How the stock market is fueling the wealth gap: Q&A with Prof. Martin Lettau

The stock market’s recent rise reflects a dramatic shift in wealth from workers to investors, according to new research by Prof. Martin Lettau

How the stock market fuels wealth inequality

In decades past, a rising stock market was a reflection of economic growth. But no longer.

New research by finance Prof. Martin Lettau has found that economic growth accounted for less than a quarter of the stock market’s rise over the past 30 years—compared with 92% of the increase in the prior three decades.

The biggest driver of the recent bull market? A dramatic shift in wealth from workers to investors, accounting for 54% of the market’s increase since 1989.

Martin Lettau
Prof. Martin Lettau (Photo: Noah Berger)

That’s the conclusion of Lettau’s new paper, “How the Wealth Was Won,” co-written with Daniel Greenwald of MIT and Sydney Ludvigson of New York University. They show that most of the stock market gains of the past three decades have come from shareholders getting a bigger and bigger piece of the economic pie.

Lettau’s research points to a potentially critical driver of the growing wealth inequality plaguing the U.S.: At a time of slowing economic growth, those at the top of the wealth distribution are reaping most of the rewards, while the share of income received by the rest of households has declined.

The research explores hot-button issues that are not the standard fare for financial economists. We spoke with Lettau, an expert in investments and financial markets who holds the Kruttschnitt Family Chair in Financial Institutions, about how the stock market has seized the lion’s share of 30 years of economic growth, and whether this trend is sustainable.

You write about a widening chasm between the stock market and the broader economy. What specifically are you referring to?

U.S. stock values have grown faster than the economy over the past 29 years. After adjusting for inflation, the stock market value of corporations outside the financial sector has risen an average of 8.4 percent a year since 1989. At the same time, the value of the economic output of corporations has climbed just 2.5 percent annually. By contrast, from 1959 to 1988, economic output was expanding faster than stock values.

What did you find was behind this trend?

We considered the entire economic pie that was produced and the different actors in the economy. We found that, over the long run, the movement in stock values stemmed largely from shifts in wealth from labor to capital. Put plainly, the long-standing bull market of past 30 years comes largely from the capital sector getting more of the economic pie than the labor sector.

How big a factor has this shift been in pushing stock prices higher, compared with other factors?

We looked at the factors that standard financial theory considers to be drivers of stock prices, including fluctuations in short-term interest rates, changes in investor tolerance of risk, and economic growth. We did a statistical analysis to measure how much each of these factors contribute to stock market valuations. We found falling interest rates and greater investor appetite for risk have each contributed 11%. Economic growth explains just 23% of the stock price increase. Meanwhile, we estimate that the reallocation of the rewards of production to shareholders and away from labor has accounted for a full 54% of the gains in stock market value since 1989. That’s a sharp turnaround from 1952 to 1988, when other factors accounted for just 8% of the rise in stock prices, while economic growth accounted for 92% of the increase.

Why has capital’s share of the pie grown and labor’s share shrunk?

Our work doesn’t directly address the underlying reasons why we’ve had these shifts. But there’s some work by labor economists that has come up with plausible explanations. One is the decline in union power, which has weakened labor’s voice in setting wages. Another is outsourcing, which moved work to cheaper domestic or international sources of labor, putting pressure on pay. Third is technology, which is replacing manual labor with intensive productive capital. Thirty years ago robotics barely existed. Now it’s everywhere. Well-educated workers reap the benefits, but those without the skills in demand today are left behind.

Inequality of income and wealth have become pressing concerns in recent years. What does your work tell us about the sources of inequality?

This is a very important question, not just in the United States, but in much of the developed world. What our work suggests is that part of increased inequality could be due to the stock market. The overall economic pie is growing, but not at very high rates. The segment of the population that owns stocks has reaped the benefits of this growth relative to those who don’t own stocks. And, while it’s true that more people hold stock today than in the past thanks to retirement investments like 401(k)s, stock ownership is still highly concentrated.

It’s striking that this shift has happened during a period of slowing economic growth—just 2.5% annually versus 4.5% in the prior period, you found. Meanwhile, the Congressional Budget Office (CBO) projects that real GDP over the next decade will grow just 1.7% annually. Is this trend sustainable?

Without fully understanding the economic forces that caused these trends in the postwar data, it is difficult to assess how they will evolve in the future.  For example, technological changes are unlikely to be reversed, but other factors could be reversible. If the Congressional Budget Office’s projections for GDP turn out to be correct, and the growth of the total economic pie is sluggish, stock market investors will not see growth rates as in the recent past unless the labor share declines further. Since the end of the great recession, income growth has been robust and kept pace with corporate profits, but it is not clear whether this signals a short-term phenomenon or a change in long-term trends.

You’re bringing together two disciplines that are usually kept separate: financial economics and labor economics. What’s the significance of this?

Our contribution is to connect broad economic trends with the financial markets. We examined the overall economy because we have plenty of data. It would be useful to know on a more granular level who has benefited from the economic shifts we describe. But to do a deeper dive into household wealth is difficult because data is limited. There’s very little information on what kinds of households hold what kinds of assets.

New research shows how companies game the system to boost CEO pay

Excessive CEO pay_Mathijs De Vaan

A rule designed to make executive compensation more transparent has instead given companies a tool to push CEO pay even higher, according to an analysis by researchers at UC Berkeley’s Haas School of Business and Columbia University.

Since 2006, the Securities and Exchange Commission has required public companies to name a group of peer companies that they use to benchmark their chief executives’ salaries, giving investors and the public a reference point to judge whether CEO paychecks are within reason. But while benchmarking is a good idea in theory—applauded by corporate governance experts—in practice companies tend to cherry-pick peers with highly paid CEOs, says Berkeley Haas Asst. Prof. Mathijs De Vaan.

“We found strong evidence that the benchmarking process has been systematically gamed,” says De Vaan, an economist in the Haas Management of Organizations Group. “Peer groups are assembled more to legitimize excessive pay than to provide objective information about an appropriate level of compensation.”

Not only that, but companies are even more likely to skew their peer group when their CEO underperforms, De Vaan concluded in a new paper published in the journal Management Science and coauthored by sociologists Benjamin Elbers and Thomas A. DiPrete of Columbia University.

Dramatic rise in CEO pay

Mathijs De Vaan_Copyright Noah Berger / 2019
Mathijs De Vaan

The dramatic rise in executive pay in recent years is fueling the growing income inequality that has become a first-order public policy issue, economists have found. Average CEO compensation jumped 12% per year from 1980 to 2004, swelling from $625,000 to $9,840,000. And while the median market capitalization for companies in the S&P 1500 grew just 22% from 2007 to 2014, median CEO compensation grew 39%, according to the paper. To allow for more public scrutiny of CEO pay, the SEC began requiring companies to disclose what peer companies pay their chief executives.

Skewed peer groups

Since then, a number of researchers have looked into whether this executive compensation benchmarking process is fair and unbiased, but measuring it has proved tricky. De Vaan and his coauthors came up with a novel way of determining whether compensation benchmarks were skewed toward higher salaries. Using data from more than 3,400 companies that reported compensation peer groups to the SEC between 2006 through 2016, they developed a model to generate alternative benchmark​ groups that were free from bias. They did this by creating reciprocal groups of peers—that is, if company A compared its CEO’s pay with that of company B, company B would also ​benchmark against company A. They used the model to simulate hundreds of alternative peer groups, and then compared these with the benchmark​ groups​ companies actually used.

The results strongly suggest that companies typically chose a skewed sample of highly paid CEOs. Not only that, but these skewed peer groups were closely associated with real increases in CEO compensation. In other words, benchmarking was used to justify high pay, and CEOs benchmarked against highly paid peers were paid substantially more, they concluded.

Underperformers get bigger rewards

In fact, the researchers found that benchmarking is even more skewed when CEOs fail to meet their performance targets, such as stock market value and profit. De Vaan and his coauthors found new evidence that these underperforming CEOs get especially generous pay packages. The researchers’ statistical analysis showed that decreases in returns on assets—a standard profitability measure—were associated with wider gaps between the selected peer group and the simulated peer groups created by the researchers.

“If you’re a CEO who doesn’t perform well, your compensation should be adjusted downward,” De Vaan says. “One way companies prevent that is by introducing more bias.”

The authors also found that companies that had greater discretion in choosing peer firms, perhaps because they didn’t fit neatly into an industry category, tended to use that flexibility to select peer groups with even higher-paid executives.

Finally, De Vaan and his coauthors looked at how peer-group benchmarking has changed over time. They found that the average level of bias has diminished, which may reflect growing shareholder and regulatory pressure on companies to avoid abusing the disclosure process. However, the association between peer group bias and executive pay has increased over time, meaning that CEOs get greater financial gains from skewed benchmarking now than they did in the past.

A role for watchdogs

Why don’t boards push back? The researchers point out that board members may want to maintain cordial relationships with their CEOs, and also that they tend to be executives themselves, and may be inherently biased toward increasing executive pay.

Although the authors did not explore the indirect effects of peer-group benchmarking, De Vaan thinks it’s probable that biased benchmarking by some companies may also affect firms that aim to select an unbiased set of peers. When a company skews its peer group to push up its own CEO’s pay, that in turn becomes a potential reference for other companies. “Given the network nature of this process, it is difficult to be honest,” he says.

Is there a way to stop the merry-go-round? De Vaan thinks probably not, as long as companies select their own peer groups for benchmarking. But the story would be different if industry watchdogs or regulators created unbiased peer groups for companies that were similar in size and business mix. That would allow benchmarking to do what it is supposed to do—give shareholders an objective way of evaluating whether CEOs deserve their pay.

Stock options worth more for women, senior managers, study finds

Stock options worth more for women_berkeley haas study

A novel new way of determining the value of employee stock options has yielded some surprising insights: Options granted to woman and senior managers are worth more because they hold them longer. And options that vest annually rather than monthly are worth more for the same reason.

The new valuation method, which combines standard option theory with real-world observations of what employees actually do with their grants, gets at a knotty problem: Even though stock options are one of the most common forms of compensation, companies don’t really know how much granting options costs them.

Berkeley Haas Prof. Richard Stanton
Richard Stanton

“We’ve come up with a practical method of valuing stock options that takes into account actual behavior of employees,” says Richard Stanton, a Berkeley Haas professor of finance and real estate who holds the Kingsford Capital Management Chair in Business.

The new approach is laid out in “Employee Stock Option Exercise and Firm Cost,” forthcoming in the Journal of Finance and co-authored by Berkeley Haas Prof. Nancy Wallace and New York University Assoc. Prof. Jennifer N. Carpenter. Their analysis also draws on behavioral economics, which considers the effects of psychology on financial decisions.

A behavioral economics approach

Nancy Wallace
Nancy Wallace

Among their original findings: Options awarded to women cost companies 2 to 4 percent more than those granted to men, who tend to exercise their options faster. And awards to the most senior employees cost 2 to 7 percent more than grants to their lower-ranking colleagues—again, because the execs hold onto them. In addition, options cost companies significantly more when they are set up to vest less frequently—that is, reach the threshold date when they become eligible to be exercised. A shift from an annual to a monthly vesting date reduces option value by as much as 16 percent because people exercise the options earlier and more often.

According to a recent survey by Meridian Compensation Partners, 42 percent of companies responding reported they awarded stock options to senior executives. And options represent more than 20 percent of CEO pay, according to one estimate. Options allow holders to buy a specific stock at a set price until a predetermined expiration date. The basic challenge in determining the cost of employee stock options is that their value depends on how long they are kept. In general, the longer they are held, the greater the cost to the company that issued them. Consequently, the key to valuing them is to predict accurately when they will be exercised. “How much the options are worth depends on what the employee is going to do with them,” Stanton notes.

A vast literature examines how to determine the value of stock options traded on exchanges. But employee stock options are a special breed with their own special characteristics. For that reason, the valuation methods originally developed for exchange-traded options are imprecise when applied to the options companies award their employees. 

Standard option theory takes into account several factors to forecast when options will be cashed in. But it was largely developed through studies of exchange-traded options, making it out of whack for employee stock options for several reasons. For one, employee stock options can’t be traded on the market—the only way employees can dispose of them is to use them to buy the underlying stock. Second, they can only be used during a multi-year window that starts when they vest and ends when they expire. Third, employees can’t easily protect themselves from the risk of having so much of their wealth tied to their employer’s stock, since the only way to reduce the risk is to exercise the option, and that impacts its value.

New model factors in behavior and risk

To arrive at a more accurate way of estimating when employees would exercise stock options, Stanton, Carpenter, and Wallace, the Lisle and Roslyn Payne Chair in Real Estate Capital Markets, analyzed a unique set of data that included complete employee stock option histories awarded to some 290,000 employees from 1981 to 2009 at 88 publicly traded corporations. The dataset gave them an unprecedented fine-grained look at option-exercise behavior. The authors then constructed a mathematical model of exercise rates that took relevant factors from standard theory and added factors related to the riskiness of the options, based on portfolio theory, along with some additional behavioral factors and information on the terms governing options grants, along with characteristics of issuing companies and option holders.

Their findings included some surprises. For example, vesting frequency had an especially powerful effect on option cost. The obvious reason is that employees are able to exercise options earlier when they vest more frequently. But something else may be at work—employees receive an email when options vest, which may prompt them to pull the trigger.  “When people’s attention is drawn to their holdings, they’re more likely to make a decision,” Stanton suggests. Similarly, men may exercise options earlier and more often than women because they are more confident making financial decisions. That finding is in line with influential work by Berkeley Haas Prof. Terrance Odean, who found that male investors trade more frequently than women—behavior that reduces their net returns.

But why do high-ranking employees hold their options longer than lower-ranking colleagues? One reason may simply be that they are wealthier and don’t need a stock options windfall to pay for a home renovation or an expensive vacation.

Almost ten years in the making, the research was funded by the Society of Actuaries in response to regulatory calls for improved employee stock option evaluation methods.


More from these researchers

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A decade after housing bust, mortgage industry is on shaky ground, experts warn

Nancy Wallace named chair of the Fed’s model validation council

A house of cards: Prof. Nancy Wallace warns of risk in real estate securities


Buy or lease? In going solar, third-party deals offer advantages

Jose Guajardo_commercial solar

When it comes to going solar, is it better to buy or lease? For businesses looking to get on the right side of climate change, choosing a provider that offers solar-as-a-service may be more efficient than buying a system outright, according to new research from the Haas School of Business.

Asst. Prof. Jose Guajardo, who has studied the operational implications of service business models in multiple industries, looked at the performance of nonresidential solar systems installed in California between January 2008 and April 2013. Analyzing data collected by the California Solar Initiative rebate program, he found third-party-owned systems enjoyed a clear performance advantage, generating a 4 percent better production yield than installations owned directly by the businesses.

“In California’s solar energy sector, this research establishes a connection between service business models and operational performance,” says Guajardo, who published his results in the Fall 2018 issue of the journal Manufacturing & Service Operations Management.

For businesses, this is no small matter: The scale of solar projects can be enormous. For example, in 2015, Apple Computer announced it was investing $850 million to help build a central California solar farm, using some of the energy generated by the project to power its Cupertino, Cal. headquarters.

Some firms, such as Ikea, are opting for direct ownership; others, such as Staples, have opted to lease. Yet while firms approach the decision based on a range of criteria, including how much they want to invest upfront, there has been little empirical evidence to help them choose between these competing business models.

Part of what makes solar so attractive is that it comes with subsidies to encourage its use: The federal government offers tax breaks, and many states offer additional incentives. California, for example, has offered performance-based subsidies to solar producers in the nonresidential sector.  In addition, power purchase agreements—in which the user pays a set rate per unit of energy generated—are commonly used by third-party ownership companies. That means the third-party owner has a double profit motive for boosting energy yield.

Better system design

Guajardo analyzed two strategies that third-party operators can pursue to improve performance: better solar panels or better system design, which means orienting equipment to make the best possible use of sunlight. He found evidence that system design, and not superior panel technology, may account for the third-party advantage. In fact, third-party owners tended to use lower-rated panels, but their better design decisions led to better performance overall.

Guajardo believes there’s a knowledge and skills gap between dedicated solar providers and businesses that run their own systems. “By installing many systems, third-party operators can benefit from learning by doing and economies of scale,” he says.

These results, Guajardo cautions, are particular to non-residential systems that received performance-based incentives in California, and may not apply in places without subsidy programs rewarding performance. He stresses, however, that service business models have been widely used not only in solar energy, but also in several other cleantech markets. Moreover, incentives for adoption of this type of technology have been common in the United States and several other countries.

When it comes to the  adoption of solar energy, Guajardo advises businesses to carefully consider how the incentives behind each ownership model can make a difference from an operational perspective.














Cryptocurrency demystified: A Q&A with Prof. Christine Parlour

Berkeley Haas Finance Prof. Christine Parlour has researched cryptocurrency prices.The surge of bitcoin brought cryptocurrencies from tech-nerd toy to household name, and they’re increasingly showing up in investment portfolios. Yet it’s still a mystery to most people how these digital currencies work. Are they even currency? And do they belong in an everyday person’s portfolio?

Haas News posed these questions to Prof. Christine Parlour, a leading scholar of financial markets and the banking system. In the past few years, Parlour has focused on how digital technologies, including new electronic payment methods like PayPal, are transforming the financial system and affecting the stability of banks. She taught a pioneering fintech course at Haas in 2015, and she is now organizing a new FinTech Center, which will be a hub for research on emerging financial technologies.

Recently, Parlour has given close attention to the value of bitcoin and other cryptocurrencies, a burning question in the world of finance. In a working paper, she analyzed market pricing on 222 digital coins and examined the initial coin offering market. Parlour, who holds the Sylvan C. Coleman Chair in Finance and Accounting at Berkeley Haas, shared some of her thoughts on the burgeoning cryptocurrency market.

Berkeley Haas Prof. Christine Parlour
Prof. Christine Parlour

Q: Many people have heard of bitcoin and other cryptocurrencies, but not many really understand what they are. So, what exactly are cryptocurrencies?

A: Essentially, they’re digital codes that give people the ability to consume and use services. As such, they can be traded and so they do have some sort of transfer-of-value characteristics.

Q: Do they meet the classic economic definition of money—that is, a medium of exchange, a unit of accounting, and a store of value?

A: Despite the great alliterative mouth-feel of “cryptocurrency,” they’re not really currency. Perhaps a more accurate designation would be “cryptocoupons.”

Turning cryptos into cash

Q: Whether they’re cryptocoupons or cryptocurrencies, what can they be used for?

A: Most cryptocurrencies essentially have a use-value associated with a specific underlying commodity or service. For example, sometimes they’re used as a way to compensate artists who are providing their intellectual property. Sometimes they’re used to compensate people who are providing some of their cloud storage capacity to other vendors. So, it’s pretty much anything that you can think of. I’ve even seen marketing specialists and influencers being paid with cryptocurrencies.

Q: Suppose the artist who is paid with cryptocurrency wants cold cash. How can he or she turn the cryptocurrency into conventional money?

A: There are many different exchanges that allow you to convert cryptocurrencies to U.S. dollars or whatever currency you prefer. So, you can switch them out for cash.

New asset class

Q: They’re often described as a new asset class. What’s distinctive about cryptocurrencies as an asset?

A: From a finance point of view, there are lots of things that we view as being assets. And the only thing we care about is that we can use them to get money. I can buy these claims and then, at some point, I can cash the claims back into dollar bills. Hopefully, my money, my piles of dollar bills, will have grown. So inasmuch as you can convert any of these cryptocurrencies to fiat money and back again, you can essentially view them as an asset class.

“Despite the great alliterative mouth-feel of ‘cryptocurrency,’ they’re not really currency.”


Q: Do they have any advantages as an addition to an investment portfolio?

A: What’s interesting about them from a portfolio construction point of view is they essentially add an element of diversification to the standard assets that most people have in their 401(k) plans.

Cryptocurrency mining on the monitor of an office computer.
Cryptocurrency mining

Overvalued or undervalued

Q: Bitcoin and other cryptocurrencies have been among the fastest appreciating assets on record. What has driven the phenomenal increases—and subsequent price plunges?

A: That question presupposes that we know exactly why prices move, but the fact is we don’t. You might as well ask why people like Pokémon Go. I hate to get metaphysical, but essentially there are sometimes things that capture the popular imagination and people just view them as being valuable.

Q: But the market price of bitcoin isn’t metaphysical. It’s real, which raises the question of why it moved the way it did.

A: Why do we have the valuations we currently have in the stock market? People will pontificate about growth rates and outlooks, but they really have no idea.

Q: The price appreciation of bitcoin and other cryptocurrencies has drawn a lot of attention, but how can we determine their value as opposed to their price?

A: I don’t really think that’s a question that should be posed to somebody in finance.

Q: Why?

A: Well, what is the value of a Treasury bond? I can tell you what the price is and I can tell you how much I can convert it into U.S. dollars tomorrow. But the value is not clear. So, instead of asking about value, we look at changes in wealth in terms of U.S. dollars and you can certainly do that for cryptocurrencies.

Q: Do you have a personal opinion about whether cryptocurrencies are overvalued or undervalued?

A: The thing I feel very comfortable saying is that there are diversification properties associated with having some cryptocurrencies in your portfolio. We know that the returns are pretty much driven by something that’s independent of the standard things we put in portfolios.  A well-diversified portfolio should have a little bit of exposure to crypto.

Buyer beware

Q: Wouldn’t it be reasonable for investors to be skittish, given the price volatility of these assets and the lack of regulation of the marketplace?

A: Yes, absolutely. But we have a lot of attempts to start up exchange-traded funds that track cryptos and these are under the usual regulatory umbrellas.

“ICOs are basically created in the febrile brain of the underlying inventor of the coin. It’s just all over the map. They’re fundamentally unregulated and the asset that’s issued doesn’t necessarily bear any resemblance to a security.”


Q: Isn’t there a concern about buying at the top of the market or buying into a heavily speculative market?

A: Yeah, but you can say the same thing about people who bought condominiums in San Francisco.

Q: I want to ask about the related area of initial coin offerings (ICOs). How does an ICO, which gives investors digital coins or tokens, differ from a standard initial public offering in which the investor gets stock providing an ownership claim in the issuing enterprise?

A: ICOs sound like IPOs linguistically, but they’re very, very different. ICOs are basically created in the febrile brain of the underlying inventor of the coin. It’s just all over the map. They’re fundamentally unregulated and the asset that’s issued doesn’t necessarily bear any resemblance to a security. If you are a smaller investor, I would say “caveat emptor,” capitalized, in italics and bold, underlined with stars around it. Basically, only buy a new coin after it has appeared on one of the crypto exchanges—or after the SEC moves forward with more oversight.

MBA grad leads the way on blockchain

Ashley Lannquist established herself as an up and coming fintech leader well before she crossed the stage at commencement at the Greek Theatre last week.

Aside from penning a popular blog about blockchain, serving as co-president of the Haas FinTech Club, investing in more than a dozen cryptocurrencies, and consulting and interning in the industry, Lannquist, MBA 18, is now deeply involved with a new global blockchain venture backed by some of the world’s largest auto companies.

Earlier this month, she helped launch the Mobility Open Blockchain Initiative (MOBI), a consortium aimed at developing applications for blockchain in the auto and related industries. She was also appointed to the board of directors of MOBI, which is backed by BMW, Ford, General Motors, and Renault, as well as an A-list group of suppliers, consultancies, and technology companies.

“We’re setting technology and data standards, and developing them with multiple hands on deck to address industry-wide problems,”  said Lannquist, who serves as MOBI’s treasurer. “More than 70 percent of global vehicle production is represented in MOBI.”

Blockchain’s big auto move

Blockchain is one of the hottest areas of development in the field of financial technology, or fintech. Blockchain started as a decentralized electronic ledger system for transactions involving bitcoin, the leading digital cryptocurrency. The technology’s association with the cryptocurrency world has given it a dubious image in some circles. But proponents stress that blockchain’s underlying technology of transparent and secure digital records shared in networks of computers has the potential to revolutionize the economy.

In the automotive field, blockchain may someday be used to track auto parts through the supply chain, or to verify odometer settings and repair and maintenance records to stamp out fraud in used-vehicle sales, Lannquist said. Blockchain may also pave the way for decentralized ride-sharing apps, with drivers and riders using peer-to-peer technology instead of going through services like Uber and Lyft.

A South Florida native and former Florida state taekwondo champion, Lannquist arrived at Haas with her sights set on fintech. She was awarded the Haas School’s C & J White Fellowship based on her essay about wanting to help start a fintech club at Berkeley, which she proceed to do before she matriculated.

“She started that essay with a (William Gibson) quote that is strikingly prescient:  ‘The future is already here — it’s just not evenly distributed,’” said William Rindfuss, executive director for strategic programs in the Haas Finance Group. “I’m incredibly proud of what Ashley has achieved as a Haas student.”

A digital currency investment pays off

During her first year at Haas, Lannquist joined Blockchain at Berkeley, a student-run organization drawing members from across the university. She took a blockchain course sponsored by the group called “Blockchain Fundamentals” and was hooked. One of her assignments was to open a cryptocurrency investing account and buy some bitcoin. The timing was perfect. Lannquist had started investing just before bitcoin and other digital currencies started their epic bull run.

The profits she pocketed paid her tuition and allowed her to cover the cost of an independent study on blockchain in Germany and Denmark last summer.  While there, she wrote and published a three-part blockchain series on Medium, which is still widely read.

While in Germany, she met a blockchain expert working for Daimler, the German automaker, who introduced her to the automotive uses of the technology.

Founding MOBI

When Lannquist returned to Berkeley, Ronen Kirsh, Blockchain at Berkeley’s co-head of consulting, asked her to lead a project to help BMW develop its blockchain strategy. In that role, she met Chris Ballinger, CFO of the Toyota Research Institute in Los Altos, who asked her to help him organize an industry-wide blockchain consortium. Since last November, she and Ballinger have met monthly with automakers and industry startups from Detroit, Europe, and Japan, contacts that led to the foundation of MOBI.

Meanwhile, Lannquist also publishes a widely followed blockchain blog and advises a venture capital fund and a hedge fund on blockchain strategy. While at Haas, she initiated and helped teach a three-day executive education course in blockchain at the UC Berkeley School of Law.

These efforts have made her a rising star in the burgeoning blockchain community and won her a dream job. After graduating, she will work as a blockchain project lead in the San Francisco office of the World Economic Forum, the foundation famous for its elite annual conference in Davos, Switzerland.

There is no question but that diving into blockchain was a great career move. But for Lannquist, it was a natural progression. “I was just interested and excited about the technology,” she stressed. “It was compelling and I was excited to be involved with it.”

How success breeds success in the sciences

Matthew effect_Mattijs De Vaan


A small number of scientists stand at the top of their fields, commanding the lion’s share of research funding, awards, citations, and prestigious academic appointments. But are they better and smarter than their peers? Or is this a classic example of success breeding success—a phenomenon known as the “Matthew effect”?

Berkeley Haas Asst. Prof. Mathijs De Vaan studied the "Matthew effect"
Asst. Prof. Mathijs De Vaan

Mathijs De Vaan, an assistant professor in the Haas Management of Organizations Group, believes it’s clearly the latter. In a paper published this week in Proceedings of the National Academy of Sciences, “The Matthew Effect in Science Funding,” De Vaan presents the results of a study of Dutch research grants that shows precisely how much of an advantage early achievement confers, and identifies the reasons behind the boost. De Vaan, who came to Haas in 2015 after earning a PhD in sociology from Columbia University, co-authored the paper with Thijs Bol of the University of Amsterdam and Arnout van de Rijt of Utrecht University.

“To those who have, more will be given”

The term “Matthew effect” was coined by sociologist Robert Merton in the 1960s to describe how eminent scientists get more recognition for their work than less-well-known researchers—the reference is to the New Testament parable that, to those who have, more will be given. Previous attempts to study this phenomenon have yielded inconclusive results, in part because it is hard to prove that differences in achievement don’t reflect differences in work quality.

To get around the quality question, De Vaan and his co-authors took advantage of special features of the main science funding organization in the Netherlands, IRIS, which awards grants based on a point system. Everyone whose application scores above the point threshold gets money, while everyone below is left out. The authors zeroed in on researchers who came in just above and just below the funding threshold, assuming that, for practical purposes, their applications were equal in quality.

First off, they found the benefits of winning an early-career grant were enormous. Recent PhDs who scored just above the funding threshold later received more than twice as much research money as their counterparts who scored immediately below the threshold. The winners also had a 47 percent greater chance of eventually landing a full professorship. “Even though the differences between individuals were virtually zero, over time a giant gap in success became evident,” De Vaan notes.

Status and participation

De Vaan says that two main mechanisms may explain the Matthew effect in science funding. First, winners achieve status that can tilt the playing field in their direction when it comes to funding, awards, and job opportunities. The second is participation, meaning that successful applicants continue seeking grant money, while unsuccessful applicants often give up, withdrawing from future competition.

De Vaan and his coauthors argue that the Matthew effect erodes the quality of scientific research because projects tend to get funded based on an applicant’s status, not merit. Groundbreaking work may not get done because the researchers are unknown or too discouraged to compete for funds. They recommend several reforms to the funding process, including limiting information grant application reviewers have about previous awards. They also suggest that rejected applicants learn their scores, which might encourage those just below the threshold to try again.

These findings may apply in many areas beyond science. For example, the Matthew effect may also widen a gulf between winning and losing entrepreneurs in the race for venture capital. Even the Academy Awards may favor big movie industry names over lesser-known talent. “There are a lot of social settings with large amounts of inequality, which could be ripe for the study of the Matthew effect,” De Vaan stresses.

A decade after housing bust, mortgage industry is on shaky ground, experts warn

Professors Richard Stanton and Nancy Wallace found the boom in nonbank lenders poses a systemic risk to the mortgage market.

Despite tough banking rules put in place after last decade’s housing crash, the mortgage market again faces the risk of a meltdown that could endanger the U.S. economy, warn two Berkeley Haas professors in a paper co-authored by Federal Reserve economists.  The threat reflects a boom in nonbank mortgage companies, a category of independent lenders that are more lightly regulated and more financially fragile than banks—and which now originate half of all US home mortgages.

“If these firms go out of business, the mortgage market shuts down, and that has dire Implications for the overall health of the economy,” says Richard Stanton, professor of finance and Kingsford Capital Management Chair in Business at Haas. Stanton authored the Brookings paper, “Liquidity Crises in the Mortgage Market,” with Nancy Wallace, the Lisle and Roslyn Payne Chair in Real Estate Capital Markets and chair of the Haas Real Estate Group. You Suk Kim, Steven M. Laufer, and Karen Pence of the Federal Reserve Board were coauthors.

Bank regulation fueled boom in nonbank lenders

Berkeley Haas Prof. Richard Stanton
Prof. Richard Stanton

During the housing bust, nonbank lenders failed in droves as home prices fell and borrowers stopped making payments, fueling a wider financial crisis. Yet when banks dramatically cut back home loans after the crisis, it was nonbank mortgage companies that stepped into the breach. Now, nonbanks are a larger force in residential lending than ever. In 2016, they accounted for half of all mortgages, up from 20 percent in 2007, the Brookings Institution paper notes. Their share of mortgages with explicit government backing is even higher: nonbanks originate about 75 percent of loans guaranteed by the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA).

Nonbank lenders are regulated by a patchwork of state and federal agencies that lack the resources to watch over them adequately, so risk can easily build up without a check. While the Federal Reserve lends money to banks in a pinch, it does not do the same for independent mortgage companies.

Scant access to cash

Prof. Nancy Wallace
Prof. Nancy Wallace

In stark contrast with banks, independent mortgage companies have little capital of their own and scant access to cash in an emergency. They have come to rely on a type of short-term funding known as warehouse lines of credit, usually provided by larger commercial and investments banks. It’s a murky area since most nonbank lenders are private companies which are not required to disclose their financial structures, so Stanton and Wallace’s paper provides the first public tabulation of the scale of this warehouse lending. They calculated that there was a $34 billion commitment on warehouse loans at the end of 2016, up from $17 billion at the end of 2013. That translates to about $1 trillion in short-term “warehouse loans” funded over the course of a year.

If rising interest rates were to choke off the mortgage refinance market, if an economic slowdown prompted more homeowners to default, or if the banks that extend credit to mortgage lenders cut them off, many of these companies would find themselves in trouble with no way out. “There is great fragility. These lenders could disappear from the map,” Stanton notes.

Risk to taxpayers

The ripple effects of a market collapse would be severe, and taxpayers would potentially be on the hook for losses posted by failed mortgage companies. In addition to loans backed by the FHA or VA, the government is exposed through Ginnie Mae, the federal agency that provides payment guarantees when mortgages are pooled and sold as securities to investors. The mortgage companies are supposed to bear the losses if these securitized loans go bad. But if those companies go under, the government “will probably bear the majority of the increased credit and operational losses,” the paper concludes. Ginnie Mae is especially vulnerable because almost 60 percent of the dollar volume of the mortgages it guarantees comes from nonbank lenders.

Vulnerable communities would be hit hardest. In 2016, nonbank lenders made 64 percent of the home loans extended to black and Latino borrowers, and 58 percent of the mortgages to homeowners living in low- or moderate-income tracts, the paper reports.

The authors emphasize that they hope their paper raises awareness of the risks posed by the growth of the nonbank sector. Most of the policy discussion on preventing another housing crash has focused on supervision of banks and other deposit-taking institutions. “Less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it,” the paper concludes.

Stanton adds, “We want to make the nonbank side part of the debate.”

Hawk or dove? For central bankers, birth year influences outlook

hawks and doves_Prof. Ulrike MalmendierFederal Reserve policymakers are among the best informed and most knowledgeable experts on the economy, and their decisions on interest rates are supposed to be based on exhaustive analysis of data. But Ulrike Malmendier, the Edward J. and Mollie Arnold Professor of Finance at Haas, believes something else may also be at work: the personal experiences of inflation that Fed decision makers have had over their lifetimes.

Prof. Ulrike Malmendier

In a working paper coauthored with Stefan Nagel of the University of Chicago and Zhen Yan of the University of Michigan, “The Making of Hawks and Doves,” Malmendier offers evidence that Fed policymakers’ lifetime experiences with rising prices help shape their projections of future inflation, influence their votes on monetary policy, and color the tone of their speeches. If they lived as adults through periods of high inflation, such as the 1970s, they tend to be much more leery of runaway prices than if they came of age during later decades, when inflation was largely under control. In short, lifetime inflation experience is important in determining whether members of the Fed’s policy body, the Federal Open Market Committee (FOMC), are “hawks” or “doves”—that is, whether they emphasize keeping prices in check or also give high priority to fostering economic growth and employment.

“Our central hypothesis is that FOMC members’ voting decisions are influenced by the inflation experiences they have accumulated during their lifetimes,” Malmendier and her coauthors conclude. “When forming beliefs about future inflation, people overweight realizations of past inflation that they have experienced in their lives so far.”

Behavioral economics lens

The study has been hailed as a landmark analysis of the policymaking process using the principles of behavioral economics, a field of study with deep roots at UC Berkeley that takes insights from psychology and has introduced ideas such as irrationality, emotion, and force of habit into economic research. The paper “is the first to provide evidence of the impact of personal experience on the decisions and expectations of central bankers,” economist Daniela Bergmann wrote in Chicago Policy Review.

Malmendier, who holds joint appointments at Haas and in UC Berkeley’s Economics Department, is a rising star in behavioral economics and a past winner of the American Finance Association’s Fisher Black Prize, awarded every second year to a leading finance scholar under 40. Along with Economics Prof. Stefano DellaVigna, Malmendier co-founded the Initiative for Behavioral Economics and Finance at UC Berkeley. In previous work, Malmendier and Nagel have explored other ways personal experience affects economic behavior, such as how willing investors are to take risks. They concluded that appetite for risk in the stock and bond markets depends on how those markets have performed over an investor’s lifetime, challenging the conventional notion that investors act rationally to maximize gains.

Going against the tide

The paper on Fed policymakers also goes against the tide. Standard economic analysis holds that FOMC members’ inflation expectations and votes on policy reflect objective information on how the economy is performing. If that were the case though, each FOMC member would take the same policy position, since all of them have access to the same information.  “We’re trying to understand why these experts have very different views,” Malmendier explains. “We think the inflation experience they have had in their lifetimes is an important reason why some people are optimistic and some pessimistic” about rising prices.

In the paper, Malmendier and her coauthors implemented a new model of experience-based learning, which holds that Fed policymakers forecast inflation based on how prices have behaved up to the time of an FOMC meeting. The researchers then applied statistical analysis to economic data to create an econometric model that incorporates lifetime inflation experience to forecast each FOMC member’s voting behavior.  They controlled for changing attitudes by age, as well as political party affiliation and academic background in economics (i.e., whether the members held a PhD in the field). When the authors compared their experience-based forecasts with members’ actual voting behavior from March 1951 to January 2014, they found that those with more inflation experience were more likely to have hawkish voting patterns. The effect was striking: An FOMC member had an above-average experience with inflation (according to the experience-based forecast) was one-third more likely to take a hawkish stance that went against the committee majority, and also one-third less likely to take a dovish stance.

Speech analysis

They also looked at whether FOMC members’ attitudes about monetary policy could be detected in their speeches.  When they performed a linguistic analysis of FOMC members’ public statements, they found that those with higher experience-based inflation forecasts used more hawkish language. In addition, they were more likely to issue higher inflation projections than internal Fed staff forecasts that had been derived from rigorous data analysis.

The authors’ most striking finding was that FOMC members’ personal experience with inflation is a key determinant of Fed policy. Specifically, the interest rate targets set at FOMC meetings—the Fed’s most important policy decisions—have often strayed from levels suggested by Fed staff and tilted toward the subjective forecasts of FOMC members. Malmendier and her coauthors estimate that, throughout most of the 2000s, the Fed’s interest rate targets would have been 0.50 to 1 percentage point lower if policy had been based exclusively on staff forecasts.

One of the implications of this research is that age matters when choosing Fed policymakers since experience of inflation differs largely according to date of birth. It’s a point The New York Times noted in 2014 when it pointed out that inflation had averaged 3.8 percent during the adult life of Charles Plosser, one of the FOMC’s most prominent hawks, but only 2.5 percent during the adult life of Narayana Kocherlakota, one of its most outspoken doves.

Malmendier’s work suggests that the times a person has lived through may someday be considered in the selection of central bank policymakers. “Our results add a twist to the practical notion that the choice of a policy maker can have a long-lasting impact on policy outcomes,” the paper concludes. “To predict a policy maker’s leanings, it is helpful to look at the person’s prior lifetime experiences.”

Want to clean up the environment? Make credit easier to get.

Berkeley Haas Prof. Ross Levine found easing credit helps the environment
A frack site by a wind farm

Prof. Ross Levine has found a new way to encourage businesses to be environmentally friendly: Make it easier for them to borrow.

Research by Levine, the Willis H. Booth Chair in Banking and Finance, is the first to show that when lending conditions ease, businesses invest more in projects to cut pollution. In a new paper published by the National Bureau of Economic Research (NBER), “Bank Liquidity, Credit Supply, and the Environment,” Levine and co-authors from two Hong Kong universities conclude that easier borrowing promotes environmental responsibility in two ways: First, as the supply of credit rises, loans to finance environmental projects become more readily available. Second, as interest rates drop, lower financing costs boost the payoff from green investments.

Berkeley Haas Prof. Ross Levine
Professor Ross Levine

“Changes in credit conditions have an impact on the environment,” Levine says. “When a company can borrow more than it could in the past and interest rates fall, the company is more likely to invest in reducing pollution.”

While these expenditures help the environment, companies are not going green merely for the sake of the environment. These investments offer real benefits to the businesses themselves, slashing the fines they pay for pollution, improving the health and productivity of their workers, and burnishing their public reputation.

Surprising results

The link between credit and the environment is largely unexplored territory in the academic literature, exemplifying Levine’s talent for uncovering economic and social connections that are important but not obvious. For example, he has previously studied links between banking deregulation and income inequality.

In his latest work, Levine says he was surprised that easier credit led to more environmental spending because he had assumed business investments in green projects were largely dictated by legal requirements. “I would have bet heavily that firms only invested in pollution abatement in a manner that satisfied minimum regulatory requirements,” he stresses.

Fracking windfalls provide test case

The NBER paper, written jointly with Chen Lin and Zigan Wang of the University of Hong Kong, and Wensi Xie of Chinese University of Hong Kong, investigates how a sudden increase in the amount of money banks have available for lending affects the environmental performance of their business customers. The authors used an ingenious method to isolate the effects of credit: They examined what happened to the environment when banks got a windfall in lendable funds because of the fracking boom.

Fracking developed explosively starting in the early 2000s as the technology to extract natural gas from shale deposits became economically viable. Energy companies began buying mineral leases from landowners in shale areas, and the landowners in turn deposited some of those payments in local banks. This surge of funds rapidly expanded the amount of money those banks had to lend. To see what effect this increase in bank deposits had on the environment, Levine and his co-authors looked at emissions of benzene—a widely used industrial chemical present in exhaust from many industries—and other pollutants in selected counties where banks receiving fracking money were active. They excluded counties where fracking was taking place to avoid having their results affected by economic changes due to gas production itself. Instead, they studied counties that weren’t producing gas, but had branches of banks that received a fracking windfall elsewhere.

The results were dramatic. Benzene levels fell 26 percent in non-gas-producing counties that had the biggest gains in credit availability—due to their banks receiving deposit windfalls in other counties—compared with benzene level changes in the average county. Other toxic pollutants showed similar declines. “After controlling for many factors and influences, including industrial and economic activity in the county, we observe sharp reductions in air pollution in those … non-shale counties,” Levine noted. The authors attribute the environmental improvements to easier credit terms.

EPA records show lower toxic emissions

The authors also analyzed the environmental performance of individual companies that got better credit terms because of the fracking bonanza. They used data on large syndicated loans to identify companies whose main lender recorded a bump in deposits because of shale gas production. The researchers then checked the Environmental Protection Agency records on these borrowers and found they reduced toxic emissions more than similar companies whose main lender did not get a shale windfall. These companies also received higher performance ratings from environmental groups and spoke out more forcefully in public on green issues than the control group.

Levine cautions that his research draws no conclusions about the environmental effects of fracking itself, which has been linked with a range of problems including groundwater contamination, release of greenhouse gases, and greater earthquake risk. Rather, he and his coauthors use fracking as a way to study the effect of easier credit on the environment.

The research on credit and the environment fits in with Levine’s broad interest in the social effects of financial regulation and credit. As a follow-up, he says he wants to explore how borrowing conditions influence worker safety.

More on Ross Levine: 

To be or not to be an entrepreneur

How stock market’s “spare tire” keeps the economy churning during crises

Profs. Ross Levine and David Teece achieve 100k citations


Janet Yellen leaves the Fed after achieving “near perfection” as chair


Many Berkeley Haas faculty members have left academia for public service, but arguably none have had a greater impact than Janet Yellen, who retired in early February as the first woman to serve as Federal Reserve chair.

Leadership of the Fed has been called the world’s most powerful economic job. The nation’s central bank makes decisions on interest rates that are critical in determining how fast the economy can grow, how readily jobs are available, and how quickly prices rise. Many economists believe Yellen, Eugene E. and Catherine M. Trefethen Professor Emeritus of Business Administration at Haas, in her four-year tenure, performed the job more effectively than any previous Fed chief.

The Fed has a dual mandate to achieve maximum employment and keep prices in check. Under Yellen’s guiding hand, unemployment fell steadily, from 6.7 percent at the beginning of her term to 4.1 percent when she left. Inflation stayed low even as the economy built up a head of steam. And, to add icing on the cake, financial markets went on a tear, sending stock prices to new levels.

“Yellen is on a glide path to near perfection, as she will probably end her term achieving the Fed’s dual mandate better than any other chair in history,” George Mason University economist Scott Sumner wrote in a blog post in October.

“A brilliant thinker”

Yellen, who earned her economics PhD at Yale, came to Haas in 1980, specializing in macroeconomics and international business. She took leave in 2004 to serve as president of the Federal Reserve Bank of San Francisco, one of 12 regional banks in the Fed system. In 2010, President Obama named her vice chair of the Federal Reserve Board of Governors in Washington, D.C. and promoted her to chair four years later.

Yellen’s colleagues from her years at Haas say they are not surprised by what she accomplished at the Fed. They remember her as a brilliant thinker and teacher who combined rigorous data analysis with a deep understanding of economic theory. “She applied the same methodology as Fed Chair that she used to teach her students,” says Prof. Andrew Rose, the Bernard T. Rocca Jr. Chair in International Business and Trade at Haas. “She’s doing in policy work what she used to do in the classroom.”

Yellen’s legacy goes far beyond a strong economy. Under her predecessor, Ben Bernanke, the Fed launched an extraordinary stimulus program a decade ago to pull the nation out of the great recession. Bernanke’s Fed slashed short-term interest rates close to zero and bought trillions of dollars in U.S. Treasury bonds and other securities to flood the economy with money.

It fell to Yellen to wean the economy from that stimulus. Move too fast and the recovery could sputter. Go too slow and a dangerous bout of inflation could take hold. Yellen chose to keep rates rock bottom far longer than conventional wisdom considered safe, presiding over just small increases in the Fed’s benchmark interest rate. Her genius was to recognize that the rules of the past no longer applied. The evolution of the global economy meant that much lower interest rates could be tolerated without triggering inflation.

A stellar Fed record

As Yellen navigated this delicate course, she had to keep one eye on financial markets. In 2013, under Bernanke, when the Fed first discussed winding down its stimulus program, interest rates spiked, an incident dubbed the “taper tantrum.” To avoid that, Yellen was scrupulous about telegraphing the Fed’s moves well in advance. That strategy succeeded in soothing the financial world. By the time the Fed started selling its hoard of bonds, markets barely reacted.

Yellen has accepted a new position in Washington, D.C., as distinguished fellow at the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. Much has been made of the fact that, despite her stellar Fed record, President Trump did not reappoint her when her term ended. Still, his nominee, Jerome Powell, is expected to closely follow the course Yellen set.

In motivating innovation, golden parachutes may have silver linings

When an executive fails to turn a profit yet still gets a rich payout, it’s certain to raise eyebrows—and possibly trigger a backlash from shareholders wary of corporate excess.

Yet in an age when companies must innovate to survive, it may be necessary to reward corporate leaders in spite of failure.

Assoc. Prof. Gustavo Manso
Gustavo Manso

A new body of research by Assoc. Prof Gustavo Manso has demonstrated benefits to compensation arrangements that many corporate governance experts have come to frown upon. His central argument: companies that want to blaze new trails should not penalize managers whose efforts don’t quickly bear fruit.

“When you want managers to innovate, the types of incentives you use are very different from traditional pay-for-performance arrangements,” explains Manso, who holds the William A. and Betty H. Hasler Chair in New Enterprise Development. “You need to reward early failure and focus on long-term results.”

Golden parachutes and other perks

Pay for performance became a watchword in the business world after last decade’s financial crisis, when the leaders of some of the nation’s largest banks and brokerages walked away with tens of millions while their companies needed taxpayer bailouts or fire-sale takeovers. Golden parachutes and generous stock options for executives who don’t perform came to be seen as improper, while linking compensation more tightly to success came into favor.

Manso has re-examined compensation for an age of innovation. In particular, his research finds that provisions such as incentive packages that pay well despite short-term failure, stock options that keep their value when share prices fall, and even generous payments when corporate leaders lose their jobs—precisely the perks shareholder activists hate—may sometimes be needed to motivate managers to take risks and try new things.

In motivating innovation, golden parachutes may have silver liningsExploitation vs exploration

Manso’s work comprises a groundbreaking mix of theory, data analysis, and experimentation. In a landmark 2011 article in The Journal of Finance, he built on the classic distinction between two approaches to management: “exploitation” and “exploration.” The first relies on tried-and-true practices that are likely to pay off. The second seeks better ways of doing things, but can lead down blind alleys.

Using a theoretical model, Manso showed that the ideal compensation plan to motivate exploration is different from the best plan for exploitation. Pay-for-performance works well when the goal is to achieve the best results from known techniques. But managers who are expected to innovate must be paid for long-term, not short-term results, and they should not have to worry about losing their jobs if new methods fall short.

In a later article, Manso modeled the impact of public vs private ownership structures on investment in innovative projects. He and he co-authors found that while public ownership incentivizes the companies to cash in on existing ideas—since the market reacts quickly to good and bad news—while the private ownership gives more leeway for exploring new ideas.

Lee Fleming, director of the Coleman Fung Institute for Engineering Leadership at UC Berkeley, says the originality of Manso’s work lies in the way he applies ideas from organizational theory to complex financial questions, such as the ideal form of executive compensation.

“The gains from exploitation are quicker, less risky, and may be on average more attractive financially, while the gains from exploration take longer to harvest and are more risky,” notes Fleming, who holds a joint appointment at the Haas School. “Gustavo’s genius has been to develop the economic and financial implications of this model.”

Encouraging experimentation

In an experiment to test his ideas about encouraging innovation, Manso and a co-researcher recruited 379 volunteers to operate computerized lemonade stands to earn small amounts of money. Participants were divided into groups and offered different compensation schemes, and then given choices between making minor or major adjustments, such as altering their product mix. Those who were allowed to fail at no cost in the first half of the experiment, and rewarded for their performance at the end of the experiment, were more likely to experiment and discover better ways of operating the lemonade stand.

Manso believes his work is broadly applicable in fields beyond business, such as scientific research and the academic world. Still, he cautions that using compensation plans to motivate innovation can prove tricky in practice. To make sure managers don’t take advantage of arrangements that tolerate short-term failure, their performance must be monitored and they must be given regular feedback. And the burden on boards is intensified because directors must create incentives for innovation while also guarding against abuses.

“It’s always a balancing act,” he says. “It’s not always optimal to experiment. Sometimes you just want to ‘exploit’—and then pay-for-performance works well.”

Berkeley-Haas to launch new Global Management Program for undergrads

Berkeley-Haas Global Management ProgramBerkeley-Haas is rolling out an intensive new international program for undergraduates in fall 2018, designed to prepare students to take their places as leaders in the multinational workplace.

The Global Management Program, a selective program for a small group of students, will be the second Haas program offered to high school seniors applying to UC Berkeley. (The Management, Entrepreneurship, & Technology (M.E.T.) Program, which launched this year, is the first.)

About 30 students will be admitted to the inaugural GMP class.

The Global Management Program is intended to be completed in four years, awarding students a bachelor of science degree in business administration. It builds on the school’s existing Global Management Concentration, which readies-upper class undergraduate business majors for international careers.

The new program features several innovations. Entering freshmen will come to campus for eight weeks in summer 2018 to do preparatory coursework, meet their fellow program participants, and connect with the university community. They will then travel as a group to the UC London Center in the British capital’s Bloomsbury district through Global Edge, a campus-wide program offering freshmen a chance to study abroad during their first semester.

Erika Walker, assistant dean of undergraduate programs at Haas, called the new program a defining approach for the next generation of business leaders. “International experience is a key requirement for business education today,” Walker said. “This program will enable students to learn first-hand what life and people are like in environments away from home, and those experiences will ultimately help shape their leadership style.”

Program administrators stressed that the program will be intense.  On top of an already demanding undergraduate curriculum, Global Management Program students will have to fulfill a language requirement and take specialized global business courses.

“This is a deeper program than we’ve ever had before at Haas,” says Dan Himelstein, a lecturer in the Berkeley-Haas Business and Public Policy Group, who serves as the Global Management Program’s faculty adviser. “In addition, it’s a cohort experience for the students, who will be working together throughout their undergraduate careers, sharing common experiences.”

For new students with an interest in management and a budding sense of wanderlust, the program may just what they’re looking for. “This is a strong opportunity to begin shaping who they are going to be as global leaders,” Walker says.

To be eligible for the program, admitted students must:




Why the sharing economy can be good news for manufacturers

The sharing economy can benefit manufacturers

The rise of Uber and Lyft has taxi companies running scared, while AirBnb is encroaching on hoteliers. Should the firms that make cars, bikes, and even lawnmowers also fear a sales drop as peer-to-peer rental apps make it easy to borrow wheels on demand?

Not necessarily, says Jose Guajardo, a Berkeley-Haas assistant professor in the Operations and Information Technology Management Group. In a recent working paper, he suggests emerging peer-to-peer rental markets represent more opportunity than menace for manufacturers.  That’s because the existence of these markets might tip the scales for ambivalent buyers who know they can recoup some money from a big purchase—and also because these markets open new opportunities for companies savvy enough to exploit them.

“There is a large variety of cases in which the peer-to-peer rentals can be good news for traditional firms,” Guajardo stressed in an interview about the paper, written with Vibhanshu Abhishek and Zhe Zhang of Carnegie Mellon University.

Renting out your ride

The peer-to-peer market is a notable feature of the sharing economy, whose rise represents one of the most innovative business trends of our time. Peer-to-peer rental companies like Turo for cars and SpinLister for bikes allow regular people to rent out their rides—similar to what Airbnb has done for apartment owners. These services are also creating a world in which consumers are not only customers, but potential competitors.

Guajardo and his co-authors built a model to analyze this rental market’s effects on manufacturers. They found that whether these companies are hurt or helped depends critically on how often people use the products.

Take car sharing, for example. Guajardo’s model showed that in a scenario where nearly all drivers use their cars with about the same frequency, manufacturers are better off without peer-to-peer rentals, which might cut in to sales. In a scenario where some car owners do a lot of driving and others just a little, a company’s best option would be to simply sell to frequent drivers and rent to occasional motorists.

It is when there is a moderate disparity in driving habits within a marketplace that manufacturers can benefit from peer-to-peer rentals. The explanation is simple: If I’m considering buying a car, even though I don’t plan to use it every day, the presence of an active car-sharing market may convince me to make the purchase. I know I can make back some of the price by renting it out on days I’m not driving. In this way, the peer-to-peer market gets some middle-range users to buy and enables infrequent drivers to rent, boosting overall consumption.

Sharing economy benefits

Guajardo and his co-authors say they believe their paper is the first to highlight variation in usage as a key factor determining peer-to-peer market effects. He says he hopes the research demonstrates the benefits available to manufacturers, which can exploit this new market by adjusting their business models and investing in or starting their own peer-to-peer operations.

It’s a lesson not lost on some of the nation’s largest corporations, especially in the auto industry. Ford has invested in bike sharing—recently rolling out a fleet of Ford GoBikes in the Bay Area. And Tesla CEO Elon Musk has declared that his company will let Tesla owners tap a button on their phones to rent out their vehicles, generating income that could make the pricy electric cars more affordable.

Meanwhile, peer-to-peer markets can save consumers money whether they’re owners or renters. “It can be a win-win situation for both manufacturers and consumers,” Guajardo says.

Berkeley-Haas Names First Winner of New Investment for Impact Prize

Job applicants will accept lower wages in order to work for a socially responsible employer, according to research by the winner of the newly launched Investment for Impact Research Prize.

Berkeley-Haas created the prize last year to encourage new academic research on the social and environmental effects of capital investment.

The competition drew a total of 48 papers. A team of 11 judges from the academic, investment, and nonprofit world selected the winners.

Vanessa Burbano
Vanessa Burbano

The first-prize winner, Vanessa Burbano, an assistant professor of management at Columbia Business School, won for her paper, Social Responsibility Messages and Worker Wage Requirements: Field Experimental Evidence from Online Labor Marketplaces.

“This paper is important because it speaks to a transition we’re seeing in the labor market,” said Adair Morse, the award’s faculty co-director (with Assoc. Prof. Ayako Yasuda of the UC Davis Graduate School of Management) and an associate professor of finance at Berkeley-Haas. “It shows that the social–plus-economic agenda, as opposed to a purely-profit agenda, can be a powerful way to understand individuals’ decision-making.”

The winning paper presents the results of two experiments in which workers applied for short-term jobs online and, in some cases, were given information about the employer’s charitable giving. In the first experiment, this information prompted applicants to accept slightly lower payments on average, with the highest performing workers responding most strongly.

In the second experiment, prospective workers submitted 44% lower bids for payment after getting information about the employer’s philanthropy. Burbano described the study as one of the first to show that social responsibility messages prompt workers to accept lower compensation. In the case of corporate social responsibility and wages, it’s hard to demonstrate cause and effect, she noted. “But, by using online labor markets, we have a clean causal story.”

Using capital for public good

The new award was created when Haas alumnus Allan Spivack, MBA 80, and CEO of RGI Home, offered last year to help the school finance a social impact research prize.

The Center for Responsible Business at Berkeley-Haas focused the prize on research into ways that capital can be used for public good, including social entrepreneurship and sustainable capital investment. The award complements Haas’s Moskowitz Prize, which concentrates on social responsibility at traditional investment funds.

“We award these prizes because Berkeley has always been a thought-leader in this space,” Morse said. “Thus, we at Berkeley-Haas want to continue to encourage rigorous scientific studies of how social agendas matter in broader contexts of economics, finance, law, management, or other social sciences.”

Two teams were awarded second prize, including Alexander Dyck of the University of Toronto, Karl Lins of the University of Utah; Lukas Roth of the University of Alberta; and Hannes Wagner of Italy’s Bocconi University, who found that institutional investors from countries with strong social responsibility values significantly influence the social and environmental performance of the companies they own. Caroline Flammer of Boston University, Bryan Hong of Ontario’s Western University; and Dylan Minor of Northwestern University showed that linking executive pay to a company’s social and environmental performance creates benefits ranging from lower carbon emissions to greater stock market value.


Berkeley-Haas Helps Spearhead Health Management Journal Relaunch

After a four-year hiatus, the journal Health Management, Policy and Innovation (HMPI), relaunched this month with a fresh editorial mission and a new group of editors, including Berkeley-Haas adjunct Prof. Kristiana Raube.

Berkeley-Haas is among the consortium of leading business school programs that reintroduced the quarterly online journal, which covers real-world problems faced by decision-makers in the health sector every day.

Kristi Raube

Many academic health journals are written for researchers and theorists, rarely addressing the practical questions of delivering care and running health systems, said Raube, who also serves as director of the Graduate Program in Health Management and the executive director of the International Business Development Program at Haas.

By contrast, HMPI targets the people who run health policy and health care institutions, as well as teachers and students in business school health care management programs. The journal’s essays and research articles are authored by a mix of scholars, policymakers, and health sector leaders, and are accessible to both academic and nonacademic readers.

Raube’s article for the first issue focuses on the Tenderloin Health Improvement Partnership, a joint public/private initiative in San Francisco’s Tenderloin neighborhood. Co-authored with Kimberly MacPherson, associate director of the Health Management Program at Haas, along with two other co-authors, the article explains how the initiative aims to coordinate the work of multiple agencies providing health services. The partnership’s approach may serve as a model for improving health care in other hard-to-serve communities.  “It’s a progressive and interesting model,” Raube said.

The online publication is sponsored by the Business School Alliance for Health Management, a consortium of 16 MBA programs in the U.S., Canada, India, and Spain that offer a concentration in health care. It covers topics ranging from fostering innovation and coordinating supply chains to the broad challenge of making affordable, high-quality care widely available. William Mitchell, professor at the University of Toronto’s Rotman School of Business, is editor-in-chief.

Other scholars publishing in the first issue include: Regina Herzlinger, Harvard Business School; Dr. Kevin A. Schulman, Duke University; and R. Lawrence Van Horn, Vanderbilt University, as well as Dr. Bill Frist, the former U.S. Senate majority leader, and Kevin A. Lobo, chairman of Stryker Corporation.




Starfish and Spiders: How a Berkeley-Haas/U.S. Military Partnership is Shattering Stereotypes

Photo: Ori Brafman (left) and Cort Worthington (right) working with MBA students

At first glance, it might seem incongruous to find senior U.S. military officers collaborating with a couple of former-peace-activists-turned-Haas-lecturers who use “touchy-feely” exercises to teach emotional intelligence.

Yet over the past few years, as the armed forces have been wrestling with complex challenges like rooting out decentralized terror networks and running humanitarian missions, lecturers Ori Brafman, BA 93 (peace & conflct studies) and Cort Worthington, BCEMBA 08, have been traveling the country to teach nontraditional leadership techniques to some of the military’s elite.

The relationship took a big step forward recently with the inauguration of the Adaptive and Agile Leadership Network Initiative, a formal partnership between Berkeley-Haas and the Washington D.C.-based National Defense University. Based within the Institute for Business and Social Impact, the program began last spring when 33 senior officers from the NDU’s Dwight D. Eisenhower School for National Security and Resource Strategy’s adaptive leadership program came to Berkeley-Haas for the first of three seminars taught by Brafman and Worthington.

The initiative has enormous symbolic as well as practical potential, Worthington believes. “Because Berkeley and the military have historically often been viewed as seeing the world very differently, this collaboration has the potential to challenge outdated, divisive mindsets in all parts of America. It starts with connecting individuals across this artificial divide, where they discover a genuine common humanity and a shared desire for better leadership in our country.”

Worthington is a former improvisational theater instructor and parachuting US Forest Service Smokejumper who learned the value of instant collaboration, open communication, and inventiveness while on the fire line. He has been teaching leadership courses at Berkeley-Haas for eight years.

The Israeli-born Brafman is the author of several influential books, including The Starfish and the Spider, which examines why flat, decentralized groups are often more nimble and effective than top-down organizations: Like a starfish, if you cut off an arm, a new one grows in its place. Terrorist organizations such as Al Qaeda have used this to great advantage.

This concept caught the attention of one the Army’s top brass, Gen. Martin Dempsey, who reached out to Brafman in 2009 and proposed that he design a program to train senior officers in network leadership principles. Brafman recalls that Dempsey, then in charge of the Army Training and Doctrine Command and later promoted to chairman of the Joint Chiefs of Staff, told him, “In order to fight networks, we need to be more network-like ourselves.” In response, Brafman set up The Starfish Seminar—an interactive small-group seminar—and asked Worthington to join him.

At their first session with army officers in 2010 at Fort Gordon in Georgia, Worthington says he was a bit nervous about how the group would react to their style of teaching. “We had them do touchy-feely stuff right away—improvisation exercises, talking about their feelings. They really took to it, much better than we expected. It took courage for them to do that,” he recalls. Since then, they’ve led immersion-training sessions at military facilities around the country.

The experience has led to some interesting moments. Neither Worthington nor Brafman have family or friends in the U.S. armed services, and both have experience with peace activism—Brafman co-founded Global Peace Networks, a network of 1,000 CEOS working on conflict resolution and economic development worldwide. During a seminar in Kansas, Brafman, a vegan, once found himself at a hunting lodge sharing beers with a group of bow hunters.

This fish-out-of-water sensation was similar for the military visitors to Berkeley, who have lectured in Worthington’s Leadership and Personal Development class decked out in battle fatigues. “People on our side haven’t worked with NGOs and Berkeley people before,” says Col. Kenneth Brownell, director of the Eisenhower School’s Adaptive and Agile Leaders Network Initiative.

As they’ve exchanged visits, they found they have more in common than they thought. Brafman and Worthington say they admire the idealism and strength of character of their military partners. And the NDU students are finding that Worthington and Brafman’s brand of improvisation exercises and emotional intelligence training has real value, Brownell says. “We do see a need to be more starfish-like. We’re looking at very complex problems and using some of Ori and Cort’s ideas. We’re learning from each other.”

The group of students studying at Haas this spring includes colonels or lieutenant colonels and their Navy equivalents, plus leaders from civilian departments such as Homeland Security. They will be joined in the seminars by an equal number of Berkeley MBA students. In addition to their coursework and exercises aimed at building adaptive leadership skills, they’ll be meeting with professionals from Bay Area philanthropic, humanitarian, and environmental groups, and examining issues like veteran re-integration. As part of the partnership, Berkeley-Haas will also serve as a hub for involvement from other academic institutions and the Silicon Valley community in the study of adaptive leadership.

The partnership will also “encourage research to better understand how to build a distributed network of military leaders, business leaders, academics, and non-governmental organizations,” according to the memorandum of understanding.

Mike Christman, MBA 16, a former Marine Corps attack helicopter pilot and Afghanistan war veteran, worked as Worthington and Brafman’s graduate student instructor this year and helped bridge the cultural gap between Haas and its military partners. It has been a gratifying experience, he says. “Getting those two bubbles to mix is really important,” he says. “A lot of stereotypes on both sides break down. Everybody has the goals of solving big problems and making the world better.”


Women Have the Edge in Crowdfunding

Academic research shows females to be at a marked disadvantage in getting bank loans, venture capital funding, and other sources of money needed to grow a business. But, in one venue, women seem to have a notable edge—the fast-growing world of crowdfunding.

Crowdfunding is the practice of raising money through contributions from large numbers of people, usually over the Internet.

According to Andreea Gorbatai, an assistant professor at UC Berkeley’s Haas School of Business, “Women are better at telling a story that resonates with potential crowdfunding investors.” In an unpublished paper, entitled “The Narrative Advantage: Gender and the Language of Crowdfunding,” authored with Laura Nelson of Northwestern University’s Kellogg School of Management, Gorbatai notes that crowdfunding pitches rely heavily on the written word. Gorbatai and Nelson cite studies showing that men and women have distinct writing styles.

Women generally express more emotion and write more about relationships, a style that is more successful than typical male writing at persuading online readers to hand over money.

The crowdfunding market is not trivial. Globally, 1.1 million campaigns raised $2.7 billion in 2012, according to a study cited by Gorbatai and Nelson, and the numbers have soared since then. Crowdfunding contributions are more like donations than investments. Donors want to support a worthy cause and aren’t looking for a financial return except in the more recently emerged equity crowdfunding market. For that reason, effective appeals usually take the form of compelling narratives that create excitement and stir emotion. “Rather than the dry language of finance, crowdfunding pitches require colorful, vivid language,” Gorbatai and Nelson emphasize.

The authors tested their ideas by examining nearly 9,000 small business and technology fundraising campaigns on the Internet crowdfunding site Indiegogo between February 2010 and December 2013. They looked at campaigns created by solo entrepreneurs and identified the probable gender of both fund seekers and donors based on first names. Gorbatai and Nelson then did a statistical analysis of funding appeals along four language dimensions, including upbeat emotion, descriptive vividness, a sense of inclusion in the project, and use of business language focused on money and finance.

Pitches created by women were more likely to express positive emotion, vividness, and inclusiveness, and less likely to use business language. And that partially accounts for why women did better. Crowdfunding campaigns that used emotional and inclusive language tended to succeed, while those that relied on dry, business language more often came up short. Vivid language had little impact on fundraising success.

These results confirm Gorbatai and Nelson’s hypothesis that differences in male and female language patterns partially explain women’s crowdfunding advantage. Interestingly, these effects didn’t depend on donor gender. Men and women responded about the same to the language style in pitches.

Prior research has found that language makes a difference in face-to-face business settings, such as movie pitches and venture capital presentations. But, in such interactions, decisions are made by a small number of people, predominantly male. Nonverbal factors, including body language and personality, may subject women to stereotyping or discrimination. By contrast, online pitches are a purer environment with no personal interaction. Written language becomes more critical for fundraising success.

The crowdfunding study is a natural extension of Gorbatai’s earlier work. She earned a PhD in Organizational Behavior from Harvard and joined the Haas faculty in 2012. Her research has focused on social networks, especially online communities. Her doctoral dissertation looked at Wikipedia as a virtual form of organizing involving millions of people around the world. “I didn’t set out to be a gender studies scholar,” she says of her crowdfunding work. “But the results were very strong. It was the natural way to go.”

For women, the business playing field is still not level, despite their mass entry into the workforce decades ago. That’s the case not only in terms of employment, but also when it comes to securing financing for business ventures.

Academic research shows females to be at a marked disadvantage in getting bank loans, venture capital funding, and other sources of money needed to grow a business. But, in one venue, women seem to have a notable edge—the fast-growing world of crowdfunding.