Public‐private partnerships versus traditional procurement: Innovation incentives and information gathering

A government agency wants a facility to be built and managed to provide a public service. Two different modes of provision are considered. In a public‐private partnership, the tasks of building and managing are bundled, whereas under traditional procurement, these tasks are delegated to separate private contractors. The two provision modes differ in their incentives to innovate and to gather private information about future costs to adapt the service provision to changing circumstances. The government agency’s preferred mode of provision depends on the information‐gathering costs, the costs of innovation efforts, and the degree to which effort is contractible.     

Costs and Benefits of Mandatory Auditing of For‐profit Private and Not‐for‐profit Companies in Australia

This paper addresses the paucity of research surrounding the mandatory auditing of for‐profit private and not‐for‐profit companies in Australia. We document the various mandatory auditing provisions under the Corporations Act and identify over 22 000 companies that lodge audited accounts with the regulator under federal law. In 2011, 6339 large proprietary companies, 186 small proprietary companies, 2797 foreign‐owned companies, 3985 unlisted public companies and 8404 public companies limited by guarantee had an obligation under the Corporations Act to lodge audited accounts. While large proprietary and foreign‐owned companies have an option to apply to the Australian Securities and Investment Commission for audit relief, we estimate that less than 10% are granted audit exemption. We document that since 1995 an additional 1500 large proprietary companies that should have lodged under the size provisions of the Corporations Act have been granted exemption from doing so (i.e., grandfathered), although these firms appear to be subject to an annual audit even though they do not lodge accounts. We estimate the costs and discuss the potential public interest and firm‐level benefits associated with the mandatory auditing of for‐profit private and not‐for‐profit companies in Australia.     

IRS Attention

We study how public and private disclosure requirements interact to influence both tax regulator enforcement and firm disclosure. To capture IRS enforcement activities, we introduce a novel data set of IRS acquisition of firms’ public financial disclosures, which we label IRS attention. We examine the implementation of two new disclosure requirements that potentially alter IRS attention: FIN 48, which increased public tax disclosure requirements, and Schedule UTP, which increased private tax disclosure. We find that IRS attention increased following FIN 48 but subsequently decreased following Schedule UTP, consistent with public and private disclosure interacting to influence tax enforcement. We next examine how private tax disclosure requirements under Schedule UTP affected firms’ public disclosure responses. We find that, following Schedule UTP, firms significantly increased the quantity and altered the content of their tax‐related disclosures, consistent with lower tax‐related proprietary costs of disclosure. Our results suggest that changes in SEC disclosure requirements altered the IRS's behavior with regard to public information acquisition, and, relatedly, changes in IRS private disclosure requirements appear to change firms’ public disclosure behavior.     

Compliance with pension‐related mandatory disclosures and debt financing

Using hand‐collected data on the level of pension‐related mandatory disclosures required by International Accounting Standard 19 Employee Benefits, we test whether compliance levels with these disclosures convey information that affects firms’ access to the public instead of the private debt market, as well as the cost of their new debt issues. We document a higher tendency to access the public debt market for firms with higher levels of pension‐related disclosure. Furthermore, we find that firms with higher levels of pension‐related disclosure enjoy a lower cost in terms of issuance of public debt, but not a lower cost for private debt issues. Thus, the benefits of disclosure in reducing information risk are only realisable when creditors rely heavily on financial statements in their decision making, due to the limited access to private information. Additional tests reveal that high compliance levels effectively mitigate the negative effect of pension deficits on the cost of public debt. These findings provide novel evidence in the extant literature on the role of mandatory (and, in particular, pension‐related) disclosures on firms’ debt financing. They also have important policy implications.     

Disease‐Specific Moral Hazard and Optimal Health Insurance Design for Physician Services

This article analyzes disease‐specific moral hazard effects in the demand for physician office visits and explores whether optimal insurance for physician services should be designed to have disease‐specific cost sharing. Generalized method of moments is implemented to address the endogeneity of private health insurance, and the nonnegativity and the discreteness of physician services use. The results indicate that the moral hazard effect varies considerably across disease‐specific specialist care. The strongest moral hazard (for no‐condition related specialist visits) is almost twice the moral hazard effect of the weakest (for chronic condition related specialist visits). Although the findings indicate some variation in the moral hazard effect across disease‐specific general practitioner visits, the variation is less considerable. The main policy implication is that optimal insurance for physician services should be designed to have differential cost sharing based on disease status rather than to have uniform cost sharing.     

Endogenous Financial Constraint and Investment‐Cash‐Flow Sensitivity

This paper studies a dynamic investment model with moral hazard. The moral hazard problem implies an endogenous financial constraint on investment that makes the firm's investment sensitive to cash flows. I show that the production technology and the severity of the moral hazard problem substantially affect the dependence of the investment‐cash‐flow sensitivity on the financial constraint. Specifically, if the production technology exhibits almost constant returns to scale in capital or the moral hazard problem is relatively severe, the dependence is negative. Otherwise, the pattern is reversed to some extent. Moreover, the calibrated benchmark model can quantitatively account for the negative dependence of investment and Tobin's Q on size and age observed in the data.     

Implementing high‐powered contracts to motivate intertemporal effort supply

We characterize the optimal contract between a principal and a risk‐neutral, wealth‐constrained agent when an adverse selection problem follows a moral hazard problem. The optimal contract in this setting often is more steeply sloped for the largest output levels than is the optimal contract in either the standard moral hazard setting or the standard adverse selection setting. The large incremental rewards for exceptional performance motivate the agent to deliver substantial effort both before and after he acquires privileged information about the production environment.     

Asymmetric Information,Asset Allocation,and Debt Financing

We analyze a signaling game where firms' financing announcements convey private information about their prospects but a moral hazard problem exists in that managers may suboptimally invest. Consequently, the attempt to address an asymmetric information problem exacerbates moral hazard. The equilibrium recognizes both imperfect information problems. Additionally, the firm must determine how to allocate funds between two technologies differing in cash flow timing and managerial accessibility. We define an above-average firm's comparative advantage as that technology which is most dominant relative to a firm with lesser prospects and show that the resultant equilibria follow the lines of the firm's comparative advantage. Finally, we show that separation may be achieved costlessly, i.e., with no explicit signaling cost.     

Private versus Public Ownership: Investment,Ownership Distribution,and Optimality

Examined in this paper is the choice between private and public incorporation of an asset for an entrepreneur (asset owner) who hires a manager with superior information about the asset's return distribution. Public sale of equity is shown to be the preferred alternative when (a) capital market issue costs are low or (b) the assest's idiosyncratic risk is high and the owner is either sufficiently risk averse or sufficiently “optimistic” about the asset's expected return. Thus, those assets deemed most valuable by their owners will tend to be publicly incorporated. The paper also explores the impact of incorporation mode—private versus public—and information structure on the firm's investment policy and ownership distribution.     

MORAL HAZARD AND CAPITAL BUDGETING

In this paper, the effect of moral hazard on capital budgeting is examined. It is shown that moral hazard may change project rankings based on net present value under perfect information. It is also shown that in certain agency relationships moral hazard increases managerial contracting costs more for projects with slower paybacks, thus producing a bias in favor of projects with faster paybacks. This effect manifests itself only under specific conditions.     

When does a public–private partnership (PPP) lead to inefficient cost management? Evidence from South Korea’s urban rail system

This paper investigates the impact of a public–private partnership (PPP) on the operational cost-efficiency of South Korea’s urban rail system. Seoul’s line 9, which is operated by a PPP, was compared with Seoul Metropolitan Rapid Transit (SMRT) which is entirely run by the public sector. Overall, no evidence was found that private operation led to clear and significant declines in costs to the public. Private shareholders, on the other hand, experienced a surprisingly high rate of return. The author explains why two characteristics defining a typical PPP—activity bundling and public–private risk-sharing—were behind this unintended outcome and makes suggestions to prevent other governments experiencing similar problems.     

Sustainable social spending

The paper discusses a number of threats to the financial sustainability of social spending: increased internationalization of national economies, gradually higher relative costs of producing a number of human services, the “graying” of the population, slower productivity growth in the private sector, low employment rates, and various types of disincentive effects related to the welfare state itself, including moral hazard. I argue that threats from gradually rising costs of providing human services and disincentive effects of welfare-state arrangements, in particular moral hazard and benefit dependency, are more difficult to deal with than the other threats. I also discuss the choice between ad hoc policy reforms and automatic adjustment mechanisms, delegated to administrative bodies, for dealing with these threats. JEL Classification E62 · H31 · H53     

Human Capital,Bankruptcy, and Capital Structure

We derive the optimal labor contract for a levered firm in an economy with perfectly competitive capital and labor markets. Employees become entrenched under this contract and so face large human costs of bankruptcy. The firm's optimal capital structure therefore depends on the trade‐off between these human costs and the tax benefits of debt. Optimal debt levels consistent with those observed in practice emerge without relying on frictions such as moral hazard or asymmetric information. Consistent with empirical evidence, persistent idiosyncratic differences in leverage across firms also result. In addition, wages should have explanatory power for firm leverage.     

Bank size and risk-taking under Basel II

We analyze the relationship between bank size and risk-taking under the Basel II Capital Accord. Using a model with imperfect competition and moral hazard, we show that the introduction of an internal ratings based (IRB) approach improves upon flat capital requirements if the approach is applied uniformly across banks and if the costs of implementation are not too high. However, the banks’ right to choose between the standardized and the IRB approaches under Basel II gives larger banks a competitive advantage and, due to fiercer competition, pushes smaller banks to take higher risks. This may even lead to higher aggregate risk-taking.     

The Determinants of Financial Structure: New Insights from Business Start‐ups

Business start‐ups lack prior history and reputation, face high failure risk, and have highly concentrated ownership. The resulting information and incentive problems, combined with entrepreneurial private benefits of control, affect initial financing decisions. This paper examines simultaneously the impact of these issues on leverage, debt mix and maturity. We find that start‐ups with high adverse selection and risk shifting problems contract less bank debt but compensate with other debt sources. Start‐ups in growing industries have lower leverage, but raise more bank debt. Entrepreneurs with large private control benefits contract less but longer term bank loans to lower the default probability.     

Audit quality and properties of analysts’ information environment

We consider how audit quality impacts sell‐side analysts’ information environment. Using the method outlined by Barron et al., we examine whether higher audit quality is associated with differences in the weight analysts place on common information relative to private information, as well as the extent to which audit quality separately impacts the precision of analysts’ private and common information. Our results show that, in instances where analysts revise their earnings forecasts for year t+1 shortly after the release of year t earnings, higher audit quality results in analysts placing more weight on public information. The precision of private (as well as public) information is improved. These results extend our understanding of how audit quality impacts on attributes of analysts’ forecasts and provides support for the argument that audit quality has important capital market implications.     

Perception of the risks and benefits of Bt eggplant by Indian farmers

Several researchers—most notably Lennart Sjoberg and his colleagues—have proposed that the moral aspects of risk provide a better explanation of risk perception than the psychometric paradigm or Cultural Theory, neither of which accounts for moral concerns. This study is possibly the first to assess empirically the perception of the risks and benefits of a transgenic food crop—transgenic Bt (Bacillus thuringiensis) eggplant—by farmers in a developing country such as India. It also aims to assess if the moral aspects of risk figure in Indian farmers' perception of Bt eggplant and if economic benefits outweigh perceived risks. To answer the research questions, a scenario was used to elicit perceptions of Bt eggplant among 100 eggplant farmers in the state of Maharashtra in India. The findings indicate that economic benefits, safety concerns, and accountability are most salient to Indian farmers' perception of the risks and benefits of Bt eggplant. Significantly, none of the farmers mentioned moral concerns as an issue. The findings also make clear that economic benefits outweigh perceived risks. This study concludes that economic benefits are more salient than moral concerns to Indian farmers' perception Bt eggplant. It also proposes that an alternative theoretical model incorporating economic benefits, safety concerns, and accountability as key variables should be developed and tested for end users in the developing world.     

S&P 500 Membership and Managers’ Supply of Conservative Financial Reports

Our study is motivated by economic theory and the debate among practitioners, standard setters, and academics on the role of conditional conservatism in financial reporting. We find that managers provide less conditionally conservative financial reports after their firms are added to the Standard and Poor's (S&P) 500 index. S&P 500 membership is expected to reduce information asymmetry between managers and outside stakeholders due to an increased flow of public and private information. As a result, the contracting benefits of conservative accounting choices are reduced, and managers are less willing to provide conditionally conservative reports. In contrast, we find that managers provide more conditionally conservative financial reports after their firms are deleted from the index. Firms being deleted from the S&P 500 index probably incur an increase in information asymmetry. Overall, our results provide evidence consistent with conditional conservatism being a response by managers to the information needs of financial statements users.     

Defining the Reporting Entity in the Not‐for‐profit Public Sector: Implementation Issues Associated with the Control Test

This paper reports the main findings of a research project carried out on behalf of the Australian Accounting Standards Board (AASB) and the New Zealand Financial Reporting Standards Board. The purpose of the research is to inform standard setters about implementation issues that had been encountered in the not‐for‐profit (NFP) public sector when applying the control concept in AASB 127, Consolidated and Separate Financial Statements. The intention is to use the findings to inform proposed implementation guidance for AASB 10, Consolidated Financial Statements. Data were collected via a literature review and meetings with various NFP public sector constituents. Identified issues were either conceptual in nature (for example, who are the relevant users of NFP public sector general purpose financial statements and what are their needs?) or related to implementation concerns (for example, is the power exerted by one NFP public sector entity over another of an ‘ownership’ or a ‘regulatory’ form?). The findings give rise to several suggested actions that standard setters could take in providing useful guidance to NFP public sector constituents.     

Hidden insurance in a moral‐hazard economy

We analyze the general equilibrium of an economy in which a competitive industry produces nonexclusive insurance services. The equilibrium is inefficient because insurance contracts cannot control moral hazard, and welfare can be improved by policies that reduce insurance by increasing its price above marginal cost. We discuss how insurance production costs that exceed expected claim payments interact with moral hazard in determining the equilibrium's inefficiency, and show that these costs can make insurance premia so actuarially unfair as to validate the standard first‐order conditions we exploit in our analysis.