A Unified Model of Firm Dynamics with Limited Commitment and Assortative Matching

We develop a unified theory of dynamic contracting and assortative matching to explain firm dynamics. In our model, neither firms nor managers can commit to arrangements that yield lower payoffs than their outside options, which are microfounded by the equilibrium conditions in a matching market. The model endogenously generates power laws in firm size and CEO compensation, and explains differences in their right tails. We also show that our model quantitatively accounts for many salient features of the time‐series dynamics and the cross‐sectional distribution of firm investment, dividend payout, and CEO compensation.     

Volatility,the Macroeconomy,and Asset Prices

How important are volatility fluctuations for asset prices and the macroeconomy? We find that an increase in macroeconomic volatility is associated with an increase in discount rates and a decline in consumption. We develop a framework in which cash flow, discount rate, and volatility risks determine risk premia and show that volatility plays a significant role in explaining the joint dynamics of returns to human capital and equity. Volatility risk carries a sizable positive risk premium and helps account for the cross section of expected returns. Our evidence demonstrates that volatility is important for understanding expected returns and macroeconomic fluctuations.     

Client Satisfaction and Big 6 Audit Fees*

This study examines whether client satisfaction can help explain cross-sectional variation in Big 6 audit fees paid by Fortune 1000 clients. After controlling for other factors related to audit fees (including audit quality attributes), client satisfaction with the audit team is positively associated with fees. It appears that a dimension of client satisfaction unrelated to audit quality attributes is the factor associated with an audit fee premium. This dimension of satisfaction may reflect other aspects of service quality not documented in the literature, or it may simply enable an auditor to earn economic rents through enhanced bargaining power. Client satisfaction with the audit firm does not appear to be priced in this segment of the audit market. The results are consistent with the view that a Big 6 audit is a service that is differentiable in the eyes of client management, and the results highlight the importance of the audit team composition in allowing a Big 6 audit firm to differentiate the audit product. Also, if auditors are earning local rents due to enhanced satisfaction levels, then a perfect competition model may not be appropriate for the audit services market.     

PRODUCT VARIETY AND DEMAND UNCERTAINTY: WHY MARKUPS VARY WITH QUALITY*

We demonstrate that demand uncertainty can explain equilibrium product variety in the presence of sunk costs. Product variety is an efficient response to uncertainty because it reduces the expected costs associated with excess capacity. We find that within the firm's product line, the highest quality product has the highest profit margin but the lowest percentage margin, while the lowest quality product has the highest percentage margin but the lowest absolute margin. Both of these relationships are consistent with evidence available from marketing studies.