First Look

June 15, 2010

Several new working papers this week focus on the finer points of high finance. Among them, "An Unfair Advantage? Combining Banking with Private Equity Investing" [PDF] looks at the risks of certain P.E. investments, especially since the share of banks in the private equity market has been significant over the last 25 years. Charting the nature of private equity investors, structure of the investments, and performance of the firms, the authors confirm that policymakers should be worried: "These investments seem to exacerbate the amplitude of waves in the private equity market, leading to more transactions at precisely the times when the private and social returns are likely to be the lowest," write INSEAD's Lily Fang and HBS professors Victoria Ivashina and Josh Lerner. Cases this week examine a South African and U.K. health insurance firm considering a run for the U.S. market ("The Vitality Group"); offer ideas for improving work-life balance in high-pressure careers ("George Martin at The Boston Consulting Group"); and revisit a key acquisition in the banking sector ("Bank of America-Merrill Lynch"), among other topics.
— Martha Lagace


Building Sustainable Hybrid Organizations: The Case of Commercial Microfinance Organizations


We explore how new types of hybrid organizations (organizations that combine institutional logics in unprecedented ways) can develop and maintain their hybrid nature in the absence of a "ready-to-wear" model for handling the tensions between the logics they combine. The results of our comparative study of two pioneering commercial microfinance organizations suggest that to be sustainable, new types of hybrid organizations need to create a common organizational identity that strikes a balance between the logics they combine. Our evidence further suggests that the crucial early levers for developing such an organizational identity among organizational members are hiring and socialization policies.

Institutional Demand Pressure and the Cost of Corporate Loans


Between 2001 and 2007, annual institutional funding in highly leveraged loans went up from $32 billion to $426 billion, accounting for nearly 70% of the jump in total syndicated loan issuance over the same period. Did the inflow of institutional funding in the syndicated loan market lead to mispricing of credit? To understand this relation, we look at the institutional demand pressure defined as the number of days a loan remains in syndication. Using market-level and cross-sectional variation in time on the market, we find that a shorter syndication period is associated with a lower final interest rate. The relation is robust to the use of institutional fund flow as an instrument. Furthermore, we find significant price differences between institutional investors' tranches and banks' tranches on the same loans, even though they share the same underlying fundamentals. Increasing demand pressure causes the interest rate on institutional tranches to fall below the interest rate on bank tranches. Overall, a one standard deviation reduction in average time on the market decreases the interest rate for institutional loans by over 30 basis points per annum. While this effect is significantly larger for loan tranches bought by structured investment vehicles (e.g., CDOs), it is not fully explained by their role.

Risks and Rewards of Celebrity Endorsements

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Working Papers

Are Democrats Conservative? Towards a Theory of the Role of Standard Setters in Standard Setting


We investigate the role of standard setters in a standard setting. In particular, we examine how the backgrounds and personal politics of FASB members influence the nature of accounting standards proposed between 1973 and 2007. Among other results, we find that length of service on the board and a prior career in investment banking/investment management are associated with proposing standards perceived as decreasing accounting "reliability"; while affiliation with the Democratic Party is associated with proposing standards perceived as increasing accounting "reliability." Broadly, the evidence suggests that individuals on the FASB have a wider influence in the political economy of standard setting than is currently understood.

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Cyclicality of Credit Supply: Firm Level Evidence


We study the effect of bank loan supply through the business cycle using firm-level data from 1990 to 2009. Our paper addresses two of the main empirical challenges in identifying the effects of bank credit supply. First, we focus on firms' choice between two close forms of external financing: bank debt and public bonds. By conditioning the sample of firms raising new debt, we can rule out a demand explanation for the drop in bank borrowing. Second, by doing the analysis at the firm level, we can directly address how the composition of firms raising finance varies through time. We find strong evidence of substitution from bank loans to bonds at times characterized by tight lending standards, high levels of non-performing loans to bank equity, low bank share prices, and tight monetary policy. To illustrate our point, in the last half of 2007, 36% of all debt issues were bank loans. However, relative loan issuance fell to 8% by the first half of 2009, the lowest level in the period from 1990 to 2009. Although the bank-to-bond substitution can only be measured for larger firms (which have access to bond markets), we confirm that this substitution has strong predictive power for lending volume by small and unrated firms.

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Unfair Advantage'? Combining Banking with Private Equity Investing


We explore the phenomenon and economics of private equity investments by bank-affiliated groups. Between 1983 and 2009, bank-affiliated private equity groups accounted for over a quarter of all private equity investments. Banks' involvement increases during peaks of the private equity cycles. In particular, deals done by bank-affiliated groups are financed at significantly better terms than other deals when the parent bank is part of the lending syndicate, especially during market peaks. Investments made by bank-affiliated groups have slightly worse outcomes than non-affiliated investments, despite the targets having superior performance prior to investments. Investments during market peaks by commercial banks have significantly higher rates of bankruptcy. The involvement of a bank's private equity subsidiary in a deal significantly increases the odds of the parent bank being selected as a future lender, an advisor, and an underwriter. Collectively, these findings suggest that there are risks in combining banking and private equity investing.

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Matching with Couples: Stability and Incentives in Large Markets


Accommodating couples has been a longstanding issue in the design of centralized labor market clearinghouses for doctors and psychologists, because couples view pairs of jobs as complements. A stable matching may not exist when couples are present. We find conditions under which a stable matching exists with high probability in large markets. We present a mechanism that finds a stable matching with high probability, and which makes truth-telling by all participants an approximate equilibrium. We relate these theoretical results to the job market for psychologists, in which stable matchings exist for all years of the data, despite the presence of couples.

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Cases & Course Materials

The Vitality Group

Regina E. Herzlinger
Harvard Business School Case 310-071

Vitality is part of a $2 billion start-up South African and U.K. health insurance firm. It has achieved excellent results in rewarding people for promoting their health. It is now contemplating how to enter the U.S. market.

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George Martin at The Boston Consulting Group (A)

Leslie A. Perlow and Kerry Herman
Harvard Business School Case 410-112

George Martin, managing partner at The Boston Consulting Group (BCG), is worried as some of his best performers have recently pulled him aside to discuss the challenges they face managing the demands of their work lives with their desire for more predictable time with their families. BCG had instituted multiple initiatives to help its consulting staff better achieve work-life balance, yet some of Martin's top consultants still struggled. The case considers the challenges professional service firm employees face in terms of work-life issues.

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The Children's Hospital of Philadelphia: Network Strategy

Michael E. Porter, Carolyn A. Daly, and Andrew Dervan
Harvard Business School Case 710-463

In 2009 Children's Hospital of Philadelphia (CHOP) had been recognized as the best children's hospital in the country for six years in a row; but leadership saw CHOP as more than the large main campus in western Philadelphia. Beginning in the 1990s, CHOP had created a large network of Primary Care Providers, Specialty Care Centers, Ambulatory Surgery Centers, and community hospital affiliations. CHOP leadership wanted to ensure that the quality they had demonstrated at CHOP would translate out to these facilities, and more, that the combination of many parts could actually work together to provide even better care than the main hospital could do on its own.

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Federal Bureau of Investigation, 2001 (Abridged)

Jan W. Rivkin and Michael A. Roberto
Harvard Business School Case 710-450

This is an abridged version of "Federal Bureau of Investigation (A)," HBS No. 707-500.

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Shanzhai! MediaTek and the 'White Box' Handset Market

Willy Shih, Chen-Fu Chien, and Jyun-Cheng Wang
Harvard Business School Case 610-081

The term "white box" is often used to describe products without a brand name. Such products are assembled from standardized parts, and they became a very popular category of desktop PCs. Hsinchu, Taiwan based MediaTek is a fabless semiconductor company that unleashed a white-box market in mobile phone handsets by offering an innovative "complete solution" for 2.5G and 2.7G handset manufacturers, dramatically lowering the barriers to entry into the business. Besides enabling many Chinese branded manufacturers to enter the business, the grey market in components unleashed a complementary market of "Shanzhai" makers. Together these firms captured a significant fraction of the Chinese market, as well as exports (both legal and grey) to 102 countries. CEO Ming-Kai Tsai is faced with the question of the best growth path. While multiple tier one handset makers are dismissive of MediaTek, perhaps because of its role in enabling the Shanzhai, the company's offerings have enabled an "army of ants" to challenge the leaders. Can MediaTek move up-market to sell its chipsets to the likes of Nokia? Under what terms?

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Bank of America-Merrill Lynch

Guhan Subramanian and Nithyasri Sharma
Harvard Business School Case 910-026

In September 2008, as Lehman Brothers struggled to survive, John Thain, CEO of Merrill Lynch, realized that his bank was also on the brink of failure. Throughout the weekend of September 13-14, 2008, Thain successfully negotiated a deal with Ken Lewis, CEO of Bank of America, for BofA to acquire Merrill. However, throughout the fourth quarter of 2008, Merrill's financial condition deteriorated at an alarming rate, with expected 4Q08 losses ballooning from $5.3 billion in November to over $12 billion by mid-December. Shareholders of both companies approved the deal on December 5, 2008, but soon after, Lewis telephoned Fed officials and declared he would invoke the MAC clause to exit the deal unless Fed officials provided government financial assistance. Fed officials instructed Lewis to "stand down" and not to invoke the MAC clause. As he convened his Board on December 22, 2008, Lewis had to make a decision. Should he close the deal "for the good of the country?" Or should he declare a MAC and exit the deal, potentially invoking the wrath of the U.S. government. Was there another way?

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Global Diversity and Inclusion at Royal Dutch Shell

Sandra J. Sucher and Elena Corsi
Harvard Business School Case 610-056

Royal Dutch Shell has been among the early players to implement diversity and inclusion policies in the 1990s, first in the U.S. and then globally. In May 2009, Peter Voser, CFO and soon-to-be CEO, wants to adjust the company's business, headcount, and cost levels to adapt to changing economic conditions after one of the worst economic downturns in decades. His all-male executive committee has raised eyebrows since it is a step back from that of his predecessor, and he must decide whether to continue to promote the firm's emphasis on global diversity and inclusion while it restructures its business and reduces its managerial workforce.

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