Knowledge that Transforms

We develop a model for valuing revenue streams from innovations. The stochastic properties of revenue from innovations create a more difficult environment in which to value options than when the underlying is a security. There is no initial revenue, and cumulative revenue cannot decrease. Revenues from innovations are characterized by different lives and different rates of the resolution of uncertainty. A common deterministic model for predicting revenue from an innovation is known as the Bass model. We embed the Bass model in a gamma process, resulting in a stochastic process with moments proportional to the mean of the Bass model. To illustrate this model we choose the valuation of options on movie box office revenue. These options enable film distributors to manage the risk of a movie, and they offer diversification opportunities for investors. We develop the econometric methodology for ex ante parameter estimation and a Bayesian updating scheme using Markov chain Monte Carlo simulation as data after release become available. Call prices obtained using the maximum likelihood (ML) parameter estimates from the full data set closely approximate the average discounted value of ex post call payouts that would have occurred at option maturity.

An important managerial question is the choice of the pricing rule. We study whether this choice depends on the uncertainty about the number of participating bidders by comparing expected revenues under discriminatory and uniform pricing within an auction model with affiliated values, stochastic number of bidders, and linear bidding strategies. We show that if uncertainty about the number of bidders is substantial, then the discriminatory pricing generates higher expected revenues than the uniform pricing. In particular, the first-price auction might generate higher revenues than the second-price auction. Therefore, uncertainty about the number of bidders is an important factor to consider when choosing the pricing rule. We also study whether eliminating this uncertainty, i.e., revealing the number of bidders, is in the seller's interests, and discuss the existence of an increasing symmetric equilibrium.

Entrepreneurs play a fundamental role in bringing new technologies to market. Because technologies are often configurable to serve a variety of different markets, it is possible for entrepreneurs to identify multiple market opportunities prior to the first market entry of their emerging firms, and if they elect to do so, to therefore have a choice of which market to enter first. The empirical results presented in this paper offer three new insights regarding this important early-stage choice in new firm creation. First, they reveal that serial entrepreneurs have learned through prior start-up experience to generate a “choice set” of alternative market opportunities before deciding which one to pursue in their new firm creation. Second, the analysis indicates that entrepreneurs who identify a “choice set” of market opportunities prior to first entry derive performance benefits by doing so. Third, the positive relationship between the number of market opportunities identified prior to first entry and new firm performance is nonlinear and subject to decreasing marginal return. The research literature has yet to acknowledge the notion of multiple opportunity identification prior to entry, and the related idea of selecting the most favorable market opportunity for the creation of a new technology firm.

The strength of bargainers' preferences for fair settlements has important implications for predicting negotiation outcomes and guiding bargaining strategy. Existing literature reports a few calibration exercises for social utility models, but the predictive accuracy of these models for out-of-sample forecasting remains unknown. Therefore, we investigate whether fairness considerations are stable enough across bargaining situations to be quantified and used to forecast bargaining behavior accurately. We develop a model that embeds a preference for fair treatment in a quantal response framework to account for noise and experience. In addition, we estimate preference for fairness (willingness to pay) using the simplest, one-round version of sequential bargaining games and then employ it to perform out-of-sample forecasts of multiple-round games of various lengths, discount factors, pie sizes, and levels of bargainer experience. Except in circumstances in which the bargaining pie is very small, the fitted model has significant and substantial out-of-sample explanatory power. The stability we find implies that the model and techniques might ultimately be extended to estimates of the influence of fairness on field negotiations, as well as across subpopulations.

The effects of appropriability on invention have been well studied, but there has been little analysis of the effect of appropriability on the commercialization of existing inventions. Exploiting a database of 805 attempts by private firms to commercialize inventions licensed from the Massachusetts Institute of Technology (MIT) between 1980 and 1996, we explore the influence of several appropriability mechanisms on the commercialization and termination of projects to develop products based on university inventions. Our central hypothesis is that the relationship between a licensee's decision to either terminate or commercialize the invention is driven by the current market value of the invention, as well as the option value of delaying its commercialization. We use a competing risks framework that allows for nonparametric heterogeneity and correlated risks. We find that better appropriability in the sense of more effective patent strength and secrecy has a strong negative effect on the hazard of license termination. The effectiveness of learning has a strong positive effect on the hazard of technology commercialization, while lead time has a negative effect.

The profitability of remanufacturing systems for different cost, technology, and logistics structures has been extensively investigated in the literature. We provide an alternative and somewhat complementary approach that considers demand-related issues, such as the existence of green segments, original equipment manufacturer competition, and product life-cycle effects. The profitability of a remanufacturing system strongly depends on these issues as well as on their interactions. For a monopolist, we show that there exist thresholds on the remanufacturing cost savings, the green segment size, market growth rate, and consumer valuations for the remanufactured products, above which remanufacturing is profitable. More important, we show that under competition remanufacturing can become an effective marketing strategy, which allows the manufacturer to defend its market share via price discrimination.

We analyze the effect of external financing concerns on managers' financial reporting behavior prior to management buyouts (MBOs). Prior studies hypothesize that managers intending to undertake an MBO have an incentive to manage earnings downward to reduce the purchase price. We hypothesize that managers also face a conflicting reporting incentive associated with their efforts to obtain external financing for the MBO and to lower their financing cost. Consistent with our hypothesis, we find that managers who rely the most on external funds to finance their MBOs tend to report less negative abnormal accrual prior to the MBOs. In addition, the relation between external financing and abnormal accruals is tempered when there are more fixed assets that can serve as collateral for debt financing.

In this paper, we explore how organizations influence the unethical behavior of their employees. Using a unique data set of over three million vehicle emissions tests, we find strong evidence of ethical spillovers from firms to individuals. When inspectors work across different organizations, they adjust the rate at which they pass vehicles to the norms of those with whom they work. These spillovers are strongest at large facilities and corporate chains, and weakest for the large-volume inspectors. These results are consistent with the economics literature on productivity spillovers from organizations and peers and suggest that managers can influence the ethics of employee behavior through both formal norms and incentives. The results also suggest that employees have persistent ethics that limit the magnitude of this influence. These results imply that if ethical conformity is important to the financial and legal health of the organization, managers must be vigilant in their hiring, training, and monitoring to ensure that employee behavior is consistent with firm objectives.

In this paper, we present a finite sample analysis of the sample minimum-variance frontier under the assumption that the returns are independent and multivariate normally distributed. We show that the sample minimum-variance frontier is a highly biased estimator of the population frontier, and we propose an improved estimator of the population frontier. In addition, we provide the exact distribution of the out-of-sample mean and variance of sample minimum-variance portfolios. This allows us to understand the impact of estimation error on the performance of in-sample optimal portfolios.

This paper studies the influence of supply-side and demand-side factors on the compensation of information technology (IT) professionals and considers the human capital and institutional explanations. We focus on returns to an MBA and the IT-related experience of IT professionals and use the largest data set of IT professionals that has been compiled to date in the United States to answer our research questions. We find that firms pay a significant premium for an MBA. Although firms value the IT experience of IT professionals, they value an MBA significantly more. The results of this study cast doubt on the belief that IT skills have a large firm-specific component. Although IT experience is valued more than non-IT experience for IT professionals, firms value IT experience at other firms much more than they value firm-specific IT experience. Likewise, contrary to popular perception, we do not find evidence for complementarities between an MBA education and IT experience. Among institutional effects, firms in IT and IT-intensive industries pay significantly more to IT professionals than do other firms, and dot-com firms also paid a significant premium in 1999 and 2000. However, these firms do not value an MBA or firm-specific IT experience any more than other firms. We discuss the implications of these findings for further research, for firms' compensation practices, and for individual IT professionals.