Insanely Great
Do Entrepreneurs Want Control? And Should They Get What They Want? A Historical and Theoretical Exploration
Naomi Lamoreaux & Jean-Laurent Rosenthal
NBER Working Paper, April 2023
Abstract:
From Elihu Thomson and Herbert Dow in the late nineteenth century to Steve Jobs a hundred years later, many entrepreneurs have been stymied by their investors. In this paper, we use a simple model to explore how outcomes might have been different if entrepreneurs, instead of the investors, had control of their firms. We also explore the importance of legal rules that enable entrepreneurs to lock in control even when, under one-share-one-vote governance, power would rest with their investors. We find that entrepreneurs take advantage of such rules when the cost of capital is low, as in Britain in the early twentieth century or the US in the early twenty-first century. We also find that firms controlled by entrepreneurs can take on more difficult projects, and thus push the technological frontier out more rapidly, than firms controlled by investors. Such firms are also superior in this way to serial startups.
Conflict, Chaos, and the Art of Institutional Design
Scott Ganz
Organization Science, forthcoming
Abstract:
The metaphor of an organization as a garbage can is often invoked as a playful insult. However, as was recognized early on by management theorists studying garbage can ideas, the unpredictability arising from garbage can decision making has the potential to be adaptively rational for organizations facing complex task environments. The chaos produced by preference conflict and fluid participation in collective decision making can aid in search by enabling organizations to escape local performance peaks or competency traps. The decades-old hypothesis that conflict and chaos could promote adaptively rational search, however, has largely been overlooked in research on organizational design. This paper uses an agent-based model to evaluate these competing views and, in the process, identify conditions under which garbage can decision making is adaptively rational for executives searching for high-quality strategies. I show that the biased and chaotic outcomes that emerge as a result of garbage can decision making -- the very features of garbage cans that lead them to be perceived to be dysfunctional -- can facilitate short-term exploitation and long-term exploration of uncertain technical landscapes when organizations engage in serial judgment of local alternatives if internal conflict over desired outcomes is not too extreme. I conclude that decision-making routines that encourage chaotic conflict are robust to bounded rationality and complex task uncertainty and thus should be included in the organizational designer’s portfolio.
Labor Unemployment Risk and CEO Incentive Compensation
Andrew Ellul, Cong Wang & Kuo Zhang
Management Science, forthcoming
Abstract:
Unemployment risk influences workers’ incentives to invest in firm-specific human capital. This paper investigates the impact of unemployment risk on chief executive officers (CEOs)’ risk-taking incentive compensation. Exploiting state-level changes in unemployment benefits, we find that after unemployment insurance benefits become more generous, boards increase the convex payoff structure of CEO pay to encourage risk taking. The increase in CEOs’ convexity payoff is stronger in firms with more independent and diverse boards, higher ownership of long-term shareholders, and in industries requiring highly skilled labor. Our findings suggest that boards internalize workers’ interests in firms’ risk-taking decisions and executive compensation is one mechanism used.
What Purpose Do Corporations Purport? Evidence from Letters to Shareholders
Raghuram Rajan, Pietro Ramella & Luigi Zingales
NBER Working Paper, March 2023
Abstract:
Using natural language processing, we identify corporate goals stated in the shareholder letters of the 150 largest companies in the United States from 1955 to 2020. Corporate goals have proliferated, from less than one on average in 1955 to more than 7 in 2020. While in 1955, profit maximization, market share growth, and customer service were dominant goals, today almost all companies proclaim social and environmental goals as well. We examine why firms announce goals and when. We find goal announcements are associated with management’s responses to the firm’s (possibly changed) circumstances, with the changing power and preferences of key constituencies, as well as from management’s attempts to deflect scrutiny. While executive compensation is still overwhelmingly based on financial performance, we do observe a rise in bonus payments contingent on meeting social and environmental objectives. Firms that announce environmental and social goals tend to implement programs intended to achieve those goals, although their impact on outcomes is unclear. The evidence is consistent with firms focusing on shareholder interests while incorporating stakeholder interests as interim goals. Goals also do seem to be announced opportunistically to deflect attention and alleviate pressure on management.
Board experiential diversity and corporate radical innovation
Aurora Genin et al.
Strategic Management Journal, forthcoming
Abstract:
How does board experiential diversity affect corporate radical innovation? We find that the combined diversity of directors' educational, industrial, and organizational experiences spurs the quantity and quality of path-breaking patents developed at a firm. Instrumental variable analysis leveraging exogenous variation in firm access to the nonlocal supply of directors with diverse experiences indicates causality, which is corroborated by difference-in-differences tests. Firm heterogeneity suggests experientially diverse directors spur radical innovation by better serving the firm's advisory needs rather than via improved governance. Our findings enrich theoretical insights into how corporate board leadership may affect innovation and long-term value creation at the firm.
Asymmetric Information and R&D Disclosure: Evidence from Scientific Publications
Stefano Baruffaldi, Markus Simeth & David Wehrheim
Management Science, forthcoming
Abstract:
We examine how asymmetric information in financial markets affects voluntary research and development (R&D) disclosure, considering scientific publications as a disclosure channel. Difference-in-differences regressions around brokerage house mergers and closures, which increase information asymmetry through reductions in analyst coverage, indicate a quick and sustained increase in scientific publications from treated firms relative to the number of publications from control firms. The treatment effects are concentrated among firms with higher information asymmetry and lower investor demand, firms with greater financial constraints, and firms with lower proprietary costs. We do not find evidence of changes in financial disclosure, nor do we find changes in patenting. Results from ordinary least squares regressions show that scientific publications by firms are positively associated with investor attention toward those firms. We complement these results with qualitative evidence from conference calls. Our results highlight the limitations and trade-offs R&D firms face in their financial market disclosure policies.
Modeling Managers As EPS Maximizers
Itzhak Ben-David & Alexander Chinco
NBER Working Paper, April 2023
Abstract:
Textbook theory assumes that firm managers maximize the net present value of future cash flows. But when you ask them, real-world firm managers consistently say that they are maximizing something else entirely: earnings per share (EPS). Perhaps this is a mistake. No matter. We take firm managers at their word and show that EPS maximization provides a single unified explanation for a wide range of corporate policies such as leverage, share repurchases, M&A payment method, cash accumulation, and capital budgeting.
Dark Knights: The Rise in Firm Intervention by Credit Default Swap Investors
András Danis & Andrea Gamba
Management Science, forthcoming
Abstract:
There have been several cases in recent years where credit default swap (CDS) buyers and sellers intervene in the restructuring of a distressed firm. We show theoretically that this can increase firm value. Intervention by CDS buyers solves the commitment problem between equity and debt holders but increases the probability of inefficient liquidation. Intervention by CDS sellers reduces the issue of excessive liquidation while keeping the benefits of CDS buyer intervention. Having both types of intervention decouples the commitment problem from the liquidation problem. Under certain assumptions, the so-called empty creditor problem can be solved, and firm value reaches first best.