First Look

July 27, 2010

As a non-partisan plan of action, The Squam Lake Report: Fixing the Financial System (Princeton University Press) collects in one volume the insights of 15 leading economists including HBS professor David S. Scharfstein. Chapters focus on hot-button topics such as recapitalizing distressed financial firms, revisiting executive compensation, and regulating the market for retirement savings. "Two central principles support our recommendations," according to the report's introduction. "First, policymakers must consider how regulations will affect not only individual financial firms but also the financial system as a whole. When setting capital requirements, for example, regulators should consider not only the risk of individual banks, but also the risk of the whole financial system. Second, regulations should force firms to bear the costs of failure they have been imposing on society. Reducing the conflict between financial firms and society will cause the firms to act more prudently." Among newly published cases, "Microfin" by Senior Lecturer Michael Chu and Enrique Kramer explores the management dilemmas of a new microfinance initiative in Latin America. In a classroom exercise, Professor Mikołaj Jan Piskorski outlines the essentials for designing an optimum social networking strategy ("Social Strategy Exercise"). And delving into the recent history of money market funds, professor Robert C. Pozen and Elizabeth M. Leonard highlight government's role in the fund landscape during the critical period of 2008-2009 ("Breaking the Buck").
— Martha Lagace


The Squam Lake Report: Fixing the Financial System


In the fall of 2008, fifteen of the world's leading economists—representing the broadest spectrum of economic opinion—gathered at New Hampshire's Squam Lake. Their goal: the mapping of a long-term plan for financial regulation reform. The Squam Lake Report distills the wealth of insights from the ongoing collaboration that began at these meetings and provides a revelatory, unified, and coherent voice for fixing our troubled and damaged financial markets. As an alternative to the patchwork solutions and ideologically charged proposals that have dominated other discussions, the Squam Lake group sets forth a clear nonpartisan plan of action to transform the regulation of financial markets—not just for the current climate—but for generations to come.

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The Impact of Corporate Social Responsibility on Investment Recommendations


Using a large sample of publicly traded U.S. firms over 16 years, we investigate the impact of corporate socially responsible (CSR) strategies on security analysts' recommendations. Socially responsible firms received more favorable recommendations in recent years relative to earlier ones, documenting a changing perception of such strategies by the analysts. Moreover, we find that higher visibility firms receive more favorable recommendations for their CSR strategies. We also find that analysts with more experience, broader CSR awareness, or those with more resources at their disposal, are more likely to perceive CSR strategies favorably. Our results show how CSR strategies can affect value creation in public equity markets through analyst recommendations.

Institutional Stock Trading on Loan Market Information


Over the past decade, one of the most important developments in the corporate loan market has been the increasing participation of institutional investors in lending syndicates. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: do institutional investors use private information received in the loan market to trade in public securities? In this paper, we examine the stock trading of institutional investors that also hold loans in their portfolio. Specifically, we look at the abnormal returns on stock trades following loan renegotiations. By collecting SEC filings of loan amendments, we are able to identify institutional investors that had access to private information disclosed by the borrower during loan renegotiations. Our results indicate that institutional managers that participate in loan renegotiations consequently trade in stock of the same company and outperform other managers by approximately 8.8% in annualized terms in the month following loan renegotiation.

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Corporate Governance at the World Bank and the Dilemma of Global Governance


Most major decisions at the World Bank are made by its Board of Executive Directors. While some countries enjoy the opportunity to serve on this powerful body, most countries rarely, if ever, get that chance. This gives rise to the question: does board membership lead to higher funding from the World Bank's two main development financing institutions, the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA)? Empirical analysis shows that developing countries serving on the board can expect more than double the funding from the IBRD as countries not on the board. In absolute terms, countries on the board receive an average $60 million "bonus" in IBRD loans, an amount that rises in years when IBRD loans are in high demand, particularly for countries in the most influential seats. This effect is more likely driven by informal rules and norms in the boardroom than by the power of the vote itself. No significant effect is found in IDA funding. These results point to challenges of global governance through representative institutions.

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Working Papers

Do Capital Market Relations Travel: An Analysis of Executives Changing Employers


We examine whether strong relations between managers and market participants lead to market participants "following" the managers to new firms. Our analyses focus primarily on analysts since much of their interaction with management occurs in public. Specifically, we investigate sell-side analyst coverage decisions in the context of CEO and CFO moves between publicly listed firms. We find that top executive moves from an origin firm to a destination firm often trigger analysts following the origin firm to initiate coverage of the destination firms. Consistent with structural constraints on the sell-side analyst profession, we find that analyst-manager "co-migration," is much stronger when both firms are within the same industry. In support of the importance of relations, analysts who move with manager's to the destination firm exhibit more intense and accurate coverage of the origin firm than they do in other firms and than other analysts covering the origin firm. However, this no longer holds after the executive's departure. Turning to institutional investors, we find similar evidence of a "co-migration" which is related to the extent of institutional investment in the managers new firm and the amount of analyst co-migration, among other factors. Overall, the evidence suggests that relationships between managers and capital market participants play a significant role in the capital market participants' coverage and investment decisions in a dynamic setting.

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Business Model Innovation and Competitive Imitation


We provide the first formal model of business model innovation in a game-theoretic framework. Our analysis focuses on sponsor-based business model innovations where a firm monetizes its product through sponsors rather than setting prices directly to its customer base. We provide a comprehensive analysis of the range of possible strategic interactions between an innovative entrant and an incumbent where their choices of business models are endogenously determined and where the incumbent may imitate an entrant's business model innovation once it is revealed. We find that the possibility of competitive imitation means an entrant needs to strategically choose whether to reveal its innovation by competing through the new business model or conceal it by adopting a traditional, established business model. We also quantify the value of business model innovations and show that the profit implications for the entrant of inventing a new business model and for the incumbent of responding with business model reconfigurations could be substantial. In particular, the value of business model innovation may be so substantial that the incumbent may strictly prefer to compete in a duopoly rather than to remain a monopolist.

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Preference Signaling in Matching Markets


Many labor markets share three stylized facts: employers cannot give full attention to all candidates, candidates are ready to provide information about their preferences for particular employers, and employers value and are prepared to act on this information. In this paper we study how a signaling mechanism, where each worker can send a signal of interest to one employer, facilitates matches in such markets. We find that introducing a signaling mechanism increases the welfare of workers and the number of matches, while the change in firm welfare is ambiguous. A signaling mechanism adds the most value for balanced markets.

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Cases & Course Materials


Michael Chu and Enrique Kramer
Harvard Business School Case 309-126

The case presents the management dilemmas of a new institution in an undeveloped microfinance market in Latin America. Supported by a globally recognized industry player, it is the result of the efforts of two fledgling local entrepreneurs with a business model they believe can achieve a substantial and profitable share of a potential $150 million market. With the backdrop of the 2002 banking crisis, the governing leftist coalition is promoting microfinance as a means to reduce poverty, but banking authorities have so far issued no regulation to promote it. Another competitor with similar characteristics to Microfin started doing business a few months earlier, and there are rumors that the largest bank in the country is studying the possibility of a fully owned subsidiary exclusively dedicated to microfinance.

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Jo Worthington (A)

Dorothy Leonard
Harvard Business School Case 911-404

A relatively inexperienced professor struggles with managing a case discussion in a class based on numeric analysis. The class is lethargic and time is tight; she considers both a number of possible reasons for their disinterest and different teaching strategies to stimulate discussion and learning.

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Jo Worthington (B)

Dorothy Leonard
Harvard Business School Supplement 911-405

A professor teaching a case discussion based on numeric analysis is pleased that a student finally "cracks" the case--but the numbers differ from her own. The instructor has to decide how to handle the discrepancy.

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Jo Worthington (C)

Dorothy Leonard
Harvard Business School Supplement 911-406

A professor has an awkward exchange with a student who has prepared numeric analysis, but whose numbers do not agree with her own.

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Social Strategy Exercise

Mikołaj Jan Piskorski
Harvard Business School Exercise 710-472

This note outlines the process of designing a social strategy.

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Breaking the Buck

Robert C. Pozen and Elizabeth M. Leonard
Harvard Business School Case 310-135

After an incredibly volatile six months since Lehman Brothers declared bankruptcy, Finbar McCall contemplated his options. As the investment manager of RPG Prime Reserve Fund, Inc. (RPGXX), McCall had just heard the news that the U.S. Treasury was extending the availability of insurance for eligible money market funds. When the insurance was first offered in September of 2008, RPGXX immediately applied for coverage. McCall's dilemma in February of 2009, when an extension of the Treasury insurance was offered, involved weighing the cost of the insurance against the comfort it might provide to skittish RPGXX shareholders and the increased flexibility it would allow in investing RPGXX's assets. This case provides a brief history and explanation of money market funds, the phenomenon known as "breaking the buck," and how the government's assistance changed the landscape of money market funds in the last months of 2008 and into 2009.

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GUIDES: Insight through Indicators

Matthew C. Weinzierl, Jonathan Schlefer, and Ann Cullen
Harvard Business School Note 710-044

GUIDES is an easily remembered framework that can help the business leader and student to confidently and quickly identify, organize, and interpret a country's key economic indicators. Alternatively, it can help them to evaluate third-party analyses and to compare such analyses across countries. In either case, this framework provides a structured way to complete and communicate analysis of a country's economic data.

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