Is it real? Can we win? Is it worth doing? Managing risk and reward in an innovation portfolio

Minor innovations make up most of a company's development portfolio, on average, but they never generate the growth companies seek. The solution, says Day--the Geoffrey T. Boisi Professor of Marketing and a codirector of the Mack Center for Technological Innovation at Wharton--is for companies to undertake a systematic, disciplined review of their innovation portfolios and increase the number of major innovations at an acceptable level of risk. Two tools can help them do this. The first, called the risk matrix, graphically reveals the distribution of risk across a company's entire innovation portfolio. The matrix allows companies to estimate each project's probability of success or failure, based on how big a stretch it is for the firm to undertake. The less familiar the product or technology and the intended market, the higher the risk. The second tool, dubbed the R-W-W (real-win-worth it) screen, allows companies to evaluate the risks and potential of individual projects by answering six fundamental questions about each one: Is the market real? Explores customers' needs, their willingness to buy, and the size of the potential market. Is the product real? Looks at the feasibility of producing the innovation. Can the product be competitive? and Can our company be competitive? Investigate how well suited the company's resources and management are to compete in the marketplace with the product. Will the product be profitable at an acceptable risk? Explores the financial analysis needed to assess an innovation's commercial viability. Last, Does launching the product make strategic sense? examines the project's fit with company strategy and whether management supports it.     

New development: Wang Anshi's Wanyanshu as the origins of modern public management?

The drive for efficiencies across all areas of public spending in the UK has accelerated the need for improvements in service performance. This article considers how police performance might be improved through the adoption of a ‘Lean’ philosophy. This is seen as a potential driver for internal police improvements and is made in response to the government's call for reform and to address the challenges of a decrease in future police funding.     

Are all types of real transaction management equal in the eyes of bank lenders?

This study examines whether bank lenders react differently to various types of real transaction management (RTM) by borrowing firms. Drawing upon the differential cash and cash flow effects of alternative forms of RTM, we predict and find that banks provide more favorable loan terms, that is, lower interest spread and reduced likelihood of required collateral, for firms reporting more discretionary reductions in research and development (R&D) expenditures. In contrast, lending banks respond unfavorably to borrowers’ engagement in RTM through aggressive sales discounts and overproduction of inventories. Additional analysis reveals that the favorable effect of discretionary R&D reductions on loan pricing is greater (smaller) for borrowing firms with a prior relationship with the bank or with a lower level of cash holdings (loans with longer maturity). Overall, our findings suggest that banks, with their unique payoff functions and monitoring incentives, do not view all forms of RTM negatively.     

Nonlinear analysis for forecasting currencies: are they useful to the portfolio manager?

The importance of a time-varying specification for both the return and the risk of financial assets is well known. The purpose of this study is to investigate if some of the most recently developed econometric models, combined with technical indicators often used by practitioners, can significantly predict future returns. While most studies have focused on either univariate series or in-sample analyses of a given econometric specification, this study considers a multivariate framework where a US based investor daily reallocates a portfolio of three currencies (Deutschmark, Swiss Franc and Japanese Yen). Series of three years out-of-sample forecasts are analysed in terms of risk and return and it is shown that some of the tested speciications can indeed signiicantly predict future daily returns and correlations over this three-year period.     

Do they do it for the money?

Using a sample of all top management who were indicted for illegal insider trading in the United States for trades during the period 1989-2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them). We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other motives.     

Dividend premium: Are dividend-paying stocks worth more?

This paper reports that the relation between dividend payout and firm value is positive. Panel data regressions suggest that the dividend premium for firms' equity is 17.4% and the dividend premium for firms' assets is 7.1%. The tests using propensity score matching methodology report a lower – but still positive and statistically significant – dividend premium: 12.5% for equity and 6.1% for assets. Thus, stock prices of dividend payers are greater by 12.5% or 17.4% on average (depending on methodology) compared to those of nonpayers. We find that policy-related economic uncertainty and the proportion of firms paying dividends explain more than half of the variation in dividend premium for assets.     

Sources of exchange rate fluctuations: Are they real or nominal?

I analyze the role of real and monetary shocks on exchange rate behavior using a structural vector autoregressive model of the US vis-à-vis the rest of the world. The shocks are identified using sign restrictions on the responses of the variables to orthogonal disturbances. These restrictions are derived from the predictions of a two-country DSGE model. I find that monetary shocks are unimportant in explaining exchange rate fluctuations. By contrast, demand shocks explain between 21% and 37% of exchange rate variance at 4-quarter and 20-quarter horizons, respectively. The contribution of demand shocks plays an important role but not of the order of magnitude sometimes found in earlier studies. My results, however, support the recent focus of the literature on real shocks to match the empirical properties of real exchange rates.     

Are regime-shift sources of risk priced in the market?

In this paper we develop a discrete-time pricing model for European options where the log-return of the underlying asset is subject to discontinuous regime shifts in its mean and/or volatility which follow a Markov chain. The model allows for multiple regime shifts whose risk cannot be hedge out and thus must be priced in option market. The paper provides estimates of the price of regime-shift risk coefficients based on a joint estimation procedure of the Markov regime-switching process of the underlying stock and the suggested option pricing model. The results of the paper indicate that bull-to-bear and bear-to-crash regime shifts carry substantial prices of risk. Risk averse investors in the markets price these regime shifts by assigning higher transition (switching) probabilities to them under the risk neutral probability measure than under the physical. Ignoring these sources of risk will lead to substantial option pricing errors. In addition, the paper shows that investors also price reverse regime shifts, like the crash-to-bear and bear-to-bull ones, by assigning smaller transition probabilities under the risk neutral measure than the physical. Finally, the paper evaluates the pricing performance of the model and indicates that it can be successfully employed, in practice, to price European options.     

Financial experts on the top management team: Do they reduce investment inefficiency?

We examine the effect of the top management team (TMT) professional finance experience on firm investment efficiency. Top managers with a career background in finance help reduce deviations of investment from the level warranted by firm fundamentals. Reductions in investment inefficiencies are achieved by financial expert managers using project-specific rather than company-wide, discount rates for project evaluation and facilitating debt and equity issuance at lower costs. Greater investment efficiency due to the financial expertise of TMT improves firm performance. We demonstrate that these improvements are driven by the collective expertise of the TMT rather than solely by chief executive officers.     

Connecting earnings management to the real World:What happens in the black box of the boardroom?

This British Accounting & Finance Association (BAFA) distinguished academic 2020 plenary address marries the researcher's two main research areas – financial reporting and corporate governance. Like Vivien Beattie (BAFA 2011 distinguished academic), the researcher commenced in the positivist tradition but was increasingly drawn to more qualitative, interdisciplinary perspectives, influencing the paper's positioning.“Accounting choice”, “income smoothing”, “earnings management”, and “earnings manipulation” are terms frequently used in the academic literature. This paper reviews these terms, highlighting the resonances and dissonances between them, and attempts to reconcile varied perspectives in the prior literature. The paper critiques taken-for-granted assumptions underlying this stream of research. The paper then examines prior earnings management research using alternative methodologies to deepen understanding of the four terms in praxis (best practice in practice). The paper reviews prior research on boards of directors using alternative methodologies to those adopted in mainstream corporate governance research, to provide a menu of opportunities to research earnings management inside the “black box” of the boardroom, including proposed research questions for future research. The paper concludes by considering the implications for policymakers and standard setters.     

Are you in with the in crowd?

At the core of your company, there is a group of people who seem to call the shots--or, rather, all the shots seem to be called for their benefit. This core group can't be found on any organization chart. It exists in people's hearts and minds. It comprises the people whose perceived interests and needs are taken into account as decisions are made throughout the organization. In most companies, talking explicitly about this group is taboo; its existence seems to contradict the vital corporate premise that we all have a common stake in the firm's success. In the best organizations, the core group can be a resource: Members represent the unique values and knowledge that distinguish their companies. When core groups display independence, creativity, and power, the rest of the company follows. Such behavior on the part of the company, in turn, creates value for shareholders, especially over the long term. But because of the core group's enormous power, members need to make themselves aware of the signals they send, both intended and unintended. For better and for worse, the core group reinforces whatever it pays attention to. A core group member who casually mentions a product might well discover three weeks later that someone has spent $1 million introducing it. If you do not know who constitutes the core group in your organization, or what the members stand for, you may find that leading will be extremely difficult--even if you are ostensibly the person in charge. If you want to move the organization in a new direction, you may need to explicitly challenge the core group. Otherwise the rest of the organization will not go along.     

Trust and affect: how do they impact risk information seeking in a health context?

This study examines college students’ intention to seek information about the H1N1 flu vaccine. We specifically focused on the relationship between trust and affect and whether they work together to influence risk information seeking. Results indicated that positive affect moderated the relationship between trust and information seeking, but negative affect did not. While both positive affect and negative affect influenced risk information seeking, when combined with trust, only positive affect remained as a significant predictor. These results suggest that by understanding the role that trust and affect play, medical professionals and disease control agencies can tailor their communication efforts to increase an individual’s intention to seek information about preventive measures. Specifically, maintaining the public’s trust and positive feelings toward these entities is key to successful communication about prevention measures such as vaccination.     

Systemic risk and financial consolidation: Are they related?

The creation of a number of very large and sometimes increasingly complex financial institutions, resulting in part from the on-going consolidation of the financial system, has raised concerns that the degree of systemic risk in the financial system may have increased. We argue that firm inter-dependencies, as measured by correlations of stock returns, provide an indicator of systemic risk potential. We analyze the dynamics of the stock return correlations of a sample of US large and complex banking organizations (LCBOs) over 1988–1999, and find a significant positive trend in stock return correlations. This finding is consistent with the view that the systemic risk potential in the financial sector appears to have increased over the last decade. In addition, we relate firms' return correlations to their consolidation activity by estimating measures of the consolidation elasticity of correlation. Consolidation at the sample LCBOs appears to have contributed to LCBOs inter-dependencies. However, consolidation elasticities of correlation exhibit substantial time variation, and likely declined in the latter part of the decade. Thus, factors other than consolidation have also been responsible for the upward trend in return correlations.     

Managerial talent and managerial practices: Are they complements?

We examine the role of managerial talent and its interaction with managerial practices in determining firm performance. We build a matched firm-director panel dataset for the universe of limited liability companies in Italy, tracking directors across different firms over time. We define managerial talent as the individual contribution to the variation of the firms’ total factor productivity, estimated using a two-way fixed effects model. Combining the data with survey information on a representative sample of firms, we then document that our measure of talent correlates with ex-ante and ex-post indicators of ability, i.e. managers’ educational attainment and their forecast precision with respect to the firm’s future performance. Most important, we leverage information on the adoption of managerial practices within the firm to examine potential synergies between managerial talent and structured managerial practices, thus bridging two separate strands of the literature. While talent and structured practices are positively associated with firm productivity on their own, there is evidence of complementarities between the two. These findings hold both in a cross-sectional setting and in a panel analysis that accounts for time-invariant firm heterogeneity. Overall, our results indicate that the effectiveness of managerial practices varies with managers’ ability to implement them.     

Re-evaluating portfolio diversification and design using cryptocurrencies: Are decentralized cryptocurrencies enough?

This paper investigates the portfolio diversification potential of a pool of cryptocurrencies classified based on their degree of leadership. We employ the mean-variance and the higher-order moments optimization approaches to evaluate the diversification potential of centralized and decentralized cryptocurrencies across multiple frameworks. While theoretical implications of the mean-variance and the higher-order moments optimization approaches are similar, our results suggest that the latter provides a more precise portfolio allocation strategy because it considers investor risk-aversion for each moment. Furthermore, we find that extending the pool of cryptocurrencies achieves marginal diversification benefits due to considerable co-movements among the cryptocurrencies. Moreover, we find that decentralized cryptocurrencies offer greater diversification potential than centralized cryptocurrencies, although centralized cryptocurrencies carry some diversification potential during alt-seasons. In order of their weights, Bitcoin, Chainlink, and Ethereum (all decentralized) offer the highest contribution to portfolio diversification across most portfolio frameworks, while Ethereum offers greater diversification benefits during the alt-seasons.     

Use of benchmarks in predicting earnings management?

This study conducts multiple approaches to identify whether earnings benchmarks are an indicator for earnings management within the Australian market. We investigate firms reporting small positive earnings and small positive earnings changes, referred to as benchmark beaters. Accrual quality models, earnings distributions and earnings persistence measures are applied to identify whether benchmark beating firms are manipulating earnings. Our findings suggest that the small positive earnings benchmark attracts earnings managers. However, we do not identify any evidence to indicate that the positive earnings change benchmark is a signal for earnings management.     

Does being a jerk work? Examining the effect of aggressive risk communication in the context of science blogs

Understanding aggressive risk communication is important because many scientists use this approach and we know little about its effects. Two studies were conducted to assess the effect of exposure to aggressive risk communication by a scientist on respondents’ perceptions of risk communication quality, supportive behavior (i.e. forwarding the communication), risk communicator likability, and overall views about scientists. Perceived aggressiveness (studies 1–2) and expectation violation (study 2) were considered as mediators. Analyses suggest both direct and indirect negative effects of aggressive risk communication in the case of likability but potentially positive effects in terms of evaluating the message quality. Moreover, expectation violation provided one possible explanation for the effect of aggression.     

Continuous-time delegated portfolio management with homogeneous expectations: can an agency conflict be avoided?

In a continuous-time framework, the issue of how to delegate an investor’s portfolio decision to a portfolio manager is studied. First, we solve the first-best problem. For the second-best case, a specific quadratic contract is introduced resolving the agency conflict completely in the sense that the solutions to the first-best and second-best problems coincide. This contract can be implemented if the investor is able to observe the value of the growth optimal portfolio at her investment horizon. If the investment opportunity set is assumed to be constant, in equilibrium the value of the market portfolio is a sufficient statistic for the value of the growth optimal portfolio. Throughout the paper, we assume that the investor and the manager have homogeneous expectations about the investment opportunity set. This, however, does not necessarily mean that investor and manager are symmetrically informed about all prices.

Acquisitions driven by stock overvaluation: Are they good deals?

Theory and recent evidence suggest that overvalued firms can create value for shareholders if they exploit their overvaluation by using their stock as currency to purchase less overvalued firms. We challenge this idea and show that, in practice, overvalued acquirers significantly overpay for their targets. These acquisitions do not, in turn, lead to synergy gains. Moreover, these acquisitions seem to be concentrated among acquirers with the largest governance problems. CEO compensation, not shareholder value creation, appears to be the main motive behind acquisitions by overvalued acquirers.