Do organizations "test" the decisions they make?

When his firm decided to introduce a Christmas menu into their restaurant chain, one of my students decided to test the profitability of the change by introducing it in only half the restaurants in his territory. By comparing sales changes at these restaurants (the "experimental group") to changes at restaurants that did not introduce the menu (the "control group"), he concluded that the change did little to increase overall sales, despite the apparent popularity of the menu.

This inference was possible only because my student constructed what economists call a difference-in-difference estimate of the change. The first difference is before vs. after introduction of the menu; the second difference is between the experimental and control groups.

The difference-in-difference methodology controls for other unobserved factors that might have accounted for the change. The FTC has released a number of studies following up on merger enforcement decisions to try to figure out whether they did the right thing. For two consumated oil mergers, FTC economists Dan Hosken and Chris Taylor (article) and John Simpson and Chris Taylor (article) found that prices in cities affected by the merger did not increase relative to prices in control cities. In the time series graph below, the three lines represent gas prices of the experimental city (Louisville) relative to gas prices in three control cities (Chicago; Houston; Arlington, VA) for the Marathon Ashland gasoline merger. The vertical line represents the date of the merger. By comparing prices before and after the merger, we see the merger had no effect, or that the FTC was correct to let it through without a challenge.
FTC General Counsel (now Commissioner) Bill Kovacic coined the term "Enforcement R&D" to describe the practice of government agencies following up on their decisions to improve policy (article).

I would like to hear stories from readers about how, or if, their organizations test decisions.

NOTE: This post is copied from our old, almost defunct blog, Management R&D.

Soft drink manufacturers collude to stay out of schools?

Is this anti-competitive behavior in the public interest?

Let’s face it. The real reason the competing beverage companies agreed to this campaign is because they want to preempt more onerous regulation and/or “sin taxes” on sugary drinks. (See these articles from Advertising Age.) Unlike the purported goal of enhancing output by creating goodwill, this goal is best served by concerted, rather than individual, action. That’s because voluntary action to preempt more onerous regulation is subject to a collective action problem. Any firm that voluntarily cuts back its sales to forestall regulatory action will want to sacrifice as few sales as possible. Each firm also knows that in deciding whether to impose restrictions, regulators tend to look at overall industry trends. Each firm therefore wants its rivals to cut back a lot (so that the industry as a whole appears to be acting responsibly) while it cuts back only a little (thereby minimizing the cost of its preemptive strategy). If every firm has this attitude, though, the total voluntary reduction by the industry as a whole won’t be sufficient to prevent regulatory action. Thus, rivals seeking to forestall more onerous regulation need to commit to each other that they will each achieve specified reductions.

Should teachers be able to unionize?

The Wisconsin legislature thinks so, but without merit pay how do they align the incentives of teachers with the goals of schools?

The result for white-collar, professional unions has been the almost complete elimination of merit pay or promotion, in favor of a salary grid based on seniority and extra credentialing that has rarely been associated with productive and quality work. For teachers the record of merit pay, career ladders, or tying rewards to how well students learn, has been abysmal. The Obama administration has placed great importance on creating merit pay tied to student outcomes, but they to date have no record of success and many experts are betting on the teacher unions to outlast the administration.

The case gets much worse at the university level. The reason is that there are three realities about American universities that are not often admitted or discussed, but may well be among the reasons that our universities remain the envy of the world, certainly at the research level. Those realities are: 1) colleges and universities are built on inequalities between campuses, within campuses, and within departments; 2) teaching is considerably less demanding than K-12 teaching, even at non-research universities; and 3) at research universities we currently fire about half of faculty hires because they fail to get tenure.

Aussies Discuss the European Financial Situation

HT: Boing Boing

All we need is Better Regulation

Who has the incentive to investigate and expose corporate fraud? In "Who Blows the Whistle on Corporate Fraud?," forthcoming in the Journal of Finance, Dyck, Morse, and Zingales investigate 216 corporate fraud cases from 1999 through 2004. They find:

... little support for the legal and private litigation views, as the associated dummies are not positive as predicted but rather negative (and significant). This is not very surprising since in Table 2 we saw that auditors catch a mere 10.5 percent of the cases, while the litigation lawyers catch 3 percent.

I reproduce the relevant information from table 2 in pie chart form here.
What does work?

By contrast, we find strong support for the importance of the other three factors. As expected, detectors with monetary or career incentives are more likely to blow the whistle, as are detectors with better access to information.

I am struck by how little fraud is found by all types of government agencies. It suggests that the currently debated financial regulation overhaul is not likely to have a major effect on actual fraud.

When should you trust your instincts?

McKinsey offers a four-point test:

1. The familiarity test: Have we frequently experienced identical or similar situations?
2. The feedback test: Did we get reliable feedback in past situations?
3. The measured-emotions test: Are the emotions we have experienced in similar or related situations measured?
4. The independence test: Are we likely to be influenced by any inappropriate personal interests or attachments?

Game Theory Videos

Here are 26 short videos on a variety of game theory topics. The videos are thanks to William Spaniel, a graduate student at University of Rochester.

(HT: Freakonomics)

Now that we have a European style welfare state, lets learn how to run it efficiently

Advice from Swedish Economist Andreas Bergh: don't spend your taxes on an inefficient public sector:

Sweden is not a socialist success story but instead owes its economic growth to the lowered tax rates and deregulation of the early 1990s, which allowed innovation and investment to flourish. Bergh also discusses how Sweden's national voucher program revitalized the country's educational system and warns that Americans who are hoping to emulate Swedish success by growing the public sector are learning the wrong lessons from Sweden.  

 

Plan B

Where is Capitalism still viable?

For the first time in decades, Singapore (1) and Hong Kong (2) have topped the USA (3) in IMD’s World Competitiveness Yearbook rankings. They are so close, however, that it would be better to define them as the leading “trio”. In the first 10 places: Australia (5), Taiwan (8) and Malaysia (10) also benefit from strong demand in Asia. Switzerland (4) maintains an excellent position characterized by strong economic fundamentals (very low deficit, debt, inflation and unemployment) and a well-defended position on export markets. Sweden (6) and Norway (9) shine for the Nordic model, although Denmark (13) surprisingly loses ground, in particular due to the pessimistic mood expressed in the survey.

Not surprisingly Germany (16) leads the larger “traditional” economies such as the UK (22), France (24), Japan (27) and Italy (40). Despite a significant budget deficit and growing debt, Germany’s performance is driven by strong trade (second largest exporter of manufactured goods), excellent infrastructure, and a sound financial reputation. It was also to be expected that China (18) would lead the other BRIC nations, followed by India (31), Brazil (38) and Russia (51). And of course the credit-worthiness storm that affects Southern Europe acts as a drag on the performance of Spain (36), Portugal (37) and Greece (46).

One day, I will be able to say that I taught them