Knowledge that Transforms

This paper investigates whether limited liability and moral hazard affect risk taking through motivated beliefs. On the one hand, limited liability encourages investors to take excessive risks. On the other, excessive risk taking makes it hard for investors to maintain a positive self-image when moral hazard is present. Using a novel experimental design, we show that subjects form motivated beliefs to self-justify their excessive risk taking. For the same investment opportunity, subjects invest more and are significantly more optimistic about the success of the investment if its failure can harm others. We show that more than one third of the investment increases under limited liability, and moral hazard can be explained through motivated beliefs. Moreover, through a treatment with limited liability but no moral hazard, we show that motivated beliefs are formed subconsciously and can lead to the paradoxical result of investors taking larger risks when their investment can harm a third party compared with when it cannot. These results underscore the importance of motivated beliefs in regulatory policy, emphasizing that policymakers must not only address bad incentives, but also address the role of bad beliefs. This paper was accepted by Bruno Biais, finance. Funding: Financial support by Deutsche Forschungsgemeinschaft [Grant CRC TRR 190, project number 280092119] is gratefully acknowledged. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.03947 .

This paper considers a firm’s investment decision determining the timing and capacity level in a dynamic setting with demand uncertainty. Its investment is financed by borrowing from a lender that has market power, generating a capital market inefficiency. We show that the firm’s investment is subject to double marginalization in the sense that the need for external financing results in a considerably smaller investment and thus, a reduction in welfare. In addition, we find that the presence of the bankruptcy option mitigates the double-marginalization effect unless the bankruptcy cost is small. The firm’s investment size is increasing in bankruptcy costs, albeit at the expense of an investment delay. Based on this, an increase of bankruptcy costs raises social welfare. This paper was accepted by Tomasz Piskorski, finance. Funding: X. Wen and H. Dawid gratefully acknowledge support from the Deutsche Forschungsgemeinschaft [Grant SFB 1283/2 2021–317210226]. The authors acknowledge financial support from the Center of Interdisciplinary Research at Bielefeld University [Research Group “Economic and Legal Challenges in the Advent of Smart Products”]. K. J. M. Huisman is appointed to a special chair at Tilburg University that is funded by ASML. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2023.01152 .

This paper develops a new approach to volatility ambiguity and studies its implications for equilibrium consumption, portfolio choice, and asset prices. Our approach does not require equivalence between priors. The measure of ambiguity is based on the statistical confidence in the reference model that can be assessed with sample statistics. The approach is analytically tractable and amenable to empirical/calibration analysis. A stochastic discount pricing formula is given. At sensible levels of volatility ambiguity, the empirical regularity of equity premium and consumption growth in U.S. data can be the equilibrium outcome of our model featuring a relative risk aversion (RRA) coefficient within a reasonable range. This paper was accepted by Will Cong, finance. Funding: H. Wang received financial support from the Tsinghua University Initiative Scientific Research Program [2023THZWJC20]. L. Zhang received financial support from the Tsinghua University Initiative Scientific Research Program [2021THZWJC28] and The National Natural Science Foundation of China [Grant 72473079]. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2022.02902 .

We study a class of robust assortment optimization problems that was proposed by Farias et al. [Farias VF, Jagabathula S, Shah D (2013) A nonparametric approach to modeling choice with limited data. Management Sci. 59(2):305–322]. The goal in these problems is to find an assortment that maximizes a firm’s worst-case expected revenue under all ranking-based choice models that are consistent with the historical sales data generated by the firm’s past assortments. We establish for various settings that these robust optimization problems can either be solved in polynomial time or can be reformulated as compact mixed-integer optimization problems. To establish our results, we prove that optimal assortments for these robust optimization problems have a simple structure that is closely related to the structure of revenue-ordered assortments. We use our results to show how robust optimization can be used to overcome the risks of estimate-then-optimize and the need for experimentation with ranking-based choice models in the overparameterized regime. This paper was accepted by Omar Besbes, revenue management and market analytics. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2021.04059 .

We find that, overall, blockholder diversity, i.e., the firm shareholder base including several different types of blocks, is detrimental to firm performance. We show that lagged disclosure, on exogenous predetermined dates, that reveals an increase in block diversity is followed by a negative market reaction. Firms held by heterogeneous blockholders consistently perform worse than firms held by homogeneous blockholders. Block diversity is particularly detrimental when uncertainty is high. Disagreement among shareholders (e.g., as reflected in the frequency of lawsuits being filed) increases when the blockholder base is diverse. We make our blockholder data set public for the benefit of other researchers. This paper was accepted by Victoria Ivashina, finance. Funding: This work was supported by the Israel Science Foundation [Grant 264/20], the Faculty of Business and Economics, University of Melbourne [Grant ECR00009FNL], and the Accounting and Finance Association of Australia and New Zealand [Grant 2020-033]. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2023.00528 .

The topic of related diversification is of fundamental interest to corporate strategy research. However, the understanding of how the potential for resource redeployment might encourage related diversification is limited. This paper explores the impact of the 2006 German real estate transfer tax (RETT) reform, which led to higher RETT rates but retained the exemption from RETT for corporate restructurings. We propose that firms might have reacted strategically to the threat of higher transfer taxes by combining related businesses into a portfolio, providing an efficient internal market for reallocating property assets in the event of business-specific shocks. Consistent with a dynamic perspective on relatedness, difference-in-differences analyses of the European retail market show that the probability of related diversification increased significantly for firms that were affected by the reform, relative to control firms. This finding contributes to the literature that links firm boundary choices to intertemporal economies of scope and offers new insights into the real effects of transfer tax policies. This paper was accepted by Alfonso Gambardella, business strategy. Funding: This work was supported by the Ministerio de Ciencia, Innovación y Universidades [Grant PID2020-115660GB-I00]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.02396 .

We examine how the supply of talent affected financial development based on an experiment that abruptly changed the allocation of talent in historical China. Under the meritocratic civil examination system, government service was the main employment for the Chinese intellectuals. The abolition of this system in 1905 reduced the status and wealth attached to government service, which led the intellectuals to turn to modern banking as a high-status sector of employment. We find that regions where there were more candidates for the civil examination produced more financial professionals after 1905, which translated to a greater development of modern banking. This paper was accepted by Lin William Cong, finance. Funding: C. Lin and C. Ma acknowledge the Research Grants Council of Hong Kong [Grant AoE/B-704/22-R], Y. Sun acknowledges the Young Scientists Fund of the National Natural Science Foundation of China [Grant 72203037] and the Fundamental Research Funds for the Central Universities in UIBE [Grant 20QD14; CXTD12-01], and Y. Xu acknowledges the Young Scientists Fund of the National Natural Science Foundation of China [Grant 72203013] for financial support. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.00456 .

We develop the operational data analytics (ODA) framework for the classical service design problem of [Formula: see text] systems. The customer arrival rate is unknown. Instead, some historical data of interarrival times are collected. The data-integration model, specifying the mapping from the arrival data to the service rate, is formulated based on the time-scaling property of the stochastic service process. Validating the data-integration model against the long-run average service reward leads to a uniformly optimal service rate for any given sample size. We further derive the ODA-predicted reward function based on the data-integration model, which gives a consistent estimate of the underlying reward function. Our numerical experiments show that the ODA framework can lead to an efficient design of service rate and service capacity, which is insensitive to model specification. The ODA solution exhibits superior performance compared with the conventional estimation-and-then-optimization solutions in the small sample regime. This paper was accepted by David Simchi-Levi, operations management. Funding: Z. Jiang’s research is supported by the National Natural Science Foundation of China [Grant 71931007]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2023.00655 .

Through a large-scale field experiment with 393,036 customers considering opening a credit card account with a nationwide retail bank, we investigate how providing transparency into an offering’s tradeoffs affects subsequent rates of customer acquisition and long-run engagement. Although we find tradeoff transparency to have an insignificant effect on acquisition rates, customers who were shown each offering’s tradeoffs selected different products than those who were not. Moreover, prospective customers who experienced transparency and subsequently chose to open an account went on to exhibit higher-quality service relationships over time. Monthly spending was 9.9% higher and cancellation rates were 20.5% lower among those who experienced transparency into each offering’s tradeoffs. Increased product use and retention accrued disproportionately to customers with prior category experience: more-experienced customers who were provided transparency spent 19.2% more on a monthly basis and were 33.7% less likely to defect after nine months. Importantly, we find that these gains in engagement and retention do not come at the expense of customers’ financial well-being: the probability of making late payments was reduced among customers who experienced transparency. We further find that the positive effects of tradeoff transparency on engagement and retention were attenuated in the presence of a promotion that provided financial incentives to choose particular offerings. Taken together, these results suggest that providing transparency into an offering’s tradeoffs may be an effective strategy for informing customer choices, leading to better outcomes for customers and firms alike. This paper was accepted by Vishal Gaur, operations management. Funding: Funding for this research, apart from the costs Commonwealth Bank of Australia internally incurred to support the experiment, was provided by Harvard Business School. R. W. Buell has received compensation from Commonwealth Bank of Australia in the past for executive education teaching. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.4985 .

The value of a firm’s service lies both in its workers and its relationship with clients. In this paper, we study the interaction between the client-specific experience accumulated by workers, poaching behaviour from clients, and strategic rotation of workers by firms. Using detailed personnel data from a security service firm, we show that an increase in client-specific experience increases both the productivity of workers and their probability of being poached. The firm reacts to this risk by rotating workers across multiple clients, and more frequently so for those workers more likely to be poached. Furthermore, we find that after a policy change that prohibited poaching, the firm sharply decreased the frequency of rotation, which in turn increased workers’ productivity. We propose a theoretical model that guides the empirical patterns and allows us to argue their external validity beyond our specific empirical setting. Finally, we provide survey evidence from the security service sector, demonstrating the consistency between our findings and industry observations. This paper was accepted by Lamar Pierce, organizations. Funding: S. Liu acknowledges financial support from the National Natural Science of China [Grants 72192844 and 72322006]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.02275 .