First Look

December 20, 2016

Among the highlights included in new research papers, case studies, articles, and books released this week by Harvard Business School faculty:

How regulation affects medical device innovation

Ariel Dora Stern looks at how the regulatory approval process affects innovation in the article Innovation under Regulatory Uncertainty: Evidence from Medical Technology. "Prior studies have found early mover regulatory advantages for drugs," she writes. "I find the opposite for medical devices, where pioneer entrants spend 34 percent (7.2 months) longer than follow-on entrants in regulatory approval." The article appears in the January 2017 issue of Journal of Public Economics.

How competition from China affects innovation in the US

A new working paper how the rise of import competition from China has affected innovation in the United States, using evidence from US patents. "Accounting for secular trends in innovative activities, we find that the impact of the change in import exposure on the change in patents produced is strongly negative," write authors David Autor, David Dorn, Gordon H. Hanson, Pian Shu, and Gary Pisano. "Rising import exposure also reduces global employment, global sales, and global R&D expenditure at the firm level. It would appear that a simple mechanism in which greater foreign competition induces U.S. manufacturing firms to contract their operations along multiple margins of activity goes a long way toward explaining the response of U.S. innovation to the China trade shock." Read Foreign Competition and Domestic Innovation: Evidence from U.S. Patents.

How firm fragmentation affects creditor recovery rates

"I examine how organizational complexity arising from fragmentation of the firm into multiple legal entities affects creditor recovery rates," writes Anywhere Sikochi in the paper Organizational Complexity and Creditor Recovery Rates. "I show that organizational complexity can diminish creditors’ ability to recover their claims upon borrower default. The greater the number of entities, the lower the creditor recoveries upon default of the parent company."

A complete list of new research and publications from Harvard Business School faculty follows.

— Carmen Nobel
 
  • forthcoming
  • Research in Organizational Behavior

The Dynamic Componential Model of Creativity and Innovation in Organizations: Making Progress, Making Meaning

By: Amabile, Teresa M., and Michael G. Pratt

Abstract—Leveraging insights gained through a burgeoning research literature over the past 28 years, this paper presents a significant revision of the model of creativity and innovation in organizations published in Research in Organizational Behavior in 1988. This update focuses primarily on the individual-level psychological processes implicated in creativity that have been illuminated by recent research and highlights organizational work environment influences on those processes. We revisit basic assumptions underlying the 1988 model, modify certain components and causal connections, and introduce four new constructs into the model: (1) a sense of progress in creative idea development, (2) the meaningfulness of the work to those carrying it out, (3) affect, and (4) synergistic extrinsic motivation. Throughout, we propose ways in which the components underlying individual and team creativity can both influence and be influenced by organizational factors crucial to innovation.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=51996

  • forthcoming
  • Quarterly Journal of Economics

Catering to Investors Through Security Design: Headline Rate and Complexity

By: Célérier, Claire, and Boris Vallée

Abstract—This paper investigates the rationale for issuing complex securities to retail investors. We focus on a large market of investment products targeted exclusively at households: retail-structured products in Europe. We hypothesize that banks strategically use product complexity to cater to yield-seeking households by making product returns more salient and shrouding risk. We find four empirical results consistent with this view. First, we show that structured products with complex payoff formulas offer higher headline rates, and that they more frequently expose investors to a complete loss of their investment. We then document that banks are more inclined to issue high-headline-rate and more complex products in low-rate environments. Finally, we find that high-headline-rate and more complex products are more profitable for banks, and that their ex post performance is lower.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52007

  • in press
  • Social Psychological & Personality Science

Agent-based Modeling: A Guide for Social Psychologists

By: Jackson, Joshua Conrad, David Rand, Kevin Lewis, Michael I. Norton, and Kurt Gray

Abstract—Agent-based modeling is a longstanding but underused method that allows researchers to simulate artificial worlds for hypothesis testing and theory building. Agent-based models (ABMs) offer unprecedented control and statistical power by allowing researchers to precisely specify the behavior of any number of agents and observe their interactions over time. ABMs are especially useful when investigating group behavior or evolutionary processes and can uniquely reveal non-linear dynamics and emergence—the process whereby local interactions aggregate into often surprising collective phenomena, such as spatial segregation and relational homophily. We review several illustrative ABMs, describe the strengths and limitations of this method, and address two misconceptions about ABMs: reductionism and “you get out what you put in.” We also offer maxims for good and bad ABMs, give practical tips for beginner modelers, and include a list of resources and other models. We conclude with a 7-step guide to creating your own model.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52002

  • January 2017
  • Journal of Public Economics

Innovation Under Regulatory Uncertainty: Evidence from Medical Technology

By: Stern, Ariel Dora

Abstract—This paper explores how the regulatory approval process affects innovation incentives in medical technologies. Prior studies have found early mover regulatory advantages for drugs. I find the opposite for medical devices, where pioneer entrants spend 34% (7.2 months) longer than follow-on entrants in regulatory approval. Back-of-the-envelope calculations suggest that the cost of a delay of this length is upwards of 7% of the total cost of bringing a new high-risk device to market. Considering potential explanations, I find that approval times are largely unrelated to technological novelty but are meaningfully reduced by the publication of objective regulatory guidelines. Finally, I consider how the regulatory process affects small firms' market entry patterns and find that small firms are less likely to be pioneers in new device markets, a fact consistent with relatively higher costs of doing so for more financially constrained firms.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=51989

  • forthcoming
  • Review of Financial Studies

The Political Economy of Financial Innovation: Evidence from Local Governments

By: Vallée, Boris, and Christophe Perignon

Abstract—We examine the toxic loans sold by investment banks to local governments. Using proprietary data, we show that politicians strategically use these products to increase chances of being re-elected. Consistent with greater incentives to hide the cost of debt, toxic loans are utilized significantly more frequently within highly indebted local governments. Incumbent politicians from politically contested areas are also more likely to turn to toxic loans. Using a difference-in-differences methodology, we show that politicians time the election cycle by implementing more transactions immediately before an election rather than after. Politicians also exhibit herding behavior. Our findings demonstrate how financial innovation can foster strategic behaviors.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52008

  • 2016
  • Political Psychology: New Explorations

Racism, Causal Explanations, and Affirmative Action

By: Vescio, Theresa K., Amy Cuddy, Faye Crosby, and Kevin Weaver

Abstract—In recent decades, research in political psychology has illuminated the psychological processes underlying important political action, both by ordinary citizens and by political leaders. As the world has become increasingly engaged in thinking about politics, this volume reflects exciting new work by political psychologists to understand the psychological processes underlying Americans’ political thinking and action. In 13 chapters, world-class scholars present new in-depth work exploring public opinion, social movements, attitudes toward affirmative action, the behavior of political leaders, the impact of the 9/11 attacks, and scientists’ statements about global warming and gasoline prices. Also included are studies of attitude strength that compare the causes and consequences of various strength-related constructs. This volume will appeal to a wide range of researchers and students in political psychology and political science, and may be used as a text in upper-level courses requiring a scholarly and contemporary review of major issues in the field.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=34240

Abstract—Cash holdings provide the crucial advantage of instant availability in competitive market conditions where the speed of investment greatly matters. Accordingly, prior studies find that cash holdings enable firms to increase product market share at the expense of their rivals. Recently, however, U.S. multinational firms have received a lot of attention for hoarding cash overseas. The spotlight, especially from the staff at the Securities and Exchange Commission, is based on the notion that cash held in overseas locations is not instantly available to meet firms’ liquidity needs. We test this proposition and find evidence consistent with the notion that overseas cash holdings impose restrictions on the instant availability of funds invested in liquid assets overseas, thereby limiting firms’ ability to rapidly and/or aggressively respond to competitive market conditions. More specifically, we show that the effects of cash holdings on future product market gains decreases with the proportions of total cash held overseas.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52017

Foreign Competition and Domestic Innovation: Evidence from U.S. Patents

By: Autor, David, David Dorn, Gordon H. Hanson, Pian Shu, and Gary Pisano

Abstract—Manufacturing is the locus of U.S. innovation, accounting for more than three quarters of U.S. corporate patents. The rise of import competition from China has represented a major competitive shock to the sector, which in theory could benefit or stifle innovation. In this paper we empirically examine how rising import competition from China has affected U.S. innovation. We confront two empirical challenges in assessing the impact. We map all U.S. utility patents granted by March 2013 to firm-level data using a novel Internet-based matching algorithm that corrects for a preponderance of false negatives when using firm names alone. And we contend with the fact that patenting is highly concentrated in certain product categories and that this concentration has been shifting over time. Accounting for secular trends in innovative activities, we find that the impact of the change in import exposure on the change in patents produced is strongly negative. It remains so once we add an extensive set of further industry- and firm-level controls. Rising import exposure also reduces global employment, global sales, and global R&D expenditure at the firm level. It would appear that a simple mechanism in which greater foreign competition induces U.S. manufacturing firms to contract their operations along multiple margins of activity goes a long way toward explaining the response of U.S. innovation to the China trade shock.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=51998

Credit Rating Adjustments Prior to Default and Recovery Rates

By: Bonsall, Samuel B., IV, Kevin Koharki, Karl A. Muller III, and Anywhere Sikochi

Abstract—This study investigates whether rating agencies apply more stringent rating adjustments leading up to issuer defaults and whether the adjustments predict lender recoveries following default. Over the two years preceding default, we find that ratings grow increasingly pessimistic relative to a standard benchmark rating model prediction, while optimism remains for similar firms that do not default. Further, we find that lender recovery rates are associated with both model-based predicted ratings and rating adjustments. These results, however, weaken when incumbent rating agencies face increased competition from other rating agencies. Together, these findings suggest that credit rating agencies strategically adjust their ratings to limit their reputational risk associated with defaulting issuers and that the adjustments are generally useful in assessing eventual lender recovery following default.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52018

Meet the Oligarchs: Business Legitimacy, State Capacity and Taxation

By: Di Tella, Rafael, Juan Dubra, and Alejandro Lagomarsino

Abstract—We analyze the role of people’s beliefs about the rich in the determination of public policy in the context of a randomized online survey experiment. A question we study is the desirability of government-private sector meetings, a variable we argue is connected to State capacity. Survey respondents primed with negative views about business leaders want fewer meetings as well as higher taxes for the top 1% and more regulation. We also study how these effects change when subjects are (additionally) primed with positive/negative views about government officials. Distrust in the government increases the preferred tax rate on the top 1% only when business legitimacy is low. A model with multiple equilibria helps interpret these findings. In one of the equilibria, meetings are allowed, business legitimacy is high, and people set a low income tax rate for businesspeople. In the other, meetings are forbidden, business legitimacy is low, and people set high taxes to punish the businesspeople for their corrupt behavior.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52003

Abstract—This working paper aims to deepen the scholarly dialogue between strategy and history. It does so by examining how historical models of change can contribute to theory and research on the competitive advantage of firms during periods of rapid innovation. Focusing on the dynamic capabilities framework, it shows how three models of historical change—evolutionary, dialectical, and constitutive—can be used to extend theory and deepen research about the origins, context, and micro-foundations of dynamic capabilities. We show how each model of historical change shaped the intellectual development of the dynamic capabilities framework, point to historical research that illustrates these processes, and discuss the methodological and conceptual implications for future research. We conclude by suggesting that recognizing and building on these historical models of change can provide a common conceptual language for a deeper dialogue between historians and strategy researchers.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52026

High-Skilled Migration and Agglomeration

By: Kerr, Sari Pekkala, William Kerr, Çağlar Özden, and Christopher Parsons

Abstract—This paper reviews recent research regarding high-skilled migration. We adopt a data-driven perspective, bringing together and describing several ongoing research streams that range from the construction of global migration databases, to the legal codification of national policies regarding high-skilled migration, to the analysis of patent data regarding cross-border inventor movements. A common theme throughout this research is the importance of agglomeration economies for explaining high-skilled migration. We highlight some key recent findings and outline major gaps that we hope will be tackled in the near future.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=51997

Henry Kissinger: Negotiating Black Majority Rule in Southern Africa

By: Sebenius, James K., R. Nicholas Burns, Robert H. Mnookin, and L. Alexander Green

Abstract—In 1976, United States Secretary of State Henry A. Kissinger conducted a series of intricate, multiparty negotiations in Southern Africa to persuade white Rhodesian leader Ian Smith to accede to black majority rule. Conducted near the end of President Gerald Ford’s term in office and against substantial U.S. domestic opposition, Kissinger’s efforts culminated in Smith’s public announcement that he would accept majority rule within two years. This set the stage for the later Lancaster House negotiations that resulted in the actual transition to black majority rule. The account in this working paper carefully describes—but does not analyze nor draw lessons from—these challenging negotiations. Forthcoming papers will provide analysis and derive general insights from Kissinger’s negotiations to end white minority rule in Rhodesia.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52023

Abstract—I document the causal link between shareholder litigation risk and cross-listed firms’ information environment by exploiting a quasi-natural experiment in the form of a reduction in litigation risk resulting from the 2010 Supreme Court ruling in Morrison v. National Australia Bank. I first show that the ruling reduced litigation risk faced by cross-listed firms as evidenced by lower directors’ and officers’ insurance premiums for Canadian firms after the ruling. I then show that the information environment deteriorated for cross-listed firms after the ruling. The results are more pronounced for firms with low U.S. share activity, in bad-news firm quarters, and for firms from countries with weak legal institutions. By implication, these findings suggest that improvements in foreign firms’ information environment upon listing in the U.S., as documented in prior literature, stem in part from the greater litigation risk associated with the U.S. listing.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52015

Abstract— I examine how organizational complexity arising from fragmentation of the firm into multiple legal entities affects creditor recovery rates. I show that organizational complexity can diminish creditors’ ability to recover their claims upon borrower default. The greater the number of entities, the lower the creditor recoveries upon default of the parent company. Moreover, recovery is lower when the parent company is a holding company with significant overseas operations in countries with weak governance. Additional tests show that during a financial crisis when creditor recoveries are generally low, organizational complexity exacerbates creditor losses.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52016

  • Harvard Business School Case 217-013

Nirvana Vihar Rehabilitation Homes

Kumar Builders (KUL) was finally nearing completion on the four luxury condominium towers that comprised the first phase of its bold vision for the redevelopment of more than 70 acres of prime real estate in downtown Pune, India. The Nirvana Hills development also involved working with the Slum Redevelopment Authority to relocate and build on the site homes in towers for at least 20,000 slum dwellers and restoring much of the site to green space. At the request of Chairman Lalitkumar Jain, KUL's project team had assembled to discuss planning for Phase II, a massive mixed-use scheme of more than 7.2 million square feet of market rate residential and commercial development. Kruti Jain, the 28-year-old daughter of Lalitkumar and CEO of KUL, and her team must weigh many decisions including figuring out the appropriate mix of uses for Phase II, determining the proper phasing, assessing a potential partnership, and managing relationships with the slum community benefiting from the development.

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  • Harvard Business School Case 217-004

Designing Performance Metrics at GoDaddy

Scott Wagner has recently joined GoDaddy, a leading provider of cloud-based software and services that helped individuals and small businesses establish a web presence, in the dual role of chief operating officer and chief financial officer. One of his first tasks is to design a set of performance metrics that can be used to run the business. This case gives students the opportunity to develop a framework for thinking about GoDaddy’s business and design performance metrics that measure the health of the business and guide employee behavior.

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https://cb.hbsp.harvard.edu/cbmp/product/217004-PDF-ENG

  • Harvard Business School Case 817-041

ZenRecruit: Sales Coaching and Performance Reviews

Amara Kaggwa leads the small but rapidly expanding sales team at ZenRecruit, a recruiting software application used by small businesses. Armed with six months of sales performance metrics, Kaggwa is preparing for her monthly performance conversations with two under-performing sales people. This case concerns a metrics-driven sales organization, challenges the students to combine quantitative and qualitative observations to craft productive sales coaching plans, and provides students with the opportunity to role play these difficult yet important performance-review discussions. It is suitable for Sales, Marketing, Organizational Behavior, and Entrepreneurial Management courses.

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This module provides tools for acquiring and allocating resources. Analytic techniques related to cash flow analysis and rate of return analysis play an important role in understanding the economic effects of acquiring new resources. However, as the assets become larger and more strategic, management judgment becomes the determining factor. For assets that enhance operating efficiencies or increase revenue, we review techniques such as discounted cash flow and internal rate of return. For assets designed to enhance competitive effectiveness, we review the necessary analyses to ensure that resources are aligned with strategic initiatives. Most importantly, this module demonstrates how asset allocation fits into and supports a business’s overall strategy.

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This module shows how to link profit plans and other performance measurement systems to internal and external markets. Any firm that transfers goods and services internally between autonomous divisions must use some form of transfer prices and adjust the profit plans of the divisions involved. This module demonstrates the different ways of designing an internal transfer pricing system and explains trade-offs among transfer pricing policies. Managers must also understand the linkage between internal operations and external markets including capital markets, customer markets, and supplier markets. To communicate effectively with these markets, managers must know how to use accounting-based tools such as profits plans, ROE, and residual income measures such as EVA.

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This module explains how to construct a strategy map and build a balanced scorecard. A strategy map gives managers a way to illustrate the cause-effect relationship between company goals and the overall business strategy. Using an internal value chain model, we discuss how the balanced scorecard can support and enable customer management, innovation, operations, and post-sale service processes. We describe how to build performance indicators to monitor financial goals, customer goals, internal process goals, and learning and growth goals. By focusing on these goals, the balanced scorecard gives managers a tracking tool for leading indicators that goes beyond traditional, backward-looking financial measures. Assigning accountability for balanced scorecard measures allows each person in the company to understand their goals and be motivated to achieve them, ensuring alignment and focus throughout the organization.

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This module introduces diagnostic and interactive control systems. Diagnostic control systems are the management-by-exception systems that managers use to monitor the achievement of their business strategy. Interactive control systems are the systems that top managers use to focus the organization on strategic uncertainties. Diagnostic control systems and interactive control systems work together to ensure the implementation of today’s strategy and, at the same time, allow the organization to position itself for tomorrow. We illustrate how managers use different interactive systems to guide bottom-up emergent strategy. In addition, we explore the specials risks that are introduced through the use of these performance measurement and control systems.

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In 2011, Songy Partners, an Atlanta-based real estate developer, was facing three distressed investments within their portfolio each with distinct sets of challenges. Having weathered a myriad of issues during the global financial crisis that included operational shortfalls, failed partnerships, bankruptcies, lender consolidations, lagging tenant demand, low investment liquidity, and pending loan maturities, Songy needed a path forward for these three assets. Songy's lenders were threatening to foreclose on all three properties and also call on corporate guarantees. The case addresses Songy's decisions leading up to and during the crisis. Which of the firm's challenges might have been avoidable? Did the company have any leverage with its creditors? What tactics might the company employ to save its properties? Within this context, what are Songy's responsibilities to his investors?

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