- 01 Sep 2009
- First Look
- 31 Aug 2009
- Research & Ideas
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. Key concepts include: Competition in credit ratings forces raters to favor issuers. This is contrary to the interest of those who rely on ratings to make investment decisions or to regulate. There are 10 nationally recognized statistical ratings organizations. The big 3 are Fitch, Standard and Poor's (S&P), and Moody's. Fitch used to be much smaller, but over the past decade has become a peer of S&P and Moody's. Becker and Milbourn used the appearance of Fitch to test for the effect of competition on corporate bond ratings. Policymakers should proceed cautiously when trying to increase competition among raters, and be aware of the potential drawbacks. If you really want to know the value of a security, there is no shortcut to doing the work yourself. Closed for comment; 0 Comments.
- 28 Aug 2009
- Working Paper Summaries
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. Key concepts include: While majority PE-backed private firms significantly benefit from the tax shield generated by leverage, they otherwise appear less tax aggressive than public firms. In contrast, private firms that are majority-owned by PE firms engage in more tax avoidance than both management-owned and minority PE-backed private firms. On average, majority PE-backed firms pay 15 cents less income tax per dollar of pretax income than other privately held firms, even after controlling for losses and debt tax shields. Closed for comment; 0 Comments.
- 27 Aug 2009
- Working Paper Summaries
Measuring and Understanding Hierarchy as an Architectural Element in Industry Sectors
In an industry setting, classic supply chains display strict hierarchy, whereas clusters of firms have linkages going in many different directions. Previous theory has often assumed the existence of the hierarchical relationships among firms, and empirical industry studies tend to focus on a single-layer industry, or a two-layer structure comprising buyers and suppliers. And yet, some industries have a multilayer structure with a multistep supply chain. Others comprise a cluster of complementary firms producing different parts of a large system. HBS professor Carliss Y. Baldwin and colleagues use network analysis to study multilayer industries both empirically (in the case of Japan) and theoretically and to explore how industries are organized at the sector level in an attempt to reveal the underlying rules that determine how industry architectures form and change. Key concepts include: Empirical analysis shows that the automotive sector in Japan exhibits a significantly higher degree of hierarchy and higher transaction breadth (average number of customers per firm) than the electronics sector. The degree of hierarchy in an industry sector may be traced back to fundamental properties of the underlying technologies. This research helps points the way to new approaches for understanding industry architectures and the factors that influence the architecture of industry sectors. Closed for comment; 0 Comments.
- 26 Aug 2009
- Op-Ed
Where Cash for Clunkers Ran Off the Road
Marketing professor John Quelch says the federal government's "Cash for Clunkers" program was poorly run and failed to meet its main objectives, proving again the government has no business trying to shape consumer behavior. Join the discussion. Key concepts include: Cash for Clunkers was an unjustifiable drain on American taxpayers. The promotion stole largely from future sales with taxpayers subsidizing over half a million new car sales that would have occurred anyway. The federal government has no experience in such initiatives and proved itself incapable of forecasting demand associated with different incentive levels. Administration expenses might well reach 10 percent of total program costs. Closed for comment; 0 Comments.
- 25 Aug 2009
- First Look
- 24 Aug 2009
- Research & Ideas
SuperCorp: Values as Guidance System
In her new book SuperCorp, professor Rosabeth Moss Kanter details how vanguard companies such as IBM, Cemex, and Omron are rewriting the nature of the business enterprise and how firms will gain sustainable prosperity in the 21st century. Read our excerpt. Key concepts include: Grounding strategy in a sense of wider societal purpose provides many significant advantages and only a few potential disadvantages. Vanguard companies gain both a moral compass and an entire guidance system. To be strategic, a principles-based initiative must contribute to the fundamental way the company makes money, with customers and clients in mind. Closed for comment; 0 Comments.
- 20 Aug 2009
- Working Paper Summaries
A Decision-Making Perspective to Negotiation: A Review of the Past and a Look into the Future
The art and science of negotiation has evolved greatly over the past three decades, thanks to advances in the social sciences in collaboration with other disciplines and in tandem with the practical application of new ideas. In this paper, HBS doctoral student Chia-Jung Tsay and professor Max H. Bazerman review the recent past and highlight promising trends for the future of negotiation research. In the early 1980s, Cambridge, Massachusetts, was a hot spot on the negotiations front, as scholars from different disciplines began interacting in the exploration of exciting new concepts. The field took a big leap forward with the creation of the Program on Negotiation, an interdisciplinary, multicollege research center based at Harvard University. At the same time, Roger Fisher and William Ury's popular book Getting to Yes (1981) had a pronounced impact on how practitioners think about negotiations. On a more scholarly front, a related, yet profoundly different change began with the publication of HBS professor emeritus Howard Raiffa's book The Art and Science of Negotiation (1982), which for years to come transformed how researchers would think about and conduct empirical research. Key concepts include: Even as it has transitioned from decision analysis to behavioral decision research to social psychology, the decision perspective to negotiation has remained central to practitioners and academics alike, offering both practical relevance and the foundation for exciting new lines of research. Some of the most recent directions being pursued are surprises that early contributors to the decision perspective could have never predicted, as negotiation scholars engage with other disciplines and draw insights from diverse fields ranging from philosophy to neurobiology. Such collaboration is a healthy sign for an ongoing line of negotiation research. Closed for comment; 0 Comments.
- 19 Aug 2009
- Working Paper Summaries
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. Key concepts include: Where large gaps between theory and policy remain, the harder question is whether policymakers need to learn more from theorists, or the other way around. Both possibilities have historical precedents. Given the worldwide trend toward tax systems with flatter tax rates, it is at least arguable that the movement toward flatter taxes is consistent with prescriptions from theory. Among OECD countries, top marginal rates have declined, marginal income tax schedules have flattened, and commodity taxes are more uniform and are typically assessed on final goods. On the other hand, some results from optimal tax theory cannot be easily identified in actual policy and seem unlikely to be found there anytime soon. Trends in capital taxation are mixed, and rates are still well above the zero level recommended by theory. Some of theory's more subtle prescriptions, such as taxes that involve personal characteristics, asset testing, and history dependence, remain rare. Closed for comment; 0 Comments.
- 19 Aug 2009
- Working Paper Summaries
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. Key concepts include: We must either advocate a tax on height or reject, or at least significantly amend, the conventional Utilitarian approach to optimal taxation. Such choices cannot be avoided. Calculations show that a Utilitarian social planner should levy a sizable tax on height. A tall person making $50,000 should pay about $4,500 more in taxes than a short person making the same income. Height is, of course, only one of many possible personal characteristics that are correlated with a person's opportunities to produce income. In this paper, the authors have avoided these other variables, such as race and gender, because they are intertwined with a long history of discrimination. Any discussion of using these variables in tax policy would raise various political and philosophical issues that go beyond the scope of this paper. Some might fear that a height tax would potentially become a "gateway" tax for the government, making taxes based on demographic characteristics more natural and dangerously expanding the scope for government information collection and policy personalization. Yet modern tax systems already condition on much personal information, such as number of children, marital status, and personal disabilities. A height tax is qualitatively similar, so it is difficult to see why it would trigger a sudden descent down a slippery slope. Closed for comment; 0 Comments.
- 18 Aug 2009
- First Look
- 17 Aug 2009
- Research & Ideas
Quantifying the Economic Impact of the Internet
Businesses around the advertising-supported Internet have incredible multiplier effects throughout the economy and society. Professor John Quelch starts to put some numbers on the impact. Open for comment; 0 Comments.
- 14 Aug 2009
- Working Paper Summaries
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. Key concepts include: Up to 24 months preceding the announcement of goodwill impairment, insiders exhibit higher net selling behavior relative to firms not reporting such losses. In addition, among firms reporting goodwill impairments, those with net selling among insiders exhibit significantly more negative abnormal stock returns relative to those not reporting net selling among insiders. Overall, these results build on prior research investigating managers' discretion over goodwill impairments by providing evidence of a managerial incentive to delay the accounting recognition of goodwill impairments. Closed for comment; 0 Comments.
- 13 Aug 2009
- Working Paper Summaries
In Favor of Clear Thinking: Incorporating Moral Rules into a Wise Cost-Benefit Analysis
Policy decisions may be the most important set of decisions we make as a society. In this realm, moral rules often play an active and dysfunctional role. The typical way in which we make decisions—by weighing them individually—leads us to overuse moral rules in a manner that is inconsistent with the more reflective set of preferences we would identify through joint consideration of options. In their response to a companion article in Perspectives on Psychological Science, Max Bazerman, of HBS, and Joshua D. Greene, of Harvard University, argue that cost-benefit analysis (CBA) is unfairly stereotyped. The critique of CBA in the companion article could be better framed as a set of considerations that can contribute to more careful CBAs. Key concepts include: Good decision analysts pay attention to potential misapplications of cost-benefit analysis. CBA is not perfect, for many reasons. But CBA needs to be compared against an alternative, and the development of that alternative thus far is limited. Closed for comment; 0 Comments.
- 12 Aug 2009
- Working Paper Summaries
Culture Clash: The Costs and Benefits of Homogeneity
Culture clash is often considered a major cause for the failing of mergers and acquisitions, and for this reason it is an important consideration for corporate strategy. Although less publicized, culture clash has also plagued alliances and long-term market relationships. It provides a unique lens on the performance effects of corporate culture itself, and thus culture's potential to generate a competitive advantage. This paper develops an economic theory of the costs and benefits of corporate culture—in the sense of shared beliefs and values—in order to study the effects of culture clash in mergers and acquisitions. Key concepts include: Culture is the degree to which members have similar beliefs about the best way of doing things. In mergers and acquisitions, the costs of culture clash will typically show up immediately and affect mainly the operational efficiency of the merged firms. The benefits of culture clash will take more time to emerge and will affect more the fit with the environment. Closed for comment; 0 Comments.
- 11 Aug 2009
- First Look
- 10 Aug 2009
- Research & Ideas
High Commitment, High Performance Management
High commitment, high performance organizations such as Southwest Airlines, Johnson & Johnson, McKinsey, and Toyota effectively manage three paradoxical goals, says HBS professor Michael Beer. His new book explains what all companies can learn. Q&A Key concepts include: High commitment, high performance (HCHP) firms carry out performance alignment, psychological alignment, and the capacity for learning and change. HCHP transformations are a unit-by-unit process. HCHP firms allow employees to speak to power in honest, collective, and public conversations. Leaders must make conscious, principled choices. Leaders develop an institution that cares about people while understanding the importance of profits. Closed for comment; 0 Comments.
- 07 Aug 2009
- What Do You Think?
Why Can’t Americans Get Health Care Right?
Change is desperately needed, agreed readers of Professor Jim Heskett's online forum. But how to make that change remains in doubt. What can Americans learn from solutions implemented by other countries? (Forum now closed; next forum begins September 4.) Closed for comment; 0 Comments.
- 06 Aug 2009
- Working Paper Summaries
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. Key concepts include: The success rate of venture capital investments in a region is an important determinant of venture capital firms' decisions to open new branches. While venture capital firms in San Francisco, Boston, and New York City outperform, their outperformance is not driven by local investments. While their performance in investments everywhere is better than that of their peers based in different cities, the outperformance is particularly striking outside the cities where they have offices. Interestingly, some of the performance disparity between local and nonlocal investments disappears when a venture firm does more than one investment in a region, suggesting that as the marginal monitoring cost falls, venture capital firms may reduce their expected success rate for investment in a distant geography. Closed for comment; 0 Comments.
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. Key concepts include: Banks with higher exposure to level 3 (or more illiquid) financial assets reflect higher information risk, revealed both in higher equity betas and higher bid-ask spreads. This is suggestive that current disclosures surrounding level 3 financial instruments are insufficient to mitigate investor perceptions of greater information risk for highly opaque financial assets. The regulatory implications may include enhancements to the disclosures (particularly for level 3 financial instruments), as well as increased movement towards risk-weighted regulatory capital. Closed for comment; 0 Comments.