K. Sivaramakrishnan

Contracts in Offshore Software Development: An Empirical Analysis

We study the determinants of contract choice in offshore software development projects and examine how the choice of contract and other factors in the project affect project profits accruing to the software vendor. Using data collected on 93 offshore projects from a leading Indian software vendor, we provide evidence that specific vendor-, client-, and project-related characteristics such as requirement uncertainty, project team size, and resource shortage significantly explain contract choice in these projects. Our analysis suggests that contract choice significantly determines project profit. Additionally, some ex ante vendor-, client-, and project-related characteristics known at the time of choosing the contract continue to significantly influence project profits after controlling for contract choice. We also provide evidence to show that project duration and team size affect project profits.

ISSUES IN TESTING EARNINGS MANAGEMENT AND AN INSTRUMENTAL VARIABLE APPROACH

In empirical studies of earnings management (EMI), a central issue is the estimation of the managed component (discretionary accruals) when outsiders observe only the sum of the managed and unmanaged (nondiscretionary) accounting numbers. Important methodological issues arise in part because the variables most useful in predicting the unmanaged components are themselves accounting numbers which are likely to be affected by EM. In this paper, we propose a simple method of addressing some of these issues in testing for EM in context-specific cases.1 Our method builds on the approach used by McNichols and Wilson [1988]. By modeling a specific type of accruals (bad debt expense), they enhance precision but do not capture accrual manipulations in many other accounts. Other studies attempt to capture a larger portion of managed accruals by modeling total accruals. However, we suggest that models following this approach are subject to simultaneity, errors-in-variables,

Who Monitors the Monitor? The Effect of Board Independence on Executive Compensation and Firm Value

Recent corporate governance reforms focus on the boards independence and encourage equity ownership by directors. We analyze the efficacy of these reforms in a model in which both adverse selection and moral hazard exist at the level of the firms management. Delegating governance to the board improves monitoring but creates another agency problem because directors themselves avoid effort and are dependent on the CEO. We show that as directors become less dependent on the CEO, their monitoring efficiency may decrease even as they improve the incentive efficiency of executive compensation contracts. Therefore, a board composed of directors that are more independent may actually perform worse. Moreover, higher equity incentives for the board may increase equity-based compensation awards to management.

Research Note---On Vendor Preferences for Contract Types in Offshore Software Projects: The Case of Fixed Price vs. Time and Materials Contracts

Prior research has indicated that, on average, offshore vendors have higher profits associated with time and materials (T&M) contracts than fixed price (FP) contracts. This research raises two questions. First, Is the relative importance of various profit drivers different across two contractual regimes? Second, Does it follow that vendors unconditionally prefer T&M contracts for all projects? We address these questions by using data on 93 offshore projects completed by a leading Indian vendor. We use an endogenous switching regression framework and the program evaluation methodology to show that profit equations are distinctly different for the two contractual regimes. Using these two profit equations, we also identify contingencies under which the vendor prefers an FP contract to a T&M contract. We hypothesize that the vendors ability leverage information asymmetry about capabilities and experiences translates into the vendor preferring FP contract to secure larger information rents. Our results support this hypothesis and suggest that the vendor would prefer the FP contract for larger and longer projects with larger teams. However, vendors would prefer a T&M contract when the risk of employee attrition from the project team is high. In addition, we discuss managerial implications of these results in the paper.

Sequential Solutions to Capacity-Planning and Pricing Decisions*

Ideally, firms should jointly solve capacity-planning and product-pricing problems. In practice, informational limitations and cognitive bounds may force firms to sequentially solve the two problems. For example, a firm may plan capacity using limited demand information, and update prices subsequently once additional demand information becomes available. In a simple setting, we characterize the economic loss due to such sequential planning. We use simulation experiments to assess the extent of this loss in more complex settings. We find a relatively low loss if the firm plans for capacity using limited demand information and subsequently adjusts product prices to reflect realized market conditions. However, even “reasonable” restrictions on the subsequent price adjustment (e.g., constraining adjusted prices to always exceed full cost) lead to significant economic loss.

Commitment issues in budgeting

Antle and Fellingham [1995] study information system design in a budgeting setting in which the center (principal) has the ability to (ex ante) commit to both what information will be gathered (tracked) and the way in which the tracked information will be used.1 In this note on the Antle-Fellingham model, we assume the principal has limited powers of commitment; he can commit to what information will be tracked but not how it will be used. Antle and Fellingham find that installing a public information system that reduces the agents informational advantage sometimes makes the agent better off, and that more public information sometimes decreases productive efficiency. However, in their model, the principal always prefers more (finer) public information to less (coarser) public information. This preference is driven by the assumed unlimited ability to commit to how the tracked information will be used. The principal can and does commit to using information in a manner that is ex post not in his own

An Analysis of Financial Analysts Optimism in Long-term Growth Forecasts

A large body of literature has rejected rational expectations in relation to analyst forecasts. In this paper we start with a boundedly rational premise that analysts and managers adopt are influenced by the availability heuristic (Tversky and Kahneman [1973]). In the presence of business cycles, a rational growth forecast presupposes precise knowledge of the factors that cause a business cycle. In contrast, under the availability heuristic the current state is overweighted in the growth forecast and so whatever part of the business cycle the economy is currently in will be preserved by the investment decision. As a result, under the hypothesis of the availability heuristic we will observe ex-post, a systematic association between the drivers of this behavior (e.g., current state of the economy, industry, current performance) and subsequent forecast errors and (realized) growth when related to specific properties of the business cycle. We test for this condition and find evidence in support of it. The boundedly rational premise also provides a prediction for the nature of information that can improve analyst forecasts. The results from our analysis provide support for conclusion that a major driver of the boundedly rational behavior is ignoring the business cycle. Together these results provide direct evidence in support of Sargents [2001] conjecture that a plausible reason for departures from rational expectations is the overly strong assumptions regarding the knowledge the agents are assumed to possess regarding the underlying laws of motion for the economy.

CAPACITY PLANNING WITH DEMAND UNCERTAINTY

ABSTRACT We examine how the ability to augment capacity on an as-needed basis affects capacity planning. If it is feasible and desirable to augment all resources on an as-needed basis, optimal capacity planning can be done separately for each resource. Optimality of this simple rule is lost if even one capacity resource imposes “hard” constraints. Simulations indicate that simplifying capacity planning to focus on an expected bottleneck resource dominates product- or resource-level capacity planning, when all resources impose hard constraints and the firms product mix problem is significant.

Managerial Entrenchment, Reputation and Corporate Investment Myopia

In this paper, we demonstrate that informational asymmetries within a firm along with managerial labor market concerns can jointly result in investment myopia being equilibrium behavior. In contrast to earlier studies (like that of Shleifer and Vishny [1989]), we find that in the presence of both reputation and entrenchment incentives, managers invest in long-term projects for reputation building and short-term projects to entrench themselves. Further, we establish conditions under which delegating project selection is optimal, even though it requires that the owner tolerate short-term project selection. Finally, we present several empirical implications of our analysis.

Short-Term Contracts, Long-Term Actions, and Information System Design

We examine how “long-term actions” (current period actions that bear fruit in the future) can be motivated when short-term contracts are employed, and derive implications for the design of performance measurement systems. In our two-period model with unknown agent type and moral hazard, the principal chooses between a fine and a coarse performance measurement system. These two systems differ in the information they convey about the agents unknown type and therefore lead to different retention/firing policies. The principals retention policy in turn influences the agents incentives to undertake long-term actions, especially if the agent has advance information about what the performance is likely to be; an employee expecting to get fired is less likely to take actions that will bear fruit only after his departure from the firm. We show that the principal may prefer a coarser performance measurement system because it can substitute for her ability to commit to retention decisions. We also show that the finer the agents private information is, the greater the benefit for the principal from coarsening the performance measurement system for contracting purposes. We discuss some practical implications of our analysis.