Motivate and select: Relational contracts with persistent types

We develop a model of relational contracts with moral hazard and asymmetric persistent information about an employee's type. We find that the form of the optimal contract depends on the job characteristics and the distribution of employees' talent. Bonus contracts are more likely to be adopted in complex jobs and when high talent is not too common or too rare. Firms with “normal” jobs are more likely to adopt termination contracts. In labor market equilibrium, different contracts may be adopted by ex ante identical firms. Hence, we offer an explanation for the coexistence of different employment systems within the same industry.     

Complexity of Outsourcing Contracts and Ex Post Transaction Costs: An Empirical Investigation*

abstract In this article, we use Transaction Cost Economics (TCE) and the Resource‐Based View (RBV) of the firm to study outsourcing agreements. We develop an original approach of contract complexity and analyse the links among exchange hazards (i.e. specificity and environmental uncertainty), the contractual aspects of outsourcing (control, incentives, penalties, price and flexibility clauses) and the level of ex post transaction costs. Both contract complexity and ex post transaction costs are operationalized and measured. Our empirical research analyses 82 outsourcing contracts. This article uses three different dimensions (proximity to the core business, switching costs and adaptation costs) to assess the strategic importance of an outsourced activity. Our findings extend TCE's validity for the outsourcing of activities with a strategic value. Finally, this study offers an indirect measurement of ex post transaction costs. In short, to restrict vendor opportunism, contracts must contain incentives and penalties, as well as pricing and monitoring clauses.     

Do tournaments solve the adverse selection problem?

This paper provides a solution to a puzzle in the analysis of tournaments, that of why there is no agent discrimination or differential contracting in certain business practice settings. The paper examines the problem of a principal contracting with multiple agents whose activities are subject to common shocks. The presence of common shocks invites the use of relative performance evaluation to minimize the costs of moral hazard. But, in the additional presence of adverse selection, the analysis shows that there may be no need for ex ante screening through menus of offers. This is so because the principal becomes better informed ex post about agent types, via the realization of common uncertainty, and can effectively penalize or reward the agents ex post. Thus, unlike the standard adverse selection problem without common uncertainty where the principal always benefits from ex ante screening, it is shown that ex post sorting through relative performance evaluation reduces the scope for ex ante screening through menus, and can eliminate it completely if agents are known to not be very heterogeneous. This is consistent with observed practice in industries where the primary compensation mechanism is a cardinal tournament which is uniform among employees. The analysis connotes that by using relative instead of absolute performance measures, firms with employees who are not substantially heterogeneous not only can alleviate the agency problem, but there is also no need to extract the agents' ex ante private information about their innate abilities via a screening menu.     

Leading Indicators for Euro‐area Inflation and GDP Growth*

In this paper, we evaluate the role of a set of variables as leading indicators for Euro‐area inflation and GDP growth. Our leading indicators are taken from the variables in the European Central Bank's (ECB) Euro‐area‐wide model database, plus a set of similar variables for the US. We compare the forecasting performance of each indicator ex post with that of purely autoregressive models. We also analyse three different approaches to combining the information from several indicators. First, ex post, we discuss the use as indicators of the estimated factors from a dynamic factor model for all the indicators. Secondly, within an ex ante framework, an automated model selection procedure is applied to models with a large set of indicators. No future information is used, future values of the regressors are forecast, and the choice of the indicators is based on their past forecasting records. Finally, we consider the forecasting performance of groups of indicators and factors and methods of pooling the ex ante single‐indicator or factor‐based forecasts. Some sensitivity analyses are also undertaken for different forecasting horizons and weighting schemes of forecasts to assess the robustness of the results.     

Targets and Resources: A Screening Perspective

To secure funding for a project, an agent (informed about the project's type) announces a target output. The principal provides more generous resources for high targets but makes compensation tied to performance relative to the projection. The incentive mechanism is geared towards screening project/agent types for resource disbursement at the ex‐ante stage and motivating appropriate efforts at the interim stage. These dual objectives are embedded in an optimal share contract solution: a pair of startup funds and output share between the principal and agent. The target mechanism's performance is then assessed with respect to implementation of the optimal share contract solution. The focus is on linear contracts for their applicability and practical relevance. Copyright © 2016 John Wiley & Sons, Ltd.     

THE ‘REFERENCE POINT’ APPROACH TO THE THEORY OF THE FIRM: AN INTRODUCTION

There is a small but growing literature on the ‘reference point’ approach to incomplete contracts as formulated by Hart and Moore. The reference point approach has begun to be applied to the theory of the firm in 3 recent papers. This introduction reviews the main theoretical aspects of each of these papers. It then discusses the relationship between the reference point approach to the firm, the transaction cost approach and the property rights approach. Here it is argued that the reference point approach is a step back towards ex post inefficiencies, away from reliance on ex ante inefficiencies.     

Quasi‐rational and ex ante price expectations in commodity supply models: an empirical analysis of the US broiler market

A statistically optimal inference about agents' ex ante price expectations within the US broiler market is derived using futures prices of related commodities along with a quasi‐rational forecasting regression equation. The modelling approach, which builds on a Hamilton‐type framework, includes endogenous production and allows expected cash price to be decomposed into anticipated and unanticipated components. We therefore infer the relative importance of various informational sources in expectation formation. Results show that, in addition to the quasi‐rational forecast, the true supply shock, future prices, and ex post commodity price forecast errors have, at times, been influential in broiler producers' price expectations. Copyright © 2003 John Wiley & Sons, Ltd.     

Vertical integration: A comparative analysis of performance and risk

Hofer's (1973) argument for strategy analysis by matched pairs forms a central methodological feature in this examination of vertical integration. With twenty matched pairs of companies we have sought to eliminate the major extraneous factors that have precluded consensus among previous research findings. Our results show that vertical integration (via whole ownership) is performance and risk-neutral. Support is generated for the fundamental notion that successful strategy selection, and subsequent performance, is a function of firm-specific competencies and opportunities. Consequently, we urge that research on vertical integration move forward to consider ex ante conditions of fit rather than continuing to pursue ex post rationalizations of performance and risk.     

Do Foreign Greenfields Outperform Foreign Acquisitions or Vice Versa? An Institutional Perspective

abstract Prior studies of the comparative performance of greenfields and acquisitions have advanced competing arguments, with some arguing that greenfields should outperform acquisitions because acquisitions are costlier to integrate, and others that acquisitions should outperform greenfields because greenfields suffer from a liability of newness. Moreover, while the costs of integration and the liability of newness are at their greatest during a subsidiary's first years, prior studies have tested their competing arguments on samples containing older subsidiaries. We extend these prior studies by (1) developing an institutional theory‐based framework that simultaneously considers the costs of integration and the liability of newness, (2) recognizing that both types of costs vary with the level of subsidiary integration, and (3) focusing on the stage of their life during which subsidiaries predominantly incur these costs. To measure subsidiary performance, we ask managers of Dutch multinationals how their ex ante performance expectations compare to the subsidiary's ex post performance during its first two years. Analysing a sample of 191 foreign subsidiaries and controlling for entry mode self‐selection and other factors, we find that acquisitions outperform greenfields at low and intermediate levels of subsidiary integration, but that greenfields outperform acquisitions at higher integration levels.     

ASSESSING THE OLYMPIC GAMES: THE ECONOMIC IMPACT AND BEYOND

This study reviews the literature on the evaluation of the Olympic Games, within the broader framework of their significance as cultural assets and opportunities for endogenous growth and sustainable development of the host city. The study reviews the main approaches to the economic assessment of the Games, from the point of view of the underlying economic concepts and methodologies, as well as of the empirical results obtained. It focuses on the effects that are measured and on those, which even though important, are generally neglected. The methodologies utilized for the quantitative assessments of the Games are reviewed with special emphasis on impact and cost–benefit analysis, both on ex ante and ex post basis. The studies surveyed are analysed from the point of view of different sets of effects on the host city, and for a limited number of cases, on the host country. While the major focus is on hosting the Summer Olympics, some attention is also paid to the bidding cities, the Winter Olympics and the Paralympics. The general findings appear to be controversial with some hints of positive overall effects, but also with a well‐documented tendency to exaggerate the benefits and underestimate the costs of holding the Games in the ex ante versus the ex post studies. The survey finally suggests that ex post cross‐country econometric studies tend to catch sizable differential and persistent benefits ignored by individual studies, especially on macroeconomic and trade variables.     

Private Debt and Timely Loss Recognition

Abstract

In this study, we investigate whether private debt contracting provides incentives for borrowers to recognize economic losses earlier in accounting earnings. Focusing on the window around firms' issuances of private loans, we document that timely loss recognition significantly increases following an issuance. This effect is significantly stronger for debt contracts that include performance covenants acting as trip-wires when firm performance deteriorates. We also find that timely loss recognition is particularly used when writing debt contracts is hampered by uncertainty about a firm's future development. These findings are consistent with timely loss recognition being used to increase contract efficiency by facilitating state-contingent control allocation based on a borrower's performance over the loan term.     

On the Performance of Linear Contracts

We examine the ability of linear contracts to replicate the performance of optimal unrestricted contracts in the canonical moral hazard setting with a wealth constrained, risk averse agent. We find that in a broad class of environments, the principal can always secure with a linear contract at least 95% of the profit that she secures with an optimal unrestricted contract, provided the productivity of the agent's effort is not too meager.     

Employee ownership motivation and individual risk-taking behaviour: a cross-level analysis of Taiwan's privatized enterprises

Privatization has long been a prevailing strategy worldwide for promoting economic liberalization. During privatization of state-owned enterprises employees are often encouraged, as part of policy design, to become equity shareholders through buying priority shares reserved for them with the goal of expediting privatization and building employees' organizational identification. Using risk-taking behaviour as a lens to observe individual-level entrepreneurial orientations after privatization, this study, in a sample of 328 employees in 14 privatized firms in Taiwan, aims to examine the behavioural consequences of two distinct types of motivation behind employee ownership and the contextual influences on such relationships. Because of the hierarchical nature of the individual- and firm-level data, we use the hierarchical linear modelling (HLM) method to test the hypotheses and find that intrinsic motivation ex ante for employee ownership can cultivate innovative behaviour ex post, whereas extrinsic motivation yields the similar effect only in the presence of a climate of self-determination and the absence of environmental hostility.     

Compensating the dead

An early death is, undoubtedly, a serious disadvantage. However, the compensation of short-lived individuals has remained so far largely unexplored, probably because it appears infeasible. Indeed, short-lived agents can hardly be identified ex ante, and cannot be compensated ex post. We argue that, despite those difficulties, a compensation can be carried out by encouraging early consumption in the life cycle. In a model with heterogeneous preferences and longevities, we show how a specific social criterion can be derived from intuitive principles, and we study the corresponding optimal policy under various informational assumptions.     

To Conform or To Perform? Mimetic Behaviour,Legitimacy‐Based Groups and Performance Consequences*

abstract The study of interorganizational imitation has been an important strand in the recent literature on institutional theory. This paper offers new insights for our understanding of mimetic isomorphism and its reliance on legitimacy: we suggest that legitimacy‐based reference groups guide firms in their mimetic behaviour, that firms undertake imitation even against their own ex ante information, and that legitimacy‐based imitation contributes negatively to firms' profitability. We examine Portuguese bank branching decisions between 1988 and 1996 and find that banks imitate their legitimacy‐based groups, and not only towards ex ante (firm‐specific) attractive locations, but also towards unattractive locations; we also find that mimetic branching produces a negative effect on profitability. We conclude that these results show the importance of legitimacy pressures on organization decisions and the tension between the pressure to conform and the pressure to perform.     

CEO Contract Design Regulation and Risk-Taking

Abstract

Since 2009, the European Commission (EC) requires firms to incorporate an array of new elements into CEO compensation contracts, such as bonus caps, claw back provisions, bonus deferral, performance-vesting, and minimum shareholding guidelines. This paper examines whether CEO contract design in line with the EC principles reduces risk-taking and its economic consequences. Using hand-collected contract design data of 763 firm-years from European listed non-financial firms, we construct an index that reflects a firm's contract fit with the EC principles. Complemented by hand-collected data of national regulatory changes consistent to the EC principles, we employ the regime shift as quasi-experiment. We find that CEOs rewarded under contracts more in line with the principles choose lower risk profiles with respect to their country peers by divergent reductions of idiosyncratic and systematic risk-taking. Moreover, intensity of change of the regulatory environment negatively affects systematic risk-taking. Furthermore, we find CEOs compensated under contracts more adhering to the principles lead to increased subsequent risk-adjusted performance.     

The Effect of Religion on Accounting Conservatism

This paper investigates whether religiosity, a key informal institutional factor, strongly influences a firm’s adoption of accounting conservatism. Using a sample from the U.S. stock market, we find that firms located in geographic areas with higher levels of religiosity tend to exhibit greater accounting conservatism. Further tests show that this effect is through the channel of engaging managers in activities that emphasize firms’ long-term growth, concern stakeholder interests, and avoid the risk of litigation. Moreover, we demonstrate that it is the religious environment in an area rather than the personal religious belief of a CEO that drives our baseline results. Finally, a supplementary test suggests that religiosity increases not only the conditional (ex post) conservatism of firms but their unconditional (ex ante) conservatism as well.     

Growth,speculation and sprawl in a monocentric city

An economic theory of sprawl in a growing, monocentric city is presented. Where decision-makers have perfect foresight, leapfrog development and discontinuous land-rent functions may occur and be efficient in both an ex post and ex ante sense. Where the extent of future growth is uncertain, decision-makers become speculators and the spatial pattern of development is more complicated. Ex post inefficiency generally occurs.     

Equity‐based incentive contracts and behavior: Experimental evidence

Equity ‐ based incentive contracts provide managers with dual incentives, motivating both effort and fraud. We report the results from an experiment in which manager subjects make effort and fraud decisions that affect a firm's value. The main treatment variable is the incentive contract, which can be of either the simple equity or stock option type. We find that both effort and fraud are increasing in a manager's share of equity and decreasing in the strike price of an option. Interestingly, the stock option contract induces relatively more fraud than the simple equity contract, even though the two induce the same effort.     

Long-Term or Short-Term Managerial Incentive Contracts

This paper deals with the strategic role of the temporal dimension of contracts in a duopoly market. Is it better for a firm to sign long-term incentive contracts with managers or short-term contracts? For the linear case, with strategic substitutes (complements) in the product market, the incentive variables are also strategic substitutes (complements). It is shown that a long-term contract makes a firm a leader in incentives, while a short-term contract makes it a follower. We find that, under Bertrand competition, in equilibrium one firm signs a long-term contract and the other firm short-term incentive contracts; however, under Cournot competition, the dominant strategy is to sign long-term incentive contracts.