First Look

September 17, 2013

Reducing Customer Churn

A process to reduce customer defections, or churn, is offered in the paper "Managing Churn to Maximize Profits," by Aurélie Lemmens and Sunil Gupta. Their system results in a customer ranking that yields, on average, a 115 percent improvement in profit compared to current methods, according to the scholars. "For a company like Verizon Wireless," they write, "this translates into a profit increase of at least $28 million from a single retention campaign, without any additional implementation cost."

How Firms Hide Bad News

Some companies call on bullish analysts during earnings calls in order to hide the revelation of bad financial news, according to the study Playing Favorites: How Firms Prevent the Revelation of Bad News." Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. More generally, "our key finding is that firms that manipulate their conference calls in this way appear to be hiding bad news, which ultimately leaks out in the future," report researchers Lauren Cohen, Dong Lou, and Christopher Malloy.

Estonia: Studying A Transition Economy

In 1991 the Soviet Union formally recognized the independence of Estonia—13 years later the tiny country was admitted to the European Union. A new case tracks Estonia's development during these years, offering students an opportunity to discuss policy reforms in a transition economy and other topics. The case, "Estonia: From Transition to EU Membership," was written by Michael E. Porter, Christian H.M. Ketels, and Orjan Solvell.

— Sean Silverthorne


  • September 2013
  • Management Science

Diasporas and Outsourcing: Evidence from oDesk and India

By: Ghani, Ejaz, William R. Kerr, and Christopher Stanton

Abstract—This study examines the role of the Indian diaspora in the outsourcing of work to India. Our data are taken from oDesk, the world's largest online platform for outsourced contracts, where India is the largest country in terms of contract volume. We use an ethnic name procedure to identify ethnic Indian users of oDesk in other countries around the world. We find very clear evidence that diaspora-based links matter on oDesk, with ethnic Indians in other countries 32% (9 percentage points) more likely to choose a worker in India. Yet, the size of the Indian diaspora on oDesk and the timing of its effects make clear that the Indian diaspora was not a very important factor in India becoming the leading country on oDesk for fulfilling work. In fact, multiple pieces of evidence suggest that diaspora use of oDesk increases with familiarity of the platform, rather than a scenario where diaspora connections serve to navigate uncertain environments. We further show that diaspora-based contracts mainly serve to lower costs for the company contacts outsourcing the work, as the workers in India are paid about the market wage for their work. These results and other observations lead to the conclusion that diaspora connections continue to be important even as online platforms provide many of the features that diaspora networks historically provided (e.g., information about potential workers, monitoring, and reputation foundations).

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  • September 2013
  • Frontiers in Perception Science

Unexpected Benefits of Deciding by Mind Wandering

By: Giblin, Colleen, Carey K. Morewedge, and Michael I. Norton

Abstract—The mind wanders, even when people are attempting to make complex decisions. We suggest that such mind wandering-allowing one's thoughts to wander until the "correct" choice comes to mind-can positively impact people's feelings about their decisions. We compare post-choice satisfaction from choices made by mind wandering to reason based choices and randomly assigned outcomes. Participants chose a poster by mind wandering or deliberating-or were randomly assigned a poster. Whereas forecasters predicted that participants who chose by mind wandering would evaluate their outcome as inferior to participants who deliberated (Experiment 1), participants who used mind wandering as a decision strategy evaluated their choice just as positively as did participants who used deliberate choice (Experiment 2). In some cases, people can spare themselves the trouble of deliberation and instead "decide by mind wandering" yet experience no decrease in satisfaction.

  • September 2013
  • Review of Financial Studies

Expectations of Returns and Expected Returns

By: Greenwood, Robin, and Andrei Shleifer

Abstract—We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.

  • September 2013
  • Management Science

The Stock Selection and Performance of Buy-Side Analysts

By: Groysberg, Boris, Paul Healy, George Serafeim, and Devin Shanthikumar

Abstract—Prior research on equity analysts focuses almost exclusively on those employed by sell-side investment banks and brokerage houses. Yet investment firms undertake their own buy-side research, and their analysts face different stock selection and recommendation incentives than their sell-side peers. We examine the selection and performance of stocks recommended by analysts at a large investment firm relative to those of sell-side analysts from mid-1997 to 2004. We find that the buy-side firm's analysts issue less optimistic recommendations for stocks with larger market capitalizations and lower return volatility than their sell-side peers, consistent with their facing fewer conflicts of interest and having a preference for liquid stocks. Tests with no controls for these effects indicate that annualized buy-side Strong Buy/Buy recommendations underperform those for sell-side peers by 5.9% using market-adjusted returns and by 3.8% using four-factor model abnormal returns. However, these findings are driven by differences in the stocks recommended and their market capitalization. After controlling for these selection effects, we find no difference in the performance of the buy- and sell-side analysts' Strong Buy/Buy recommendations.

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  • September 2013
  • Review of Financial Studies

The Growth and Limits of Arbitrage: Evidence from Short Interest

By: Hanson, Samuel G., and Adi Sunderam

Abstract—We develop a novel methodology to infer the amount of capital allocated to quantitative equity arbitrage strategies. Using this methodology, which exploits time-variation in the cross section of short interest, we document that the amount of capital devoted to value and momentum strategies has grown significantly since the late 1980s. We provide evidence that this increase in capital has resulted in lower strategy returns. However, consistent with theories of limited arbitrage, we show that strategy-level capital flows are influenced by past strategy returns as well as strategy return volatility, and that arbitrage capital is most limited during times when strategies perform best. This suggests that the growth of arbitrage capital may not completely eliminate returns to these strategies.

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  • September 2013
  • Organizational Behavior and Human Decision Processes

Cheating More for Less: Upward Social Comparisons Motivate the Poorly Compensated to Cheat

By: John, Leslie, George Loewenstein, and Scott Rick

Abstract—Intuitively, people should cheat more when cheating is more lucrative, but we find that the effect of performance-based pay rates on dishonesty depends on how readily people can compare their pay rate to that of others. In Experiment 1, participants were paid 5 cents or 25 cents per self-reported point in a trivia task, and half were aware that they could have received the alternative pay rate. Lower pay rates increased cheating when the prospect of a higher pay rate was salient. Experiment 2 illustrates that this effect is driven by the ease with which poorly compensated participants can compare their pay to that of others who earn a higher pay rate. Our results suggest that low pay rates are, in and of themselves, unlikely to promote dishonesty. Instead, it is the salience of upward social comparisons that encourages the poorly compensated to cheat.

  • September 2013
  • Empirical Methods in Natural Language Processing

Using Text Analysis to Target Government Inspections: Evidence from Restaurant Hygiene Inspections and Online Reviews

By: Kang, Jun Seok, Polina Kuznetsova, Yejin Choi, and Michael Luca

Abstract—Restaurant hygiene inspections are often cited as a success story of public disclosure. Hygiene grades influence customer decisions and serve as an accountability system for restaurants. However, cities (which are responsible for inspections) have limited resources to dispatch inspectors, which in turn limits the number of inspections that can be performed. We argue that Natural Language Processing (NLP) can be used to improve the effectiveness of inspections by allowing cities to target restaurants that are most likely to have a hygiene violation. In this work, we report the first empirical study demonstrating the utility of review analysis for predicting restaurant inspection results.

  • September 2013
  • Journal of Industrial Economics

Prizes, Publicity, and Patents: Non-Monetary Awards as a Mechanism to Encourage Innovation

By: Moser, Petra, and Tom Nicholas

Abstract—This paper exploits the selection of prize-winning technologies among exhibitors at the Crystal Palace Exhibition in 1851 to examine whether-and how-ex post prizes that are awarded to high-quality innovations may encourage future innovation. U.S. patent data indicate a 40% increase after 1851 in patenting for prizewinners compared with other exhibits. Results are robust to controlling for technology-specific pre-trends and for the quality of patents. A comparison of changes in patenting for prizewinners with changes for technologies that were described on the front page of the Scientific American suggests that publicity for promising research fields may be an important mechanism by which ex post prizes encourage future innovation.

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  • September 2013
  • Academy of Management Perspectives

Organizational Ambidexterity: Past, Present and Future

By: O'Reilly, Charles A., III, and Michael Tushman

Abstract—Organizational ambidexterity refers to the ability of an organization to both explore and exploit-to compete in mature technologies and markets where efficiency, control, and incremental improvement are prized and to also compete in new technologies and markets where flexibility, autonomy, and experimentation are needed. In the past 15 years there has been an explosion of interest and research on this topic. We briefly review the current state of the research, highlighting what we know and don't know about the topic. We close with a point of view on promising areas for ongoing research.


Working Papers

Abstract—Although Strategy research aims to understand how firm actions have differential effects on performance, most empirical research estimates the average effects of these actions across firms. This paper promotes Random Coefficients Models (RCMs) as an ideal empirical methodology to study firm heterogeneity in Strategy research. Specifically, we highlight and illustrate three main benefits that RCMs offer to Strategy researchers-testing firm heterogeneity, predicting firm-specific effects, and estimating trade-offs in strategy-using both synthetic and actual datasets. These examples showcase the potential uses of RCMs to test and build theory in Strategy, as well as to perform exploratory and definitive analyses of firm heterogeneity.

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Investment Incentives in Open-Source and Proprietary Two-Sided Platforms

By: Casadesus-Masanell, Ramon, and Gaston Llanes

Abstract—We study incentives to invest in platform quality in open-source and proprietary two-sided platforms. Open platforms have open access, and developers invest to improve the platform. Proprietary platforms have closed access, and investment is done by the platform owner. We present five main results. First, open platforms may benefit from limited developer access. Second, an open platform may lead to higher investment than a proprietary platform. Third, opening one side of a proprietary platform may lower incentives to invest in platform quality. Fourth, the structure of access prices of the proprietary platform depends on (i) how changes in the number of developers affect the incentives to invest in the open platform and (ii) how investment in the open platform affects the revenues of the proprietary platform. Finally, a proprietary platform may benefit from higher investment in the open platform. This result helps explain why the owner of a proprietary platform such as Microsoft has chosen to contribute to the development of Linux.

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Playing Favorites: How Firms Prevent the Revelation of Bad News

By: Cohen, Lauren, Dong Lou, and Christopher Malloy

Abstract—We explore a subtle but important mechanism through which firms manipulate their information environments. We show that firms control information flow to the market through their specific organization and choreographing of earnings conference calls. Firms that "cast" their conference calls by disproportionately calling on bullish analysts tend to underperform in the future. Firms that call on more favorable analysts experience more negative future earnings surprises and more future earnings restatements. A long-short portfolio that exploits this differential firm behavior earns abnormal returns of up to 101 basis points per month. Further, firms that cast their calls have higher accruals leading up to call, barely exceed/meet earnings forecasts on the call that they cast, and in the quarter directly following their casting tend to issue equity and have significantly more insider selling.

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Abstract—In this study, we investigate the role of an important information-disclosure mechanism-patent publication-in facilitating transactions in the market for ideas. We do so by analyzing the effects of the American Inventor's Protection Act (AIPA) of 1999, which required, as of November 29, 2000, that U.S. patent applications be published 18 months after their filing rather than at the time of patent grant. We develop a simple theoretical framework that yields predictions about the effects of AIPA on the timing of licensing. We then test the predictions using a sample of 339 licenses of biomedical inventions protected by patent applications filed between 1995 and 2005. Consistent with the predictions, we find that post-AIPA patent applications experience a sharp increase in the probability of licensing after 18-month publication, and, on average, are 18 percentage points less likely than pre-AIPA patent applications to wait until allowance to be licensed. Even for patent applications that are not licensed until allowance, 18-month publication shortens the time to licensing. Overall, for inventors that choose to license, 18-month publication accelerates licensing by 8.5 months on average. We conclude that information disclosure through patent publications plays an important role in facilitating transactions in the market for ideas.

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Crowdsourcing Peer Firms: Evidence from EDGAR Search Traffic

By: Lee, Charles M.C., Paul Ma, and Charles C.Y. Wang

Abstract—Using Internet traffic patterns from the Securities and Exchange Commission Electronic Data-Gathering, Analysis, and Retrieval (EDGAR) website, we show that firms appearing in chronologically adjacent searches by the same individual are fundamentally similar on multiple dimensions. In fact, traffic-based peer firms identified by our algorithm significantly outperform peer firms based on six-digit Global Industry Classification Standard (GICS) groupings in explaining cross-sectional variations in base firms' stock returns, valuation multiples, forecasted and realized growth rates, research and development expenditures, and various other key financial ratios. Our results highlight the usefulness of EDGAR data, as well as the latent intelligence in search traffic patterns.

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Managing Churn to Maximize Profits

By: Lemmens, Aurélie, and Sunil Gupta

Abstract—Customer defection or churn is a widespread phenomenon that threatens firms across a variety of industries with dramatic financial consequences. To tackle this problem, companies are developing sophisticated churn management strategies. These strategies typically involve two steps-ranking customers based on their estimated propensity to churn, and then offering retention incentives to a subset of customers at the top of the churn ranking. The implicit assumption is that this process would maximize firm's profits by targeting customers who are most likely to churn. However, current marketing research and practice aims at maximizing the correct classification of churners and non-churners. Profit from targeting a customer depends on not only a customer's propensity to churn, but also on her spend or value, her probability of responding to retention offers, as well as the cost of these offers. Overall profit of the firm also depends on the number of customers the firm decides to target for its retention campaign. We propose a predictive model that accounts for all these elements. Our optimization algorithm uses stochastic gradient boosting, a state-of-the-art numerical algorithm based on stage-wise gradient descent. It also determines the optimal number of customers to target. The resulting optimal customer ranking and target size selection leads to, on average, a 115% improvement in profit compared to current methods. Remarkably, the improvement in profit comes along with more prediction errors in terms of which customers will churn. However, the new loss function leads to better predictions where it matters the most for the company's profits. For a company like Verizon Wireless, this translates into a profit increase of at least $28 million from a single retention campaign, without any additional implementation cost.

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The Impact of Conformance and Experiential Quality on Healthcare Cost and Clinical Performance

By: Senot, Claire, Aravind Chandrasekaran, Peter T. Ward, and Anita L. Tucker

Abstract—The quality of operational processes is an important driver of performance in hospitals. In particular, processes that reliably deliver both evidence-based and patient-centered care, which we call conformance and experiential quality respectively, have been argued to result in better clinical outcomes. However, hospitals, in general, struggle to perform well on these quality dimensions. Operations management theory suggests that this may be due to the cost involved in combining these dimensions. In other words, there may be a tradeoff between clinical and financial performance. To investigate this issue in detail, we use longitudinal data from 3,458 U.S. acute care hospitals and examine the relationships between conformance and experiential quality and two important dimensions of hospital performance: cost efficiency and clinical outcomes. We find that hospitals with high levels of both conformance and experiential quality demonstrate better clinical outcomes as measured by length of stay and readmissions, but have worse performance with regard to cost efficiency. This may result in hospitals inability to invest in both conformance and experiential quality due to the greater financial burden. We conclude by highlighting that although hospitals may need to persevere through a short-term financial hardship to achieve high levels of both conformance and experiential quality, financial performance benefits are likely to emerge in the longer term. Our results have implications for researchers and policy makers investigating the operational processes, clinical outcomes, and financial performance of hospitals.

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Abstract—Operational failures persist in hospitals, in part because employees work around them rather than attempt to prevent recurrence. Drawing on a process improvement tool-the Andon cord-we examine three work design components that may foster improvement-oriented behaviors: 1) blockages to prevent workarounds, 2) a support person to assist with problem-solving, and 3) education portraying operational failures as "waste" to be removed from the system. Using laboratory experiments, we test each component's impact on whether hospital nurses speak up about medication administration problems and contribute improvement ideas. We find that each component provides its own contribution to organizational performance. Blockages encourage people to suggest improvement ideas, while education sparks improvement suggestions even when there are no blockages. Blockages can backfire, however, if they are difficult to work around in a policy-compliant manner and problem-solving support is unavailable. Under these conditions, blockages led to a risky workaround associated with a 10X overdose of insulin. Risky workarounds can be mitigated with a readily available support person whose presence also elicits higher levels of speaking up about operational failures.

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Abstract—Management-By-Walking-Around (MBWA) is a widely adopted technique in hospitals that involves senior managers directly observing frontline work. However, few studies have rigorously examined its impact on organizational outcomes. This paper examines an improvement program based on MBWA in which senior managers observe frontline employees, solicit ideas about improvement opportunities, and work with staff to resolve the issues. We randomly selected 19 hospitals to implement the 18-month long MBWA-based improvement program; 56 work areas participated. We find that the program, on average, had a negative impact on performance. To explain this surprising finding, we use mixed methods to examine the impact of the work area's problem solving approach. Results suggest that prioritizing easy-to-solve problems was associated with improved performance. We believe this was because it resulted in greater action taking. A different approach was characterized by prioritizing high value problems, which was not successful in our study. We also find that assigning to senior managers responsibility for ensuring that identified problems get resolved resulted in better performance. Overall, our study suggests that senior managers' physical presence on their organizations' frontlines was not helpful unless it enabled active problem solving.

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Organizational Factors That Contribute to Operational Failures in Hospitals

By: Tucker, Anita L., W. Scott Heisler, and Laura D. Janisse

Abstract—The performance gap between hospital spending and outcomes is indicative of inefficient care delivery. Operational failures-breakdowns in internal supply chains that prevent work from being completed-contribute to inefficiency by consuming 10% of nurses' time (Hendrich et al. 2008, Tucker 2004). This paper seeks to identify organizational factors associated with operational failures with a goal of providing insight into effective strategies for removal. We observed nurses on medical/surgical units at two hospitals, shadowed support staff who provided materials, and interviewed employees about their internal supply chain's performance. These activities created a database of 120 operational failures and the organizational factors that contributed to them. We found that employees believed their department's performance was satisfactory, but poorly trained employees in other departments caused the failures. However, only 14% of the operational failures arose from errors or training. They stemmed instead from multiple organizationally driven factors: insufficient workspace (29%), poor process design (23%), and a lack of integration in the internal supply chains (23%). Our findings thus suggest that employees are unlikely to discern the role that their department's routines play in operational failures, which hinders solution efforts. Furthermore, in contrast to the "Pareto Principle," which advocates addressing "large" problems that contribute a disproportionate share of the cumulative negative impact of problems, the failures and causes were dispersed over a wide range of factors. Thus, removing failures will require deliberate cross-functional efforts to redesign workspaces and processes so they are better integrated with patients' needs.

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Cases & Course Materials

No abstract available.

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  • Harvard Business School Case 213-034

A Note on Valuation in Private Equity

This note will provide an overview of valuation methodologies in private equity.

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  • Harvard Business School Case 813-188 Growing a Filipino E-Commerce Company

AVA is a three-year old e-commerce company in the Philippines. From its early start mimicking the Gilt Groupe concept of online flash sales, the company has grown into a broader e-commerce platform for local fashion commerce. Oliver Segovia needs to evaluate where AVA should go next and answer some complicated personal questions. The case considers issues related to e-commerce platforms, diaspora-based international exchanges, business location choice, and global entrepreneurship broadly.

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  • Harvard Business School Case 713-479

Estonia: From Transition to EU Membership

The case discusses the economic development of Estonia, focusing on the period regaining independence from the Soviet Union in 1991 to 2007. It tracks the process from the initial transition towards a market economy to becoming an EU member country and profiles the economy, its key clusters, and the quality of its business environment in 2007 when the first signs of overheating were emerging. The case provides the background for a discussion of policy reforms in a transition economy and the role of legacy and geographical neighborhood in the process of economic upgrading.

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