Dan Weiss

The Economics of Service Upgrades

Many service providers offer different service classes (e.g., first class, second class). Because the capacity of each class is set in advance, providers may end up with unfilled first-class capacity at the time of service delivery. When this happens, providers often upgrade some of their customers from a lower service class to a higher one. One way in which service providers manage upgrades is by selling, in advance, tickets that entitle the holder to an upgrade if space becomes available in a higher service class. This article investigates the circumstances under which upgradeable tickets are profitable, how to price them, and how many to issue. Upgradeable tickets increase the provider’s profits when the probability of obtaining full price for first-class service is sufficiently high. With upgradeable tickets, more of the available capacity can be reserved for potential customers who are willing to pay a high price for high-end service.

Communication Traps: Applying Game Theory to Succession in Family Firms

Using game theory to expand our understanding of the interaction between a founder and a successor in a family business, we explore the impact of poor interpersonal communication on family harmony during the succession process. Results show how deficient communication leads to disagreements and clashes between the founder and the successor and systematically reduces family harmony during the succession process. We term these situations communication traps. The findings demonstrate how inadequate communication hampers a transition process above and beyond psychological effects, even when the involved individuals share the same priorities, attitude, and interests.

The 'big pharma' dilemma: develop new drugs or promote existing ones?

Pharmaceutical companies decide how much to invest in developing new drugs and promoting existing ones, thereby influencing the rate of drug discovery and the state of biomedical research funding1. The relative emphasis on innovation compared with marketing depends on how these activities affect the short-term profitability and the long-term value of the company. To understand why companies invest extensively in promoting existing products when drug discovery seems to be their core value-generator, we examined the spending on research and development (R&D) versus sales and marketing by pharmaceutical companies over the past three decades.

Internal Controls in Family-Owned Firms

Abstract This study investigates the relationship between family ownership and material weaknesses in internal controls over financial reporting. Recent Sarbanes-Oxley (SOX) regulation and mandatory disclosure of family relations among block shareholders and directors in Israel offer an ultimate setting for exploring this relationship. The findings reveal that (i) family ownership is significantly associated with less material weaknesses in internal controls, (ii) material weaknesses in internal controls are associated with lower earnings quality in family-owned firms than in non-family-owned firms, and (iii) investors find weaknesses in internal controls to be more serious in their potential to lessen future performance in family-owned firms than in non-family-owned firms. The contribution of the study is threefold. First, the findings expand our understanding of how ownership structure influences financial reporting procedures. Second, they suggest that family-owned firms use internal controls as a mechanism to enhance earnings quality. Third, they extend the literature on the implications of the SOX legislation by highlighting the joint effect of family ownership and effective internal controls in achieving high-quality financial reports.

Implications of Cost Behavior for Analysts’ Earnings Forecasts

Recent work in management accounting offers several novel insights into firms’ cost behavior. This study explores whether financial analysts appropriately incorporate information on two types of cost behavior in predicting earnings - cost variability and cost stickiness. Since analysts’ utilization of information is not directly observable, we model the process of earnings prediction to generate empirically testable hypotheses. The results indicate that analysts “converge to the average�? in recognizing both cost variability and cost stickiness, resulting in substantial and systematic earnings forecast errors. Particularly, we find a clear pattern - inappropriate incorporation of available information on cost behavior in earnings forecasts leads to larger errors in unfavorable scenarios than in favorable ones. Overall, enhancing analysts’ awareness of the expense side is likely to improve their earnings forecasts, mainly when sales turn to the worse.

Earnings Variability and Disclosure of R&D: Evidence from Press Releases

This study explores press releases in the pharmaceutical industry to expand our understanding of how investments in R&D outlays influence uncertainty of future earnings. The findings make two contributions to the literature. First, they provide evidence that equal investments in different R&D ventures are associated with differential variability of future earnings. This result suggests that non‐financial information contained in press releases captures attributes of firm‐specific R&D investments that are not revealed through R&D expenditures reported in financial statements. Second, prior studies have indicated that investments in pharmaceutical R&D are associated with the highest variability of future earnings among all industries. The results, however, suggest that for a large class of low‐risk pharmaceutical R&D investments, the relative variability of future earnings is low and similar to that generated by capital expenditures. The findings hold when we control for endogeneity in voluntary disclosure of press releases.

Some Informational Aspects of Conservatism

Abstract When two value estimates are about equally likely, conservatism dictates reporting the less optimistic one (e.g. Lower of Cost or Market). We use an analytical model to investigate informational implications of this dictum, and identify types of environments where the conservative accounting treatment is more informative than a predetermined choice. The bias induced by the conservative choice is found to be adequately moderate, never excessive. It benefits users of the financial statements that take the reported figures at face value whenever upside errors are more costly (possibly only slightly more costly) than similar downside errors. Sophisticated users, who know how to give the reports the best possible interpretation, benefit from the lower variability, not from the bias. These latter benefits are least ambiguous when upside errors and downside errors are about equally costly.

Managerial Incentives, Options, and Cost-Structure Choices

This study explores the relationship between changes in managerial risk-taking incentives and adjustments of firms’ cost structures, particularly the operating leverage (fixed-to-variable cost ratio). We find managers reduce operating leverage by substituting fixed costs with variable costs, mainly in the selling, general, and administrative (SG&A) and research and development (R&D) cost components, in response to reductions in option-based compensation following the issuance of FAS 123R. Managers facing a decrease in risk-taking incentives adjust operating leverage downward because high operating leverage intensifies the downside potential of earnings. Overall, we present compelling evidence that managers adjust the cost structure of their firms in response to a reduction in risk-taking incentives.