First Look

February 12, 2008

Finance specialists will be happy this week, with 10 research articles focused on a wide variety of financial issues ranging from risk management to personal taxes. For instance, HBS professor Christopher J. Malloy has coauthored a paper (available for download) about long-run risks in asset pricing from the stockholder point of view. Professor Paul Healy and Krishna Palepu release the fourth edition of their book Business Analysis and Valuation: Using Financial Statements, which explains how to conduct financial statement analysis using a four-part framework. In an article due out from the Review of Quantitative Finance and Accounting, HBS professor Michael D. Kimbrough and colleagues describe results from analysis of over 2,400 management earnings forecasts. New cases highlight a brand crisis at General Mills, knowledge management at French consumer goods company Danone, and an activist hedge fund mixing with Ligand Pharmaceuticals Inc.
— Martha Lagace

Working Papers

Colonial Land Tenure, Electoral Competition and Public Goods in India

No abstract is available at this time.

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Rewriting History


Comparing two snapshots of the historical I/B/E/S database of research analyst stock recommendations, taken in 2002 and 2004 but each covering the same time period 1993-2002, we identify 54,729 ex-post changes (out of 280,463 observations), including alterations of recommendation levels, additions and deletions of records, and removal of analyst names. The changes appear non-random across brokerage firms, analysts, and tickers, and have a significant impact on the overall distribution of recommendations across stocks and within individual stocks and brokerage firms. They also affect trading signal classifications, back-testing inferences, track records of individual analysts, and models of analysts' career outcomes in the three years following the changes.

Long-Run Stockholder Consumption Risk and Asset Returns


We provide new evidence on the success of long-run risks in asset pricing by focusing on the risks borne by stockholders. Exploiting micro-level household consumption data, we show that long-run stockholder consumption risk better captures cross-sectional variation in average asset returns than aggregate or non-stockholder consumption risk and provides more plausible economic magnitudes. We find that risk aversion estimates around 10 can match observed risk premia for the wealthiest stockholders across sets of test assets that include the 25 Fama and French size and value portfolios, the market portfolio, bond portfolios, and the entire cross-section of stocks.

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Testing a Purportedly More Learnable Auction Mechanism


We describe an auction mechanism in the class of Groves mechanisms that has received attention in the computer science literature because of its theoretical property of being more "learnable" than the standard second price auction mechanism. We bring this mechanism, which we refer to as the "clamped second price auction mechanism," into the laboratory to determine whether it helps human subjects learn to play their optimal strategy faster than the standard second price auction mechanism. Contrary to earlier results within computer science using simulated reinforcement learning agents, we find that both in settings where subjects are given complete information about auction payoff rules and in settings where they are given no information about auction payoff rules, subjects converge on playing their optimal strategy significantly faster in sequential auctions conducted with a standard second price auction mechanism than with a clamped second price auction mechanism. We conclude that while it is important for mechanism designers to think more about creating learnable mechanisms, the clamped second price auction mechanism in fact produces slower learning in human subjects than the standard second price auction mechanism. Our results also serve to highlight differences in behavior between simulated agents and human bidders that mechanism designers should take into account before placing too much faith in simulations to test the performance of mechanisms intended for human use.

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Business Analysis and Valuation: Using Financial Statements. 4th ed.


Financial statements are the basis for a wide range of business analysis. Managers, securities analysts, bankers, and consultants all use them to make business decisions. There is strong demand among business students for course materials that provide a framework for using financial statement data in a variety of business analysis and valuation contexts. The fourth edition of Business Analysis and Valuation: Using Financial Statements allows you to undertake financial statement analysis using a four-part framework—(1) business strategy analysis for developing an understanding of a firm's competitive strategy; (2) accounting analysis for representing the firm's business economics and strategy in its financial statements and for developing adjusted accounting measures of performance; (3) financial analysis for ratio analysis and cash flow measures of operating; and (4) prospective analysis. Then, you'll learn how to apply these tools in a variety of decision contexts, including securities analysis, credit analysis, corporate financing policies analysis, mergers and acquisitions analysis, and governance and communication analysis.

The Oxford Handbook of Business History


This Handbook provides a state-of-the-art survey of research in business history. Business historians study the historical evolution of business systems, entrepreneurs and firms, as well as their interaction with their political, economic, and social environment. They address issues of central concern to researchers in management studies and business administration, as well as economics, sociology and political science, and to historians. They employ a range of qualitative and quantitative methodologies, but all share a belief in the importance of understanding change over time.

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The Effect of Macro Information Environment Change on the Quality of Management Earnings Forecasts


The 1990s were characterized by substantial increases in the performance of an investor reliance on financial analysts. Because managers possess superior private information and issue forecasts to align investors' expectations with their own, we predict that managers increased the quality of their earnings forecasts during the 1990s in order to keep pace with the improved forward-looking information provided by financial analysts, upon which investors increasingly relied. Using a sample of 2,437 management earnings forecasts, we document an increase in management earnings forecast precision, management earnings forecast accuracy, and managers' tendency to explain earnings forecasts in 1993-1996 relative to 1983-1986. Given that these forecast characteristics are linked to greater informativeness and credibility, we also document that the information content of management earnings forecasts, as measured by the strength of share price responses to forecast news, increased in 1993-1996 relative to 1983-1986. As expected, the increased information content of management forecasts primarily occurred for firms covered by financial analysts.

Where Do Transactions Come From? Modularity, Transactions, and the Boundaries of Firms


This article constructs a theory of the location of transactions and the boundaries of firms in a productive system. It proposes that systems of production can be viewed as networks, in which tasks-cum-agents are the nodes and transfers—of material, energy and information—between tasks and agents are the links. Transactions are defined as mutually agreed-upon transfers with compensation and are located within the task network. Placing a transaction in a particular location in turn requires work to define, count (or measure), and pay for the transacted objects. The costs of this work (labeled mundane transaction costs) are generally low at the thin crossing points of the task network, which correspond to module boundaries. Therefore, transactions are more likely to be located at module boundaries than in their interiors. Several implications arise from this theory. Among these: Modularizations create new module boundaries, hence new transaction locations. Areas in the task network where transfers are dense and complex should be located in transaction-free zones, so that the cost of transacting does not overburden the system. The thin crossing points between transaction-free zones constitute breakpoints, where firms and industries may split apart.

Untapped Potential in the Study of Negotiation and Gender Inequality in Organizations


Negotiation is a process that creates, reinforces, and reduces gender inequality in organizations, yet the study of gender in negotiation has little connection to the study of gender in organizations. We review the literature on gender in job negotiations from psychology and organizational behavior, and propose ways in which this literature could speak more directly to gender inequality in organizations by incorporating insights from research on gender in intra-household and collective bargaining. Taken together, these literatures illuminate how negotiations at the individual, household, and collective levels may contribute to the construction and deconstruction of gender inequality in organizations.

Why Employees Are Afraid to Speak Up


In a word—self-preservation. And they're just as afraid to share innovative ideas as to blow the whistle.

'Chimerica' and Global Asset Markets


In this essay we present a potential explanation for the persistent and, to some eyes, puzzling buoyancy of global asset markets in recent years. We argue that the current world economic conjuncture is the product of a large and unusual divergence or "wedge" between the returns on capital and the cost of capital. Globalization—in particular the integration of the massive Asian labor force into the world economy—has significantly increased the returns on capital. However, contrary to what economic theory might lead us to expect, the cost of capital as measured by long-term real interest rates has not increased, but actually fallen. We call this phenomenon "Chimerica" because it is a consequence of the symbiotic economic relationship that has developed between the People's Republic of China and the United States of America. The entry of Chinese labor into the world economy has significantly boosted the returns on capital relative to the returns on labor. At the same time, by accumulating large currency reserves and channeling them (until very recently) almost exclusively into U.S. government securities, China has kept nominal and real long-term interest rates artificially low. In our view, it is this wedge between returns on capital and the cost of capital, rather than excess liquidity or a shortage of financial assets, that explains the boom in global asset markets as well as the recent upsurge of leveraged buy-out activity.

Effect of Personal Taxes on Managers' Decisions to Sell Unrestricted Equity


We examine how personal taxes affect CEOs' decision to sell their vested equity and compare it against diversification, managerial overconfidence and other determinants of CEOs' sale of equity. While CEOs frequently sell large amounts of their unrestricted firm equity, we find that the tax burden associated with the sale deters CEOs from selling their equity. The effect of taxes remains significant even after controlling for other determinants of CEOs' sale of equity. We also find that taxable institutional investors and CEOs both respond to taxes in their selling of equity, although the CEOs appear to be less tax-sensitive. Other determinants affect CEOs' selling decisions largely as predicted in the existing literature.

Transforming Giants


Large corporations have long been seen as lumbering, inflexible, bureaucratic—and clueless about global developments. But recently some multinationals seem to be transforming themselves: They're engaging employees, moving quickly, and introducing innovations that show true connection with the world. Harvard Business School's Kanter ventured with a research team inside a dozen global giants—including IBM, Procter & Gamble, Omron, CEMEX, Cisco, and Banco Real—to discover what has been driving the change. After conducting more than 350 interviews on five continents, she and her colleagues came away with a strong sense that we are witnessing the dawn of a new model of corporate power: The coordination of actions and decisions on the front lines now appears to stem from widely shared values and a sturdy platform of common processes and technology, not from top-down decrees. In particular, the values that engage the passions of far-flung workforces stress openness, inclusion, and making the world a better place. Through this shift in what might be called their guidance systems, the companies have become as creative and nimble as much smaller ones, even while taking on social and environmental challenges of a scale that only large enterprises could attempt. IBM, for instance, has created a nonprofit partnership, World Community Grid, through which any organization or individual can donate unused computing power to research projects and see what is being done with the donation in real time. IBM has gained an inspiring showcase for its new technology, helped business partners connect with the company in a positive way, and offered individuals all over the globe the chance to contribute to something big.

Expanding Ethical Standards of HRM: Necessary Evils and the Multiple Dimensions of Impact


The book examines ethics and employment issues in contemporary Human Resource Management (HRM). Written by an international team of academics from universities in the UK, the US, Australia and New Zealand, it examines the problems and opportunities facing employers and employees. The book subdivides into three sections: Part I assesses the context of HRM; Part II analyzes contemporary debates, continuity and change in HRM; and Part III proposes likely developments for the future seeking to identify a more proactive HRM approach toward ethical issues arising in employment.

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Applying Modern Risk Management to Equity and Credit Analysis


Traditional conventions of accounting and actuarial science distort the valuation of capital risk in corporations with pension plans because under these conventions, pension assets and liabilities are not included in balance sheet calculations. The modern risk management tools of derivatives technologies can improve both corporate decision making and external analysis of corporations.

The Future of Retirement and Planning

Risk Management and Calculative Cultures


Enterprise risk management (ERM) has recently emerged as a widespread practice in financial institutions. A burgeoning literature of regulatory and practitioner texts is indicative of the daunting diversity of ambitions, objectives and techniques that constitute the ERM agenda.

Presenting field-based evidence from two large banking organizations, I argue that systematic variations in ERM practices exist in the financial services industry. The cases illustrate four risk management ideal types and show how they form the 'risk management mix' in a given organization. Further, drawing on the literature of the roles and uses of management control systems (MCS), the paper explores how ERM achieved organizational significance in the studied settings. The findings are indicative of the current co-existence of alternative models of ERM. In particular, two types of ERM models are postulated: one driven by a strong shareholder value imperative ('value-based' ERM), the other corresponding to the demands of the risk-based internal control imperative ('holistic' ERM). The paper explains the differences in the two risk management mixes pointing towards alternative logics of calculation (Power, 2007), which I conceptualize and describe as different calculative cultures.

The study suggests that calculative cultures, which in these cases shaped managerial predilections towards ERM practices, are relevant, albeit so far neglected, constituents of the fit between MCS and organizational contexts.

Psychosocial Development and Leader Performance of Military Officer Cadets


Efforts to educate and develop future military officers aim to produce highly competent, ethical and effective leaders to serve the nation. But while there is general agreement about desired outcomes, the underlying developmental processes associated with these outcomes are not well understood. How do we grow such leaders? This paper reports on a longitudinal study of West Point college students over four years, addressing three questions: (1) do military officer-cadets grow or change in their basic level of psychosocial development [Kegan, R. (1982). The Evolving Self: Problem and Process in Human Development. Cambridge, MA: Harvard University Press.]; (2) is the level of psychosocial development related to performance as leaders; and (3) do activities in high school predict later psychosocial development? Two groups of cadets were studied from their freshman or sophomore year to their senior year at the academy. Results show significant positive developmental growth over time for 47% of study participants, with most of this growth occurring from sophomore to senior year. Furthermore, psychosocial development predicts several peer, subordinate and supervisor ratings of cadet performance as leaders during the upper-class (junior and senior) years, a time when cadets take on substantial leadership roles. In addition, early performance ratings by high school teachers, as well as active participation in high school extracurricular activities both predict psychosocial development levels for freshman and sophomores. These findings lend support to Kegan's theoretical model and suggest that greater attention be paid to these basic processes of human psychosocial development that can influence leader performance in important ways.


Cases & Course Materials


Harvard Business School Case 508-033

Entrepreneur Pearse Lyons had built Alltech into the fastest-growing company in the global animal health industry through innovative technology, creative marketing, and strong branding. Sel-Plex, a proprietary Alltech product, had shown important health benefits for animals and humans. Although numerous branded selenium-enriched products were being sold in supermarkets around the world, the company's current business model (selling Sel-Plex as an ingredient) did not allow it to participate in the value created. Lyons and Alltech's directors must choose between three different options for Sel-Plex, which include continuing with the current strategy, partnering with animal producers, or marketing Sel-Plex directly to consumers in tablet form.

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European Integration: Meeting the Competitiveness Challenge

Harvard Business School Case 708-421

The case discusses the origins and development of the European Integration process up to 2004, focusing in particular on the Lisbon Agenda for upgrading Europe's competitiveness. It discusses the different policy areas that have been approached at the European level over time, and provides background on the architecture of European institutions. The case enables students to understand how European integration has affected competitiveness across the continent's regions. It provides a platform to discuss why the Lisbon Agenda has up to 2004 failed to achieve its goals and what European integration experience can serve as a model for other world regions.

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General Mills (A)

Harvard Business School Case 608-004

General Mills is an 80-year-old company that specializes in consumer foods such as cereal, snacks, baking, and dinner products. Although General Mills is, on the whole, a very successful company, they have, in the recent past, had to face challenges as a result the changing environment in the food manufacturing industry. Three main factors have affected this industry including: (1) the rise of Wal-Mart and the resulting shift of pricing power from the manufacturer to the retailer, (2) the infiltration of more private-label products into the market, and (3) the rise in commodity costs as a result of inflation (for example, the Producer Price Index (PPI) which tracks the inflation/deflation for raw materials used by food manufacturers increased by 5.9% from April 2003 to April 2004).

In June 2004, as the newly appointed vice-president of the meals division, Jim Murphy was facing a crisis with one of General Mills' key brands, Hamburger Helper. The metrics for this brand had universally declined with marketing margin, volume, penetration, buy rate, facings, and advertising target rating points all down. In addition, Hamburger Helper was facing an increasingly competitive environment in the dinner category with Kraft, Lipton, ConAgra and Campbell's all recently entering the market.

Brainstorming by Hamburger Helper's brand management team resulted in two potential solutions: (1) to reduce production costs through the simplification of the Hamburger Helper line by reducing the complexity of the product and eliminating the less successful SKUs. Did the consumer really value real cheese vs. artificial cheese or vitamin C fortification? Did the consumer need so many flavors of Hamburger Helper? and (2) to re-consider the way that innovation was employed in brand development. Innovation had been a longstanding tradition at General Mills. Maybe the key was to re-evaluate how innovation was used and to re-adjust the balance between break-through innovation (a big change to the brand) and incremental innovation (a small change to existing products).

Which strategy should Jim Murphy and his brand management team choose to turn this brand crisis around?

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General Mills (B)

Harvard Business School Supplement 608-067

Supplements the (A) case.

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Global Knowledge Management at Danone

Harvard Business School Case 608-107

This case explores French consumer goods company Danone's novel approach to knowledge management. In 2007, Human Resource Chief (Executive Vice President) Franck Mougin assesses the company's knowledge-sharing tools and considers his options going forward. Through informal knowledge marketplaces and sharing networks, Danone had helped managers connect with each other and share good practices peer-to-peer, rather than relying on traditional hierarchical lines of communication or IT repositories. From 2004 to 2007, Mougin and his team had found that 5,000 Danone managers around the world—the company conducted business in 120 countries—had shared about 640 now-documented good practices. In 2007, the strategic importance of saving time in a decentralized organization through adoption of colleagues' good practices was put to a test. Should the knowledge management tools be extended to include all employees and external partners on a regular basis? And on top of sharing good practices, could it be extended to include the creation of new solutions and processes? Would this require more formalization of processes and more tracking of results? The case illustrates Mougin's options on taking knowledge management into the future of Danone.

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Ligand Pharmaceuticals Incorporated

Harvard Business School Case 208-019

In an activist role, the hedge fund Third Point LLC has three board seats and an ownership stake of 9.5% in Ligand Pharmaceuticals, Inc., a specialty pharmaceutical company. Third Point believed that Ligand had a strong drug portfolio and pipeline but that it was highly undervalued due to poor management. After gaining board representation, Third Point convinced the other directors to try to sell the company. Six months have passed since Ligand began soliciting bidders, but no buyer has emerged. With the sale of the company appearing to have stalled, Third Point has to decide whether to restart the bidding process, hold onto a longer-term position, or walk away.

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Tetra Pak Argentina

Harvard Business School Case 708-402

Deals with the hands-on management of a difficult situation facing the subsidiary of a multinational corporation (Tetra Pak) in a developing country (Argentina). The situation arises from a major economic, social, and institutional breakdown that jeopardizes the subsidiary's existence. Argentina defaulted on it sovereign debt and devalued the peso by over 200%, but it differentiated the treatment of the FX rate to be applied to various transactions, depending on the jurisdiction of creditors and debtors. Local dollar-denominated credits and liabilities were converted on a 1:1.40 ratio, while obligations held with foreign entities continued to be enforceable at the new rate of 1:3. The crisis led to the impoverishment of a large portion of the Argentine population, and to an institutional breakdown where the rule of law was shattered in the country, thus posing challenges not just related to the current situation, but also to the future of the operation. The crisis bore consequences for Tetra Pak Argentina on both ends of its value chain, involving suppliers and customers. Tetra Pak focuses its growth on developing nations where it feels there is room for a valuable business, and it attains leading market positions. Shows how the foreign firm must cope with difficult domestic situations where the levers of control are beyond its reach. The existence of value after the crisis turns out to be a relevant consideration.

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Vegpro Group: Growing in Harmony

Harvard Business School Case 508-001

Vegpro, a horticulture company, is Kenya's largest exporter of fresh vegetables and flowers to top supermarkets in the U.K. and Europe. In 2007, Vegpro's business is threatened by growing consumer concern about the environmental impact of food production and transport, including "food miles". The case describes the company's growth, which includes the use of owned land and outgrowers for production, the addition of value-added processing to obtain premium prices, and the introduction of global certification to ensure food safety and meet retailer and consumer requirements. The case also discusses the potential impact of increased consumer awareness of ethical sourcing and introduces the potential trade off between local production and economic development.

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