The Value of Precontract Information About an Agent's Ability in the Presence of Moral Hazard and Adverse Selection

We analyze the expected value of information about an agent's type in the presence of moral hazard and adverse selection. Information about the agent's type enables the principal to sort/screen agents of different types. The value of the information decreases in the variability of output and the agent's risk aversion, two factors that are typically associated with the severity of the moral hazard problem. However, the value of the information about agent type first increases but ultimately decreases in the severity of adverse selection. The decrease comes about because the means available to the principal to induce effort—namely, the pay–performance sensitivity—must also be used to sort/screen agents, and these two goals conflict. This decline in value occurs despite the monotonically increasing importance of the information in determining the principal's expected profits. Further, we show that the peak value of information occurs at a predictable level of adverse selection. These results imply that over some range, the importance of the information will be increasing, and the value of the information will be simultaneously decreasing, in the severity of adverse selection.     

Variance analysis: A unifying cost function approach*

Abstract. This paper investigates the use of variance analysis when inputs are assumed to be substitutable. When input prices change after the budget is formulated, cost minimization behavior requires substitution of relatively cheaper input(s) for the more expensive input(s). An explicit incorporation of this substitution effect is necessary to provide proper incentives to production managers. The traditional variance analysis which depends upon “standards” is tantamount to assuming a fixed proportion production technology, even when inputs are substitutable. Thus the traditional variance analysis can yield a misleading and incorrect analysis which in turn can lead to a nonoptimal input combination. The paper provides a general framework for variance analysis which accounts for and, therefore, encourages substitution. Budgets are “flexible” not only with respect to output levels, but also with respect to input prices. The framework explicitly accounts for a new standard based upon realized conditions. To do so, a duality between production and cost functions is exploited so that the optimal input mix is obtained with ease under different price regimes. Four examples of cost functions are offered. They can be regarded as the new flexible standards which depend on both output levels and input prices. Résumé. L'auteur étudie l'utilisation de l'analyse des écarts lorsqu'on suppose que les intrants peuvent être substitués. Lorsque le prix des intrants change une fois le budget établi, le comportement de minimisation des coûts exige que l'on substitue un ou des intrants relativement plus économiques à l'intrant ou aux intrants plus dispendieux. L'incorporation explicite de cet effet de substitution s'impose si l'on veut offrir des stimulants appropriés aux gestionnaires de la production. L'analyse des écarts traditionnelle qui dépend des «normes» équivaut à supposer que la technologie de fabrication prévoit des proportions fixes, même lorsque les intrants peuvent être substitués. L'analyse des écarts traditionnelle peut donc mener à des observations erronées et incorrectes qui, à leur tour, peuvent mener à une combinaison d'intrants qui n'est pas optimale. L'auteur propose un cadre général pour l'analyse des écarts quitient compte de la substitution et, par conséquent, la favorise. Les budgets sont «variables» non seulement en ce qui a trait au niveau des extrants, mais aussi en ce qui a trait au prix des intrants. Le cadre tient compte de façon explicite d'une nouvelle norme fondée sur les conditions réalisées. Pour y parvenir, l'on exploite la dualité entre la production et les fonctions de coût, de sorte que la combinaison optimale d'intrants soit obtenue facilement compte tenu de différents régimes de prix. L'auteur présente quatre exemples de fonctions de coût qui peuvent être considérées comme de nouvelles normes souples dépendant à la fois du niveau des extrants et du prix des intrants.     

HOW DO HIGH SCHOOL GRADUATES IN JAPAN COMPETE FOR REGULAR,FULL‐TIME JOBS? AN EMPIRICAL ANALYSIS BASED UPON AN INTERNET SURVEY OF THE YOUTH*

We use a survey of Japanese youth within 10 years after high school graduation to investigate impacts of academic and social skills on their success in the job market. We find three major factors account for the job market outcome immediately after school: school characteristics and job‐placement services, academic performance, and social skills, including negative impacts of problematic behaviors at school. Second, when we run a probit regression on whether or not the surveyed individuals hold regular, full‐time jobs, we find the persistent but declining (over age) impact of the job placement immediately after school. Moreover, we find that the impact of variables pertaining to social skills remain significant even after controlling for the job‐placement outcome after school, whereas other variables, such as grade point average or attributes of high schools, are largely irrelevant to the current employment status.     

VENTURE CAPITAL AND INNOVATION: WHICH IS FIRST?

Policy‐makers typically interpret positive relations between venture capital (VC) investments and innovations as evidence that VC investments stimulate innovation (VC‐first hypothesis). This interpretation is, however, one‐sided because there may be a reverse causality that innovations induce VC investments (innovation‐first hypothesis): an arrival of new technology increases demand for VC. We analyze this causality issue of VC and innovation in the US manufacturing industry using both total factor productivity growth and patent counts as measures of innovation. We find that, consistent with the innovation‐first hypothesis, total factor productivity growth is often positively and significantly related with future VC investment. We find little evidence that supports the VC‐first hypothesis.     

Wealth Heterogeneity and Escape from the Poverty–Environment Trap

A mutual link between poverty and environmental degradation is examined in an overlapping generations model. Environmental quality affects labor productivity and wealth dynamics, whereas wealth distribution determines the degree to which agents rely on technology that has a large environmental load, and therefore the evolution of environmental quality. This interaction creates a “poverty–environment trap,” where a deteriorated environment lowers income, which, in turn, accelerates environmental degradation. We show that greater wealth heterogeneity is the key to escaping from the poverty–environment trap, although it can have negative effects on both the environment and output when not in the trap.     

Moral Hazard and Adverse Selection: The Question of Financial Structure

This paper looks at the moral hazard and adverse selection problems confronting an entrepreneur offering securities to an uninformed, but competitive financial market. The adverse selection aspect of the problem is generated by the unobservable entrepreneur's ability to transform effort into value. Moral hazard arises because the investment decision is made subsequent to financing. We consider the joint use of both debt and equity, and characterize the equilibrium relation between capital structure and unobservable attributes. It is shown that: (1) investment and financing are not separable; (2) there is an underinvestment problem for “better” firms; and (3) simultaneous use of both debt and equity can resolve this difficulty. We also establish a connection between expected terminal firm value and debt-promised payment level and between share retention and standard deviation.     

Do Insiders Manipulate Earnings When They Sell Their Shares in an Initial Public Offering?

In this article we examine whether insider share selling in an initial public offering (IPO) influences R&D expenditures. Insiders (managers and venture capitalists) who sell their pre‐offering shareholdings might try to increase the IPO offer price (1) by overinvesting in R&D to signal the firm's prospects (the signaling hypothesis) or (2) by underinvesting in R&D to increase current reported earnings (the earnings fixation hypothesis). We find that, for a sample of 243 IPOs from 1986 to 1990, change in R&D spending in the year of the IPO is negatively related to managerial selling. Because reductions in R&D spending increase current earnings at the expense of future earnings, our evidence suggests that managers believe that investors place more emphasis on current earnings and less emphasis on R&D and therefore spend less on R&D. We also document a positive association between discretionary current accruals in the offering year and managerial selling, suggesting that selling managers manipulate accruals as well.