Management Science current issue

Management Insights

2009-06-10

No abstract available.

Mobility, Skills, and the Michigan Non-Compete Experiment

Marx, M., Strumsky, D., Fleming, L. — 2009-06-10

Whereas a number of studies have considered the implications of employee mobility, comparatively little research has considered institutional factors governing the ability of employees to move from one firm to another. This paper explores a legal constraint on mobility—employee non-compete agreements—by exploiting Michigan's apparently inadvertent 1985 reversal of its non-compete enforcement policy as a natural experiment. Using a differences-in-differences approach, and controlling for changes in the auto industry central to Michigan's economy, we find that the enforcement of non-competes indeed attenuates mobility. Moreover, non-compete enforcement decreases mobility more sharply for inventors with firm-specific skills and for those who specialize in narrow technical fields. The results speak to the literature on employee mobility while offering a credibly exogenous source of variation that can extend previous research on the implications of such mobility.

Employment Horizon and the Choice of Performance Measures: Empirical Evidence from Annual Bonus Plans of Loss-Making Entities

Matejka, M., Merchant, K. A., Van der Stede, W. A. — 2009-06-10

We examine the extent to which employment horizon concerns affect the relative emphasis on financial versus nonfinancial performance measures in annual bonus plans. We argue that managers of loss-making firms are likely to voluntarily or forcibly depart in the near future and, consequently, have a shorter employment horizon. Loss-making firms then need to increase the emphasis on forward-looking nonfinancial performance measures to motivate long-term effort of their managers. Thus, we hypothesize that the emphasis on nonfinancial performance measures is greater in loss making than in profitable firms even after controlling for the informativeness of earnings. We find consistent support for our hypothesis using different (archival, survey, and field) data sources and various proxies for short employment horizon and the emphasis on nonfinancial performance measures.

Formal Contracts in the Presence of Relational Enforcement Mechanisms: Evidence from Technology Development Projects

Ryall, M. D., Sampson, R. C. — 2009-06-10

Formal contracting addresses the moral hazard problems inherent in interfirm deals via explicit terms designed to achieve incentive alignment. Alternatively, when firms expect to interact repeatedly, relational mechanisms may achieve similar results without the associated costs. However, as we now know from a growing body of theoretical and empirical work, the resulting intuition—that relational mechanisms will be substituted for formal ones whenever possible—does not generally hold. The extent to which firms substitute relational mechanisms for formal ones in the presence of repeated interaction is an empirical question that forms the basis of this paper. We study a sample of 52 joint technology development contracts in the telecommunications and microelectronics industries and devise a coding scheme to allow empirical comparison of contract terms. Counter to the above intuition (but consistent with recent research), we find that a firm's contracts are more detailed and more likely to include penalties when it engages in frequent deals (whether with the same or different partners). Our results suggest complementarity between formal and relational contracts, and have implications for optimal contracting, particularly in high technology sectors.

Optimal Entry Timing in Markets with Social Influence

Joshi, Y. V., Reibstein, D. J., Zhang, Z. J. — 2009-06-10

Firms routinely face the challenging decision of whether to enter a new market where a firm's strong presence in an existing market has a positive influence (the leverage effect) on product adoption in the new market, but the reciprocal social influence on the existing market is negative (the backlash effect). In this paper, we show that a firm's optimal entry strategy in this situation cannot be characterized by the familiar "now or never" or "now or at maturity" strategies proposed in the literature. We show that a strong leverage effect does not necessarily provide the justification for a firm to enter a new market, and neither should a strong backlash effect necessarily deter a firm from embracing a new market. The optimal strategy is predicated on a judicious trade-off between the three factors of leverage, backlash, and patience. Thus, an astute manager can always find the opportune time to enter the new market if she takes into account the dynamic and recursive nature of cross-market interaction effects, where leverage enhances the backlash but backlash weakens the leverage in a nonlinear, dynamic fashion. We illustrate that firms stand to benefit from explicit considerations of these effects in deciding whether and when to enter a new market. Furthermore, we explore how the optimal time of entry into the new market relates to the time of peak sales for the existing market, demonstrating that depending on the interactive effects of leverage and backlash, entry could be optimal either before or after peak sales in the existing market.

Electronic and Physical Market Channels: A Multiyear Investigation in a Market for Products of Uncertain Quality

Overby, E., Jap, S. — 2009-06-10

Many markets that have traditionally relied on collocation of buyers, sellers, and products have introduced electronic channels. Although these electronic channels may provide benefits to buyers and sellers by lowering the transaction costs of participating in the market, there are trade-offs related to quality uncertainty and increased risk that may limit the adoption of the electronic channels. As a result, buyers and sellers use physical channels for some transactions and electronic channels for others. These usage patterns may evolve over time, particularly when the electronic channels are new. We examine buyer and seller use of electronic and physical channels in a market for products of uncertain quality (used vehicles) over a 2.5-year period. Results indicate that transactions involving low quality uncertainty and relatively rare products occurred in the electronic channels, whereas transactions involving high quality uncertainty and relatively plentiful products occurred in the physical channels. These patterns became clearer over time as buyers and sellers gained experience with the electronic channels. The electronic channels led to discounts for products of high quality uncertainty, but not for those of low quality uncertainty.

Pioneering Plus a Broad Product Line Strategy: Higher Profits or Deeper Losses?

Boulding, W., Christen, M. — 2009-06-10

Previous research suggests firms can build a market share advantage by preempting later entrants with a broad product line and expanding rapidly into related markets. Whether such a strategy leads to a pioneering profit advantage relative to followers also depends on its cost effects. In this paper, we examine when the market share advantage of a pioneering firm with a broad product line strategy translates into a profit advantage by examining the cost effects of this strategy. Using the profit impact of marketing strategies data and an estimation method that controls for various unobserved factors, we find significant differences between different industry settings. From these contrasting findings, we generate an emerging theoretical framework that we subject to empirical testing. We conjecture, and empirically verify, that creating a broad product line with a versioning strategy—creating variety from a standard product in anticipating customer demand—does not increase the pioneering cost disadvantage, and thus results in a pioneering profit advantage. On the other hand, with a tailoring strategy—creating variety by customizing a product to actual customer demand—a broad product line substantially increases the pioneering cost disadvantage, thereby making a preemption strategy counterproductive.

The Name-Your-Own-Price Channel in the Travel Industry: An Analytical Exploration

Wang, T., Gal-Or, E., Chatterjee, R. — 2009-06-10

Name-your-own-price (NYOP) retailers, such as Priceline, offer an alternative distribution channel for service providers in the travel industry such as airlines, hotels, and car rental companies. Our research employs an analytical model to identify and understand key trade-offs driving the decision by a service provider to employ an NYOP channel, assuming that such a channel is available. This decision requires the existence of forces that counteract the adverse consequences of cannibalization of sales through traditional posted-price channels. Our analysis provides some insight into these forces. Contracting with the NYOP retailer facilitates market segmentation and price discrimination, and allows for disposal of excess capacity after meeting business travel demand. However, the cost of this flexibility is that the service provider can no longer credibly precommit to maintaining high prices when there is unsold capacity. Also, when contracting with an independent retailer, the service provider is unable to extract the entire revenue generated from NYOP consumers. A key insight from our model is that the rationale for contracting with an NYOP retailer is driven by the uncertainty in business travel demand, not the expectation of excess capacity. Indeed, all else equal, the larger the capacity, the less likely it is that contracting with an NYOP retailer is the right decision on the part of the service provider.

When Is Price Discrimination Profitable?

Anderson, E. T., Dana, J. D. — 2009-06-10

We consider a general model of monopoly price discrimination and characterize the conditions under which price discrimination is and is not profitable. We show that an important condition for profitable price discrimination is that the percentage change in surplus (i.e., consumers' total willingness to pay, less the firm's costs) associated with a product upgrade is increasing in consumers' willingness to pay. We refer to this as an increasing percentage differences condition and relate it to many known results in the marketing, economics, and operations management literatures.

Jackknife Estimator for Tracking Error Variance of Optimal Portfolios

Basak, G. K., Jagannathan, R., Ma, T. — 2009-06-10

We develop a jackknife estimator for the conditional variance of a minimum tracking error variance portfolio constructed using estimated covariances. We empirically evaluate the performance of our estimator using an optimal portfolio of 200 stocks that has the lowest tracking error with respect to the S&P 500 benchmark when three years of daily return data are used for estimating covariances. We find that our jackknife estimator provides more precise estimates and suffers less from in-sample optimism when compared to conventional estimators.

Barter Markets for Conjoint Analysis

Ding, M., Park, Y.-H., Bradlow, E. T. — 2009-06-10

We propose a new alternative preference measurement method, barter conjoint, to contrast with traditional choice-based conjoint (CBC) approaches. Barter conjoint collects a substantially larger amount of data compared to CBC and allows for information diffusion among respondents. We conducted two empirical studies that compare CBC (with and without incentive alignment) and barter conjoint. The studies employed a total of three product categories, each with two validation tasks (one follows immediately and one conducted two weeks later). Our results confirmed prior research that incentive alignment, in general, substantially improves out-of-sample predictive performance of CBC. Furthermore, we found barter conjoint performs substantially better than the incentive-aligned CBC. However, in the spirit of "no free lunch," barter conjoint is more taxing (in various ways) than CBC, suggesting a potential trade-off between consumer resource allocation (at the time of the task) and (managerial) predictive accuracy downstream. Given that this is the first study on barter conjoint, we discuss various limitations of the current implementation and fruitful directions for future research.

Hindsight Bias, Risk Perception, and Investment Performance

Biais, B., Weber, M. — 2009-06-10

Once they have observed information, hindsight-biased agents fail to remember how ignorant they were initially; "they knew it all along." We formulate a theoretical model of this bias, providing a foundation for empirical measures and implying that hindsight-biased agents learning about volatility will underestimate it. In an experiment involving 66 students from Mannheim University, we find that hindsight bias reduces volatility estimates. In another experiment, involving 85 investment bankers in London and Frankfurt, we find that more biased agents have lower performance. These findings are robust to differences in location, information, overconfidence, and experience.

An Extension of the Internal Rate of Return to Stochastic Cash Flows

Hazen, G. — 2009-06-10

The internal rate of return (IRR) is a venerable technique for evaluating deterministic cash flow streams. Part of the difficulty in extending this measure to stochastic cash flows is the lack of coherent methods for accounting for multiple or nonexistent internal rates of return in deterministic streams. Recently such a coherent theory has been developed, and we examine its implications for stochastic cash flows. We devise an extension of the deterministic IRR, which we call the stochastic rate of return on mean investment. It has significant computational and conceptual advantages over the stochastic internal rate. For instance, in the deterministic case, the standard result is that under proper conditions a cash flow stream is acceptable (in the sense of positive present value) if its internal rate exceeds the interest rate. We show that a stochastic cash flow stream is acceptable (in the sense of positive certainty equivalent expected value) if the rate of return on mean investment has a suitably defined certainty equivalent exceeding the risk-free interest rate.

Forecast Accuracy Uncertainty and Momentum

Han, B., Hong, D., Warachka, M. — 2009-06-10

We demonstrate that stock price momentum and earnings momentum can result from uncertainty surrounding the accuracy of cash flow forecasts. Our model has multiple information sources issuing cash flow forecasts for a stock. The investor combines these forecasts into an aggregate cash flow estimate that has minimal mean-squared forecast error. This aggregate estimate weights each cash flow forecast by the estimated accuracy of its issuer, which is obtained from their past forecast errors. Momentum arises from the investor gradually learning about the relative accuracy of the information sources and updating their weights. Empirical tests validate the model's prediction of stronger momentum in stocks with large information weight fluctuations and high forecast dispersion. We also identify return predictability attributable to changes in the information weights.

Highbrow Films Gather Dust: Time-Inconsistent Preferences and Online DVD Rentals

Milkman, K. L., Rogers, T., Bazerman, M. H. — 2009-06-10

We report on a field study demonstrating systematic differences between the preferences people anticipate they will have over a series of options in the future and their subsequent revealed preferences over those options. Using a novel panel data set, we analyze the film rental and return patterns of a sample of online DVD rental customers over a period of four months. We predict and find that should DVDs (e.g., documentaries) are held significantly longer than want DVDs (e.g., action films) within customer. Similarly, we also predict and find that people are more likely to rent DVDs in one order and return them in the reverse order when should DVDs are rented before want DVDs. Specifically, a 1.3% increase in the probability of a reversal in preferences (from a baseline rate of 12%) ensues if the first of two sequentially rented movies has more should and fewer want characteristics than the second film. Finally, we find that as the same customers gain more experience with online DVD rentals, the extent to which they hold should films longer than want films decreases. Our results suggest that present bias has a meaningful impact on choice in the field, and that people may learn about their present bias with experience and, as a result, gain the capacity to curb its influence.

Strategic Resource Dynamics of Manufacturing Firms

Jayanthi, S., Roth, A. V., Kristal, M. M., Venu, L. C.-R. — 2009-06-10

We conceptualize strategic decision-making processes within a manufacturing firm as streams of resources allocated to short- and long-term changes. The analogous ecological model, referred to as the Lotka-Volterra model, captures this dynamic tension between decisions made by the firm and its manufacturing operations. This representation leads to evolutionarily stable manufacturing strategies (ESMSs), which contribute to a firm's competitive advantage in different ways. Using a random sample of 30 firms from the U.S. semiconductor industry, we estimate parameters of the model and arrive at four ESMSs or strategic manufacturing groups that reflect theoretically and empirically distinctive adaptation patterns through their dynamic resource allocations. We observe that a majority of the firms were classified in one of the four groups, with relatively fewer firms in the other three. Notably, our classification based on ecology models agrees well with taxonomies in manufacturing and business strategy theory. Furthermore, our analysis shows significant differences among manufacturing practices and competitive capabilities of the four strategic groups. Managerially, these insights could provide the foundation to implement strategic changes that enable firms to leapfrog from one ESMS to another. This study also paves the way for development of a meso theory of the dynamics of manufacturing strategy.