Organizations and Markets

Overconfidence

| Peter Klein |

Busenitz and Barney (1997) famously argued that entrepreneurs (founders) are particularly susceptible to overconfidence and representativeness biases. Compared to professional managers, entrepreneurs systematically overestimate the probability that a new venture will succeed and tend to draw unwarranted generalizations about the future from small samples. Overconfidence is now one of the major themes in the contemporary entrepreneurship literature (Bernardo and Welch, 2001; Forbes, 2005; Koellinger, Minniti, and Schade, 2007).

A new NBER paper by Itzhak Ben-David, John Graham, and Campbell Harvey finds evidence for a particular kind of overconfidence, “miscalibration,” among corporate executives. Miscalibration occurs when the agent’s forecast probability distribution is too narrow, meaning that the likelihood of extremely positive or negative events is unrealistically discounted. The idea is that agents with miscalibrated expectations are overconfident, not in the success of their activities (what the authors label “optimism”), but in their ability to predict the success of their activities. Survey evidence from a sample of CFOs reveals a number of interesting regularities about the relationship between miscalibration and past financial performance, corporate investment, and other observables. Here’s the abstract:

Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.

I’m not aware of any entrepreneurship studies that distinguish miscalibration from optimism, in the sense those terms are used here. Am I missing something?

26 July 2010 at 12:56 pm Peter G. Klein 5 comments

Performance Evaluation Links

| Peter Klein |

Performance evaluation is a favorite topic here at O&M; readers may enjoy these miscellaneous items on measurement:

“Is Impact Measurement a Dead End?” by Alanna Shaikh, guest blogging at AidWatch.
Moneyball’s Michael Lewis on basketball player statistics (HT: PB).
The Urban Institute’s Outcome Indicators Project for nonprofits.
Relevant Demotivators: Flattery, Ineptitude, and Mediocrity.

22 July 2010 at 10:59 pm Peter G. Klein Leave a comment

Summary of Dodd-Frank Act

| Peter Klein |

The Dodd-Frank Wall Street Reform and Consumer Protection Act — I’ll refrain from snarks about the title — was signed into law today by President Obama. Here is a very useful summary by William Sweet of the Act’s contents and likely consequences. In a nutshell: “The Dodd-Frank Act effects a profound increase in regulation of the financial services industry. The Act gives U.S. governmental authorities more funding, more information and more power. In broad and significant areas, the Act endows regulators with wholly discretionary authority to write and interpret new rules.” Aren’t you shocked that it passed?

Update: Larry Ribstein is not happy. Weil Gotshal provides further details.

21 July 2010 at 11:33 am Peter G. Klein 5 comments

The Organizational Economics of the BP Oil Spill

| Peter Klein |

Now that passions are cooling regarding the BP disaster, it’s time to bring organizational issues into the discussion.

1. Everyone knows about the liability caps and the role they may have played in encouraging moral hazard. Just as bank deposits are guaranteed by government deposit insurance, and large banks themselves are probably Too Big to Fail, liability for property damage from oil spills off US waters is limited to $75 million (plus cleanup costs), based on a 1990 law passed after the Exxon Valdiz spill. This presumably mitigates drillers’ incentives to manage environmental risk. Indeed, oil companies enjoy a very cozy relationship with their ostensible guardians; as the NY Times noted, “[d]ecades of law and custom have joined government and the oil industry in the pursuit of petroleum and profit.” The federal agency that oversees drilling, the Minerals Management Service, rakes $13 billion a year in fees in what amounts to a public-private partnership. And does anyone really think the British government would “stand idly by” if BP’s status as an ongoing concern were threatened by criminal or civil penalties?

2. As Bill Shughart points out, BP did not own the Deepwater Horizon platform, but leased it from a company called Transocean. To Bill this suggests “a classic principal-agent problem in which the duties and responsibilities of lessor and lessee undoubtedly were not spelled out fully, especially with respect to maintenance and testing of the rig’s blowout preventer as well as to the advisability of installing a second ‘blind sheer ram,’ which may have been able to plug the well after the first (and only one then in service) failed to do so.” Would BP have paid more attention to safety if it owned, rather than leased, the platform? (more…)

20 July 2010 at 11:58 am Peter G. Klein 7 comments

Misc Academic Links

| Peter Klein |

Academia’s love-hate relationship with wikis.
Deathbed witticisms from Voltaire, Hegel, and other interesting persons.
Should research universities exploit the internal division of labor?
Tips on academic job talks from Fabio’s valuable series.

19 July 2010 at 12:49 pm Peter G. Klein 2 comments

Political and Methodological Individualism

| Peter Klein |

Further to Nicolai’s post, it is also widely believed that methodological individualism — the chief explanatory principle of economics and rational-choice sociology and political science — implies or justifies political individualism or, even worse, some kind of metaphysical or ontological individualism. “But people are social beings!” cry the critics. Well, sure. Methodological individualism is simply the view that social phenomena should be explained, or understood, in terms of the values, beliefs, plans, and actions of the individual that make up the social whole. It makes no claims about the ultimate source of these values and beliefs, the degree to which people are influenced by society, etc. It is a principle of explanation, nothing more.

Here’s a plain statement from Schumpeter, the guy who coined the term “methodological individualism” (okay, he used methodische Individualismus, and borrowed the concept from Weber), writing in 1908:

[W]e must strictly differentiate between political and methodological individualism, as the two have virtually nothing in common. the former starts form the general assumption that freedom, more than anything, contributes to the development of the individual and the well-being of society as a whole and puts forward a number of practical propositions in support of this. The latter is quite different. It has no specific propositions and no prerequisites, it just means that it bases certain economic processes on the actions of individuals. Therefore the question really is: is it practical to use the individual as a basis and would there be enough scope in doing so, or would it be better, in view of specific problems and the national economy as a whole, to use society as a basis. This question is purely methodological and involves no important principle. The socialists can answer it in terms of methodological individualism and the political individualists in terms of their social concept of things, without getting into conflict with their convictions.

See also the Mises quotes discussed here.

18 July 2010 at 3:23 pm Peter G. Klein 8 comments

“De Gustibus Non Est Disputandum”?

| Nicolai Foss |

History of econ nerds (wonks?) will know that John Stuart Mill was trained by his father (James Mill) from the age of three in the Greek and Latin languages. Since Mill, economists’ Latin capabilities have deteriorated rather badly (a result of the dominance of Greek notation? ;-)). In fact, most economists only know two Latin sentences (or rather, dicta) that, however, they love to blurt out, often with a smug smile. One is a sound analytical principle, namely the ceteris paribus principle. The other is a much more problematic (if applied outside of economics) claim, made famous to economists by George Stigler and Gary Becker, namely “de gustibus non est disputandum.”

I have always been surprised by the readiness of many economists to endorse this claim as a general claim that goes beyond the simple implication that in economics we take preferences as given and applies on the aesthetic domain (perhaps this simply reflects the fact that many people nowadays subscribe to total or near-total relativism in aesthetics). However, understood as an aesthetic claim, “de gustibus non est disputandum” lies entirely outside of the orbit of economics (and economists-as-economists should shut up), and is emphatically not implied by subjective value theory, or any related branch of subjectivism in economics. (more…)

18 July 2010 at 5:07 am Nicolai Foss 2 comments

Miscellaneous Organizational Links

| Peter Klein |

The much-anticipated KKR IPO turned out to be a snoozer. But what the heck is a publicly traded private-equity firm anyway?
Is the flattening hierarchy an illusion, driven by job-title inflation?
How call centers use behavioral economics.
Belén Villalonga’s new paper on ownership concentration and internal-capital-market efficiency — highly recommended.

16 July 2010 at 12:22 am Peter G. Klein 3 comments

Mises Quote of the Day

| Peter Klein |

From Human Action, chapter 15, section 11 (via JGL):

In order to succeed in business a man does not need a degree from a school of business administration. These schools train the subalterns for routine jobs. They certainly do not train entrepreneurs. An entrepreneur cannot be trained. A man becomes an entrepreneur in seizing an opportunity and filling the gap. No special education is required for such a display of keen judgment, foresight, and energy. The most successful businessmen were often uneducated when measured by the scholastic standards of the teaching profession. But they were equal to their social function of adjusting production to the most urgent demand. Because of these merits the consumers chose them for business leadership.

15 July 2010 at 11:25 am Peter G. Klein 4 comments

Incentives Matter, Soviet Edition

| Dick Langlois |

As economists like Benito Arruñada and Eric Hilt have shown, fishing and whaling have always used an incentive system in which crew members are paid a share of the profits of the voyage. Recall that Ishmael in Moby Dick contracted for a 300^th lay, a 300^th “part of the clear nett proceeds of the voyage, whatever that might eventually amount to.” This provides relatively high-powered incentives, in that it is a reward based on results, though it works only when team members can monitor each other easily and when the market for workers is competitive. (This contrasts with the reward system in, say, professional sports, where one is rewarded on the basis of one’s own performance rather than on that of the team. But that may be changing.)

I was surprised to discover that even Soviet factory ships used a similar system, as described in the Martin Cruz Smith novel Polar Star — a work of fiction but clearly well researched and probably accurate. “The Polar Star’s pay was shared on a coefficient from 2.55 shares for the captain to 0.8 share for a secondclass seaman. Then there was a polar coefficient of 1.5 for fishing in Arctic seas, a 10 percent bonus for one year’s service, a 10 percent bonus for meeting the ship’s quota, and a bonus as high as 40 percent for overfulfilling the plan. The quota was everything. It could be raised or lowered after the ship left dock, but was usually raised because the fleet manager drew his bonus from saving on seamen’s wages. Transit time to the fishing grounds was set at so many days, and the whole crew lost money when the captain ran into a storm, which was why Soviet ships sometimes went full steam ahead through fog and heavy seas.”

Presumably, however, the share was not of profit but of some fixed amount. The incentive came from the quota bonuses, which, as the novel details, were subject to political manipulation. Interesting nonetheless that the system used incentives of the broadly traditional kind, and that it explicitly rewarded workers differently for different skill level and status.

14 July 2010 at 3:12 pm Dick Langlois 3 comments

Hayek Interviews

| Peter Klein |

In 1983 the Earhart Foundation sponsored a lengthy set of interviews with F. A. Hayek in Los Angeles. The transcripts have long been available (and form the basis of the interview parts of Hayek on Hayek), but the complete set of videos has just now been put online, courtesy of the Universidad Francisco Marroquín. The interviewers are an impressive lot as well: James Buchanan, Armen Alchian, Axel Leijonhufvud, Robert Bork, Tom Hazlett, Jack High, Bob Chitester, Leo Rosten, and Earlene Craver. (I hardly recognized the youthful Hazlett!) You can also get the transcripts, if you prefer plain text.

14 July 2010 at 10:51 am Peter G. Klein 2 comments

Incentives Matter, Little Big Horn Edition

| Peter Klein |

Thanks to Norman Van Cott for this tidbit, which I hadn’t known before:

The crux of Roger McGrath’s review of Nathaniel Philbrick’s “The Last Stand” (Bookshelf, June 18) is that George Custer’s “undoing was the wildly inaccurate information he [Custer] received about the number of Indian warriors he might face.” Left unnoted by Mr. McGrath is the role perverse public-sector economic incentives played in generating this information.

To wit, Indian reservation agents’ salaries varied directly with reservation populations. More Indians, more money. This provided agents an incentive to inflate reservation population counts, which led in turn to underestimates of the number of Indians on the warpath. For the economist, the Little Bighorn debacle is an excellent example of public choice economics in action.

Details about how these incentives affected the population counts appear in a previous decade’s classic study of Custer, Evan Connell’s 1984 “Son of the Morning Star.” For example, prior to the battle, agents reported 37,391 Indians on the reservations. A U.S. Army count after the battle turned up 11,660. That Custer’s soldiers ended up facing perhaps twice as many Indians as they had been told to expect is not surprising. Incentives matter.

13 July 2010 at 11:11 am Peter G. Klein 1 comment

Tesla (the Car)

| Dick Langlois |

Speaking of Tesla: as I was waiting to cross Page Mill Road in Palo Alto the other day, I saw a real live Tesla drive by — the car, not the long-dead inventor. There are several dealerships along El Camino.

In their recent comment, Mari Sako and Susan Helper suggested that electric vehicles might be an example in which, because of the systemic nature of innovation, we might see considerable vertical integration à la Chandler. They talked about the complementary network of charging stations, etc. But it seems to me that what vertical integration the electric vehicle will bring about is more likely to be in the design and production of the car itself. For example, the Tesla website notes that the “Roadster is controlled by state-of-the-art vehicle software. Rooted in Silicon Valley tradition, the code is developed in-house with an intense focus on agile and constant innovation.” Presumably they mean that the code itself, not the vertical integration, is rooted in Silicon Valley tradition.

Apparently, Tesla (along with Toyota) is going to reopen the famed NUMMI plant in Fremont to make its new passenger-car model.

12 July 2010 at 1:29 pm Dick Langlois 4 comments

The History of Nikola Tesla

| Peter Klein |

Saturday was Nikola Tesla’s birthday. Here’s Jeremiah Warren’s video in Tesla’s honor:

Tesla was, of course, the great inventor whose technical achievements outshone those of his great rival, Thomas Edison, but who was unable to commercialize any of his discoveries. Tesla, unfortunately, put his faith in intellectual property-rights protection, while Edison emphasized management and marketing. As Danny Quah puts it, “Public relations and entrepreneurial savvy trump the raw intellectual idea.”

12 July 2010 at 11:05 am Peter G. Klein 1 comment

Stanford Conference on the Asian Firm

| Dick Langlois |

I’m in Palo Alto, having just participated in an extremely interesting conference at Stanford called “The Future of Industry and Innovation in Asia: Firms, Alliances and Networks.” (Papers are not on the website, but you can email the authors.) The conference was organized by Mark Fruin and Raffiq Dossani, and featured people like Martin Kenney, Masao Nakamura, Tim Sturgeon, and Eleanor Westney.

10 July 2010 at 10:00 am Dick Langlois Leave a comment

Too Much Research

| Peter Klein |

Bill McKelvey is one of the signatories to a controversial Chronicle piece that ran last month, “We Must Stop the Avalanche of Low-Quality Research.” The five authors, from a variety of academic disciplines, argue that “the amount of redundant, inconsequential, and outright poor research has swelled in recent decades, filling countless pages in journals and monographs.” As evidence they point to increases in the numbers of journals, journal pages, and authors and decreases in average citation rates.

[I]nstead of contributing to knowledge in various disciplines, the increasing number of low-cited publications only adds to the bulk of words and numbers to be reviewed. Even if read, many articles that are not cited by anyone would seem to contain little useful information. The avalanche of ignored research has a profoundly damaging effect on the enterprise as a whole. Not only does the uncited work itself require years of field and library or laboratory research. It also requires colleagues to read it and provide feedback, as well as reviewers to evaluate it formally for publication. Then, once it is published, it joins the multitudes of other, related publications that researchers must read and evaluate for relevance to their own work. Reviewer time and energy requirements multiply by the year. The impact strikes at the heart of academe.

I think this assessment is generally on target, in my own field at least. What percentage of the articles in your favorite scholarly journal do you read, let alone remember? How much of the research in your field really adds value? Of course, search tools make it easier to find relevant information, so I’m not sure the point about lit reviews is all that compelling. Still, it does seem increasingly difficult to sort wheat from chaff.

I’m less impressed with the authors’ proposed solutions — limiting the number of publications that can be considered for promotion and tenure, making greater use of impact factors, and enforce tighter page restrictions. These strike me as superficial fixes. The main problem is the vast increase in the scale and scope of the “scientific” enterprise itself, almost all of it due to public funding. There are simply too many universities and institutes, too many research faculty, too many granting agencies, too much research money. It’s a self-perpetuating process, almost exclusively driven by supply-side considerations (who on earth “demands” the output of most English departments?). Some of you will be shocked by the claim that there’s “too much” research money, particularly in today’s austere climate. But I mean too much relative to some social optimum, not too much relative to what university professors want.

Why would we expect this kind of system to produce high-quality research? Perhaps it’s a miracle that any good work gets done at all.

8 July 2010 at 2:50 pm Peter G. Klein 13 comments

SMS India Workshop on Strategic Entrepreneurship

| Peter Klein |

In 2008 C. K. Prahalad, along with Charles Dhanaraj and O&M friend M. B. Sarkar, established the SMS India Research Initiative. The next event is a paper development workshop on strategic entrepreneurship, 10-12 December 2010 in Bangalore, aimed at “Western scholars interested in research on emerging markets, and aspiring scholars primarily in Indian business schools.” See the link above for the CFP and the list of senior scholar-participants including Dean Shepherd, Candy Brush, Saras Sarasvathy, Harry Sapienza, Jay Barney, Will Mitchell, Zoltan Acs, Mike Hitt, and many more.

7 July 2010 at 9:43 am Peter G. Klein Leave a comment

Speak Like a Philosophy Professor

| Peter Klein |

From Shrek the Third (text courtesy of IMDB):

Prince Charming: You! You can’t lie! So tell me puppet… where… is… Shrek?
Pinocchio: Uh. Hmm, well, uh, I don’t know where he’s not.
Prince Charming: You’re telling me you don’t know where Shrek is?
Pinocchio: It wouldn’t be inaccurate to assume that I couldn’t exactly not say that it is or isn’t almost partially incorrect.
Prince Charming: So you do know where he is!
Pinocchio: On the contrary. I’m possibly more or less not definitely rejecting the idea that in no way with any amount of uncertainty that I undeniably
Prince Charming: Stop it!
Pinocchio: …do or do not know where he shan’t probably be, if that indeed wasn’t where he isn’t. Even if he wasn’t at where I knew he was,
[Pigs and Gingerbread Man begin singing]
Pinocchio: That’d mean I’d really have to know where he wasn’t.

6 July 2010 at 2:12 pm Peter G. Klein 4 comments

Thanks to Craig!

| Peter Klein |

I’ve been remiss in thanking Craig Pirrong for his excellent guest posts this past Spring — really great stuff! Remember that you can follow Craig at his personal site, Streetwise Professor. Thanks, Craig, for your contributions!