Knowledge that Transforms

Upward channel decentralization occurs when firms choose to not manufacture products by themselves and procure products from upstream suppliers. Current voices from marketing scholars and practitioners have predominantly focused on the cost benefits when production is outsourced to lower-cost upstream suppliers. In this paper, we study the effects of upward channel decentralization where competing firms can outsource their production to upstream suppliers who do not have any advantages on production costs. We show how downstream firms can still benefit from upward channel decentralization provided their product positioning is endogenous. Thus, we provide a new theory on the strategic benefits of upward channel decentralization. We also use this framework to show a new benefit to manufacturers selling through downstream retailers rather than directly. We examine the implications of our theory for consumer and social welfare, and also draw managerial implications.

Comarketing alliances often involve multiple partners, and a given partner's marketing efforts on behalf of the alliance can indirectly affect the demand of the other partners. Individual partners, however, can ignore the effects of such an externality and invest suboptimally to the detriment of the alliance. This paper examines the relative effectiveness of outcome- and action-based contracts in providing the alliance partners with the incentives to invest appropriately. We develop a mathematical model in which a focal firm (e.g., Sony) contracts with two partners (e.g., McDonald's and Old Navy) when each of these partners is privately informed about the impact of the alliance on its demand. Our analysis evaluates the strengths and weaknesses of outcome- (or output-) and action-based (or input-based) contracts in settings with varying levels of the demand externality. We find that when there is either no externality or a relatively weak positive externality, there is a strict preference for output-based contracts; that preference, however, is reversed with a sufficiently strong positive externality. This paper explains the underlying rationale for these findings.

We introduce two new methods to calculate bounds for zero-sum game options using Monte Carlo simulation. These extend and generalize upper-bound duality results to the case where both parties of a contract have Bermudan optionality. It is shown that the primal-dual simulation method can still be used as a generic way to obtain bounds in the extended framework, and we apply the new results to the pricing of convertible bonds by simulation.

This paper derives two mechanisms through which Bayesian-rational individuals with differing priors will tend to be relatively overconfident about their estimates and predictions, in the sense of overestimating the precision of these estimates. The intuition behind one mechanism is slightly ironic: In trying to update optimally, Bayesian agents overweight information of which they overestimate the precision and underweight in the opposite case. This causes overall an overestimation of the precision of the final estimate, which tends to increase as agents get more data.

This paper investigates the effect of founders' professional-education background on the adoption of an open-science technology strategy, using a sample of 512 young biotechnology firms. After controlling for founders' prior work experience and other organizational and environmental factors, I find that firms with proportionally more Ph.D.-holding entrepreneurs on the founding team have a higher probability of adopting open science. In addition, founders' educational background can mitigate the constraint of organizational environments on strategy. A crowded technological niche provides a more challenging environment for firms to implement open science, due to higher scooping risks. The deterrent effect, however, of such a high-risk environment is smaller among firms founded by proportionally more Ph.D.-holding entrepreneurs. There is also some evidence of a stronger effect of founders' educational background on open science in an institutional environment in which open science has yet to become the industry norm. This finding is consistent with and complements the growing body of research that emphasizes the importance of entrepreneurial background in developing knowledge about new-venture strategy and structure.

We develop a unified model of the interactions among investors, fund companies, and fund managers. We show that the interplay between a manager's incentives from her compensation structure and career concerns leads to a nonmonotonic (approximately U-shaped) relation between her risk choices and prior performance relative to her peers. Significantly outperforming (underperforming) managers are less (more) likely to be fired in the future and are also more likely to increase relative risk. Ceteris paribus, relative risk declines with the level of employment risk faced by a manager. Using a large sample of mutual fund managers, we find strong support for the hypothesized U-shaped relation between relative risk and prior performance. Our findings also highlight the importance of employment risk as the underlying driver of risk shifting by fund managers. Our theoretical model also generates additional hypotheses that link determinants of the fund flow–performance relation and managers' employment risk to their risk-taking behavior. In support, our empirical analysis shows that funds with higher expense ratios have less convex fund flow–performance relations and less convex U-shaped relations between relative risk and prior performance; funds with younger managers, who face greater employment risk, have more convex U-shaped relative risk–prior performance relations; and managers in larger fund families have lower incentives to engage in risk shifting, thereby leading to a less convex U-shaped relation.

This paper aims to extend the analytical tractability of the Black–Scholes model to alternative models with arbitrary jump size distributions. More precisely, we propose a jump diffusion model for asset prices whose jump sizes have a mixed-exponential distribution, which is a weighted average of exponential distributions but with possibly negative weights. The new model extends existing models, such as hyperexponential and double-exponential jump diffusion models, because the mixed-exponential distribution can approximate any distribution as closely as possible, including the normal distribution and various heavy-tailed distributions. The mixed-exponential jump diffusion model can lead to analytical solutions for Laplace transforms of prices and sensitivity parameters for path-dependent options such as lookback and barrier options. The Laplace transforms can be inverted via the Euler inversion algorithm. Numerical experiments indicate that the formulae are easy to implement and accurate. The analytical solutions are made possible mainly because we solve a high-order integro-differential equation explicitly. A calibration example for SPY options shows that the model can provide a reasonable fit even for options with very short maturity, such as one day.

This paper studies assortment planning and pricing for a product category with heterogeneous product types from two brands. We model consumer choice using the nested multinomial logit framework with two different hierarchical structures: a brand-primary model in which consumers choose a brand first, then a product type in the chosen brand, and a type-primary model in which consumers choose a product type first, then a brand within that product type. We consider a centralized regime that finds the optimal solution for the whole category and a decentralized regime that finds a competitive equilibrium between two brands. We find that optimal and competitive assortments and prices have quite distinctive properties across different models. Specifically, with the brand-primary model, both the optimal and the competitive assortments for each brand consist of the most popular product types from the brand. With the type-primary choice model, the optimal and the competitive assortments for each brand may not always consist of the most popular product types of the brand. Instead, the overall assortment in the category consists of a set of most popular product types. The price of a product under the centralized regime can be characterized by a sum of a markup that is constant across all products and brands, its procurement cost, and its marginal operational cost, implying a lower price for more popular products. The markup may be different for each brand and product type under the decentralized regime, implying a higher price for brands with a larger market share. These properties of the assortments and prices can be used as effective guidelines for managers to identify and price the best assortments and to rule out nonoptimal assortments. Our results suggest that to offer the right set of products and prices, category and/or brand managers should create an assortment planning process that is aligned with the hierarchical choice process consumers commonly follow to make purchasing decisions.

This paper studies how covenants are included in contracts between venture capitalists (VCs) and entrepreneurs. I show that VCs hold covenanted veto rights even though they are shareholders who have access to other powerful governance solutions. Unlike bank loans and bonds, venture capital (VC) contracts exhibit considerable variation in their contractual designs. I exploit this variation to confirm the argument that covenants are in place to overcome a conflict of interest that arises from debt-like contractual features of a venture capitalist's preferred stock. In particular, I find that contracts with higher fixed payoffs include 1.6 more covenants than do contracts with lower fixed payoffs. Similarly, VC contracts with no VC board majority requirement include 0.6 more covenants than do contracts that require a VC board majority. Covenants are also more common with older companies and when fewer VCs invest in a round. My findings contribute to both the debt covenant literature and the entrepreneurial finance literature.

We examine how firms can create word-of-mouth peer influence and social contagion by designing viral features into their products and marketing campaigns. To econometrically identify the effectiveness of different viral features in creating social contagion, we designed and conducted a randomized field experiment involving the 1.4 million friends of 9,687 experimental users on Facebook.com. We find that viral features generate econometrically identifiable peer influence and social contagion effects. More surprisingly, we find that passive-broadcast viral features generate a 246% increase in peer influence and social contagion, whereas adding active-personalized viral features generate only an additional 98% increase. Although active-personalized viral messages are more effective in encouraging adoption per message and are correlated with more user engagement and sustained product use, passive-broadcast messaging is used more often, generating more total peer adoption in the network. Our work provides a model for how randomized trials can identify peer influence in social networks.