Working Papers
Investable Tax Credits: The Case of the Low Income Housing Tax Credit
| Authors: | Mihir A. Desai, Dhammika Dharmapala, and Monica Singhal |
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Abstract
The Low Income Housing Tax Credit (LIHTC) represents a novel tax expenditure program that employs "investable" tax credits to spur production of low-income rental housing. While it has grown into the largest source of new affordable housing in the U.S. and its structure is now being replicated in other programs, the LIHTC has also drawn skepticism and calls for its repeal. This paper outlines a conceptual framework for exploring the conditions under which investable tax credits may be the most effective mechanism to deliver a production subsidy and discusses the desirability of employing investable tax credits in other policy domains. Estimates of tax expenditures under this program are provided and efficiency costs, distributional issues, and the likely effects of reforms to tax provisions such as the AMT are considered.
Download the paper from SSRN.com ($5): http://www.nber.org/papers/w14149
Inexperienced Investors and Bubbles
| Authors: | Robin Greenwood and Stefan Nagel |
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Abstract
We use mutual fund manager data from the technology bubble to examine the hypothesis that inexperienced investors play a role in the formation of asset price bubbles. Using age as a proxy for managers' investment experience, we find that around the peak of the technology bubble, mutual funds run by younger managers are more heavily invested in technology stocks, relative to their style benchmarks, than their older colleagues. Furthermore, young managers, but not old managers, exhibit trend-chasing behavior in their technology stock investments. As a result, young managers increase their technology holdings during the run-up, and decrease them during the downturn. Both results are in line with the behavior of inexperienced investors in experimental asset markets. The economic significance of young managers' actions is amplified by large inflows into their funds prior to the peak in technology stock prices.
A Gap-Filling Theory of Corporate Debt Maturity Choice
| Authors: | Robin Greenwood, Jeremy C. Stein, and Samuel Hanson |
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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.
Download the paper from SSRN.com ($5): http://papers.nber.org/papers/w14087
Earnings Quality and Ownership Structure: The Role of Private Equity Sponsors
| Author: | Sharon Katz |
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Abstract
This study explores how firms' ownership structures affect their earnings quality and long-term performance. Focusing on a unique sample of private firms for which there is financial data available in the years before and after their initial public offering (IPO), I differentiate between those that have private equity sponsorship (PE-backed firms) and those that do not (non-PE-backed firms). The findings indicate that PE-backed firms generally have higher earnings quality than those that do not have PE sponsorship, engage less in earnings management and report more conservatively both before and after the IPO. Further, PE-backed firms that are majority-owned by PE sponsors exhibit superior long-term stock price performance after they go public. These results stem from the professional ownership, tighter monitoring, and reputational considerations exhibited by PE sponsors.
Download the paper from SSRN.com ($5): http://papers.nber.org/papers/w14085
Publications
Public Action for Public Goods: Theory and Evidence
| Authors: | Abhijit Banerjee, Lakshmi Iyer, and Rohini Somanathan |
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| Publication: | In Handbook of Development Economics. Vol. 4, edited by T. Paul Schultz and John Strauss. Elsevier Science & Technology Books, 2008 |
Abstract
This chapter focuses on the relationship between public action and access to public goods. It begins by developing a simple model of collective action which is intended to capture the various mechanisms that are discussed in the theoretical literature on collective action. We argue that several of these intuitive theoretical arguments rely on special additional assumptions that are often not made clear. We then review the empirical work based on the predictions of these models of collective action. While the available evidence is generally consistent with these theories, there is a dearth of quality evidence. Moreover, a large part of the variation in access to public goods seems to have nothing to do with the "bottom-up" forces highlighted in these models and instead reflects more "top-down" interventions. We conclude with a discussion of some of the historical evidence on top-down interventions.
Economic Catastrophe Bonds
| Authors: | Joshua D. Coval, Jakub W. Jurek, and Erik Stafford |
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| Publication: | American Economic Review (forthcoming) |
Abstract
The central insight of asset pricing is that a security's value depends on both its distribution of payoffs across economic states and state prices. In fixed-income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default is likely to occur. Such investors are likely to be attracted to securities whose payoffs resemble those of economic catastrophe bonds-bonds that default only under severe economic conditions. We show that many structured finance instruments can be characterized as economic catastrophe bonds but offer far less compensation than alternatives with comparable payoff profiles. We argue that this difference arises from the willingness of rating agencies to certify structured products with a low default likelihood as safe and from a large supply of investors who view them as such.
Domestic Effects of the Foreign Activities of U.S. Multinationals
| Authors: | Mihir A. Desai, C. Fritz Foley, and James R. Hines Jr. |
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| Publication: | American Economic Journal: Economic Policy (forthcoming) |
Abstract
Do firms investing abroad simultaneously reduce their domestic activity? This paper analyzes the relationship between the domestic and foreign operations of American manufacturing firms between 1982 and 2004 by instrumenting for changes in foreign operations with GDP growth rates of the foreign countries in which they invest. Estimates produced using this instrument indicate that 10% greater foreign investment is associated with 2.6% greater domestic investment, and 10% greater foreign employee compensation is associated with 3.7% greater domestic employee compensation. These results do not support the popular notion that expansions abroad reduce a firm's domestic activity, instead suggesting the opposite.
The Finance Function in a Global Corporation
| Author: | Mihir A. Desai |
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| Publication: | HBS Centennial Issue. Harvard Business Review 86, nos. 7/8 (July - August 2008) |
Abstract
As corporations globalize, capital markets open up within them, giving companies a powerful mechanism for arbitrage across national financial markets. Managing these internal markets to build an advantage requires that CFOs must balance new financial opportunities with the managerial and institutional challenges of operating in multiple environments.
Reduce the Risk of Failed Financial Judgments
| Authors: | Robert G. Eccles, Jr., and Edward J. Riedl |
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| Publication: | HBS Centennial Issue. Harvard Business Review 86, nos. 7/8 (July - August 2008). |
Abstract
When crucial financial estimates rely on judgment, companies can minimize their risk by turning to appraisers, actuaries, and evaluators, whether internal, external, or a combination.
The Competitive Imperative of Learning
| Author: | Amy C. Edmondson |
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| Publication: | HBS Centennial Issue. Harvard Business Review 86, nos. 7/8 (July - August 2008): 60-67 |
Abstract
Most executives believe that relentless execution—efficient, timely, consistent production and delivery of goods or services—is the surefire path to customer satisfaction and positive financial results. But this is a myth in the knowledge economy, argues Edmondson, a Harvard Business School professor. She points to General Motors, which for years has remained wedded to a well-developed competency in centralized controls and efficient execution but has steadily lost ground, posting a record $38.7 billion loss in 2007. Such an execution-as-efficiency model results in employees who are exceedingly reluctant to offer ideas or voice questions and concerns. Placing value only on getting things right the first time, organizations are unable to take the risks necessary to improve and evolve. By contrast, firms that put a premium on what Edmondson calls execution-as-learning focus not so much on how a process should be carried out as on how it should evolve. Since 1980 General Electric, for instance, has continued to reinvent itself in every field from wind energy to medical diagnostics; and it enjoyed a $22.5 billion profit in 2007. Organizations that foster execution-as-learning provide employees with psychological safety. No one is penalized for asking for help or making a mistake. These companies also employ four distinct approaches to day-to-day work: They use the best available knowledge (which is understood to be a moving target) to inform the design of specific process guidelines. They encourage employee collaboration by making information available when and where it's needed. They routinely capture data on processes to discover how work really happens. Finally, they study these data in an effort to find ways to improve execution. Taken together, these practices form the basis of a learning infrastructure that makes continual learning part of business as usual.
Cases & Course Materials
The Broad Institute: Applying the Power of Genomics to Medicine
Harvard Business School Case 608-114
In June 2003, Harvard University and MIT announced an unprecedented partnership to create a biomedical institute, The Broad Institute. The culture of the Broad centered on science, and those involved considered it to be at the edge of the scientific frontier. In just four years the Broad had made many important scientific contributions to the biomedical field. These included understanding genetic alterations in cancer; building an RNAi Consortium to better understand the role of every gene in the human body; creating an integrated database that mapped the connections among drugs, genes, and diseases; and cataloging inherited genetic variations of Type 2 Diabetes. Opportunities for additional important scientific advances beckoned but would require both funding and physical space. The Broad Institute's leaders, including Altshuler, Director of the Program in Medical and Population Genetics, and Golub, Director of the Cancer Program, needed to decide how big was too big. How many projects could the Broad productively support? What happened when the Broad outgrew its physical space? Altshuler and Golub knew that the Broad had made tremendous strides in the past year. It had minimized barriers and attracted many young scientists who viewed the Broad as an exciting place to do research. That success made the question of how to balance the priorities of growth and the preservation of the culture that had made everything possible all the more important.
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Convertible Arbitrage
Harvard Business School Note 208-116
The goal of this simulation is to understand how convertible bonds can be viewed as a portfolio of simpler securities and to introduce an over-the-counter market. The convertible bonds that are available during the simulation are at-the-money and in-the-money so that changing credit risk exposure is not much of an issue. A convertible bond can be viewed as a simple coupon paying corporate bond plus a conversion option. A bond pricing model discounts the promised payments at a rate that compensates for time, risk, and expected loss (maturity matched Treasury yield plus a credit rating matched yield spread). The conversion option can be valued using the Black-Scholes call option pricing formula. The key is to recognize that each conversion option (one per bond) is equivalent to several equity call options (the conversion ratio determines how many equity options are implicit in each bond).
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Customer-Operator Letter Writing Exercise
Harvard Business School Exercise 608-126
The exercise involves having students write letters to an organization of their choice describing their operating experience at a detailed level. The companies' responses are paired with the students' letters and the entire collection is made available to the class. The collection can be compelling. Students are quick to sense which organizations value customer communications as meaningful operational input. They find highly instructive the frequency with which situations laboriously recounted by their "valued customers" elicit generic responses from companies, and replies to detailed letters of praise get the tone dramatically wrong. At HBS, it is incorporated in a second-year elective, taught in a module devoted to utilizing customer-operators to improve operations (HBS No. 608-135).
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Equity Derivatives
Harvard Business School Note 208-117
The goal of these simulations is to understand the dynamic replication technique behind the Black-Scholes/Merton options model. The simulations focus on a single stock and a risk-free discount bond, which are used to replicate a contingent payoff. The underlying stock and bond prices are randomly generated from the assumptions of the model, so that this simulation is testing the student's understanding and ability to use the model, rather than testing whether the model accurately explains prices. In each of the four simulations that make up this lesson, students are trying to replicate a contingent payoff, which is specified in terms of the closing stock price in one month (European-style derivative). The students are essentially working on an equity derivatives desk at a large bank and are responsible for delivering a derivative payoff to a client. The desk has taken in a premium upfront for guaranteeing the contingent payoff in one month's time. In the Black-Scholes/Merton model, a trader should be able to exactly match the contractual payment at expiration. Therefore, students are penalized based on the absolute difference between their actual ending value and a target ending value (starting value + derivative payoff). In particular, this difference is cumulated across all four simulations and then subtracted from their account.
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Equity Options
Harvard Business School Note 208-118
The goal of this simulation is to understand the reliance of option values on volatility. When an investor trades an option, they are essentially trading volatility. Therefore, much of the focus in this lesson is on forecasting volatility. Students are able to use two primary methods for forecasting volatility in this lesson-historical and implied. Students are provided with a historical dataset, from which they can estimate historical volatility of the stock returns. They can also use the dataset to study various statistical relations between the securities. In particular, two of the three securities behave independently of the others. Thus, students are able to analyze the dataset to form views of how the security prices are likely to evolve relative to each other.
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Finding Information for Industry Analysis
Harvard Business School Note 708-481
This note provides detailed instructions on finding resources for conducting industry analysis, with a special focus on resources available at Harvard Business School. It allows students to transition from doing a Five Forces analysis on the basis of a case, where all relevant facts are provided, to doing a Five Forces analysis in a work setting, without the benefit of a prepackaged case. Exhibits provide detailed information on top resources for industry analysis, instructions for accessing prominent databases, notes on using the Internet and other new media, and some publication-related tricks of the trade pertinent to each step in the industry analysis process.
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Index Options
Harvard Business School Note 208-119
The goal of this simulation is to understand the patterns in index option prices that are not predicted by the Black-Scholes model. In particular, the simulation focuses on two properties of options prices. First, at-the-money implied volatilities from index options tend to be larger than the realized volatility. Second, the implied volatilities from index options are increasing as the strike price falls relative to the current index level (i.e., out-of-the-month call options have larger implied volatilities than at-the-money call options). Students are given a dataset of relevant market information to analyze. From these materials, students are expected to develop an investment strategy that attempts to deliver low-risk profits from the index options market. The actual simulation is fairly short and simple. Students trade 1-month put and call options on the S&P 500 (SPX) at three different strike prices (10% out-of-the-money, at-the-money, and 10% in-the-money). The simulation covers five months of calendar time (5 sets of options) in about 35 minutes.
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InnoCentive.com (A)
Harvard Business School Case 608-170
InnoCentive.com, a firm connecting R&D labs of large organizations to diverse external solvers through innovation contests, has to decide if it will enable collaboration in its community. Case covers the basics of a distributed innovation system works and the advantages of having external R&D. Links how concepts of open source are applied to a non-software setting. Describes the rationale for participation by solvers in innovation contests and the benefits that accrue to firms. Raises the issue if a community can be shifted to collaboration when competition was the basis of prior interaction.
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Kenny Kahn at Muzak (A)
Harvard Business School Case 408-057
Founded in 1934, Muzak pioneered the industry of background music. Equipped with propriety technology and a vast music library, over the ensuing decades the Muzak franchise organization expanded geographically. Despite a history of innovation, by the late 1990s Muzak had anemic financials and low employee morale. When new CEO Bill Boyd took the helm in 1997, he assembled a new management team. The new VP of Marketing, Kenny Kahn, worked with design firm Pentagram to re-brand the company, not just for customers but to spark organizational change. But because Muzak was a franchise organization, Kahn had to convince independent affiliates to pay for what turned out to be an extensive re-branding. This case can be used to teach how branding can be used as a tool for spearheading culture change-not to exercise influence without authority-and how businesspeople can effectively work with a design firm.
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Note on the Law of Sexual Harassment
Harvard Business School Note 308-096
This note provides an introduction to the law of sexual harassment. It has three parts. Part One describes the laws on harassment in the United States. Part Two explores controversial and emerging aspects of the American legal framework. Part Three gives a brief overview of sexual harassment laws and policies in several regions of the world, including Europe, Asia, and Latin America.
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The Offshoring of America
Harvard Business School Case 708-030
The movement from jobs in the United States to developing countries, in a process known as offshoring, has become quite a controversial topic. Managers not only need to decide which activities, if any, to move offshore, but where to move them. This case describes the nature of offshoring and its effect on developing countries.
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Opening Pandora's Box
Harvard Business School Case 607-135
Pandora.com provided a highly customizable online radio service tailored to listeners' musical preferences and had registered explosive growth since its September 2005 launch. But proposed changes in royalty rates threatened to kill off many Internet radio sites, including Pandora. Explores Pandora's business model and whether it can evolve to remain viable.
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Philips Medical Systems in 2005
Harvard Business School Case 706-488
No abstract is available at this time.
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Rackspace Hosting in Late 2000
Harvard Business School Case 808-166
The leadership team of Rackspace, faced with accommodation of its service offering and dwindling financial reserves, decides to make customer focus the rallying cry of its new strategy. This short case was designed as the discussion igniter for a series of short video clips describing the shift to a more customer-focused approach.
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Sara Campbell Ltd. (A)
Harvard Business School Case 108-070
Describes a situation in which Sara Campbell, the CEO of a women's apparel company, must decide how to resolve the tense relationship with her Financial Controller and ex-brother-in-law, Stephen Holt. Holt was employed by Campbell for 10 years, took on the majority of financial responsibilities for the firm, and knew the business very well. Although he was bright, Campbell was often disappointed by his poor judgment and disorderly nature. By 1999, two incidents by Holt forced Campbell to question how she should proceed in terms of his employment. Students are given context to debate whether Holt's behavior was detrimental enough to overshadow a successful ten-year working relationship and his monetary obligations to Campbell's immediate family.
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Southern Company's Investment in CEMIG
Harvard Business School Case 707-512
In the spring of 1997, Southern Company had the opportunity to acquire a significant portion of the electric utility in the Brazilian state of Minas Gerais. The shares in the utility, CEMIG, were being sold by the state government as part of a comprehensive privatization of Brazil's electric sector. Brazil's privatization was, in turn, part of a worldwide movement toward deregulation and privatization of the electric sector. Like many of its rivals in the utility sector, Southern had committed itself to a strategy of growth by taking advantage of the significant opportunities for cross-border investment that were being created by this trend. The privatization of CEMIG was a particularly appealing opportunity for Southern. Not only was CEMIG one of the largest utilities in Latin America, but this investment would provide a base in the Brazilian market, which was expected to have the largest potential for further growth on the continent. Brazil was in the process of reforming its system of regulating electric utilities and of introducing competition into Brazil's wholesale generating market. These changes would further enhance the potential profitability of investing in CEMIG. In addition to the attractiveness of the investment, Southern had been able to secure non-recourse financing for half of the required amount. Keeping in mind Brazil's volatile economic history, this financing would substantially limit Southern's downside risk. The state government had set a price of $1.1 billion for the block of shares. Was the investment in CEMIG worth that price?
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Starbucks Coffee Company in the 21st Century
Harvard Business School Case 808-019
The case explores the opportunities and challenges confronting Starbucks in the early 21st century. For more than 15 years, Starbucks has grown swiftly and successfully, helping create a large, dynamic market for specialty coffee, building one of the world's most powerful brands and forging a new business model based on industry disrepair and responsible global citizenship. In 2008, Starbucks leadership faces a range of issues—inside and out of the company—related to that success. This case examines these issues in the context of a changing economy, increased competition, evolving consumer priorities, and the organization's place on the larger global stage.
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