Dear fellow faculty, administration, staff and not at least students: Poets & Quants chose the Cornell Teach MBA as the program of the year. See the article here.
Congratulations and well deserved!
When obtaining a post-secondary education in Economics and/or Business related fields, one typically spends a considerable amount of time studying various models of decision-making. Arguably two prominent reasons for teaching those models to students not targeting an academic career—most notably the majority of undergraduate students as well budding MBAs—are a) to provide them with frameworks to forecast and foresee the decisions of others and b) to sharpen their ability in making decisions themselves (which, in turn, is closely related to a)).
For their lack of opportunities to make significant decisions themselves while still in training, we typically resort to (real-world) examples featured in the business press or to (fictitious) business cases. In order to provide them with practice, we jointly tackle questions as in “how would you decide in this situation” or “what do you predict as the likely outcome of that scenario” in class. To put it bluntly, we teach them how to read, analyze and understand subject-specific articles. In the age of “fake news” and ubiquitous news coverage, I truly hope we also teach them how not to.
I typically challenge the class to feed each other with interesting and currently published information related to course content. Recently, a student of mine sent me this article published in the Economist linking the National Football League (NFL) with game theory. This student conceivably made a brilliant choice. The major sports leagues in the United States constitute an arena of decision-making commonly beloved by students, game theory is exciting as it adds the strategic component and The Economist is a highly reputable media outlet of business and politics. On the surface, I could not have chosen better myself.
In short, the article describes the contract situation between the (in recent decades) chronically unsuccessful Buffalo Bills and Tyrod Taylor, their current starting quarterback (the one who throws the ball), in early 2017. The Buffalo Bills benched Taylor for their last regular season game on New Year’s eve. At this point, Buffalo had no chance of reaching the playoffs anymore, i.e. it was de facto the last game of their season. After Taylor had played through a groin injury for several weeks, he opted for surgery at the very beginning of the offseason, i.e. 3 days after the last game (in which he did not feature).
The Economist argues that both actions, the Bills benching Taylor for their last game as well as Tyrod opting for surgery were direct consequences of the incentive structure inherent to their contractual situation. While, as claimed in the article, Taylor was an above average (top third) quarterback at an average quarterback salary, the Bills had the option to cut Taylor for negligible expenses until the beginning of March. However, if Mr. Taylor was rendered not fit to perform football services, the Bills would owe him close to $30M if they fired him.
This, for the Economist, constituted a so-called prisoner’s dilemma, a strategic stand-off between multiple parties in which each party has an unequivocally optimal action, which, if employed by everyone relevant to the game results in the socially worst scenario. In other words, the Bills had an incentive to bench Taylor for the last game whereas he should try everything possible not to be fit to play during the offseason (at least until March). What is more, it was stipulated that the Bills overlooked that they were in fact caught in a repeated prisoner’s dilemma with varying actors, that is other players with who they would have to deal in the future.
The main predictions based on their analysis were that, while not explicitly claimed, it was likely that the Bills were either going to fire Tyrod Taylor while injured (a costly endeavor) or opt not to due to the financial penalty of doing so although they would prefer to part ways. In any case, acting according to their best option would somehow sever the bond between the Bills and their quarterback. Moreover, by not realizing the more general implications of crossing a star player, the Bills would significantly reduce their chances of hiring popular players in the future. All of these implications taken together would even prolong and worsen the Buffalo Bills drought and their absence from the playoffs (17 years and counting). Lastly, it was argued that Rex Ryan, the coach of the Bills until their last season game was fired by the club’s owners since he disagreed with benching Taylor for the last season game.
In fact, the Buffalo Bills and Tyrod Taylor did not part way in the offseason of 2017. Instead, they renegotiated Taylor’s contract to keep him as a quarterback on a significantly lower salary. During the season the Bills took Kelvin Benjamin, a highly rated wide receiver (the one who catches the ball) from the Carolina Panthers, under contract. While the Bills traded assets (future draft picks) for the receiver and the trade was not directly Benjamin’s decision, it seems unlikely that the Bills would part with valuable options for today’s college players for an athlete who was not eager to play for the franchise. As of week 15 of the current season (two more games to follow), the Bills show a record of 8 wins and 6 losses and are at the brink of qualifying for the playoffs for the first time in 18 years.
While one time negative results do most certainly not refute the validity of predictions in the first place, a strategic analysis delivers similar results. A football player who opts for surgery only 3 days after the end of the season, a surgery which has an average recovery time of 7 weeks for non-athletes, does not seem to try everything possible to be deemed unfit when March comes around. If Taylor was above average in quality but paid below peers of his level, would it not be optimal for the team if he took care of his injuries as quickly as possible (to ensure his availability for team as long as possible before the start of the next season)? Many teams in various sports bench their star players in games that are inessential to their season goals. Why was this such a particular move in the case of the Buffalo Bills and Tyrod Taylor and why does this move necessarily carry negative consequences for an already injured player? Why, if Tyrod Taylor was overpaid against the league’s standards, did he agree to continue on the team for a substantially lower salary? Is it more likely that the Bills fired their head coach over a singular disagreement regarding the line-up or due the fact that Mr. Ryan did repeatedly not manage to lead a talented team to the playoffs and that he had an abysmal record in close games?
The model-theoretic analysis of the quoted article is as little capable of answering those questions as its predictions coincide with what unraveled after its publication. Bar a very few superstars, the National Football League (NFL) and its teams have tremendous power over their players as most NFL players would be expected to earn only a tiny fraction of their actual salaries if they were not to make it into or would have to exit the league. This fact paired with a salary cap, which ensures talent to the distributed across teams, guarantees teams significant bargaining power.
Dazzled by the institution of a reputable magazine and by the connection of buzz words and sports, I initially forwarded the article to the remainder of my students without any specific comments. After thoroughly reading and reflecting, however, I decided to scrutinize the article in class. In addition to teaching students how to filter business press articles and other relevant outlets for information and conducting an analysis based on these premises, I believe we ought to realize that, in a world characterized by the ubiquity of unfiltered content, teaching them to challenge this very information is the first crucial step towards a successful analytical contribution. While this sounds trivial, it clearly has to begin with questioning the intentions of author and publisher when reading an article. Whether the creators of an article intend to push a dogma, support a particular political view or simply myopically attempt to maximize readership, abstracting from those intentions should be the very first step in the process of filtering information.
Kenneth J. Arrow, the youngest economist ever to be awarded a Nobel (jointly with John R. Hicks) for “for their pioneering contributions to general economic equilibrium theory and welfare theory”, died aged 95. Arrow, undoubtedly one of the most brilliant minds of recent times, is considered a founding influence of several sub-fields of Economics and among the architects of the advancement of Economics as a science in the twentieth century.
Many share the opinion that his ground-breaking contributions to social choice, innovation, health economics and the economics of risk have been even more ground-breaking for the Economics community than his work on general equilibrium theory for which he was awarded the Nobel Memorial Prize in 1972. Arrow is among a selected very few who consistently made it on the bookies’ list to win another Nobel.
I have briefly pondered about writing a piece on his research contributions to make the unbelievable wealth of his ideas accessible to a broader audience. There is, however, no need to reinvent the wheel. My former classmate Kevin Bryan (who btw considers Arrow to only be the second greatest economist of all time), professor at the University of Toronto, and among other things an expert in the history of Economic Thought, started a brilliant mini series of four posts on Ken Arrow today on his blog A Fine Theorem.
Usually I would not—especially not here—but for once I cannot resist. For all those who have not seen the Austrian government’s (fake) message to the recently elected president of the United States, please enjoy the following link:
Companies in today’s economy compete not only via prices, quantities, marketing or product characteristics but also on a very different level, showings of corporate social responsibility. While it is impossible to disentangle the motivations behind these actions—may it be to achieve a competitive advantage or due to true societal concern— UBER’s strategy is certain to set new standards.
A French businessman once had the brilliant idea to log in to his wife’s UBER app with his credentials to order a ride for the both of them. While he insists to have logged out after doing so, due to an alleged software glitch, the UBER app continued to send reports of all his rides thereafter to his wife’s cell phone. Comparing a real-time record of her husband’s whereabouts with his accounts led her to realize that he was having an affair and ultimately to divorce from the adulterer.
Now, apparently, the left alone Frenchman sued UBER for €45m in damages. It is to be expected that the trial outcome will decisively influence UBER’s future CSR efforts to protect the family as an institution.
Read here about the hilarious events in The Guardian.
The recently established Cornell College of Business, umbrella to the Charles H. Dyson School of Applied Economics and Management, the School of Hotel Administration, and Samuel Curtis Johnson Graduate School of Management, has been renamed Cornell SC Johnson College of Business after a $150 million gift from SC Johnson and its CEO H. Fisk Johnson who holds five Cornell degrees. Due to parts being dedicated as a challenge grant the potential impact of the gift amounts to $300 million.
Read the Wall Street Journal’s account here.
The NY Times connected, if only loosely, surging populist movements in Western Europe to the election of Donald Trump in this article yesterday. While not explicitly stated, I would argue it creates the impression Trumps’s election acts as a catalyst for their cause. In my opinion, Austria’s presidential election from Sunday suggests quite the contrary may be true as well. The idiosyncratic social environment of (in particular Western) European countries and the political positioning of the political parties in questions seem to be factors substantially contributing to whether the outcome of the US presidential election supports or weakens the populist movement’s chances for success.
Critics denounce the Austrian presidential election as irrelevant and of no importance, since the president of Austria is not a “head of government” comparable to the United States or France. On the other hand, however, he is responsible to uphold the balance between the executive, legislative and judicial powers and is enabled to do so by a number of constitutional rights. Once elected, the Austrian president temporarily suspends his party membership to serve as an independent bridge builder. In other words, the Austrian president is definitely more than a figurehead or welcoming clown (the German “Gruss-August” is a frequently seen defamation of the German president who is not equipped with similar constitutional powers).
The recent Austrian presidential election last Sunday was initially supposed to take place at the beginning of May of this year. And it did. Since none of the candidates achieved the necessary absolute majority on the fist ballot, a run-off two weeks later saw the former university professor and political representative of the Green Alternative party (according to their charter driven by direct democracy, nonviolence, ecology, solidarity, feminism and self-determination), Alexander Van der Bellen, come out on the top against Norbert Hofer, candidate for the Freedom party of Austria, a national conservative, anti-immigration and Eurosceptic party.
A novelty in Austrian history, the run-off did not feature a candidate from either of the two (former) major parties, the social democratic and the people’s party, who basically led the Austrian government since the country’s inception as a republic (and do so currently). While Hofer won 50% more votes than Van der Bellen on the first ballot, the latter won the run-off by the thinnest of margins (50.35% to 49.65%) as many moderates and traditional voters of the major parties united behind the former university professor to oppose a major right shift in Austrian politics.
The results of this run-off, however, were annulled after the constitutional court of Austria found that Austrian electoral law had been disregarded by counting over 77,900 votes improperly too early, however without any indication of votes having been fraudulently manipulated. The second round re-vote was planned for October, but embarrassingly had to be postponed to December 4th 2016 due to faulty glue on the voting envelopes.
Although neither candidate was a member of either of the two reigning parties, Norbert Hofer was much more perceived as an anti-establishment candidate, in particular after Van der Bellen received endorsements by member of of both major parties. This fact, coupled with infrequent but persistent accusations of fraud had more than a few experts and many Austrians contemplate that Hofer was going to win the re-vote quite comfortably. Polls conducted after the annulling supported this stance. Then, however, things turned out quite differently from what was expected. Alexander Van der Bellen also won the second run-off and, this time around, with a margin as significant as unexpected 53.79% to 46.21%, i.e. by more than 7%.
Donald Trump did not win the US presidential election because he and his supporters mobilized voter types he was not supposed to attract. The forecasts rather got the numbers of people showing up at the urn horribly wrong. The turnout among Trump supporters was significantly underestimated whereas the opposite held true for Clinton supporters. Austrian voters, many of whom closely followed the US election, learned their lesson from the events in the US. Overall voter turnout was about 75%, a very decent outcome when compared to recent trends. In particular, better educated Austrians, the majority of which tends to vote more around and even left from the political middle are more likely to follow international news. The other force which potentially made a difference were anti-establishment protest voters getting cold feet the second time around. Without knowing the exact numbers, this could explain why the absolute number of votes Norbert Hofer received decreased, although overall voter turnout rose by 2%. These voters may haven been discouraged by the uncertainty and the controversial choices for public office in the aftermath of the Trump election.
The above mentioned NYT article lists European populists and does not differentiate between those positioned on the left from those on the right side of the political spectrum. An interesting (untested) hypothesis is that the outcome of the recent US presidential election may, however, influence populist movements in Europe differently, depending on their political position. Trump’s election may well act as a catalyst for anti-establishment movements in general. On the other hand it might induce hesitation of anti-establishment protesters to vote for the right and a higher voter turnout among liberals. As a consequence, Trump’s triumph ironically may well halt or at least slow down some of the nationalist tendencies observed in recent elections across Europe and potentially swing the pendulum towards liberals in particularly hard fought and tight elections.
Lastly, dedicated to my economist friends: To the best of my knowledge, Austria is now the first and only country ever, whose president published an article in Econometrica.
OPEC has finally agreed on a deal, in Vienna of course, to cut oil output causing the oil price to immediately surge by 8%. While there is still uncertainty whether the once mighty cartel still has the ability to enforce, the questions whether they will ever again agree on deal seem to be answered.
Look here for a comprehensive treatment in the Wall Street Journal.
This post is not intended as a critical statement about the ultimate outcome of the presidential election last Tuesday. If one believes in democracy paired with the power of an absolute majority and the equality of all people—independent of gender and ethnicity—being the highest goods a free nation has to strive for, one also has to accept the fact that at times the outcome of an election may collide with one’s worldview.
But that’s also the crux of the matter. Irrespective of this week’s popular vote, the American people are not as equal as the famous passage of the constitution suggests. Putting aside the even less transparent discontinuities implied by the block vote of a state’s electoral college (which encourages parties and their candidates to go after the pivotal voter in a non-exhaustive number states rather than the national one), an elector in Texas is represented by approximately 700,000 voters whereas a member of Wyoming’s college is backed by around 180,000. In an overly simplistic way, that means that a Wyoming vote weighs about four times as much as the vote of a Texan.
Even worse, the electoral college goes back in part to James Madison and his three fifth rule, a rule ensuring the ability of the south to prevail in presidential elections by allocating three fifth of the vote of a “free man” to every slave. Far more scandalous than the fact that votes were not equally important, weighed the fact that this three fifth vote did not even allow slaves to express their free will at lower value but effectively endowed their owner with one massive vote.
Now, slavery has long gone, but inexplicably the inequality of votes remained. The American presidential election, as of now, is based on an imbecilic (and non-transparent to its actors) concept partially based on an even worse ancient rule. While Americans are known to be rather mobile when compared to other nations, the high ratio of people living in the state where they were born suggests that the choice of where to settle is far from a free one for many. Thus, essentially the electoral college system discriminates by birth place.
Many voices currently point at the popular vote with frustration and express the need for change. These comments are however identical to what we heard after the 2000 presidential election. Due to the fact that the electoral college favors parties with more support in rural areas, the incentive to switch to a popular vote is one-sided. Thus, do not expect the popular vote to come in the foreseeable future as it would require a wide consensus. In particular, the so-called swing states are unlikely to collaborate as it would significantly diminish their importance.
While we have undoubtedly seen progress since the three fifth rule, there is so much yet to do to eradicate discrimination from our daily lives. The electoral college system, though, will happily guarantee that many living in the self-proclaimed leading country of the free world are discriminated by birth, independent of how much we achieve on other fronts.
A recent (seemingly unsuccessful) stint hunting for non-academic articles on spatial aggregation of stores produced curious results. Naturally, many people observe at some point that a.) supposed fierce competitors like Exxon/Mobile and Shell or CVS and Walgreen’s surprisingly frequently appear in tandem, that is to say right next to each other and b.) often even bigger groups of competing stores like car dealerships seem to cluster in certain areas.
Eager for knowledge as human beings (ideally) are, the internet provides massive evidence for users on the quest for the roots of the above described phenomena. Now, the curious part are the answers floating around on the world wide web. Surprisingly, there seems to be no popular trusted media outlet which answers the question (I am thankful if proved wrong and pointed towards the desired direction). Among the attempts showing the most hits is a short SAP article published via Forbes’ BrandVoice feature which can be found here. A few seconds suffice to realize that this article is merely an executive summary of a blog post of author Presh Talwalkar which itself can be found here. These two pieces are (near) perfect representatives of the majority of (non-academic) justifications of the two above scenarios on the internet.
They, correctly, link scenario a.) above to the basic Hotelling model. Hotelling explains in a simple model why strategic reasoning leads two competing stores to choose an identical location in a local duopoly. In order to stress the old example once more, consider a (linear) beach served by two ice cream stands. Assume the beach to be busy, such that potential customers are distributed uniformly over its entire length. Further assume, for simplicity, that the stands offer the same flavors and quality of ice cream at identical prices and competition is purely executed via location. Since walking over hot sand is uncomfortable, every customer opts to buy ice cream as close as possible to her towel spot. Game theory predicts that both ice cream vendors end up in the middle back to back. Why is that? Suppose one of the vendors to position his stand anywhere north (south) of the middle. Its competitor could swiftly just move an inch south (north) of it to ensure himself more than half of the customers. As a consequence, both stands right next to each other in the middle constitutes the unique Nash equilibrium of the outlined game since in any other scenario at least one of the vendors can make himself better off by unilaterally moving his stand. This is a “strict” Nash equilibrium in the sense that every unilateral deviation causes a vendor to be worse off.
While this simplistic model does not capture the entirety of location choice in duopolies in reality, it is a perfectly reasonable approach to explain why CVS and Walgreen’s can be frequently found across the street of each other, or, as in this special case in Edina, Minnesota, in such close proximity to each other that drive through clerks can wave to each other. In fact, numerous academic articles have claimed that the simple Hotelling approach is a powerful predicition tool in local duopolies. It is, however, crucial to understand that this behavior is nothing specific to representatives of national or global chains as some articles on the internet want us to believe. The simple Hotelling duopoly model applies to strategic competition of national giants CVS and Walgreens in downtown Chicago or San Francisco as much as it does to family operated pharmacies in a rural village in Maine (as long as the village is sufficiently populous to have two pharmacies operate profitably).
The more striking claim to be found in the above referenced articles and the set of pieces they represent is, however, that this logic generalizes to clusters of competing stores like car dealerships. It is straightforward to falsify this claim. Reconsider the above discussed ice cream vendors and bring a third one into play. If this entrant positions himself right in the middle of the beach next to the two incumbents he can expect to serve approximately a third of the beach population drooling over ice cream. Moving slightly north or south of the middle, however, ensures him nearly half the customers. As a result, the basic Hotelling model does not explain why you typically drive by car dealerships for minutes once you passed the first. The logic of the Hotelling model does simply not extend to a scenario featuring a number of competitors in excess of two. Analogously, the same reasoning explains why in a two party system winning the median voter is key, whereas in a multi party system we witness parties positioning significantly to the left or right of each other.
Clustering of car dealerships, furniture stores, etc. is much more likely to be caused by a common effort to reduce customers’ search costs combined with zoning restrictions set by municipalities. Simplified, as car dealerships (to stick to one story) are typically located on the outer fringes of urban areas, it would be mighty costly for a potential customer to drive all over town to compare and test drive vehicles of multiple brands. Thus, she is likely to pre-select a smaller number of manufacturers to visit in the first place. This, in turn, would result in a lower average number of potential customers to enter a car dealership every given day. This reasoning is also consistent with the fact that it has been observed that brands which are closer substitutes to each other are more likely to be found in clusters. Chicago’s northern suburbians for instance may find Subaru, Volkswagen, Mazda, Nissan and Fiat in the Evanston/Skokie area whereas Mercedes, BMW, Infiniti, Volvo and Land Rover are located on the same road in Glencoe.
In the case of dealerships selling bulky and expensive items which require huge parking lots, loading and storing capacity or direct access to roads in the case of cars, regulations passed and incentives provided by local governments seem to further foster clusters. In order to raise their attractiveness to potential customers and residents alike, municipalities might restrict potential storefront locations via zoning or grant tax reliefs to induce the birth of shopping parks. While such factors might also come into play regarding clustering of pharmacies or gas stations, they seem to be less likely the driving forces behind the location coupling of competitors. On the other hand, central strategic positioning predicted in the Hotelling duopoly does not account for suburban clusters of car dealerships as exemplified with three ice cream vendors above.