Stanford Business Magazine November 2007

Exponential Education

The Business School’s highly selective doctoral program shapes business education and practice.

Monika Piazzesi, PhD '00 and professor at the University of Chicago, is “probably the superstar of the new generation of specialists in asset pricing,” says her GSB thesis advisor, Darrell Duffie.

By Margaret Steen

When members of the Federal Reserve are contemplating a change in interest rates, one way they predict how the bond markets will react is to use a model developed by Monika Piazzesi, PhD ’00. Piazzesi’s work models the relationship between bond prices, which are tied to interest rates, and trends in the macro economy such as unemployment or a recession.

She started on this work because one of her professors at the Stanford Graduate School of Business, Darrell Duffie, has the confidence to tell his students what he doesn’t know as well as what he does, and then guide them as they find the answers. In Duffie’s class Piazzesi learned that standard bond pricing models did not take overall economic trends into consideration, an omission she set out to rectify.f

Crombez

Athey Receives Award
Read how Susan Athey, PhD '95,
received the prestigious John Bates
Clark Medal in the August 2007
Stanford Business magazine.
The award to an economic theorist
is seen as a "return to
fundamentals" in her field.

Built on this sort of interplay between professors’ research and that of their students, the GSB’s doctoral program produces work that often changes the practices of businesses and other institutions. Because doctoral students must make a substantial, original contribution to knowledge in their field to earn their degree, faculty members play an unusual role: They must guide their charges toward answering a question when they don’t know the answer themselves. The answers may affect how governments auction off access to the public airwaves or the way businesses do accounting. At the pharmaceutical company Merck, for example, some executives were known in the 1990s to call one of their accounting analysis tools “The Darrell.”

The PhD Program is much smaller than the MBA Program, with only about two dozen new students enrolled each year. Each has his or her tuition paid and also receives a combination of fellowships and research and teaching assistantships.
“One of the biggest challenges any PhD student faces is the transition from coursework to independent research,” said Ken Singleton, the Adams Distinguished Professor of Management, senior associate dean for academic affairs, and faculty director of the doctoral program, which has students and faculty in seven different areas of study. The school is developing its research practicum to help students make this leap, as well as a teaching practicum so they can gain experience in the classroom.

The PhD Program is critical to the Business School’s culture as an academic institution as well as to the scholarly reputations of its tenured faculty, nearly all of whom are considered top scholars in their field and who continue to produce new insights, partly by guiding the research projects of PhD students. Because the program trains future teachers at other institutions, it also helps disseminate the GSB’s approach to business education. Recent doctoral graduates have been hired at universities that include Harvard, Massachusetts Institute of Technology, Columbia, Northwestern, the University of Pennsylvania, and the University of Chicago.

The program is “one of the things that make this place a great intellectual environment,” said Mary Barth, the Joan E. Horngren Professor of Accounting and senior associate dean for academic affairs. “It’s great to have young minds around who are asking ‘why?’”

As the faculty expands and becomes more engaged in research that requires a greater number of assistants, the PhD Program may grow slightly, Singleton said. Faculty like to collaborate with PhD students because “it increases people’s productivity and enjoyment and strengthens the School as a whole,” he said.

Doctoral students also like to collaborate with faculty and often develop lifelong working relationships with their mentors. Here are examples of PhD alumni and four Business School faculty whose intellectual reach was expanded through their former students.

Nonmarket Forces on Business

Christophe Crombez, PHD ’94, came
to the Business School because of
Professor Dave Baron’s reputation
for studying the impact of politics
and other nonmarket forces on
business. Now a professor
at the University of Leuven in
Belgium, Crombez also teaches
at Stanford.

In 1988 when Christophe Crombez, a college student in Belgium, was looking through brochures for graduate programs, he happened on one that seemed a perfect combination of his interests in politics and economics: a PhD in political economy from the Stanford Graduate School of Business. It was, at the time, an unusual field of study, so he asked his professors for advice. They spoke very highly of the Stanford professor who had set up the program and encouraged him to apply.

That Stanford professor was David Baron, today the David S. and Ann M. Barlow Professor of Political Economy and Strategy, Emeritus. Baron had been working at the intersection of business, economics, and politics since the 1970s when he began studying regulation. As he looked at the calls for deregulation by critics of government intervention, Baron realized that economics alone couldn’t explain the interaction between government and business.

Establishing a new field of scholarship doesn’t happen overnight. In 1981, the GSB hired Baron away from Northwestern to focus on how firms respond to outside pressures. “It wasn’t a recognized field of study at the time,” Baron recalled. “We sought to change that. Our objective was to have an impact on business education and to develop this particular area that hovered around government, social issues, and ethics.” He started developing a base of scholarship on nonmarket forces; for instance, how outside groups can threaten boycotts and drive media coverage in an attempt to make companies change their conduct.

“One of the many things I admire about Dave Baron is how he was both willing and able to switch from doing world-class research in the economics of regulation and incentives to doing world-class work in political economy and nonmarket strategies,” said Dennis A. Yao, PhD ’84, the Lawrence E. Fouraker Professor of Business Administration at Harvard Business School. Yao, who was hired in 2004 by Harvard, in part to expand that school’s teaching and research in nonmarket strategies, was a PhD student when Baron arrived at Stanford. He knew about Baron’s work, so he simply went to his office and introduced himself.

“Dave is such a gracious guy,” Yao said. “He said, ‘I’d be delighted to talk with you—let’s just meet every so often.’ The level of his commitment to his students has been extraordinary.”

Today, Baron’s contributions in both political science and economics have led to courtesy appointments in both those academic departments at Stanford. And the field has enough active faculty participants to hold an annual conference and teach courses at many business schools.

The courses often use Baron’s textbook, which, Yao said, “has become the reference manual for people working in the business environment and nonmarket strategy area.” Deregulation, the rise of nongovernmental organizations, and increased media interest in business all have raised the level of interest in nonmarket forces on business.

Crombez, PhD ’94, who adapted the ideas to a European setting and developed a similar class at the University of Leuven in Belgium, said Baron “has been very influential in several fields of research, and has definitely had lots of impact on the curriculum of business schools in the U.S. and abroad.” Crombez now splits his time between Leuven and Stanford’s Freeman Spogli Institute for International Studies. He also teaches a class on European politics and business at the GSB.

Baron’s way of thinking about external forces on business has had effects beyond academia. Yao said that when he spent three years as a commissioner at the Federal Trade Commission, Baron’s ideas helped him analyze the FTC’s relationship to the businesses it regulated, especially in situations where the regulator lacked critical information that the firms had.

Reshaping Accounting

When Mary Barth researches questions such as whether stock-based compensation should count as an expense, she has firsthand knowledge of how her results may affect companies. Barth was an audit partner at accounting firm Arthur Andersen before a conversation with the GSB’s Bill Beaver, the Joan E. Horngren Professor of Accounting, Emeritus, sparked her interest in getting a PhD.

Doctoral students each year honor a professor whom they consider to be an outstanding mentor.
Professors honored in recent years include, from left: Dave Baron, the David S. and Ann M. Barlow
Professor of Political Economy and Strategy, Emeritus; Mary Barth, the Joan E. Horngren Professor
of Accounting; Darrell Duffie, the Dean Witter Distinguished Professor of Finance;
and Bob Wilson, the Adams Distinguished Professor of Management, Emeritus.

Today, Barth is firmly rooted in the academic world, but she also spends half her time as a member of the International Accounting Standards Board (IASB), which develops and promotes accounting standards used in more than 100 countries.

“In many cases as a standard-setter, she’s facing questions that the IASB doesn’t know the answer to. Those questions spur some of her research,” said Stephen Stubben, PhD ’06 and assistant professor of accounting at the University of North Carolina at Chapel Hill. As a student, Stubben worked with Barth to answer some of those questions. “It is very rare to find someone as accomplished and respected as she is in both academia and business practice. And I think the reason she’s able to do that so successfully is that she finds synergies between the two.”

On the question of whether companies should treat stock option grants as expenses, Barth examined share prices, returns, and accounting numbers to understand how investors viewed the issue. “Our studies showed pretty clearly that investors do perceive it as an expense,” she said.

Research like Barth’s was key to Stubben’s switch from a planned career as a public accountant to the academic world. “I was interested in how accounting research could be used to form accounting standards, which affect the whole economy,” he said. When he came to Stanford, he hoped to work with Barth.

“At the end of my first year, she contacted me, knowing that I had an interest in her line of research, and asked if I wanted to work with her on a project that she was just starting,” Stubben said.

The project, which was related to a question facing the IASB, had to do with how a company’s debt should be accounted for and whether changes in a company’s credit risk should affect the reported value of debt. “A lot of people don’t think debt values should incorporate changes in credit risk,” he said. “But the evidence suggests that it reflects an economic reality.”

In an extreme case, he explained, if a company has no chance of paying off a $1 million debt, then that debt has no value. By contrast, a $1 million debt that is certain to be paid back is highly valuable. Some people argue that $1 million owed should appear on a company’s financial statements as a $1 million debt, regardless of credit risk. And it may seem counterintuitive that the company with the better credit risk would have a worse balance sheet. Stubben and Barth found that companies’ stock prices do generally decline when their credit risk increases. But they fall less for companies with more debt than for those with less.

Stubben learned more from his work with Barth than just the outcome of the research, which they and a third author, Leslie Hodder of Indiana University, are still finishing. “She was teaching me how to conduct academic research,” Stubben said, from framing questions to presenting findings.

Barth is also an expert on accounting in other countries. She advised Kazbi Soonawalla, PhD ’02 and now a tenured lecturer at the London School of Economics and Political Science, on her dissertation, which looked at how capital markets reflected the different accounting treatments for joint ventures in the United Kingdom, the United States, and Canada. She helped Peter Joos, PhD ’97, finish his dissertation on how different accounting systems affected the capital markets in the European Union.

Barth’s comfort with both the corporate and academic worlds rubs off as well: Joos recently left an academic position to work in Morgan Stanley’s equity research office in Hong Kong. “It’s like being a professor, but within a bank,” he said. “It’s a real-world application of a lot of the stuff I’ve studied.”

Modeling Financial Risk
Darrell Duffie’s research on credit-risk modeling takes him to the world’s investment capitals where he leads seminars on how to measure the risk of loaning money to a corporation or a country, and how to price credit derivatives that protect against that risk.

Although Duffie, the Dean Witter Distinguished Professor of Finance, has done groundbreaking work on credit risk and more generally on securities markets, he is also quick to point out the holes in the models academic researchers use. As a result, his students have plenty of research topics.

“When I started working with Darrell during my dissertation, models of bond prices didn’t relate bond prices to what was going on in the macro economy,” said Piazzesi, professor of finance at the University of Chicago Graduate School of Business. “There was no connection between interest rates and GDP growth or whether we were in a recession or not. Darrell said early on that this was an important connection to make.”

Building on mathematical models that Duffie and Ken Singleton had developed, Piazzesi found a way to add these variables to the models for predicting interest rates.

“There had been some unexplained features in the behavior of interest rates that only became clear once Monika’s work was done,” Duffie said. For example, the price of an option to buy a bond reflects how much uncertainty there is about how much the bond will cost in the future. A lot of uncertainty means the option is worth more, since there’s a better chance that the price will go up and make the option more valuable. For reasons that no one had understood, the uncertainty regarding bond prices seemed to be greatest for those options expiring in roughly two years. Now, because of Piazzesi’s research, it is more clear that this time profile for uncertainty is connected to the availability of macroeconomic information and to how the Federal Reserve might act on it.

The Federal Reserve uses Piazzesi’s models in reverse, to assess the potential effects of changes in interest rates. “They don’t want to generate big chaos in the financial markets,” she said.

Piazzesi has since extended these ideas and is now the head of the Program in Asset Pricing at the National Bureau of Economic Research. “She’s probably the superstar of the new generation of specialists in asset pricing,” Duffie said.

Piazzesi credits Duffie with giving her the idea for some of her more current work in real estate as well. “In his class, I remember he mentioned that most of the models we’re using today do not have, for example, real estate as one of the assets that households choose,” even though for most households their home is their largest asset. She has written a number of papers that try to account for real estate when considering individuals’ investing decisions.

Piazzesi, whose first PhD student graduated earlier this year and is taking a job at MIT, said she still relies on Duffie for advice. “I don’t have the luxury of having Darrell in the office next door,” she said. “But when there’s something that I find very difficult to think about, I ask Darrell.”

Market Designers
Decades of research by Robert Wilson and his academic protégés have influenced markets for everything from electricity to advertising to higher education.

Wilson, the Adams Distinguished Prof- essor of Management, Emeritus, was one of the first people to apply the principles of game theory—the idea that how people interact in a market affects the outcome—to market design.

“Bob was very interested in practice,” said Chris Avery, PhD ’93 and professor of public policy at Harvard’s Kennedy School of Gov-ernment. “We were in this very high-powered program—who can prove the most theorems, take on the most mathematically challenging problems.” Yet Wilson said it was OK to think about real-world applications as well.

“What was so extraordinary about Bob as an advisor was that his students had worked on a wide range of different topics, all connected broadly to his area of expertise,” Avery said. A few of those topics:

Wilson and former students Paul Milgrom, PhD ’79, and Peter Cramton, PhD ’84, have helped design spectrum auctions, government auctions of the public airwaves.

Auctions are a particularly good area for economic theorists who want to gain a deeper understanding of markets and price setting, because participants tend to be well informed and have a lot at stake, said Cramton, professor of economics at the University of Maryland. He recently worked with regulators in the United Kingdom to design a spectrum auction there. “The distance between the state-of-the-art theory and the application is essentially zero.”
Spectrum auctions are complicated because the value of different parts of the spectrum may vary depending on who is buying and what else they can get along with it.

“It could be that an existing cell phone operator wants to deepen service and another only wants it to cover the whole country for national service,” said Milgrom, the Shirley and Leonard Ely Professor of Humanities and Sciences in Stanford’s Department of Economics. “It makes this much more complicated than the sale of a single item.” Along with Wilson, he advised the Federal Communications Commis- sion as a consultant to Pacific Bell in the early 1990s. Many of their suggestions were adopted wholesale by the FCC.

The market for electricity is “the most complex thing you could imagine,” Wilson said. He and Cramton consult with system operators in the United States and abroad. “The idea is to design these markets that enable the buyers and sellers to express their preferences and then have reliable electricity at the lowest possible price,” Cramton said.
Google, Yahoo, and other internet search engines use auctions to sell ads on their sites. The losers don’t leave empty-handed, as in a more traditional auction, but instead pay less for a less desirable placement for their ad. Michael Ostrovsky, assistant professor of economics at the GSB, who studied with one of Wilson’s students, Alvin Roth of Harvard University, PhD ’74, has researched these auctions and figured out how rational advertisers would bid in them. Understanding bidders’ behavior can help improve the design of these auctions, making them more efficient and lucrative. Ostrovsky now advises one of the search engines on ad auction design.

“I think that’s something very much in line with the Bob Wilson tradition—the research has very direct practical implications,” he said.
Education may seem far afield from auctions, but game theory can be used to assess the impact of college admissions programs. Wilson’s former student Avery has done research that may have played a role in some colleges’ decisions to change their early admissions policies. “We documented that colleges were favoring early applicants,” Avery said. Since students who didn’t have counselors helping them through the admissions process were less likely to apply early, they were at a disadvantage.

Wilson’s wide-ranging interests make students eager to work with him. When Milgrom entered the PhD Program, a fellow student told him he needed to land Wilson as an advisor, so Milgrom took a class from Wilson and wrote a term paper extending Wilson’s work on competitive bidding. It worked: “Bob was extremely excited by my paper,” said Milgrom, who now lives across the street from Wilson and sees him out walking his dogs. “He said, ‘Well, this is nearly a PhD thesis. All you have to do is write an introduction and a conclusion.’”

Once they were working with him, students found Wilson a dedicated advisor. “I would go to Bob thinking that I had just discovered something that had totally invalidated all my results and I would have to start over,” Avery recalled. “An hour later I’d come out, thinking, ‘Bob just saved my dissertation.’”

It was two of Wilson’s students who started Ostrovsky on his own research path. Ostrovsky took a class on market design with Roth and Milgrom, who was visiting at Harvard. “I knew that I liked economics, math, and game theory,” Ostrovsky said. “I was very excited by this combination. It’s interesting mathematically, it’s very rigorous, and at the same time it has these very obvious real-world applications. However, I didn’t want to just keep doing research on the same specific markets. I wanted to look at something that hasn’t been studied before.”

This combination of academic rigor and real-world application is at the heart of the Business School’s PhD Program, whose graduates’ influence extends to businesses around the globe. “We’re disseminating a view of the world and management education,” Singleton said. “We’re enhancing the training of future managers all over the world.”

Wilson et al

Game theorist Bob Wilson has been a prolific producer of university professors, many of whom came to a 2002 conference held at Stanford in honor of his 65th birthday. Front row from left: Avraham Beja, ’67, University of Tel Aviv; Steinar Ekern, ’73, Norwegian School of Economics and Business Administration; Claude d'Aspremont, ’73, University of Louvain; Bob Wilson; Muhamet Yildiz, ’01, MIT. Middle row: Paul Milgrom, ’79, Stanford; Takao Kobayashi, ’78, University of Tokyo; Peter Cramton, ’84, University of Maryland; Sridhar Moorthy, ’83, University of Toronto; Jean-Pierre Ponssard, ’72, Ecole Polytechnique; Howard Raiffa, Wilson’s thesis advisor at Harvard; Peter Jennergren, ’71, Stockholm School of Economics. Back row: Marciano Siniscalchi, ’98, Northwestern; Joseph Sakovics, ’90, University of Edinburgh; David McAdams, ’01, MIT; Alvin Roth, ’74, Harvard; Christopher Avery, ’93, Harvard; Sushil Bikhchandani, ’86, UCLA; and Bengt Holmstrom, ’78, MIT.

Ph.D. Program Facts
ANNUAL APPLICANTS	over 500
ACCEPTANCE RATE	5 to 8 percent
ENTERING STUDENTS EACH YEAR	20 to 25
SEVEN AREAS OF SPECIALIZATION	Accounting; Economic analysis and policy; Finance; Marketing; Operations, information, and technology; Organizational behavior; Political economics
LENGTH OF PROGRAM	4-5 years
TOTAL PHD PROGRAM GRADUATES	685
COUNTRIES REPRESENTED	over 20
AVERAGE AGE OF NEW STUDENTS	23.5
AVERAGE COST OF PROGRAM	$250,000

Stanford Business magazine

Exponential Education

The Business School’s highly selective doctoral program shapes business education and practice.

Monika Piazzesi, PhD '00 and professor at the University of Chicago, is “probably the superstar of the new generation of specialists in asset pricing,” says her GSB thesis advisor, Darrell Duffie.