Entrepreneurial Musings

Smith School MBAs Secure Lockheed Martin Investment in UMD Technology

2011-02-10T11:47:00.000-08:00

Shameless self promotion!

Smith School MBAs Secure Lockheed Martin Investment in UMD Technology

Aspersions!

2009-10-19T08:35:00.000-07:00

There is a nice new paper out in California Management Review by Charles A. J. O'Reilly (Stanford GSB), Bruce Herreld (IBM) and Michael Tushman (HBS). The paper provides a cool example of corporate entrepreneurship in IBM. It also cites a paper that I wrote with Nick Dew (NPS) and Saras Sarasvathy (Darden), but casts aspersions (intentionally or not...) on me and my co-authors.

Here is the email I wrote to O'Reilly, Herreld and Tushman (Herreld's email bounced though). Either they were carelessly trying to create controversy, or they got mixed up in the editing process. So either poor judgment or carelessness. Take your pick.

Charles, Jarred and Mike,

I wish to congratulate you for your recent CMR article and thank you for citing our work in your. I just wish that your quotation of us was an accurate portrayal of our views.

You write:

"Taken uncritically, these high mortality rates have led some researchers to question the efficacy of management. Dew, Goldfarb and Sarasvarthy (2006, p. 79) conclude that ―…the strategic manager‘s job is in fact futile in the face of environmental disruptions.".

This is a misrepresentation and not our conclusion at all. In the full quote (below), we were clearly summarizing our interpretation of the views of organizational ecologists (which we are not!).

I hope that you will be more careful and accurate in the future when you imply that your fellow scholars are "uncritical".

Regards,

Brent Goldfarb

"Organizational ecologists have built a successful academic mini-industry by examining organizational dynamics based on assumptions about the role played by these structural factors (Dobrev, Kim, & Carroll, 2003; Dobrev, Kim, & Solari, 2004; Po´ los, Carroll, & Hannan, 2002; Po´ los & van Witteloostuijn, 2005; van Witteloostuijn, 1998, 2003). Ruef’s chapter in this volume is also informed by these ideas (Ruef, 2006). The underlying tenor of these arguments suggests that the strategic manager’s job is in fact futile in the face of environmental disruptions: there is no chance of corporations staying alive and thriving under all circumstances; nimbleness is simply not what organizations are about. Instead, inertia is structurally built into organizations, and failure in one period is often a concomitant of success in a previous one." [Bold added]

Organizational Ambidexterity: IBM and Emerging Business Opportunities
O’Reilly, Charles A., J. Bruce Harreld, and Michael L. Tushman
51/4 (Summer 2009): 75-99

Optimal Inertia: When Organizations Should Fail, Nick Dew, Brent Goldfarb, Saras Sarasvathy, Advances in Strategic Management 2006 Vol. 23: 73 - 99

http://www.emeraldinsight.com/10.1016/S0742-3322(06)23003-1

Late Update: O'Reilly writes back:

from	charles o'reilly
sender-time		Sent at 11:45 AM (GMT-07:00). Current time there: 8:56 AM. ✆
to		Brent Goldfarb
date		Mon, Oct 19, 2009 at 11:45 AM
subject		Re: Citation

Brent:

Thanks.

Charles

Late late update: Mike Tushman writes back:

Brent,

Thanks for your note and for your clarification.

Mike

Dot Com Redux

2009-05-19T10:05:00.001-07:00

Economist, 1883

Have we learned nothing?

2009-05-19T09:30:00.000-07:00

From The Economist, (May 20th, 1882) in the midst of the London stock bubble in electric arc lighting companies:

"The electric light is very probably a great invention, and, for the sake of argument, let us take it for granted that its future development will be vast. But this, unhappily, cannot be urged as a reason why the pioneer companies should be prosperous. The history of our company manias has always proved the contrary. The greatest invention of the century resulted in the railway mania of 1845-6, and few were bold enough then to say it was not justified. In August, 1846, London and North-Western stock was selling at 235, North British at 155. Eastern Counties (now Great Eastern) at 160, and Mr Hudson was king ; yet for years afterwards even the best of our rail-ways were at a serious discount, while many became bankrupt, and never since, prosperous as our railways have latterly been, have such high prices been touched. Later, we have witnessed the introduction of submarine telegraphy, and there can be no doubt that here again was a legitimate field for enterprise. The Anglo-American stock has not maintained its high premium ; nor looking to other, and perhaps less well-grounded, manias, are such concerns as Asphalte, or Sewage Companies, quoted as they were in 1871. We might extend this list to any length, and always with the same result. One striking fact remains, that however great a revolution may possibly be in store for us, the inevitable competition amongst the rival electric systems will effectually prevent the shareholders from becoming millionaires, though that rôle may possibly be played by the vendors. Yet competition has generally been to the public advantage, and will doubtless be so in the instance before us."

Newspaper Business Models

2009-05-11T06:54:00.001-07:00

This is a must read for anyone vaguely interested in entrepreneurship, creative destruction, economic growth or the future (oh - and the newspaper business):

Clay Shirky on the Newspaper Business

There is a debate brewing....

2009-04-14T17:03:00.001-07:00

I guess our research is stimulating debate. Looks like one side is based on some evidence , while the other is not.

Form or Substance: Business plans and venture capital fundraising

2009-04-14T13:37:00.000-07:00

I've received some coverage of my paper joint with David Kirsch and Azi Gera on business plans. We find that they aren't that helpful for VC fundraising. The WSJ wrote about it, along with peHUB and Healy Jones at startable.com has some particularly insightful comment. Here is some video for those that don't like to read.

Healy Jones writes that it makes much more sense to get an introduction from a successful entrepreneur - but that if you don't have much of a track record, getting someone successful to introduce you is hard. That is precisely the point! Writing a business plan has become very easy - so its production does not help a VC distinguish between good and bad prospects - a business plan is the equivalent of cheap talk. Getting an introduction is hard - and so it may be a better signal of how entrepreneurial an entrepreneur is.

Our study is silent about about the importance of planning - only that a planning document does not help very much in the VCs initial screening stages.

email me for copies of the paper if you're interested.

Signs spam is outsourced

2009-04-03T06:29:00.000-07:00

Subject lines from my spam filter inbox (I'm particularly offended by the second one):

Tired of spending your evenings on the couch in front of TV because of your male problems,

Your power will be so strong that you will think that you are sleeping.

Prepare to catch the jealous looks on your hair.

You can catch me on Smith Business Close-up here:

2009-03-30T13:19:00.000-07:00

Perfect the business, not the business plan!

I'm now part of the VC blog over at Berkeley.

2009-03-25T12:05:00.000-07:00

http://vc.berkeleylawblogs.org/, Here is my latest (and first) post:

Does Angel Participation Matter? An Analysis of Early Venture Financing

In our paper, Does Angel Participation Matter? An Analysis of Early Venture Financing, Jerry Hoberg, David Kirsch, Alex Triantis and I investigate how Angels and VCs investment terms and outcomes differ. As expected, we find that angels typically invest on more founder-friendly terms than do VCs. It might be good to give founders greater autonomy if they have a very good understanding of their business or are if a lot of patience is required. In contrast, we more investor-friendly terms when VCs invest together with angels, and even more investor-friendly terms when VCs invest without angels. Giving the investor greater control over the venture may make sense when investor expertise can add significant value. If private equity markets function well, we should expect that, on average, investors and entrepreneurs match according to their relative skills.

We test this premise using a unique sample of Series A private equity deals in which we observe angel-only deals, VC-only deals and mixed deals. We find that when deals are relatively small (less than $3.5M), angels and VCs compete on equal footing. Consistent with the idea that there is efficient matching in the small-deal market, we find no difference in the likelihood of liquidity events for angel-backed deals, VC-backed deals or mixed deals. However, when deals are large (greater than $3.5M), we find that angel-only deals are rare, and this suggests that angels can not really compete for larger deals - even if they might be the best suited investors. Consistent with this premise we find that large VC-only deals out perform large mixed deals, and this difference becomes even starker when comparing VC only deals to those mixed deals with the most founder-friendly terms, i.e., those most similar to angel-only deals. Our findings suggest that entrepreneurs who would best be suited to match with angels alone turn to the next best alternative - VC funding while including some angels in the round. However, these entrepreneurs would fare better if they could match with only angels.

Our findings are not necessarily critical of VCs, in fact just the opposite! Without VCs, some of these large “angely” deals would never get funded. And even if their outcomes are inferior to those who experience really good matches with VCs, they are still good. However, our findings also suggest that VCs are not necessarily the best financiers for all entrepreneurs and that due to capital constraints of angels, the private equity market may work sub-optimally.

"Fool's Gold" double entendre?

2009-02-25T13:24:00.000-08:00

Scott Shane's recent book about business angels, Fool's Gold states (p. 126-127): "To see what I mean, take a look at the data. ... "Many angels do not accept unsolicited deals but only accept referrals from people they know and trust"7

Footnote 7 refers to Stephen Prowse, (1998). Angel investors and the market for angel investments. Journal of Banking and Finance 22, 785–792.

Here's the relevant passage from Prowse on page 789: "The primary criterion that angels use to screen proposals is whether the entrepreneur is previously known and trusted by them or by an associate who they trust." But this is based on "impressions from interviews with a dozen or so business angels in the Dallas/Fort Worth area." (p. 786).

Catch my latest on business plans...

2009-02-19T09:44:00.000-08:00

http://www.rhsmith.umd.edu/news/stories/2009/SBCU_Feb09.aspx

Elena in the Snow

2009-02-16T07:34:00.001-08:00

SnowDC-8937
Originally uploaded by Stephen Elliot

On the differences between innovation and business

2009-02-16T06:44:00.001-08:00

Experiences Of A Newbie iPhone Developer

Posted using ShareThis

Here is me being all wrong about the magnitude of our current depression back in March and its effect on high-tech startups...

2009-02-15T17:19:00.000-08:00

I told Wired that I thought the recession would last a few quarters - and that investors wouldn't get cold feet back in March 2008.

I guess I was wrong..., from the Wall Street Journal on Feb 12:

More Tech Start-Ups Call It Quits
"The deepening recession is speeding up the shakeout in Silicon Valley, forcing droves of start-ups to shut down or sell themselves at fire-sale prices."

To my credit I thought that the problems may not be as severe in the "Green" sectors - and that still may be true..

Rosenberg on the Endogeneity of Strategy (1986)

2009-02-10T10:49:00.000-08:00

"Even within the same industry, modern concepts of business strategy severely complicate comparisons between rates of R&D expenditure by large and small corporations. The percentage of sales revenue spent by a small specialist automobile manufacturer on R&D may exceed that of a mass manufacturer, simply because a strategy of serving a relatively small number of enthusiasts may require relatively more R&D than one of serving a large number of buyers with only average interest in the product. When two enterprises differ markedly in size and rate of R&D expenditure, thety may also differ so much in business strategy an din economic function as not to be comparable."

-Rosenberg & Birdzell, How the West Grew Rich, p. 287.

So why does so much strategy research fail to recognize that strategy is endogenous?

Repeal Prop 8

2009-02-06T18:07:00.000-08:00

Our friends Rick and Jose at 3:03!

"Fidelity": Don't Divorce... from Courage Campaign on Vimeo.

You can support the cause here.

Why are our political debates so asinine?

2009-02-06T07:31:00.000-08:00

I keep noticing that it is not just that our election discourse is infantile, it is really that our political discourse is infantile, but much of our business discourse as well. But the real question is why McConnell's strategy has the potential to be successful. How many people, when they first heard about spending $1M since Jesus was in diapers bothered to think about it more than nod their head and say "that's sounds like a lot to me"? Framed another way, why don't people think?

Latest from "Reader BW" via David Kurtz at TPM

TPM Reader BW has had it with Mitch McConnell's new gag line that if you spent $1 million every day since the day Jesus was born, you still wouldn't have spent $1 trillion:

This may be maddening and juvenile but Democratic lawmakers have to knock these sound bytes down with their own.

Please, anyone:

"Senator McConnell is flaunting his economic ignorance because if you started the day Jesus was born and created TWENTY million dollars in wealth every day you would have the wealth created in the US economy each year. AND if you flushed TWO million dollars down the toilet every day since Jesus was born you would have the credit losses in the US economy just last year. AND if you flushed THREE million a day, you would have lost less than the money that this recession is projected to cost by the end of next year. We no longer measure boats by cubits and we should not design economic stimulus based on a Jesus' birthday, so will the Minority Leader please either engage in a serious talk about economic policy or step aside and let the adults handle it?"

I haven't checked BW's math, but I think we can safely assume that the numbers are out there to support a riff along these lines, if not this precise one.

Where I stopped worrying that Jon Stewart would run out of material with the inauguration of Barack Obama

2009-01-23T11:03:00.000-08:00

The Daily Show With Jon StewartM - Th 11p / 10c

Fox News Fear Imbalance

Barack Obama Interview
John McCain Interview

Sarah Palin Video
Funny Election Video

12/12 and 9/11: Tales of Power and Tales of Experience in Contemporary History

2009-01-23T06:40:00.000-08:00

In this time of rising collectivism, Georgetown historian Michael Kazen has some interesting (if slightly dated) insight into how unhelpful Bush really was in this regard.

http://hnn.us/articles/1675.html

A summary of competitive markets from a six year old.

2009-01-21T13:33:00.000-08:00

My family and I went to see Sweet Honey and the Rock's annual children's benefit concert last Sunday. The concert was in a church, we were in the second row, to the side. My six year old daughter asked if she could go to the open space right in front of the stage. She did, along with other kids. Soon, it became quite crowded. Tired and frustrated she reported,

"Everyone copied me and it got too crowded, so I came back".

Thoughts on the current war in Gaza

2009-01-16T07:19:00.000-08:00

I have been thinking about the current conflict quite a bit. I have my own personal thoughts as well, but here is a pretty well reasoned piece by a colleague of mine at Ben Gurion University of the Negev in Beer Sheva:

Five Bogus Criticisms of Israel by Bradley Ruffle

In the war between Israel and Hamas, the battle for the hearts and minds of the world
ought to be a slam-dunk victory for Israel. A free, multicultural, liberal society is pitted against a radical Islamic terrorist group bent on the extermination of all those who oppose their jihadist vision. And yet, the world condemns the modern liberal democracy of Israel and embraces the terrorists' intolerance and death culture, much like it did when Israel fought the Hezbollah terrorist group in 2006.

So, why do the world’s sympathies lie overwhelmingly with the Palestinians?

The “Israel as occupier” narrative became inapposite in 2005 when Israel uprooted its settlements in the Gaza Strip and turned over Gaza's keys to the Palestinians. Notwithstanding, within hours of Israel's complete withdrawal, Palestinian rocket fire resumed. Israel ignored the rockets. Not surprisingly, the rocket fire continued unabated until, more than 3,000 rockets later, the government decided that too many was enough, bringing us to the conflict at hand.

Demographics and the natural affinities they engender provide one clue for understanding the imbalance in world opinion. With 1.5 billion Muslims worldwide and a meager 14 million Jews, Muslims outnumber Jews by more than 100 to 1. In addition, Israel has no oil, while the Arab states possess more than their share.

Here I explore the Palestinians' success in injecting the public debate with slogans and concepts seemingly supportive of their cause. My purpose is to expose the erroneous reasoning that underlies five pervasive criticisms of Israel. To do so, I rely on straightforward logic and common sense.

1. “The Palestinians are the weaker side of the conflict and therefore deserve our sympathy and support” – In sports, cheering for the weaker team (the underdog) makes sense. A match in which the stronger team’s victory is a foregone conclusion is without suspense and no fun to watch. Dirt poor lottery winners are a more satisfying outcome than a multi-millionaire who holds the winning ticket.

However, the weaker side of an international conflict is not inherently the more worthy, moral or deserving claimant. In fact, closer inspect leads to the opposite conclusion. It is not by chance that the weak region or country is weak, while the strong region or country became so. Successful countries achieve their status through well-functioning economic institutions like well-defined property and ownership rights and a legal system to champion such institutions. These institutions promote the development of technology, goods and services and encourage long-term investment in infrastructure like roads, a public transportation network and education. Poor countries, by contrast, fail to provide the basic conditions and certainty necessary to encourage private investment. Their governments are often corrupt, choosing to
pocket funds rather than invest in their citizens.

This analysis is particularly pertinent for understanding the power imbalance between
Israel and the Palestinian territories.

Israel has spent the past 60 years of its modern existence investing massively in construction, education, health services, transportation and, by necessity of its hostile neighbors, its military. Consequently, it has transformed what began as a subsistence agricultural economy into an advanced scientific and technological powerhouse at the forefront of numerous modern industries. For this, Israel deserves our congratulations for resources put to good use, not our scorn.

Corrupt Palestinian leaders, by contrast, have squandered their resources and opportunities to provide their citizens with better lives. The elite leadership lives like kings indifferent to their subjects' abject poverty. Although we may pity the Palestinian people for their plight and wish them a brighter future, supporting their leadership in a conflict against Israel dooms their fate to even greater desperation.

2. “The Israeli army has claimed many times more victims than Hamas has” – The number of victims on each side of the conflict is a simple enough statistic to fit into a headline that can be understood by all. Yet its simplicity masks more meaningful measures and, worse still, distorts incentives.

First, a total body count does not categorize the number of victims by terrorists, soldiers and civilians. The extermination of a terrorist about to launch a rocket aimed at an urban center would be considered a blessing in most folks' accounting.

Second, counting bodies encourages ruthless regimes that care little for their people to make no effort to protect them. More perverse still, the public's reliance on this misleading statistic encourages Hamas to place Palestinian children in the line of fire. Hamas and the Hezbollah are infamous for launching their missiles at Israel from local schools and crowded residential neighborhoods and placing children on rooftops of buildings in which terrorists hide.

By contrast, Israel has adopted numerous life-saving measures to minimize the number of casualties from hostile neighboring attacks. For instance, all Israeli villages and cities – Jewish and Arab alike – within range of Hamas or Hezbollah have air missile sirens that alert the population to impending missile attacks on their city. These sirens can also be heard on radio broadcasts. Civilians then make their way to the nearest bomb shelter either in their neighborhood, workplace, lobby of their apartment building or right in their home. Iraq's missile attacks on Israel during the First Gulf War in 1991 prompted the government to legislate that one room in each new home must be a hermitic bomb shelter. My family and I now sleep in our
apartment's bomb shelter.

3. “Israel uses disproportionate force against the Palestinians” – I haven’t the faintest idea how to deter terrorism without relying on "disproportionate force" either in the quality or quantity of the response.

Criminal law operates on the basis that to deter crime the punishment must exceed the criminal's benefit from the crime; otherwise, crime pays. Deterrence of terrorism is no different. To induce Hamas to end their attacks on Israel, the cost they incur must exceed the benefits from successful terrorist operations. To achieve this, the Israeli army makes use of its technological sophistication to conduct pinpoint assassinations from the air. This force is qualitatively disproportionate or superior to the less accurate rockets that Hamas fires.

Elsewhere, I've written about an alternative response to terrorism based on quantitative disproportionate force. The idea is that Israel builds an automatic rocket-launching system. Each time Hamas, Hezbollah or any other group or nation launches a rocket at Israel, this system detects the rocket and launches N rockets of the same variety back at the enemy. N needs to be a number greater than one to achieve deterrence.

I suspect the world would be equally outraged at my solution because the world doesn't appreciate the necessity of disproportionate force to deter terrorism. Instead, many suggest that Israel's response needs to be "balanced". A balanced response would be appropriate if the conflict was between two societies with similar values, intentions and regard for human life. However, Hamas' aspirations to kill as many civilians (while Israel takes every precaution to ensure the safety of Palestinians civilians) compel Israel to employ disproportionate force against Hamas operatives to put a stop to their wanton violence as soon as possible.

4. “Israel’s military response perpetuates the cycle of violence” – Critics apparently anticipate Israel to take it on the chin. Against a terrorist organization whose charter calls for the “obliteration” of Israel, a non-response is not a viable long- term strategy.

The cycle of violence argument suggests that Israel is to blame for entering an interminable spiral of death and destruction anytime it defends itself. Yet Israel's peace with Jordan and Egypt shows that the cycle of violence can be broken. These two Muslim nations ended their wars against Israel when their leadership accepted Israel's existence and abandoned the Arab mantra of "pushing Israel into the sea". Only when the Palestinian people demand of their leadership to recognize and respect Israel will the cycle of violence stop.

5. “Israel is committing genocide in Gaza” – This charge is a red flag. Anyone who claims that Israel is or has in any of its previous conflicts attempted genocide is either ignorant of the meaning of the word – direct them to a dictionary and point out that Hamas' targeting of densely populated civilian centers aptly fits the definition – or hopelessly full of hate and a toxic ideology aimed at Israel. Don't waste your time trying to change this person's mind. No amount of logic, reasoning or historical facts will succeed.

My hope is that the above rebuttals to commonly heard criticisms of Israel will help replace the public’s slogans and knee-jerk reactions with more thoughtful, reasoned arguments. Such progress will benefit Israel, its supporters and, ultimately, the Palestinians.

My own criticism of Israel is that this initiative comes nearly four years too late. Israel needed to respond to the very first rocket. A non-response encouraged the next 2,999- plus rockets. Terrorism, like any other bad behavior, exists because it is tolerated.

Where Erick Schonfeld writes something silly

2008-12-08T19:09:00.001-08:00

Erick Schonfeld of Techcrunch.com is imitating Chicken Little. Schonfeld identifies that A. the VC industry is in crisis as limited partners withhold funds and that B. it is now cheaper to create some types of high technology startups. He then concludes that VCs will go away, as they will no longer be needed to invest in startups that are cheaper to create.

This is a very silly statement. Schonfeld is correct that the private equity market is highly affected by the downturn (as I and others have documented for previous downturns). There may also be technology shifts reducing the costs of building certain types of technologies. But there is no evidence that VC partnerships are waning in general. VCs historically have entered and exited different industrial segments (e.g., biotechnology, nanotechnology, international investments, green technologies). Private equity was a major force in early development of the automobile and electric lighting. They are not big players there today (Cerberus notwithstanding). Private equity is alive and well! The future of Venture Capital is as bright as any other sector in the economy, though perhaps not in the narrow space that Schonfeld covers.

Jonathan Ehrlich gets it:

2008-12-02T10:04:00.000-08:00

It's worth watching Jonathan Ehrlich's description of his escape from the Oberoi hotel in Mumbai. Jonathan's view of how a private citizen can combat terrorism is dead on.

Pollution Credits

2008-11-26T10:29:00.000-08:00

This one has been stewing in my mind for a few years... Ever since I first hear George Lakoff discuss framing of political issues.

The price of a barrel of oil dropped from over $140 to $50 in six months. This reflects in part a decrease in demand, (and in part, a bursting of a speculative bubble --- more on that in a few weeks).

Driving has all sorts of externalities (congestion, noise), but the most important one today is pollution. However, historically, gasoline taxes have been a non-starter in the US - superseded by economic concerns.

One problem may be how the tax is framed. At universities, tuitions rise, but many of these increases are labeled fees - which make explicit what the student is getting for his or her money. We should do the same for gasoline tax.

In other words, the government shouldn't "tax" gasoline, the government should sell the right to pollute. Hence, we would call the tax what it really is: pollution credits. This is different than the cap-and-trade systems for industrial producers (I am not proposing a system to trade them), and simple to implement - as the government already collects a modest polution credit.

If anyone else has seen a similar proposal, I'd like to hear about it.

NY Times on the Dot-Com bubble, with lessons for today

2008-11-23T14:54:00.001-08:00

David Kirsch's digital archive project was featured in the New York Times today. David is a frequent co-author and he and I have made a cottage industry of developing social science insights from the data in his archive - usually with additional co-authors. The article mentions a few of these key insights.

We were privileged to have David Miller, a theoretical economist at UCSD, as one of our collaborators. Our joint work, published in the Journal of Financial Economics, studied investment patterns in the Dot Com boom and bust. David M. spent some time today reinterpreting the findings of our joint work in light of the current financial crisis. His interpretation is very insightful. His full post is below, but here is a (slightly) shorter version:

Fund managers all made a single bet: that rating agencies' ratings of AAA bonds could be trusted.
We (i.e., investors, who entrusted fund managers with their money) have now learned that this was a poor bet.
While fund managers now know that their bet was misplaced, we investors (optimally) can't yet be sure that they are investing prudently. We won't trust that they are investing prudently until we see some results that indicate that they are. This is because investors can't actually observe what the fund managers are doing very well, and because the fund managers' incentives may be too distorted due to an "other people's money problem".
If and when we see some good evidence that fund managers are fulfilling their fudiciary responsibilities well, and investing prudently, investor confidence will increase.
It is possible that the government infusion will provide the fund managers enough capital to demonstrate that they have mended their ways. In this sense, the "bailout" may be useful.

Here is his post in full:

The New York TImes published a nice article today on David Kirsch and the Dot-Com Archive . The article briefly mentions a paper that David, Brent Goldfarb, and I published in the Journal of Financial Economics a few years ago. As the article mentions, our paper interprets the Dot-Com bubble as a strategy gone wrong — too many startup firms adopted "Get Big Fast" strategies (trying to emulate Yahoo!, Google, eBay, and Amazon), when they would have had better success targeting smaller niche businesses.

However, the article does not mention that our paper also makes a broader contribution to the theory of investment bubbles and crashes in general — one that can help us interpret more recent events in markets like residential housing, public equities, and mortgage backed securities. The basic insight is that straightforward herding behavior among the relatively well-informed financial fund managers (like venture capitalists, hedge funds, and investment banks) can lead to a boom-bust cycle because these intermediaries are managing the funds of less informed investors (like pension funds, institutional investors, and individuals). A herd forms among the fund managers when enough of them decide that a certain kind of security or asset is a good investment that the rest find it optimal to "pile on" without investigating the fundamentals any further. Such a herd can be temporary and self-correcting, as the fund managers learn about the investment over time. However, investors on the outside, like you and me, don't know as much as the people we hired to manage our funds, and we don't fully trust them either because they're not playing with their own money. What Brent, David, and I showed in the paper is that once a bubble starts to pop, we (the investors) may find it optimal to withdraw our funds entirely, just as our fund managers have corrected their strategies to account for the collapse of the bubble.

In the current financial crisis, we can see these kinds of effects, as banks raise their interest rates and collateral requirements, investors "flee to quality" and seek refuge in treasury securities, and investment banks fail one after another. To make these ideas concrete in the context of the current crisis, we can think of AAA-rated corporate bonds (rather than equity shares in Dot-Com startups) as the overvalued security, mutual fund managers (instead of venture capitalists) as the well-informed intermediaries, and blindly trusting the bond rating agencies (rather than Get Big Fast) as the misguided strategy. According to our theory, once we see corporate bonds starting to crumble, we investors can find it optimal to withdraw from the corporate bond market in favor of Treasury bills, even though our mutual fund managers are learning to do a better job gauging the default risk of bond-issuing firms.

What does it take to get the market started again under this theory? We investors need to see some evidence that the financial intermediaries are investing wisely again. An infusion of government equity into the financial industry may help, if it gives the intermediaries a chance to demonstrate that they can be trusted once again. Otherwise we can get stuck in a bad equilibrium in which nobody invests because the intermediaries haven't demonstrated that they are trustworthy, and the intermediaries can't demonstrate that they are trustworthy because nobody is investing. So the theory suggests that the kinds of financial bailouts currently underway might actually be useful.

2008-11-20T10:22:00.001-08:00

Ping is a microblog service that appears to work pretty well.

Larry Page on Effectual Reasoning

2008-10-31T10:28:00.000-07:00

While Larry does not use Sarasvathy's language, the "do what you know" part is very effectual.

(video credits to Stanford University's Entrepreneurship Corner).