Too big to fail: Measures,remedies, and consequences for efficiency and stability*

This paper evaluates whether reform efforts addressing “too big to fail” actually enhance the stability of the financial system, and whether trade‐offs exist between stability and efficiency. We also present and discuss various measures of bank size and complexity since such measures are essential for implementing appropriate corrective remedies. As we will show, there are no unambiguous measures of size or complexity that can fully capture a bank's contribution to systemic risk. Their effects on efficiency are also impossible to capture with certainty. While we recognize the need for additional research and empirical evidence, we do identify weaknesses and strengths of proposed and implemented reforms that could have consequences for bank stability and efficiency.     

Accounting for Macroeconomic Influences on the Firm

Accounting based measures of exposure to macroeconomic shocks in exchange rates, interest rates and inflation do not capture the economic effects on the corporation of such shocks. We suggest measures that conceptually are coefficients in a multiple regression. The coefficients capture the sensitivity of a firm's real value or cash flows to unanticipated changes in each variable holding other variables constant. Information about such sensitivity coefficients would enable external stakeholders to distinguish between risk caused by firm-specific factors on the one hand and macroeconomic factors on the other. Scenario analysis is discussed as an alternative method for evaluating sensitivity coefficients. Information requirements for scenario and regression analysis are compared. Sensitivity coefficients can be used to identify a firm's functional currency or currency basket in which cash flows are independent of exchange rate changes. An example built on an actual case in Appendix demonstrates how insights can be gained from estimates of the suggested exposure measures.     

Talking in the present,caring for the future: Language and environment

This paper identifies a new source that explains environmental behaviour: the presence of future tense marking in language. We predict that languages that grammatically mark the future affect speakers’ intertemporal preferences and thereby reduce their willingness to address environmental problems. We first show that speakers of languages with future tense marking are less likely to adopt environmentally responsible behaviours and to support policies to prevent environmental damage. We then document that this effect holds across countries: future tense marking is an important determinant of climate change policies and global environmental cooperation. The results suggest that there may be deep and surprising obstacles for attempts to address climate change.     

On the macroeconomic effects of establishing tradability in weak property rights

The New Economy is closely associated with computing & communications technology, notably the Internet. We discuss property rights to, and trade in, the difficult-to-define intangible assets increasingly dominating the New Economy, and the possibility of under-investment in these assets. For a realistic analysis we introduce a Schumpeterian market environment (the experimentally organized economy). Weak property rights prevail when the rights to access, use, andtrade in intangible assets cannot be fully exercised. The trade-off between the benefits of open access on the Internet, and the incentive effects of strengthened property rights, depend both on the particular strategy a firm employs to secure property rights, and the protection offered by law. Economic property rights can be strengthened if the originator can find innovative ways to charge for the intangible assets. The extreme complexity of the New Economy and the large number of possible innovative private contract arrangements make it more important to facilitate the use and enforcement of private individualized contracts to protect intellectual property than to rely only on standard patent and copyright law. Enabling law is one proposed solution. Current patent legislation in the US has led to costly litigation processes weakening the position of small firms and individuals in patent disputes. The property rights of such firms and individuals could be strengthened with insurance or arbitration procedures.JEL Classification: D21, D23, D52, D82, H54, K11, K22, K41, L11, L23, M13, O14, O33An earlier version of this paper was presented at the 9th Congress of the International Joseph A. Schumpeter Society (ISS), Gainesville, Florida, USA, March 28-30, 2002. The paper is part of the Nödfor project on Schumpeterian Creative Destruction, notably the exit and bankruptcy process, based at the Ratio Institute, Stockholm.     

ASSET PRICING WITH IN- AND OUTFLOW CONSTRAINTS: THEORY AND EMPIRICAL EVIDENCE FROM SWEDEN

The paper analyzes asset pricing and portfolio choice when domestic investors collectively cannot hold foreign assets beyond a maximum value. We add the constraint that foreign investors cannot hold more than a fraction of the shares of domestic assets. Consistent with Swedish stock market data, both domestic and foreign investors pay premiums for investing in the other country's assets. Some empirical observations are inconsistent with the CAPM framework.     

RECOGNIZING MACROECONOMIC FLUCTUATIONS IN VALUE BASED MANAGEMENT

Value Based Management (VBM) has become a common tool for evaluating corporate strategies and projects from the perspective of shareholder value maximization, and can be an important input for corporate compensation systems. But traditional VBM frameworks make no systematic effort to distinguish between changes in performance attributable to macroeconomic fluctuations beyond management's control and changes in performance that reflect the intrinsic competitive position of the firm.
The authors have developed an approach for "filtering out" the impact of macroeconomic fluctuations on cash flows for purposes of performance evaluation. Such fluctuations are captured by changes in exchange rates, interest rates, and aggregate price levels (both domestically and abroad) that are significantly correlated with a particular company's cash flows. The authors also provide a method for distinguishing between expected and unanticipated cash flow effects of macro events and recommend insulating managers' performance only from the changes they cannot anticipate and manage. In applying the framework to Electrolux, a Swedish multinational, the authors show that unanticipated changes in the krona/pound exchange rate and various interest rates contribute significantly to the variability of the firm's cash flows; and with the help of the sensitivity coefficients used to measure such exposures, they calculate measures of "intrinsic" cash flow that are purged of such macro effects.     

Macroeconomic Fluctuations as Sources of Luck in CEO Compensation

Macroeconomic fluctuations in interest rates, exchange rates, and inflation can be considered sources of good or bad “luck” for corporate performance if management is unable to adjust operations to these fluctuations. Based on a sample of 2,091 US firms, we decompose the impacts of macroeconomic fluctuations on three measures of CEO compensation. Our study provides empirical support for the importance of considering macroeconomic fluctuations in designing CEO incentive schemes. It adds to the managerial power literature on moral hazard and CEO compensation by pinpointing the obvious risk that the CEO in an asymmetric and non-linear reward system will be inclined to prioritize his/her own cash flow at the expense of fulfilling an assumed agency role. The policy conclusion for remuneration committees and board of directors is to filter out macroeconomic influences on performance to be rewarded whenever an asymmetric compensation scheme has been opted for.