Goliath Corporation: An instructional case in transfer pricing policy

This case illustrates some of the issues associated with setting firms’ transfer pricing policies. The simulation requires students to assume the roles of top management and divisional management for Goliath Corporation in negotiating transfer prices. The student playing the role of top management first selects a transfer pricing policy from four possible mechanisms: market-based, cost-based, negotiated, and dual-pricing. Given the top manager’s policy choice, divisional managers are then constrained to use that policy as they decide whether to purchase internally or externally based on their respective negotiations. In each negotiation, there is an ex ante best decision for Goliath as a whole. The case is thus useful in demonstrating how managers’ transfer price policy choices can lead to bad sourcing decisions.     

The challenges of longitudinal surveys in the flood risk domain

Abstract

There has been much research regarding the perceptions, preferences, behaviour, and responses of people exposed to flooding and other natural hazards. Cross-sectional surveys have been the predominant method applied in such research. While cross-sectional data can provide a snapshot of a respondent’s behaviour and perceptions, it cannot be assumed that the respondent’s perceptions are constant over time. As a result, many important research questions relating to dynamic processes, such as changes in risk perceptions, adaptation behaviour, and resilience cannot be fully addressed by cross-sectional surveys. To overcome these shortcomings, there has been a call for developing longitudinal (or panel) datasets in research on natural hazards, vulnerabilities, and risks. However, experiences with implementing longitudinal surveys in the flood risk domain (FRD), which pose distinct methodological challenges, are largely lacking. The key problems are sample recruitment, attrition rate, and attrition bias. We present a review of the few existing longitudinal surveys in the FRD. In addition, we investigate the potential attrition bias and attrition rates in a panel dataset of flood-affected households in Germany. We find little potential for attrition bias to occur. High attrition rates across longitudinal survey waves are the larger concern. A high attrition rate rapidly depletes the longitudinal sample. To overcome high attrition, longitudinal data should be collected as part of a multisector partnership to allow for sufficient resources to implement sample retention strategies. If flood-specific panels are developed, different sample retention strategies should be applied and evaluated in future research to understand how much-needed longitudinal surveying techniques can be successfully applied to the study of individuals threatened by flooding.     

Information acquisition and voting with heterogeneous experts

A social planner selects heterogeneously biased experts to (either sequentially or simultaneously) acquire costly signals, and then agents vote between two alternatives. To maximize social welfare, the social planner adopts an alternating mechanism—choosing extremely biased experts whose preferences oppose the pivotal voter's current preference—in the optimal sequential mechanism, whereas she chooses mildly biased experts in the optimal simultaneous mechanism. Despite the flexibility of a sequential mechanism, the optimal simultaneous mechanism can achieve strictly higher social welfare when information cost is low. Supermajority rules can dominate simple majority rule in terms of both information acquisition and social welfare.     

Inefficient sales delays by a durable‐good monopoly facing a finite number of buyers

This article offers a new explanation for unscheduled price cuts and slow adoption of durable goods. We study a standard durable‐good monopoly model with a finite number of buyers and show that this game can have multiple subgame perfect equilibria in addition to the Pacman outcome—including the Coase conjecture. Of particular interest is a class of equilibria where the seller first charges a high price and only lowers that price once some—but not all—high‐valuation buyers purchase. This price structure creates a war of attrition between those buyers, which delays market clearing and rationalizes unscheduled purchase and price cut dates.     

A constraint-free approach to optimal reinsurance

Reinsurance is available for a reinsurance premium that is determined according to a convex premium principle H. The first insurer selects the reinsurance coverage that maximizes its expected utility. No conditions are imposed on the reinsurer's payment. The optimality condition involves the gradient of H. For several combinations of H and the first insurer's utility function, closed-form formulas for the optimal reinsurance are given. If H is a zero utility principle (for example, an exponential principle or an expectile principle), it is shown, by means of Borch's Theorem, that the optimal reinsurer's payment is a function of the total claim amount and that this function satisfies the so-called 1-Lipschitz condition. Frequently, authors impose these two conclusions as hypotheses at the outset.     

Information and delay in an agency model

This article studies how delay in contracting depends on an exogenous signal. The agent whose cost is his private information may produce in the first period or be delayed until the second period. A signal about the cost of the agent is available between the two periods. The quality of the good can vary; in the benchmark case of no signal, the principal offers the standard Baron‐Myerson contract and there is no delay. Delay is determined by the considerations at the margin and may increase or decrease with a better signal. The value of information can be negative, as a better signal may aggravate the principal's commitment problem. A better signal may also increase the agent's rent and decrease social welfare.     

Bayesian Solutions for the Factor Zoo: We Just Ran Two Quadrillion Models

We propose a novel framework for analyzing linear asset pricing models: simple, robust, and applicable to high-dimensional problems. For a (potentially misspecified) stand-alone model, it provides reliable price of risk estimates for both tradable and nontradable factors, and detects those weakly identified. For competing factors and (possibly nonnested) models, the method automatically selects the best specification—if a dominant one exists—or provides a Bayesian model averaging–stochastic discount factor (BMA-SDF), if there is no clear winner. We analyze 2.25 quadrillion models generated by a large set of factors and find that the BMA-SDF outperforms existing models in- and out-of-sample.     

Noise fit,estimation error and a Sharpe information criterion

When the in-sample Sharpe ratio is obtained by optimizing over a k-dimensional parameter space, it is a biased estimator for what can be expected on unseen data (out-of-sample). We derive (1) an unbiased estimator adjusting for both sources of bias: noise fit and estimation error. We then show (2) how to use the adjusted Sharpe ratio as model selection criterion analogously to the Akaike Information Criterion (AIC). Selecting a model with the highest adjusted Sharpe ratio selects the model with the highest estimated out-of-sample Sharpe ratio in the same way as selection by AIC does for the log-likelihood as a measure of fit.     

Bitcoin – Its Economics for Financial Reporting

Despite its increasing popularity, no official guidance on the financial reporting of Bitcoin transactions has been provided by standard setters, although tax accounting guidance began to appear in 2014. Designed as a decentralised currency, Bitcoin is not intended to become a reporting currency and will instead complement fiat money. We argue that in the case of Bitcoin the accounting principle of faithful representation requires interpretation of the economic substance for financial reporting that varies with reporting entity: trading firms recognise Bitcoin like a foreign currency and measure the revenue, or expense, at the equivalent amount of the reporting currency and digital currency exchanges recognise Bitcoin as goods in line with tax accounting treatment. An Economica paper by Radford (1945), which describes the use of cigarettes as commodity money in a prisoner of war camp alludes to this economic basis. This paper applies accounting principles to a practical issue and contributes to the process by which standard setters may issue an interpretation.     

How Do Investors Interpret Announcements of Earnings Delays?

Unlike in the case of delays of 10‐K or 10‐Q filings, the SEC does not require managers to disclose delays of earnings announcements to the public. Thus, for companies that are unable to report earnings by their expected date, managers face a decision: remain silent or announce the delay. Prior research has investigated all earnings delays, whether or not they are accompanied by announcements of the delay announcement, and found that the market reaction is slightly negative, on average, for companies that allow their expected earnings dates to pass without disclosing results. It's not clear, however, whether this negative reaction was due to the absence of news or to the information contained in the announcements of the earnings delays. The authors' recent study documents that earnings delay announcements are associated with an average one‐day abnormal stock return of a negative 6%. This statistically as well as economically significant reduction in value is consistent with anecdotal evidence in the popular business press as well as predictions of disclosure theories, in particular the explanation that concerns about legal liability and managerial reputation motivate managers to disclose bad news. The study also shows that almost all managers who announce earnings delays attempt to influence the market reaction by disclosing the underlying cause. Finally, the study shows that the market reaction to earnings delay announcements is positively related to future earnings changes, consistent with the role of these disclosures in providing a signal of deteriorating financial performance.     

Negotiating contract types and contract clauses in the German construction industry during the Third Reich

This article examines the determinants of contractual form and renegotiations in the German construction industry during the Third Reich. At the beginning of World War II, firms dealt with growing uncertainty by convincing procurement agencies either to use cost‐plus contracts or to include an additional risk premium in fixed‐price contracts. In the later years of the war, procurement agencies initiated renegotiations over contract clauses to reduce the extraordinary profits resulting from information rents and high‐risk premiums. This regulatory course undermined the credibility of the regulatory commitment, thereby weakening the incentives of the fixed‐price contracts still in use.     

Aggregate Dividend Behavior and Permanent Earnings Hypothesis

The study examines the aggregate dividend behavior of U.S. corporations based on the permanent earnings hypothesis. Using annual data of aggregate earnings and dividends from 1871–1993, I find that although managers change dividends proportional to permanent earnings changes, they make revisions with a larger percentage change in dividends than in permanent earnings. The results from the post‐war data show that firms follow a partial adjustment policy with a long‐term dividend payout target in mind and make revisions with a delay. The quarterly data analysis yields results similar to those of the post‐war annual data.     

Liquidity and Optimal Market Transparency

In this paper I explore some of the consequences of greater market transparency for market performance in the presence of a strategic specialist. Although numerous studies have dealt with this issue, previous work has only considered either fully transparent or fully opaque markets. My model allows for different levels of transparency, and therefore sheds light on how transparency affects market performance. I show that an intermediate level of transparency can improve market performance relative to the more extreme cases of full transparency or no transparency at all.     

Parisian ruin probability with a lower ultimate bankrupt barrier

The paper deals with a ruin problem, where there is a Parisian delay and a lower ultimate bankrupt barrier. In this problem, we will say that a risk process get ruined when it stays below zero longer than a fixed amount of time ζ > 0 or goes below a fixed level ?a. We focus on a general spectrally negative Lévy insurance risk process. For this class of processes, we identify the Laplace transform of the ruin probability in terms of so-called q-scale functions. We find its Cramér-type and convolution-equivalent asymptotics when reserves tends to infinity. Finally, we analyze few explicit examples.     

Factor one: the next great war

This article is the first of four that will conclude the present series. One by one they will consider the principal factors that were responsible for creating the specific 19th century modes of writing about the future—the tales of the war-to-come, the organization of future societies, the certain triumph of man and mechanism, and the analysis of social trends and future possibilities. In this article I. F. Clarke looks at the ways in which the first industrial societies invented La Guerre qui vient, Der Zukunftskrieg, and The Next Great War—fictional devices dedicated wholly, solely and exclusively to showing the nation-states of the 19th century how the next war should, or should not, be fought.     

Spend More Today Safely: Using Behavioral Economics to Improve Retirement Expenditure Decisions With SPEEDOMETER Plans

This article examines how behavioral economics can be used to improve the spending decisions of retirees, using a SPEEDOMETER (or Spending Optimally Throughout Retirement) retirement expenditure plan that employs defaults within a choice architecture. The plan involves just four key behavioral nudges: (1) first, make a plan—ideally by being auto‐enrolled into one or with the help of a financial adviser; (2) automatic phasing of annuitization, which is designed to tackle the aversion to large irreversible transactions and losing control of assets, and so allows the greatest possible degree of flexibility in managing the rundown of retirement assets; (3) capital protection in the form of “money‐back” annuities that deals with loss aversion, that is, the fear of losing your money if you die early; and (4) the slogan “spend more today safely” that utilizes hyperbolic discounting to satisfy the human trait of wanting jam today, and to reinforce the idea that “buying an annuity is a smart thing to do.”     

A time-inconsistent Dynkin game: from intra-personal to inter-personal equilibria

This paper studies a nonzero-sum Dynkin game in discrete time under non-exponential discounting. For both players, there are two intertwined levels of game-theoretic reasoning. First, each player looks for an intra-personal equilibrium among her current and future selves, so as to resolve time inconsistency triggered by non-exponential discounting. Next, given the other player’s chosen stopping policy, each player selects a best response among her intra-personal equilibria. A resulting inter-personal equilibrium is then a Nash equilibrium between the two players, each of whom employs her best intra-personal equilibrium with respect to the other player’s stopping policy. Under appropriate conditions, we show that an inter-personal equilibrium exists, based on concrete iterative procedures along with Zorn’s lemma. To illustrate our theoretical results, we investigate a two-player real options valuation problem where two firms negotiate a deal of cooperation to initiate a project jointly. By deriving inter-personal equilibria explicitly, we find that coercive power in negotiation depends crucially on the impatience levels of the two firms.

     

Managing risk through the veil of ignorance

Background. We view overconfidence within risk management as a problem likely to manifest within philosophical preferences for anticipationism over resilienism, and in assumptions that risks are objectively real external powers or potentialities rather than subjective knowledge propositions. Methods. We argue that the realist tradition within Italian social theory, first crystallised by Niccolò Machiavelli and later elaborated by the sociologist Vilfredo Pareto, offers valuable lessons for corporate risk management praxis by demanding that we map out the complex relations between the risk subjectivities of risk managers, and their objective risk environments, from a standpoint of psychological and sociological realism which stresses the risk ignorance of practitioners. We caution that risk management efforts to improve risk subjectivities to achieve perfect veridicality to objective risk environments might often amount to a wishful bildungsroman of epistemological growth, reflecting the common aspirations of risk managers to demonstrate professional competence. We suggest that the profession should control this overconfidence problem by stressing the corrigibility of risk subjectivities with reference to sociological understandings that reflect on the widespread risk ignorance that can persist and even intensify where risk management effort is made. Results. Following the macrosociological framework sketched by Pareto, we show how two common ‘modes of uncertainty’ can be scrutinised for their adaptive fitness to two common types of risk environment. Conclusions. It can be helpful to think sociologically of organisations as engaging with some highly significant strategic risks blindly through a veil of ignorance.     

Fallacies of risk

In addition to traditional fallacies such as ad hominem, discussions of risk contain logical and argumentative fallacies that are specific to the subject‐matter. Ten such fallacies are identified, that can commonly be found in public debates on risk. They are named as follows: the sheer size fallacy, the converse sheer size fallacy, the fallacy of naturalness, the ostrich's fallacy, the proof‐seeking fallacy, the delay fallacy, the technocratic fallacy, the consensus fallacy, the fallacy of pricing, and the infallibility fallacy.     

The Influence of Foreclosure Delays on Borrowers' Default Behavior

This paper conducts loan‐level analysis to investigate the influence of expected foreclosure delay on a borrower's default propensity. We include the actual foreclosure times in the analysis to capture the dynamic nature of foreclosure duration. Consistent with theoretical predictions, we find a statistically and economically significant impact of foreclosure delay on borrower default behavior. In the current market condition where many borrowers have negative equity, the increase in delay may make default an optimal choice for more borrowers. The negative effect of increased foreclosure delay may need to be considered when devising policies to aid troubled borrowers.