First Look

Abstract—We study how career concerns influence banking analysts' forecasts and how their forecasting behavior benefits both them and bank managers. We show that banking analysts issue early in the year relatively more optimistic and later in the year more pessimistic forecasts for banks that could be their future employers. This pattern is not observed when the same analysts forecast earnings of companies that are not likely to be their future employers. Moreover, we use the Global Settlement as an exogenous shock, which limited outside opportunities and therefore exacerbated career concerns, and show that this forecast pattern is more pronounced after the Settlement. Both analysts and bank executives benefit from this behavior. Analysts issuing more biased forecasts for potential future employers are more likely to face favorable career outcomes and bank executives appear to profit from the analysts' bias since the bias is associated with higher levels of insider trading. Our results highlight the bias created by asking analysts to rate their outside opportunities in the labor market.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52495

Abstract—This article discusses the empirical challenges that researchers face when demonstrating the existence and effects of resale price maintenance (RPM). We outline three approaches for finding price effects of RPM and the corresponding hurdles in data and methodology. We show that the quantity test that was suggested by Posner (1977; 1981) does not identify the change to welfare when demand-enhancing effects are considered generally. Finally, we present some solutions to the challenge of identifying welfare effects, and we suggest guidelines for future research.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52479

Abstract—Past work has shown that failure tolerance by principals has the potential to stimulate innovation but has not examined how this affects which projects principals will start. We demonstrate that failure tolerance has an equilibrium price—in terms of an investor's required share of equity—that increases in the level of radical innovation. Financiers with investment strategies that tolerate early failure will endogenously choose to fund less radical innovations, while the most radical innovations (for whom the price of failure tolerance is too high) can only be started by investors who are not failure tolerant. Since policies to stimulate innovation must often be set before specific investments in innovative projects are made, this creates a tradeoff between a policy that encourages experimentation ex-post and one that funds experimental projects ex-ante. In equilibrium it is possible that all competing financiers choose to offer failure-tolerant contracts to attract entrepreneurs, leaving no capital to fund the most radical, experimental projects in the economy. The impact of different innovation policies can help to explain who finances radical innovations and when and where radical innovation occurs.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52506

Abstract—Many public and private efforts in coming years will focus on research in precision medicine, developing biomarkers to indicate which patients are likely to benefit from a certain treatment so that others can be spared the cost—financial and physical—of being treated with unproductive therapies while more easily uncovering therapeutic signals. However, such research initiatives alone will not deliver new medicines to patients in the absence of strong incentives to bring new products to market. We examine the unique economics of precision medicines and associated biomarkers, placing an emphasis on the factors affecting their development, pricing, and access.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52453

Abstract—Algorithms—scripts for mathematical calculations—are powerful. Even though algorithms often outperform human judgment, people resist allowing a numerical formula to make decisions for them (Dawes, 1979). Nevertheless, people increasingly depend on algorithms to inform their decisions. Eight experiments examined trust in algorithms. Experiments 1A and 1B found that advice influenced participants more when they thought it came from an algorithm than when they thought it came from other people. This effect was robust to presenting the advisor jointly or separately (Experiment 2). Experiment 3 tested a moderator: excessive confidence in one’s own knowledge attenuated reliance on algorithms. These tests are important because participants can improve their accuracy by relying more on algorithms (Experiment 4). Experiments 5 and 6 tested a mechanism for reliance: subjectivity of the decision. For objective decisions, participants preferred algorithmic advice, and for subjective decisions, participants preferred advice from people. Experiment 6 tested the interaction of subjectivity and the availability of expert advice. Participants preferred an expert to an algorithm, regardless of the domain (Experiment 6). Experiment 7 examined how decision makers’ own expertise influenced reliance on algorithms. Experts in national security, who regularly make forecasts, relied less on algorithmic advice than lay people did. These results shed light on the important question of when people rely on algorithmic advice over advice from people and have implications for the use of technological algorithms.

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Abstract—This paper conducts a theoretical and empirical investigation of the risks of globally diversified portfolios of stocks and bonds and of optimal intertemporal global portfolio choice for long horizon investors in the presence of permanent cash flow shocks and transitory discount rate shocks to asset values. We show that an upward shift in cross-country one-period return correlations resulting from correlated cash flow shocks increases the risk of global portfolios and reduces investors' willingness to hold risky assets at all horizons. However, a similar upward shift in cross-country one-period return correlations resulting from correlated discount rate shocks has a much more muted effect on long-run portfolio risk and on the willingness of long horizon investors to hold risky assets. Correlated cash flow shocks imply that markets tend to move together at all horizons, thus reducing the scope for global diversification for all investors regardless of their investment horizon. By contrast, correlated discount rate shocks imply that markets tend to move together only transitorily, and long-horizon investors can still benefit from global portfolios to diversify long-term cash flow risk. We document a secular increase in the cross-country correlations of stock and government bond returns since the late 1990s. We show that for global equities this increase has been driven primarily by increased cross-country correlations of discount rate shocks, or global capital markets integration, while for bonds it has been driven by both global capital markets integration and increased cross-country correlations of inflation shocks that determine the real cash flows of nominal government bonds. Therefore, despite the significant increase in the short-run correlation of global equity markets, the benefits from global equity portfolio diversification have not declined nearly as much for long-horizon investors as they have for short-horizon investors. By contrast, increased correlation of inflation across markets implies that the benefits of global bond portfolio diversification have declined for long-only bond investors at all horizons. However, it also means that the scope for hedging liabilities using global bonds has increased, benefiting investors with long-dated liabilities. Finally, we show that the well documented negative stock-bond correlation in the U.S. since the late 1990s is a global phenomenon, suggesting that the benefits of stock-bond diversification have increased in all developed markets.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52494

In February 2013, US Airways announced that it would merge with American Airlines to create the world’s largest airline. Doug Parker, the CEO of US Airways, would become CEO of the new American Airlines Group (AAL). The case describes a number of critical decisions Parker made and actions that he took in the course of the acquisition integration process. All focused on how best to combine the two airlines’ core systems and operating processes as well as the appropriate scope and speed of strategic changes. Now, Parker must decide on the composition of AAL’s senior executive team. Should Parker select a team dominated by US Airways executives with whom he has successfully worked for decades? Or should he establish a new team with roughly equal representation from both airlines? Parker’s choice will send important signals to employees about the extent to which the transaction will be viewed as a merger of equals or as a takeover by US Airways.

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T. Rowe Price’s mutual funds, separate accounts, institutional investors, and retirement accounts were, in the aggregate, Dell Inc.’s third largest shareholder in 2013 when Dell announced a management-led buyout, or MBO, structured as a merger. In considering whether to vote for or oppose the transaction, Brian C. Rogers, chairman and chief investment officer at T. Rowe, and his team had to consider whether the price offered represented the fair value of Dell. In addition, if Rogers concluded the merger price did not represent fair value, should T. Rowe simply sell its shares, or was it in the best interests of T. Rowe’s fund and other investors to oppose the deal, risking its possible collapse? And if T. Rowe opposed the transaction but it was nevertheless approved, should T. Rowe pursue appraisal of its shares in the Delaware courts?

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After deciding to oppose the Dell MBO, T. Rowe Price, together with other dissident Dell shareholders, sought appraisal of their shares in the Delaware courts. The appraisal process resulted in a significant increase in the price to be paid to dissenting shareholders for their Dell shares. T. Rowe Price discovered, however, that a voting glitch had resulted in T. Rowe’s shares being voted in favor of the transaction thus potentially disqualifying it from obtaining the increased value resulting from the appraisal. What obligations did T. Rowe have to its fund and other investors, and what should it do?

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Rajat Gupta, former managing director of McKinsey & Company; a director of Goldman Sachs, Procter & Gamble, and AMR; and a well-known philanthropist, was convicted of engaging in insider trading. The case explores Gupta’s rise and the later legal problems he faced.

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The (B) case provides an update to the (A) case by illustrating how charter school management organization Uncommon Schools responded to the disparity in its students’ 2013 standardized test results. In 2015, CEO Brett Peiser and his management team decided to align the previously decentralized network of schools around core practices. Now in 2016, the (B) case describes the new structure as Peiser and his team review their progress so far and determine if it is the right path forward as the team sets out to reach new expansion goals. This case allows students to analyze the opportunities and potential limitations of Uncommon’s new approach to alignment, innovation, and scaling while maintaining high levels of academic achievement. The (B) case can be used independently of the (A) case to focus on issues of growing school networks while maintaining quality.

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As the largest company, by revenue, in the world, Walmart has been a lightning rod for criticism. However, in an attempt to stay ahead of traditional and digital retailers, and keep customers satisfied with evolving demands, the company is strengthening its competitive advantage by creating Shared Value. Current CEO, Doug McMillon outlines his strategy for fending off competition, navigating a challenging retail landscape, and positioning Walmart as a leading retailer for today and the future.

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This case explores how a company can use shared value as a lens to think about competition and strategy choices in a challenging and evolving industry. The case takes a historical look at the structure of the retail pharmacy industry and the changing nature of rivalry among competitors. The case examines how CVS was able to surpass the long-time industry leader, Walgreens, and highlights CVS Health's shift in strategy starting in the mid-2000s.

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By 2016, Count Anton-Wolfgang von Faber-Castell had led the 255-year-old pencil manufacturer Faber-Castell through waves of technological change. The pocket calculator decimated Faber-Castell’s slide rule business in the 1970s, and computer aided design technology undermined the company’s manual drafting tools in the 1980s. With each new threat the Count had to decide whether to adapt to new technologies or maintain focus on the company’s core products and identity. Analysts continued to ask Count Anton-Wolfgang the same question they had posed to his grandfather: Could the company strategy endure in the modern era?

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Supplements the (A) case.

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Otis Gates, the only African-American in his HBS graduating class, is an entrepreneur from greater Boston area and has built a successful affordable housing firm. Along the way, he and his partners have contributed countless hours of community service to the neighborhoods in which they own properties. Now 80 and ready to retire, Gates is creating a request for proposal for his firm. In doing so, he has to evaluate his firm’s total value and decide whether their social-good mission is helping or harming their bottom line.

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Mikey Dickerson and Haley Van Dyck found themselves far from home and far from certain about where to take the U.S. Digital Service (USDS) next. In the summer of 2015, they had landed in London to meet with Mike Bracken, director of the United Kingdom’s Government Digital Service (GDS). In 2014, President Barack Obama had given USDS a monumental task: transform how the federal government worked for the American people, digitally. The seeds of USDS had grown out of the rescue of HealthCare.gov, the federal website meant to allow consumers to shop for private health insurance. Its launch and crash in October 2013 had threatened one of Obama’s signature policy achievements. Dickerson and a small team had been drafted to help fix HealthCare.gov and had successfully done so in a matter of months. While in London, Dickerson and Van Dyck wondered, of the other areas that most cried out for new technology approaches, which should be tackled next? Moreover, GDS had embedded satellite teams into the UK’s government agencies to guide, assist, and in some cases control, each agency’s digital presence. Did London hold lessons for if, and how, these teams could be successful in the U.S. government? USDS had begun to experiment with this model too, embedding teams in a handful of departments in the U.S federal government. How could USDS best work with the dozens of agencies that were actually doing the work of government?

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