Knowledge that Transforms

We study a seller that starts with an initial inventory of goods, has a target horizon over which to sell the goods, and is subject to a set of financial milestone constraints on the revenues and sales that need to be achieved at different time points along the sales horizon. We characterize the revenue maximizing dynamic pricing policy for the seller and highlight the effect of revenue and sales milestones on its structure. The optimal policy can be written in feedback form, where the price at each point in time is selected so as to track the most stringent among all future milestones. Building on that observation, we propose a discrete-review policy that aims to dynamically track the appropriate milestone constraint and show that this simple and practical policy is near optimal in settings with large initial capacity and long sales horizons even in settings with no advance demand model information. One motivating application comes from the sales of new multiunit, residential real estate developments, where intermediate milestone constraints play an important role in their financing and construction. This paper was accepted by Gérard P. Cachon, stochastic models and simulation.

This paper studies the optimal contract between risk-neutral shareholders and a constant relative risk-aversion manager in a continuous-time model. Several interesting results are obtained. First, the optimal compensation is increasing but concave in output value if the manager is more risk averse than a log-utility manager. Second, when the manager has a log utility, a linear contract is optimal when there is no explicit lower bound on the compensation, and an option contract is optimal when there is an explicit lower bound. Third, optimal effort is stochastic (state dependent). Fourth, consistent with empirical findings and contrary to standard agency theory predictions, the relationship between pay-performance sensitivity and firm performance and that between pay-performance sensitivity and firm risk can be nonmonotonic. This paper was accepted by Wei Xiong, finance.

We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.16, higher than that of the market factor or the SMB and HML factors of Fama and French. According to rational frictionless asset pricing models, the ability of accruals to predict returns should come from the loadings on this accrual factor-mimicking portfolio. However, our tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings suggest that investors misvalue the accrual characteristic and cast doubt on the rational risk explanation. This paper was accepted by Brad Barber, Teck Ho, and Terrance Odean, special issue editors.

We integrate a case-based model of probability judgment with prospect theory to explore asset pricing under uncertainty. Research within the “heuristics and biases” tradition suggests that probability judgments respond primarily to case-specific evidence and disregard aggregate characteristics of the class to which the case belongs, resulting in predictable biases. The dual-system framework presented here distinguishes heuristic assessments of value and evidence strength from deliberative assessments that incorporate prior odds and likelihood ratios following Bayes' rule. Hypotheses are derived regarding the relative sensitivity of judged probabilities, buying prices, and selling prices to case- versus class-based evidence. We test these hypotheses using a simulated stock market in which participants can learn from experience and have incentives for accuracy. Valuation of uncertain assets is found to be largely case based even in this economic setting; however, consistent with the framework's predictions, distinct patterns of miscalibration are found for buying prices, selling prices, and probability judgments. This paper was accepted by Brad Barber, Teck Ho, and Terrance Odean, special issue editors.

This paper provides a novel explanation for the use of supply chain intermediaries. We find that even in the absence of the well-known transactional and informational advantages of mediation, intermediaries improve supply chain performance. In particular, intermediaries facilitate responsive adaptation of the buyers' supplier base to their changing needs while simultaneously ensuring that suppliers behave as if they had long-term sourcing commitments from buying firms. In the face of changing buyer needs, an intermediary that sources on behalf of multiple buyers can responsively change the composition of future business committed to a supplier such that a sufficient level of business comes from the buyer(s) that most prefer this supplier. On the other hand, direct buyers that source only for themselves must provide all their committed business to a supplier from their own sourcing needs, even if they no longer prefer this supplier. Unlike existing theories of intermediation, our theory better explains the observed phenomenon that although transactional barriers and information asymmetries have steadily decreased, the use of intermediaries has soared, even among large companies such as Walmart. This paper was accepted by Martin Lariviere, operations management.

We study an order promising problem in a multiclass, available-to-promise (ATP) assembly system in the presence of pseudo orders. A pseudo order refers to a tentative customer order whose attributes, such as the likelihood of an actual order, order quantity, and confirmation timing, can change dynamically over time. A unit demand from any class is assembled from one manufactured unit and one inventory unit, where the manufactured unit takes one unit of capacity and needs a single period to produce. An accepted order must be filled before a positive delivery lead time. The underlying order acceptance decisions involve trade-offs between committing resources (production capacity and component inventory) to low-reward firm orders and reserving resources for high-reward orders. We develop a Markov chain model that captures the key characteristics of pseudo orders, including demand lumpiness, nonstationarity, and volatility. We then formulate a stochastic dynamic program for the ATP assembly system that embeds the Markov chain model as a short-term forecast for pseudo orders. We show that the optimal order acceptance policy is characterized by class prioritization, resource-imbalance-based rationing, and capacity-inventory-demand matching. In particular, the rationing level for each class is determined by a critical value that depends on the resource imbalance level, defined as the net difference between the production capacity and component inventory levels. Extensive numerical tests underscore the importance of the key properties of the optimal policy and provide operational and managerial insights on the value of the short-term demand forecast and the robustness of the optimal policy. This paper was accepted by Martin Lariviere, operations management.

We propose a new method for measuring the quality of banks' credit portfolios. This method makes use of information embedded in bank share prices by exploiting differences in their sensitivity to credit default swap spreads of borrowers of varying quality. The method allows us to derive a credit risk indicator (CRI). This indicator represents the perceived share of high-risk exposures in a bank's portfolio and can be used as a risk weight for computing regulatory capital requirements. We estimate CRIs for the 150 largest U.S. bank holding companies. We find that their CRIs are able to forecast bank failures and share price performances during the crisis of 2007–2009, even after controlling for a variety of traditional asset quality and general risk proxies. This paper was accepted by Wei Xiong, finance.

We consider a supply chain with a single supplier and two retailers. The retailers choose their orders strategically, and if their orders exceed the supplier's capacity, quantities are allocated proportionally to the orders. We experimentally study the capacity allocation game using subjects motivated by financial incentives. We find that the Nash equilibrium, which assumes that players are perfectly rational, substantially exaggerates retailers' tendency to strategically order more than they need. We propose a model of bounded rationality based on the quantal response equilibrium, in which players are not perfect optimizers and they face uncertainty in their opponents' actions. We structurally estimate model parameters using the maximum-likelihood method. Our results confirm that retailers exhibit bounded rationality, become more rational through repeated game play, but may not converge to perfect rationality as assumed by the Nash equilibrium. Finally, we consider several alternative behavioral theories and show that they do not explain our experimental data as well as our bounded rationality model. This paper was accepted by loana Popescu, guest editor, operations management.

We propose a measure of managerial ability, based on managers' efficiency in generating revenues, which is available for a large sample of firms and outperforms existing ability measures. We find that our measure is strongly associated with manager fixed effects and that the stock price reactions to chief executive officer (CEO) turnovers are positive (negative) when we assess the outgoing CEO as low (high) ability. We also find that replacing CEOs with more (less) able CEOs is associated with improvements (declines) in subsequent firm performance. We conclude with a demonstration of the potential of the measure. We find that the negative relation between equity financing and future abnormal returns documented in prior research is mitigated by managerial ability. Specifically, more able managers appear to utilize equity issuance proceeds more effectively, illustrating that our more precise measure of managerial ability will allow researchers to pursue studies that were previously difficult to conduct. This paper was accepted by Mary E. Barth, accounting.

This paper examines the relationship between information technology (IT) and trademarks. Using an 11-year panel data set (1987–1997) of IT capital stock, trademark holdings, and other measures for 116 Fortune 1000 manufacturing firms, we find that IT contributes to higher trademark holdings. Further, we find evidence suggesting that firms with more IT capital tend to apply for more new trademarks and retire existing trademarks more quickly, leading to a shorter trademark life cycle. Because trademarks are mainly used by firms to communicate differences among similar products to the marketplace, these results suggest that the business value of IT can be realized in greater product variety. This paper was accepted by Barrie Nault, information systems.