Misperception and misplaced confidence

Saw this blog post by James Hamilton that commented on the Federal Reserve’s exit strategy. In essence, he argued that to know where we go from here (i.e. the current financial crisis), we need to know what happened. In other words,

A successful exit strategy requires a vision of where you want to go, and how it’s going to be different from the place from which you just came

James Hamilton disputed Ben Bernanke’s assertion that the success of the 2004-2006 securitization is spurred mainly by financial innovations such as

technological advances facilitated credit scoring by making it easier for lenders to collect and disseminate information on the creditworthiness of prospective borrowers [and] new techniques for using this information to determine underwriting standards, set interest rates, and manage their risks.

Rather, James Hamilton said that 

… the success of securitization in 2004-2006 was due to (1) misperception on the part of the buyers and raters of the ABS of the degree to which aggregate risks could be diversified by pooling disparate loans, and (2) a misplaced confidence in the implicit or explicit guarantees provided by the securitizer, by derivatives used to hedge ABS holdings, or by the U.S. government, the latter in particular introducing a moral hazard component that rendered the system seriously unstable. And I hope we’d further agree that these factors resulted in a profoundly malfunctioning credit market that caused an unsustainable run-up in U.S. real estate prices and household debt that are the primary reason we’re in such trouble today.

Unfortunately, I think such excesses are simply the nature of the capitalistic machine. Sometimes, on the aggregate over the long term, misperception and misplaced confidence can be good. For example, asset bubbles in the railroads two centuries ago, overproduction in the dot com era, the perpetual biotech bubble model and even overproduction of engineering and science PhDs had help the United States in innovation. And sometimes, in the case of real estate and finance, it may not be.  But the capitalistic machine does not discriminate on the basis of good asset bubbles from bad asset bubbles.

My budget proposal for California – $10 million surplus

I used to LA Times State Budget Balancer to see how the budget deficit for this year can be eliminated. It’s really interesting!

New Taxes = $15, 910,000,000

Raise gasoline tax by $0.32 per gallon [5.8 Billion]

Increase top income tax brackets to 10% for $300000 a year & 11% over $600000 [5 Billion]

Commercial property: Allow assessment for commercial property to rise [2 billion]

Increase cigarettes tax by $1.50 per pack [1.2 Billion]

9.9% oil severance tax [855 Million]

Increase alcohol tax by one nickel per drink [585 Million]

Borrowing = $7,500,000,000

Borrow money against next year tax receipts [5.5 Billion]

Take 8% of local government property tax revenue. Repay it with interest after three years [2 billion]

Budget Cuts = $600, 000, 000

One-year early release for inmates with no violent or sex offences [120 Million]

Reduce prison time for parole [95 Million]

Hire inspectors to reduce MediCal fraud [50 Million]

Hire inspectors to reduce In-home service fraud [15 Million]

Cut Legislative Budget in half [120 Million]

Eliminate redundant boards [50 Million]

Eliminate dental coverage for adults and other services not required by Federal law [150 Million]

Is that where the bailout monies went?

JP Morgan and Goldman Sachs reported record profits for the second quarter. According to New York Times,

Goldman posted the richest quarterly profit in its 140-year history and, to the envy of its rivals, announced that it had earmarked $11.4 billion so far this year to compensate its workers.

A significant amount of Goldman Sachs’ sources of capital and trading profits in the financial crisis had came from the government’s bailout monies

As well as receiving federal assistance last fall under the government’s Troubled Asset Relief Program, Goldman, along with other banks, has benefited from a government program that allows it to issue debt cheaply with the backing of the Federal Deposit Insurance Corporation. In addition, it received money from the government’s bailout of the American International Group, being paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer.

Also, the “pick winners and losers” approach of the bailout meant that there is now greater inudstry concerntration – another source of the new trading  profits, which Robert Reich talked about in his blog:

The resurgence of JPMorgan and Goldman Sachs gives both banks more financial clout than any other players on the Street — allowing both firms to lure talent from everywhere else on the Street with multi-million pay packages, giving both firms enough economic power to charge clients whopping fees, and bestowing on both firms even more political heft in Washington.

But the job of an intermediary like Goldman Sachs is supposed to help funnel resources to the organizations that need financing to produce innovative goods for America – not to enrich itself. However, as Paul Krugman point out, in “The Joy of Sachs”,

Goldman’s role in the financialization of America was similar to that of other players, except for one thing: Goldman didn’t believe its own hype. Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman, famously, made a lot of money selling securities backed by subprime mortgages — then made a lot more money by selling mortgage-backed securities short, just before their value crashed. All of this was perfectly legal, but the net effect was that Goldman made profits by playing the rest of us for suckers.

And Wall Streeters have every incentive to keep playing that kind of game.

The huge bonuses Goldman will soon hand out show that financial-industry highfliers are still operating under a system of heads they win, tails other people lose. If you’re a banker, and you generate big short-term profits, you get lavishly rewarded — and you don’t have to give the money back if and when those profits turn out to have been a mirage. You have every reason, then, to steer investors into taking risks they don’t understand.

And the social network analyses diagram that Glenn Beck provides is both, in a way, amusing, but also unfortunately, could potentially be true.

 

Do not underestimate the power that money can buy in a lobby-crazed country like United States. As Professor Domhoff remarked

Who has predominant power in the United States? The short answer, from 1776 to the present, is: Those who have the money have the power.… the reasons behind it are complex. They involve an understanding of social classes, the role of experts, the two-party system, and the history of the country, especially Southern slavery. In terms of the big world-historical picture, and the Four Networks theory of power…money rules in America because there are no rival networks that grew up over a long and complex history…So, the only power network of any consequence in the history of the United States has been the economic one…

But while Professor Domhoff had in mind a business-owning capitalist class, what’s especially scary now is that the guys handling other people’s money may be the real power brokers. How does this changes the equation? 

Traditionally, economic theories generally assume that intermediaries like investment banks have reputation capital to defend; this ensure they will do a good job serving both ends of the market (Beatty and Ritter, 1986). Even some economic sociologists argue that high status middlemen get by because status is perceived as loosely coupled with quality in highly uncertain context (Podolny, 1993). But when investment banks trade on their own account and bank on political connections, they aren’t really earning significant amount of money from their reputation anymore. They are simply structurally located to take advantage of the situation.

And that’s the scary part – when mediated markets stop functioning the way it used to be because the middlemen has redefine their jobs. Gosh, if we know that the middlemen handling the money would be this powerful, how did we end up letting them get so powerful in the first place?

Thinking aloud: Regulation FD, “quiet period” and issuers’ disclosure to the IPO underwriters

Historically, firms going public are advised not to engage in communications that stimulate investors’ interest in the IPO before the filing of the registration statement . Anecdotally, this “quiet period” begins one to two years before filing the registration statement . Thus, firms are advised to act like public companies, disclosing information properly to the public around one or two years before going public. 

If that is the case, should Regulation FD apply to the firms that plan to go public in the near future? Regulation FD, formally known as Regulation Fair Disclosure, was implemented as a SEC ruling on 23rd October, 2000. It mainly require that disclosure to investors be non-selective so that large institutional investors do not receive market moving information before small retail investors. From an information perspective, Regulation FD tries to stamp out insider trading.

Since IPO firms are confined to communicating information in the registration statement in the road show, I guess that suggests, at the minimum, that Regulation FD would apply to the firms that have filed the registration statement.

But in terms of disclosure to the IPO underwriter, Regulation FD is probably irrelevant. Remember, the IPO underwriter is different from the stock analyst. The stock analyst compile information from conference calls, company visits and various sources, and package that information to pass along to their selected clients. Hence, there is a problem with selective disclosure. However, the underwriter is responsible for helping the issuer to draft the registration statement . As stated by Hanley and Hoberg (2008)

the writing of the prospectus is collaborative effort involving underwriters, legal counsel, auditors and the issuing firm with different authors performing separate functions in the disclosure of information.

Consequently, the underwriter is not only the initial party that the issuer discloses information to but also has a duty, as regulated by SEC, to ensure that the information communicated to the investors are basically what was disclosed in the IPO prospectuses.

Given this premise, there is no reason for the issuer to restrict disclosure to the underwriter – such information presumably remain in the private domain until both the parties jointly discloses the information for the public offering.

MCMULLEN AND SHEPHERD (2006)

I’m reading the McMullen and Shepherd (2006) two-stage entrepreneurial action model.

In their action model, McMullen and Shepherd (2006) talked about how individuals take action because of their willingness to bear perceived uncertainty. Thus, even though entrepreneurial activity occurs in the market, their focus is on the individual psychological beliefs that lead to the entrepreneurial behavior. Quoting Werner Greve, McMullen and Shepherd (2006) remarked,

… action, by definition, is intentional behavior. Therefore, one cannot start with the behavioral portion of the action and argue that increases in the intention caused the action. This would be tautological, given that the action partially consists of the intention. However, one could avoid tautology by starting with the strength of the intention and subsequently predicting whether the intended behavior subsequently ensues.

My interpretation of McMullen and Shepherd (2006) is that they essentially argued that entrepreneurial actions are composed of both intentions and behavior with the former preceding the latter. Thus, while it is not possible to predict action, it is possible to separate intentions and behavior longitudinally and use intentions to predict behavior.

McMullen and Shepherd (2006) were right to argue that the role that perceived uncertainty plays in obstruction, however important, is an insufficient explanation because it says

nothing about the unwillingness to bear the uncertainty that is perceived.

The Schumpeterian entrepreneur is willing to act because s/he perceived less uncertainty, arguably due to superior knowledge. Or as McMullen and Shepherd (2006) argued, the risk-return ratio may justify capitalizing select opportunities for the knowledgeable actor.

But what happens if it is mainly the stakeholders and not the entrepreneur who pony up the resources? When this happens, the entrepreneur has to either somehow convince these stakeholders that the returns are good or convince them that the uncertainty is low. The former is immensely more difficult because there’s no telling what the returns should be if the uncertainty is truly unknowable.

Thus, to me, the “action” has just begun once the entrepreneur reaches the stage of first-person opportunity. In particular, in knowledge-intensive industries, entrepreneurs frequently seek other people’s money because the scale of viable commercial ventures is much larger. This happens on multiple fronts. For example, the entrepreneurial firm may need to ask suppliers to commit capital upfront to help build customized products, may expect customers to bear part of the risk by introducing updated versions of the product over time and finally, may seek external capital. In these scenarios, the entrepreneur transfer uncertainty to its stakeholders because of the need for resources. Yet, the entrepreneur is unlikely to convince these stakeholders to bear the perceived uncertainty. Even investors want maximum profits and minimal uncertainty.

In other words, the issue about the willingness to bear perceived uncertainty comes right back once we considered the socialized nature of entrepreneurship in mediated markets – i.e. entrepreneurs are taking risks with other people’s money.

REFERENCE

McMullen, J.S. and Shepherd, D.A. (2006). “Entrepreneurial Action and the Role of Uncertainty in the Theory of the Entrepreneur”. Academy of Management Review 31: 132–152.

The biotech community in San Diego

Biotech hubs are not for everyone. As reported by Shaila Dewan in “Despite Odds, Cities Race to Bet on Biotech”, there are only a handful of cities that can truly be crowned as biotech hubs. After briefly discussing how cities like Charlotte, Shreveport, Huntsville, and states like Oklahoma and Hawaii are splurging cold hard cash to compete for biotech investments, Shaila reported 

[T]he industry is highly concentrated in established epicenters like Boston, San Diego and San Francisco, which offer not just scientific talent but also executives who know how to steer drugs through the arduous approval process.

“Most of these states probably don’t stand much of a chance to develop a viable biotech industry,” said Gary P. Pisano, a Harvard Business School professor and the author of “Science Business: The Promise, the Reality and the Future of Biotech.”

“You can always get a few top people,” Mr. Pisano said, “but you need a lot of critical mass.”

As a graduate student interested in studying Scientific Advisory Boards (SABs), this article suggests that there are probably only three places for me to go to, at least with regard to conducting qualitative research efficiently. Among the top destinations, only San Diego come close to within three hours commuting distance from the Marshall School of Business, where I am working on my PhD. So the choice is pretty obvious as to where I should based myself in for the next two years – Yes, San Diego.

Participant observation in public settings– online versus off-line

Is there any difference between on-line versus off-line qualitative research? Here’s what I’ve been thinking – in terms of ethics, there is not much difference with regard to intensive interviewing. The same IRB procedures apply.

And I would argue that’s the case for participant observation as well.  Specifically, with regard to ethnography, a lot of on-line research is like doing participant observation but with the aid of technology. Consider, for example, doing the type of work that Erving Goffman conducted in “The Presentation of Self in Everyday Life” but done exclusively in the web, like in online public spheres such as Linkedin, Meebo chat rooms, youtube,  message boards and many other online locations. In fact, Goffman-like analyses can be done at the entrance of the shopping mall if it is publicly video-taped and connected real-time to the internet.

What is especially efficient about doing online participant observation is that you can go back in time and pore over the conversations/interactions that the different actors had in the past. Moreover, because many internet users have pseudonyms that comes along with virtual identities, the study can be highly compartmentalized – many users only bring along a portion of themselves when they go online and of course, this affects interaction since one user only see that portion of his or her counterpart. Consequently, the researcher’s interpretation can be confined to a narrow segment. While this might sounds bad for researchers seeking “complete data”, this is actually good for those who are publishing in journals with page limits because journal-type researchers must focus on a sufficiently narrow question that can be addressed in around 40pages. Some journals like AJS allow authors to submit longer-length manuscript for qualitative research but still…..it’s good to narrow down.

Academic blogging

CV Harquail is going to offer a PDW on blogging at the 2009 Academy of Management Annual Conference. This workshop is broken into three phases that will teach members how to use blogs at three levels of increasing engagement:

1. Phase one – reading selected management scholars’ blogs. This list includes quite a few good scholars such as Orgtheory.net by Brayden King & Teppo Felin, and WorkMatters by Bob Sutton. But I’m surprised that it also misses other names such as Rob Salomon at NYU,  Organization & Markets by Nicolai & colleagues and the Gifts of Athena founded by Pierre Azoulay.
2. Phase two – writing. The goal for this phase is to help participants learn how to find their niche, adjust their writing and contribute to existing blogs as writers 
3. Phase three – publishing. Teach participants how to create their own blog. AOM members interested in this phase should contact CV Harquail at [cvharquail at AuthenticOrganizations dot com].

My impression is that what’s really cool about the potential of this workshop is not only that it will teaches you how to blog but that it promises to eventually create a community of bloggers by leveraging on an AOM emerging group blog called Insights to Actions. This group blog promises to do something really great for the AOM members:

1. Aggregate feeds from interested members’ blogs,
2. Provide members with an outlet to publish essays & commentaries as blog posts
3. Provide members with a virtual site to discuss with each other.
4. Experiment with new ways of reaching across and outside the Academy to expand our influence.

Cool!!!!!!!!!!!

But it’s too bad that it falls on the 7th of August, 8am to 6pm. On that same day, same time, I’m committed to the 2009 BPS Doctoral Consortium. If anyone of you is going on that day, do let me know how was your experience is after the PDW.

How do networks contribute to the development of innovations?

Tilburg university has issued a call for paper that relates to innovation. The conference is titled as “Innovation at the Intersection of Strategy, Organization and Learning. It is scheduled for June 10-12, 2010 and the submission date for the full paper is  February 15, 2010.

The organizers invite papers that predominantly, though not exclusively, reflect some of the following issues:

*       What organizational capabilities are needed to deploy and govern
innovative activities effectively, especially in fast-changing environments
and across great distances?
*       How does organizational structure affect the learning inputs and
outcomes involved in innovation?
*       In what ways do networks of organizations contribute to the
development of innovations?
*       How do institutional forces affect the innovative performance of
organizations?

I wonder what I can contribute, with regard to networks and institutional forces? Hmm…..

Readers interested in the Tilburg conference call for paper can click the second page.

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Developing an interview guide

For the purpose of conducting qualitative research on scientific advisory boards at San Diego, I recently developed an interview guide. How did I do it?

The task, obviously, is to come up with the questions. So how did I do it? Well, I began by jotting down things that are puzzling to me, at various moments over a pretty long period of time. Sometimes, these questions occur at odd moments, while I’m driving, eating or taking a shower. Sometimes, the questions pop up when I was reading or listening to conversations. Over time, the puzzles accumulate and I began to sort the puzzles and questions into clusters, which I refined over time into a much more coherent framework that is understandable not just to me but also to other researchers. And I plan to gradually modify the questions into “versions” that take the perspective of the interviewees. As a bonus, extended versions can include customized probes.

In the interview guide, I included an introduction that will prompt me to (i) explain the purpose and nature of the study, (ii) give assurance that the data will be kept highly confidential and the interviewee will remain anonymous in any written reports, and (iii) indicate that there are no right or wrong answers, (iv) let the interviewee know that he or she should feel free to interrupt, seek clarification or even criticize a line of questioning, and (v) tell the interviewee something about myself with regard to background, training and research interest, and finally, (vi) seek the interviewee’s permission to record the interview.

Of course, it is important to keep the format flexible since every interviewee is different. This means that it may be useful to customize each interview guide, responding to ad-hoc responses. Not only is this better for eliciting responses from the interviewees, each interview guide will also contain unique information and serve as a memory device at the time of writing up the interview.

Along this line of reasoning, I am currently considering adding a factsheet to each customized interview guide. The factsheet should contain a code number rather than the interviewee’s name, date of interview and place of interview. If it is necessary to add additional information about the interviewee, perhaps I will create a post-interview comment sheet. This post-interview comment sheet can contain information such as the description of the social setting, any particular methodological difficulties that were encountered, insights and reflections gained during or after the interview. If the interviewee furnishes more information some time later after the interview, I may also add the extra-interview observation to the post-interview comment sheet.