This is probably a naive question. Maybe someone can answer it quickly for me.
The Manhattan Project started in 1942 and in 1945 the United States detonated three nuclear bombs, including an enriched uranium bomb and a plutonium bomb.
Fast forward sixty years: The Iranians have been allegedly working for several years on developing a nuclear bomb but are, by some projections, still years away from being able to produce one (leaving aside the ability to deliver it).
What is going on here?
Tuesday, January 16, 2007
Friday, January 12, 2007
Apple's Effects on Competitors
What a wonderful company Apple is. Who else can you turn to for virtually all of your Christmas presents? From iMacs to Macbooks to iPods, plus all the third-party complementary products, the possibilities for great gifts are unending.
But the topic of the evening is profiting from induced changes in competitors' market values.
S. Jobs announced this past week the new iPhone from Apple (so long as it works on Verizon, I see several such phones in my family's future).
Apple's share price increased by 8.3% on the day. This is pretty amazing, given that the market was expecting a big announcement. Apple clearly surpassed expectations.
But who should suffer from Apple's mobile phone innovation? Two companies that should be hurt by Apple's perceived successful entry into the mobile phone market, in terms of revenues, profitability and value, are Palm and Research in Motion (makers of the Blackberry). Palm fell by 6%. Research in Motion fell by 7.9%.
Now Apple officers trading in Apple shares would clearly violate insider trading laws as the officers of Apple owe a fiduciary duty to Apple shareholders. But that legal argument does not apply to Apple officers, or Apple itself, trading in the shares of Palm or Research in Motion. No fiduciary duty owed there, and mere trading on proprietary information is clearly not illegal. In fact, one could argue that Apple created and owns the information on its innovation, so why can't it trade on it?
Wouldn't it have been a great trade to sell short Palm or Research in Motion, if you knew just what S. Jobs was going to do at MacWorld? And guess what -- for an Apple employee to do such a trade would not be illegal (to the best of my knowledge that is, and I do note that it could violate Apple corporate policy). Perhaps the best idea would have been for Apple's corporate pension fund to have sold short shares in competitors prior to the conference. Not only would Apple make money from the entry into the mobile phone market, but it would also make a fortune from the decline in fortunes of its competitors!
But the topic of the evening is profiting from induced changes in competitors' market values.
S. Jobs announced this past week the new iPhone from Apple (so long as it works on Verizon, I see several such phones in my family's future).
Apple's share price increased by 8.3% on the day. This is pretty amazing, given that the market was expecting a big announcement. Apple clearly surpassed expectations.
But who should suffer from Apple's mobile phone innovation? Two companies that should be hurt by Apple's perceived successful entry into the mobile phone market, in terms of revenues, profitability and value, are Palm and Research in Motion (makers of the Blackberry). Palm fell by 6%. Research in Motion fell by 7.9%.
Now Apple officers trading in Apple shares would clearly violate insider trading laws as the officers of Apple owe a fiduciary duty to Apple shareholders. But that legal argument does not apply to Apple officers, or Apple itself, trading in the shares of Palm or Research in Motion. No fiduciary duty owed there, and mere trading on proprietary information is clearly not illegal. In fact, one could argue that Apple created and owns the information on its innovation, so why can't it trade on it?
Wouldn't it have been a great trade to sell short Palm or Research in Motion, if you knew just what S. Jobs was going to do at MacWorld? And guess what -- for an Apple employee to do such a trade would not be illegal (to the best of my knowledge that is, and I do note that it could violate Apple corporate policy). Perhaps the best idea would have been for Apple's corporate pension fund to have sold short shares in competitors prior to the conference. Not only would Apple make money from the entry into the mobile phone market, but it would also make a fortune from the decline in fortunes of its competitors!
Friday, December 08, 2006
Environmental Dilemmas
More craziness from across the river in Vermont.
So the voters in Norwich approved a bond issue to install a wood-fired boiler for the elementary school. Hanover's new Middle School has one of these, and I imagine that with heating oil prices being so high, the investment's ROI ex post is looking pretty nice. (By the way, I live about half a mile from that boiler and do not notice any ill effects, including no ill effects from the wood chip delivery trucks.)
Norwich voters had one study by a consulting firm available to them when they approved the boiler, and the study said that the emissions from the wood boiler would be nothing to worry about.
Now a new study has been presented (why was this new study done...hmmmm?) showing not only that emissions would be worse, but that the emissions would fall outside of the EPA rules that would be enforced...starting in 2010!!
Even more hilariously, all the EPA regulations are irrelevant in the regulatory sense, since the Norwich furnace is too small to fall under the EPA's regulatory umbrella.
But nonetheless, this new study has put the boiler on hold.
I imagine that in Norwich, VT, more copies per capita of Al Gore's book on climate change have been purchased than anywhere else. Yet here we have an economically sound investment that will reduce net CO2 emissions...and it fails because of the age-old "not in my backyard" argument. Give me a break, please.
Sometime in the future we are going to face some real tradeoffs and we will not be able to say no to everything. Boy, if we can't even put a wood stove in Norwich, how are we ever going to site a nuke in Burlington??
So the voters in Norwich approved a bond issue to install a wood-fired boiler for the elementary school. Hanover's new Middle School has one of these, and I imagine that with heating oil prices being so high, the investment's ROI ex post is looking pretty nice. (By the way, I live about half a mile from that boiler and do not notice any ill effects, including no ill effects from the wood chip delivery trucks.)
Norwich voters had one study by a consulting firm available to them when they approved the boiler, and the study said that the emissions from the wood boiler would be nothing to worry about.
Now a new study has been presented (why was this new study done...hmmmm?) showing not only that emissions would be worse, but that the emissions would fall outside of the EPA rules that would be enforced...starting in 2010!!
Even more hilariously, all the EPA regulations are irrelevant in the regulatory sense, since the Norwich furnace is too small to fall under the EPA's regulatory umbrella.
But nonetheless, this new study has put the boiler on hold.
I imagine that in Norwich, VT, more copies per capita of Al Gore's book on climate change have been purchased than anywhere else. Yet here we have an economically sound investment that will reduce net CO2 emissions...and it fails because of the age-old "not in my backyard" argument. Give me a break, please.
Sometime in the future we are going to face some real tradeoffs and we will not be able to say no to everything. Boy, if we can't even put a wood stove in Norwich, how are we ever going to site a nuke in Burlington??
Friday, November 17, 2006
Unbelievable
It still has not really hit me that we have a socialist in the US Senate. And, even more amazing, he is from the state just across the river from me. Vermont.
It's funny how smoking marijuana affects some people.
It's funny how smoking marijuana affects some people.
An AMT Idea
There has been some more talk about fixing the Alternative Minimum Tax since the Democrats took over Congress (also see my earlier post). Maybe we can actually get some tax reform in the next couple years? That would be a real miracle. The Bush administration’s failure to get Social Security reform and failure to get any tax reform loom large in my evaluation of its overall success.
So here is a free idea for the Democrats. From this point on I start charging.
The issue of revenue neutrality is not being looked at creatively. Discussion has focused on making sure that if some people gain from tax reform, others will have to lose, if we are to maintain revenue neutrality. This ignores the fundamental inefficiency of taxes, which is that they drive a wedge between what one individual earns and what that individual takes home. The wedge causes individuals to forego income-earning possibilities that do not yield enough after-tax income to compensate for the opportunities sacrificed as a result of earning the income (e.g., leisure). If the tax wedge is reduced, then individuals will earn more, yielding more tax revenue, and making themselves better off.
The problem has always been that if you reduce taxes to reduce the wedge, you lose a lot of revenue on income that would have been earned and taxed anyway. This makes tax reduction costly from the point of view of the government’s treasury. The point is very similar to the concept of marginal revenue in the economics of pricing: if a company reduces its price to sell more product, it picks up some additional revenue from the new units sold, but if it has to reduce price on all the units that would have been sold anyway, then total revenue could actually decline.
But the principle remains: tax rate reduction is mutually beneficial, between individuals and the government. In principle, we should be able to strike a bargain that makes both entities better off.
So here is how we might do that. Now all the details of this are not worked out, but I am rather intrigued by the idea.
Right now, I don’t really know if my marginal tax rate for income earned in 2007 is going to be around 42% or around 26%. It will be 42% if I don’t get caught by the AMT and it will be 26% if I do get caught by the AMT. So let me choose at the beginning of the year how I want to be taxed. I will promise the IRS that, so long as my income is at least as high as it was in 2006, then I will pay at least the same amount of taxes that I paid in 2006. But, and this is the kicker, for any additional income that I earn over and above my 2006 income, I will pay only the AMT marginal tax rate, i.e., 26%.
Imagine that I have an opportunity to make an additional $10,000 in 2007. If my marginal rate were 42%, my take-home pay would only be $5800. At that rate, I might choose to spend that time out at my camp instead of earning the income. But if my marginal rate were only 26%, I would forego $7400 by going to camp instead of to work.
So promise me a lower rate on only my incremental income, and I will earn more. The IRS will take in more revenue than it did before, and possibly more than it would have without this tax innovation (I say possibly more since some people would have taken the income earning option even with the higher tax rate).
The point of this scheme is to make tax reform revenue neutral at the level of the individual, not necessarily across individuals. And we define revenue neutrality relative to the prior year’s tax payments.
To make this even more attractive, you could let me “buy down” my marginal tax rate on new income by foregoing some deductions such as mortgage payments. So I would agree to pay 26%, say, on more of my income (I won’t deduct mortgage interest) if you lower the rate of taxation on new income I earn to, say, 24%.
This idea is very similar to health insurance plans that require us to choose at the beginning of the year what kind of plan we want, and how much money we want to put into a reimbursement account. Let’s extend that principle to taxation, remove some inefficiency, and make everyone better off.
So here is a free idea for the Democrats. From this point on I start charging.
The issue of revenue neutrality is not being looked at creatively. Discussion has focused on making sure that if some people gain from tax reform, others will have to lose, if we are to maintain revenue neutrality. This ignores the fundamental inefficiency of taxes, which is that they drive a wedge between what one individual earns and what that individual takes home. The wedge causes individuals to forego income-earning possibilities that do not yield enough after-tax income to compensate for the opportunities sacrificed as a result of earning the income (e.g., leisure). If the tax wedge is reduced, then individuals will earn more, yielding more tax revenue, and making themselves better off.
The problem has always been that if you reduce taxes to reduce the wedge, you lose a lot of revenue on income that would have been earned and taxed anyway. This makes tax reduction costly from the point of view of the government’s treasury. The point is very similar to the concept of marginal revenue in the economics of pricing: if a company reduces its price to sell more product, it picks up some additional revenue from the new units sold, but if it has to reduce price on all the units that would have been sold anyway, then total revenue could actually decline.
But the principle remains: tax rate reduction is mutually beneficial, between individuals and the government. In principle, we should be able to strike a bargain that makes both entities better off.
So here is how we might do that. Now all the details of this are not worked out, but I am rather intrigued by the idea.
Right now, I don’t really know if my marginal tax rate for income earned in 2007 is going to be around 42% or around 26%. It will be 42% if I don’t get caught by the AMT and it will be 26% if I do get caught by the AMT. So let me choose at the beginning of the year how I want to be taxed. I will promise the IRS that, so long as my income is at least as high as it was in 2006, then I will pay at least the same amount of taxes that I paid in 2006. But, and this is the kicker, for any additional income that I earn over and above my 2006 income, I will pay only the AMT marginal tax rate, i.e., 26%.
Imagine that I have an opportunity to make an additional $10,000 in 2007. If my marginal rate were 42%, my take-home pay would only be $5800. At that rate, I might choose to spend that time out at my camp instead of earning the income. But if my marginal rate were only 26%, I would forego $7400 by going to camp instead of to work.
So promise me a lower rate on only my incremental income, and I will earn more. The IRS will take in more revenue than it did before, and possibly more than it would have without this tax innovation (I say possibly more since some people would have taken the income earning option even with the higher tax rate).
The point of this scheme is to make tax reform revenue neutral at the level of the individual, not necessarily across individuals. And we define revenue neutrality relative to the prior year’s tax payments.
To make this even more attractive, you could let me “buy down” my marginal tax rate on new income by foregoing some deductions such as mortgage payments. So I would agree to pay 26%, say, on more of my income (I won’t deduct mortgage interest) if you lower the rate of taxation on new income I earn to, say, 24%.
This idea is very similar to health insurance plans that require us to choose at the beginning of the year what kind of plan we want, and how much money we want to put into a reimbursement account. Let’s extend that principle to taxation, remove some inefficiency, and make everyone better off.
Thursday, November 09, 2006
On Fisheries and Science in the Headlines
Last week, a group of scientists were very successful in getting their study on fisheries reported broadly throughout the world's media. See, for example, Collapse of All Wild Fisheries Predicted in 45 Years.
Anyone who knows me knows that I care a lot about the state of fisheries, both fresh and saltwater. I value fisheries for recreation and for food, as well as for their overall role in a healthy ecosystem.
But I cannot support the headline claim of this recent study. A story in the Seattle Times ,"Will seafood nets be empty? Grim outlook draws skeptics," tears it apart particularly well, showing first the graph that supposedly supports the prediction of complete collapse in 45 years. It looks like the authors were not content to simply project a trend forward, they actually projected a nonlinear trend forward -- a nonlinear trend with increasing negative slope!! Even worse, one of the authors accidentally included the Seattle Times in an email meant for someone else. Quoting from the ST article:
"In a note to colleagues that was mistakenly sent to The Seattle Times, Worm wrote that the projection could act as a "news hook to get people's attention."
"One reason why nobody cares about marine biodiversity is that there seemed no clear end in sight," he continued. "...
Well, it's time to wake up — IF the current trend continues we will see drastic consequences in our own lifetime."
I know how nice it is to get one's research results written up well in the national media. But doing bad science to get people's attention is really sad.
Anyone who knows me knows that I care a lot about the state of fisheries, both fresh and saltwater. I value fisheries for recreation and for food, as well as for their overall role in a healthy ecosystem.
But I cannot support the headline claim of this recent study. A story in the Seattle Times ,"Will seafood nets be empty? Grim outlook draws skeptics," tears it apart particularly well, showing first the graph that supposedly supports the prediction of complete collapse in 45 years. It looks like the authors were not content to simply project a trend forward, they actually projected a nonlinear trend forward -- a nonlinear trend with increasing negative slope!! Even worse, one of the authors accidentally included the Seattle Times in an email meant for someone else. Quoting from the ST article:
"In a note to colleagues that was mistakenly sent to The Seattle Times, Worm wrote that the projection could act as a "news hook to get people's attention."
"One reason why nobody cares about marine biodiversity is that there seemed no clear end in sight," he continued. "...
Well, it's time to wake up — IF the current trend continues we will see drastic consequences in our own lifetime."
I know how nice it is to get one's research results written up well in the national media. But doing bad science to get people's attention is really sad.
The Political Party We Need
It was getting a little hard to defend some parts of the Republican Party's agenda and actions, so I am not entirely heartbroken over the election. And the rest of the world should note how quickly and smoothly the US can change its political standing. The system does work. I think a strong case can even be made for Allen to not challenge the Virginia result. The chance of overturning it would seem to be low, while the benefits of taking the high road seem large.
What I long for is a political party that would be conservative on economics (especially spending and regulation), and on national defense, but liberal on many social issues, particularly those concerning individual rights and privacy. If the Democrats could claim that ground, they would get a lot of Republican support. Or, I could imagine a part of the Republican Party discarding some of the more religious, social conservatives for a more Libertarian leaning party. The problem there is that we would have three parties, with the two on the right sure to lose to the one on the left. Could a three party system be sustained in the US today? Maybe.
I worry that the Democrats will go too far to satisfy those furthest to the left on spending, regulation, and general "government is the answer to all questions" issues. If they resist that, relying more on Bill Clinton's views on the role of government in the economy, they could be a real powerhouse.
What I long for is a political party that would be conservative on economics (especially spending and regulation), and on national defense, but liberal on many social issues, particularly those concerning individual rights and privacy. If the Democrats could claim that ground, they would get a lot of Republican support. Or, I could imagine a part of the Republican Party discarding some of the more religious, social conservatives for a more Libertarian leaning party. The problem there is that we would have three parties, with the two on the right sure to lose to the one on the left. Could a three party system be sustained in the US today? Maybe.
I worry that the Democrats will go too far to satisfy those furthest to the left on spending, regulation, and general "government is the answer to all questions" issues. If they resist that, relying more on Bill Clinton's views on the role of government in the economy, they could be a real powerhouse.
Those Missing Bass Signs...
See my post immediately below on the lack of Bass signs around Hanover during the recent campaign. Now it seems that some of the Bass signs may have been stolen.
I was reading a story in the Valley News last night about someone in Enfield who had been arrested for taking Bass signs from alongside the road. The police followed the individual home and, when the perp failed to respond to their requests to appear at the front door, they knocked the door down! The poor fellow was arrested on two counts of possession of stolen property.
As I have had my own campaign signs stolen from my front yard, and my Bush sticker ripped off my truck's bumper, I was feeling pretty good about this story. But then I realized I knew the culprit! He is the son of a friend, and he used to babysit for my kids all the time! Ah, the follies of the youth. I hope they go a little easy on him. I don't think Bass lost because of a few signs being stolen.
I was reading a story in the Valley News last night about someone in Enfield who had been arrested for taking Bass signs from alongside the road. The police followed the individual home and, when the perp failed to respond to their requests to appear at the front door, they knocked the door down! The poor fellow was arrested on two counts of possession of stolen property.
As I have had my own campaign signs stolen from my front yard, and my Bush sticker ripped off my truck's bumper, I was feeling pretty good about this story. But then I realized I knew the culprit! He is the son of a friend, and he used to babysit for my kids all the time! Ah, the follies of the youth. I hope they go a little easy on him. I don't think Bass lost because of a few signs being stolen.
Monday, November 06, 2006
Bass vs. Hodes, US Representative for NH
So I have observed many electoral campaigns in the Upper Valley of NH, having lived here now for 23 years. Republicans have been an endangered species for a long time around here, and it is getting even more lonely of late. That said, I have never seen such a dearth of Republican campaign materials. No signs, no posters, no ads in the papers...Well, one sad little ad in the Valley News half-heartedly telling Republicans that their vote matters. Meanwhile, the Democrat Hodes has simply blanketed the landscape with campaign stuff. I can't drive anywhere without Hodes intruding on my thoughts.
If Charlie Bass loses his House seat, I will not be surprised. I understand better than anyone the idea of optimizing use of resources, but the incremental cost of doing a LITTLE SOMETHING even in a Democrat stronghold is so low that it has to be worthwhile. The complete lack of any effort around here makes me suspect that the Bass campaign is asleep at the wheel. Not a good indicator.
Well, I would be perfectly happy if the result tomorrow is Democratic control of the House and Republican control of the Senate. For a Libertarian, gridlock reads: Less new legislation.
Tomorrow should be interesting. Of course, given the last couple elections, we might not get final results for some time.
If Charlie Bass loses his House seat, I will not be surprised. I understand better than anyone the idea of optimizing use of resources, but the incremental cost of doing a LITTLE SOMETHING even in a Democrat stronghold is so low that it has to be worthwhile. The complete lack of any effort around here makes me suspect that the Bass campaign is asleep at the wheel. Not a good indicator.
Well, I would be perfectly happy if the result tomorrow is Democratic control of the House and Republican control of the Senate. For a Libertarian, gridlock reads: Less new legislation.
Tomorrow should be interesting. Of course, given the last couple elections, we might not get final results for some time.
Sunday, October 22, 2006
Private Equity and Venture Capital Firms Acting Anti-Competitively?
An interesting story last week suggested that the Justice Department was investigating private equity firms for possible anti-competitive behavior.
Just this last spring, a student of mine at Tuck did an independent study on the incentives and potential for cooperative behavior in the private equity and venture capital arenas. How's that for prescience?
Justice's focus appears to be on private equity firms and their behavior in auctions for companies (by the way, I have a paper with exactly that title: "Auctions of Companies", Economic Inquiry Vol 39 Issue 1 January 2001). Judging from the news reports, the investigation focuses on behavior by the firms that could reduce competition in the auctions and result in lower prices. This reminds me a bit of claims that the major audit firms were not aggressively competing against one another in bidding for audit jobs, since they realized that they were in a repeated game with the same players. Certainly there are good arguments from game theory to suggest that in a repeated context there are numerous strategies that evoke ongoing cooperative behavior and overcome any tendency to the classic "prisoners' dilemma." One strategy that has gotten a lot of play in theory is "tit for tat." In the private equity world, this would mean that if one firm were to bid aggressively for a company in one auction, then in the next auction a competitive private equity firm would bid aggressively just to punish the first firm. Of course, in the Middle East tit-for-tat seems to cause unrelenting cycles of escalating retaliation...
This is also nothing more than an interesting theoretical possibility without any convincing empirical evidence. And the story can be applied to almost every industrial setting where a relatively small number of firms compete with one another in a repeated context. So at this point it sounds like a Justice Dept. fishing trip.
My student and I were more interested in other areas where cooperation would pay. This story goes back to work by John Lott and myself: "Externalities and Corporate Objectives in a World with Diversified Shareholder/Consumers," Journal of Financial and Quantitative Analysis, March 1996.
Suppose one venture capital firm has investments in two portfolio companies, which we will call A and B. What if A and B have some competitive fronts, or even more interesting, areas where there are complementarities? Then the venture capitalist should internalize those externalities and make sure that the two firms act so as to maximize their JOINT value rather than maximizing values independent of one another. If the two firms are interacting competitively, then joint value maximization could be contrary to consumer welfare, but if the two firms interact with complementarities, then joint value maximization would enhance consumer welfare.
Or to take it another step, suppose there are two venture capital firms, VC1 and VC2. And suppose that, through the syndication process, each venture capital firm has investments in both of the client firms A and B. Typically in these situations, one VC firm takes the lead investment role in each syndication. So VC1 might be the lead in Firm A and VC2 would be the lead in Firm B. On the surface, since the two VCs would have unequal stakes in the two clients, they would not each have incentives to maximize joint value of A and B. However, if VC1 runs Firm A as to maximize value of A at the loss of value to Firm B, VC2 will suffer. Similarly if VC2 runs B so as to destroy value at client Firm A, then VC1 will suffer. The two VCs might see that they would both be better off if they managed their clients with an eye to joint maximization. As with the private equity firms, any such coordination like this is much more likely to arise if VC1 and VC2 are in repeated syndications.
In 1953, the US government brought suit against 17 investment banking firms (US v. Morgan et al), alleging that they had used the syndication system as a means to perpetuate their coordination in investment banking. The case was lost, with the judge concluding that the defendants had acted independently and that the syndication system had an efficiency role to play.
My prediction is that history will repeat itself. Maybe this time we will be spared the cost of an extensive fishing trip. On the other hand, maybe the guys in Justice agree with me on something: A bad day fishing is better than a good day at work.
Just this last spring, a student of mine at Tuck did an independent study on the incentives and potential for cooperative behavior in the private equity and venture capital arenas. How's that for prescience?
Justice's focus appears to be on private equity firms and their behavior in auctions for companies (by the way, I have a paper with exactly that title: "Auctions of Companies", Economic Inquiry Vol 39 Issue 1 January 2001). Judging from the news reports, the investigation focuses on behavior by the firms that could reduce competition in the auctions and result in lower prices. This reminds me a bit of claims that the major audit firms were not aggressively competing against one another in bidding for audit jobs, since they realized that they were in a repeated game with the same players. Certainly there are good arguments from game theory to suggest that in a repeated context there are numerous strategies that evoke ongoing cooperative behavior and overcome any tendency to the classic "prisoners' dilemma." One strategy that has gotten a lot of play in theory is "tit for tat." In the private equity world, this would mean that if one firm were to bid aggressively for a company in one auction, then in the next auction a competitive private equity firm would bid aggressively just to punish the first firm. Of course, in the Middle East tit-for-tat seems to cause unrelenting cycles of escalating retaliation...
This is also nothing more than an interesting theoretical possibility without any convincing empirical evidence. And the story can be applied to almost every industrial setting where a relatively small number of firms compete with one another in a repeated context. So at this point it sounds like a Justice Dept. fishing trip.
My student and I were more interested in other areas where cooperation would pay. This story goes back to work by John Lott and myself: "Externalities and Corporate Objectives in a World with Diversified Shareholder/Consumers," Journal of Financial and Quantitative Analysis, March 1996.
Suppose one venture capital firm has investments in two portfolio companies, which we will call A and B. What if A and B have some competitive fronts, or even more interesting, areas where there are complementarities? Then the venture capitalist should internalize those externalities and make sure that the two firms act so as to maximize their JOINT value rather than maximizing values independent of one another. If the two firms are interacting competitively, then joint value maximization could be contrary to consumer welfare, but if the two firms interact with complementarities, then joint value maximization would enhance consumer welfare.
Or to take it another step, suppose there are two venture capital firms, VC1 and VC2. And suppose that, through the syndication process, each venture capital firm has investments in both of the client firms A and B. Typically in these situations, one VC firm takes the lead investment role in each syndication. So VC1 might be the lead in Firm A and VC2 would be the lead in Firm B. On the surface, since the two VCs would have unequal stakes in the two clients, they would not each have incentives to maximize joint value of A and B. However, if VC1 runs Firm A as to maximize value of A at the loss of value to Firm B, VC2 will suffer. Similarly if VC2 runs B so as to destroy value at client Firm A, then VC1 will suffer. The two VCs might see that they would both be better off if they managed their clients with an eye to joint maximization. As with the private equity firms, any such coordination like this is much more likely to arise if VC1 and VC2 are in repeated syndications.
In 1953, the US government brought suit against 17 investment banking firms (US v. Morgan et al), alleging that they had used the syndication system as a means to perpetuate their coordination in investment banking. The case was lost, with the judge concluding that the defendants had acted independently and that the syndication system had an efficiency role to play.
My prediction is that history will repeat itself. Maybe this time we will be spared the cost of an extensive fishing trip. On the other hand, maybe the guys in Justice agree with me on something: A bad day fishing is better than a good day at work.
The Media Cascading into Falsehoods Once Again?
There are numerous reports in both newspapers and on the radio (I haven't had the TV on, but no doubt it is there too) of an American diplomat who supposedly said on Al Jazeera that the US has been "arrogant and stupid" in Iraq.
The only problem is that the diplomat was speaking in Arabic (good to hear that they can do that!) and Arabic can be tough to translate into English.
So do we think that every media outlet that passes this story on has had their own translator check the accuracy of the translation? Or is everyone just assuming that since someone ran the first story, and then someone else respectable ran the story, that it must be right?
In information cascades, you will frequently have everyone coming to the same wrong conclusion, even when their own private information suggests a different conclusion. The situation above could be a perfect example: a reporter who knows a little Arabic might check the actual words, but if they are not expert, then they will put more weight on the cascade of everyone else saying the original translation was right than on their own opinion. The result? A cascade of the same story, with the same translation.
The only problem is that the diplomat was speaking in Arabic (good to hear that they can do that!) and Arabic can be tough to translate into English.
So do we think that every media outlet that passes this story on has had their own translator check the accuracy of the translation? Or is everyone just assuming that since someone ran the first story, and then someone else respectable ran the story, that it must be right?
In information cascades, you will frequently have everyone coming to the same wrong conclusion, even when their own private information suggests a different conclusion. The situation above could be a perfect example: a reporter who knows a little Arabic might check the actual words, but if they are not expert, then they will put more weight on the cascade of everyone else saying the original translation was right than on their own opinion. The result? A cascade of the same story, with the same translation.
Friday, October 13, 2006
Record Breaking, and Deadly, Early Snow
An update: A state of emergency in the Buffalo area from the record early snowfall, and tragically, three deaths attributed to the snow. Health care workers had to bring dialysis patients in to the hospital and bring other medical supplies to people who could not get out.
Two Feet of Snow in October!
Ah, how I wish I were in Buffalo today, getting socked by lake effect snow. Brings me right back to home in the good old UP of Michigan. Soon we will be getting some snow in NH as well, but we don't get blizzards out here like we did in the UP. I still remember one snowstorm that stranded hundreds of cars along US 41 for at least a whole day.
By the way, if climate change reduces the severity and frequency of snowstorms like this in the large metropolitan areas of the Northeastern US, do the financial savings and reduced lives lost (how many people die from heart attacks every year shoveling snow?) count as a benefit?
By the way, if climate change reduces the severity and frequency of snowstorms like this in the large metropolitan areas of the Northeastern US, do the financial savings and reduced lives lost (how many people die from heart attacks every year shoveling snow?) count as a benefit?
An Admirable Peace Prize
The 2006 Nobel Peace Prize has been awarded to economist Muhammad Yunus and the pioneering microfinance organization, Grameen Bank. This is wonderful. Microfinance is a great institutional innovation that helps get capital, in small amounts, to entrepreneurs who can help eliminate poverty and provide goods and services in developing areas of the world. A good number of Tuck's MBA students are interested in microfinance. While it will be hard to get mainstream capital markets involved in any large way in microfinance, the point of developments like these is that they do not need to be huge to have a significant effect.
Wednesday, October 11, 2006
Two Papers for the Price of One
I was meeting with a very famous economist last week, lamenting the deterioration in coverage of business news by the Wall Street Journal. My guest said, yes, one of his friends laughs about getting two papers for the price of one with the WSJ: the traditionally conservative opinions on the editorial page, and now increasingly, a liberal slant towards the news in the rest of the paper.
This blog of mine started with my observations of poor reporting in the WSJ's front page story on the British Petroleum "corner" of the US propane market. I will now add another observation to the database, this time from the October 6 edition, an article on the front page entitled,"How Quiet Moves by a Publisher Sway Billions in Drug Spending." Ominously, this is noted as the fourth in a series titled "Health Care Goldmines. Middlemen Strike it Rich." Not off to a very good start with those leading words, are we now?
Since the WSJ online is a subscription service, and I don't have an account, I don't know of any way to link to the article. I apologize for that, but using the title and the author and date you could easily find it.
My apologies to the writer, Barbara Martinez, if I appear a little harsh here.
But this article is one of the more breathless juvenile attempts at creating (not exposing) a business scandal that I have ever seen. I really expect more from what was once the world's leading economics and business newspaper.
The thrust of the story and situation, as best I can fathom, is as follows: One company, First DataBank, has historically collected data on average wholesale prices for pharmaceuticals. These data were used in setting a benchmark that determined what retail pharmacies would be paid by insurers when the pharmacies dispensed drugs to individuals. From the sounds of it, the average wholesale price (AWP) would be used as a base, from which an insurer would tack on a margin to compensate the pharmacy. The higher the AWP, the higher the compensation for the pharmacy,
That is all well and good. The main claim, from a court case in Boston, is that First DataBank was collecting shoddy data -- that in the past several years, only one firm was being surveyed, the drug wholesaler McKesson. A second claim seems to be that First DataBank raised its reported average wholesale price around 2002 -- and since there was not really a valid survey being conducted at the time, any such raise of the reported AWP would be unjustified. The article, by innuendo, attempts to rope McKesson into this business. McKesson would not appear to benefit directly from any increase in the AWP. Its customers, the pharmacies, conceivably could benefit from an increase in AWP that was not actually caused by a real increase in wholesale prices, for the pharmacies would get more compensation but would not be paying more at the wholesale level. I suppose you could say that McKesson would benefit indirectly, if its customers were to benefit. There are no claims anywhere in the article that First DataBank and McKesson were colluding actively to raise AWP. There are some emails reported in the article, including one from some unnamed McKesson manager, saying "that is awesome" about how pharmacies would get higher compensation.
So there are several things that really bug me about this story. The naivete is striking. Here is one example: "Between the manufacturer and the end user stand a variety of middlemen who take their cuts." Standing alone, that may not be too bad. In the context of the article, it shows a view of middlemen as parasites that should be driven out of any college freshman's mind by their introductory economics course. Another example of naivete is a paragraph that attempts to show how pharmacies have been profiting in the last few years. The paragraph mixes stock returns with Walgreen's doubling of net income and ends with "Share prices of the three major PBMs (pharmacy benefit managers) are also sharply up over the past few years." I love to get reports written by students like that; they are so much fun to tear apart. "Sharply up?" Is that some scientific term, "sharply up?" Are they up relative to a relevant index? Up relative to zero?
Another major point of mine is that I think the reporter simply has the whole story wrong. I find it very difficult to believe that contracts of any significance were as reliant on the AWP as the article asserts. It is just very hard to believe that billions of dollars of reimbursement are based on such poor data. The article mentions that AWPs are not taken seriously in the industry, with some referring to AWP as "ain't what's paid." So the data are a joke, but billions of dollars ride on it. If this is true, then THAT is the story! Why would insurers be using such a terrible metric for their reimbursement schemes, a metric that is not only inaccurate but subject to manipulation because only one company is being sampled. Rather than a story on middlemen making profits, we should have a story on stupidity in the insurance and reimbursement industry.
A third point is the needless and slanted language throughout the whole story. I have already pointed out the headline and the title of the series. Here are just a few more juicy quotes:
"For years, a little known unit...played a powerful role...
"The new prices had the effect of fattening the profits...
" Now a tentative legal settlement, reached quietly in a Boston court...
"Even as patients face higher co-payments...many pharmacies and PBMs are prospering...
"Documents ... suggest that McKesson had a key part...
Wow. I am just breathless from the excitement of reading this. A little known unit, playing a powerful role, fattening profits, a quiet settlement, companies prospering while patients pay more, a wholesaler playing a key part...
When is the movie coming out? Will it star Meryl Streep?
Come on, Wall street Journal. I expect bias and slanting on the editorial page, and I love it. But nobody can complain because it is known to be opinion. But to have this kind of reporting on the front page? I expect better.
This blog of mine started with my observations of poor reporting in the WSJ's front page story on the British Petroleum "corner" of the US propane market. I will now add another observation to the database, this time from the October 6 edition, an article on the front page entitled,"How Quiet Moves by a Publisher Sway Billions in Drug Spending." Ominously, this is noted as the fourth in a series titled "Health Care Goldmines. Middlemen Strike it Rich." Not off to a very good start with those leading words, are we now?
Since the WSJ online is a subscription service, and I don't have an account, I don't know of any way to link to the article. I apologize for that, but using the title and the author and date you could easily find it.
My apologies to the writer, Barbara Martinez, if I appear a little harsh here.
But this article is one of the more breathless juvenile attempts at creating (not exposing) a business scandal that I have ever seen. I really expect more from what was once the world's leading economics and business newspaper.
The thrust of the story and situation, as best I can fathom, is as follows: One company, First DataBank, has historically collected data on average wholesale prices for pharmaceuticals. These data were used in setting a benchmark that determined what retail pharmacies would be paid by insurers when the pharmacies dispensed drugs to individuals. From the sounds of it, the average wholesale price (AWP) would be used as a base, from which an insurer would tack on a margin to compensate the pharmacy. The higher the AWP, the higher the compensation for the pharmacy,
That is all well and good. The main claim, from a court case in Boston, is that First DataBank was collecting shoddy data -- that in the past several years, only one firm was being surveyed, the drug wholesaler McKesson. A second claim seems to be that First DataBank raised its reported average wholesale price around 2002 -- and since there was not really a valid survey being conducted at the time, any such raise of the reported AWP would be unjustified. The article, by innuendo, attempts to rope McKesson into this business. McKesson would not appear to benefit directly from any increase in the AWP. Its customers, the pharmacies, conceivably could benefit from an increase in AWP that was not actually caused by a real increase in wholesale prices, for the pharmacies would get more compensation but would not be paying more at the wholesale level. I suppose you could say that McKesson would benefit indirectly, if its customers were to benefit. There are no claims anywhere in the article that First DataBank and McKesson were colluding actively to raise AWP. There are some emails reported in the article, including one from some unnamed McKesson manager, saying "that is awesome" about how pharmacies would get higher compensation.
So there are several things that really bug me about this story. The naivete is striking. Here is one example: "Between the manufacturer and the end user stand a variety of middlemen who take their cuts." Standing alone, that may not be too bad. In the context of the article, it shows a view of middlemen as parasites that should be driven out of any college freshman's mind by their introductory economics course. Another example of naivete is a paragraph that attempts to show how pharmacies have been profiting in the last few years. The paragraph mixes stock returns with Walgreen's doubling of net income and ends with "Share prices of the three major PBMs (pharmacy benefit managers) are also sharply up over the past few years." I love to get reports written by students like that; they are so much fun to tear apart. "Sharply up?" Is that some scientific term, "sharply up?" Are they up relative to a relevant index? Up relative to zero?
Another major point of mine is that I think the reporter simply has the whole story wrong. I find it very difficult to believe that contracts of any significance were as reliant on the AWP as the article asserts. It is just very hard to believe that billions of dollars of reimbursement are based on such poor data. The article mentions that AWPs are not taken seriously in the industry, with some referring to AWP as "ain't what's paid." So the data are a joke, but billions of dollars ride on it. If this is true, then THAT is the story! Why would insurers be using such a terrible metric for their reimbursement schemes, a metric that is not only inaccurate but subject to manipulation because only one company is being sampled. Rather than a story on middlemen making profits, we should have a story on stupidity in the insurance and reimbursement industry.
A third point is the needless and slanted language throughout the whole story. I have already pointed out the headline and the title of the series. Here are just a few more juicy quotes:
"For years, a little known unit...played a powerful role...
"The new prices had the effect of fattening the profits...
" Now a tentative legal settlement, reached quietly in a Boston court...
"Even as patients face higher co-payments...many pharmacies and PBMs are prospering...
"Documents ... suggest that McKesson had a key part...
Wow. I am just breathless from the excitement of reading this. A little known unit, playing a powerful role, fattening profits, a quiet settlement, companies prospering while patients pay more, a wholesaler playing a key part...
When is the movie coming out? Will it star Meryl Streep?
Come on, Wall street Journal. I expect bias and slanting on the editorial page, and I love it. But nobody can complain because it is known to be opinion. But to have this kind of reporting on the front page? I expect better.
Tuesday, October 03, 2006
Raising High before Smiting Down
Last night at Tuck, yours truly was on a panel discussing climate change. It was fun, and we had Professors Richard Howarth and Walter Sinott-Armstrong from "up the street" here as well.
I detect a certain cockiness in some of the climate change scientist crowd, and it infects even the more casual observers of the science. A telltale remark is along the lines of, "Well, 1000 scientists believe it to be right, so how can we argue?" (Now what exactly "it" is that is right is of course very interesting. I said numerous times that I believe some climate change has occurred and that humans are likely responsible for some of it, but people still asked me after what it would take to make me believe...)
So if a 1000 scientists believe a paradigm or theory to be absolutely true, that is the end of the story right?
Just in my short academic career, I can think of three paradigms in economics that have been overturned quite dramatically. At least two of them were characterized before the fall of extreme confidence in the paradigm -- yes, cockiness.
Two examples come from finance. The Capital Asset Pricing Model in the 70s and early 80s was held to be the key to understanding asset pricing, in particular the cross section of stock market returns. It is now dead.
A second related one comes from finance as well -- versions of market efficiency, especially that rational investors determine prices and that any inefficiencies in prices would be quickly eliminated. Now I and others can still argue this one pretty well, but there is no doubt that two decades of empirical studies on stock market pricing anomalies, along with experimental work on behavioral economics and finance, has removed the aura of invincibility around strong forms of market efficiency.
A third one is outside of my area a bit, but a colleague suggested it this morning: the death of structural equation macroeconomic modeling upon the development of the rational expectations critique by Robert Lucas. The Lucas critique effectively brought a whole industry of macro modeling to a stop.
So let's be a little respectful of the scientific process. The beauty of these examples is that knowledge does evolve: that even in a discipline as self-sure as the finance profession, a steady stream of contrary theory and evidence, even when produced by a small set of contrarians (think Richard Thaler of behavior finance), can lead to upheavals in the fundamental structure of theory.
I detect a certain cockiness in some of the climate change scientist crowd, and it infects even the more casual observers of the science. A telltale remark is along the lines of, "Well, 1000 scientists believe it to be right, so how can we argue?" (Now what exactly "it" is that is right is of course very interesting. I said numerous times that I believe some climate change has occurred and that humans are likely responsible for some of it, but people still asked me after what it would take to make me believe...)
So if a 1000 scientists believe a paradigm or theory to be absolutely true, that is the end of the story right?
Just in my short academic career, I can think of three paradigms in economics that have been overturned quite dramatically. At least two of them were characterized before the fall of extreme confidence in the paradigm -- yes, cockiness.
Two examples come from finance. The Capital Asset Pricing Model in the 70s and early 80s was held to be the key to understanding asset pricing, in particular the cross section of stock market returns. It is now dead.
A second related one comes from finance as well -- versions of market efficiency, especially that rational investors determine prices and that any inefficiencies in prices would be quickly eliminated. Now I and others can still argue this one pretty well, but there is no doubt that two decades of empirical studies on stock market pricing anomalies, along with experimental work on behavioral economics and finance, has removed the aura of invincibility around strong forms of market efficiency.
A third one is outside of my area a bit, but a colleague suggested it this morning: the death of structural equation macroeconomic modeling upon the development of the rational expectations critique by Robert Lucas. The Lucas critique effectively brought a whole industry of macro modeling to a stop.
So let's be a little respectful of the scientific process. The beauty of these examples is that knowledge does evolve: that even in a discipline as self-sure as the finance profession, a steady stream of contrary theory and evidence, even when produced by a small set of contrarians (think Richard Thaler of behavior finance), can lead to upheavals in the fundamental structure of theory.
Saturday, September 23, 2006
The Opening Salvo in a New Health Care Battle?
I am most intrigued by WalMart's new drug-pricing strategy: $4 per prescription for up to a 30-day supply for a generic version of the drug. The program is being rolled out in Florida, but the company appears to have plans to go nationwide. Right now there are almost 300 drugs available at the $4 rate, covering some of the more common ailments (diabetes, cholesterol, high blood pressure, depression).
Many people are focusing on the "corporate social responsibility” aspects of WalMart's move. Under pressure from commentators for its "poor" treatment of employees (not providing health care for part-time employees, for example), this move certainly will give the company some community goodwill. That is fine. But I suspect there is more to the story than that. And I suspect there is more to this than simply WalMart's ability to cut costs out of the chain of distribution.
What intrigues me the most about this pricing program is precisely that it has the hallmarks of a PROGRAM: it is almost like consumers are enrolled in a WalMart prescription drug insurance plan or program. Many health insurance plans offer similar sorts of prescription drug policies --– for instance, each prescription will cost $5, or $15. But those deals have traditionally only been offered with health insurance, which of course requires a large up front cost. Here is WalMart essentially offering Blue Cross- level prescription drug pricing, but offering it to anyone, including the uninsured, without any subscription price!
The other programmatic aspect of the pricing policy is that all drugs are being offered at the same low price of $4. From WalMart's point of view, that cannot be optimal pricing when you look at it on a drug-by-drug basis. Some drugs have higher marginal costs to WalMart and should be priced higher, again if you were looking at the drugs individually. Clearly, WalMart is viewing this as a package deal, and they must have some research supporting the idea that consumers will value greatly the certainty of the $4 price for any drug.
With more consumers going to WalMart pharmacies, the company will have even more bargaining power with the pharmaceutical manufacturers: the ability to move WalMart-level volume from one manufacturer to another does wonders for the ability to extract price concessions. But the real question is to what extent this represents WalMart taking a shot at the United States' very high-cost health care business model? Maybe as they move beyond just 300 drugs, they will start charging a monthly premium in order to get the $4 per prescription pricing? That starts sounding like an insurance plan, but of course it is really not different from Net Flix' DVD plans or even Amazon's new pricing for shipping (pay an annual amount and get free two day shipping). And what if WalMart decides that it could also start hiring doctors and nurses and providing basic health services? Wouldn'’t that be something? Anyone want to bet that WalMart could provide many health care services at much lower prices than our nearby hospital or doctor’s clinic -- with probably very similar quality?
Many people are focusing on the "corporate social responsibility” aspects of WalMart's move. Under pressure from commentators for its "poor" treatment of employees (not providing health care for part-time employees, for example), this move certainly will give the company some community goodwill. That is fine. But I suspect there is more to the story than that. And I suspect there is more to this than simply WalMart's ability to cut costs out of the chain of distribution.
What intrigues me the most about this pricing program is precisely that it has the hallmarks of a PROGRAM: it is almost like consumers are enrolled in a WalMart prescription drug insurance plan or program. Many health insurance plans offer similar sorts of prescription drug policies --– for instance, each prescription will cost $5, or $15. But those deals have traditionally only been offered with health insurance, which of course requires a large up front cost. Here is WalMart essentially offering Blue Cross- level prescription drug pricing, but offering it to anyone, including the uninsured, without any subscription price!
The other programmatic aspect of the pricing policy is that all drugs are being offered at the same low price of $4. From WalMart's point of view, that cannot be optimal pricing when you look at it on a drug-by-drug basis. Some drugs have higher marginal costs to WalMart and should be priced higher, again if you were looking at the drugs individually. Clearly, WalMart is viewing this as a package deal, and they must have some research supporting the idea that consumers will value greatly the certainty of the $4 price for any drug.
With more consumers going to WalMart pharmacies, the company will have even more bargaining power with the pharmaceutical manufacturers: the ability to move WalMart-level volume from one manufacturer to another does wonders for the ability to extract price concessions. But the real question is to what extent this represents WalMart taking a shot at the United States' very high-cost health care business model? Maybe as they move beyond just 300 drugs, they will start charging a monthly premium in order to get the $4 per prescription pricing? That starts sounding like an insurance plan, but of course it is really not different from Net Flix' DVD plans or even Amazon's new pricing for shipping (pay an annual amount and get free two day shipping). And what if WalMart decides that it could also start hiring doctors and nurses and providing basic health services? Wouldn'’t that be something? Anyone want to bet that WalMart could provide many health care services at much lower prices than our nearby hospital or doctor’s clinic -- with probably very similar quality?
Thursday, September 14, 2006
A Simple Math Question
Here is, I believe, a great math question for any kids in grades 8 or above...in case you have to ever prove the relevance of math to your kids.
So I had a great time today out at my beloved camp on a remote lake in New Hampshire. Unfortunately, the pump in my septic system burned out so I had to get the guys out to replace it. I was there, of course, to oversee the process.
It turned out that because of the tendency towards freezing temperatures in this area, the piping that goes from the septic pump to my leach field would empty back into my pump tank once the pump shut off (which it does automatically, through a float mechanism). Since the leach field is 100 yard from the tank, this is potentially a lot of liquid coming back into the tank after the pump shuts off. One could envision a situation where the pump would be on more or less continuously: the tank would fill, the pump would turn on from a float mechanism, it would pump until the level in the tank went down to a certain point and then shut off, all the liquid in the 100 yards of 2 inch piping would run back into the tank, at which point the pump would turn back on....You can imagine the electricity bill from this endless do-loop, as well as imagine how long the new pump would last under such circumstances.
So two math questions emerged. How much liquid will 100 yards of 2 inch piping hold? (Let's assume that the 2 inches is the internal diameter, not external.) Two, what is the capacity of a pump tank that is 4 feet in diameter and 5 feet tall? And last, if the pump turns off and on in a range of 2 feet vertically, how much liquid will be pumped out in one pumping?
All this should help us figure out if the back draining of the water in the pipe will simply fill the tank enough to turn the pump back on, or if that is an issue we can ignore and go to sleep.
Good math stuff. What I haven't gotten into is the really interesting thing, which is how we used a little logic and a little knowledge of electrical circuits to figure out that there has to be a short somewhere between the house and the pump. Now I get to dig up the cable and find if our theory is true! Ah, the pursuit of truth! I love it.
So I had a great time today out at my beloved camp on a remote lake in New Hampshire. Unfortunately, the pump in my septic system burned out so I had to get the guys out to replace it. I was there, of course, to oversee the process.
It turned out that because of the tendency towards freezing temperatures in this area, the piping that goes from the septic pump to my leach field would empty back into my pump tank once the pump shut off (which it does automatically, through a float mechanism). Since the leach field is 100 yard from the tank, this is potentially a lot of liquid coming back into the tank after the pump shuts off. One could envision a situation where the pump would be on more or less continuously: the tank would fill, the pump would turn on from a float mechanism, it would pump until the level in the tank went down to a certain point and then shut off, all the liquid in the 100 yards of 2 inch piping would run back into the tank, at which point the pump would turn back on....You can imagine the electricity bill from this endless do-loop, as well as imagine how long the new pump would last under such circumstances.
So two math questions emerged. How much liquid will 100 yards of 2 inch piping hold? (Let's assume that the 2 inches is the internal diameter, not external.) Two, what is the capacity of a pump tank that is 4 feet in diameter and 5 feet tall? And last, if the pump turns off and on in a range of 2 feet vertically, how much liquid will be pumped out in one pumping?
All this should help us figure out if the back draining of the water in the pipe will simply fill the tank enough to turn the pump back on, or if that is an issue we can ignore and go to sleep.
Good math stuff. What I haven't gotten into is the really interesting thing, which is how we used a little logic and a little knowledge of electrical circuits to figure out that there has to be a short somewhere between the house and the pump. Now I get to dig up the cable and find if our theory is true! Ah, the pursuit of truth! I love it.
Business Schools and "Business and Society"
Yes, it has been too long since my last post. Too busy, plus I suppose there has not been that much in the news of late to stimulate me. We did definitely have some record cold the other night in northern New England, and oil and gas prices appear to be starting their predicted decline. But not enough excitement to warrant anyone's time.
Here is an issue, though. It is somewhat close to home, and I generally don't like to write about things that are Tuck School related, but this one does have some generality that makes it OK.
I am Faculty Director of the Allwin Initiative for Corporate Citizenship at the Tuck School. I am currently trying to define just what this Initiative should be and do. It is sort of like a Center, if you know what centers at universities tend to do. But it has lacked clarity in its area of focus and its mission, and I think it has suffered somewhat from taking on a bit too much of an "advocacy" role. If there is one thing I feel strongly about, it is that academic institutions should advocate only for the truth, not for any particular value system. If you look across business schools and even universities, you will see many centers or programs in environmental areas or in corporate social responsibility generally where it is real clear that the institution has taken a stand on what the proper policy of either corporations, individuals, or governments is. That kind of advocacy bothers me. I think we should stand for the pursuit of knowledge and of truth and not much else.
That said, any modern business school has to have some kind of organizational structure that facilitates students and faculty in exploration of issues that, in the language that I find most illuminating, lie at the intersection, or interface, of business and society. The trick is in defining this area, and the activities that the organization will engage in, in ways that are true to the "pursuit of truth" ideal but that also stimulate student, faculty, and broad audience excitement. There can be no doubt that in today's cultural environment, there are many MBA students who want to discuss those issues that fall in the arena known as "corporate social responsibility." The discussion just has to be consistent with our pursuit of knowledge and truth rather than advocacy (if you don't understand the difference, go watch Al Gore's movie...).
So here is some language that I wrote this evening that attempts to define the area of focus for the Allwin Initiative for Corporate Citizenship at Tuck (and yes, the name may not be perfect either). Reaction is welcome.
The Allwin Initiative focuses its attention on the intersection between business and broader society -- where issues of the overall impact of business activity on social welfare, of corporate objectives and responsibility, and of ethics, citizenship, and leadership become paramount . Rather than defining the precise areas where the Initiative will work, we prefer to set the defining characteristics of the areas that are most interesting and relevant for us. These defining characteristics are three-fold: first, the topic should be one that involves a large potential impact on society; two, the topic should be one that is mainstream, in that a typical Tuck MBA student would be likely to encounter such an issue in their career; and third, the issue should involve a situation where laws, regulations, and/or cultural norms are non-existent, poorly defined, or changing. The first two conditions are self-explanatory, but the third needs clarification. We wish to work in areas where the quality of management, leadership and knowledge will make a large difference. At the intersection of business and society, it is those situations where it is unclear what should be done -- what the right course of action is -- that are important to highlight for both Tuck students as a learning experience and for faculty as scholars, for research purposes. When regulations, laws and cultural norms and expectations are lacking in clarity, that is when the value-added from leadership and from knowledge will be greatest.
It will be useful to note just a few specific topics that meet these criteria at this point in time. Part of our desire to state only the defining characteristics rather than particular areas is our belief that the world is always changing, and the topics that are relevant today will not be tomorrow. We should also note that situations of classic market failure – in the formal economics sense – will almost always be of potential interest to us, but that there may be topics that are not clearly classic market failures, but will still be of interest to us. To put it differently, conditions of market failure are sufficient but not necessary to create interest by the Allwin Initiative. Here are four examples of topics that would currently meet our tests for interest and relevance:
1.
The case developed by a certain Tuck professor of a cement factory being constructed in Vietnam. There are issues of environmental damage and cultural damage. Both of these issues could be construed as classical market failures, with the cement factory not being made to bear the cost of damage to the environment and to cultural artifacts and sacred areas. There are also issues related to the exposure of banks and other lenders due to possible liability from future laws and regulations. There are important embedded questions for the plant managers, for the banks and lenders, for non-governmental organizations, and for governments. The issues are common in large scale economic development projects in the developing and developed world and are therefore mainstream.
2.
There has recently been much criticism of WalMart, in regard to its effect on communities; its employment practices; and even its effect on international trade and our relations with China. Questions concerning the impact on broader society of new business practices and organizational forms, like those related to WalMart, are prime fodder for the Allwin Initiative. Note, however, that it is not at all obvious that these issues are ones of classic market failure. They are instead questions on the overall impact of business on broader society that get to the heart of the role of free enterprise and market economies. Note also that the laws, regulations, and customs surrounding the role of "“big box"” retailers are definitely in a state of flux, not just in the US but globally.
3.
• Another traditional topic for an entity like the Allwin Initiative would be the impact of plant closings, perhaps especially when brought on by a merger or acquisition. This is a topic that falls clearly in the realm covered by “corporate social responsibility” as typically defined, and would be of interest to the Allwin Initiative. These issues are definitely mainstream for Tuck students, and there can be no doubt that the laws, regulations and customs around issues of plant closings and employment reductions are in flux.
4.
One last one, and one that we used at Tuck as the theme for the Halpern Lecture on Business Ethics in 2006: the topic of executive compensation. There is a lot of interest of late in this topic, and it is clearly important (with recent academic papers calculating the relatively large fractionof corporate earnings that actually go to compensation for top executives). Laws and regulations concerning executive compensation are also in flux.
We believe that by studying situations like these, from both a student perspective and from a scholarly/faculty perspective -- and in both a traditional academic learning environment as well as a more active, experiential learning environment -- we can add to knowledge and we will be better able to prepare our students to be effective managers and leaders of tomorrow'’s organizations.
Here is an issue, though. It is somewhat close to home, and I generally don't like to write about things that are Tuck School related, but this one does have some generality that makes it OK.
I am Faculty Director of the Allwin Initiative for Corporate Citizenship at the Tuck School. I am currently trying to define just what this Initiative should be and do. It is sort of like a Center, if you know what centers at universities tend to do. But it has lacked clarity in its area of focus and its mission, and I think it has suffered somewhat from taking on a bit too much of an "advocacy" role. If there is one thing I feel strongly about, it is that academic institutions should advocate only for the truth, not for any particular value system. If you look across business schools and even universities, you will see many centers or programs in environmental areas or in corporate social responsibility generally where it is real clear that the institution has taken a stand on what the proper policy of either corporations, individuals, or governments is. That kind of advocacy bothers me. I think we should stand for the pursuit of knowledge and of truth and not much else.
That said, any modern business school has to have some kind of organizational structure that facilitates students and faculty in exploration of issues that, in the language that I find most illuminating, lie at the intersection, or interface, of business and society. The trick is in defining this area, and the activities that the organization will engage in, in ways that are true to the "pursuit of truth" ideal but that also stimulate student, faculty, and broad audience excitement. There can be no doubt that in today's cultural environment, there are many MBA students who want to discuss those issues that fall in the arena known as "corporate social responsibility." The discussion just has to be consistent with our pursuit of knowledge and truth rather than advocacy (if you don't understand the difference, go watch Al Gore's movie...).
So here is some language that I wrote this evening that attempts to define the area of focus for the Allwin Initiative for Corporate Citizenship at Tuck (and yes, the name may not be perfect either). Reaction is welcome.
The Allwin Initiative focuses its attention on the intersection between business and broader society -- where issues of the overall impact of business activity on social welfare, of corporate objectives and responsibility, and of ethics, citizenship, and leadership become paramount . Rather than defining the precise areas where the Initiative will work, we prefer to set the defining characteristics of the areas that are most interesting and relevant for us. These defining characteristics are three-fold: first, the topic should be one that involves a large potential impact on society; two, the topic should be one that is mainstream, in that a typical Tuck MBA student would be likely to encounter such an issue in their career; and third, the issue should involve a situation where laws, regulations, and/or cultural norms are non-existent, poorly defined, or changing. The first two conditions are self-explanatory, but the third needs clarification. We wish to work in areas where the quality of management, leadership and knowledge will make a large difference. At the intersection of business and society, it is those situations where it is unclear what should be done -- what the right course of action is -- that are important to highlight for both Tuck students as a learning experience and for faculty as scholars, for research purposes. When regulations, laws and cultural norms and expectations are lacking in clarity, that is when the value-added from leadership and from knowledge will be greatest.
It will be useful to note just a few specific topics that meet these criteria at this point in time. Part of our desire to state only the defining characteristics rather than particular areas is our belief that the world is always changing, and the topics that are relevant today will not be tomorrow. We should also note that situations of classic market failure – in the formal economics sense – will almost always be of potential interest to us, but that there may be topics that are not clearly classic market failures, but will still be of interest to us. To put it differently, conditions of market failure are sufficient but not necessary to create interest by the Allwin Initiative. Here are four examples of topics that would currently meet our tests for interest and relevance:
1.
The case developed by a certain Tuck professor of a cement factory being constructed in Vietnam. There are issues of environmental damage and cultural damage. Both of these issues could be construed as classical market failures, with the cement factory not being made to bear the cost of damage to the environment and to cultural artifacts and sacred areas. There are also issues related to the exposure of banks and other lenders due to possible liability from future laws and regulations. There are important embedded questions for the plant managers, for the banks and lenders, for non-governmental organizations, and for governments. The issues are common in large scale economic development projects in the developing and developed world and are therefore mainstream.
2.
There has recently been much criticism of WalMart, in regard to its effect on communities; its employment practices; and even its effect on international trade and our relations with China. Questions concerning the impact on broader society of new business practices and organizational forms, like those related to WalMart, are prime fodder for the Allwin Initiative. Note, however, that it is not at all obvious that these issues are ones of classic market failure. They are instead questions on the overall impact of business on broader society that get to the heart of the role of free enterprise and market economies. Note also that the laws, regulations, and customs surrounding the role of "“big box"” retailers are definitely in a state of flux, not just in the US but globally.
3.
• Another traditional topic for an entity like the Allwin Initiative would be the impact of plant closings, perhaps especially when brought on by a merger or acquisition. This is a topic that falls clearly in the realm covered by “corporate social responsibility” as typically defined, and would be of interest to the Allwin Initiative. These issues are definitely mainstream for Tuck students, and there can be no doubt that the laws, regulations and customs around issues of plant closings and employment reductions are in flux.
4.
One last one, and one that we used at Tuck as the theme for the Halpern Lecture on Business Ethics in 2006: the topic of executive compensation. There is a lot of interest of late in this topic, and it is clearly important (with recent academic papers calculating the relatively large fractionof corporate earnings that actually go to compensation for top executives). Laws and regulations concerning executive compensation are also in flux.
We believe that by studying situations like these, from both a student perspective and from a scholarly/faculty perspective -- and in both a traditional academic learning environment as well as a more active, experiential learning environment -- we can add to knowledge and we will be better able to prepare our students to be effective managers and leaders of tomorrow'’s organizations.
Friday, September 01, 2006
The Decline of the Mainstream Media and the Theory of Informational Cascades
The recent Israeli/Hezbollah conflict made me think of some current issues in the mainstream media. While I do think that my game theoretic analysis of this recent conflict was good -- and may end up being right on yet -- it certainly did not answer all my questions. As that conflict went on, additional questions and issues emerged. One that has been written about in the blogosphere a fair amount concerns the way that Hezbollah seemed to control the battlefield of the media. While Israel may have gained some strategic advantage from the conflict (granted that the final outcome is still unclear) I don't think anyone would argue with the view that Hezbollah won the communications war.
So let's put this into a broader context.
And I do want to give the Economist credit for its cover story this past week, "Who Killed the Newspapers?" There was not too much to follow inside the cover, but a few points were made.
Since the onset of the TV (geez, I remember our first black and white!) the newspapers have fought for market share of readers and of advertisers. The recent Internet-based economic changes have further affected the market position of not only newspapers, but the whole "mainstream media," TV and news magazines as well. Richard Posner had a great review article in the Sunday New York Times a while back, laying out very well how the new technology destroys the old economies-of-scale model of the old media business (see here).
The point is that the old business model of the TV news service, newspaper, or news magazine is seriously suffering. They are now seriously losing readers and advertisers to the Internet.
Whether this is the correct response or not, I don't think there can be argument over the proposition that the mainstream media are cutting their investigative journalism budgets. In the face of declining revenues and profits, a natural reaction is to cut the number of reporters.
So we have a situation where the amount of true investigative reporting in the industry, worldwide, has declined. This now sets us up for situations where information cascades and "rational herding" will occur more frequently. Once I explain these, you ask yourself if you do not agree that we are seeing more herding and cascades in the media.
A good link to the theory of informational cascades and herding is by Ivo Welch at Brown, here.
Let me briefly describe the theory. I think informational cascades are the easiest and most illuminating. Suppose you are uncertain about something, say whether a news story is true or not. You have some private information on whether the story is true or not, and so does everybody else. You don't observe other people's information directly, but you do observe how other people behave -- say, whether they choose to pass the story on to other people. If other people only pass on stories that they believe are true, then when you see someone passing on a story, you should rationally infer that their information supported the truth of the story. With fairly reasonable underlying assumptions on the structure of the information, once you observe even two people pass the story on, you will have to rationally assume from that point on that the story is true. You will therefore pass the story on, and now the next person has seen three people act as if the story is true. They will have even more reason to disregard their own information and act just like everyone before them...hence the term informational cascade.
A key point, of course, is that those two people who made the initial decisions to pass the story on could have had bad information (this is all in a world of uncertainty). No matter, once they decide to pass the story on, everyone thereafter will behave in the same way. So we will get a lot of false stories passed on as truthful, and everyone will believe them to be true!
And not to get ahead of ourselves too much, but suppose you know that this is how the world is operating, and you (Hezbollah) decide to be those two people who make the first decisions that everyone else is going to use to infer what is actually going on...
This is the theory of informational cascades. The theory of rational herding is very similar; the term herding refers to the tendency of people to make similar decisions under conditions of uncertainty. Herding can be reinforced by other incentive issues. For example, in the investments world, managers of mutual funds might "herd" not only because they are watching one another, but because their compensation is based on relative performance. If I know what other fund managers are doing in terms of stock picks, then if I mimic that, I cannot go too far astray in my performance.
I think the applications to the media industry are now apparent. With the decline in resources devoted to true investigative reporting, the tendency towards informational cascades and herding are stronger. Nobody really knows what is going on, so when we see someone with some information, we will rationally believe it. I cannot yet present data to support my claim, but my casual observation is that "herding" is more rampant in the media than before. It seems that one story or one fact has much longer and stronger "legs" than ever before. Deaths in Iraq are one example; someone puts out the data on how many were killed, and everyone reports that story. The craziness over Mr. Karr who confessed to killing Jon Benet Ramsey is another good example. Does anyone want to write a paper with me that would create some measure of "herding" for the media and show that it is negatively correlated with the resources devoted to investigative reporting by the mainstream media?
Two further observations. The first is really important, I think. In a world with less investigative reporting by the Fourth Estate, the ability for governments or other organizations and individuals (read Hezbollah, OBL, etc.) to influence people's beliefs is enhanced. I hinted above how someone like Hezbollah could start an informational cascade. Does that story describe pretty well what happened in the recent Lebanese conflict? I think so. Any country that enters into a conflict without a grand strategy of controlling the media is in for a real battle. Israel certainly lost the battle for world opinion, and increasingly, it appears to have done so on the basis of just a couple stories that were exaggerated.
Amazingly, in this new world of technology, we are getting less information being produced, yet more (false) consensus in the world on what is truth, and therefore worse decisions being made.
The second observation related to an earlier post of mine on the tendency for bloggers to simply link to other sites (see here). Bloggers are not yet fully replacing the investigative reporting role of the mainstream media. They (and I) are serving at best an analytic role, trying to opine on the facts that we assume are being collected by others. This is a classic free-riding situation! Who is going to start collecting the information that the old-style reporters used to collect? Discovering the economic model that will support bloggers actually doing more primary data collection will be a challenge, but the potential economic rewards could be huge.
So let's put this into a broader context.
And I do want to give the Economist credit for its cover story this past week, "Who Killed the Newspapers?" There was not too much to follow inside the cover, but a few points were made.
Since the onset of the TV (geez, I remember our first black and white!) the newspapers have fought for market share of readers and of advertisers. The recent Internet-based economic changes have further affected the market position of not only newspapers, but the whole "mainstream media," TV and news magazines as well. Richard Posner had a great review article in the Sunday New York Times a while back, laying out very well how the new technology destroys the old economies-of-scale model of the old media business (see here).
The point is that the old business model of the TV news service, newspaper, or news magazine is seriously suffering. They are now seriously losing readers and advertisers to the Internet.
Whether this is the correct response or not, I don't think there can be argument over the proposition that the mainstream media are cutting their investigative journalism budgets. In the face of declining revenues and profits, a natural reaction is to cut the number of reporters.
So we have a situation where the amount of true investigative reporting in the industry, worldwide, has declined. This now sets us up for situations where information cascades and "rational herding" will occur more frequently. Once I explain these, you ask yourself if you do not agree that we are seeing more herding and cascades in the media.
A good link to the theory of informational cascades and herding is by Ivo Welch at Brown, here.
Let me briefly describe the theory. I think informational cascades are the easiest and most illuminating. Suppose you are uncertain about something, say whether a news story is true or not. You have some private information on whether the story is true or not, and so does everybody else. You don't observe other people's information directly, but you do observe how other people behave -- say, whether they choose to pass the story on to other people. If other people only pass on stories that they believe are true, then when you see someone passing on a story, you should rationally infer that their information supported the truth of the story. With fairly reasonable underlying assumptions on the structure of the information, once you observe even two people pass the story on, you will have to rationally assume from that point on that the story is true. You will therefore pass the story on, and now the next person has seen three people act as if the story is true. They will have even more reason to disregard their own information and act just like everyone before them...hence the term informational cascade.
A key point, of course, is that those two people who made the initial decisions to pass the story on could have had bad information (this is all in a world of uncertainty). No matter, once they decide to pass the story on, everyone thereafter will behave in the same way. So we will get a lot of false stories passed on as truthful, and everyone will believe them to be true!
And not to get ahead of ourselves too much, but suppose you know that this is how the world is operating, and you (Hezbollah) decide to be those two people who make the first decisions that everyone else is going to use to infer what is actually going on...
This is the theory of informational cascades. The theory of rational herding is very similar; the term herding refers to the tendency of people to make similar decisions under conditions of uncertainty. Herding can be reinforced by other incentive issues. For example, in the investments world, managers of mutual funds might "herd" not only because they are watching one another, but because their compensation is based on relative performance. If I know what other fund managers are doing in terms of stock picks, then if I mimic that, I cannot go too far astray in my performance.
I think the applications to the media industry are now apparent. With the decline in resources devoted to true investigative reporting, the tendency towards informational cascades and herding are stronger. Nobody really knows what is going on, so when we see someone with some information, we will rationally believe it. I cannot yet present data to support my claim, but my casual observation is that "herding" is more rampant in the media than before. It seems that one story or one fact has much longer and stronger "legs" than ever before. Deaths in Iraq are one example; someone puts out the data on how many were killed, and everyone reports that story. The craziness over Mr. Karr who confessed to killing Jon Benet Ramsey is another good example. Does anyone want to write a paper with me that would create some measure of "herding" for the media and show that it is negatively correlated with the resources devoted to investigative reporting by the mainstream media?
Two further observations. The first is really important, I think. In a world with less investigative reporting by the Fourth Estate, the ability for governments or other organizations and individuals (read Hezbollah, OBL, etc.) to influence people's beliefs is enhanced. I hinted above how someone like Hezbollah could start an informational cascade. Does that story describe pretty well what happened in the recent Lebanese conflict? I think so. Any country that enters into a conflict without a grand strategy of controlling the media is in for a real battle. Israel certainly lost the battle for world opinion, and increasingly, it appears to have done so on the basis of just a couple stories that were exaggerated.
Amazingly, in this new world of technology, we are getting less information being produced, yet more (false) consensus in the world on what is truth, and therefore worse decisions being made.
The second observation related to an earlier post of mine on the tendency for bloggers to simply link to other sites (see here). Bloggers are not yet fully replacing the investigative reporting role of the mainstream media. They (and I) are serving at best an analytic role, trying to opine on the facts that we assume are being collected by others. This is a classic free-riding situation! Who is going to start collecting the information that the old-style reporters used to collect? Discovering the economic model that will support bloggers actually doing more primary data collection will be a challenge, but the potential economic rewards could be huge.
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