First Look

August 19, 2008

Yes indeed, CEOs and CFOs suffer career penalties when their companies fail to meet quarterly Wall Street forecasts, according to a new working paper available for download. Harvard Business School professor Suraj Srinivasan with coauthors Rick Mergenthaler and Shiva Rajgopal report that execs who miss the numbers suffer reduced bonuses, smaller equity grants, and a greater chance of forced dismissal during the study period of 1993-2004. They conclude: "Our evidence suggests that (i) boards appear to react directly to managers' ability to meet earnings targets or to the information that is reflected in meeting such benchmarks; and (ii) senior managers' preoccupation with meeting earnings benchmarks might be based at least partly on career concerns." Also new this week, the working paper "Exploring Inventory Trends in Six U.S. Retail Segments" finds that retailers have generally increased both inventory levels and gross profit dollars across retail segments. Another paper, "New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability,"describes how central banks can improve the way they analyze and manage the financial risks of a national economy. Ever thought of being a whistleblower at work? Available for purchase is a new note, "Solving a Problem or Sounding the Alarm? Guidelines on Blowing the Whistle."
— Sean Silverthorne

Working Papers

Exploring Inventory Trends in Six U.S. Retail Segments


Our paper describes inventory trends for both public and private U.S. firms in six retail segments between 1993 and 2005. This period coincided with the deployment of large-store formats, multiple-store formats and extensive channel blurring in the U.S. retail industry. Our analysis is based on aggregate segment-level data from the Annual Retail Trade Survey (ARTS), the Monthly Retail Trade Survey (MRTS), and the U.S. Bureau of the Census end-of-month inventory survey. We find that the end-of-month inventory significantly increased in four of the six retail segments studied and that, after controlling for sales and macroeconomic factors, the positive time trends for the end-of-month inventory remained significant. Though all categories of macroeconomic factors investigated were found to be significant for at least one segment, only consumer price index, personal savings rate, and real gross domestic product were strongly significant. To explore further the dynamics of the segments and to provide an explanation for the increasing inventory trends, we examined the relationships between inventory, gross profit dollars, and gross margin return on inventory. We find that inventory is positively correlated to gross profit dollars but negatively correlated to gross margin return on inventory. This supports a potential explanation: Inventory trends may reflect the use of higher inventory levels by retailers to drive increased profits but with overall reduced gross profitability returns on the inventory investment. These results support the notion that the increased deployment of large-store, multiple-store formats and the strategy of channel blurring by retailers have generally increased both inventory levels and gross profit dollars across retail segments.

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New Framework for Measuring and Managing Macrofinancial Risk and Financial Stability


This paper proposes a new approach to improve the way central banks can analyze and manage the financial risks of a national economy. It is based on the modern theory and practice of contingent claims analysis (CCA), which is successfully used today at the level of individual banks by managers, investors, and regulators. The basic analytical tool is the risk-adjusted balance sheet, which shows the sensitivity of the enterprise's assets and liabilities to external "shocks." At the national level, the sectors of an economy are viewed as interconnected portfolios of assets, liabilities, and guarantees—some explicit and others implicit. Traditional approaches have difficulty analyzing how risks can accumulate gradually and then suddenly erupt in a full-blown crisis. The CCA approach is well-suited to capturing such "non-linearities" and to quantifying the effects of asset-liability mismatches within and across institutions. Risk-adjusted CCA balance sheets facilitate simulations and stress testing to evaluate the potential impact of policies to manage systemic risk.

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CEO and CFO Career Consequences to Missing Quarterly Earnings Benchmarks


We find that missing quarterly earnings benchmarks, especially the analyst consensus earnings number, is associated with career penalties in the form of a reduced bonus, smaller equity grants, and a greater chance of forced dismissal for both CEOs and CFOs during the period 1993-2004. These results are obtained after controlling for the magnitude of the earnings surprise, operating and stock return performance, and are significant in a statistical and in an economic sense. Career penalties for failing to meet the analyst consensus estimate are higher for firms that give quarterly earnings guidance and in the post-SOX period. Our evidence suggests that (i) boards appear to react directly to managers' ability to meet earnings targets or to the information that is reflected in meeting such benchmarks; and (ii) senior managers' preoccupation with meeting earnings benchmarks might be based at least partly on career concerns.

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A Perceptions Framework for Categorizing Inventory Policies in Single-stage Inventory Systems


In this paper we propose a perceptions framework for categorizing a range of inventory decision making that can be employed in a single-stage supply chain. We take the existence of a wide range of inventory decision making processes, as given, and strive not to model the reasons that the range persists but seek a way to categorize them via their effects on inventory levels, orders placed given the demand faced by the inventory system. Using a perspective that we consider natural and thus appealing, the categorization involves the use of conceptual perceptions of demand to underpin the link across three features of the inventory system: inventory levels, orders placed and actual demand faced. The perceptions framework is based on forecasting with Auto-Regressive Integrated Moving Average (ARIMA) time series models. The context in which we develop this perceptions framework is of a single-stage stochastic inventory system with periodic review, constant lead times, infinite supply, full backlogging, linear holding and penalty costs and no ordering costs. Forecasting ARIMA time series requires tracking forecast errors (interpolating) and using these forecast errors and past demand realizations to predict future demand (extrapolating). So-called optimal inventory policies are categorized here by perceptions of demand that align with reality. Naturally then, deviations from optimal inventory policies are characterized by allowing the perception about demand implied by the interpolations or extrapolations to be primarily different from the actual demand process. Extrapolations and interpolations being separate activities can, in addition, imply differing perceptions from each other and this can further categorize inventory decision making.

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Il leader interno che guarda all’esterno. (The Leader which Looks Outside)


In his interviews and data analysis, Harvard Business School professor Bower found that companies performed better when they appointed insiders to the job of CEO. CEO succession is a process taking many years, not an event that takes place shortly before a transition. It reflects the way a company is organized and managed. Yet Bower finds far too many companies are managed without leadership development as an objective; as a result, when the time comes to name a new chief executive, those firms turn to outsiders.

The Leader Within: The Best CEO Succession Plans Groom Independent-minded Insiders for the Top Job

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Help Employees Give Away Some of That Bonus


Employees who spend some or all of their bonuses on others—thereby creating what the authors call a "prosocial" workplace—are happier as a result. Managers can enhance that effect by providing opportunities to share the wealth.

Aurora Capital Group-Douglas Dynamics

Harvard Business School Case 209-010

Aurora Capital, a U.S. Private Equity firm, contemplates whether to acquire Douglas Dynamics, the leading U.S. maker of snow plows. Does a business that is highly dependent on the weather, and is seasonal, make a good LBO candidate? This case provides a good introduction to the LBO business. What are the characteristics of a successful LBO? And how do successful PE firms create value by acquiring such companies?

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Carlyle Japan (A)

Harvard Business School Case 508-092

Tamotsu Adachi, Managing Director of Carlyle Japan, wants to formulate a strategy to improve his firm's ability to source high-quality deals at competitive valuations, or prices. Buyout funds like Carlyle typically have two deal phases: sourcing and monitoring. These correspond to (i) "selling" the benefits to a business owner of going with Carlyle as a buyout partner, and then (ii) increasing the value of that business following the buyout. Since the profitability of a buyout depends on finding high-quality deals, the firm has focused to date on leveraging its contacts in the banking business, which has been a powerful institution in Japan for many years. These contacts have brought to Carlyle a number of good quality companies, but the volume of buyouts done by Carlyle in Japan has not been what they hoped it would be. Students are asked how the firm can improve on this deal sourcing approach.

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Danaher Corporation

Harvard Business School Case 708-445

Between 1985 and 2007, Danaher has been one of the best-performing industrial conglomerates in the U.S. This case examines the corporate strategy of this diversified, global corporation. It describes the firm's portfolio strategy and the Danaher Business System—a systematic and wide-ranging set of organizational processes the firm has developed to drive growth and create value. In 2008, the firm confronts various challenges in sustaining its impressive historical performance. First, can it continue to balance organic and acquisition-led growth? Second, what will be the impact of increased competition from private equity players? Third, for how long can its strategy of continuous improvement continue?

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Horizontal Specialization and Modularity in the Semiconductor Industry

Harvard Business School Note 609-001

Well-codified interfaces have enabled horizontal specialization in the global semiconductor industry. This Technical Note describes the modern integrated circuit value chain and the motivation for the reuse of blocks of intellectual property in modern IC designs. It briefly examines ARM Limited as an example of an IP specialist supplier and looks at the evolution to complete Systems-on-Chip and Systems-in-Packages so that students may examine the evolution of industry structure in the accompanying case "System-on-a-Chip 2008: Global Unichip Corporation."

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Leading from the Side

Harvard Business School Case 409-023

Harriet Cornwall, a partner at the law firm of Kensington Palmer, LLP, is made lead over a fellow group of attorneys. Put in charge of guiding her colleagues in their annual goal-setting initiative, she notices four that need special attention. Cornwall must address their poor performance and goals as a colleague rather than as a manager.

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Negotiating Equity Splits at UpDown

Harvard Business School Case 809-020

Michael Reich is having severe doubts about how he split the equity with his co-founders two months ago, when they completed a one-page "November Agreement." Since then, Michael has found an angel investor and has worked non-stop on the business, while one co-founder was off enjoying the winter break with his family and the other worked on lucrative consulting contracts for other companies. Michael has just sent his co-founders a proposal that would re-allocate the equity within their founding team, and all three founders are getting ready to reopen a negotiation they thought had been finalized.

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A Note on Limited Partner Advisory Boards

Harvard Business School Note 808-169

This note explores the limited partner advisory boards. Based on interviews with seven experienced limited partners who serve on a number of different advisory boards, it presents the roles of the advisory board, the ways it can influence the general partner, and the reasons for limited partners to serve on them. It also contrasts the findings of this survey with a paper on the performance differential between university endowments and other institutional investors and hypothesizes the reasons behind it.

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The Producing Manager: A Double-Barreled Role

Harvard Business School Note 908-415

The purpose of this note is to ground and amplify on the characteristics and challenges of the producing manager role. It is in response to requests from participants for a piece of "take away" material that can be shared with colleagues in professional service firms that is detailed and operational in nature.

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Smartix: The 'Inside' Story

Harvard Business School Case 808-116

Vivek Khuller has built Smartix by attracting classmates to co-found it with him, learning how to pitch it to top VC firms and potential strategic partners and honing the concept and business model by testing it in smaller venues. Now, he is facing the implications of the choices he has made in each of these areas and has to decide how to manage those implications.

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Solving a Problem or Sounding the Alarm? Guidelines on Blowing the Whistle

Harvard Business School Note 308-005

Many of us will at some point in our professional lives encounter situations involving what we believe to be wrongful or injurious activities that may cause harm to innocent parties, our company, or the public. It may be necessary to bring the matter to the attention of someone who can do something about it—to engage in what is sometimes called "whistleblowing." This note outlines some factors that should be considered when that happens.

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Sony Ericsson WTA Tour (A)

Harvard Business School Case 409-018

Larry Scott, the new CEO of the Women's Tennis Association, arrives amidst turmoil. Players and tournaments clash over opposing interests. As a result, the board members who represent them are equally divided and feel conflicted about their role. They aren't sure how to help their constituents while also fulfilling their duty of oversight of the WTA as a whole. In order to make women's tennis more popular and profitable, Scott must find a way to get the board of directors to resolve their differences and work together for the greater good of the organization.

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Stakeholder Analysis Tool

Harvard Business School Exercise 808-161

This exercise enables users to identify stakeholders and analyze their interests and expectations, categorize interests and expectations based on importance, and develop an action plan.

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Strategic Renewal

Harvard Business School Module Note 708-503

While it is relatively easy to identify why strategies fail, it is much harder to explain how to fix a failing strategy or build an organization that can continuously renew its strategy. This note identifies some patterns that distinguish companies whose renewal efforts made headway from firms whose efforts fell flat.

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Venture Capital Vignettes: Difficult Financings

Harvard Business School Case 809-003

These three short vignettes depict investment professionals considering difficult financings for companies in their portfolios. For one reason or another, each company has underperformed expectations. Should the protagonist recommend that the firm participate or not, or should he try to revise it? Can the firm exercise any influence, and are the potential gains worth the time and effort that will be required?

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