Kogod Now - Spring 2013 by American University, Kogod School of Business

STOCK OPTIONS How to educate employees to take optimal advantage of this increasingly common perk

BRAND VALUE Are top global brands insulated from harm when the market tanks?

FINANCIAL FUTURES The Consumer Financial Protection Bureau details a plan for educating youth about money

THE AMERICAN UNIVERSITY KOGOD SCHOOL OF BUSINESS | SPRING 2013

MADE IN AMERICA?

OWNED AND DESIGNED IN

THE UNITED STATES

GLUED IN

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2. STITCHED IN

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COTTON CANVAS SOURCED FROM

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PRODUCED IN 9 COUNTRIES IN 61 FACTORIES

FROM THE DEAN Human nature is unpredictable. Human nature is predictable. It all depends on whom you ask. Academic research enables us to delve deeply into the behaviors of individuals, companies, and markets and to discover order where only randomness was apparent. Oftentimes, it also uncovers two answers for every question.

THE BEHAVIOR ISSUE 1 FROM THE DEAN 2 STOCK OPTIONS 6 THE MYSTERIOUS FIRST SALE 10 WHY THE MARKET DOESN’T LIKE CHANGE 12 HOW MUTUAL FUND FEES DRIVE MANAGERS’ DECISIONS COVER STORY 14 Country of Origin 26 IN BRANDS WE TRUST 34 DATA REVOLUTION 38 KOGOD STANDOUT Moving the Needle

PRACTITIONER PERSPECTIVE 44 The Science of Motivating Consumer Behavior Daniel Yates, CEO of Opower 46 Raising a Generation of Financially Savvy Citizens Gail Hillebrand, Associate Director Consumer Financial Protection Bureau

ON THE COVER Generalized data on the manufacturing of Nike-owned Converse footwear. Sources: Nike, the United Nations.

TYPES OF BEHAVIOR BRAND

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EMPLOYEE INVESTMENT CONSUMER ENTREPRENEUR

consumers. If consumers are our “first line of defense” in identifying and preventing financial fraud in the market, how should we educate the next generation of consumers and influence their future behavior? Harvesting the quadrillion pieces of data our daily choices now generate online and through point-of-sale transactions into meaningful, actionable data is one of the fastest emerging industries today. Professor William DeLone developed a business intelligence class in close collaboration with IT market leaders to provide Kogod students with the skill set required to shape market behavior using big data. This type of innovative collaboration between our faculty and employers is central to the new strategic vision I laid out for Kogod last fall. Through carefully developed experiential learning opportunities, our faculty will help our students shape their intellect and intuition in ways that will enable them to add value to their current or future employers from day one. A rigorous business education is not a luxury reserved for those with skyscraper, corner-office ambitions. We believe it is an imperative for any purposedriven individual who seeks to contribute to a sustainable organization—for it will be these individuals and their organizations that help shape the thriving global economy of tomorrow. As we push ever forward with our commitment to the belief that profit and purpose are not at odds, our faculty and students regularly uncover new ideas and opportunities that speak to this viewpoint. As Elisabeth Murdoch, daughter of the much maligned media magnate Rupert Murdoch, remarked recently to the New Yorker: “Profit without purpose is a recipe for disaster. It’s us, human beings, we the people, who create the society we want, not profit…Independence from regulation and the freedom we need to innovate and grow is only democratically viable when we accept that we have a responsibility to each other and not just to our bottom line. Profit must be our servant, not our master.” We couldn’t agree more.

LETTER BY MICHAEL J. GINZBERG DEAN, KOGOD SCHOOL OF BUSINESS

KOGOD NOW SPRING 2013 | kogodnow.com

KOGOD TAX CENTER 40 How Do Employers Get Workers to Save for Retirement?

Moving from intuition and hypothesis to data sets and observations—the insight and knowledge achieved only through measured research—can literally move markets. Our Kogod faculty have cast a critical eye toward a wide range of behaviors in their recent research. Consider Associate Professor Frank DuBois’s development of a new index that evaluates how “American” the cars sold in the United States really are. Drawing on publicly available data, he turns the notion that buying from Detroit means buying American on its head. Can consumer demand to buy American really be met when a globally sourced supply chain is central to the US auto industry? Would “buy American” advocates change their buying behavior if they knew a Toyota Avalon might be more American than a Ford Explorer? Moving from the showroom to the local mall, Assistant Professor Cristel Russell examines whether country of origin bias affects consumer shopping decisions on smaller items. She considers if a brand can really outweigh the cultural or political biases between countries that impact consumer behavior. Professor Barbara Bird focuses on a gap in the research on entrepreneur behavior, specifically in the area of sales, identifying the specific behaviors that need to be studied further. Curious as to why employees were potentially leaving money on the table by not fully exercising company stock options, Associate Professor Susan Krische discovered that a lack of knowledge and misplaced assumptions are resulting in a misunderstood and underutilized company benefit. Mutual fund investors take note: Having incentives in the wrong place can result in undesirable managerial behavior, according to Assistant Professor Phil English. Fund managers may not have your best interest or highest return in mind. We are privileged to have Gail Hillebrand, associate director of community engagement at the Consumer Financial Protection Bureau, write in this issue about how can we create a society of more educated

ARE YOU LEAVING MONEY ON THE TABLE? Stock options were once the exclusive perk of the Jack Donaghys of the world—well-coiffed executives in the top echelon of corporate America, as Alec Baldwin’s “30 Rock” character was. In the last several decades, though, Employee Stock Options (ESOs) have trickled down the ladder, bestowed on middle managers and even, in many companies, rank-and-file employees. 1. Some decide the option is worth nothing until its vesting date, so they value it at zero, underestimating the value of the option.

ARTICLE BY AMY BURROUGHS

2. Other employees decide the option is worth its current price on the market. This group overlooks, however, that they will have to pay the exercise price for the option—which means they value the option too highly. “Both groups are focused on the here and now, and I would say under-appreciate the possibility of what will happen in the future as the options continue to be available to them,” Krische said. Finally, more savvy employees may calculate the option’s intrinsic value as the stock price minus the exercise price. But again, they’ve left out something important: time. The stock price will fluctuate between today, when the employees evaluate it, and the last day that they could exercise the option. The value could rise above the exercise price, staying “in the money,” or it could fall below the exercise price, becoming “underwater.” Both have implications for the value that the employee is able to capture from the option. According to Krische, the general recommendation is to hold onto options until the last possible date before they expire. If the option is in the money, exercise it; if not, let it go. Instead, many employees exercise their options as soon as they vest. Surprisingly, others simply let their options expire—even when they are in the money. “There’s a lot of misunderstanding,” Krische said. “And often, employees are inadvertently leaving money on the table.”

KOGOD NOW SPRING 2013 | kogodnow.com

Stock options, which allow employees to purchase company stock for an exercise price, can be a great reward for a job well done. The employer’s goal is to generate a personal, long-term investment and sense of ownership in valuable staff. But for many employees, ESOs are a confusing benefit whose value is hard to ascertain. About 10 million employees held stock options as of 2010, according to the nonprofit National Center for Employee Ownership. Yet many employees undervalue their ESOs—and therefore fail to take full advantage of them, according to Associate Professor Susan Krische. She uses behavioral research methods to investigate how people evaluate, and use, financial information. “Unless you’ve already been trained in how to think about stock options, they’re complicated animals,” Krische said. “We found that people tend to revert to fairly simple rules of thumb in evaluating employee stock options.” These mental shortcuts, or “anchors,” simplify employees’ decision making on whether or not to exercise stock options and attempts to gauge their worth. The problem, said Krische, is that employees often oversimplify, failing to consider the time element of ESOs that ultimately impacts their value. The time factor means, for instance, that the stock has one value today, but another on the day it vests— that is, when the employee is allowed to exercise the option, and potentially different values as time goes on—until the day that the options expire. When employees discount time value, they overlook the full range of valuation possibilities. Employees often take one of three simplified approaches to evaluating ESOs, Krische said.

“THE GREATER THE VALUE AN EMPLOYEE PLACES ON THE STOCK OPTION, THE MORE LIKELY THE COMPANY REALIZES INCENTIVE BENEFITS.” SUSAN KRISCHE, ASSOCIATE PROFESSOR

TIME-VALUE TRAINING To find out how real-world employees value their ESOs, Krische and her coauthors, Anne Farrell of Miami University and Karen Sedatole of Michigan State University, obtained data from Net Worth Strategies, Inc., an Oregon-based firm that provides equity compensation decision support. They analyzed subjective ESO valuations from 210 employees of five companies who had received stock options and participated in ESO training programs. The employees took surveys about their assessment of ESOs’ value and their perception of incentive effects. Then they participated in a training session, which included the concepts of option valuation based on the Black-Scholes model. Specifically, the employees learned to incorporate options’ time value—for example, an option that is underwater today still holds potential value because it could become “in the money” before it expires. Employees received two kinds of training, Krische said: 1. Outcome feedback, or numerical estimates of ESO value, and 2. Cognitive feedback, or information about the factors that help determine ESO value. In other words, they learned both a calculated outcome and a way to think through the valuation process themselves. After the employees completed their training, they took the survey again. The researchers recorded a drop in the number of employees who relied on the three simplistic

“anchors” to determine ESO value: from 30 percent to 23 percent. What’s more, when employees re-evaluated their ESOs after training, 71 percent increased their valuations. The employees also affirmed that ESOs do indeed carry motivational and loyalty-inspiring benefits—a belief that further increased after training. To the researchers, that supported the relationship between employees’ valuation of stock options, their perception of benefits, and the payoff accrued to the company: “The greater the value an employee places on the stock option, the more likely the company realizes the ESO incentive benefits it desires.” The researchers continued their analysis with an experiment involving 196 students in master’s degree business programs. These participants valued a hypothetical ESO grant, underwent a training session including either outcome feedback or cognitive feedback (or both), and then revalued that grant along with two other cases. Again, results showed that training in valuation techniques led to a more sophisticated analysis. Before training, 46.9 percent of participants used one of the three simplistic methods. After training, only 19 percent to 30 percent did so. Unlike participants who relied on simple anchors to value the ESO, those who used more sophisticated techniques incorporated a time-value factor, such as stock price volatility over time, or the fact that time remained before the options expired and thus their value could increase. In this experiment, a key finding related to whether participants received outcome feedback or cognitive feedback training. Krische found that outcome feedback increased students’ valuations of ESOs, but cognitive feedback had more lasting effects. For companies, this sheds light on how to help employees: “Cognitive feedback that provides participants with a better conceptual understanding about how the time value of money affects stock option value could be more effective in the longer term than training that merely provides numerical outcome feedback.”

Krische pointed out that this also could assuage companies’ concerns about getting too specific in discussions of ESO value. Instead, the research suggests, employees can develop more sophisticated valuations when they are shown how to think through the process; they may not be executing the BlackScholes model, but they are much better off than when grappling with their own rough anchors. Knowing that individuals revert to simplistic problem-solving aids when confronted with decisionmaking challenges, the trick is to arm them with useful tools, Krische said. “On average, simple rules of thumb work well enough,” she acknowledged. “It’s just that ‘well enough’ in some circumstances isn’t well enough after all. There are circumstances where greater understanding and a more reasoned approach to analysis can lead you to a better outcome.”

Anne Farrell, Susan Krische, Karen Sedatole. "Employees' Subjective Valuations of Their Stock Options: Evidence on the Distribution of Valuations and the Use of Simple Anchors." Contemporary Accounting Research (2011).

KOGOD NOW SPRING 2013 | kogodnow.com

AIN’T GOT NO EDUCATION Fixing the problem might seem simple: companies could provide guidance to employees in valuating ESOs. But research has suggested that liability concerns make employers leery of being held to a stock value projection that might fail to materialize. As a consequence, companies may leave employees to sort things out for themselves. Yet companies do have an interest in how employees perceive and value ESOs, so it behooves them to find a way to boost employees’ valuation skills. After all, a major purpose of ESOs is to incentivize, which only works if employees appreciate the options’ potential value. Krische recommended that companies could nevertheless educate employees about time—the valuation piece most individuals overlook. Because ESOs represent a future value—that is, the option to purchase a share of stock at some later point—researchers have debated for years how to value them, just as standard setters have debated whether and how to record these transactions in companies’ financial statements, she explained. A common valuation method has been the Black-Scholes option-pricing model, a mathematical formula originally devised for market-traded options. And there’s the rub, according to Krische: ESOs differ from market-traded options, so some have argued that while Black-Scholes may be widely used, it’s not an exact fit. For one thing, employees typically have five to 10 years to exercise ESOs. There is a vesting period, which prevents employees from exercising options until a certain time has passed. Finally, ESOs may carry trading restrictions. These factors made Krische curious about employees’ thought process when it came to valuing their ESOS. If employees better understood the fundamentals of valuation, she wondered, would they move away from applying simple rules of thumb and toward a valuation method that approximated a Black-Scholes estimate?

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A single, crumpled bill encased in a frame: the first dollar. It’s an accomplishment so momentous for entrepreneurs that years and possibly millions of dollars later, they proudly display it. “You are not in business until you make a dollar,” said Professor Barbara Bird, an expert on entrepreneurship and leadership. “But there is not a lot researchers know about selling.” Somewhere between the image of the bootstrapping entrepreneur and the serious study of him, there is a missing link. Bird and others in her field know a bit about the way entrepreneurs think and the motivation they possess to work long hours, seek investor funding, and stay focused even after rejection. But no one knows much about what those entrepreneurs actually do to make it happen. While there is an extensive body of research surrounding entrepreneurial ventures, Bird noted that it tends to focus on everything except the specific actions that entrepreneurs take to get their business off the ground. Bird points to research that explores what entrepreneurs think, research that tells us how they behave once they are in a more established business, and research that shows how investors approach entrepreneurs. “I have come to realize that entrepreneur behavior is really underrepresented,” said Bird, who has been mining the topic for more than two decades, ever since she wrote her doctoral dissertation on entrepreneurs’ intentions. That’s why she is currently leading efforts to find common terms and measures for entrepreneurial behavior. “What I want to know,” says Bird, “is how entrepreneurs got their first sale.”

BEYOND JEFF BEZOS But why—in a culture seemingly full of admiration for entrepreneurs—is there so little knowledge about the way they work to build a business? Bird and other academics who study the topic say it comes down to a couple of key, interrelated problems: The difficulty in obtaining good data. Research is only as good as the underlying data, but researchers have historically struggled to locate a large enough pool of entrepreneurs to constitute a representative sample. “In early research into entrepreneurship, we took what we could get,” said Kelly Shaver, professor at the College of Charleston, who, like Bird, served as chair of the entrepreneurship division of the Academy of Management. Shaver said that researchers often would find entrepreneurs from tax records or member lists from groups such as the Better Business Bureau,

ARTICLE BY ANDREA ORR

THE FIRST DOLLAR IS THE HARDEST Much of Bird’s research surveys the state of knowledge about entrepreneurs and highlights what is missing from it—something she has referred to as the “inattention to the concept of behavioral repertoire.” She calls for greater research into what exactly early-stage entrepreneurs do to sell their product or service. “If we can agree on some basic behaviors and find common, reliable, and valid measures, we could build

a theory of entrepreneurs’ behavior—when are certain behaviors more useful and effective in key outcomes such as gaining funding, gaining sales, hiring talent, survival, and when do they matter less,” Bird argues in her forthcoming paper, which will be published as a chapter in the Handbook of Entrepreneurial Cognition. “Professor Bird is, hands down, one of the most influential people driving attention to entrepreneur behavior,” said Leon Schjoedt, Associate Professor at Indiana University South Bend's Judd Leighton School of Business and Economics. Schjoedt, who worked with Bird to co-edit the Fall 2012 issue of the journal Entrepreneurship Theory and Practice, says that understanding more about the behavior and decision-making processes of entrepreneurs would serve students who hope to one day start a business, and would also drive economic benefits. In a healthy economy, he noted, new businesses create more new jobs than are lost in established businesses, and also serve consumers by filling gaps in markets and driving innovation.

KOGOD NOW SPRING 2013 | kogodnow.com

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THE MYSTERIOUS FIRST SALE

EXAMPLE ENTREPRENEURIAL BEHAVIORS TO BE STUDIED

“THERE ARE A LOT OF ENTREPRENEURS WITH GOOD IDEAS BUT BAD EXECUTION.” JEFFREY POLLACK, ASSISTANT PROFESSOR UNIVERSITY OF RICHMOND

Barbara Bird and Leon Schjoedt,"Entrepreneurial behavior: Its nature, scope, recent research, and agenda for future research" Understanding the Entrepreneurial Mind (A. L. Carsrud & M. Brannback, Eds.) (2009). J. Robert Baum, Barbara Bird, and Leon Schjoedt, Eds., Entrepreneurship Theory and Practice (September 2012). Barbara Bird, "Fast Forward: State of Entrepreneurial Behavior" Handbook of Entrepreneurial Cognition (Rob Mitchell, Ron Mitchell, & Brandon Randolph-Seng, Eds.) (forthcoming).

Creating a team

Finding competitive intelligence and using it to identify a sustainable competitive niche

Defining what is faster, cheaper, or better about the idea

Contacting potential first customers

Communicating the idea appropriately to the many potential stakeholders

Developing prototypes and testing them

Finding the right location (if needed) and negotiating a lease

"Bootstrapping” financial and other critical resources

Using speed to market only when it makes sense

NO EASY ANSWER One of the most reliable ways to extract a research sample of entrepreneurs from the general population is a process known as “random dialing,” in which the researcher contacts large numbers of households by phone (or some other means), in the same fashion that large national surveys such as the Labor Depart-

ment’s monthly employment surveys are conducted. The researcher asks if the participant is in the process of starting a business, and then proceeds with a series of yes or no questions. The researcher eventually collects a set of data that can compare entrepreneur behavior to that of the general population, but the process is time consuming and costly. Bird believes there is great merit in this sort of research, but that it tends to yield surface data rather than deeper insights. Another option, she said, is observational research, which is, like it sounds, based on observing individual entrepreneurs rather than asking them questions. As with random dialing, the process is time consuming. “The researcher pays a price for rich observation,” said Bird. “Two or three years of observation might produce enough data for a single article.” One possible hybrid of these two methods, she suggested, would be a beeper or cell phone “ping”type method, where nascent entrepreneurs agree to be interrupted at random times during the day to report on their action. Although most of the methods she thinks have merit take time and are expensive, Bird said that this sort of exhaustive research is the only way to advance the study of entrepreneurship and fill in the gaps. “If you want to be an entrepreneur, it’s important to know yourself—your skills, your willingness to persist, fail, and try again. You need to ‘know the territory’ and your audience as you pitch your idea and build a team and gather resources. You need to know when to act and when to restrain action.”

KOGOD NOW SPRING 2013 | kogodnow.com

but such an approach did not tend to produce a representative sample, nor did it provide a control group. As a result, even academic papers on the topic are likely to include a lot of “conceptualization” in the absence of hard data. And measuring behavior in particular is hard, Bird explained, noting that one common form of research based on surveying individuals often has issues with validity, and observation-based forms of research are time consuming. The persistence of stereotypes. The romanticized stereotype of the startup that was built with an idea and a lot of sweat is so pervasive that it may influence students, researchers, and entrepreneurs themselves. The popularity of this not entirely accurate story may be due in part to the lack of good data on entrepreneur behavior. But students who accept the stereotype may mistakenly see the process of building a business as simply creating a product when, in reality, it is a set of activities. According to Bird, the persistence of such stereotypes poses a problem with surveying entrepreneurs. “They will tell you what sounds good, rather than what is true,” she explained. Biases are also prevalent in the classroom, where many teachers have found that students, asked to name an entrepreneur, are more likely to name the late Steve Jobs—who at the time of his death oversaw one of the world’s largest companies—than someone who more recently had success starting a company. Although the information technology sector has indeed produced many successful entrepreneurs, high-tech startups are only a small portion of new businesses. Each year about 600,000 new businesses are started in the United States, and most of them are not in the high-tech sector, said Schjoedt.

FROM IDEA TO ACTION Bird and other researchers hope that if they can push past the stereotypes with sound data, they can help arm would-be entrepreneurs with better information. There may not be a single formula for success, but they say there is clearly room to bring down the high failure rate among entrepreneurs. “There are a lot of entrepreneurs with good ideas but bad execution,” said Jeffrey Pollack, assistant professor at the University of Richmond’s Robins School of Management. “Entrepreneurs are often so focused on getting the resources for their venture that they fail to take a step back and think about what they are doing in a systematic way.” Pollack said that Bird’s research has helped to “focus the field of entrepreneurship in a different direction” based on better data collection and concrete observation. While every business student stands to benefit from better information about best practices, Bird maintains that this information is especially critical in the startup venture, where behavior probably plays a more crucial role than in larger businesses with established practices in place. Some of the entrepreneur behaviors she believes warrant closer study include the time the entrepreneur spends developing contacts, the way entrepreneurs communicate with customers, the way they display emotion, whether and how they improvise, and how they approach investors. A core question she keeps returning to relates to that first dollar and what she calls “the behavior of selling.” In addition to identifying the right questions, Bird said that researchers have a few options in collecting accurate data. They can base their research on surveys of the entrepreneur, but take steps to control for biases and ensure that they have a representative sample.

WHY THE MARKET DOESN’T LIKE CHANGE Much like the surprised parents’ reply to the swift engagement of their honor student to an ex-convict, the stock market has a negative reaction when a company with a stellar financial track record announces a merger or acquisition. ARTICLE BY JACKIE SAUTER

What drives the negative perception of these announcements—and what can be done about it? Enter H. Kent Baker, university professor of finance, who has spent his distinguished 40-plus-year career studying corporate finance and financial markets. With coauthors Shantanu Dutta (University of Ontario Institute of Technology), Samir Saadi (Queen’s University), and PengCheng Zhu (University of the Pacific), Baker set out to examine the relationship between “wellperforming” acquirers and M&A announcements. The researchers formulated three theories for the market reaction:

• Empire Building—This thread essentially says that people who have been successful in the past are driven to continue to build their empires.

1. The firm had superior operating behavior in the past, 2. The firm subsequently took over the new company, and 3. The performance declined. Earlier studies did not examine long-term performance post-acquisition. “So good performers turn out to be bad acquirers,” Baker said. “And one of the reasons is because they’re doing this for an empire-building motive that we document through our statistics.” Such empire-building strategies damage shareholder value by diminishing future operational efficiencies. One factor moderated the negative market reaction: the presence of “insiders” on the acquiring

H. Kent Baker, Shantanu Dutta, Samir Saadi, PengCheng Zhu. “Are good performers bad acquirers?” Financial Management (2012).

• CEO Overconfidence—This hypothesis gives a nod to behavioral finance, which is one of Baker’s areas of expertise. The idea: people with a good track record develop an inflated ego and need to acquire additional firms. To return to the sports analogy, a football coach decides to acquire and manage a baseball team.

WORTHY DOMAIN The verdict was in: empire-building was the market’s shortterm concern. But what about long-term performance? The researchers turned their attention to companies’ subsequent financial records, and discovered that performance dropped significantly for the acquiring firms over the next decade. In fact, again and again, the story went like this:

firm’s board of directors. Of course, there’s a catch; the insiders only mitigate the reaction if the board has to approve the M&A decision. “The board of directors has a strong impact… because of course they approve these deals,” Baker explained. “So, let’s examine the board.” The market’s sentiment appeared to consider the fact that insider directors have more day-to-day involvement in the acquiring firm, and thus bring more weight to an M&A decision. However, you likely don’t want a board composed entirely of insiders. “As they say in the South, it’s like having a fox guard the henhouse,” Baker said. Still, contrary to what many corporate governance scholars would argue, the researchers concluded with statistical significance that a “non-independent board could bring more strategic insights and affect financial outcome more positively.” Their data supports the unexpected argument that board independence could harm financial performance. The award-winning study, published in Financial Management, took several years and multiple revisions to complete—like some mergers. “As with much empirical research, this study was a very laborintensive activity,” Baker said.

KOGOD NOW SPRING 2013 | kogodnow.com

• Managerial Ability—The straightforward theory that excellent managers have previously generated excellent performance. To use a sports example: in football, a good head coach who takes over another football team is expected to perform well.

If the market responded positively to news of one company taking over another, the authors reasoned, that would provide support for the managerial ability hypothesis. On the other hand, if the market perceived that what the company was doing through the M&A was building an empire—or if it felt that the CEO was overconfident—that may explain a negative market reaction. To test their hypotheses, they used a sample of Canadian firms listed on the Toronto Stock Exchange (TSX) that had acquired other firms, both private and public, from 1993 to 2003. The third-largest stock exchange in North America, TSX is seventh-largest in the world by market capitalization. After controlling for a set of traditional M&A variables, the researchers found that the acquiring firm’s CFTA—cash flow to total assets, adjusted for industry—“significantly and negatively affects cumulative abnormal returns around the announcement dates.” In other words, the managerial ability hypothesis was the first to go. This suggested that empire building, CEO overconfidence, or both could explain the phenomenon. To disentangle the two, they introduced a “mediabased” CEO overconfidence variable. Using news media coverage, they catalogued comments about the M&A announcements—words such as “frugal,” “steady,” or “not confident”—and related the overall results to coverage from the previous year.

“Our results show that basically what is driving this situation—how the market reacts to M&As with past superior operating performance—is not the managerial ability, or overconfidence, but the empirebuilding approach,” the authors noted. The Canadian market experienced a boom in M&A activity during the 1990s and a crisis in 2000, followed by a decline in M&As. “Including both preand post-crisis data enables us to check the robustness of the results,” the researchers concluded.

HOW MUTUAL FUND FEES DRIVE MANAGERS’ DECISIONS ARTICLE BY DANIELLE MARKS

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Investors looking to put money into mutual funds would do well to zero in on funds with low management fees.

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It’s a concept that doesn’t make much sense to English. Existing shareholders are required to pay fees so as to convince other investors to buy shares in the fund—but all of the benefits go to the fund manager. “It’s a mutual fund,” English said. “The performance of it should be testimony to whether they want to buy into that fund.” The use of 12b-1 fees had long been prohibited, but in the early 1980s, the US Securities and Exchange Commission lifted a ban on fund managers using the assets of the fund to pay for fund distribution expenses. English’s research indicated that 12b-1 fees also play into exit timing, particularly when managers delay in merging the funds so that they can hold onto the fees. Across all funds, the researchers found a pecking order for mutual fund exit mode and timing, where in-family mergers are favored over betweenfamily mergers or liquidation, and funds with higher fees will be exited at a delay. The same can be said for funds with high 12b-1 fees. By making these decisions, English said, fund managers are not doing anything wrong. They are just making sure that their businesses serve them well. “Ultimately the question everyone has is: Are managers taking advantage of shareholders? It’s going to be impossible to ever know,” he said. “We’re not saying that managers are setting out to intentionally hurt their investors,” English said. “The managers are running a publicly traded business, and they are in essence saying if the shareholder doesn’t like what we’re doing, they’ll take their money and go somewhere else.”

“Mutual Fund Exit and Mutual Fund Fees” was published in the Journal of Law and Economics in 2010.

English noted. “For shareholders, funds perform poorly when they aren’t providing a return great enough to justify the risk or beat another comparison fund.” While the manager has a fiduciary duty to ensure best service for the fund shareholders, he is also running a business that needs to profit to survive. They further determined that fund managers influence the method and timing of a fund exit with higher fees to retain the fee income by merging the fund with in-family mergers—merging into funds that are run by the same investment management company—rather than between-family mergers to funds handled by other companies. When a between-family merger does become necessary on higher-fee funds, fund managers will delay for as long as possible in order to retain the income. Likewise, they will delay liquidating a fund with high fees for the same reason. Mutual funds are often considered relatively safe, low-maintenance ways for consumers to invest money. The research “reaffirms the message that low-fee funds should represent the first line of selection for those interested in mutual funds as investments,” English said. “It also draws into light the possibility that boards of directors don’t actively police the managers of funds as closely as they should, particularly those funds with high fees. We are continuing research along this line and hope to shed some light on this in the near future.” The group began studying mutual funds because Dukes had a strong disdain for 12b-1 fees, a special set of fees attached only to mutual funds that charge current shareholders in order to defray the expense of marketing and distributing shares of the fund to new shareholders.

KOGOD NOW SPRING 2013 | kogodnow.com

APR

The obvious reason is that lower fees mean more cash lining their pockets, but higher fees also often influence how long a fund manager might hold onto a failing fund. That’s because mutual funds are run like businesses, according to research done by Assistant Professor Philip English, a Chartered Financial Analyst® who studies investments, mutual funds, and corporate governance. “We anticipated, both from my own industry experience and from conversations with mutual fund managers, that they would run the fund like a business. If it was making a sufficient profit, they would continue running it; if it wasn’t, they’d either “sell” it [taking the form of a merger] or shut it down,” he said. English completed his research with Professor William P. Dukes of Texas Tech University and Ilhan Demiralp, now a professor at the University of Oklahoma. English and his colleagues studied the effect of mutual fund fee structure on the timing of exits by managers. They define an exit or failure as mutual fund shares transformed into shares of another mutual fund or cashed out through any method other than voluntary shareholder redemption (which occurs when shareholders “vote with their feet”). The professors’ research is innovative because even though a lot of studies have been done on mutual funds, prior research has typically concluded that fund failure is associated with poor performance. This research indicates that low revenue for managers is potentially the culprit for a failed fund. Whether performance is poor also depends, in part, on whose viewpoint is considered. “For managers, funds perform poorly when they’re not making enough to cover the costs of running the fund and a profit,”

Y R T N U O C ORIGIN

UNITED STATES 5 FACTORIES

MEXICO 12 FACTORIES

BULGARIA 1 FACTORY

BRAZIL 20 FACTORIES

GLOBAL R E TA I L

In Henry Ford’s day, consumers knew exactly where their cars came from. Ford made everything under one roof, processing steel and splitting lumber for wheel spokes at the massive River Rouge plant in Dearborn, Michigan. But that level of manufacturing purity hasn’t been the case for a long time. INDIA 10 FACTORIES

CHINA 73 FACTORIES

TAIWAN 5 FACTORIES

VIETNAM 12 FACTORIES

MALAYSIA 4 FACTORIES

ABOVE: FACTORIES WHERE CONVERSE SHOES ARE MANUFACTURED

In this age of globalization, suppliers can be anywhere. Beginning in the 1960s, auto manufacturers stopped making everything themselves in favor of farming out parts production to lower-cost suppliers. Ford and GM pioneered the process, and it picked up speed over the next few decades.

MAXIMA

RESEARCH & DEVELOPMENT PERFORMED IN MICHIGAN, THE UNITED KINGDOM, AND CHINA

TRANSMISSION MADE IN MEXICO

NO. 101 MOST AMERICAN MADE VEHICLE ON DUBOIS'S 2013 INDEX

PROFIT MARGIN HEADQUARTERED IN JAPAN INVENTORY, CAPITAL, OTHER EXPENSES ASSEMBLED IN THE US ENGINE MADE IN JAPAN

BODY, INTERIOR, CHASSIS, ELECTRICAL, OTHER 25% US

But the AALA data are critically flawed and easily manipulated, according to DuBois. He has created a new index that he believes more accurately reflects vehicles’ country of origin, including several factors not addressed by the AALA. For consumers who insist on buying American, DuBois’s index enables them to make a more informed decision. Compared to the AALA index, he said, it “gives consumers more knowledge, and knowledge is power.” DuBois argues that his index provides a more accurate assessment of a vehicle’s true country of origin: “All that automakers are required to do is abide by the terms of the AALA, and I would argue the AALA is a flawed measure.” MADE IN AMERICA? In smaller industries—apparel, furniture, foodstuffs— the country classification is often simple. But with automobiles, it’s a very different story. DuBois first learned about country-of-origin issues in the early 1970s, as a Volkswagen mechanic in Virginia Beach. The shop did a brisk business replacing mufflers; the parts came from Germany and popped easily onto the cars. But when the shop began sourcing mufflers from Brazil, it took a lot more work to wrestle them onto the VWs. That’s when DuBois became aware of the increasing globalization of manufacturing.

To DuBois, American-made is not a term that can be applied wholesale; instead, it reflects a percentage of content. While purists may shudder at the globalized economy, pure American-ness is no longer realistic, he said. “We’re not at the point where everything can be American-made anymore.” The impetus for DuBois’s research was a conversation with an alumnus, Robert Engel, BS '82/MA '04, who serves at the American Automotive Policy Council (AAPC). Using data from the AALA, automakers’ annual reports, and Form 10-K filings to the US Securities and Exchange Commission, DuBois’s index ranks 253 models based on: • where the manufacturer’s headquarters is located; • where most research and development (R&D) occurs; • where assembly occurs; • where the engine and transmission come from; and • the AALA score. Each category is scored higher for US-based parts and operations. For example, a car gets a 6 if its R&D is domestic, a 3 if R&D is foreign but the car is assembled in the US, and a 1 if R&D is foreign and the vehicle is imported. Scores are summed for a possible total of 100.

FOR THE CONSUMER WHO SIMPLY WANTS TO KNOW “WAS THIS CAR MADE IN AMERICA, OR NOT?” A CLEAR ANSWER IS ALMOST IMPOSSIBLE. According to his analysis, a GM, Ford, or Chrysler vehicle designed and sourced in the US but assembled outside the US scores higher than a vehicle assembled in the US using a foreign engine and transmission by a foreign automaker. He anticipates the index will draw criticism from manufacturers. His response? “Show me something better.” BORN IN THE USA Even the most homegrown manufacturers are now global corporations. DuBois noted that of Ford’s 56 research centers, 45 are in the United States—which means 11 are elsewhere. On the other hand, four out of every 10 Ford workers are based in the US, while Toyota has just one out of 10. BMW operates one of the largest manufacturing plants in the US: about 7,000 workers staff its Greer, South Carolina, plant. Yet most of the content used to assemble the BMWs comes from overseas, and about 70 percent of the cars go back there, according to DuBois.

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Now, break down a single “American-made” transmission and you’ll find many smaller parts, each stamped with its own country of origin.”You may well find 80 percent of the parts inside that transmission didn’t come from the US,” said Frank DuBois, associate professor of international business. “You start disaggregating vehicles, and you’ve got thousands of primary and secondary suppliers that have some hand in creating those parts.” For the consumer who simply wants to know, “Was this car made in America or not?” a clear answer is almost impossible. In 2013, when Toyota is newly sponsoring NASCAR, Chrysler has a plant in Canada, and BMW employs thousands of South Carolinians, what does it mean to be American-made? An expert on global supply chains and a car buff, DuBois saw that this fundamental shift in manufacturing had not been reflected accurately in existing measurements. He turned his attention to the American Automotive Labeling Act (AALA), which purports to inform consumers about the “American-ness” of the vehicles they buy. Since 1994, the regulation has stipulated that vehicles must carry labels stating what percentage of their parts came from the US or Canada, and which countries contributed at least 15 percent of the content. Also listed are the country of assembly and where the engine and transmission were made.

COVER STORY COUNTRY OF ORIGIN COST ALLOCATION For each $1 spent on a car INVENTORY, CAPITAL, AND OTHER

PROFIT MARGIN

6.5%

BODY

11%

INTERIOR

14% CHASSIS

6.5%

ENGINE

VEHICLE

MAKE/MODEL

R&D

TRANSMISSION

This table demonstrates how six different models are scored in DuBois’s 2013 index, based on where the automaker HQ is located, where the car is assembled, where its transmission and engine are assembled, and its NHTSA AALA “domestic content” score.

GMC

HONDA

CHRYSLER NISSAN

BMW

TOYOTA

ACADIA

ODYSSEY

GRAND CARAVAN

LEXUS ES

MAXIMA

COUNTRY OF ASSEMBLY

USA USA CANADA USA USA JAPAN

AALA%

0.77 0.75 0.80 0.50 0.20 0.00

PROFIT MARGIN: 6%

6 0 6 0 0 0

6 IF US COMPANY; 0 IF FOREIGN

LABOR: 6%

6 6 0 6 6 0

ASSEMBLY

6 IF ASSEMBLED IN US; 0 IF FOREIGN

R&D: 6%

6 3 6 3 3 1

6 IF US COMPANY; 3 IF FOREIGN AND ASSEMBLED IN US; 1 IF FOREIGN AND IMPORTED

INVENTORY, CAPITAL, AND OTHER EXPENSES: 11%

11 11 0 11 11 0

11 IF ASSEMBLED IN US; 0 IF ASSEMBLED OUTSIDE US

PARTS & MATERIALS

ENGINE: 14%

14 14 14 0 0 0

14 IF US PRODUCED; 0 IF NOT

TRANSMISSION

7 7 7 0 0 0

2013 AALA% DIVIDED BY 2

BODY, INTERIOR, CHASSIS, ELECTRICAL, AND OTHER: 50%

38.5% 37.5% 40% 25% 10% 0%

2013 AALA% DIVIDED BY 2

TOTAL DOMESTIC CONTENT: 100% SUM OF ALL SCORES

88.5% 78.5% 73% 45% 30% 1%

TOTALED BEYOND REPAIR? In theory, transparency of manufacturing was what the AALA was intended to address when it was created almost two decades ago. But its numbers were tangled from the start.

CAR-BY-CAR ANALYSIS: SIX EXAMPLES

ELECTRICAL, ELECTRONICS, AND OTHER

28%

LABOR

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Given these complexities, what makes a car American-made depends on whom you ask. In the 2012 Cars.com American-Made Index, the top-ranking vehicle isn’t a Ford, Chevrolet, or GM—it’s the Toyota Camry, made in Kentucky with an American engine and transmission. In DuBois’s 2013 index, by contrast, the Camry is in a six-way tie for 12th, with a score of 78.5. According to his analysis, the most American car is a three-way tie between the GM Acadia, Enclave, and Traverse, all with a total score of 88.5. Although non-US vehicles may rank higher in terms of the country of origin of parts and components, the fact that GM does most of its research and development in the US, and is headquartered there, moves it to the top of his ranking. DuBois argues that an index of this sort must account for the country of origin of the manufacturer and the location of R&D operations. Some Japanese models do rank higher than domestic models, but only 17 of the top 65 vehicles on his index are from foreign manufacturers. However, none of the Big Three gets a perfect 100 on DuBois’s index. When scores are averaged, GM is in the high 70s, followed by Chrysler and Ford. Still, their averages are significantly higher than Honda, Toyota, and other foreign manufacturers. The data also vary depending on whether you are looking for a sedan, a pickup, or a minivan. The sedan shopper who insists on buying American may be surprised to learn that the Ford Fusion and Chrysler 300 rank lower on DuBois’s index than several Japanese models. Pickups, on the other hand, consistently rank as full-blooded—well, mostly—American. And if you’re in the market for a minivan, the highest-ranking models are from Honda and Toyota.

For one thing, AALA reports do not distinguish between US and Canadian parts. As DuBois pointed out, Windsor, Ontario, is just five miles from Detroit across the US-Canada border. That proximity, combined with an exchange rate advantage, once prompted many domestic manufacturers to set up plants in Canada. But that’s just one problem with the numbers. DuBois sees many more, starting with the fact that automakers report their own data: there are no auditors, no third-party verification. That means manufacturers can massage their reports in any number of ways. For example, automakers submit one report for each model—say, the Honda Civic—without accounting for differences among the Civic Coupe, Civic Sedan, Civic Si Sedan, and so on. The most dramatic opportunity to fudge the numbers lies in the part of the legislation that says if manufacturers have at least 70 percent domestic content, they can round up to 100 percent. That means engineers can assemble a car with almost one-third of its parts from another country and tout it as fully American-made. DuBois’s index addresses those weaknesses by broadening the factors used to determine country of origin. Beyond physical parts, other factors—such as R&D, corporate overhead, and assembly—often represent money flowing to the country where the automaker is headquartered. “They want to be a global enterprise with a strong local presence, but where the rubber meets the road, where do the profits go? The profits go, more often than not, back to the home country of the manufacturer,” DuBois said. An accurate assessment is crucial because auto manufacturing remains a critical sector of the US economy, in both job creation and the economic multiplier effect. An estimated 14 million new cars and trucks were sold in the US last year, each costing an average of $30,303, according to Forbes. Accuracy also matters because post-recession consumers pay more attention to where cars come from. And automakers are responding with investments in “Made in America” advertising. But, as with most advertising, the devil is in the details. DuBois pointed to Volkswagen, which heavily promoted its new plant in Chattanooga, Tennessee, even building a $40 million visitor center, according to Motor Authority. Yet only one of VW’s 21 models, the Passat, is assembled in the US, compared with 29 of 34 GM models.

TOTAL

ENGINEERS CAN ASSEMBLE A CAR WITH ALMOST ONE-THIRD OF ITS PARTS FROM ANOTHER COUNTRY AND TOUT IT AS FULLY AMERICAN-MADE.

SOME BRANDS HAVE THE POWER TO RISE ABOVE POLITICS. “FOR THOSE BRANDS, BEING POSITIONED IN AMERICA HAS WORKED IN THEIR FAVOR BECAUSE THEY ARE ABLE TO CAPITALIZE ON GOOD ASSOCIATIONS.” CRISTEL RUSSELL, ASSISTANT PROFESSOR

around. One strategy is to employ counter-stereotypic association training, or playing against type. For example, a prevalent stereotype of the US is “everything is big and plenty,” Russell said. A branding strategy to counteract this impression would play up features people do not associate with that image. First, however, companies must understand how strongly consumers view their products as American. BUYER BIAS Working with Dale Russell, a researcher at the Uniformed Services University, Assistant Professor Russell set out to test whether the strength of a brand-country association influenced the relationship between consumers’ animosity toward a country and their attitudes toward certain brands. In other words, if a consumer strongly associates McDonald’s with the US and has anti-American feelings, is that person less likely to patronize McDonald’s than an anti-American consumer who only loosely associates McDonald’s with the US? First, the researchers measured the strength of country associations for several brands. Then they used different advertising images to manipulate those associations and measure whether consumers’ attitudes were affected. Previous research had confirmed that animosity toward a country affects consumers’ willingness to buy its products. Researchers also know these attitudes are powerful even when inaccurate; in one study, participants incorrectly identified the country of origin for one-third of 84 brands. They surveyed 731 university students in France. The country was chosen in part because among US allies, France’s anti-Americanism is most pronounced. The researchers were also intimately familiar with the ins and outs of Franco-American relations, as Cristel is French and Dale an American. The French present an interesting case of ambivalence because their feelings toward America are

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CONSUMER-DRIVEN While American and foreign automakers play up “Made in America,” that may not be the best strategy for companies targeting consumers overseas. While DuBois’s work speaks to consumers who want American-made products, the research of Assistant Professor Cristel Russell touches the other side of the coin: international consumers whose anti-American views lead them to spurn products with strong American branding. Russell’s work has serious implications for how companies should promote products in international markets. Those exports, by the way, totaled $2.1 trillion in 2011, according to the US State Department. Russell found that, for individuals with a negative attitude toward the US, the more strongly they associate a brand with America the more deeply they will be prejudiced against those products. The catch? Most people’s views are not blackand-white. According to Russell, numerous factors influence attitudes about distant nations. Historical relationships and media coverage play a role. The biggies—war, the economy, environmental crises—all shape the way we view other nations. At the micro level, someone who has visited America will likely have a different impression than someone with only secondhand knowledge. Some brands have the power to rise above politics. Levi’s jeans, for example, are widely viewed as authentically American, Russell said: “For those brands, being positioned in America has worked in their favor because they are able to capitalize on good associations.” Companies pay attention to such things because, ultimately, humans are malleable. “We’re very easily manipulated…which is why marketers have a job,” Russell said. “They’ve figured out they can shift people’s views.” Yet anti-American feelings, where they exist, are deeply anchored. When such views are entrenched, even clever marketers have a tough time turning them

COVER STORY COUNTRY OF ORIGIN

SACRÉ BLEU, CRÈME DE LA CRÈME, OOH, LÀ LÀ!

CONSUMERS WHO HARBOR BOTH POSITIVE AND NEGATIVE VIEWS OF A COUNTRY ARE LESS WILLING TO PURCHASE EMBLEMATIC BRANDS FROM THAT COUNTRY.

association with the US, with one interesting exception: Levi’s, thanks to its perceived authenticity. The more consumers think of these brands as American, the researchers found, the more negative they feel toward them.

events, Russell said, but “once you scratched the surface, a lot of them were talking about rock and roll and jeans and all the things they quite love about America.”That led Russell to her next project: a formal study of the effects of ambivalence. STRONG VS. WEAK The complexities of ambivalence vary, but a common stance toward America is to embrace its popular culture while rejecting its politics. When researchers detect such mixed opinions, it is “clearly a signal that what’s going on there doesn’t line up,” Russell said. She attributes the discrepancy to the fact that people are good at compartmentalizing, disentangling “I like American movies” from “I hate what the American government does.” This study, also conducted in France, was the first to measure how consumers’ ambivalence toward a country related to their willingness to buy associated brands. The researchers’ prediction? The more ambivalent people are about the US, the less willing they will be to buy American brands.

SWALLOW IT WHOLE Building on that finding, they conducted a second study of 77 French residents between the ages of 20 and 35. This time, their goal was to evaluate consumers’ responses to a fictitious new beverage, V, when it was shown in American and non-American contexts. Consumers viewed one advertisement showing the Statue of Liberty and the tagline “V is soon arriving from America.” They viewed a second advertisement creating a weak US association, with the tagline “V is soon arriving from afar” against the skyline of Melbourne. After participants viewed the ads, the researchers measured their attitudes toward V, including how American they perceived it to be. They then told the participants they could enter a lottery for free beverages

and choose from an assortment that included V and other brands. This captured whether participants’ attitudes could actually extend into a purchasing decision. The results confirmed that consumers with low animosity toward the US showed little difference in their attitudes toward V, regardless of whether it was pitched against a New York City skyline or not. But the most anti-American consumers did adjust their attitudes in response to whether V was presented as American. This finding was substantiated in participants’ choice of which beverage they would select to drink: those who felt animosity toward America and perceived V as American were less likely to choose it. “With a single picture, you can completely shift people’s perceptions and responses to brands in this case,” Russell said. “It’s fascinating to see this because there’s been lot of talk about, ‘Does this matter for brands? Should marketing managers worry about this kind of stuff?’ Clearly you see, yes, it does.” The French participants in the study elicited vocal criticisms of America when it came to current

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complex, she said. On the one hand, America came to France’s aid in World War II. The French also embrace American pop culture. On the other hand, many French view the influx of American fast-food restaurants as a threat to their traditional way of life. “That’s French culture, so at the same time that they have all this deep-felt love and respect for America’s help in the past, they find themselves always criticizing the invasion of McDonald’s and Coca-Cola and how that’s ruining culture,” Russell said. “That’s why we talk about ambivalence, because people have really mixed feelings about this.” The students answered questions measuring their attitudes about 14 brands, half of which were American. One month later, 291 of the students took a survey rating their agreement with 12 statements measuring attitudes toward America. The Russells found that four of the US brands were strongly perceived as American, four were not, and the remainder fell somewhere in the middle. Analysis showed that, indeed, consumers’ animosity toward brands was related to the strength of their

CREATING THE COVER STORY

COVER STORY COUNTRY OF ORIGIN

HOME GROWN?

USA

The researchers used in-depth interviews of French residents to come up with 20 statements capturing common beliefs about the US, and 291 university students then rated their agreement with the statements. In the next phase, the researchers chose seven US brands that were perceived as very American and seven non-US brands. Participants rated their attitudes toward the brands, along with their frequency of consumption and future purchase intent. They also completed a questionnaire designed to provide an objective assessment of their ambivalence toward the US. The researchers then paired these results to evaluate the relationship between ambivalence and brand attitudes.

They found that “consumers who harbor both positive and negative views of a country are less willing to purchase emblematic brands from that country.” Resisting the purchase, it turns out, is one way we cope with inner conflict. According to Russell, researchers know that ambivalence is uncomfortable—the more conflicted we feel toward something, the more likely we are to avoid it. For businesses, she said, that means companies should strive to reduce consumers’ ambivalence and overcome it with stronger arguments. Corporate research into overseas markets also should measure that ambivalence and the strength of brand associations.

THINK GLOBAL, ACT LOCAL As with auto manufacturing, the ever-expanding reach of global corporations has blurred the lines of what is purely American and what has taken on a life of its own, well beyond our borders. Some entrepreneurs find opportunity in anti-Americanism. When Coca-Cola struggled in the Middle East market, French businessman Tawfik Mathlouthi introduced Mecca Cola in 2003 in a bid for anti-American soda drinkers, according to a BBC report. (He also, however, played up the Coke resemblance with white letters on a red label.) Mecca Cola is now sold in many countries, from Algeria to the United Arab Emirates. Like Coca-Cola, famous brands that originated in the US are often viewed as American, regardless of how global they have become. Starbucks is for sale in 60 countries. McDonald’s burgers are in 119 countries. Consumers, however, still view them as American. In the midst of this fragmentation of ownership, campaigns like the farm-to-table movement have sprung up. Growing in popularity, the focus is on the consumption of goods grown locally, thus supporting the local economy. A dollar spent at a local business, supporters argue, translates to 45 cents reinvested locally—as compared to 15 cents of dollars spent on products made by large corporations, according to Eat Local First. Is that good for business, or bad? Just as with vehicles, it depends on whom you ask.

Academic papers that gave rise to the cover story: Frank DuBois, "Evaluating 'Made in America': A Critique of the American Automotive Labeling Act And a Proposed Alternative," accepted to the Academy of International Business Annual Meeting (July 2013). Cristel A. Russell, Dale W. Russell, and Jill Klein, “Ambivalence Toward a Country and Consumers’ Willingness to Buy Emblematic Brands: The Differential Predictive Validity of Objective and Subjective Ambivalence Measures on Behavior,” Marketing Letters (2011). Cristel A. Russell and Dale W. Russell, “Guilty by Stereotypic Association: Country Animosity and Brand Prejudice and Discrimination,” Marketing Letters (2011).

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E C I O H C P O T GRADE ADE A

FAMOUS BRANDS THAT ORIGINATED IN THE US ARE OFTEN VIEWED AS AMERICAN, REGARDLESS OF HOW GLOBAL THEY HAVE BECOME.

CC RR II SS II SS

22 00 00 88

ARTICLE BY WILLIAM H. WOODWELL JR.

If you were to compare the 2008 financial crisis to a car crash, could a strong company brand act as an airbag to soften the concussive blow?

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Assistant Professor Sanal Mazvancheryl wanted to find out. In a modern economy, where a significant portion of a company’s market value derives from intangible assets—including its brand—were companies with strong brands afforded any protection during the crisis?

WHILE OTHERS SINK, WHO RISES?

IN BRANDS WE TRUST

An overwhelming majority of US companies were negatively affected by the financial crisis, as buying slumped and value dropped sharply for physical assets such as land, buildings, and equipment. But the marketing researcher was less interested in the causes of the crisis than in its varying effects on companies. He was focused on whether a firm’s brand value related to its financial performance during the market meltdown—and how that value was calculated. “[The crisis] was a shock to the system,” Mazvancheryl said. “And while there was plenty of research on how brand value can have a positive effect on financial performance over time, no one had looked into the question of whether companies with strong brands can do better when everything’s going down the tubes.” It was an intriguing question for Mazvancheryl, who began his professional career in brand management and advertising, working on Fortune 500 accounts for large, multinational agencies. As he pursued an academic career, his research centered on how marketing actions influence firm performance.

“NO ONE HAD LOOKED INTO THE QUESTION OF WHETHER COMPANIES WITH STRONG BRANDS CAN DO BETTER WHEN EVERYTHING’S GOING DOWN THE TUBES.” SANAL MAZVANCHERYL, ASSISTANT PROFESSOR

In other words, how are a firm’s profits and stock action affected by factors such as customer satisfaction, brand equity, and brand loyalty? Researchers cannot begin to answer questions like this without reliable measures of a company’s brand attributes and strength. There are two main approaches to developing such a measure. One is to look at brand equity at the consumer level—through survey-based measures of customer loyalty and brand image, for example. A leading source of this kind of data is Harris Interactive’s EquiTrend study, which ranks brands based on an annual survey of 38,000 US consumers.

Another approach uses financial measures to determine the dollar value of a brand. The top commercial practitioner of this type of research is the London-based consulting firm Interbrand. In its latest ranking of the top 100 global brands, for example, Coca-Cola is in the No. 1 spot with an estimated brand value of nearly $78 billion. Over the years, academic researchers have used many such measures to establish various connections and positive correlations between marketing and financial indicators. But there was still no published research on how well “high-equity” brands perform in a crisis relative to their name recognition. Most people would expect that firms with higher-equity brands, like Coca-Cola, are more likely to escape the worst effects of a crisis. Among the reasons: • High-equity brands should be able to sustain a higher level of sales relative to their peers, and therefore keep more revenues coming in; and • The stocks of firms with higher-equity brands should offer some protection for investors because they are viewed as safer investments.

During the 2008 holiday season, consumers left traditional retailers out in the cold. But they cozied up to one niche: craft stores. From chains like Jo-Ann Fabric and Craft Stores to smaller shops to online marketplaces (Etsy.com), the sector saw a soar in sales.

DISCOUNTED Discount chain stores like Walmart saw a boost from grocery sales and markdowns on brands in demand: flatscreens and Blu-ray players from big-name brands at rock-bottom prices. While those global brands suffered, their discount distributors thrived.

B2B AID In the B2B sector, financial and legal companies that offer services to struggling businesses flourished. Think: employment law firms that negotiate severance packages; restructuring advisory service companies that consult for other firms in financial distress.

Charlie Dale Source: The New York Times

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But there was nothing in the research to confirm or disprove this. For Mazvancheryl and his colleagues, Claudiu Dimofte and Johny Johansson, the financial crisis of 2008 offered a perfect opportunity to put their hypotheses to the test. “In our research, we are always looking for opportunities to place marketing front and center as a factor in financial performance, and here was a chance to do that in a way that could potentially reinforce the case that brand equity matters,” Mazvancheryl said.

CRAFTY

Below is a selection of 16 of the 50 brands used in Mazvancheryl's research paper

INTER 2008

INTER 2012

INTER % INCREASE

EQUI 2012

EQUI % INCREASE

13.72 76.57 458%

60.24 66.0 59.6%

10.88 12.03 11%

65.98 68.59 4.0%

66.67 77.84 17%

71.20 72.30 1.5%

25.58 30.09 18%

55.75 61.02 9.5%

11.70 7.6

62.66 61.01 -2.6%

7.90

-35%

7.96 1%

53.09 43.68 -18%

7.61

3.86 -49%

70.60 63.98 -9.4%

23.51 26.09 11%

64.89 64.91 0.0%

3.50

62.59 67.42 7.7%

31.05 40.06 29%

65.18 64.65 -0.8%

13.25 16.59 25%

69.98 70.07 0.1%

13.58 9.11 -33%

67.62 63.58 -6.0%

34.05 30.28 -11%

63.52 62.51 -1.6%

3.34

71.31 71.13 -0.3%

4.94 48%

63.29 64.52 2.4%

2012 Interbrand score not available because Marriott fell out of the Top 100

2012 EquiTrend score is an average of Sony's computer, tablet computer, home electronics, and digital camera brands

The research also was a chance to compare and contrast the two dominant approaches to measuring brand strength. Using both the EquiTrend and Interbrand data, Mazvancheryl and his colleagues set out to see if there were notable differences in what the two measures said about the relative performance of major brands during the crisis. The researchers analyzed the stock market performance of 50 of the Interbrand Top 100 global brands from September 1 to December 31, 2008, a period when the S&P 500 declined in value by more than 30 percent. Those top brands were compared to overall market performance. And, contrary to expectations, brands with high Interbrand scores did not perform any better than the broader market as share values tanked. In fact, the high-scoring Interbrand firms performed slightly worse than the broader market, even controlling for factors such as firm size, varying industry-by-industry performance, and more. Had Mazvancheryl and his colleagues stopped there, the resulting paper might have proved a disheartening read for those in the marketing

profession who regularly advocate the importance of building strong brands for good times and bad. But the consumer-based EquiTrend data produced markedly different results. Among the same 50 brands, high EquiTrend measures resulted in lower volatility and better stock performance. “Brand equity as measured by EquiTrend helped lower riskiness and also helped limit overall losses in the Fall 2008 crisis,” the researchers concluded. One company, the cereal maker Kellogg’s, shows how the two measures can deliver starkly different assessments of brand strength. Kellogg’s had a low Interbrand value when compared to many of the other 50 brands, but its EquiTrend value was relatively high. And Kellogg’s stock loss during the four-month period? Just shy of 21 percent, well short of the decline in the broader market. Mazvancheryl suspects that EquiTrend proved a better predictor of firm performance during the crisis because the data are based on consumer loyalty and allegiance. “The assumption is that firms scoring highly on EquiTrend have a sustainable edge in the marketplace. Customers know and trust these brands,” he said. What’s more, Mazvancheryl suggested that this

21.16 26.93 31%

“BRAND EQUITY AS MEASURED BY EQUITREND HELPED LOWER RISKINESS AND ALSO HELPED LIMIT OVERALL LOSSES IN THE FALL 2008 CRISIS.”

47.50 50.53 6.4%

57.68 62.55 8.4%

-100%

2012 EquiTrend score is an average of Apple's computer, tablet computer, and mobile phone brands

55.90 62.10 11.1%

19.08 17.28 -9%

—

NOTES

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EQUI 2008

BRAND (MIS) MANAGEMENT IN THE US AUTO INDUSTRY

IN BRANDS WE TRUST

competitive edge might grow even bigger in difficult times as consumers stick to the tried-and-true. In contrast, the rankings and measures from Interbrand are based on financial projections and specific assumptions about a company’s future growth. When an economic crisis comes along, all of that goes out the window: financially-based assumptions no longer hold. Mazvancheryl is careful to say that his research isn’t meant to suggest that one gauge of brand strength is more worthy than another; rather, they have different potential uses. Interbrand, he noted, can provide a good picture of brand strength and the contribution of a brand to a company’s overall value. But his research suggests it is not nearly as effective as EquiTrend when it comes to identifying firms whose brands might help them weather a storm.

What lessons businesses should take from this research? Mazvancheryl said trying to predict the next crisis and its causes can be a futile exercise. “These events can be hard to predict and they are very often outside a company’s control,” he said. The more important question, he noted, is how can firms protect themselves when the next crisis comes along. The work of Mazvancheryl and his colleagues seems to suggest an answer: Build trust in your brand. Claudiu Dimofte, Johny Johansson, Sanal Mazvancheryl. "The Performance of Global Brands in the 2008 Financial Crisis: A Test of Two Brand Value Measures." International Journal of Research in Marketing (2012).

Faculty Program Director Michael Clayton knows a thing or two about the performance of big global brands in difficult times. Before he became an educator, Clayton worked on the Chevrolet and Dodge accounts at two advertising agencies in Detroit.

VEHICLE SALES IN PERCENT * DECEMBER 2008

** YEAR 2008

-31.4%* -22.9%**

-31.7%* -20.2%** -53.1%* -30.0%**

Source: Edmunds.com

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As auto sales started to decline in the early 2000s, Clayton said, US car companies “got hooked” on price-based messages that had a negative effect on their brands. Zero-percent financing, cash-back deals and rebates, special lease rates, and the like might have moved cars off dealer lots, but focusing on pricing rather than the positive attributes of their brands cost the US carmakers dearly. According to Clayton, “The auto companies got caught up in the tendency to focus on price-based promotions when things are bad and sales are slow.” Over time, however, this approach begins to eat away at a brand. Indeed, the market share of the “Big Three” US automakers dropped precipitously in the 2000s, which Clayton partially attributes to the misguided strategy. As the financial crisis hit in late 2008, Ford, Chrysler, and GM were selling just 53 percent of the cars purchased in the United States, down from 70 percent in 1998. Chrysler’s sales alone declined by 30 percent between 2007 and 2008, and all three American automakers saw yearly US sales declines that were larger than those of Toyota, Nissan, or Honda. Clayton wasn’t surprised when the US auto industry entered a crisis period from 2008 to 2010. During this time period, mismanaged auto brands Pontiac and Saturn were also eliminated. “These companies had been struggling for some time to define their brands, and it got to the point where consumers just weren’t interested,” he said. “Simply offering the cheapest product or the best deal isn’t going to cut it.”

companies are already it to their advantage. ARTICLE BYusing JESSE CHIMES

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When the Industrial Revolution changed the face of US commerce in theWhen early the 19thIndustrial century, it was because innovators figured outcommerce how to turn Revolution changed the face of U.S. coal and iron19th intocentury, steam engines and railroads. Today, data isout thehow raw in the early it was because innovators figured material poised to transform business, and many innovative companies to turn coal and iron into steam engines and railroads. Today, data is are already it to their advantage. the raw material poised to using transform business, and many innovative

“IF YOU LOOK AT ALL THE DATA YOU MIGHT COLLECT—CRIME, TRAFFIC, WEATHER— IT JUST GIVES YOU AN IDEA OF WHAT AN INTELLIGENT CITY MIGHT LOOK LIKE.” WILLIAM DELONE, PROFESSOR

A CHANGE IN PERSPECTIVE Traditionally, data has been used to describe past performance and to gauge how well an organization is doing. And while that is useful, DeLone says finding out what will happen tomorrow is much more important than knowing what happened yesterday. “So, where we are today is predictive and prescriptive analytics,” he said. “Predictive meaning ‘What are people going to be buying tomorrow?’ and prescriptive meaning ‘Can I influence that?’ That is what we call business intelligence.” In the course, DeLone and McConaty broke business intelligence down into three main components: 1. Interpretation—Knowing what questions to ask of the data and understanding what the answers mean. Good business intelligence professionals find meaningful trends within the data that can be used to predict and influence results. 2. Consumability—Making sure the information is easy to understand and use properly. 3. Visualization—Using the right charts and graphs to display different types of data analysis.

GAINING AN EDGE MIT recently studied 179 large, publicly traded companies and found that those applying data-driven decision making were 5 to 6 percent more productive and profitable than their competitors. In most industries, that could be the difference between success and failure. “Many businesses do or die around data,” said McConaty. IBM, for example, recently made one of the largest investments in its history—$14 billion over eight years— to put together analytics capabilities aimed at reducing fraud, managing financial performance, and predicting customer behavior. The company anticipates $16 billion in business analytics revenue in 2015 alone. “That’s because of the growing need for analytics in the government,” DeLone said. ANALYSTS WANTED In short, the demand for qualified analytics professionals has boomed. More than half (51.7 percent) of the 1,300 companies across industries that responded to a recent TechRepublic survey said they use data analytics in everyday decision making and processes. Another 18.1 percent plan to by the end of 2013. And that spells jobs. McKinsey Global Institute projected last year that there is a need for 1.5 million more data-literate managers in the US

alone. That’s across every industry, in both the private and public sectors. “The data is everywhere,” said McConaty, “but there’s a scarcity of talent with the skills to create value from it.” She says the government, in particular, is hungry for individuals with these skills. Last year, the federal government began a $200 million research initiative to find insights and make better decisions using the massive amounts of data it produces, gathers, and stores. JOB SEEKERS ARE TAKING NOTE An alumnus who is now working at a technology-based consulting firm came to DeLone for advice on improving the firm’s business intelligence capabilities. Other technology professionals chose to audit the course just to learn the skill set. “They consider themselves to be very underresourced in the area of business intelligence,” he said. “They’re hiring our students, but they have an entire staff of consultants who came and joined the company before this move toward analytics…they understand the need for this talent, and they don’t have enough of it.” DeLone believes this business intelligence course is just a toe in the vast pool that is big data. “Everywhere we look is this expanded use of information,” he said. For the past two semesters, he has been co-teaching the course with Kamalika Sandell, American University’s associate chief information officer. One of his undergraduate teams working on emerging technologies is looking into “intelligent lampposts” connected to microprocessing chips. They can turn on or off by judging the amount of movement on the street, but can also collect data for other purposes. “These lampposts would be well placed for data collection,” DeLone said, “and if you look at all the data you might collect—crime, traffic, weather—it just gives you an idea of what an intelligent city might look like.”

“What we’re trying to train our students to do is take the important business decisions that companies have and break those down into research questions,” explained DeLone. “Figure out what data is needed, figure out what analytical technique is needed, and then interpret the results and articulate them.” Tyler Coffey, MBA ’12, was one of those students. He had a concentration in information systems consulting and took DeLone’s course to gain a better understanding of the key topics surrounding company data. “I believe that business intelligence will transform the way that most companies conduct business in the long term,” said Coffey, now technology services manager at Sigal Construction Corporation. “As a

consultant or employee, it is a strong value proposition to have experience and real insight in this field.” In addition to learning the theory of business intelligence, students in DeLone’s course get hands-on experience with state-of-the-art software MicroStrategy Express—MicroStrategy’s new Software as a Service product released in November 2012. American University uses MicroStrategy’s enterprise business intelligence tool to support its administrative decision making.

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Whereas coal and iron helped revolutionize manufacturing and transportation—the production and distribution of goods—data is changing the way decisions are made within an organization. It is behind a shift from decision making based on fine-tuned instincts and experience, to a reliance on careful analysis of facts and trends. “The numbers and the analysis allow us to have data-driven connections that experienced people who use their hunches would never have guessed,” said Professor William DeLone, whose expertise is in the measurement of information systems’ effectiveness. “That’s the power of information,” he said. “It doesn’t lie.” According to DeLone, the recent explosion of data sources has brought these truths to life. Cars, mobile phones, membership cards, Internet searches, and virtually anything else consumers interact with can collect useful behavioral data for businesses. In 2011, the volume of available digital data exceeded 1.8 zettabytes. To put that into perspective: each zettabyte is 1 trillion gigabytes. That’s more than 62 billion 16GB iPhones worth of information. “The challenge is no longer that we don’t have enough data to make a decision,” said DeLone. “The challenge is that we have too much.” This information, valuable though it may be, is of little use to a company without qualified analytical professionals to make sense of it. That’s where DeLone comes in. He designed a business intelligence course with alumna Yana McConaty, MBA ’98. McConaty is co-founder and principal of Washington, DC-based Neubrain—a consulting firm that specializes in business intelligence. Their mission was to teach a new wave of analytical decision makers, in the form of graduate students, to turn all that raw data into a useful strategic resource.

KOGOD STANDOUT

MOVING THE NEEDLE

It’s been 15 years since Susan Matthews Apgood, MBA ’96, took the entrepreneurial plunge and founded News Generation, Inc., a media relations firm specializing in radio and television content. Now her Bethesda, Maryland-based company—which also has a studio and office in Atlanta— has served clients Discovery Communications, Expedia, Microsoft, and the Annie E. Casey Foundation.

To start, she turned to The New Venture Handbook, originally purchased for Professor Barbara Bird’s class. “I used it as a bible to write my business plan,” she said. “And I still remember Professor [H. Kent] Baker’s class on reading financial statements.” Now News Generation is home to 16 employees, and Apgood regularly networks with a local group of CEOs to share ideas. Another startup venture is undeniably on her playlist.

Photographer: Vincent Ricardel

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As a young professional with experience in politics, Apgood transitioned into public relations while earning her MBA. She specialized in finance to deliberately grow her skill set, which was anchored in business development, sales, and marketing. When a loyal client suggested she venture out on her own, Apgood decided, “Why not?”

CAUSAL RELATIONSHIP

KOGOD TAX CENTER

HOW DO EMPLOYERS GET WORKERS TO SAVE FOR RETIREMENT? Gone are the days of reliable promises when it comes to pensions. Such perks, once considered untouchable, have all but disappeared for the modern worker.

ARTICLE BY DAVID J. KAUTTER

When the Employee Retirement Income Security Act, commonly known as ERISA, was enacted in the mid-1970s, more than 70 percent of all employersponsored plans were defined benefit pensions that were managed entirely by the company. In the nearly 40 years since President Gerald Ford signed ERISA into law on September 2, 1974— appropriately, Labor Day—the number of defined benefit plans has steadily dwindled and the number of defined contribution pension plans, especially so-called 401(k) plans, has grown. What does this mean for the retirement security of American workers? In effect, the responsibility for funding and managing retirement benefits has switched hands from employer to employee. It is generally acknowledged that most employees are not adequately saving for retirement. Without changes in this behavior, many employees will discover a future much different from the one they imagined.

• Lawsuits and government delay in issuing guidance with respect to defined benefit plans

EMPLOYEE ATTITUDES A Congressional Research Service study identified several reasons why non-highly compensated employees weren’t enrolling in employer-sponsored 401(k) plans. First and foremost, most nonparticipating workers did not believe that they were eligible to participate in the plan. For those who were aware that they could participate, the study found that some

• An increasingly mobile workforce

• did not believe they could afford to participate,

• Changes in employers’ attitudes with respect to their responsibilities to their workers

• did not want to tie up their money until retirement,

• Global competitive pressures on US employers • Changes in the tax law that made defined benefit plans increasingly more complicated and defined contribution plans more attractive • Changes in the financial accounting treatment for defined benefit plans

401(K) PLANS In these plans, the contribution made by a highly compensated employee (in 2013, someone making more than $115,000) is limited to a multiple of what the non-highly compensated employees contribute. Basically, highly compensated employees (as a group) cannot contribute a percentage of their compensation exceeding the greater of 1. 125 percent of the percentage of compensation contributed by the non-highly compensated (as a group), or 2. 200 percent of the percentage of compensation contributed by the non-highly compensated employees (as a group) with a limit of two percentage points.

• in the case of lower-income workers, believed that Social Security benefits would replace a relatively high percentage of their pre-retirement income. In addition, many employees are intimidated by the enrollment process: when to start contributing, how much to contribute, how to invest the contributed funds. This, combined with their hectic daily lives, means that the inertia of doing nothing is a controlling motivation behind their unwillingness to participate in the plan. CHANGING EMPLOYEE BEHAVIOR In an attempt to encourage greater participation by non-highly paid employees, employers first tried educating them about the benefits of saving for retirement, especially on a pre-tax basis such as the 401(k) plan offers. These efforts included email campaigns, written educational materials, live group presentations, personalized analyses, and, in some cases, individual counseling. Although this approach met with some

NON-HIGHLY COMPENSATED EMPLOYEES*

1% 2% 3% 4% 5% 6% 7% 8% 9% 10% * Ceiling is annual salary of $115,000

HIGHLY COMPENSATED EMPLOYEES

2% 4% 5% 6% 7% 8% 9% 10% 11.25% 12.50%

Therefore, an employer cares about how much its non-highly compensated employees contribute annually to its 401(k) plan for two reasons. First, the amount the employer’s highly compensated employees can contribute to the plan is directly tied to the amount the non-highly compensated employees contribute. Second, some employers are legitimately

• had more immediate saving goals,like saving for the down payment on a home or for their children’s education, and,

The tax law encourages employers to care about how much their non-highly paid employees contribute to their 401(k) plans. The law ties the amount that a firm's highly paid employees can contribute to how much the nonhighly paid employees contribute.

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DIFFERENCES HIGHLIGHTED In a defined benefit pension plan, eligible employees are automatically enrolled in the plan when they reach the prescribed criteria. The employer makes all the contributions, and at retirement the employee receives an annuity for life based on length of employment and compensation. Today, less than 7 percent of all employer-sponsored retirement plans are defined benefit plans. More than 74 percent of the 700,000 employer-sponsored retirement plans today are 401(k) plans, a type that did not even exist in 1974. In a 401(k) plan, employees make contributions with pre-tax dollars. Those contributions go into an account on their behalf along with any contributions their employer might make, usually either a “matching contribution” or an across-the-board contribution for all employees. The benefit received by the employee at retirement is the balance in that account.

There are a number of reasons for the decline of defined benefit plans and the rise of 401(k) plans. Some of the most significant ones are:

concerned about whether their employees will have saved enough to retire comfortably. Despite employers’ efforts, it is generally acknowledged that employees who are eligible to contribute to a 401(k) plan, especially non-highly compensated employees, are not participating in sufficient numbers—and those who do participate are not setting aside enough for retirement.

KOGOD TAX CENTER

AUTO-ENROLLMENT THE FINE PRINT

EMPLOYERS MUST…

EMPLOYEEES HAVE THE RIGHT TO…

Provide notice of autoenrollment to employees.

Opt out of auto-enrollment within 90 days.

Contribute at least 3 percent of the employee’s pay in the first year.

Control the percentage of their net pay that is contributed.

A) I ncrease contribution by at least 1 percent each year, to a minimum of 5 percent but no more than 10 percent.

Control the investment of their contributions across provided investment options.

B) or make a 3 percent of pay contribution for all nonhighly paid employees.

Provide employee with investment options approved by the Department of Labor.

Immediately vest 100 percent in their own contributions and vest 100 percent after two years in any employer contributions.

NOT THERE YET Many employers were not satisfied with these participation rates, however, and continued to search for ways to increase participation. As employers and employee benefit consultants continued to analyze the issue, some proponents of behavioral economics concluded that many of the nonparticipants had not deliberately rebuffed the idea, but rather were simply passive procrastinators. According to a study by the General Accountability Office, “Workers may intellectually understand the importance of saving for retirement but have trouble overcoming their own inertia to start saving or to save effectively. …Further, workers may also decline to participate, in part, because they believe the decision to participate in a 401(k) plan requires time-consuming and complex decisions, such as choosing how much to contribute and how to invest their contributions.” In response, employers started to look at the possibility of automatically enrolling employees in a 401(k) plan and using the employees’ inertia in favor of saving instead of not participating in the plan. Under this arrangement, employees would become plan participants unless they explicitly opted out. Since this was a novel approach to 401(k) plan design, there was concern as to whether the IRS would view such an arrangement favorably and whether the employer might have other legal liability. Yet in 1998,

SOME EMPLOYEES EVEN INTERPRET AUTOMATIC ENROLLMENT PROGRAMS AS IMPLICIT ADVICE FROM THEIR EMPLOYER. and again in 2000, the IRS affirmed that 401(k) plan sponsors could automatically enroll new employees and current employees who were not participating. In 2006, Congress and the IRS used further legal and regulatory changes to facilitate automatic enrollment programs with incentives and the promise of protection from legal liability. Under the Pension Protection Act of 2006, if a “safe harbor” automatic enrollment design is followed, the plan is considered qualified and the employer is protected from fiduciary liability under ERISA, and state laws governing wage garnishment are preempted. Most studies that have looked at the effect of automatic enrollment have concluded that it substantially increases the level of 401(k) participation. One study published in the Quarterly Journal of Economics looked at comparison groups before and after adoption of automatic enrollment. Participation skyrocketed from 37 percent to 86 percent. Another study by Fidelity Investments found that overall participation rates for plans with automatic plan enrollment is, on average, 28 percent higher than for other plans. Individual employers have seen participation rates as high as 95 percent after instituting automatic enrollment. There’s also proof that the practice has a significant effect on demographic groups that do not traditionally have a high participation rate, such as lowerincome workers and young employees. Some employees even interpret automatic enrollment programs as implicit advice from their employer with respect to optimal saving and investment choices. GOING FORWARD There seems to be little question that adding an automatic enrollment feature to a 401(k) plan can overcome the inertia, procrastination, and sense of intimidation employees feel when it comes to saving for retirement. Up to this point, large employers have been more inclined than smaller ones to adopt these programs. Regardless of size, employers who want to encourage more employees to save for retirement should carefully consider instituting automatic enrollment.

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Match 100 percent of the first 1 percent contributed by employee, and at least 50 percent of following contributions, up to 6 percent of total employee pay.

success, many employers had difficulty raising the level of non-highly compensated employee participation above 50 percent. The next step in the process of expanding participation by non-highly paid employees was the addition of employer matching contributions. While a wide range of matching contribution formulas continue to be used, under most matching arrangements employers agree to match a percentage of employee contributions up to a specified percentage of income. For example, one of the common matching formulas involves an employer match equal to 50 percent of an employee’s contributions up to 6 percent of compensation. Under this sort of matching formula, an employee making $50,000 a year who contributed 6 percent of her compensation ($3,000) to a 401(k) plan would receive an employer matching contribution of $1,500. Other formulas matched less as contributions increased, while others provided an employer match in excess of the amount the employee contributed. The addition of matching contributions when combined with educational efforts resulted in an upsurge that often raised participation rates for nonhighly compensated employees from the 50 percent range to 65 percent or above.

PRACTITIONER PERSPECTIVE

THE SCIENCE OF MOTIVATING CONSUMER BEHAVIOR In 2005, my wife Tobie and I set out for a 10-month, 27,000-mile drive from the northern tip of Alaska to Ushuaia, Argentina. We saw vast and expansive seas, beautiful glaciers and rainforests, but also devastation caused by pervasive commercialism. DANIEL YATES IS CEO OF OPOWER, WHICH HE CO-FOUNDED WITH ALEX LASKEY IN 2007. PREVIOUSLY, YATES WAS FOUNDER AND CEO OF EDUSOFT, AN EDUCATIONAL SOFTWARE COMPANY SOLD IN 2004.

Motivated to do something to help the environment, I linked up with my college friend Alex Laskey, who had spent several years as a campaign manager and strategist. We wanted to use our experience in technology and policy to create a company that would benefit both the environment and society, but was different from the numerous other renewable and cleantech companies starting up at the time. We discussed a variety of ideas, but kept coming back to the one area we thought had the greatest potential: energy efficiency. Or, simply put, motivating consumers to use less power—a task easier said than done. That same year, we came across a study from the renowned behavioral scientist Robert Cialdini. He set out to answer the question “What motivates behavior change?” after California was forced to implement rolling blackouts to alleviate excessive demand on the power supply in the early 2000s. Cialdini and his students ran a series of field tests during one hot summer. Every week, the students would leave door hangers on homes, each with one of four different messages printed on it: • The first said, “Turn off your AC and turn on a fan—you can save money.”

• The third said, “Turn off your AC and turn on your fan—it’s your civic duty.” • The fourth said, “4 in 10 of your neighbors turned off their AC and turned on a fan.”

• 400—the amount of money, in billions, wasted every year through inefficiency. • 90—the percentage of Americans who think saving energy is a good idea. • 7—the number of minutes Americans spend each year thinking about their energy consumption, according to Accenture. We realized there was a significant gap between the portion of people who want to do something to save money and energy and the amount of time they spend thinking about energy use. Using these constraints and working with Cialdini, who became our chief scientist, we utilize the best behavioral science to create a model that engages and motivates customers. By giving them insights and information about their energy consumption, in customer-friendly and targeted ways, consumer behavior can be changed. We created our first product, the Home Energy Report, in 2007. The report combined normative messaging with personalized tips for saving energy and money. That year, we signed our first utility partner, Sacramento, California's Municipal Utility District, and set out to prove our concept would work.

BIG DATA We also realized early on that to truly scale this business, we needed a software platform that could transform the vast analytics potential of the utility industry into information that was actionable for consumers. Utilities manage massive amounts of data for each of their customers. We developed a platform that analyzes energy and third-party data, derives insight from that data, and determines how best to deliver that insight. The data we receive from our utility partners is supplemented with third-party demographic data, program participation data, and other third-party data to create a comprehensive customer profile. From these profiles, we derive actionable insights for each customer.

Our analytics engine processes data from more than 50 million homes and analyzes 96 billion meter reads every year, making us one of the largest stores of energy data in the world. LOOK AHEAD Behavioral science could be applied to a number of other industries, including education and health care. Currently, the majority of health care spending goes toward better medicine, facilities, and doctors—but it’s small things that really make an impact on health, such as exercising, not smoking, and eating healthy. There is a huge potential to change the way people think about and act on their health through behavioral norms and comparisons. Behavioral science and normative comparison tap into our greatest resource—our people—in order to create lasting and significant change. As a company, we hope our impact will continue to grow and we will continue to make better use of the limited resources we have on this planet.

Opower works with more than 80 utility partners in six countries, including the US, the UK, France, and Australia. It has proved that providing better information to customers can drive savings—an average of 1.5-3.5 percent—while substantially improving customers’ satisfaction with their utility. To date, it has saved more than two terawatt hours of energy, enough to power a city the size of Sacramento, California for one year, and has saved customers more than $220 million.

After three weeks, the students analyzed the homes’ energy use and found that the first three messages had zero impact on consumption. In fact, some of the homes actually started using more energy. However, homes that received the fourth door hanger used, on average, 6 percent less electricity than the control group.

BY THE NUMBERS Having seen the power of behavioral science on energy usage, Alex and I then came across three numbers that shaped what would become Opower: 400, 90, and 7.

“NORMATIVE COMPARISONS ARE EFFECTIVE IN MOTIVATING BEHAVIORAL CHANGE BECAUSE THEY TAP INTO HUMANS’ INNATE COMPETITIVENESS.”

KOGOD NOW SPRING 2013 | kogodnow.com

• The second said, “Turn off your AC and turn on a fan—you can save the environment.”

What Cialdini found is counter to the general perception that money or environmental concerns have an impact on consumption. What actually motivates consumers is the fourth door hanger: normative comparisons. The discovery of the impact of social norms was a catalyst for the creation of Opower. Normative comparisons motivate behavioral change because, like other tools such as goal setting, usage ranking, and historical usage comparisons, they tap into humans’ innate competitiveness.

COMPARE AND CONTRAST The Opower platform is designed to deliver better information to customers in a way that not only informs, but also motivates customers to take action. Opower collects energy use data from the utility and merges it with third-party data to create individual customer profiles, then uses it to accurately compare customers to similar homes in their neighborhood. We have found that the average customer is unfamiliar with—and uninterested in—complex graphs of his energy use. Instead, he cares primarily about the answers to two questions: “How am I using energy?” and “What can I do to save energy and money?” Knowing that households are more likely to take efficient actions their neighbors have already committed to, Opower rates the popularity of efficiency tips by noting the number of people in the service territory who have committed to specific efficiency actions. We also include “loss language” in our tips and recommendations, encouraging customers to feel they are missing an opportunity to save if they turn down the tip or recommendation. The most popular actions reported by energy report recipients, such as adjusting thermostats and unplugging appliances, are common sense, easy to do, and universally applicable. The potential for behavioral energy efficiency comes from a subtle shift in customers’ mindset, eventually making a simple action as second nature as placing a can in the recycling bin.

PRACTITIONER PERSPECTIVE

RAISING A GENERATION OF FINANCIALLY SAVVY CITIZENS

The United States needs a financial services market that truly works for consumers, responsible businesses, and the economy as a whole. Yet the many consumers who were caught up in the mortgage meltdown over the past five years did not experience such a marketplace. GAIL HILLEBRAND IS ASSOCIATE DIRECTOR FOR CONSUMER EDUCATION AND ENGAGEMENT, CONSUMER FINANCIAL PROTECTION BUREAU

2. ADD MONEY QUESTIONS TO THE TESTS AND MONEY TOPICS TO THE CORE STANDARDS Standardized tests that measure student progress could use questions based on money math. The President’s Advisory Council on Financial Capability has recommended integrating the essentials of personal finance into the widely used Common Core State Standards in mathematics and English language arts, which would be an important step forward. Integrating financial lessons into nonfiction reading and into math problems would introduce students to financial basics. It would also strengthen the Common

4. OTHER FINANCIAL SKILLS DEVELOPMENT FOR YOUNG PEOPLE Providing students with finance-related learning opportunities that are relevant, real, and practical may improve financial literacy. Some schools invite financial institutions to work with their students to run youth credit unions or student banks on campus. The young people who help run the program get hands-on business experience, and their peers may get their first bank accounts. Having savings in a student’s name has been shown to make a difference in whether young people

3. TEACHER TRAINING IN PERSONAL FINANCE WILL BENEFIT STUDENTS Approximately eight out of 10 K-12 teachers say that personal finance should be taught in school, yet only three out of 10 say they have taught lessons about money. Teachers who have taken a personal finance course are more likely to teach financial lessons, but personal finance is not a required part of teacher training. Colleges and universities should consider offering effective financial education courses to all of their students. These courses may have special value for education students who will later become teachers, and for students studying to become social workers and may later work with families facing financial difficulties. Teachers also should receive continuing education credits or professional development credits for taking personal finance courses.

easy and even appear attractive. They are offered products that may appear to be cheaper than the true full cost, because some fees or costs are triggered after buying the product. Francis Bacon said, “Knowledge is power,” but the emerging literature in behavioral economics and in financial capability suggests that knowledge is just part of the puzzle. Financial capability requires a combination of knowledge, skills, and habits, as well as access to financial products and services. We need to build a nation where every consumer is financially capable. First, for those who are already seeking information about financial decisions, the CFPB designs and offers information, resources, and tools that enable consumers to clearly see the costs and risks of financial products and services so that they make the decisions that will best serve their own life goals. Second, we want to help spark a national conversation about money, especially in families and schools. Parents should talk to kids. Teachers should talk to kids, to each other, and to experts who can help them learn more about financial concepts and teach those concepts more effectively. Third, we support and stand ready to help increase the amount and effectiveness of financial education, especially in schools. Finally, we see roles for people and institutions across society in building financial capability. Let’s focus on some of the opportunities to give our young people a strong foundation for their financial futures.

Core by engaging students with real-world applications of the concepts they are learning. Even though education policy is generally a state and local matter, the CFPB is ready to work with regulators, educators, parents, the financial services sector, and others to identify ways to bring practical, sustained, effective financial education to K-12 students.

KOGOD NOW SPRING 2013 | kogodnow.com

The Consumer Financial Protection Bureau is working toward an improved marketplace by providing effective rules, consistent oversight, and evenhanded enforcement. At the same time, the CFPB is working to provide tools, information, and assistance to consumers as they make financial decisions. There is much to be done to help US consumers build strong decision-making skills about money. For example, a majority of American adults say they haven’t formed a savings cushion to protect them from unexpected economic shocks, according to the FINRA Foundation 2009 Financial Capability Survey. This same survey found that many Americans do not shop around, or engage only in limited comparison shopping, for the best deal on mortgages, car loans, and credit cards. Raising the level of financial capability, which includes being able to manage financial resources effectively, will require active participation and cooperation from a wide range of entities. The relatively new field of behavioral finance is developing and documenting an important conceptual framework about how people make financial choices. Although much of this framework is new, it includes concepts that marketers have used for a long time. For example, advertisements often feature one attractive fact about a product, which can be an attempt to focus the consumer on that feature above others. Salespeople know that the order in which choices are presented makes a difference in what the buyer ultimately chooses. Consumers face a marketplace in which effective marketing can make overspending and over-borrowing

1. TEACH MONEY CONCEPTS IN SCHOOLS Knowing how to manage money is an important life skill. Education that helps to foster familiarity with financial concepts can be integrated into all levels of educational curriculum. Too often, young people are not offered formal opportunities to learn about financial concepts and decision making. Only 14 states require a course on personal finance to be offered in school. The CFPB wants to work with teachers, administrators, and policymakers to encourage the inclusion of lessons about money that start in elementary school and build through high school graduation. These lessons should be fully integrated with K-12 curricula. Math problems could address the benefits of compound interest on savings. Math classes could discuss the way in which the monthly payment doesn’t fully illustrate the true cost of a loan, because a loan with a higher interest rate and a longer duration can have a lower monthly payment than a shorter-duration, lower-priced loan. Language arts classes could help students develop critical thinking skills that will help them later in life when reading marketing material. And let’s hope that the recent period of economic disruption in our society associated with the mortgage crisis will soon be a lesson for history classes.

KOGOD NOW EDITOR

Jackie Sauter PUBLISHER

Lara Kline CONTRIBUTORS

Amy Burroughs Jesse Chimes Charlie Dale Laura Herring David J. Kautter Andrea Orr Danielle Ulman William H. Woodwell MARKETING

fulfill their intentions to attend a four-year college. A study in the Journal of Children & Poverty examined rates of “wilt”—when high school students who say they expect to attend a four-year college don’t reach that goal. A young person who had a savings account in his or her own name and planned to attend a four-year college was six to seven times more likely to achieve that dream than a student without such an account—independent of such factors as family income and household net worth. Some local governments are experimenting with kindergarten-to-college savings accounts that provide a small opening deposit and matching money for regular savings, so that parents and kids start going to the bank together to save for a future that includes college.

KOGOD NOW SPRING 2013 | kogodnow.com

5. ROLES FOR PARENTS, EMPLOYERS, AND TRUSTED COMMUNITY ORGANIZATIONS Any discussion about how we teach our children must include parents. Through our Office of Financial Education, the CFPB is exploring how just-in-time information, together with age-appropriate activities for parents to engage in with their children, could help equip parents who want to answer their children’s questions about money choices. We are developing frequently asked questions and answers for parents, which will supplement the existing “Ask CFPB” offering that now serves US adults. As we work toward increased financial capability across the country, there are also important roles for employers and community- and faith-based organizations. Automatic enrollment in the workplace for retirement plans increases the number of employees saving for their futures. A financial education program for workers with a one-on-one financial planning component has been shown to decrease the number of 401(k) loan requests and advance pay requests, and to decrease overall financial stress. Churches, other faith communities, and other trusted commu-

MONEY CHOICES ARE A PERSONAL RESPONSIBILITY, BUT EACH ONE OF US WHO TOUCHES THE LIFE OF A YOUNG PERSON ALSO HAS A PERSONAL RESPONSIBILITY TO ENABLE AND EMPOWER TOMORROW’S CONSUMERS TO LEARN TO MANAGE MONEY. nity organizations can reach out to those they serve with important information about how to avoid scams and frauds, spot elder financial exploitation, and get information from sources such as “Ask CFPB.” While researchers continue to learn more about why people behave in certain ways with money, there is work to be done right now. Money choices are a personal responsibility, but each one of us who touches the life of a young person also has a personal responsibility to enable and empower tomorrow’s consumers to learn to manage money. This will enhance both individual futures and the future of our country.

Charlie Dale Charlotte Hutchison DIGITAL SUPPORT

Laura Caruso DESIGN AND ILLUSTRATION

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Carmel Ferrer

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