Working Papers

Authors: Colin Mayer, Julian Franks, Luc Renneboog

Apr 2001

Economic theory points to five parties disciplining management of poorly performing firms: holders of large share blocks, acquirers of new blocks, bidders in takeovers, non-executive directors, and investors during periods of financial distress. This paper reports the first comparative evaluation of the role of these different parties in disciplining management. We find that, in the UK, most parties, including holders of substantial share blocks, exert little disciplining and that some, for example, inside holders of share blocks and boards dominated by non-executive directors, actually impede it. Bidders replace a high proportion of management of companies acquired in takeovers but do not target poorly performing management. In contrast, during periods of financial constraints prompting distressed rights issues and capital restructuring, investors focus control on poorly performing companies. These results stand in contrast to the US, where there is little evidence of a role for new equity issues but non-executive directors and acquirers of share blocks perform a disciplinary function. The different governance outcomes are attributed to differences in minority investor protection in two countries with supposedly similar common law systems.

JEL Codes: G3

Keywords: Corporate governance, control, restructuring, board turnover, regulation

Reference: 1999-FE-01

Authors: Daniel John Zizzo

Apr 2001

This paper presents an experimental test of the multi-stage patent race model by Harris and Vickers (1987). Tied competitors invested more when nearer the end of the race, but this may have followed from a more general and unexplained pattern of a positive correlation between investment and progress in the race. The relationship between investment and gap between competitors was mostly not as predicted. Also, leaders did not invest more than (not heavily lagging) followers, and the race did not approach monopoly as the gap between competitors widened. Overall, the evidence brings only limited support to the theory.

JEL Codes: C91, O31

Keywords: patent races, dynamics, experimental economics

Reference: 68

Authors: James Malcomson, Martin Chalkley, University of Dundee

Apr 2001

Fixed price payments for treatment of patients with a specified diagnosis are widespread in both US Medicare and the British NHS even though there are substantial variations in the cost of treatment. Theory suggests that, when there is asymmetric information about those costs, total payment can be reduced by cost sharing. This paper uses data from Medicare to assess the cost savings that might be feasible in practice from cost sharing. For diagnosis related groups with low cost variation, the calculated cost savings are approximately 7%. For those with high cost variation, the calculated cost savings are more than 60%.

JEL Codes: I11

Keywords: health services, Medicare, cost sharing, fixed prices

Reference: 69

Authors: Tim Jenkinson, William Wilhelm, Alexander Ljungqvist

Apr 2001

We examine the costs and benefits of the global integration of primary equity markets associated with the parallel diffusion of U.S. underwriting methods. We analyze both direct and indirect costs (associated with underpricing) using a unique dataset of 2,143 IPOs by non-U.S. issuers from 65 countries in 1992-1999. Bookbuilding typically costs twice as much as a fixed-price offer, but on its own, does not lead to lower underpricing. However, when conducted by U.S. banks and/or targeted at U.S. investors, bookbuilding can reduce underpricing significantly, relative to fixed-price offerings or bookbuilding efforts conducted by `local` banks. Compared to estimates of the benefit of secondary-market integration, the effects we find are substantially larger. These results are obtained after allowing for the endogeneity and interdependence of issuers` choices. For the great majority of issuers, the gains associated with lower underpricing outweighed the additional costs associated with hiring U.S. banks or marketing in the U.S. This suggests a quality/price trade-off contrasting with the findings of Chen and Ritter [Journal of Finance 55, 2000], particularly since non-U.S. issuers raising US$20m-80m also typically pay a 7% spread when U.S. banks and investors are involved.

JEL Codes: G32, F36, G24, G15

Keywords: Initial public offerings, bookbuilding, underwriting spreads, international finance, market integration

Reference: 2001-FE-06

Authors: Michael Biggs

Apr 2001

Formal models prove the possibility of positive feedback in collective action; the metaphors of historically minded observers convey the same insight. It is still neglected in the literature on social movements, which emphasizes exogenous factors above all, political opportunities rather than endogenous processes. This paper draws on an intensive investigation of strikes for the eight-hour day in Chicago in May 1886. It demonstrates that changes in economic and political circumstances cannot explain the magnitude of the strike wave. More importantly, it provides evidence for positive feedback in collective mobilization, showing how optimistic expectations percolated through the working class in the spring of 1886. As each new group of workers became hopeful enough to organize, the fact of their organization inspired other groups to follow suit. New hopes gave rise to new organization; new organization became evidence that such hopes were justified.

Reference: 040

Authors: Alan Morrison, Lucy White

Mar 2001

We analyse a general equilibrium model in which there is both adverse selection of and moral hazard by banks. The regulator has two tools at her disposal to combat these problems - she can audit banks to learn their type prior to giving them a licence, and she can impose capital adequacy requirements. When the regulator has a strong reputation for screening she uses capital requirements to combat moral hazard problems. For less competent regulators, capital requirements substitute for screening ability. In this case the banking system exhibits multiple equilibria so that crises of confidence in the banking system can occur. We also show that in either case, a system of deposit insurance funded through general taxation will be welfare-improving and will allow capital requirements to be eased.

Reference: 2001-FE-04

Authors: Peter Temin

Mar 2001

I argue that the economy of the early Roman Empire was primarily a market economy. The parts of this economy located far from each other were not tied together as tightly as markets often are today, but they still functioned as part of a comprehensive Mediterranean market. This conclusion is important because it brings the description of the Roman economy as a whole into accord with the fragmentary evidence we have about individual market transactions. In addition, this synthetic view provides a platform on which to investigate further questions about the origins and eventual demise of the Roman economy and about conditions for the formation and preservation of markets in general.

Reference: 039

Individual View

Authors: William Wilhelm

Mar 2001

Financial markets provide for trade in information because money is just a means of scorekeeping, a way of tallying the relative purchasing power of individuals and organizations. It can be a physical tally such as a coin made from rare metals or a paper claim on a government or other reputable agent that is difficult to counterfeit. But records of relative purchasing power also can be stored digitally as strings of ones and zeros if the storage medium is secure. Information generally is costly to produce but not to reproduce. In fact, information is perhaps too easy to reproduce once it is revealed, it is difficult to exclude others from further use of information. When the value of information mainly is strategic, as often is the case in financial markets, information producers have incentive to protect their investment by holding their cards close to the vest. But doing so obstructs trade and undermines the social interest in informationally efficient markets. Financial intermediaries promote trade in financial markets by balancing the tension between self interest and collective interests in information. Financial intermediaries endure a similar tension in their dealings with one another. Competition among intermediaries traditionally was fueled by the human capital of key families and individuals Morgan, Rothschild, Goldman, etc. whose names still dominate the financial landscape. Primitive information technology led early financial intermediaries to form information networks by scattering human repositories for information as widely as possible. 1 Fair dealing over time within the network led to strong relationships bound by trust through which information moved about more freely than it would have otherwise. Reputations and relationships, the foundations for trust, likewise are composites of information but information that is not so easily disembodied from its originator you can`t buy a reputation. Innovation flourished in the context of close relationships and powerful intermediaries that tempered competition and thereby protected easily copied ideas and products assuring at least a fair return on investment. The internet upsets this delicate balance. We may look back on the internet as having punctuated the evolution of financial market, but its effect will most likely be interpreted as different in degree not in kind from the effects of motorized transportation, the telegraph and telephone, low-cost computers, etc. The internet is just another technological advance along a path where human capital is being transformed and in some instances displaced by information technology that codifies what previously was embodied in human intermediaries. The tension between human capital and information technology, however, has profound consequences for the organization and management of intermediary firms. The small family partnerships that dominated early financial markets provided an environment in which human capital was nurtured and passed from one generation to the next. By contrast, the modern financial firm depends far more on financial capital to support the large-scale but low margin operations that remain when intermediary functions are codified.

Reference: 2001-FE-07

Authors: William Wilhelm, Alexander Ljungqvist

Mar 2001

Using a sample of both U.S. and international IPOs we find evidence of the following: IPO allocation policies favor institutional investors both in the U.S. and worldwide. Constraints on the discretion bankers exercise in the allocation of IPO shares reduce institutional allocations. Constraints on allocation discretion result in offer prices that deviate less from the indicative price range established prior to bankers` efforts to gauge demand among institutional investors. We interpret this as indicative of diminished information production. Initial returns, which reflect a significant indirect cost of going public, are directly related to this measure of information production and inversely related to the fraction of shares allocated to institutional investors.

JEL Codes: G32

Keywords: Initial public offerings; Bookbuilding; Underpricing; Intermediation.

Reference: 2001-FE-08

Authors: Daniel John Zizzo

Jan 2001

An experiment on choices between single and compound lotteries is presented, and results are calibrated with neural network models. Many subjects tend to average out probabilities, though behaviour becomes more rational with more exposure to compound lotteries in the practice stage. The Prior Knowledge Model hypothesizes that subjects categorize stimuli according to the prior knowledge acquired in their long-run learning history; practice stage cues help them referring to the relevant learning history. The trained networks predict the behaviour of about 3/4 of the subjects with transitive preferences; the model can explain where we would expect the trained networks to fail.

JEL Codes: C91, D81

Keywords: conjunction fallacy, neural networks, heuristics, probability compounding

Reference: 57

Individual View

Authors: Gregor Irwin

Jan 2001

This paper demonstrates how a currency board can become vulnerable to a crises in which the policymaker is forced to devalue. The model is built from two blocks: first, incomplete information about the devaluation cost faced by the policymaker; and second, unemployment persistence. Incomplete information can result in multiple equilibria. In one class of equilibrium the policymaker has a credibility problem and maintaining the currency board is costly in terms of unemployment. If unemployment is persistent then pressure to devalue can build up over time until it becomes unbearable and the policymaker is forced to devalue.

JEL Codes: F33, F41

Keywords: currency boards, crises

Reference: 65

Individual View

In this paper a valuation framework known as Resource Margin Accounting (RMA) is described and elucidated. The framework overcomes a number of the deficiencies of traditional cash-flow methods, and is methodologically superior to Economic Value Added (EVA). Resource margins have their origins in the microeconomics of industrial structure, and are robust performance measures well-captured by accounting systems. Through the adoption of clean-surplus accounting, resource margins may be made entirely compatible with financial portfolio theory, and at the level of individual companies they may be the focus of value creation through competitive strategy initiatives. In a further paper empirical evidence to validate this new approach to valuation of companies and strategies will be presented.

Reference: 2001-FE-16

Authors: Hans-Martin Krolzig, Michael P. Clements, Department of Economics, University of Warwick

Jan 2001

The ability of Markov-switching (MS) autoregressive models to replicate selected classical business-cycle features found in US post-war consumption, investment and output is compared to that of linear models. Univariate MS models appear to offer more dynamically parsimonious representations, but generally are unable to reproduce features missed by linear models. In the multivariate models, some cointegration restrictions were found to have a crucial impact, and the ability of models that imposed cointegration to reproduce business cycle features was enhanced by Markov-switching

JEL Codes: C52, E32

Keywords: business cycle asymmetries, Markov-switching models, cointegration

Reference: 58

Individual View

Authors: Rosa M. Fernandez, Etsuro Shioji, Yokohama National University

Jan 2001

This paper explores the effects of unemployment on the school enrolment decisions. A few studies that have taken up this issue in the past have produced results that are seemingly contradictory with each other. We build a model of the enrolment decision that is capable of explaining these results in a unified manner. In this model, unemployment affects the enrolment decision both through changing costs of and returns to education (investment effect) and through changing parental wealth and thus affecting intergenerational transfers (wealth effect). We develop an empirical framework that allows us to test presence of these two effects separately, and apply this to panel data of Spanish regions on university enrolment. We find that both effects are present.

JEL Codes: I1, J2, J6

Keywords: education, participation, unemployment, intergenerational transfers, opportunity costs

Reference: 66

Individual View

Authors: Hans-Martin Krolzig, Juan Toro, European University Institute, Florence

Jan 2001

This paper proposes a new framework for the impulse-response analysis of business cycle transitions. A cointegrated vector autoregressive Markov-switching model is found to be a congruent representation of post-war US employment and output data. In this model some parameters change according to the phase of the business cycle which effects employment and output simultaneously. The long run dynamics are characterized by a cointegrating vector including employment, output and a trend as a proxy for technological progress and capital accumulation. Short-run and long-run dynamics are jointly estimated in a Markov-switching vector-equilibrium-correction model with three regimes representing recession, growth and high growth. For the analysis of the dynamics of output and employment, a new set of impulse-response exercises is considered.

JEL Codes: E32, E37, C32, E24

Keywords: business cycles, impulse-response analysis, cointegration, regime shifts, Markov switching, labour hoarding

Reference: 59

Individual View

Authors: Ben Cooper, Chris Wallace

Jan 2001

`Group selection` is often cited as an explanation for the survival of altruism. The idea of group selection is a controversial one - much effort has been expended on its justification (and refutation). Relatively little effort has gone into formally testing whether or not it can actually provide a reasonable explanation for altruistic behaviour. This paper concentrates solely on whether or not a group structure enables the survival of altruism in an evolving population. If altruism is to flourish either groups need to be isolated from each other for multiple generations, or groups themselves need to be constructed in a positively assortative manner. In the former case the size of the group, the relative benefit to cost of altruism and the number of generations in isolation play a crucial role in determining the survival chances of altruism. In the latter case, when groups are short-lived phenomena, a precise condition is given on the assortative mechanism for the survival of altruism in the long run. The probability distribution of the dispersion-rematching process and the group size are of critical importance in this case.

JEL Codes: C72, C73

Keywords: altruism, group selection, evolution, assortative matching, dispersion

Reference: 67

Individual View

Authors: Hans-Martin Krolzig, Juan Toro, European University Institute, Florence

Jan 2001

This paper intends to harmonize two different approaches to the analysis of the business cycle and in doing so it retrieves the stylized facts of the business cycle in Europe. We start with the `classical` approach proposed in Burns and Mitchell (1946) of dating and analyzing the business cycle; we then adopt the `modern` alternative: the Markov-switching time series model proposed in Hamilton (1989a). The model`s regime probabilities provide an optimal statistical inference of the turning point of the European business cycle. For assessing the capacity of the parametric approach to generate the stylized facts of the classical cycle in Europe, the stylized facts of the original data are compared to those of simulated data. The MS VAR model is shown to be a good candidate for use as a statistical instrument to improve the understanding of the business cycle.

JEL Codes: E32, F43, F47, C32

Keywords: international business cycles, European Union, Markov switching, structural breaks, time series analysis

Reference: 60

Individual View

Authors: Alexander Guembel

Jan 2001

This paper investigates the incentives of investors to set up an actively managed fund in an emerging market or asset class. The analysis highlights the role of agency problems between fund managers and investors in determining this entry decision. It is shown that investors may wish to set up a fund in a new market, only when another fund is also active in that market. Fund entry into a new market can therefore be subject to a co-ordination problem, which may result in no entry of funds. This problem is acute when fund managers have little information about underlying asset values. Equilibrium wage contracts for managers are derived for the case when one or two managers are active in a market. It is shown that wage contracts induce (i) overly aggressive trading by managers when two funds are active in a market, and (ii) insufficiently aggressive trading when only one manager is active. The evidence of country fund inception for emerging markets is reviewed in light of this analysis and policy implications are presented.

JEL Codes: D82, G14, G23

Keywords: Emerging markets, fund management, moral hazard, comparative performance information

Reference: 2001-FE-12

Authors: Gavin Cameron, John Muellbauer, Jonathan Snicker

Jan 2001

The Welsh economy has undergone rapid structural change in recent years. This paper uses data from the New Earnings Survey to examine how earnings in Wales changed relative to those of Great Britain between 1975 and 1994. There are five main findings. First, earnings of workers in Wales have declined relative to those in Great Britain. Second, the shift away from full-time men has been an important factor in the fall in average relative earnings. Third, the decline in the relative earnings of full-time men is mostly explained by falling relative earnings in construction, distribution, and transport, as well as the failure of workers in banking and financial services in Wales to keep up with their counterparts in Great Britain. Fourth, the shift in full-time employment to health, education and other services has tended to support relative earnings. Fifth, the decline in full-time men`s earnings seem to be an equilibrium phenomenon that will not naturally reverse itself.

JEL Codes: C33, E24, J3, R23

Keywords: earnings, unemployment, Wales, structural change, New Earnings Survey

Reference: 61

Individual View

Authors: William Wilhelm, Pegaret Pichler

Jan 2001

We relate the organizational form of investment banking syndicates to moral hazard in team production. Although syndicates are dissolved upon deal completion, membership stability across deals represents a barrier to entry that enables the capture of quasi-rents. This improves incentives for individual bankers to cultivate investor relationships that translate into greater expected proceeds. Reputational concerns of lead bankers amplify the effect. We derive conditions under which restricted entry and designation of a lead banker strictly Pareto dominate, in which case it is also strictly Pareto dominant for the syndicate`s fee to be greater than members` cost of participation.

Reference: 2001-FE-05

Authors: Patrick Toche, Lyon

Jan 2001

Why might there be a long-run trade-off between growth and unemployment? In general equilibrium, the returns on the factors of production are interdependent. This paper develops a model where the determination of the wage is central to the evolution of these incentives. The incentive to hire responds little (and in some cases not at all) to changes in the rate of interest. If the wage grows in line with productivity, there is a positive relation between growth and unemployment. If the wage rises as the labour market tightens, the incentive to invest in human and physical capital rises relative to the incentive to hire. There emerges a trade-off between growth and unemployment.

JEL Codes: E24, J30, O41

Keywords: endogenous growth, unemployment, human capital

Reference: 62

Individual View

Authors: Patrick Toche, Lyon

Jan 2001

This paper characterises the dynamic behaviour of a growing economy where individuals `keep up with the Joneses` and face uninsurable labour income risk. Idiosyncratic uncertainty about future labour income reduces the marginal propensity to consume out of financial wealth and raises the effective rate of discount in the aggregate consumption Euler equation. The higher the average rate of income growth, the higher the saving rate. If individuals have uncertain lifetimes, a higher mortality rate reduces the marginal propensity to consume out of wealth, and raises the ratio of marginal utilities between employment and unemployment.

JEL Codes: B40, D81, E21

Keywords: precautionary saving, comparison utility, consumption, growth

Reference: 63

Individual View

Authors: Gerardo A. Guerra

Jan 2001

This paper shows that a monopolistic certifying party can have incentives to disclose revealing information about the agent he is certifying. Using a three-person game-theoretic model and allowing certificate users (buyers) to have noisy estimates of the quality level of the agent being certified (seller), a disclosure in the form of ordered ranking of levels is predicted. This contrasts with previous results in certification theory stating that monopolistic certifiers disclose a minimum amount of information (with no informational value) about the party being certified, in order to extract all informational rents from the market. The predicted disclosure is consistent with real life observations of certification disclosure as found in debt rating (notches) and hotels listings (using a discrete system of stars). The model is robust enough to explain the results of previous models. The paper also adds to the existing literature an evaluation of four different strategies of information disclosure that are available to a certifier.

JEL Codes: C72, D18, D82, L15, L86

Keywords: certification, information asymmetry, disclosure strategies

Reference: 64

Individual View

Authors: Andrew Glyn, Stewart Wood

Dec 2000

To what extent does the policy of Tony Blair`s government reflect the traditional aspirations of social democracy? In macroeconomic policy the emphasis has been on stability, an understandable response to recent UK economic history, but one which has left sterling dangerously overvalued for an extended period. The strongest policy emphasis has been on a battery of measures aimed at increasing the incentive to work. Paradoxically, for a government which has often treated redistribution as old-fashioned and inappropriate, the greatest impact of these measures has been to redistribute income towards low-income families which already have family members working. Effects on the labour supply appear to be modest, and a particular weakness has been the denial of a strong regional dimension to joblessness. The decision to stick with Conservative spending plans for the government`s first two years brought a squeeze on the public services, and even the rapid growth in health and education spending planned for the next few years is predicated on very slow growth in social security spending rather than increased taxation. Labour`s policies on training and on industrial relations imply greater responsibility for individuals and employers, rather than the state, and private sector solutions with regard to investment in and management of industry and services - even traditionally public services - are instinctively preferred.

JEL Codes: E60, O52, P16

Keywords: labour, unemployment, household income

Reference: 49

Individual View

We consider an economy in which banks increase social welfare by monitoring but where the verifiable part of banking income is stochastic. Banks abstract non-verifiable returns and this can render banking contracts unattractive to investors. The survival of the banking sector is ensured by a regulator who determines the rent, or charter value, which accrues to the holder of a banking license and who sets deposit insurance levels. High charter values encourage bankers to reduce the opacity of their activities and deposit insurance mitigates the effects upon depositors of perquisit consumption. We show that there is a tradeoff between increased charter value and reduced deposit insurance. Moreover, optimal competition levels are a decreasing function of regulator reputation.

Reference: 2000-FE-07

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