First Look

December 11, 2007

Quick history test: What serial entrepreneur accurately predicted a "crash" shortly before October 1929? The answer: Roger Babson. Babson (1875-1967) may be better known today as the founder of Babson College, but he was also a pioneer of the business-forecasting industry, a tenacious entrepreneur, and a bit of an eccentric, as detailed in a new working paper by Harvard Business School's Walter Friedman. Most academics and many businessmen looked askance at Babson's ideas, modeled after his appreciation of Isaac Newton's "actions and reactions," as if economic depressions and expansions should always be equal. However, he also combined statistical methods with common sense, and some investors took note—not enough, unfortunately, in 1929. Also new this week: an article in Harvard Business Review on how China and India are learning to cooperate despite differences; a working paper for download on the influence of local communities on organizations; and lots more.
— Martha Lagace

Working Papers

The Seer of Wellesley Hills: Roger Babson and the Babson Statistical Organization


Roger Babson was a pioneer of the business-forecasting industry in the United States in the early twentieth century. He built the largest private economic forecasting agency in the period and published a great range of economic statistics in his weekly newsletters. As a forecaster, he was best known for advising investors in the month prior to October 1929 that a "crash" was coming that "may be terrific." Most academics, and many businessmen, ridiculed Babson's forecasting methods, which were informed by his belief, based on his reading of Isaac Newton, that economic "actions and reactions" (or depressions and expansions) would always be equal. But Babson was able to gain a following among investors who thought he was either wise or lucky. His blend of new statistical methods and old common-sense reasoning helped him profit as the forecasting industry first developed.

Irving Fisher, Economic Forecasting, and the Myth of the Business Cycle


A premier economist of the twentieth century and a founder of neoclassical thought, Irving Fisher was also an active participant in the field of economic forecasting. Fisher made theoretical contributions to the understanding of economic fluctuations, popularized the use of index numbers, and wrote frequently on the importance of future expectations to businesspeople. He also published forecasts through syndicated newspaper columns and made public pronouncements on the future of the economy—including a notorious statement on the eve of the October 1929 stock-market crash that optimistically predicted that a new high "plateau" for stock prices had been reached. Despite Fisher's poor prediction on that occasion, he played a neglected, but significant role in the growth of the forecasting industry and in the rise of a class of early business analysts.

An Interdisciplinary Model for Effective Software Requirements Engineering


In recent studies, the success rate of software development projects has been found to be low (about 29%). The majority of the challenges can be traced back to the requirements engineering workflow (RE). Although it is widely acknowledged that the difficulties faced in RE are multifarious, recent research has primarily focused on limited factors. This ongoing research project addresses this limitation by integrating the fields of social and organizational psychology, organizational behavior, and software engineering. The primary goals are to (a) develop and validate an interdisciplinary multidimensional model, which focuses on the complex interrelationships among requirements workflow related risk factors, individual, team and organizational competencies, software processes, techniques, tools, and requirements workflow success and (b) develop a set of instruments to assess RE risk factors and to design, evaluate, and apply effective measures to mitigate those risks. The data collection consists of interviews with RE experts and other experienced practitioners (e.g., managers, business and technical people) in eight major North American and European financial services companies as well as an international internet survey in collaboration with journals and organizations. The present paper gives an overview of the initial findings of 61 interviews and highlights some of the key factors.

Acting Globally but Thinking Locally? The Influence of Local Communities on Organizations


We develop an institutional theory of how local communities continue to matter for organizations, and why community factors are particularly important in a global age. Since globalization has taken center stage in both practitioner and academic circles, research has shifted away from understanding effects of local factors. In this paper, our aim is to redirect theoretical and empirical attention back to understanding the determinants and importance of local influences. We review classical and contemporary research from organizational theory, sociology and economics that have focused on geographic influences on organizations. We adapt Scott's (2001) influential three pillars model, including regulative, social-normative and cultural-cognitive features to conceptualize an overarching model of how communities influence organizations. We suggest that because organizations are simultaneously embedded in communities and organizational fields, by accounting for both of these different levels, researchers will better understand isomorphism and change dynamics. Our approach thus runs counter to the idea that globalization is a homogeneity-producing process and the view that society is moving from particularism to universalism. With globalization, not only has the local remained important, but in many ways local particularities have become more visible and salient, and so understanding these dynamics will be helpful for researchers addressing institutional isomorphism and change.

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Entrepreneurship and Global Capitalism


This set of insightful papers demonstrates the importance of historical perspectives in the study of entrepreneurship. By exploring the role of entrepreneurship in the history of global capitalism, these volumes show that historical knowledge can challenge widely accepted generalizations made about entrepreneurship. The selected articles cover the best historical research on the role of entrepreneurship in creating global capitalism; the cultural and institutional explanations for geographical and temporal variations in entrepreneurship; the deep historical origins of 'born global' companies; the importance of networks and diaspora in new international market development; the key role of public policy in shaping cross-border entrepreneurial activity; and the impact of international entrepreneurship on local economies. This comprehensive collection will be of great interest to scholars of entrepreneurship, international business and business history.

Psychology and Experimental Economics: A Gap in Abstraction


Experimental economics and social psychology share an interest in a widening subset of topics, relying on similar lab-based methods to address similar questions about human behavior, yet dialogue between the two fields remains in its infancy. We propose a framework for understanding this disconnect: The different approaches the disciplines take to translating real-world behavior into the laboratory create a ''gap in abstraction,'' which contributes to crucial differences in philosophy about the roles of deception and incentives in experiments and limits cross-pollination. We review two areas of common interest—altruism and group-based discrimination—which demonstrate this gap yet also reveal ways in which the two approaches might be seen as complementary rather than contradictory.

The Effect of Safe Experience on a Warnings' Impact: Sex, Drugs, and Rock-n-Roll


In many contexts we are warned against engaging in risky behavior only after having past safe experience. We examine the effect of safe experience on a warning's impact by comparing warnings received after having safe personal experience with those received before people start making choices. A series of five experiments studies this question with a paradigm that combines both descriptive information (i.e., the warning) and experiential information (safe outcomes). The results demonstrate two separate advantages to an early warning that go beyond the warning's mere informational content. When an early warning coincides with the beginning of a decision-making process, the warning is both weighted more heavily in future decisions (the primacy effect) and induces safer behavior that becomes the status quo for future choices (the initial history effect). While both effects operate indirectly through choice inertia, the primacy effect also operates directly on choices. This pattern of behavior is inconsistent with the "ideal" Bayesian for whom the order of information revelation does not influence subsequent behavior. The effect was robust across settings with and without forgone payoffs and when the consequences for risk taking are delayed until the end of the experiment. The results imply that, even after being adequately warned, some people may continue to take risks simply because they incurred good outcomes from the same choice in the past. Implications for policy and theory are discussed.

Transforming Organizations: Embrace the Paradox of E and O


When it comes to transforming big corporations, there are two fundamentally different strategies, says Harvard Business School professor Michael Beer. He calls these Theory E and Theory O (where E stands for economic value and O for organizational capabilities). Chief executive officers who employ Theory E are driven by one thing: increasing shareholder value. They often conclude that the way to generate the best shareholder returns is through drastic restructuring-to slash and burn. People are laid off, facilities closed, and the portfolio of businesses reshuffled. A good example of a pure Theory E approach was Al "Chainsaw" Dunlap's attempt to transform Scott Paper (now owned by Kruger Inc.) between 1996 and 1998. CEOs who employ Theory O, on the other hand, put their faith in developing the organization's skills and culture as the vehicle to produce improved performance. This is by necessity a longer-term strategy. Andrew Sigler, CEO of Champion International (now part of International Paper Company), pursued this approach in the 1980s and early 1990s. Which is the more effective strategy? Professor Beer argues that both E and O can boost performance. Theory E, however, does not produce long-term sustained improvements. The E transformation at Scott Paper, for example, resulted in some immediate gains for shareholders, but undermined the organization's future. The O transformation at Champion International, by contrast, resulted in culture change and some improvements in performance, but negligible enhancement of shareholder value. In the end, Professor Beer notes, neither concept on its own will deliver sustainable long-term improvement in shareholder value and organizational capability. A more effective strategy, he writes, is to combine E and O, switching back and forth between the two approaches to fit the company's needs. Knowing when to apply one or the other theory is the key to being a successful chief executive.

Can They Take It with Them? The Portability of Star Knowledge Workers' Performance: Myth or Reality


This paper examines the portability of star security analysts' performance. Star analysts who switched employers experienced an immediate decline in performance that persisted for at least five years. This decline was most pronounced among star analysts who moved to firms with lesser capabilities and those who moved solo, without other team members. Star analysts who moved between two firms with equivalent capabilities also exhibited a drop in performance, but only for two years. Those who switched to firms with better capabilities and those who moved with other team members exhibited no significant decline in short-term or long-term performance. These findings suggest that firm-specific skills and firms' capabilities both play important roles in star analysts' performance. In addition, we find that firms that hire star analysts from competitors with better capabilities suffered more extreme negative stock-market reactions than those that hire from comparable or lesser firms. These findings suggest that hiring stars may be perceived as value-destroying and may not improve a firm's competitive advantage.

Bank Debt and Corporate Governance


In this article, we investigate the disciplining role of banks and bank debt in the market for corporate control, focusing on takeovers between 1992 and 2005. We find that relationship bank lending intensity and bank client network (the number of firms that the bank deals within the same industry) have a significant and positive effect on the probability of a borrowing firm becoming a target. We find that this effect is enhanced in cases where the target and acquirer have a relationship with the same bank and is robust to the inclusion of several firm characteristics including the presence of large external shareholders. Moreover, we utilize a natural experiment to show that the effect of relationship bank lending, intensity on takeover probability is not driven by endogeneity issues. Finally, we investigate reasons motivating a bank's role in the market for corporate control, including concerns regarding its credit risk exposure and fee generation.

China + India: The Power of Two


China and India are burying the hatchet after four-plus decades of hostility. A few companies from both nations have been quick to gain competitive advantages by viewing the two as symbiotic. If Western corporations fail to do the same, they will lose their competitive edge—and not just in China and India but globally. The trouble is, most companies and consultants refuse to believe that the planet's most populous nations can mend fences. Not only do the neighbors annoy each other with their foreign policies, but they're also vying to dominate Asia. Moreover, the world's fastest-growing economies are archrivals for raw materials, technologies, capital, and overseas markets. Still, China and India are learning to cooperate, for three reasons. First, these ancient civilizations may have been at odds since 1962, but for 2,000 years before that, they enjoyed close economic, cultural, and religious ties. Second, neighbors trade more than non-neighbors do, research suggests. Third, China and India have evolved in very different ways since their economies opened up, reducing the competitiveness between them and enhancing the complementarities. Some companies have already developed strategies that make use of both countries' capabilities. India's Mahindra & Mahindra developed a tractor domestically but manufactures it in China. China's Huawei has recruited 1,500 engineers in India to develop software for its telecommunications products. Even the countries' state-owned oil companies, including Sinopec and ONGC, have teamed up to hunt for oil together. Multinational companies usually find that tapping synergies across countries is difficult. At least two American corporations, GE and Microsoft, have effectively combined their China and India strategies, allowing them to stay ahead of global rivals.

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Business Methods Patents as Real Options: Value and Disclosure as Drivers of Litigation


This chapter proposes that patents are real options that allow holders of patents the right but not the obligation to sue others. We suggest that the likelihood of a patent's being litigated is positively associated with the value of the patent and the extent of disclosure (prior art cited) in the patent. However, under the conditions of greater value, increases in disclosure reduce the likelihood of litigation of the focal patent. Similarly, under conditions of greater disclosure, increases in value reduce the likelihood of litigation of the focal patent. Rare events logit analyses of business method patents that were litigated compared to patents that were not litigated offer empirical evidence supporting the hypotheses.


Cases & Course Materials

The AtekPC Project Management Office

Harvard Business School Case 308-049

Presents one company's efforts to implement a project management organization, or PMO, and the challenges they faced in doing so. Issues brought out in the case include defining the PMO's purpose and mission, the structure and governance of the PMO, and how to successfully implement it in what appears to be a resistant culture. John Strider, AtekPC's chief information officer (CIO), had strong convictions that the PMO-light model was the way to go. He had held back on hiring full-time employees for the PMO and was moving very slowly and cautiously so as not to violate AtekPC's culture. He was also concerned about the many issues that the PMO implementation had already raised. Were small steps building on small successes going to get the job done fast enough? With the ever increasing challenge of successfully managing information technology (IT), organizations are recognizing the need for greater discipline in managing IT projects. For many organizations, this has meant ratcheting up project management skills, processes, and governance structures within the organization by implementing a project management office (PMO). Unfortunately, there is little shared understanding of the challenges of implementing a PMO. Therefore, managers and their organizations have inadequate guidance to help them identify and overcome the obstacles they are likely to encounter.

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The Beijing Dream

Harvard Business School Case 208-015

The purchase of a single-family home is generally the major investment for most young couples in China. Shows in detail the process that a young couple goes through in late April 2007 to find, finance, and close on an apartment in Beijing within what they believe to be their financial capabilities. Takes place in the context of the rapidly developing Chinese real estate market and introduces issues concerning the search and property acquisition that are specific to Beijing. Also deals with the direct and indirect cost involved in home acquisition, and compares these costs to the rental alternative. Also explores the role that the Internet can play in the home-buying process in China.

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British Land

Harvard Business School Case 208-064

British Land's shares traded below NAV. Laxey investments tried to force British Land into share buybacks and criticized its corporate governance. Laxey voted borrowed shares at the AGM.

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Evaluating M&A Deals—Equity Consideration

Harvard Business School Note 208-077

What the acquiring company pays for a target in a merger or acquisition is called "consideration." Consideration can be in the form of cash, shares, or a combination of the two. Lays out the basic mechanics of equity consideration. Derives formulas for the Deal NPV of an all-equity deal and shows how to calculate and interpret key parameters, including percentage ownership, the exchange ratio, the acquisition premium, the wealth transfer, and the target's downside protection. Explains how synergies and over-valued shares affect the Deal NPV. Also shows how to calculate critical break-even exchange ratios. Ends by looking at cash-and-stock deals.

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Ockham Technologies: Living on the Razor's Edge (Abridged)

Harvard Business School Case 808-089

Describes the issues facing a Founder-CEO regarding building a board, assembling an executive team, managing tension between co-founders, and outsourcing system development work. The abridged version does not include the introduction and final sections of the full case in order to give case-writing workshop participants practice writing those sections.

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Valuation at Novartis

Harvard Business School Case 108-041

An abstract is not available for this case.

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