Management Insights

In our monthly Management Insights we highlight—without using technical jargon—the insights and implications for practicing managers that are explored and developed in each article published in the issue.

Which U.S. Market Interactions Affect CEO Pay? Evidence from UK Companies (p. 2413)

Joseph J. Gerakos, Joseph D. Piotroski, Suraj Srinivasan

How are different types of interactions with U.S. markets by non-U.S. firms associated with compensation of employees? The authors find that there are higher levels of CEO pay, greater emphasis on incentive-based compensation, and smaller pay gaps with U.S. firms in non-U.S. companies that interact with U.S. markets. Using a sample of CEOs of UK firms and using both broad cross-sectional and narrow event-window tests, they find that capital market relationship in the form of a U.S. exchange listing is related to higher UK CEO pay; however, the effect is similar when UK firms have a listing in any foreign country, implying that a foreign listing effect is not unique to the United States. Product market relationships measured by the extent of sales in the United States by UK companies are associated with higher pay, greater use of U.S.-style pay arrangements, and a reduction in the U.S.–UK pay gap. The product market effect is incremental to the effect of a U.S. exchange listing, the extent of the firm's non-U.S. foreign market interactions, and the characteristics of the executive. The U.S.–UK CEO pay gap reduces in UK firms that make U.S. acquisitions. Furthermore, the firm's use of a U.S. compensation consultant increases the sensitivity of UK pay practices to U.S. product market relationships. The insight for management: Interactions with U.S. markets can drive foreign firms to U.S.-style compensation.

Learning from My Success and from Others' Failure: Evidence from Minimally Invasive Cardiac Surgery (p. 2435)

Diwas KC, Bradley R. Staats, Francesca Gino

Do we learn from our successes or from our failures? Learning from past experience is central to an organization's adaptation and survival. A key dimension of prior experience is whether an outcome was successful or unsuccessful. The authors investigate how individuals learn from their own past experiences with both failure and success and from the experiences of others. They use 10 years of data from 71 cardiothoracic surgeons who completed more than 6,500 procedures using a new technology for cardiac surgery. They find that individuals learn more from their own successes than from their own failures, but they learn more from the failures of others than from others' successes. They also find that individuals' prior successes and others' failures can help individuals overcome the inability to learn from their own failures. The insight for management: Individuals tend to learn from their own successes and others' failures.

Price Competition with Consumer Confusion (p. 2450)

Ioana Chioveanu, Jidong Zhou

Buy one, get one free or half off? Price frames, or ways to present price information, are used regularly in retail to attract buyers. Frame choices affect the comparability of price offers and may cause consumer confusion and lower price sensitivity. The authors find that firms randomize their frame choices to obfuscate price comparisons and sustain positive profits. Furthermore, the authors suggest that an increase in the number of competitors induces firms to rely more on frame complexity. The insight for management: Where there is confusion, there is profit; confusing price frames reduces consumer price comparisons, which may boost industry profits and lower consumer surplus.

Missing Links: Referrer Behavior and Job Segregation (p. 2470)

Brian Rubineau, Roberto M. Fernandez

How does referral recruitment contribute to job segregation? The importance of networks in labor markets is well known. Such networks create a job-segregating effect in organizations. The segregation is attributed to the homophilous nature of contact networks, the tendency of individuals to associate and bond with similar others. The authors investigate the role of referrers in the segregating effects of network recruitment. They show that referrer behaviors can segregate jobs beyond the effects of homophilous network recruitment. They also show that referrer behaviors can also mitigate most, if not all, of the segregating effects of network recruitment. The insight for management: Referrers can provide opportunities for organizations to influence the effects of network recruitment.

Salesforce Compensation with Inventory Considerations (p. 2490)

Tinglong Dai, Kinshuk Jerath

How do inventory level decisions affect the effort levels of a salesforce? Ideally, the salesforce generates demand to match the inventory stocked because if demand is below inventory level, the firm incurs a cost for the leftover inventory, and if demand is above inventory level, the salesperson's effort is wasted. If the stock of inventory is insufficient, the salesforce is demotivated, and it is typically not possible to keep track of demand that was, or could have been, realized but was not fulfilled due to lack of inventory. The authors find that it may be optimal for the firm to stock more than the first-best inventory level, because this enables the firm to obtain a more precise indicator of the salesperson's effort. The possibility of stockouts due to limited inventory also leads to several counterintuitive results, including the following: (i) relative to when stockouts are not considered, it may be optimal for the firm to pay a higher bonus even though limited inventory constrains sales; (ii) as inventory becomes more expensive, thereby forcing the firm to lower its inventory, the firm may nevertheless pay the agent a higher bonus; and (iii) if there is a lower probability that the agent's effort exertion leads to high demand, rather than lowering inventory due to the lower sales potential, the firm may increase inventory. The insight for management: Inventory levels and salesforce compensation strategies interact.

Overconfidence in Newsvendor Orders: An Experimental Study (p. 2502)

Yufei Ren, Rachel Croson

How can overconfidence adversely affect decision quality in supply chain and inventory settings? The authors test whether orders deviate from optimal when individuals are overconfident (in particular, overprecise) in their estimation of order variation. They find that overprecision explains almost one-third of the observed ordering mistakes and that the effect of overprecision is robust to learning and other dynamic considerations. They propose a new technique to exogenously reduce overprecision. They find that participants demonstrate less overprecision and less bias than those who don't use the proposed technique. The insight for management: Overconfidence creates errors in supply chain ordering and inventory management that can be remedied through new techniques.

When Smaller Menus Are Better: Variability in Menu-Setting Ability (p. 2518)

David Goldreich, Hanna Hałaburda

Are large menus better than small menus? Recent literature argues that individuals' apparent preference for smaller menus can be explained by their behavioral biases or informational limitations. These explanations imply that absent behavioral or informational effects, larger menus would be objectively better. However, in an important economic context—401(k) pension plans—the authors find that larger menus are objectively worse than smaller menus, as measured by the maximum Sharpe ratio achievable. The authors propose a model in which menu setters differ in their ability to preselect the menu. We show that when the cost of increasing the menu size is sufficiently small, a lower-ability menu setter optimally offers more items in the menu than a higher-ability menu setter. Nevertheless, the menu optimally offered by a higher-ability menu setter remains superior. The insight for management: There is a negative relation between menu size and menu quality; smaller menus are better than larger menus.

Invariant Probabilistic Sensitivity Analysis (p. 2536)

Manel Baucells, Emanuele Borgonovo

How does uncertainty affect investing decisions? In evaluating opportunities, investors wish to identify key sources of uncertainty. The authors propose a new way to measure how sensitive model outputs are to each probabilistic input (e.g., revenues, growth, idiosyncratic risk parameters). The authors propose a metric that robustly measures the sensitivity of decisions to such uncertainty. The insight for management: New approaches improve the ability to measure the sensitivity of decisions to uncertainty.

Are Analysts' Forecasts Informative to the General Public? (p. 2550)

Oya Altıkılıç, Vadim S. Balashov, Robert S. Hansen

Contrary to the common view that analysts are important information agents, intraday returns evidence shows that announcements of analysts' forecast revisions release little new information, on average. Further cross-sectional evidence from returns around the announcements confirms that revisions are virtually information free. Daily announcement returns used in the literature appear to overstate the analyst's role as information agent, because forecast announcements are often issued directly after reports of significant news about the followed firm. The evidence reveals a sequential relationship between events and news and forecast revisions indicative of analyst piggybacking, not prophecy. The insight for management: Price reactions to analysts' reports reveal little new information.

When the Tail Wags the Dog: Industry Leaders, Limited Attention, and Spurious Cross-Industry Information Diffusion (p. 2566)

Ling Cen, Kalok Chan, Sudipto Dasgupta, Ning Gao

How does industry diffusion affect stock returns? Within an industry, stock returns of larger firms lead those of smaller firms, suggesting an intraindustry information diffusion process. Most industry leaders, however, have business segments in other “minor-segment” industries, whereas most small firms are pure players operating in one industry only. If investors cannot filter out the irrelevant information from the leaders' minor segments, the pure players will be mispriced due to spurious cross-industry information diffusion. The authors document both a strong contemporaneous and a lead–lag relation in stock returns between firms from industry leaders' minor-segment industries and pure players in the industry leaders' major-segment industry. The insight for management: Because of limited attention and information of investors, the market may misprice pure industry players and those that participate in multiple industries.

How Does Rivals' Presence Affect Firms' Decision to Enter New Markets? Economic and Sociological Explanations (p. 2586)

Özgecan Koçak, Serden Özcan

Four distinct theoretical programs have examined market entry decisions of multiunit firms, advancing different explanations for the relationship between a firm's likelihood of entry into a geographical market and the number of rivals that are already present in the target market. Within the strategy literature, theory of strategic interactions explains that firms will want to establish a foothold in markets where their multimarket competitors are scarce but avoid markets where there are many multimarket competitors. Within economic geography, positive externalities such as increase in demand explain firms' desire to locate close to their rivals whereas negative externalities such as competition explain their desire to avoid them. Within the ecological tradition, density dependence theory explains this relationship in terms of legitimation of an organizational form in a particular market and subsequently increased competition for resources there. Within new institutional theory, the presence of rivals is seen as a signal that a particular market is suitable for entry. The insight for management: Various explanations of market entry are reconciled, and their scope of operations is demonstrated.

The Impact of Consumer Attentiveness and Search Costs on Firm Quality Disclosure: A Competitive Analysis (p. 2604)

Bikram Ghosh, Michael R. Galbreth

How do consumer attentiveness and search costs affect firm quality disclosure? Firms can invest to disclose quality information about their products to consumers, but consumers are not always perfectly attentive to these disclosures. Indeed, technologies such as digital video recorders have increased the ease with which disclosures can be avoided by consumers. Although such inattention may result in a consumer's missing information from one or more competing firms, consumers who have missed disclosures might decide to search for quality information to become fully informed before making a purchase decision. The authors incorporate consumer attentiveness, as well as the related endogenous search decision, into a model of quality disclosure. The insight for management: Firms should disclose less quality information as the share of partially informed consumers (informed about one firm but not the other) increases, or as consumer search costs increase.

How Video Rental Patterns Change as Consumers Move Online (p. 2622)

Alejandro Zentner, Michael Smith, Cuneyd Kaya

How will consumption patterns for popular and “long-tail” products change when consumers move from brick-and-mortar to Internet markets? The authors address this question using customer-level panel data obtained from a national video rental chain as it was closing many of its local stores. These data allow the authors to use the closure of a consumer's local video store as an instrument, breaking the inherent endogeneity between channel choice and product choice. The results suggest that when consumers move from brick-and-mortar to online channels, they are significantly more likely to rent “niche” titles relative to “blockbusters.” The insight for management: A significant amount of niche product consumption online is due to the direct influence of the channel on consumer behavior, not just due to selection effects from the types of consumers who decide to use the Internet channel or the types of products that consumers decide to purchase online.