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    First Look: August 11, 2009

    First Look

    11 Aug 2009
    It has been tough to address insider trading without knowing precisely what types of private information are hoarded. Research now suggests that employees with knowledge of upcoming goodwill impairments losses may profit unduly. "This study provides evidence of a specific reporting item, goodwill impairments, about which insiders are able to strategically trade prior to its full discovery by the equity market and its recognition with the financial statements," write HBS professor Edward J. Riedl and coauthors Karl A. Muller, III and Monica Neamtiu in "Insider Trading Preceding Goodwill Impairments" [PDF]. Insiders may take advantage of almost two years lead time before a firm announces its accounting recognition of goodwill impairments. Another paper this week challenges the common wisdom that privatization is a necessary ingredient for reenergizing state-owned entities (SOEs). SOEs in India control up to one-third of all industrial activity yet the introduction of new leadership at more than 40 state-owned laboratories nonetheless allowed the labs to significantly boost their revenue and share of U.S. patents, write HBS doctoral candidate Prithwiraj Choudhury and Professor Tarun Khanna. They discuss the implications of these surprising findings in "State Owned Entity Reform in Absence of Privatization: Reforming Indian National Laboratories and the Role of Leadership" [PDF]. —Martha Lagace
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    Working Papers

    State Owned Entity Reform in the Absence of Privatization: Reforming Indian National Laboratories and Role of Leadership

    Authors:Prithwiraj Choudhury and Tarun Khanna
    Abstract

    The literature on state-owned entity (SOE) reform has been focused on privatization. We, however, show that even in the absence of property rights, SOEs may significantly improve performance, and document 42 Indian state-owned laboratories over 1993-2006—starting from a base of negligible U.S. patents—being granted more patents than all domestic private firms combined. Patent licensing revenue increases from 3% to 15% as a fraction of government budget without negatively affecting publication quality and quantity. This follows incentive policy change and leadership change at labs, an event whose timing is plausibly exogenous being dictated by government employment rules.

    Download the paper: http://www.hbs.edu/research/pdf/10-006.pdf

    Banking Deregulations, Financing Constraints and Firm Entry Size

    Authors:William R. Kerr and Ramana Nanda
    Abstract

    We examine the effect of U.S. branch banking deregulations on the entry size of new firms using micro-data from the U.S. Census Bureau. We find that the average entry size for startups did not change following the deregulations. However, this result masks the differences in entry size among startups that failed within three years of entry and those that survived for four years or more. Long-term entrants started at a 2% larger size relative to their size in their fourth year, while churning entrants were no larger. Our results suggest that the banking deregulations had two distinct effects on the product market. On the one hand, they allowed entrants to compete more effectively against incumbents by reducing financing constraints and facilitating their entry at larger firm sizes. On the other hand, the process of lowering financing constraints democratized entry and created a lot more churning among entrants, particularly at the low end of the size distribution. Our results highlight that this large-scale entry at the extensive margin can obscure the more subtle intensive margin effects of changes in financing constraints.

    Download the paper: http://www.hbs.edu/research/pdf/10-010.pdf

    Insider Trading Preceding Goodwill Impairments

    Authors:Karl A. Muller III, Monica Neamtiu, and Edward J. Riedl
    Abstract

    We investigate whether insiders strategically sell shares prior to the disclosure of goodwill impairment losses. We provide evidence that insiders of goodwill impairment firms engage in abnormal selling of their shares quarters prior to the announcement of such losses. In addition, of firms recording goodwill impairments, we provide evidence that those firms with insiders selling prior to the announcement of the loss face significantly more negative abnormal returns. Our findings are robust to subsample analysis examining firms reporting goodwill impairments and having low quality information environments (i.e., delayed price discovery). This isolates a setting wherein observed strategic trading behavior more likely reflects insiders' private information regarding goodwill, as opposed to other (non-goodwill related) economic performance. Overall, the results are consistent with corporate insiders being able to profit from their private information relating to a specific financial reporting element, goodwill impairments, prior to its incorporation by the equity market or recognition by the firm's accounting system.

    Download the paper: http://www.hbs.edu/research/pdf/10-007.pdf

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

    Authors:Edward J. Riedl and George Serafeim
    Abstract

    Finance theory suggests that information risk—that is, the uncertainty regarding valuation parameters for an underlying asset—is reflected in firms' equity betas and the information asymmetry component of bid-ask spreads. We empirically examine these predictions for a sample of large U.S. banks, exploiting recent mandatory disclosures of financial instruments designated as fair value levels 1, 2, and 3, which indicate progressively more illiquid and opaque financial instruments. Consistent with predictions, results reveal that portfolios of level 3 financial assets have higher implied betas and lead to larger bid-ask spreads relative to those designated as level 1 or level 2 assets. Both results are consistent with a higher cost of capital for banks holding more opaque financial assets, as reflected by the level 3 fair value designation.

    Download the paper: http://www.hbs.edu/research/pdf/10-008.pdf

    Does Competition Favor Delegation?

    Author:Christian Alejandro Ruzzier
    Abstract

    This paper studies the consequences of product-market competition on firms' decisions to delegate more or fewer decision-making responsibilities to managers. By simultaneously addressing the choice of both competitive actions and organizational design, the paper makes an attempt at bringing economic theory and management strategy closer together.

    An increase in substitutability between the products of the different firms triggers a different response depending on the size of the firm: larger firms delegate more responsibility, whereas smaller firms centralize decision making. The increase in substitutability also causes some firms to exit the market, which pushes in the direction of reduced managerial autonomy. Stronger competition also leads to less discretion in markets in which the possibilities for product differentiation are important.

    For a given number of firms, an increase in market size increases centralization, as the owner of the firm finds it more costly to accept rent seeking by the managers. However, this increase in market size will lead to the entry of more firms, which calls for more decentralized decision making. Under reasonable conditions, the aggregate effect leads to a U-shaped relationship where firms in both small and large markets are characterized by high levels of discretion, while there is less discretion for intermediate market sizes. Finally, a reduction in entry barriers leads unambiguously to an increase in the level of discretion given to the agent, as it results in a larger number of firms entering the market and, for a given market size, in lower concentration or expected firm-level demand, which reduces the value of having control and pushes in the direction of increased autonomy.

    Download the paper: http://www.hbs.edu/research/pdf/10-009.pdf

    Coming Clean and Cleaning Up: Is Voluntary Self-Reporting a Signal of Effective Self-Policing? (revised)

    Authors:Michael W. Toffel and Jodi L. Short
    Abstract

    Administrative agencies are increasingly establishing voluntary self-reporting programs, both as an investigative tool and as a way of encouraging regulated firms to police themselves. Effective self-policing is critical to contemporary regulatory designs, which rely heavily on regulated entities to monitor and assure their own regulatory compliance. We investigate whether self-reporting, or the voluntary disclosure of legal violations, can serve as a reliable signal of the discloser's effective self-policing efforts, which might warrant a reduction in regulatory scrutiny. We find that voluntary disclosures are associated with improvements in regulatory compliance and environmental performance, indicating that self-reporting is associated with effective self-policing. In addition, we find evidence that regulators subsequently reduced their scrutiny over voluntary disclosers, which suggests that self-reporting can help regulators economize government enforcement resources and develop cooperative relationships with firms that are committed to self-policing.

    Download the paper: http://www.hbs.edu/research/pdf/08-098.pdf

     

    Publications

    High Commitment, High Performance: How to Build a Resilient Organization for Sustained Advantage

    Authors:Michael Beer
    Publication:Jossey-Bass, 2009
    Abstract

    Integrating knowledge from strategic management, performance management, and organization design, strategic human resource expert and Harvard Business School Professor Michael Beer outlines what the high-commitment, high-performance organization looks like and provides practitioners with the transformation process to help them get there. Starting with leaders who have the right values, Beer shows how to weave together a complete system that includes top-to-bottom communication, organization design, HR policies, a leadership transformation process, and outlines what practitioners must do in HR, structure, systems, goals, culture, and strategy to create high-performance organizations.

    Publisher's Link: http://www.wiley.com/WileyCDA/WileyTitle/productCd-0787974382.html

    American Business Since 1920: How It Worked (2nd ed.)

    Authors:T. K. McCraw
    Publication:Wheeling, Ill.: Harlan Davidson, 2009
    Abstract

    Unique for its breadth of coverage and depth of analysis, this book is certain to become a classic. Six of its eight chapters provide in-depth analyses of representative companies and the remarkable people who led them. These firms include Google, eBay, Amazon.com, McDonald's, Procter & Gamble, Boeing, General Motors, and Ford—all of which began as entrepreneurial startups and later became big businesses. Their success stories are counterbalanced by a dissection of the monumental failure of RCA, long the world leader in electronics but today all but extinct. For all of these companies except RCA and Ford, a key to their early success was a rigorous policy of decentralized decisionmaking, which is a major theme of the book. In addition to the company-centered chapters, there are two overview chapters: one on women and minorities in business, the other on the financial system, including an analysis of the events that led to the meltdown of 2008. With 44 photographs and a comprehensive bibliographic essay, this uncommonly readable book answers the questions of how American business powered most of the twentieth century and was then severely challenged in the twenty-first, first by its own mistakes and then by globalization.

    Institutional Work and the Paradox of Embedded Agency

    Authors:Julie Battilana and T. D'Aunno
    Publication:In Institutional Work: Actors and Agency in Institutional Studies of Organizations, edited by Thomas B. Lawrence, Roy Suddaby, and Bernard Leca. Cambridge, U.K.: Cambridge University Press, 2009

    Publisher's Link: http://www.cambridge.org/uk/catalogue/catalogue.asp?isbn=9780521518550

    In Favor of Clear Thinking: Incorporating Moral Rules into a Wise Cost-benefit Analysis

    Authors:Max Bazerman and Joshua D. Greene
    Publication:Perspectives on Psychological Science (in press)
    Abstract

    Bennis, Medin, and Bartels (2009) have contributed an interesting paper on the comparative benefit of moral rules versus cost-benefit analysis (CBA). Many of their specific comments are accurate, useful, and insightful. At the same time, we believe they have misrepresented CBA and have reached a set of conclusions that are misguided and, if adopted wholesale, potentially dangerous. Overall, they offer wise suggestions for making CBA more effective, rather than eliminating CBA as a decision-making tool.

    A Gap-Filling Theory of Corporate Debt Maturity Choice

    Authors:Robin Greenwood, Samuel Hanson, and Jeremy C. Stein
    Publication:Journal of Finance (forthcoming)
    Abstract

    We argue that time-series variation in the maturity of aggregate corporate debt issues arises because firms behave as macro liquidity providers, absorbing the large supply shocks associated with changes in the maturity structure of government debt. We document that when the government funds itself with relatively more short-term debt, firms fill the resulting gap by issuing more long-term debt, and vice-versa. This type of liquidity provision is undertaken more aggressively: i) in periods when the ratio of government debt to total debt is higher; and ii) by firms with stronger balance sheets. Our theory provides a new perspective on the apparent ability of firms to exploit bond-market return predictability with their financing choices.

    Regulate, Baby, Regulate

    Author:T. K. McCraw
    Publication:The New Republic 240, no. 4 (March 18, 2009)
    Abstract

    The U.S. today faces its biggest economic crisis since the Great Depression. That is why Barack Obama and his team have been looking to Franklin Delano Roosevelt for help. The stimulus measure passed by Congress in February that includes money for building infrastructure, strengthening unemployment insurance, and helping state governments is reminiscent of FDR's New Deal. Here, McCraw details that putting money into people's pockets and into institutions is politically easy and economically sensible. But, he stresses that if the government doesn't reinvigorate regulation as well, the credit system will remain sick, banks won't fully recover, and investors and borrowers will keep on believing that they've been hoodwinked and fleeced. Moreover, he points out that only a thorough repair of the agencies that handle securities and banking regulation can prevent new crises down the road.

    I'll Have the Ice Cream Soon and the Vegetables Later: A Study of Online Grocery Purchases and Order Lead Time

    Authors:Katherine L. Milkman, Todd Rogers, and Max Bazerman
    Publication:Marketing Letters (in press)
    Abstract

    How do decisions made for tomorrow or two days in the future differ from decisions made for several days in the future? We use data from an online grocer to address this question. In general, we find that as the delay between order completion and delivery increases, grocery customers spend less, order a higher percentage of "should" items (e.g., vegetables), and order a lower percentage of "want" items (e.g., ice cream), controlling for customer fixed effects. These findings are all consistent with theories suggesting that people's "should" selves exert more influence over their choices the further in the future outcomes will be experienced. However, orders placed for delivery tomorrow versus two days in the future do not show this want/should pattern, and we discuss a potential explanation.

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

    Authors:Edward J. Riedl and Suraj Srinivasan
    Publication:Contemporary Accounting Research (forthcoming)
    Abstract

    This paper investigates whether managers' presentation of special items within the financial statements reflects economic performance or opportunism. Specifically, we assess special items presented as a separate line item on the income statement (income statement presentation) to those aggregated within another line item with disclosure only in the footnotes (footnote presentation). Our study is motivated by standard-setting interest in performance reporting and financial statement presentation, as well as prior research investigating managers' presentation choices in other contexts. Empirical results reveal that special items receiving income statement presentation are less persistent relative to those receiving footnote presentation. These results are consistent across numerous alternative specifications. Overall, the findings are consistent with managers using the income statement versus footnote presentation to assist users in identifying those special items most likely to differ from other components of earnings—that is, for informational, as opposed to opportunistic, motivations.

    A Decision-making Perspective to Negotiation: A Review of the Past and a Look into the Future

    Authors:Chia-Jung Tsay and Max Bazerman
    Publication:Negotiation Journal (in press)
    Abstract

    Through the decision-analytic approach to negotiations, the past quarter century has seen the development of a better dialog between the descriptive and the prescriptive, as well as a burgeoning interest in the field for both academics and practitioners. Researchers have built upon the work in behavioral decision theory, examining the ways in which negotiators may deviate from rationality. The 1990s brought a renewed interest in social factors, as work on social relationships, egocentrism, attribution and construal processes, and motivated illusions was incorporated into our understanding of negotiations. Several promising areas of research have emerged in recent years, drawing from other disciplines and informing the field of negotiations, including work on the influence of ethics, emotions, intuition, and training.

     

    Cases & Course Materials

    What Happened at Citigroup?

    Harvard Business School Case 310-004

    What went wrong at Citigroup? In 1998, the Travelers Group and Citicorp merged to create Citigroup Inc., considered the first true global "financial supermarket" and a business model to be envied, feared, and emulated. By year-end 2006 the firm had a market capitalization of $274 billion, with $1.9 trillion in assets and $24.6 billion in earnings. But, ten years after the merger, it ended in tears. In July 2009, the firm was effectively nationalized, with billions of dollars in bailout money converted into a 34% ownership stake for the U.S. government. Citigroup was worth less than $16 billion, having lost more than $250 billion in value from its peak. This case examines Citi's business model, the challenges it faced, its leadership, and key decisions to better understand what contributed to the failure of one of the most powerful financial firms in the world.

    Purchase this case:
    http://cb.hbsp.harvard.edu/cb/product/310004-PDF-ENG

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