First Look

October 20, 2009

Does geographic proximity of shareholders make for better corporate governance? Small shareholders, despite extensive legal rights, often seem to wield little control over management, perhaps because the shareholders are too widely dispersed to keep an eye on things. A new working paper argues that large shareholders—individuals who hold large blocks of shares—might be better monitors due to their financial interest especially if they reside closer to the firm in question. Research by HBS professor Bo Becker and colleagues detailed in the paper "Estimating the Effects of Large Shareholders Using a Geographic Instrument" [PDF] found that more than half lived in the same state as the firm in which they held a block. Being neighbors to firms they invest in means that large shareholders keep closer tabs on firms' spending, too. As the researchers learned, "The presence of a large shareholder significantly reduces a firm's investments, reduces corporate cash holdings, increases payouts to shareholders, reduces total top-executive pay, and increases firm performance.... Firms with blockholders also have significantly more outside directors on their boards." This week a variety of cases investigate entrepreneurial opportunities and challenges worldwide. Examples include a look at Kenya, in "Acumen Fund: Measurement in Venture Philanthropy"; at Jordan, in "Endeavor: Creating a Global Movement for High-Impact Entrepreneurship"; and at Latin America generally, in "Root Capital."
— Martha Lagace

Working Papers

Gray Markets and Multinational Transfer Pricing (revised)


Gray markets arise when a manufacturer's products are sold outside of its authorized channels, for instance when goods designated for a foreign market are resold domestically. One method multinationals use to combat gray markets is to increase internal transfer prices to foreign subsidiaries in order to increase the gray market's cost base. We illustrate that when a gray market competitor is present, the optimal price for internal transfers not only exceeds marginal cost, but is also a function of the competitiveness of the upstream economy. Moreover, the presence of a gray market competitor may cause unintended social welfare consequences when domestic governments mandate the use of arm's length transfer prices between international subsidiaries. When markets are sealed, arm's length transfer pricing strictly increases domestic social welfare. In contrast, we demonstrate that when a gray market competitor is present, mandating the use of arm's length transfer pricing decreases domestic social welfare when the domestic market is sufficiently large relative to the foreign market. Specifically, a shift to arm's length transfer pricing erodes domestic consumer surplus by making the gray market less competitive domestically, which in turn may offset any domestic welfare gains that accompany a shift to arm's length transfer pricing. Finally, the analysis illustrates that in a gray market setting, the transfer price that maximizes a multinational's profits may also be the same one that maximizes the social welfare of the domestic economy that houses it.

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Estimating the Effects of Large Shareholders Using a Geographic Instrument


Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework which allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument—the density of wealthy individuals near a firm's headquarters—for the presence of a large, non-managerial individual shareholder in a firm. These shareholders have a large impact on firms, controlling for selection effects.

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Government Advertising and Media Coverage of Corruption Scandals


We construct measures of the extent to which the four main newspapers in Argentina report government corruption on their front pages during the period 1998-2007 and correlate them with the extent to which each newspaper is a recipient of government advertising. The correlation is negative. The size is considerable: a one standard deviation increase in monthly government advertising (0.26 million pesos of 2000) is associated with a reduction in the coverage of the government's corruption scandals by almost half of a front page per month, or 37% of a standard deviation in our measure of coverage. The results control for newspaper, month, and individual corruption scandal fixed effects.

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Global Capital and National Institutions: Crisis and Choice in the International Financial Architecture


All managers face a business environment in which international and macroeconomic phenomena matter. International capital flows can significantly affect countries' development efforts and provide clear investment opportunities for businesses. During the 1990s and early 2000s, the world witnessed an explosion in capital flows at the global level. Gross foreign assets and liabilities stood at two or three times GDP for many countries, as compared to just two decades ago. This explosive growth, especially in emerging markets, has been fueled both by changes in world politics (e.g., the end of the Cold War, collapse of the Soviet Union, shifting political climate in China, and political changes in Latin America and Asia) and advances in technology. Private capital flows—debt finance, equity capital, and foreign direct investment (FDI)—became larger than current and past official capital flows. This new era of foreign capital mobility has also been characterized by low interest rates in industrial countries, growing external imbalances in the U.S. economy, and the rise of China, all of which posed new challenges to policy management. In 2009, the global economy remained mired in a deep crisis following the subprime meltdown in the U.S. The situation was also a true testimony of how intertwined individual economies had become over the years. The effect of policies to deal with the ongoing global crisis and new policy choices remain to be seen. Understanding these phenomena—the determinants of capital flows, the effects of foreign capital on host countries, the impact of exchange-rate movements, and the genesis of financial and currency crises—is a crucial aspect to making informed managerial decisions. The cases in this book have been designed to give students an appreciation of the critical role of institutions and policies in affecting patterns of international capital flows and the abilities of government to manage them effectively. The case studies are tied together by two broad themes: (1) the determinants and effects of international capital, and (2) policy-makers' management of these flows. The cases approach these themes by exploring institutional detail in deep local context. The cases expose students to recent key events that have shaped the way economists think about these subjects. The events covered have a clear global perspective as the cases are set in Africa, Asia, Europe, and Latin America, as well as the United States. The cases also cover events that occurred during the last three decades as not only do they affect the business environment that managers face today but they also hold important lessons. An important feature the cases reveal is the cyclical nature of international capital flows. Global Capital and National Institutions: Crisis and Choice in the International Financial Architecture is composed of three intellectual segments: (1) Determinants and Effects of International Capital Flows, (2) Policies and Strategies for Harnessing the Benefits of Financial Globalization, and (3) Challenges and Policies of Large Economies. Chapter I presents a detailed overview of the cases and readings in the module and relates the cases included to the main patterns of international capital flows in the last thirty years. Finally, the chapter also presents the key insights from the field of international economics covered in the cases as well as the current state of debate among policy-makers.

Stakeholder Marketing 2.0


As more companies pursue "open innovation" and adopt social networking and Web 2.0 tools, there is an emerging opportunity for them to connect with a diverse body of stakeholders and incorporate their interests and ideas. However, this also introduces many new challenges. The author identifies key properties that such networking mechanisms must satisfy if they are to succeed. He introduces a simple framework based on two dimensions of choices for designing such mechanisms—how the stakeholders are motivated to participate and how the company uses their inputs and makes decisions. For any choice there are trade-offs to be considered. He concludes by identifying the design most likely to succeed in fundamentally advancing the state-of-the-art of stakeholder marketing. Examples of many pioneering companies, Starbucks, Dell, Staples, Muji, and several others, are included in the discussion to illustrate the key propositions presented.


Cases & Course Materials

Acumen Fund: Measurement in Venture Philanthropy (A)

Harvard Business School Case 310-011

Acumen Fund is a global venture capital firm with a dual purpose: it looks for a return on its investments, and it also seeks entrepreneurial solutions to global poverty. This case examines Acumen's new projects in Kenya. The organization's investment committee and its chief investment officer, Brian Trelstad, must decide whether or not to fund two for-profit ventures. The first provides clean and accessible shower and toilet facilities in urban areas, serving a critical need for low-income populations—its financial sustainability, however, is less clear. The second investment is a network of successful private health clinics that primarily serve middle-income populations but which have the potential to reach low-income markets. On what basis should Acumen decide whether or not to invest? What performance metrics should it use? As the investment committee nears a decision, political and social unrest breaks out in Kenya following a highly contested presidential election. Acumen Fund must now also consider the political risks of investing.

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Acumen Fund: Measurement in Venture Philanthropy (B)

Harvard Business School Supplement 310-017

As Acumen Fund, a global venture philanthropy firm, moves forward with an investment portfolio exceeding $22 million, it runs into two critical measurement problems. First, how should it track the performance of each investment when its interest is not just the bottom line, but also social impact? What should its performance tracking system look like to enable ease of comparison and to identify problems before they become too significant to fix? The second challenge involves attracting investors. Acumen wants to build the field of "social investing" by creating a new asset class for investors who care about social impact. Doing so will require working with competitors in the field in order to establish benchmarks and standards of measurement. How can Acumen build industry-wide benchmarks when peer organizations are concerned about confidentiality of data? Without such comparisons, how will Acumen attract investors to the field?

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Colombia: Organizing for Competitiveness

Harvard Business School Case 710-417

The case is designed to explore the process of building competitiveness, particularly in an unstable environment, with a focus on organizations for competitiveness.

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Endeavor: Creating a Global Movement for High-Impact Entrepreneurship

Harvard Business School Case 810-049

This case describes a critical inflection point in the growth of an international development "mentor capitalist" nonprofit, Endeavor. As Endeavor aims to scale its high-impact entrepreneurship model globally, founder Linda Rottenberg must determine what success looks like for the organization and which growth option will most effectively take Endeavor in that direction. The case begins with a panel of business leaders selecting a new class of Jordanian entrepreneurs to join the ranks of Endeavor's prestigious portfolio. Their decision forces them to wrestle with the following questions: "What is high impact entrepreneurship, and how will it contribute to the economic development of a country like Jordan?"

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Intel NBI: Image Components Organization

Harvard Business School Case 610-028

The Image Components Organization (ICO) was an internal venture that was part of Intel's New Business Initiatives. It sought to initially develop and sell a high performance integrated CMOS image sensor module for cellular phones. ICO's opening assumptions were that it could combine externally licensed technology with internal design work, and then manufacture using the company's leading edge manufacturing facilities. Initial implementation challenges led to delays and additional engineering work, but as the designated Intel manufacturing site went to full capacity utilization, ICO faced increasing marginalization. This case complements 609-043 "Intel NBI: Intel Corporation's New Business Initiatives (A)" and 609-102 "Intel NBI: Intel Corporation's New Business Initiatives (B)." It is one of the failed ventures cited in those cases.

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Pandora: Royalties Kill the Web Radio Star? (A)

Harvard Business School Case 310-026

Joe Kennedy, president and CEO of Pandora, one of the largest and most popular web (Internet) radio broadcasters, had just received bad news. The Copyright Royalty Board (CRB) had announced its decision to increase the royalties required to be paid by the web radio industry by 2.5 times over the next five years, effectively pushing profitability for Pandora out of sight. Pandora was a "webcaster" that was based on the Music Genome Project, which codified various attributes of a song (making "music DNA"). Using this technology, Pandora could provide a selection of songs with similar "music DNA" to the user's initial choice. Pandora, however, along with other webcasters, was subject to a special statutory scheme regarding royalties, which were higher than the royalties for satellite radio and from which AM/FM radios were totally exempt. This case examines issues of copyright, the economics of new media, and the specialized laws established to regulate a new subset of an existing industry.

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Peter Schultz at The Scripps Research Institute

Harvard Business School Case 910-408

Peter Schultz, Professor of Chemistry at The Scripps Research Institute, managed an extremely productive lab. This case examines how Schultz recruited, motivated, and inspired the students and scientists that worked with him.

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Root Capital

Harvard Business School Case 510-035

Founded in 1999, Root Capital had loaned $150 million to nearly 250 small and growing businesses, mainly in Latin America. In 2009, as the organization launched a five-year, $55 million capital campaign, it had to determine a strategic path going forward in keeping with its goal of achieving financial sustainability by 2013.

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The Termination of U.S. Auto Dealerships in 2009

Harvard Business School Case 510-044

The case chronicles the sudden termination of many U.S. autodealers in the wake of the economic crisis in the fall of 2008.

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