First Look

Abstract—This paper investigates how dealers’ trading relationships shape their trading behavior in the corporate bond market. Dealers charge lower spreads to dealers with whom they have the strongest ties, and more so during periods of market turmoil. Systemically important dealers exploit their connections at the expense of peripheral dealers as well as clients, charging higher markups than to other core dealers. We also show that intermediation chains lengthened by 20% following the collapse of a flagship dealer in 2008 and even more for institutions strongly connected to this dealer. Finally, dealers drastically reduced their inventory during the crisis.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=51405

Abstract—We estimate the causal effect of sovereign default on the equity returns of Argentine firms. We identify this effect by exploiting changes in the probability of Argentine sovereign default induced by legal rulings in the case of Republic of Argentina v. NML Capital. We find that a 10% increase in the probability of default causes a 6% decline in the value of Argentine equities and a 1% depreciation of a measure of the exchange rate. We examine the channels through which a sovereign default may affect the economy.

Abstract—This study examines the geography of the global wind energy industry before 2000. Between 1980 and 2000, the global generating capacity of wind power grew from 13 megawatts to 17,400 megawatts, but two-thirds of that capacity was in Denmark, Germany, Spain, and the United States. Wind turbine manufacture was clustered in Denmark and the United States through to the late 1980s, when there was a sudden rise of new entrants, especially Germany. The study shows that natural resource endowment is a poor explanatory variable for this geographical skewing. Public policy was a more important factor, although its impact was nuanced. The most important policy development was in California with the adoption of feed-in tariffs, subsidies, and tax credits in the 1980s. However the poor technological capabilities of U.S.-based firms meant that it was Danish and other foreign companies that benefitted most. Subsequently the combination of public policies to grow wind energy and local manufacturer requirements provided a major stimulus for the emergence of local firms in Germany and Spain. U.S. firms were unable to develop internationally competitive products partly because of a rush to capture lucrative contracts dependent on transient public policies and partly because of a failure to develop institutional structures for the industry as a whole.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52613

Abstract—Many senior executives struggle to describe how they make strategic decisions. That’s a serious problem since the process for making strategic decisions can shape the strategy itself. To understand better how companies really make strategic choices, we interviewed 92 current CEOs, founders, and senior executives and asked each to answer detailed questions about his or her approach to strategic decision-making. Their replies revealed a typology of four approaches. Our results can’t say that any single approach to strategy is always best, but we do offer some evidence that one of the approaches is often flawed.

Publisher's link: http://www.hbs.edu/faculty/Pages/item.aspx?num=52604

Abstract—What is the optimal form of firm organization during “bad times”? Using two large micro datasets on firm decentralization from U.S. administrative data and 10 OECD countries, we find that firms that delegated more power from the Central Headquarters to local plant managers prior to the Great Recession outperformed their centralized counterparts in sectors that were hardest hit by the subsequent crisis. We present a model where higher turbulence benefits decentralized firms because the value of local information and urgent action increases. Since turbulence rises in severe downturns, decentralized firms do relatively better. We show that the data support our model over alternative explanations such as recession-induced reduction in agency costs (due to managerial fears of bankruptcy) and changing coordination costs. Countries with more decentralized firms (like the U.S.) weathered the 2008–2009 Great Recession better: these organizational differences could account for about 16% of international differences in post-crisis GDP growth.

Abstract—Platform, open/user innovation, and ecosystem strategies embrace and enable interactions with external entities. Firms pursuing these approaches conduct business and interact with environments differently than those pursuing traditional closed strategies. This paper considers these strategies together highlighting similarities and differences between platform, open/user innovation, and ecosystem strategies. We focus on managerial and organizational challenges for organizations pursuing these strategies and identify four institutional logic shifts associated with these strategic transitions: 1) increasing external focus, 2) moving to greater openness, 3) focusing on enabling interactions, and 4) adopting interaction-centric metrics. As mature incumbent organizations adopt these strategies, there may be tensions and multiple conflicting institutional logics. Additionally, we consider four strategic leadership topics and how they relate to platform, open/user innovation, and ecosystem strategies: 1) executive orientation and experience, 2) top management teams, 3) board-management relations, and 4) executive compensation. We discuss theoretical implications and consider future directions and research opportunities.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52312

Abstract—Equity compensation is widely used for incentivizing skilled employees, particularly in new technology businesses. Traditional theories explaining why firms offer equity suggest that workers with higher rank should receive compensation packages more heavily weighted in equity. However, we observe the puzzle that many firms adopt an equality-in-equity strategy: they offer different cash salaries across all jobs but the same equity compensation. We propose a behavioral theory of domain-contingent inequality aversion to explain this finding: we argue that workers view salary and equity as two domains and are more inequality averse in the equity domain. Inequality in equity has a negative asymmetric effect on effort whereas the effect of inequality in salary can be positive. Our experimental findings are consistent with the existence of domain-contingent inequality aversion; we also find that inequality aversion in equity is more severe than in salary because of the perceived scarcity of equity.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=52605

Abstract—Relative performance metrics are widely used as a lens with which market participants judge and incentivize managerial performance. But such measures' informativeness about managerial effort and talent depends critically on the judicious selection of peer firms as performance benchmarks. By evaluating the efficacy of firms' chosen relative TSR benchmarks in performance-based contracts, we document that, relative to a normative benchmark, index-based benchmarks perform 14% worse in their time-series return-regression R2 and 16% worse in measurement error variance; firms' choices of specific peers only modestly underperform. Calibration estimates suggest that, in the absence of frictions, the underperformance of index-based benchmarks implies a counterfactual performance penalty of 106–277 basis points in annual returns. Consistent with these estimates, firms that choose index-based benchmarks exhibit lower annual returns and ROA. Finally, reduced-form analyses suggest that the inefficient benchmarking is associated with governance-related frictions. Collectively, these findings provide new evidence on the explicit practice of using relative performance benchmarks and on its implications for corporate governance and firm performance.

Abstract—Why do incumbent firms so frequently reject non-incremental innovations? One reason is due to the firm’s top management team’s (TMT) lack of frame flexibility, i.e., an inability to expand the organization’s categorical boundaries so as to encompass a wider range of emotionally resonate capabilities in the context of innovative change. For incumbent firms, we argue that the way the TMT cognitively thinks about, and emotionally frames, non-incremental innovation and organizational capabilities drives innovation adoption. We show that frame flexibility is both cognitive, through claimed beliefs and understandings, and emotional, through claimed appeals to feelings and aspirations. First, we reexamine an assumption that cognitive frames are static and suggest how they evolve to become flexible—via shifts in perceived categorical hierarchies and in the ability to reconcile incompatible organizational capabilities. Second, we theorize and attend to the role of emotional frames in innovation adoption. Thus, we advance a model that articulates how cognitive and emotional framing affects the likelihood of non-incremental innovation adoption and, over time, the breadth of the organization’s innovation practices. We delineate these processes, as well as the internal and external contingencies that influence them and offer directions for future research.

Abstract—In the presence of managerial short-termism and asymmetric information about skill and effort provision, firms may opportunistically shift earnings from uncertain to more certain times. We document empirically that when financial markets are less certain about a firm's future value, the firm reports more negative discretionary accruals. Stock-price responses to earnings surprises are moderated when firm-level uncertainty is high, consistent with performance being attributed more to luck rather than skill and effort, which can create incentives to shift earnings toward lower-uncertainty periods. We document that the resulting opportunistic earnings management is concentrated in CEOs, firms, and periods where such incentives are likely to be strongest: (1) where CEO wealth is sensitive to change in the share price, (2) where announced earnings are particularly likely to be an important source of information about managerial ability and effort, and (3) before implementation of Sarbanes-Oxley made opportunistic earnings management more challenging. Our evidence highlights a novel channel through which uncertainty affects managerial decision making in the presence of agency conflicts.

Download working paper: http://www.hbs.edu/faculty/Pages/item.aspx?num=50792

In 2016, Fitbit remained the world’s leading producer of activity trackers—an increasingly crowded space—with over 21 million units sold that year. Fitbit’s suite of products allowed users to track the number of steps taken, calories burned, and heart rate activity. Fitbit devices were marketed to individual consumers as well as corporate wellness programs and employers. Though Fitbit was primarily focused on wellness, should management consider evolving into a chronic disease management company?

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Sesame Workshop was transforming in 2016. CEO Jeff Dunn had reorganized and shifted the iconic institution to respond to digital disruption and a consensus culture. This case examines his efforts to turn Sesame Workshop around. It notes Sesame's storied history and the underlying financial troubles that Dunn confronted upon taking over in 2014. It shows how Dunn's leadership changes, increased communication, new partnership deals, and a focus on digital, sought speed, innovation, and accountability to better fulfill Sesame's educational mission. By 2016, Sesame was in the middle of its change, and Dunn contemplated how best to position the organization for success in the future.

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BYJU’S The Learning App (BYJU’s) is India’s largest K-12 education app with about 300,000 annual paid subscribers. The mobile app uses a mix of video lessons and interactive tools to personalize learning for every student. Although there is room to grow exponentially in India, BYJU’s decides to enter the United States and other English speaking international markets. It believes that the United States has a large demand for “better learning,” a strong digital payment infrastructure, and a willingness to pay subscription fees. At the same time, winning in U.S.’s education market, where most students attend public schools and many ed-tech companies are proliferating, is challenging. Is it wise to expand to the U.S., even though India presents such a vast untapped opportunity with so many students in need?

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In June 2016, Benjamin (Bibi) Netanyahu, Prime Minister of Israel, wrestled with how to sustain Israel’s strong innovation track record and the country’s reputation as the “start-up nation.” Despite the economic miracle the country had wrought since its founding, he knew he could not be complacent. On the one hand, in 2015 Israeli start-ups raised record-breaking amounts of venture capital, and exits for the year totaled over $8 billion. On the other hand, government expenditure on R&D had decreased and Israel’s position in the Global Innovation Index had fallen. Several other indicators, such as achievement tests among elementary school students in math and science, painted a grim picture. Furthermore, in spite of the wealth created by many high-tech Israeli firms, socioeconomic gaps in the country had widened. A two-tier economy had formed. The long-term sustainability of the “innovation economy” was in doubt, as the sector faced increased competition from foreign innovation hubs, was being reshaped by the growth of Multinational Corporations (MNCs) locating R&D centers in Israel, and had to contend with a vexing shortage of human capital and low labor force participation among some groups. Netanyahu had to assess whether it was time to sound the alarm, and whether drastic and immediate measures were needed to right the innovation economy ship. Bibi mulled over which policies or interventions would best curb the erosion of Israel’s competitive position as an innovation powerhouse and how best to promote social equality. He pondered whether public policy could make a difference or whether the market and societal currents, responsible for these trends, were too strong for him and his government to try to contend with. Several prominent figures, including the Governor of the Central Bank of Israel, Knesset members, Israel’s Chief Scientist, prominent business leaders, academics, and journalists weigh in on the formation of the Israeli entrepreneurial and innovation ecosystem, the challenges it faces going forward, and what approaches might help it continue to thrive.

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In spring 2016, Kameda’s CEO, Michiyasu Tanaka, is facing difficult questions from board members over the lackluster performance of the company’s U.S. subsidiary. Kameda was the leading player in the Japanese rice cracker market and was looking to expand overseas to achieve growth, with the vision of becoming a global food company. Starting in 2008, it had tried to market its best-selling product in Japan, Kakinotane, as well as other types of rice-based snacks to U.S. consumers. Despite years of offering samples to consumers, modifications to the naming and packaging design, the addition of new flavors, changes in the supermarkets where it placed its product, and offering retailers slotting fees—sales were well below expectations and losses were mounting. The situation was especially baffling as the company believed that the gluten-free trend as well as a growing desire for healthier food should have bode well for its rice-based snacks; moreover, several Japanese food makers had recently achieved success in the U.S. (such as Calbee with Snapeas and Ito En with teas). On the bright side, Kameda’s recent acquisition of a U.S. company, Mary’s Gone Crackers, was showing steady sales growth, though profits were very low due to high manufacturing and raw ingredient costs, and distribution coverage was limited. Tanaka and his management team had only a few years to turn things around or consider closing the Kameda USA subsidiary. Every marketing element was on the table: from changing the packaging to rethinking the retail approach to accepting private label deals to investing in more efficient plants to partnering with a well-known U.S. brand in the snack food space. Could Tanaka save Kameda USA and dramatically improve the profits of Mary’s Gone Crackers?

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