Haas Research News - Haas School of Business

Making a Case for Transparent Corporate Accounting Information

Pamela Tom — Wed, 12 Jun 2013 22:09:59 +0000

Prof. Yaniv Konchitchki finds accounting earnings transparency increases shareholders’ value

A new study by accounting professor Yaniv Konchitchki finds greater transparency in firms’ earnings has a positive effect on the bottom line.

“Cost of Capital and Earnings Transparency,” (published in the Journal of Accounting and Economics, April-May 2013) establishes that the transparency of a firm’s accounting earnings is a telling indicator of the company’s cost of capital and thus its valuation, according to Konchitchki. The paper is co-authored with Mary E. Barth, Stanford Graduate School of Business, and Wayne R. Landsman, University of North Carolina at Chapel Hill’s Kenan-Flagler Business School.

Cost of capital is defined as the rate of return that capital could be expected to earn in an alternative investment of equivalent risk. It is used to evaluate new projects within a company to give investors information and assurance of a minimum return for providing capital.

The paper, says Konchitchki, has the potential to change how capital market participants consider the quality of accounting data from corporate financial statements because the findings illuminate the importance of transparency for stock valuation. “Our findings are especially notable today, when these market participants are concerned with accounting financial statements becoming less transparent and thus less useful,” says Konchitchki. “In fact, many blame corporations’ lack of accounting transparency for the recent financial crisis in the U.S. and the recession that followed.”

A firm’s valuation is often determined by discounting future cash flows by the firm’s cost of capital, Konchitchki explains. The study finds that the cost of capital is negatively related to transparency. Intuitively, when there is less earnings transparency, the risk to investors is higher, resulting in higher cost of capital. Likewise, if there is more earnings transparency, one has access to more information about a company’s value by observing its earnings, resulting in lower risk and, in turn, lower cost of capital. Ultimately, lower cost of capital equates to higher firm value.

Konchitchki says the study’s conclusion becomes clearer by observing the calculations: the cost of capital is the important denominator when calculating a company’s value. If future cash flows provided by the investment are divided by the cost of capital, the result equals the value of the investment, i.e., the firm value.

Konchitchki, assistant professor, Haas Accounting Group, specializes in capital markets research and financial statements analysis. He particularly examines the usefulness of accounting information through its links to macroeconomics (e.g., inflation; GDP) and valuation (e.g., cost of capital; asset pricing).

The researchers studied a sample of publicly traded U.S. companies over a 27-year period. They tested their hypothesis that transparency affects a firm’s value by modeling how the cost of capital changes dependent on the lack or abundance of information. They considered “transparency” on a range from zero percent to 100 percent whereas categories of information may include sales, growth, management quality, global offices, cost of goods sold, etc. For example, 100 percent earnings transparency means that accounting earnings offer the ability to fully explain changes in a firm’s value. Lower percentages of transparency means more information than earnings is needed to explain changes in a firm’s value.

Konchitchki refers to the economic mechanism that drives the link between transparency and cost of capital as the “information asymmetry” effect.

“When the amount of available information is not symmetrical, some investors will have more information, others will have less. This drives the significant negative relation between earnings transparency and the cost of capital, and thus our paper also provides the economic intuition that links between transparency and valuation,” says Konchitchki.

See full paper.

Asst. Prof. Yaniv Konchitchki

Finance Prof. Martin Lettau Honored with 2013 AQR Insight Award

Pamela Tom — Fri, 24 May 2013 19:31:04 +0000

Finance Professor Martin Lettau has received the 2013 AQR Insight Award for his research about how an extension of the widely taught capital asset pricing model can explain returns of equity, commodity, sovereign bonds, and currencies and offer a unified risk view of these investments.

The winning paper, “Conditional Currency Risk Premia,” is co-authored with Haas alumnus Matteo Maggiori, PhD 12, and Michael Weber, a current Haas PhD student. They will share the first prize of $60,000.

The paper weighs into the ongoing debate on whether currency returns can be explained by their exposure to risk factors. The authors find that currency returns can be explained by a risk model where investors are particularly concerned about downside risk, called “the downside risk capital asset pricing model.”

According to Lettau, it is well known that high-yield currencies earn higher returns than low yield currencies. The authors show that returns of high-yield currencies are highly correlated with aggregate market returns when market returns are particularly low. Low-yield currencies have the opposite correlation pattern. If investors are particularly concerned about times when market returns are very low, the difference in downside risk of high-yield currencies relative to low-yield currencies can explain their differences in returns. This relationship is characteristic not only of currencies but also of equities, commodities, and sovereign bonds, thus providing a unified risk view of these markets.

Lettau is a member of the Haas Finance Group and the Kruttschnitt Family Chair in Financial Institutions.

The winning paper was presented to AQR investment teams in Greenwich, Conn., last month.

Applied Quantitative Research (AQR) provides global investment services, including investment philosophies based on empirical finance research. AQR established the Insight Award to honor finance research that offers significant practical implications for improving investment performance.

“This paper is an example of relevant empirical research motivated by economic intuition and financial theory. It explores the implication of securities' downside risk (the risk of losses during period of market distress), a topic of extreme relevance for both asset managers and investors,” says AQR co-founding principal David G. Kabiller. “This is the precisely kind of empirical research the AQR Insight Award was created to encourage: rigorous, relevant empirical analysis motivated by economic theory.”

See the full paper.

Prof. Martin Lettau

Bonuses for Doctors Pay Off for Patients

Pamela Tom — Mon, 13 May 2013 21:48:16 +0000

A study in Rwanda by Prof. Paul Gertler shows that financial incentives for medical providers improve service and health outcomes.

Everyone knows money talks. Prof. Paul Gertler found this to be the case in Rwanda, where, in conjunction with the national government, he evaluated a new and novel pay-for- performance model for the health care industry designed to increase access to high quality maternal and child health services.

He outlines his findings in his paper, “Using Performance Incentives to Improve Medical Care Productivity and Health Outcomes,” co-authored by Christel Vermeersch, a World Bank senior economist.

"Instead of investing more in the current healthcare system, we can try to get more out of our existing resources. The problem in Rwanda and most of the world is that medical care providers’ deliver a quality of care that is below their capabilities and training," says Gertler, director of the UC Berkeley Clausen Center for International Business and Policy and the Li Ka Shing Foundation Chair in Health Management.

Gertler found that when providers were offered financial incentives, their compliance with clinical care guidelines increased by 30 percent and their productivity increased 20 percent. The study showed that these improvements resulted in large increases in child health outcomes as measured by increased height and weight of children treated by these providers.

The Rwandan government offered health care providers payments for services such as institutional childbirth deliveries and emergency referrals to hospitals for obstetric services, new contraceptive user visits, referrals of at-risk pregnancies to hospitals, and referrals of malnourished children to higher level facilities for treatment. For example, a provider receiving $.55 for four standard prenatal care visits received $1.47 for providing higher quality care such as administering tetanus and malaria vaccines or detecting a high-risk patient and referring her to a hospital.

The pay-for-performance model is now being tried in Africa and parts of Latin America and is an important part of Obamacare, according to Gertler. “One of the nice things about the Affordable Care Act or Obamacare is the plan to offer financial incentives for providers,” Gertler explains. “If we are going to make progress in reducing costs of Medicare and Medicaid, pay for performance can make the system more efficient and dramatically improve the quality of health care.”

See the full paper.

Prof. Paul Gertler

Corporate Accounting Earnings Data Relevant for Determining Value of the Aggregate Stock Market

Pamela Tom — Mon, 01 Apr 2013 19:56:42 +0000

While teaching a course on financial information analysis, Asst. Prof. Panos Patatoukas observed that capital market participants and policy makers are increasingly turning to accounting earnings data from corporate financial reports for hints regarding the prospects of the aggregate stock market. This observation indicated that, at the aggregate level, accounting earnings data could be relevant for gauging the value of the entire stock market.

Patatoukas, Haas Accounting Group, became so intrigued that he decided to undertake an in-depth investigation of the information that decision makers interested in stock market valuation could extract from accounting earnings data aggregated across publicly traded firms in the U.S.

Patatoukas’ study, “Detecting News in Aggregate Accounting Earnings: Implications for Stock Market Valuation” is published in The Review of Accounting Studies (March 2013).

Patatoukas’ study develops a theoretical framework for understanding the relation between aggregate accounting earnings and stock market valuation. Patatoukas shows that this relation is complicated by the fact that stock market prices are very sensitive to even small revisions in investors’ expectations about discount rates. His study provides strong empirical evidence that this is the case.

Using a comprehensive sample of U.S. publicly traded firms from 1981 to 2009, Patatoukas shows that aggregate accounting earnings are tied to news about both expected future cash flows and discount rates. A comprehensive investigation of the link to discount rates reveals that aggregate accounting earnings are tied to news about the real riskless rate, expected inflation, and the expected equity risk premium (i.e., the expected excess return of the stock market over the nominal riskless rate). In fact, over the sample period studied, cash flow news and discount rate news in aggregate accounting earnings move together and have opposite impacts on the value of the aggregate stock market. An increase in expected future cash flows is positive for valuation, while an increase in discount rates is negative for valuation. Importantly, however, prices capture the net impact of cash flow news and discount rate news and so the stock market appears to be insensitive to aggregate accounting earnings.

“My findings illuminate the importance of separating cash flow news from discount rate news when evaluating the information content of aggregate accounting earnings for the stock market valuation,” says Patatoukas. “Although the stock market appears to be insensitive to aggregate accounting earnings that does not mean that accounting earnings data are not informative. In fact, aggregate accounting earnings are very relevant for determining the value of aggregate stock market!”

Patatoukas’ theory and evidence has the potential to change how capital market participants and policy makers use accounting data from corporate financial reports when making inferences at the aggregate stock market level. “Maybe it is not a pure speculation to expect that future research will uncover even more evidence on the relevance of aggregate accounting data for stock market valuation,” says Patatoukas.

See full paper.

Asst. Prof. Panos Patatoukas

Study Finds Successful Entrepreneurs Share a Common History of Getting in Trouble as Teenagers

Pamela Tom — Tue, 19 Feb 2013 20:07:34 +0000

Watch Prof. Ross Levine discuss his research.

Independence. Creativity. Money. Those are the benefits associated with successful entrepreneurs such as Steve Jobs and Mark Zuckerberg. But is being an entrepreneur really more lucrative than working for a salary? And who is best cut out to succeed? A new study by Professor Ross Levine of the Haas Economic Analysis and Policy Group answers both of these questions.

Levine and co-author Yona Rubinstein of the London School of Economics and Political Science found that entrepreneurs earn on average 50 percent more than their salaried counterparts who are working in the same industry and have the same education, contrary to a large body of research finding that entrepreneurship does not pay. Levine explains that many previous studies broadly define entrepreneurship, including people who are self-employed such as an accountant or a plumber. In this study, an entrepreneur is defined as a person who undertakes a novel, risk-taking activity. Levine says think Michael Bloomberg or Bill Gates.

Furthermore, they found that successful entrepreneurs possess distinct traits identifiable back when they were teenagers. These traits turn out to be accurate predictors of entrepreneurial success. Some of the not-so-surprising traits include having a high IQ, coming from a stable family, having parents who earn a higher than average income, and having exceptionally high self-esteem and confidence. However, some other common traits are often associated with juvenile delinquency.

“Our data revealed that many successful entrepreneurs exhibited aggressive behavior and got in trouble as teenagers. This is the person who wasn’t afraid to break the rules, take things by force, or even be involved in minor drugs,” says Levine, the Willis H. Booth Chair in Banking and Finance.

The researchers combed data from the National Longitudinal Survey of Youth (NLSY79), a representative sample of 12,686 young men and women who were 14 to 22 years old when they were first surveyed in 1979. The interviews have continued ever since.

“What we find is that a particular constellation of traits turns out to be a strong predictor of who is going to become an entrepreneur later in life and whether that person is going to be a high-earner when he or she launches a business,” says Levine.

In terms of earnings, the study found that successful entrepreneurs displaying these traits typically started their careers as top high earning salaried workers, and when they branched out on their own and successfully established their companies, they tended to enjoy a boost in earnings of 70 percent more than they received as salaried workers.

See full paper.

Prof. Ross Levine

Investor Beware: Stock Analysts’ Rounded Forecasts Are More Inaccurate and Upwardly Biased

Pamela Tom — Tue, 22 Jan 2013 23:48:03 +0000

In an era when a stock can take a beating if earnings fall a penny short of analysts' predictions, what factors influence whether forecasters seek precision to the penny or round off -- and how should their choice affect investors?

Berkeley-Haas Accounting Professor Patricia Dechow found that rounded forecasts are not only significantly more inaccurate than those that strive for penny-precision but also significantly more upwardly biased. The sharpest differences in both respects occur in companies with annual earnings per share of less than $10.

Dechow is the Donald H. and Ruth F. Seiler Professor in Public Accounting and a member of the Haas Accounting Group. The study, "Analysts' Motives for Rounding EPS Forecasts," co-authored by Haifeng You of the Hong Kong University of Science and Technology, was recently published in the American Accounting Association’s Accounting Review.

Dechow's research shows rounded estimates for firms with earnings per share of less than a dollar (amounting to about 26 percent of the sample) are on average about 70 percent more inaccurate than unrounded ones and almost 125 percent more upwardly biased. For companies with annual earnings per share between $1 and $10 (accounting for about 61 percent of the study's total sample), rounded estimates are on average about 40 percent more inaccurate and 68 percent more upwardly biased than those that are unrounded.

The study also finds that the market takes rounding into account in its response to analysts' forecasts. Investors responded less to earnings surprises when forecasts were rounded than when they were not. Investors also anticipated the upward bias of rounded forecasts, though not fully.

Previous research has found that analysts who rounded tended to work for small brokerage firms, to have relatively poor prior records of accuracy, to update their forecasts only infrequently, to have long forecast horizons, and to follow an above-average number of firms from multiple industries. Dechow's research confirms these findings and corroborates the counterintuitive earlier discovery that experienced analysts tend to round more often than less seasoned colleagues, perhaps "because they are compensated less for accuracy as their tenure with the firm increases."

"Analyst incentives impact the likelihood of rounding," Dechow explains in her article. ".Analysts can choose to be less informed about a particular stock and this choice affects how certain they feel about their forecasts, and, as a consequence, their decision to round...Analysts have limited time and so will rationally focus their forecasting efforts on firms for which the benefits of doing so are the highest."

And what firms yield the most benefits? The study identifies these:

Firms with relatively small earnings per-share

About 34 percent of forecasts are rounded when annual earnings per share (EPS) is $1 or less, in contrast to 49 percent when it is from $1 to $10 and 60 percent when it is from $10 to $100. According to the authors, "As the level of EPS increases (1) the economic importance of the penny digit declines and so is less relevant to investors, and (2) the precision of the analyst's information is not as likely to hold to the penny."

Firms with high stock-trading volume

As the authors explain, a high-volume stock "offers greater opportunities for trades to pass through the brokerage division.” Analysts who provide more informative research are likely to generate more trading business, and this can benefit the analyst...In contrast, low trading volume offers fewer brokerage fee opportunities."

Growth companies

Although assessing the prospects of growth firms "requires the analyst to exert effort and incur higher information-gathering costs to determine potential future opportunities...investors are also more interested in growth companies because of the greater potential gains, and this creates an increased demand for analyst guidance...Low-growth firms are likely to be less lucrative for the employers of analysts, and so we expect less forecasting effort."

Companies that offer investment-banking business opportunities

Regulators have assumed that the potential to procure investment-banking business for their employers leads analysts to inflate the prospects of a stock. In addition, the study finds that it inspires the extra effort required of precise forecasts. In the words of the study, "Firms that are raising financing frequently select the investment bank that has a favorable analyst following the firm to underwrite the deal. Understanding this relation, an analyst who is covering a firm that is likely to need financing is likely to exert more effort in forecasting [and will be] less likely to round forecasts."

Small companies or those with few business segments

The tendency to round increases with company size and complexity. In the words of the study, "larger firms are more complex than small firms, making them more difficult to analyze and value. In addition, if an analyst does provide an informative report, then this information is likely to be quickly dispelled among market participants and not necessarily captured by the analysts' brokerage division." As for number of segments, "companies with complicated business models require more effort to understand and therefore impose more costs on analysts...Controlling for firm size, firms with more business segments will have more rounded forecasts."

What practical lessons can investors derive from the study? "Generally to be a little wary of rounded analyst forecasts," Dechow says, "particularly for small companies or high-growth firms with heavily traded stocks (especially if they're likely to want to raise money soon) or simply companies with low earnings per share. Those are all characteristics that should motivate precise forecasts. If they don't, it could very well be a tip-off to hurried or cursory analysis."

Prof. Patricia Dechow

Finance Professor Ulrike Malmendier Receives 2013 Fischer Black Prize

Pamela Tom — Thu, 17 Jan 2013 00:56:30 +0000

Berkeley-Haas Finance Professor Ulrike Malmendier has been awarded the 2013 Fischer Black Prize from the American Finance Association, which honors the top finance scholar under the age of 40 years old. The prize was announced to the public Jan. 7, 2013.

The prize was established in 2002 in honor of Fischer Black, who was a co-inventor, along with Myron Scholes, of the Nobel-prize winning Black-Scholes-Merton Options-Pricing Model. The prize is modeled after the Fields Medal in mathematics and the Clark Medal in economics.

Malmendier is the fifth recipient of the biennial prize. (No prize was awarded in 2005, when no candidate met the standards.) She holds a joint position as a professor of economics at UC Berkeley, which she joined in 2006, and has been at Haas since 2010.

“I’m thrilled and honored that the American Finance Association selected me for the award from a very select group of people,” says Malmendier. “I can't fully believe that this has actually happened yet.”

The American Finance Association’s award citation referred to Malmendier’s work in corporate finance, behavioral economics and finance, contract theory, and the history of the firm, particularly noting the originality and creativity of Malmendier’s research.

“The Fischer Black Prize is one of the most prestigious academic prizes—this is a great honor for an outstanding scholar,” says Berkeley-Haas Dean Rich Lyons. “We are delighted that the finance profession has recognized Malmendier’s accomplishments, and we’re proud that she’s a member of Berkeley-Haas.”

Malmendier feels particularly thankful for the recognition since her area of research, the intersection between economics and finance or behavioral corporate finance, is less mainstream. Malmendier says, “I have always been interested in both economics and finance and in particular, why and how individuals make decisions—specifically how individuals make mistakes and systematically biased decisions. Some applications are in finance, but often my research questions are far from mainstream finance.”

One of Malmendier’s recent research papers, “Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?” published in the Quarterly Journal of Economics in 2011 with co-author Stefan Nagel of Stanford, is representative of the originality and creativity of her research. The paper shows that groups of people who have experienced macro-economic shocks such as low market returns, for example, tend to take less risk later in their lives, and vice versa. "Malmendier’s results have been observed anecdotally, but she was able to show them econometrically, which is not easy to do, ” says Haas Finance Professor Terry Odean, who holds the Rudd Family Foundation Chair and chairs the Finance Group at Berkeley-Haas.

Another research paper, “Paying Not to Go to the Gym,” published in the American Economic Review in 2006 and co-authored with Berkeley Economics Professor Stefano DellaVigna, shows that people with monthly gym memberships tend to use their membership far too infrequently to justify the monthly dues – paying per visit would be much cheaper. Regardless, they tend to stay enrolled rather than cancelling it. Odean says, “For a gym member to actually end their membership is to admit that they won’t exercise—that they give up. From an economist point of view, this is interesting because it is expensive to maintain this membership and to get no value out of the membership.”

Andrew Rose, associate dean and faculty chair at Berkeley-Haas and professor of economic analysis and policy, is proud of Malmendier and the school’s entire finance faculty who have recently won numerous awards, “In addition to Ulrike Malmendier’s Fischer Black Prize, Professor Adair Morse has recently won the Brattle Prize for the best corporate finance paper published in the Journal of Finance and Professor Nicolae Gârleanu has recently won the Smith Breeden Prize for the best finance research paper in the Journal of Finance in any area other than corporate finance. We have much to celebrate with our outstanding finance faculty.”

Prof. Ulrike Malmendier

Haas Professors Teece, Gârleanu, Morse Honored for Excellence in Research and Scholarly Service

Pamela Tom — Thu, 17 Jan 2013 00:42:35 +0000

Berkeley-Haas professors David Teece, Nicolae Gârleanu, and Adair Morse have been honored for their research achievements and excellence in their respective academic fields.

Prof. David Teece, the Thomas W. Tusher Professor in Global Business and faculty director of the Institute for Business Innovation, received the Royal Honour of Companion of the New Zealand Order of Merit. Associate Prof. Nicolae Gârleanu , the Paul H. Stephens Chair in Applied Investment Analysis, is the winner of the Smith Breeden Prize from the Journal of Finance. Assistant Prof. Adair Morse, a visiting professor in the Haas Finance Group, is the recipient of the Journal of Finance’s Brattle Prize.

David Teece
Royal Honour

Teece received the Companion of the New Zealand Order of Merit for his services to New Zealand/United States relations. It is a Royal Honour and is made by the Governor General on behalf of Queen Elizabeth II. The Order of Merit is awarded to those “who in any field of endeavor have rendered meritorious service to the Crown and nation or who have become distinguished by their eminence, talents, contributions or other merits.”

Teece holds multiple directorships of business and policy groups and is a leading scholar in the fields of corporate strategy and innovation. A 2008 analysis by Thomson Scientific found him to be one of the top-10 most-cited scholars in economics and business from 1997 to 2007. He has been recognized by Accenture as one of the world's top 50 business intellectuals. In addition, he is among the "A-List of Management Academics 2011," an honorary group of 30 accomplished and distinguished U.S. business professors. He holds four honorary doctorates.

In 2001, Teece cofounded the Kea Global Network. The not-for-profit organization aims to increase trade by providing New Zealand businesses with greater access to international markets and U.S. companies’ greater access to the New Zealand and Australian markets. Teece has assisted many startup companies in the United States and elsewhere. Teece also pioneered Mt. Beautiful Vineyards in North Canterbury, New Zealand. In addition to his role at Berkeley-Haas, Teece is chairman of the Berkeley Research Group LLC (BRG), a global consulting firm that provides expert testimony, strategic advice, and data analytics to government and private businesses.

Nicolae Gârleanu
Smith Breeden Prize

Each year, the Journal of Finance recognizes three finance research papers (other than corporate finance) for excellence. Gârleanu’s winning paper, “Technological Growth and Asset Pricing,” is co-authored by Stavros Panageas of the University of Chicago’s Booth School of Business and Jianfeng Yu of the University of Minnesota’s Carlson School of Management.

The paper explores the phenomenon that financial-asset returns tend to predict such ``real’’ quantities as GDP growth. The reason is that stock and bond prices react instantly to news of technological breakthroughs, such as the Internet, while implementation and achieving economies of scale in production can take many years.

“Given that such breakthroughs tend to happen only occasionally, technological cycles arise naturally. The breakthrough is made and, at some later time only, early adopters start implementing the technology, followed by more and more firms, until it permeates the entire economy,” says Gârleanu. “Our paper models this phenomenon and carefully studies its implications for financial returns (such as stock prices and interest rates) and real quantities (e.g., GDP), and in particular the relation between the two throughout a cycle.”

Gârleanu is also the 2012 recipient of the Review for Financial Studies’ prestigious Barclays Global Investors Michael Brennan award for his paper, “Margin-Based Asset Pricing and Deviations from the Law of One Price,” co-authored by Lasse Pederson, NYU’s Stern School of Business. The paper found that assets with virtually identical cash flows, such as corporate bonds insured with default swaps (CDS) and Treasury bonds, offered different returns during the financial crisis because lower margin assets present lower risk and require a lower capital contribution from investors.

Adair Morse
Brattle Prize

Morse’s paper on how to use psychology-induced methods to improve disclosure on consumer borrowing products earned her the prestigious, first place Brattle Prize. The prize is awarded annually by the Brattle Group, an economic and financial experts consultancy, for outstanding papers in the field of corporate finance published in the Journal of Finance.

Morse’s paper, “Information Disclosure, Cognitive Biases and Payday Borrowing,” was co-authored by Marianne Bertrand of the University of Chicago’s Booth School of Business. The authors assert that individuals who borrow quick cash from payday lenders may not use this service optimally because they may not fully understand the product or because they have biases about their own behavior, such as their ability to pay back a loan quickly.

The study showed that disclosing more information on the accumulation of fees over time from using payday loans impacts borrowing decisions. Getting consumers to think about the broader implications of payday loans, in particular to adding up of costs over time, they found, reduced the amount of borrowing by about 11 percent in a four-month window following exposure to the new information.

“I was elated to hear my name announced for the Brattle Prize. It is such a thrill to know that the best minds in finance voted to honor me for my research,” says Morse.

See more Berkeley-Haas research awards.

Prof. David Teece

Assoc. Prof. Nicolae Gârleanu

Visiting Prof. Adair Morse

Tax Evasion in Greece: Billions Earned by High Income Professionals Go Untaxed

Pamela Tom — Thu, 06 Dec 2012 00:42:30 +0000

Wide-scale tax evasion in Greece accounts for 28 billion Euros in unreported taxable income –just among the self-employed, according to a new study, “Tax Evasion Across Industries: Soft Credit Evidence from Greece,” by Adair Morse, a visiting assistant professor of finance at Berkeley-Haas.

At a tax rate of 40 percent, that’s a revenue loss responsible for nearly one-third of Greece’s deficit in 2009 or almost 50 percent of the deficit in 2008, according to the study co-authored by Margarita Tsoutsoura, assistant professor, University of Chicago Booth School of Business, and Nikolaos Artavanis, PhD candidate, Virginia Tech Pamplin College of Business.

Using bank data on household borrowing, the paper finds that highly paid, highly educated professionals are at the forefront of tax evasion in Greece: doctors, engineers, private tutors, financial services agents, accountants, and lawyers. Morse contends the findings are troubling from a perspective of inequality in the financially struggling country.

“The goal of the paper is to use our rich bank data to provide a country-representative estimate of tax evasion in aggregate and by occupation, and to offer analysis relating to factors that allow the tax evasion to persist,” says Morse. “But we were also very aware that understanding who is paying taxes and who is not is important to the people of Greece. One might ponder how it can be a good thing that the higher-income professions ‘tax evade’ a higher proportion of this income.”

The researchers further sought to understand how such dramatic tax evasion could exist and continue, with two main conclusions. First, the tax evaders tend to work in occupations that are least likely to leave a verifiable “paper trail” for tax collectors. Second, legislation, including a 2010 bill addressing the widespread tax evasion, has been slow to win approval. Morse asserts that it may not be mere coincidence that the majority of Greek Parliament members’ professions correlate with the largest tax evaders’, even excluding lawyers. “Industry associations are strong,” Morse suggests. “Parliament members face enormous loyalty pressure.”

The data consist of credit applications for consumer credit products at one of the ten large Greek banks from 2003 to 2010. The authors study situations in which the bank determines the credit level such as refinance loans, new credit cards, and a sample of loans in which borrowers requested more money than they received. In these situations, Morse uses the bank decision on the appropriate credit level to understand how much income the bank must perceive individuals to have to back out the bank’s estimate of true income. The authors term such lending “soft credit” since the information about true income is soft information. The researchers infuse this new insight with the observation that Greek banks have learned to adapt to an economy where income is often hidden to remain competitive.

Morse hopes the study’s findings will encourage EU and Greek policymakers to create incentives for more accurate income reporting such as paper trial mandates or occupation licenses for tax evading industries. Already the research is having an impact on the rhetoric in Greece, encouraging the population to think about the culture of tax evasion and how tax evasion does not equally benefit all Greeks. The Greek government recently approved new regulations requiring all businesses to issue receipts for transactions so it may track business taxes due. If a business doesn’t comply, the customer can reportedly walk away –without paying.

See full paper.

Visiting Prof. Adair Morse

More Female Board Directors Add Up to Improved Sustainability Performance

Pamela Tom — Thu, 15 Nov 2012 00:21:49 +0000

As a corporate responsibility consultant, Kellie McElhaney publicly criticized Apple’s recent appointment of another man to an already all-male executive team. McElhaney’s new research goes one step further, indicating that the number of women on a corporate board correlates with a firm’s sustainability performance.

“While not studied in this paper, the cases of strong ESG performance leading to improved financial and more women in leadership leading to better financial performance has been well documented,” says Adj. Asst. Prof. McElhaney. “The gap we want to fill in this study is to investigate a linkage between women and ESG performance to make this scenario a win-win-win.”

McElhaney found that companies with one or more women on their boards are significantly more likely to have improved sustainability practices. “This is not a women’s or men’s issue, it’s a collective and business opportunity,” says McElhaney who is also faculty director, Center for Responsible Business at the University of California, Berkeley’s Haas School of Business.

The study, “Women Create A Sustainable Future,” is co-authored by Sanaz Mobasseri, PhD candidate, Berkeley-Haas Management of Organizations Group, and sponsored by KPMG and Women Corporate Directors (WCD). MSCI Inc. provided the dataset of Fortune 1500 companies and their environmental, social, and governance (ESG) performance, which they have been measuring since 1992.

To measure corporate performance, the authors reviewed each organization’s ESG performance. Environmental criteria include steps to improve energy efficiency of operations, to measure and reduce carbon emissions, the reduction of packaging, and investment in renewable power generation. Examples of social factors include health care access for underserved populations in developing market supply chains, strong employment benefits and performance incentives, products with improved health or nutritional benefits, and products and services to communities with limited or no access to financial products. Finally, governance is defined as avoiding corruption and bribery, clean accounting, and a high level of disclosure and transparency about business practices.

ESG is a widely accepted measure of corporate sustainability among the investment community as indicators of risk management, opportunity recognition, and strong leadership.

“We also found, like researchers before us, that the sweet spot is three. Companies with at least three female board members had a better ESG performance but we’re talking about very few companies who meet this threshold–just three of the 1,500 we studied: Kimberly-Clark, General Motors, and Walmart,” says McElhaney.

McElhaney interviewed several female directors to learn more about their personal experiences on a board.

“Women and sustainability are two sides of the same coin …. Corporations build better societies if they have balanced boards,” says Halla Tomadottir, executive chair and co-founder of Audur Capital in Iceland, interviewed in the study.

The study’s authors also spoke with former U.S. Secretary of Agriculture Ann Veneman, who serves on the board of Nestle. “The voices of women are critical in advancing the goals of corporate shared value,” says Veneman in the study.

Others female directors told McElhaney that they evaluate invitations to sit on boards based on the organizations’ ESG factor. Dina Dublon, former executive vice president and chief financial officer of JP Morgan Chase, is a director at PepsiCo, Accenture, and Microsoft. “There is an element of self-selection for me,” says Dublon. “I choose to serve on boards who have openness to ESG issues because I care deeply about these issues.”

McElhaney points out that “causality” remains problematic. “Is a company that’s not managing risk like ESG going to realize that it’s a risk not to have more women in senior leadership–Which happens first –adding more women to a board or improving sustainability initiatives?”

The next phase of McElhaney’s research will be to interview more female, as well as male board members. McElhaney also cites four critical next steps to expand female board membership: conduct more research in this area, continue to build a pipeline of women to serve on corporate boards, foster a business community of sponsors for females that includes both men and women, and train business leaders of both genders to be “change agents.”

See full paper.

###

Kellie McElhaney

Criminal Punishment and Politics: Elected Judges Take Tougher Stance Prior to Elections

Pamela Tom — Wed, 17 Oct 2012 23:56:18 +0000

The last few months leading up to an election can be a critical, political game changer. One right or one wrong move can quickly change a candidate’s standing at the polls. New research suggests that judges who are elected, rather than appointed, respond to this political pressure by handing down more severe criminal sentences – as much as 10 percent longer –in the last three months before an election compared with the beginning of their terms.

“We can’t say if more severe sentencing is better for society or worse, but our findings show us how political pressure can distort the sentencing process and can lead to starkly different sentences for similar criminals sentenced at different times,” says Noam Yuchtman, assistant professor of business and public policy at the Haas School.

Yuchtman and Carlos Berdejó, associate professor of law, Loyola Law School, are co-authors of “Crime, Punishment, and Politics: Analysis of Political Cycles in Criminal Sentencing,” forthcoming in the Review of Economics and Statistics.

The study examined the felony sentences of 265 full-time Superior Court judges between July 1995 and December 2006 in the state of Washington, covering three elections in 1996, 2000, and 2004. The authors focused on the most high-profile crimes such as murder, assault, rape, and robbery, which represent 6.7 percent of 18,447 sentences conferred. Case-specific controls included the defendant’s age, gender, race, and prior criminal history, as well as an indicator of whether the sentence resulted from a plea agreement. The study also accounted for a number of potentially confounding variables such as changes in attorney behavior, case re-assignment, political cycles of other officials, and seasonal variations; for example, if more homicide sentencing hearings than usual happened to occur right before an election.

Yuchtman and Berdejó find that sentence lengths increase at the end of judges’ political cycles, then sharply fall when their next term begins, only to rise again as their next election approaches. Importantly, they do not find an increase in sentencing severity at the end of terms of judges who are not seeking re-election. Judges only increased the severity of their sentences at the end of a political cycle when they were facing re-election.

The findings also indicated that toward the end of their terms, judges tend to become more calculated in making their sentencing decisions, deviating from normal sentencing guidelines 50 percent more often at the end of the electoral cycle compared with the beginning. These deviations account for a large fraction of the harsher sentencing, suggesting that the influence of politics on sentencing crucially depends on the discretion judges have in sentencing.

History reveals that most judges are re-elected and don’t even face competition at the polls. These findings from the state of Washington suggest that just the threat of political competition can affect behavior. “Judges may fear that a lenient sentence for a violent criminal might be turned into a political opportunity for an ambitious prosecutor seeking a harsher sentence,” says Yuchtman.

Yuchtman and Berdejó’s study helps to inform the debate on whether judges should be elected or appointed. The authors say while they cannot predict whether society would benefit from appointed-only judges across all jurisdictions, their results conclusively determine that sentencing patterns would differ.

Yuchtman says, “When you tell people in other countries that some American judges are elected, they are often shocked. Maybe they’re right: we don’t like to think of judges as being influenced by external pressure. On the other hand, our results suggest that elections do make judges feel accountable. This is a simple, but important, tradeoff.”

See full paper.

Asst. Prof. Noam Yuchtman

Study Finds Flirting Can Pay Off for Women in Negotiations

Pamela Tom — Mon, 08 Oct 2012 18:17:32 +0000

When Madeleine Albright became the first female U.S. Secretary of State, she led high-level negotiations between mostly male foreign government leaders. In 2009, comedian Bill Maher asked Albright if she ever flirted on the job and she replied, “I did, I did.” Flirtatiousness, female friendliness, or the more diplomatic description “feminine charm” is an effective way for women to gain negotiating mileage, according to a new study by Haas School Professor Laura Kray.

“Women are uniquely confronted with a tradeoff in terms of being perceived as strong versus warm. Using feminine charm in negotiation is a technique that combines both,” says Kray, who holds the Warren E. and Carol Spieker Chair in Leadership.

The study, “Feminine Charm: An Experimental Analysis of its Costs and Benefits in Negotiations,” is published in the October journal of Personality and Social Psychology Bulletin and co-authored by Haas PhD alumna Connson C. Locke of the London School of Economics and Haas PhD candidate Alex B. Van Zant.

Flirtation that generates positive results, says Kray, is not overt sexual advances but authentic, engaging behavior without serious intent. In fact, the study found female flirtation signals attractive qualities such as confidence, which is considered essential to successful negotiators.

To determine whether women who flirt are more effective in negotiating than men who flirt, the researchers asked 100 participants to evaluate to what extent they use social charm in negotiation on a one-to-seven scale. Earlier that week, the participants evaluated their partners’ negotiating effectiveness. Women who said they used more social charm were rated more effective by their partners. However, men who said they used more social charm were not regarded as more effective.

In the second experiment, the researchers asked subjects to imagine they were selling a car worth $1,200 and asked for how much would they sell the car. Next, the subjects read one of two scenarios about a potential buyer named Sue. The first group meets Sue, who shakes hands when she meets the seller, smiles, and says, “It’s a pleasure to meet you,” and then “What’s your best price?” in a serious tone. The second group reads an alternate scenario in which Sue greets the seller by smiling warmly, looking the seller up and down, touching the seller’s arm, and saying, “You’re even more charming than over email,” followed by a playful wink and asking, “What’s your best price?”

The result? Male sellers were willing to give the “playful Sue” more than $100 off the selling price whereas they weren’t as willing to negotiate with the “serious Sue.” Playful Sue’s behavior did not affect female car sellers.

Kray says many of her students who are senior women executives admit they love to flirt and describe themselves as “big flirts.” Kray maintains flirting is not unprofessional if it remains playful and friendly.

“The key is to flirt with your own natural personality in mind. Be authentic. Have fun. That will translate into confidence, which is a strong predictor of negotiation performance.”

See Full Paper: http://www.haas.berkeley.edu/groups/online_marketing/facultyCV/papers/kray_paper2012.pdf

Prof. Laura Kray

My Research: Organizational Culture Matters on the Bottom Line: Evidence from the High-Tech Industry

Pamela Tom — Fri, 21 Sep 2012 05:54:40 +0000

By Jennifer Chatman

Organizational culture has been the latest and greatest fad since the 1990s with many different views getting valuable airtime. Conventionally, researchers have argued that strong cultures that align employee behavior with organizational objectives should boost performance. More recently, research has shown that a strong culture can actually stifle creativity and innovation in dynamic environments because people are adhering too closely to routines creating behavioral uniformity, inertia, and an inward focus.

Despite all the differing views, existing research and debates have tended to oversimplify culture and have failed to definitively resolve one key question: How does organizational culture influence an organization’s financial performance over time?

My research with colleagues Charles O’Reilly at Stanford, Dave Caldwell at Santa Clara University, and Bernadette Doerr at the University of California, Berkeley, suggests that neither the conventional view of culture nor the recent view paints a full picture of the culture-performance relationship, and instead, a third, more nuanced relationship exists.

Our research shows that strong cultures are not necessarily a disadvantage in dynamic environments. In fact, we learned that firms with strong cultures actually perform better financially, growing more over time, in economically turbulent periods but only if they intensely hold a cultural norm of adaptability.

More specifically, our data shows that strong-culture firms with a high level of consensus across many norms and an intensive emphasis on adaptability have higher revenue, net income growth, and return on investment over the economically volatile three-year period from 2009 through 2011.

By “adaptability,” we mean a firm’s support of risk-taking, willingness to experiment, initiative-taking, along with the ability to be fast-moving and quick to take advantage of opportunities. Firms that successfully cultivate adaptability tend to permit their people to express themselves in wide-ranging behaviors, and this freedom of expression helps employees to fully explore divergent solutions to a problem.

A secondary result that also came from our research is that firms with strong cultures that are adaptive also have better reputations. Our data shows a strong correlation between cultural adaptiveness and a firm’s ranking on Fortune Magazine surveys in 2010 in several categories such as “Most Innovative,” “Most Admired,” and “Best Places to Work.”

However, we also found that focusing intensely on adaptability is only advantageous if high consensus exists across the firm about its culture more generally. Our most surprising finding was that firms that emphasized adaptability intensely but had low consensus about their overall culture performed worse over the three-year period—even worse than firms with weak cultures and no emphasis on adaptability. Firms that intensely value adaptability but have low agreement on their overall culture are typically more siloed in their orientation. As a result, their efforts to adapt to changing environmental circumstances were thwarted by a lack of coordination and strategic alignment.

How We Arrived at our Findings

One of the strengths of our research was the number of firms we studied, allowing us to draw conclusions with more confidence than looking at one or a few firms. We focused our research on high-technology companies since they operate in one of the most dynamic industries in terms of competitive challenges and the pace of technological advancements. We analyzed the cultures of 54 of the largest and most prominent publically traded U.S.-based technology firms over a three-year period beginning in 2009. We used a culture assessment approach that we have developed over the last 25 years, the Organizational Culture Profile, to assess participating firms’ cultures. More than 800 informants provided culture profiles on their organization.

Our research delves more deeply into culture than previous research to avoid oversimplification. We deconstruct culture into three dimensions to better understand the link between culture and a firm’s financial growth: 1) culture content (e.g. norms like adaptiveness, teamwork, integrity); 2) culture intensity (how forcefully the culture is held by employees); and 3) culture consensus (how widely employees share and agree about cultural norms).

Nailing down the advantages and disadvantages of organizational culture has been elusive because researchers haven’t been specific enough about various aspects of culture. We label an organization where members understand what top management values but attach no strong approval or disapproval to these beliefs as a high consensus but low intensity culture or a “vacuous culture.” Low consensus, high intensity cultures can be characterized as “warring factions,” and low consensus and low intensity cultures as a “weak culture.” A “strong culture” exists when there is both intensity around one or two key norms, and broader consensus about culture content (both high consensus and high intensity).

Distinguishing between the variations within culture content among strong culture organizations as well as distinguishing between culture content and culture consensus resolves conflicting perspectives about the culture-performance relationship.

For example, we believe that recent research arguing that strong cultures, because of their uniformity and routines, lead to less reliable performance in turbulent environments is insufficient because the researchers failed to analyze the actual content of cultural norms. When we deconstruct culture into our three dimensions (content, consensus, and intensity), we see that a firm with higher levels of consensus across many cultural norms, as well as an intensive emphasis on adaptability in particular, is actually more likely to recognize environmental volatility and discover alternative routines than are strong culture firms that focus on norms emphasizing behavioral uniformity.

Similarly, the conventional view that strong cultures boost performance might not always be true. For example, a strong culture that emphasizes uniformity, even around performance-related norms like being results oriented, likely will not boost performance in dynamic environments that require greater nimbleness, adaptiveness, and innovation.

Importantly, in our research, we controlled for other factors such as firm size and technology sector such as software or hardware, and we controlled for six other culture dimensions such as customer-oriented and results-oriented in order to rule out the possibility that our results could be due to other cultural norms besides adaptability.

Thus, based on our research, organizational culture is not just another business fad that firms should take lightly or ignore altogether. Firms should reconsider the latest research that contends that those with strong cultures are at a disadvantage in turbulent environments, much like the environment we operate in today. At the same time, a strong culture doesn’t always boost performance. Rather, our research suggests that those firms that focus on and cultivate a culture that members agree about and that specifically focuses on adaptability will grow faster financially than their competitors. They will enjoy better external reputations, helping them to weather whatever current and future storms come their way.

Prof. Jennifer Chatman

Back to Berkeley: Prof. Carl Shapiro Returns from Presidential Adviser Post

Pamela Tom — Thu, 06 Sep 2012 20:39:40 +0000

Carl Shapiro at the White House with Pres. Obama (April 2012)

A familiar face returned to the Berkeley-Haas campus this fall. Haas School economics professor Carl Shapiro, the Transamerica Chair in Business Strategy, served in two high-ranking positions in the Obama Administration. From March 2009 through February 2011, Shapiro served as chief economist in the Antitrust Division of the U.S. Department of Justice (DOJ). He then moved to the White House, where he advised President Obama as a member of the President’s Council of Economic Advisers (CEA).

Trading in his humongous office with a White House view for a smaller one framed with Berkeley’s Campanile is “a delightful change,” he says.

“I was here at Berkeley for almost 20 years before I went to Washington. It’s a big change. East coast vs. west coast, D.C. vs. Berkeley, wearing a suit vs. wearing a Hawaiian shirt! I’ve always been an academic. My time in D.C. was an exciting but temporary posting,” says Prof. Shapiro.

Haas NewsWire recently sat down with Shapiro to learn more about what is was like to advise President Obama and make decisions that could potentially affect the country’s economic policies.

What was a typical day as an adviser like?

My days were very fast-paced, with questions arriving all the time, needing a quick answer. And I mean quick. Academics take months or years to study a problem; we often had hours, days if we were lucky, to come up with our answer. My portfolio as a Member of the CEA was extremely wide-ranging. I spent a lot of time on housing and housing finance, energy and environmental issues, international trade –especially our trade relations with China –manufacturing, and health care. I also was involved in tax policy and Federal budget issues. Happily, I also had the opportunity to work on topics quite close to my own research expertise – issues involving innovation, intellectual property, and federal research funding. During my time at the CEA, Congress passed the Leahy-Smith America Invents Act for patent reform and authorized the Federal Communications Commission to run “incentive auctions” to redeploy valuable spectrum from over-the-air broadcasting to high-speed wireless Internet access.

Intellectual property and patent law are at the heart of today’s entrepreneurism, especially here in the Bay Area. How effective is the America Invents Act?

The America Invents Act (AIA) is the biggest change to our patent system since the 1950s. The AIA should significantly improve patent quality by providing more stable funding to the U.S. Patent and Trademark Office and by establishing new post-grant review procedures by which patents that have been improperly granted can be challenged. The AIA constitutes a distinct improvement in patent policy, but it was a compromise, leaving unaddressed some of the biggest issues facing the tech industry. The issues we’re seeing, for example in the Apple-Samsung patent infringement case, at the International Trade Commission, and in the patent wars over mobile devices, signal that the patent system is still not working properly. Plus, the stakes have increased, as we’re now seeing patent portfolios trade for billions of dollars. Now that Congress has spoken, the action will turn to the business community and the courts. As I return to my research and my consulting practice, I plan to delve into these issues.

You were the chief economist at the Antitrust Division at the DOJ for two years, overseeing 60 Ph.D. economists. What is your most memorable experience?

My single biggest area of activity was merger review. We worked intensively on the Comcast-NBC and LiveNation-Ticketmaster mergers. Our job was to figure out whether these mergers –and many others–would have anti-competitive effects and be harmful to consumers.

How do you distinguish between what’s a negative impact and what’s fair for business and free trade?

DOJ looks very closely at mergers between direct competitors in concentrated industries. The authoritative description of how the DOJ and the Federal Trade Commission (FTC) review mergers can be found in the “Horizontal Merger Guidelines” which informs businesses how their mergers will be evaluated by the federal government. One of the things I‘m most proud of during my tenure at the DOJ is that I played a leading role in revising these guidelines. They were 20 years old and no longer reflected enforcement practice or the best economic thinking. Professor Joseph Farrell, a UC Berkeley economist, took the lead at the FTC. Working together we finished the revision after one year, in August 2010.

What will you miss about Washington, if anything?

Serving President Obama, and working in the White House, was a tremendous honor. I certainly miss having regular meetings in the West Wing, not to mention my White House Mess privileges! Working on such a broad range of fascinating issues was very exciting –and exhausting– on a day-to-day basis. Dealing with issues outside my area of specialty was a great learning opportunity. I will miss that challenge. But I’m very happy to be back at Berkeley. I am especially enjoying bringing some of my White House and DOJ experiences into the classroom here at Haas.

Prof. Shapiro is currently teaching “Economics for Business Decision Making” (MBA201A) in the Full-time MBA Program.

Why are people overconfident so often? It’s all about social status

Ronna Kelly — Mon, 13 Aug 2012 21:26:35 +0000

Researchers have long known that people are very frequently overconfident – that they tend to believe they are more physically talented, socially adept, and skilled at their job than they actually are. For example, 94% of college professors think they do above average work (which is nearly impossible, statistically speaking). But this overconfidence can also have detrimental effects on their performance and decision-making. So why, in light of these negative consequences, is overconfidence still so pervasive?

The lure of social status promotes overconfidence, explains Haas School Associate Professor Cameron Anderson. He co-authored a new study, “A Status-Enhancement Account of Overconfidence,” with Sebastien Brion, assistant professor of managing people in organizations, IESE Business School, University of Navarra, Haas School colleagues Don Moore, associate professor of management, and Jessica A. Kennedy, now a post-doctoral fellow at the Wharton School of Business. The study will be published in the Journal of Personality and Social Psychology (forthcoming).

“Our studies found that overconfidence helped people attain social status. People who believed they were better than others, even when they weren’t, were given a higher place in the social ladder. And the motive to attain higher social status thus spurred overconfidence,” says Anderson, the Lorraine Tyson Mitchell Chair in Leadership and Communication II at the Haas School.

Social status is the respect, prominence, and influence individuals enjoy in the eyes of others. Within work groups, for example, higher status individuals tend to be more admired, listened to, and have more sway over the group’s discussions and decisions. These “alphas” of the group have more clout and prestige than other members. Anderson says these research findings are important because they help shed light on a longstanding puzzle: why overconfidence is so common, in spite of its risks. His findings suggest that falsely believing one is better than others has profound social benefits for the individual.

Moreover, these findings suggest one reason why in organizational settings, incompetent people are so often promoted over their more competent peers. “In organizations, people are very easily swayed by others’ confidence even when that confidence is unjustified,” says Anderson. “Displays of confidence are given an inordinate amount of weight.”

The studies suggest that organizations would benefit from taking individuals’ confidence with a grain of salt. Yes, confidence can be a sign of a person’s actual abilities, but it is often not a very good sign. Many individuals are confident in their abilities even though they lack true skills or competence.

The authors conducted six experiments to measure why people become overconfident and how overconfidence equates to a rise in social stature. For example:

In Study 2, the researchers examined 242 MBA students in their project teams and asked them to look over a list of historical names, historical events, and books and poems, and then to identify which ones they knew or recognized. Terms included Maximilien Robespierre, Lusitania, Wounded Knee, Pygmalion, and Doctor Faustus. Unbeknownst to the participants, some of the names were made up. These so-called “foils” included Bonnie Prince Lorenzo, Queen Shaddock, Galileo Lovano, Murphy’s Last Ride, and Windemere Wild. The researchers deemed those who picked the most foils the most overly confident because they believed they were more knowledgeable than they actually were. In a survey at the end of the semester, those same overly confident individuals (who said they had recognized the most foils) achieved the highest social status within their groups.

It is important to note that group members did not think of their high status peers as overconfident, but simply that they were terrific. “This overconfidence did not come across as narcissistic,” explains Anderson. “The most overconfident people were considered the most beloved.”

Study 4 sought to discover the types of behaviors that make overconfident people appear to be so wonderful (even when they were not). Behaviors such as body language, vocal tone, rates of participation were captured on video as groups worked together in a laboratory setting. These videos revealed that overconfident individuals spoke more often, spoke with a confident vocal tone, provided more information and answers, and acted calmly and relaxed as they worked with their peers. In fact, overconfident individuals were more convincing in their displays of ability than individuals who were actually highly competent.

“These big participators were not obnoxious, they didn’t say, ‘I’m really good at this.’ Instead, their behavior was much more subtle. They simply participated more and exhibited more comfort with the task – even though they were no more competent than anyone else,” says Anderson.

Two final studies found that it is the “desire” for status that encourages people to be more overconfident. For example, in Study 6, participants read one of two stories and were asked to imagine themselves as the protagonist in the story. The first story was a simple, bland narrative of losing then finding one’s keys. The second story asked the reader to imagine him/herself getting a new job with a prestigious company. The job had many opportunities to obtain higher status, including a promotion, a bonus, and a fast track to the top. Those participants who read the new job scenario rated their desire for status much higher than those who read the story of the lost keys.

After they were finished reading, participants were asked to rate themselves on a number of competencies such as critical thinking skills, intelligence, and the ability to work in teams. Those who had read the new job story (which stimulated their desire for status) rated their skills and talent much higher than did the first group. Their desire for status amplified their overconfidence.

De-emphasizing the natural tendency toward overconfidence may prove difficult but Prof. Anderson hopes this research will give people the incentive to look for more objective indices of ability and merit in others, instead of overvaluing unsubstantiated confidence.

See the present version of the full paper at http://haas.berkeley.edu/faculty/papers/anderson/status%20enhancement%20account%20of%20overconfidence.pdf.