- Back in the 1990s, there was a war being fought for the hearts, minds, and desktops of computer users around the world. Apple had thrust the personal computer into the modern age with the original Macintosh in 1984, introducing users to the now-familiar mouse-driven interface. But the company quickly lost ground to Microsoft. Ten years later, Microsoft solidified that dominance with Windows 95. Two years later, when the United States Department of Justice filed an antitrust complaint against the software firm, the war was already over. The Windows platform had won.
When two platforms-like Windows and Mac OS-are in competition with each other, it seems inevitable that one will win. Yet that is not always the case. Consumers have many different choices when it comes to credit card platforms, including Visa, MasterCard, American Express, and others. Fans of video games currently have three choices when it comes to consoles-Nintendo's Wii, Microsoft's Xbox 360, and Sony's Playstation 3. And people seeking dates have many, many sites to visit on the Internet. In each of these three industries, consumers have enjoyed a choice of platforms for many years. Unlike what happened with Windows and Mac OS, none of those markets has tipped to favor one over the others.
Signs of whether and when a market may tip are closely watched by both economists and regulators. Yet as the PC wars showed, there may be little warning that a market might tip. In fact, tipping may only be obvious when it has already happened. By the same token, no one is certain why markets such as online dating have not tipped. That is in part because tipping is little understood.
"Tipping is really hard to study in the real world," says Dylan Minor, an assistant professor of managerial economics and decision sciences at the Kellogg School of Management. "We just get a snapshot in time. We don't know for sure if a market is tipping or actually coexisting."
To Tip or Not to Tip
To study the moment when a market tips, Minor and his colleagues Tanjim Hossain, a professor at the University of Toronto, and John Morgan, a professor at the University of California, Berkeley, moved to the laboratory, where they could control conditions that might cause tipping. "A unique feature of the lab is that we could actually simulate and recreate competing market platforms to see when they tip and why," Minor says.
In the lab, they first constructed a number of different markets in which participants could choose one platform over another. Four (or eight) players participated in a session and played four sets of fifteen periods each. Each player was assigned to be one of two types, a triangle or a square, and two or four players of each type constituted a market. In each period, the players selected a platform based on their type and the respective payoff each platform offered (e.g., one platform may have offered lower fees and a higher payoff for certain triangles, luring those players to it). Minor and his colleagues adjusted the markets such that half would tip and half would coexist.
Oddly, nearly all of them tipped. Even when platforms and their payoffs were identical-which should have encouraged people to stick with their first choice-players still converged on one platform. "Tipping was so pervasive," Minor says. "We were very puzzled." Whatever fosters coexistence seemed to be missing from their experimental markets.
Back to the Lab
So Minor and his colleagues ran another set of experiments, this time adding elements of horizontal differentiation. Horizontal differentiation is the term for a situation in which one platform appeals to one group more than another. In the lab, Minor and his colleagues rigged the markets so that one platform would pay one set of player types more than another. Yet even then, coexistence was not guaranteed. Tipping only subsided when the type-specific payoffs substantially outweighed the benefits of the higher-quality platform. In economic terms, horizontal differentiation in those markets dominated vertical differentiation.
In the case of Windows vs. Mac, Apple's vertical differentiation was not enough to maintain a two-platform market. For the majority of users, Macs did not offer a substantially better experience than Windows, and so the operating system market tipped.
In the online dating world, however, coexistence is the norm. "Dating sites are a good example of a very fragmented market," Minor notes. "But they also have different kinds of dating sites geared toward a different kind of people, as opposed to some other markets, like say an operating system." So while Match.com has the largest market share, it controls less than 20 percent of the market. Broad appeal may be good for operating systems, but not necessarily for dating sites. Niche players like jdate.com-which caters exclusively to Jewish people-thrive in the dating world by attracting certain people who may be turned off by large sites like Match.com or eHarmony.
Online dating is not the only market where competitors coexist. As mentioned earlier, the market for video game consoles is currently split relatively evenly among Nintendo, Microsoft, and Sony. Job market postings are divvied up almost equally among CareerBuilder, Yahoo!, and Monster. Coexistence is persisting in the smartphone market, too, where many observers have been predicting the eventual dominance of one platform over another. Years ago it was Blackberry, with its firm grasp on the business market. Then Apple introduced the iPhone. Though the iPhone was not and is still not available on all networks, Blackberry's market share waned. Google has also joined the fray with its Android operating system. To date, no platform seems to be dominating. Coexistence in the smartphone market seems assured for the near future, at least.
But in markets where tipping seems inevitable-or even beneficial if the efficiencies of one platform are large enough-regulators keep a close watch. "Indeed, regulators are concerned" about the effects of tipping, Minor says. Where coexistence is possible or beneficial, they may act to preserve competition. But in cases like Windows, where one firm already has control of the market, regulators may act to protect consumers from potential abuse. "That's where the attention of the regulator comes in," Minor says. "That's a big reason why tipping is studied by economists."
While Minor and his colleagues' discovery that horizontal differentiation can prevent tipping may not help regulators prevent monopolies from forming, it could help potential market entrants determine the best way to succeed in a tight marketplace. "A new platform entrant is most likely to succeed in a platform space serving heterogeneous customers," Minor advises.
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- The public has been concerned about income inequality for at least twenty years, says Camelia M. Kuhnen, an associate professor of finance at Kellogg School of Management. Long before there was an Occupy Wall Street, articles in the press were denouncing excessive compensation. What, if anything, she wondered, was the effect of all this negative press on how firms paid chief executives?
As it turns out, the public and the media have more influence on how CEOs are paid than most of us probably realized. This does not mean, however, that the resulting changes in how executives were paid are necessarily a good thing.
In order to uncover whether there was a link between the sentiment expressed in the news about executive pay and how that pay was subsequently doled out, Kuhnen and her collaborator, Alexandra Niessen, an assistant professor at the University of Mannheim, wrote software to crunch through a database of 26,000 articles spanning the years 1990 to 2010. By identifying key words that indicated negative coverage in the context of stock options-"backdating" was one of them, given the options backdating scandal that broke during that period-they were able to determine the overall tone of coverage in each of the years they examined.
A Focus on the Wealth Gap
Because as much as the focus of public ire during this period was on stock options, Kuhnen believes that it was probably more about the gulf between rich and poor in general. "I think the public did care about the level of CEO pay," Kuhnen says. "You see this in surveys done in that time period. The public has cared a lot about income inequality for the past couple of decades."
Companies that were attacked over options, according to the media data gathered, responded to the pressure by changing their compensation practices, often lowering the amount of the options grants given to CEOs. This effect was more pronounced for chief executives who were younger or at firms with more independent boards. In other words, companies whose leaders were more concerned about their reputation, or who had more power to act to protect that reputation, were more responsive.
Yet in the wake of all this negative press, overall CEO compensation did not decline. Kuhnen and Niessen found that compensation taken away in the form of options was replaced with salary, bonuses, and shares of restricted stock, leaving CEOs with the same nominal income as before. This shift away from options had the effect of reducing the sensitivity of CEO pay to the stock performance of the firm. This is one of the reasons that Kuhnen is not sure that, at least in this case, the responsiveness of CEO compensation to public pressure was a good thing.
"When you shift away from options pay into, for example, salary, you diminish the strength of the connection between how a CEO is paid and how the company is doing," Kuhnen says. In other words, loosening the coupling between pay and performance means CEOs have less incentive to work hard.
Shifting Away from Options
At the time that options were in the news in the 1990s and early 2000s, the stock market was going through periodic surges that inflated the value of these options, making them more visible. But given that the origin of much of the public's outrage was income inequality, it seems that options may have become a proxy for this inequality. "This is just one potential explanation," Kuhnen says, "but people were hearing in the media about managers receiving very large option grants, and it's possible in people's minds they equated the pay of the CEO with the size of the option grant."
It is not just that reducing options compensation could have influenced the subsequent decision-making of CEOs in a way that was less than helpful; it seems that it also did not accomplish the original goal of the public, which was by most accounts the reduction of the wage gap.
While options were the focus of the most scrutiny and subsequent changes, they were not the only kind of CEO pay transformed during the period studied. In 2008 options gave way to bonuses as the most excoriated type of compensation. From 2008 to 2009 the type of compensation that dropped the most was bonuses. "So depending on what the public is focused on, we see firms react by diminishing that type of pay," Kuhnen says.
With a grinding financial crisis threatening to turn into a global recession, as well as all the attention on the Occupy movement, we are living through a time when people are more focused on income inequality than ever. Kuhnen says that if the protestors of Occupy Wall Street were to focus on executive pay rather than income inequality in general, she thinks that firms would react.
Whether or not that would be a good thing, however, depends on your perspective. In a normal economy, no one knows how to shape compensation in a firm better than the people who work for it, and as Kuhnen's research reveals, public pressure has in the past had the paradoxical effect of making CEOs somewhat less accountable, at least in terms of their compensation.
"It's a complicated issue," Kuhnen says. "It's not as simple as, 'The public is a wonderful governing mechanism and will help all firms do better.' "
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- Major technological advances have the power to shake up the marketplace. As investment shocks, technological innovations do not affect all firms equally. Some firms benefit, while others lose market share. Because of these risks, investors demand a premium for investing in companies that appear unable to adapt to new technologies, argues Dimitris Papanikolaou, an assistant professor of finance at the Kellogg School of Management.
Papanikolaou cites the rise of the Internet as an example of an innovation that produced major winners and losers in the marketplace. Companies that were able to implement the investment shocks and adapt to the Web environment-Amazon, for example-found a new structure and were able to take advantage of the major innovation. Other firms were not able to adapt, and some eventually went out of business, such as Borders. "People buy stock in a firm, and then the next Internet arrives, and they don't know how the firm will fare in that environment," Papanikolaou says.
The difference in the ability of companies to take advantage of new advances makes a big difference for investors. For example, investors who bought equity in a bricks-and-mortar bookstore in the 1990s would have found that their investment strategy did not pay off-many bookstores did not adapt to the rise of the Internet. That gave Amazon an opportunity to take substantial market share. "As an investor in those types of firms, I'm afraid that stock prices will go down and demand a higher risk premium," Papanikolaou says.
He adds that the idea of investment shocks has helped scholars understand long-term growth, and that concept has been incorporated into many models used to predict how stock prices will fluctuate. His model is a type of "real business cycle model," in which market fluctuations are largely explained by shocks to the business environment. The problem with some of these models, Papanikolaou says, is that they attempt to account for the impact of technological innovation by using "disembodied shocks." In other words, these models assume that the ability to adopt or benefit from innovation is automatic and equal across all firms. In the real world, of course, this is not the case-in order to benefit from an innovation, a firm must have the means to adopt or implement it.
For example, take the case of better computers. People who use models with disembodied shocks assume that the benefits from the new machines fall equally on all companies. But as Papanikolaou explains, "My old laptop is still very slow-it doesn't go any faster because Intel released a new processor. In order to benefit from this innovation, I need to go out and buy this new computer. It's not going to magically land on my desk." That is why his model accounts for the fact that firms will implement technological advances differently, which is an important factor in understanding how they will fare in the wake of an investment shock that affects the whole market.
Value vs. Growth
Another important factor in Papanikolaou's model is the difference between value firms and growth firms. Based on the results from his model, Papanikolaou argues that investment shocks "benefit producers of capital goods relative to producers of consumption goods, and within each sector, benefit firms with opportunities to invest relative to those that lack growth opportunities." This results in lower risk premiums for growth firms as compared to risk premiums for value firms, "because they act as hedges for shocks to real investment opportunities," he reports in the recent paper.
He explains that when a value firm-a firm whose market value is lower than the value of its assets-owns substantial physical assets, the risk is increased that the firm may not be able to efficiently adapt to the next big thing. For example, although Blockbuster owned a lot of stores that rented videotapes, its market value was relatively low because the market perceived that Blockbuster would have trouble adapting to the Internet.
Papanikolaou notes that this fear about Blockbuster turned out to be well founded-Netflix came along and stole its market share. Blockbuster as we knew it is now out of business. When investors buy a value stock like Blockbuster, they run the risk that a Netflix will come along and take that company's market share. Therefore, investors require a higher rate of return to buy stock in a company like Blockbuster.
Another thing Papanikolaou argues, based on his model, is that when innovations emerge, the economy diverts resources to new investment and away from current consumption. This happens because in the short run, we must all pay a cost to benefit from innovation. "As a result, if I invest in a value firm like Blockbuster, whose value drops when my consumption drops, I am unhappy. In contrast, I like growth firms like Netflix, because they do well when I choose to divert resources away from consumption," Papanikolaou says.
Understanding what creates stock market movements is very important, Papanikolaou believes. The overall challenge, he notes, is to link stock market prices to the state of the economy, rather than viewing the stock market as something that fluctuates randomly. His model's findings are a piece of that puzzle.
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- By the time most people reach middle age, they could probably name a long list of things they regret from their past-the job opening they ignored, the disastrous vacation, the stock they did not buy, or even worse the one they did.
But the most frequent regrets involve romance, according to a new study by Neal J. Roese, a professor of marketing at the Kellogg School of Management, and Mike Morrison, a graduate student at the University of Illinois at Urbana-Champaign. This and other findings contradict some of the results of previous, smaller studies, which had ranked education-related regrets in first place.
Whatever the cause of the regret, Roese says that people should not see it as a negative. "Regret is an essential part of the human experience-something everybody has as long as they have life goals," he says. "Rather than avoid it, it's better to try to take some insights out of the regret experience."
Roese and Morrison undertook the new study in order to analyze a more broad-based population than in prior research, which mainly used college students. The two authors arranged telephone surveys of 207 women and 163 men across the United States, selected by standard random-sampling methods. The respondents were asked to describe, in detail, one significant incident of regret. In addition, the survey group provided information about their gender, age, education, and relationship status. Then their answers were analyzed according to predetermined criteria to gauge the severity of the regret-mild, moderate, severe-and to assign the regret to one of twelve categories-career, community, education, family, finances, friends, health, leisure, parenting, romance, self-improvement, or spirituality.
Relationship Regrets
"The key finding," Roese says, "was that romance was the number one regret," cited by 18.1 percent of the respondents. The second choice-family, at 15.9 percent-was also related to personal relationships. "People crave strong, stable social relationships and are unhappy when they lack them," the authors write. Next came education (13.1 percent), career (12.2 percent), finance (9.9 percent), and parenting (9 percent).
This general pattern was observed across all demographic boundaries-race, age, relationship status, education-except one: gender. Women were more likely to cite romance-related regrets, whereas men's regrets usually centered on work. (The fact that there were more responses from women than men-coupled with this gender tilt-did not affect the overall totals in the survey, because the calculation was weighted for such demographic imbalances, Roese says.) This male-female dichotomy seems to support clichés such as the assumption that men are the breadwinners, or that women want to get married, but that should not be surprising, Roese says. "Sometimes clichés speak to a truth about our nature or society," he points out, but he adds that traditional gender roles seem to be changing.
Regrets of Omission
Another key finding had to do with whether people felt more regret about actions they did or did not take. Research by Victoria Medvec, a professor of management and organizations at the Kellogg School, had previously established a connection between time and regret: The more time that has passed since an event, the more likely people are to focus on what they failed to do, rather than what they actually did. "Lost opportunities linger in our memory longer," Roese puts it. That is because people can quickly rationalize their actual actions, even when they went wrong. But for a possible action that was never taken, "there are so many ways in which you can see different things you could have done," he explains.
He illustrates the concept with a romantic example-asking someone for a date. In remembering an unsuccessful attempt, an unlucky suitor might think, "I asked this person out on a date, she shot me down, it's done." But if he never even tried, the suitor might ponder all sorts of scenarios: "What if I had asked her when I saw her in the hallway? What if I had phoned right after we first met? What if I had sent flowers?"
Roese and Morrison's new study analyzed people's feelings about unrealized actions by asking respondents questions such as, "Does the regret focus on something you should have done, or something you should not have done?" and "When did the event happen that made you feel regret?" Through their broad sampling, Roese and Morrison found that the time disparity, too, applies to a wide cross-section regardless of race, education level, marital status, and age.
Learning from Regrets
At its best, regret can "direct behavior toward fixing what evoked the regret," Roese and Morrison write. In fact, they continue, "regret is more intense" precisely when there is a chance to reverse an unhappy decision, which then "serves to motivate the individual toward new corrective behavior."
However, the possibility of a do-over shrinks with age. Younger respondents like college students obviously have more hope of a second chance. For the broader cross-section in the new study, more people may feel that time is running out.
While that sounds dour, there may be a silver lining to looking back on wistful memories. "At the end of the day, regrets are highly useful emotions that signal to us where in life we need to improve, and motivate us to actually make those improvements," Roese points out. "We should listen to our regrets rather than pretend that we do not have them."
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- Imagine a local policymaker trying to pull his district out of an economic crisis. Since his funds are limited, he must decide how best to distribute them to ensure the most successful recovery. Reaching that decision requires him to answer several questions. For example, should he subsidize corporations rather than workers or vice versa? Should one type of industry receive more funds than others? And should the policymaker put greater focus on encouraging new investment than on supporting existing investments?
Those conundrums are not restricted to municipalities. National policymakers faced them in 2009 when they developed the stimulus bill intended to put the economy back on course. At issue was the anticipated behavior of the individuals and organizations, otherwise known as "agents," that were expected to receive the subsidies.
Game theorists refer to this issue as one of coordination. "Coordination is a situation when, out of selfish motives, you want to do what other people are doing-such as speculating against currencies you want to short when other people are shorting," says Jakub Steiner, assistant professor of managerial economics and decision sciences at the Kellogg School of Management. "This type of behavior is based on self-fulfilling beliefs."
Playing a Coordination Game
Interactions among several agents are referred to as a game. It becomes a coordination game when multiple stable outcomes-or equilibria-exist and the agents can coordinate equally well in any of them. "Depositors would play a coordination game when deciding whether or not to withdraw their money from a bank," Steiner explains. "So would traders when they each decide individually to short a currency."
The challenge for a policymaker facing an economic crisis is to identify the agents in the game with the most influence on the process of recovery, who are thus most worthy of receiving the bulk of the available funds. A poor choice could result in a coordination failure-what Steiner describes as "an equilibrium that's individually rational but catastrophic overall, such as a bankruptcy, or everyone investing in what turns out to be a bank run."
Until recently, little guidance has been available on how to choose the most appropriate agent. "It's a natural question that's important now but hasn't been studied in the past because there hasn't been a good method of studying it," Steiner explains. "We have found a simple technical way of doing it precisely," he continues, referring to a model that he and economist József Sákovics, a professor at The University of Edinburgh, have developed.
Two Basic Criteria
"We derive novel results for large coordination games…that allow us to give policy advice over a wide range of situations," the two report in their paper on the new model. "In the canonical case of investment subsidization we find that ideal candidates for the subsidy need to satisfy only two criteria: (i) their investment has a relatively large direct impact on the incentives of others, but (ii) they are relatively insensitive to the investment of others." Steiner puts the model's message more pithily. "You subsidize those industries with high spillover to other agents," he says, "and those who don't care too much about the activity of the others."
The first criterion is fairly obvious. The second is much less so. Why, after all, should one rely on largely independent agents to lead a team effort to avoid disaster? Explains Steiner, "If you subsidize the insensitive agents, by definition those who are not subsidized are quite sensitive to what other people are going to do. So they'll be quite excited by the increased economic activity of the subsidized ones. That maximizes the indirect effect of the subsidies."
To illustrate the power of their model, Steiner and Sákovics cite the way in which shopping mall developers set their rental fees. Typically, they point out, the brand-name department stores that anchor any mall receive large discounts on their rents. "Anchor shops bring in loyal customers who end up shopping at other stores as well; thus their decisions have large impact on the decisions of others," they write. "At the same time their sales are relatively unaffected by the custom of shoppers derived from other stores-as shown by the similarity of their sales per square feet between regional and super-regional malls."
A Serendipitous Beginning
Steiner and Sákovics's approach came about serendipitously. "We were playing around with a set of models without anything practical in mind," Steiner recalls. "Once we found a way to solve problems we hadn't solved before, it gave us some mathematical way of solving other problems."
To develop their model, Steiner and Sákovics relied on two critical concepts, one well tried and the other that they devised specifically to deal with coordination problems. "The risk dominance criterion is an old and important concept," Steiner says. "It shows that in times of uncertainty, mutual worries can become self-fulfilling." In other words, people and organizations can coordinate in such a way as to harm all parties. For example, they all might withdraw their money from an otherwise solvent bank in the face of a possible bank run, thereby spoiling the bank's chances of surviving the run.
The other concept-the belief constraint-"is our technical contribution," Steiner says. "It recognizes that when you ask groups of people with different incentives how optimistic they are about what will happen, you can't make everybody completely optimistic; there will always be doubts." Generalizing the belief constraints for many players in a coordination game, the two write, "allows us to characterize the coordination outcome and specify the optimal policy for a broad range of payoffs and information structures."
Financial Regulation and New Technology
The model provides guidance on situations well beyond mall rentals. Financial regulation is one arena that can potentially benefit from it. Take, for example, a country in such financial distress that it has frozen all bank deposits but then decides to allow some depositors to withdraw their money to maintain liquidity. "Our model allows us to track how a discriminatory withdrawal policy affects the probability of a run, thus informing the policy discussion," Steiner and Sákovics write.
Similarly, the model can play a role in a corporation's introduction of new technology, such as videoconferencing. Typically, organizations seed a group of employees to adopt the technology first, in hopes that they will highlight any technical problems and help to convince coworkers to accept the technology. "Our model can easily be adapted to find the optimal seeding policy," the pair writes. And in the example of economic crisis withdrawal that opened this summary, Steiner says, "the model gives an idea of whom to subsidize to stimulate the economy."
Awaiting Experimentation
Steiner emphasizes that he and Sákovics have not applied their model to formal examination. "It's a theory paper; it hasn't been tested. As a piece of mathematics it's a speculative model," he says. "We don't know empirically in what domains it works and doesn't work. It may work equally well or badly. It's a new model. We'll have to do experiments to test it. And if the profession finds it sufficiently useful, somebody will test it."
But before that, Steiner continues, "the model may stimulate public policy discussions." He envisions such discussions in the continuing disagreements over the stimulus program that the Bush and Obama administrations devised to deal with the effects of the economic meltdown of 2008. "I hope that somebody who knows much more about the details of how the stimulus has been done and how other stimuli may be done in the future may find this model useful in organizing his or her thoughts," he says. "We hope that it will be a useful tool in the discussion."
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