that the current accounting oligopoly will become even stronger? Closed for comment; 12 Comments posted.

Rating Fund Managers by the Company They Keep

A new method for rating the performance of mutual fund managers looks less at past performance, and more at where smart managers are investing. A Q&A with Harvard Business School professor Randolph B. Cohen. Read More

Why Expensing Options Doesn’t Solve the Problem

Stock options for executives have certainly been abused, but reforms requiring companies to expense option grants on their financial statements don't solve the fundamental problems, argues Harvard Business School professor William A. Sahlman. Read More

Most Accountants Aren’t Crooks—Why Good Audits Go Bad

The Sarbanes-Oxley Act sets stiff penalties for auditors and executives who commit fraud. Problem is, says Harvard Business School professor Max H. Bazerman and his collaborators, most bad audits are the result of unconscious bias, not corruption. Here's a new look at how to audit the auditors. Read More

‘Let the Buyer Beware’ Doesn’t Protect Investors

"Let the buyer beware" is a poor warning for investors, says HBS professor D. Quinn Mills. In this excerpt from his new book, Buy, Lie, and Sell High: How Investors Lost Out on Enron and the Internet Bubble, he offers a way to shape up the system. Plus: Author Q&A. Read More

A Cure for Enron-Style Audit Failures

In an opinion piece in the Financial Times, Harvard Business School professor Jay Lorsch argues for legislation to create an independent, self-regulatory organization to oversee accounting firms. Enron, he says, is not an isolated incident. Read More

Profits and Prophets: The Role of Values in Investment

What are the tradeoffs of socially responsible investing? In a lively debate, social fund manager Amy Domini and a Harvard investment scholar, Samuel L. Hayes, explore the margins of moral versus amoral investing. Read More

Are Assets Only for America’s Wealthy?

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. Read More

Case Study: A Lesson in Private Venture Financing

Using a case discussion on Gray Security Services, Harvard Business School associate professor Walter Kuemmerle highlights issues confronting entrepreneurs and investors interested in Africa. Read More

Wrap-up: Software, Telecom, and Recovery

How is the VC industry doing on its own and in partnership with software and telecoms? These were just three topics discussed in special panel sessions at the recent conference. Here, a few highlights from those conversations. Read More

Venture Capital: Hot Markets and Current Industry Trends

Yes, the economy has soured. But that doesn't mean venture capitalists are waiting on the sidelines. VC panelists discuss what is hot (healthcare), what is not (wireless), and how daily life has changed (a lot). Read More

Why Corporate Budgeting Needs To Be Fixed

Not to mince words, but corporate budgeting is a joke, argues HBS professor emeritus Michael C. Jensen in this Harvard Business Review excerpt. The problem isn't with the budget process—it's when budget targets are used to determine compensation. Read More

Women Entrepreneurs Use Springboard for Funding

The Springboard Venture Capital Forum, held recently at Harvard Business School, was a platform for twenty-three women entrepreneurs seeking heavy-duty financing. Read More

Venture Capital Goes Boom—or Bust?

In The Money of Invention: How Venture Capital Creates New Wealth, HBS professors Paul Gompers and Josh Lerner demystify the role VC plays in the economy. Read an excerpt. Plus: Q&A with the authors. Read More

Does Misery Love Companies? How Social Performance Pays Off

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. Read More

Tech Investment the Wise Way

Can elephants dance? Large companies are perceived to be less inclined to invest in new technologies than start-ups. But HBS professor Henry Chesbrough and Professor Emeritus Richard S. Rosenbloom say look to your business model—not the technology itself—to judge investment decisions. Read More

Not All M&As Are Alike—and That Matters

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. Read More

The Determinants of Corporate Venture Capital Success

Corporate-sponsored venture capital funds do not have to fail. But as HBS professors Paul Gompers and Josh Lerner explain, hybrid organizations such as Xerox Technology Ventures face considerable challenges on the road to success. Read More

Networked Incubators: Hothouses of the New Economy

Are business incubators a fleeting phenomenon or a lasting way of bringing start-ups to fruition? Four HBS professors argue that one particular model—the "networked incubator"—is most likely to endure. Read More

Big Deals: Financing Large-Scale Investments

Multimillion dollar start-ups are all over the news these days. But HBS Professor Benjamin Esty's research provides insight into a much bigger kind of venture, with start-up costs on the order of billions, rather than millions, of dollars. Read More

Value Maximization and Stakeholder Theory

Many managers, says HBS Professor Michael C. Jensen, are caught in a dilemma: between a desire to maximize the value of their companies and the demands of "stakeholder theory" to take into account the interests of all the stakeholders in a firm. The way out of the conflict, says Jensen, lies in a new way of measuring value. Read More

The State of the Markets

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." Read More

Stock Options Are Not All Created Equal

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. Read More

The Future of the Venture Capital Cycle

Despite many success stories and a rapid rise to prominence, the venture capital industry remains a mystery to most, and questions about its sustainability persist. In this excerpt from their pathbreaking book The Venture Capital Cycle, HBS Professors Paul Gompers and Josh Lerner look toward the future of this misunderstood financial intermediary. Read More

Where Main Street Meets Wall Street

Its phenomenal growth, based on its near-perfect fit with consumer needs and aspirations, has made the mutual fund one of this century's big success stories. How is it adapting to the age of the Internet and 21st century change? HBS Professors Jay O. Light and Peter Tufano and three alumni take a look at the state of the mutual fund industry 75 years after its beginnings in Boston's financial district. Read More