Management Insights
Authors: Gorman Michael F. 
Published: May 2011

Jeremiah Green, John R. M. Hand, Mark T. Soliman Can market inefficiencies persist? In 1996, Richard Sloan found in his research an accruals anomaly, namely, that hedge fund accruals consistently outperform the market. Sloan noted in a 2004 Business Week article, “[I]nvestors are clamoring to exploit this market inefficiency. They seem in a bit of a frenzy about it, but as more people catch on, this trading opportunity should diminish.” The authors of this research find that, consistent with public statements made by sophisticated practitioners, the accruals anomaly appears to have decayed in U.S. stock markets to the point that it is, on average, no longer reliably positive. The authors suggest that the anomaly's demise in part stems from an increase in the amount of capital invested by hedge funds into exploiting it. The insight for management: The opportunity to leverage market anomalies is short-lived, and the more people who catch on, the shorter the life of the opportunity.

Jonah Berger, Devin Pope “I'll bet they come back” is a common halftime wager, but is it a good one? Of course, staking the opposition to a big lead does not bode well for any competitor. However, through the analysis of more than 18,000 professional basketball games, the authors show that being slightly behind at halftime actually leads to a surprising increase in winning percentage. Analysis of more than 45,000 collegiate basketball games finds consistent, though smaller, results. Teams behind by a point at halftime, for example, actually win more often than teams ahead by one, or approximately six percentage points more often than expected. The authors find that being slightly behind increases success because of increased motivation of the losing team. This psychological edge is estimated to be roughly half as large as the vaunted “home field advantage.” The insight for management: Losing can sometimes lead to winning.

Catherine Tucker, Juanjuan Zhang Does the bandwagon effect hold for niche products? Popularity information is usually thought to reinforce existing sales trends by encouraging customers to flock to mainstream products with broad appeal. The authors suggest that such popularity information may benefit niche products with narrow appeal even more. If “everybody” is buying a product of narrow appeal, it must “really” be good, whereas lots of people buy a popular product just because it has wide appeal. Through a field experiment from a website that lists wedding service vendors, the authors find that niche vendors benefit from touting the “visitor count” as measured by click-throughs. The authors propose that the visitor count is a better indicator of quality for niche products than for products of broad appeal. The insight for management: Items with narrow appeal benefit more from popularity information than items with broad appeal.

Kevin J. Boudreau, Nicola Lacetera, Karim R. Lakhani How many contestants should be allowed in a competition that requires innovation? In 2006, the Internet movie rental company Netflix sponsored a $1 million competition challenging participants to develop a 10% improvement in its movie recommendation algorithm. Netflix encouraged wide participation and received entries from more than 5,000 competitors. InnoCentive.com is a website that posts regular competitions and regularly encourages wide participation. Of course, a multitude of competitors increases the likelihood that at least one competitor will find an extreme-value solution. However, widely held economic theory suggests that greater rivalry reduces the incentives of all competitors in a contest to exert effort and make investments. Using a unique data set of 9,661 software contests, the authors show that the effort-reducing effect of greater rivalry is less important for highly uncertain problems; in these competitions adding competitors systematically increases overall contest performance for high-uncertainty problems. The implications for management: When it comes to competitions with challenging, uncertain problems, the more the merrier; adding competitors increases the chances of breakthrough solutions.

Hua Chen, Sung H. Ham, Noah Lim Is the popularity of “March Madness” of the NCAA basketball tournament the result of the massive disparity in potential of the number 1 and number 16 seeds? In an experiment, the authors test whether the presence of “favorites” and “underdogs” actually increases the effort expended in such competitions. The answer is yes; the authors find that both favorites and underdogs exert extra effort as a result of this disparity. They find that the social and psychological elements of such competitions give added incentives. For favorites, the psychological losses from losing carry a social stigma. For underdogs, winning gives them bragging rights. The insight for management: Equal starting points are not necessary to incentivize effort; in fact, the presence of underdogs and favorites actually increases effort.

Eric Van den Steen How sure are you? The author suggests that if someone is relatively overconfident about their estimates and predictions, they can make mistakes when presented with new and conflicting information. The more confident someone is about such uncertainties, the more they tend to overestimate the precision of these estimates. The intuition is slightly ironic: When adjusting predictions in the face of new information, the overconfident person will overweight both the information and its precision. The insight for management: Avoid overconfidence bias; such misguided thinking leads to decreased ability to adjust to and benefit from new information.

Nathan Williams, P. K. Kannan, Shapour Azarm How did the exclusive AT&T deal with Apple iPhone affect Apple's optimal new product design, in terms of engineering design specifications and profits? Will adding Verizon as a retail channel help Apple? The authors develop a strategic framework that enables them to evaluate both profit and product development implications. They find that, via a monopoly retailer, the design preferences of the price-insensitive customers are better represented. Opening up to multiple retailers exposes the product to a wider variety of customers, increasing overall customer welfare through more popular designs. Interestingly, the single-channel strategy leads to lower profits but a higher probability of success for the manufacturer. The insight for management: A single-retailer strategy reduces risk and design options but can hamper overall profitability and consumer welfare.

Iain M. Cockburn, Megan J. MacGarvie To what extent are firms kept out of a market by patents covering related technologies? Do patents held by potential entrants make it easier to enter markets? The authors evaluate the relationship between market entry and patents for 27 narrowly defined categories of software products during the period 1990–2004. They find that a 10% increase in the number of patents relevant to market reduces the rate of entry by 3%–8%. However, potential entrants with patent applications relevant to a market are more likely to enter it. The insight for management: Patents have both entry-deterring and entry-promoting effects for firms.

Terrence August, Tunay I. Tunca Who should be responsible for software security? In recent years, vendor liability for software security vulnerabilities has been the center of an important debate in the software community and a topic gaining government attention in legislative committees and hearings. The importance of this question is amplified when one considers the increasing emergence of zero-day attacks where hackers take advantage of vulnerabilities before the software vendor has a chance to release protective patches. The authors compare the effectiveness of three software liability policies: vendor liability for damages, vendor liability for patching costs, and government-imposed security standards. The right choice depends on the cost of software patches and the probability of zero-day attack. The insight for management: There is no single most effective policy for software security policy; tailored solutions must be created based on cost of patches and the probability of a hacker attack.

Christopher Beveridge, Mark Joshi What is a fair price for a convertible bond? The sale of a convertible bond is a zero-sum game for the two parties. The authors introduce two new methods to calculate pricing bounds using Monte Carlo simulation and apply the new methods to the pricing of convertible bonds by simulation. The insight for management: Boundaries on bond pricing can be established with new methods.

Mohammed Abdellaoui, Enrico Diecidue, Ayse Öncüler Does the timing of a payout affect preferences? Of course, a dollar today is better than a dollar tomorrow. The same two options deferred on year are equivalently delayed, but if there is risk with either option, preference for each can be affected. The researchers evaluate the impact of time on risk preferences, and they report the results of an experimental study that examines how delayed resolution and payment of risky options influence individual choice. The authors find that subjects become more risk tolerant for delayed lotteries. The insight for management: To encourage participation in riskier options, defer payouts; the passage of time on payouts tends to create probabilistic optimism resulting in a higher risk tolerance for delayed lotteries.