Business Research in Action - Fall 2011

Business Research in Action Mays Business School, Texas A&M University

FALL 2011

Trading against the prophets can prove profitable  Middle of the road a preferable position for CEOs  Don’t challenge giants, marketing experts advise  Changing course, particularly in golf, can diminish experience  Employers wise to tighten the ties that bind 

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Trading against the prophets can prove profitable

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magine borrowing from someone else’s stockpile of corporate stocks, then selling shares, later buying them back and returning them, keeping any profit. That’s what some investors do on a regular basis, and they tend to out-perform the analysts.

The practice is called short selling, and research by two

Texas A&M University business professors and a former Ph.D. student shows that ordinary investors can profit by trading with the short sellers.

Their research investigated whether short sellers and analysts differ in how they use information that predicts future returns. It appears short interest significantly anticipates the expected direction, while analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios, despite these variables having a negative association with future returns.

“Investors frequently observe and use recommendations from analysts on whether to buy or sell a stock,” says Arthur Andersen Professor in Accounting Lynn Rees. “But, our

Short selling sometimes best strategy

research suggests that analysts do not always use accounting information, such as accounting accruals and cash flows, in forming their recommendations; whereas, short sellers appear to do much better in using these signals.”

Co-authors are Edward P. Swanson, holder of the Durst Chair in Accounting; and Mays doctoral graduate Michael Drake of BYU. The researchers have presented the paper to professionals, as well as academic audiences, and a NYC capital management company that uses short interest as an input in an investment model.

A low percentage of investors do short selling, but a very high percentage of investors would be interested in what they are doing, Rees says, because the short sellers tend to do better than the market. “Our evidence suggests that using the level of short interest combined with analysts’ forecasts allows investors to make more profitable investment decisions,” he says.

For more information about this research, contact Rees at lrees@mays.tamu.edu, or Swanson at eswanson@mays.tamu.edu.

“Trading against the prophets: Using short interest to profit from analyst recommendations,” by Michael Drake, Lynn Rees and Edward P. Swanson, was published in The Accounting Review January 2011.

Our evidence suggests that using the level of short interest combined with analysts’ forecasts allows investors to make more profitable investment decisions.

Some overoptimism usually preferred

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Middle of the road a preferable position for CEOs

s a stockholder, would you prefer a CEO who is strictly rational about her firm’s future prospects, or a CEO who is somewhat overoptimistic? Researchers at Mays show theoretically that for risk-averse CEOs, being somewhat overoptimistic is a good thing for shareholders.

Most CEOs are undiversified, meaning that a large fraction of their personal wealth is invested in their company. Stockholders, on the other hand, are typically well diversified, with investments across numerous companies. These differences mean that a riskaverse CEO who is strictly rational will turn down some risky investment projects that the stockholders would like the firm to make. If this happens, the result is lower firm value.

“We show theoretically that overoptimism (excessive optimism) can help offset the effect of the CEO’s risk aversion,” says Leland Memorial Chair in Finance Shane Johnson. “The result is that a CEO who is moderately overoptimistic will invest the way shareholders would want her to invest—this maximizes firm value.” In contrast, a purely rational CEO turns down too many investment projects relative to the optimal level, whereas a CEO who is too overoptimistic accepts too many investment projects. Both underinvestment and overinvestment produce firm values below what it could be.

“If the theory is correct, CEOs who are somewhat overoptimistic should face a lower probability of termination than rational CEOs or too-overoptimistic CEOs face. A board

doesn’t necessarily know a CEO’s level of optimism when it hires her. It learns by watching her decisions over time,” Johnson says.

If CEOs who are somewhat overoptimistic maximize firm value, they should be more likely to keep their jobs than would CEOs with too-low or too-high optimism. Using a large sample of CEO terminations, the team finds strong empirical support for the theoretical predictions. The results are consistent with the view that CEOs who are somewhat overoptimistic maximize firm value.

Before this research was conducted, the common belief was that any level of overoptimism was bad, says Johnson. “Our paper is one of a series that argues that some level of over-optimism is good for CEOs,” he says. “Given a choice between a very rational CEO and a moderately overoptimistic one, the somewhat overoptimistic one is the better choice.”

The research was conducted by Johnson; Mays doctoral students T. Colin Campbell, Jessica Rutherford and Brooke Stanley; and former Mays Professor Michael Gallmeyer, who is at the University of Virginia.

For more information, contact Johnson at shaneajohnson@tamu.edu.

“CEO Optimism and Forced Turnover” by T. Colin Campbell, Michael Gallmeyer, Shane A. Johnson, Jessica Rutherford and Brooke W. Stanley was published in Journal of Financial Economics in September 2011.

Don’t challenge giants, marketing experts advise

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usinesses competing with larger companies—particularly those that enter a market by acquiring an established business—will fare better if they differentiate themselves from the “behemoths” rather than imitate them or take them head-on, suggests Mays research on the topic.

The researchers found that competitors who imitated the large newcomer had poorer performance, which was counter to prior research.

The phenomenon of acquiring a company to enter a marketplace—common in banking, pharmaceuticals and technology—hasn’t been studied as thoroughly as the path companies take to enter a market through other means, such as introducing a new product, says Alina Sorescu, an associate professor of marketing and Mays Research Fellow.

She and several other researchers tackled the topic in the paper “Behemoths at the Gate: How Incumbents Take On Acquisitive Entrants (And Why Some Do Better Than Others),” which has been accepted for publication in Journal of Marketing.

The research was centered on the banking industry because firms and the actions they take in this industry are well documented. The researchers looked at 1995–2003 bank data from the FDIC, such as deposit summaries, and interviewed banking officials. The data covers 839 acquisitions in 583 Metropolitan Statistical Areas in the U.S. banking industry. The research specifically focuses on how banks modify their product mix when a large bank enters their market through an acquisition.

In this context, the product mix of banks includes various types of loans such as commercial and industrial loans and loans secured by real estate. Changes in product mix were assessed at the twoyear and three-year marks after the acquisitions.

Results indicate that incumbents are more likely to align their product mix strategy with that of the behemoth if: (1) the incumbent is large; (2) the behemoth’s past performance has been strong; and (3) the market served by the incumbent is small.

The size of the market tends to set the tone of the competition, Sorescu says. “The smaller the market, the more likely the incumbent is to imitate the acquirer,” she observes. “It’s like a big fish in a small pond making a big splash—they compete with the same small base of customers.”

Sorescu concludes it’s a bad idea to go head-on with the acquirer.

Let behemoths be

Researchers found that the competitors who imitated the large companies had poorer performance.

“It’s best to try to diverge from the acquiring company, even though it is a threatening presence and it is tempting to try to mimic what it is doing,” she says. “You assume the larger corporations have identified a strong path and an advisable product mix, but you must differentiate yourself from it in order to survive. The small firms that imitate the large firms may not be able to offer the same products and services as efficiently as large firms do, and they could suffer more harm than if they focused on what they already do well.”

For more information, contact Sorescu at asorescu@tamu.edu.

The research paper, “Behemoths at the Gate: How Incumbents Take On Acquisitive Entrants (And Why Some Do Better Than Others),” was in press in late 2011 at Journal of Marketing.

It is a collaboration among Alina Sorescu, Prokriti Mukherji, Jaideep Prabhu and Rajesh Chandy. Mukherji is senior research associate at the Carlson School of Management, University of Minnesota. Prabhu is Jawaharlal Nehru Professor of Indian Business at Judge Business School, University of Cambridge. Chandy is Professor of Marketing and Tony and Maureen Wheeler Chair in Entrepreneurship at London Business School.

Dramatic redesigns can have ill effects

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Changing course, particularly in golf, can diminish experience

ntuitively, it is clear that changes in a service environment can reduce the quality of a service at least temporarily. But what is not clear is how deeply, and for how long, major changes affect operating performance—that is, until Texas A&M University business professors Gregory Heim and Michael Ketzenberg decided to answer those questions.

They chose a dramatic example of redesign and decided to focus on experience-based service companies, in general, and an area that had not been previously studied in depth: golf courses.

Many service managers redesign their services periodically to keep their offerings fresh, competitive and desirable to customers.

Prior research has shown that it could increase repeat business.

What Heim and Ketzenberg, both Mays Research Fellows, wondered was how service firm managers and employees relearn to improve their performance after these major redesigns.

That was the extent of Heim’s golf knowledge at the start of this project. He sought out a colleague to fill the gaps. He did not have to search far. Ketzenberg was just a chip shot down the hall.

Ketzenberg has two passions: research and golf, and he considers the opportunity to combine both a godsend. Heim says he focused on the data analysis, while Ketzenberg provided golfing expertise. “It was an ideal pairing for this project,” Heim says.

A major research challenge is obtaining real-world operating data from companies upon which to base the research. Most companies are reluctant to share it. For this study, the authors were looking for data from multiple companies over multiple years. Golf courses posed less of a problem, since the data were publicly reported.

The data came in the form of “panel data” from The Dallas Morning News. The newspaper tracks the top Texas golf courses annually through ratings and evaluations of top courses by golf professionals, as well as information on when the courses were designed and redesigned.

Heim and Ketzenberg chose to study the data from 1989 to 2009. Their study provides managerial insight by demonstrating the extent of learning; illustrating how redesigns can negatively affect

service outcomes; showing how relearning occurs; and discussing tactics for success when redesigning services.

Major redesigns, intended to improve products and services, tend to throw the quality of service off track, the researchers found. The question was how long the service suffers, which they studied through learning effect patterns during routine operation periods as well as “window of opportunity” effects the local service crews felt after outside firms had completed the major redesigns.

“We wanted to see what we could learn about what happens when you destroy the course to redesign it; how age affects the long-term experience; and whether the quality of service gets better with time,” says Heim. “When you redesign it, there’s a period of time when the customers miss the familiar old course and they have to re-learn to navigate the course—the hazards, slope of the course, shape of the greens, and so forth. The argument for improving a course is to make it better, but we wanted to find out if people really thought that was true. Some people embrace change, while others don’t.”

The topic is a nontraditional one for the field of information and operations management, but both of them say it was fun to do. The lessons learned were to carefully consider changes, communicate about them with stakeholders and make the investment in training staff for the transition. “Discontinuous events that lead to dissatisfaction on the customer’s part are not going to pan out to be good investments,” Heim says.

Both Mays researchers plan to continue golf-related research: Heim intends to update the golf data for new studies while Ketzenberg is working with Rogelio Oliva, another Mays professor, and a colleague from Europe, Mozart Menezes, on a paper titled “Optimal Scheduling of Golf Beverage Carts.”

Ketzenberg explains, “We are trying to answer the often-heard golfer’s lament of why there is never a beverage cart around when you want one. Fun stuff.”

For more information, contact Heim at gheim@mays.tamu.edu or Ketzenberg at MKetzenberg@mays.tamu.edu.

The paper “Learning and Relearning Effects with Innovative Service Designs: An Analysis of Top Golf Courses” by Heim and Ketzenberg was released in July 2011 in Journal of Operations Management.

Employers wise to tighten the ties that bind

Attachments help keep valued employees in place

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t’s complicated, an employee’s decision to leave a job—even more complicated than previously believed, Texas A&M University researchers conclude after conducting research on when job searches result in turnover.

As expected, turnover was higher when employees had lower levels of embeddedness and job satisfaction and higher levels of available alternatives. What wasn’t expected, or previously explained, was that there is more complexity to the process than believed, and specifically, that these factors play a key role in whether search behavior actually results in the decision to quit.

Embeddedness means how attached someone is to his current environment, says Mays Management Associate Professor and Nichols Endowed Professor Wendy Boswell, who collaborated on the research with Assistant Professor Ryan Zimmerman and doctoral candidate Brian Swider. The trio examined factors that may help explain under what conditions employee job search effort may most strongly (or weakly) predict subsequent turnover.

“How tied you are to not only the place but also the community—if you own a home, your spouse has a job there, you belong to a church or are involved in schools, determines how much incentive it takes to get you to leave,” Boswell explains.

“Fit” is also important—whether the values of a community (as well as the organization) align with the individual’s—and characteristics such as metropolitan versus small-town, or urban versus industrial. “The practical implication for an employer is to know who is really vulnerable to leaving, then going and intercepting those high performers—retention isn’t ‘one size fits all,’ ” explains Boswell.

The culture of the organization and community also carry great weight in the decision, Swider says. “Say I’m working in New York City and a job opens in a small southern suburb.

Whether I pursue that opportunity depends on my personal preferences,” Swider says. “It could be the opportunity I’ve been waiting for or it could sound like a nightmare.”

Employers do a poor job of predicting impending turnover, Swider says. These findings suggest that there may be a number of factors interacting to influence employees’ turnover decisions, indicating greater complexity to the process than described in previous prominent sequential turnover models.

Boswell explains the assumed process: An employee

experiencing job dissatisfaction searches for alternatives, evaluates them against his current position, then either quits or stays put. But, often times, employees search and don’t leave. Online applications make it easier to search and even apply for positions, but the likelihood of an employee actually accepting another position depends on his level of enmeshment or “stuckness” as well as how important it is for the person to leave and whether he or she even has the opportunity.

“The more of these attachments you have, the more likely you are to want to stay somewhere,” Boswell explains. “It used to be the defined benefit plan, but now it is all these other factors that you might have to sacrifice if you were to leave.”

The key for an employer to stay ahead of the turnover is to know his or her employees. “Are they satisfied, embedded, on the fence?” Boswell says. “Are they flight risks? If so, and if they are top employees, you might be wise to invest in trying to retain them.”

For more information, contact Swider at BSwider@mays.tamu.edu, Boswell at WBoswell@mays.tamu.edu, or Zimmerman at rdzimmerman@tamu.edu.

“Examining the job search - turnover link: The role of embeddedness, job satisfaction, and available alternatives,” by Brian W. Swider, Wendy R. Boswell, and Ryan D. Zimmerman, was published in the March 2011 issue of the Journal of Applied Psychology.

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