Jan Tinbergen's Income distribution: Analysis and policies

Summary This paper is a detailed review and critique of Jan Tinbergen'sIncome Distribution: Analysis and Policies. In Part I, the books primary findings and their bases are recounted. This presentation serves as the basis for a number of questions regarding the merits of the overall approach — in particular, the empirical methodology — and the reliability of the findings. These questions are posed in Part II. In Part III, an overall appraisal of the work is offered.North-Holland Publishing Co., Amsterdam, 1975.Professor of Economics and Fellow of the Institute for Research on Poverty, University of Wisconsin-Madison. This article was prepared while the author was a Fellow at the Netherlands Institute for Advanced Study. The work was supported in part by the Netherlands Institute for Advanced Study and by funds granted to the Institute for Research on Poverty at the University of Wisconsin-Madison by the U.S. Department of Health, Education and Welfare pursuant to the Economic Opportunity Act of 1964. Helpful comments on an earlier draft by Hans Daudt, Arthur Goldberger, Victor Halberstadt, Arnold Heertje, and Jan Pen are acknowledged. A discussion with Jan Tinbergen on issues raised in his volume was especially valuable, This review article appeared in a slightly different form in the Winter, 1975 issue of theJournal of Human Resources.     

Horizon‐Dependent Underreaction in Financial Analysts' Earnings Forecasts*

This paper provides empirical evidence that underreaction in financial analysts' earnings forecasts increases with the forecast horizon, and offers a rational economic explanation for this result. The empirical portion of the paper evaluates analysts' responses to earnings‐surprise and other earnings‐related information. Our empirical evidence suggests that analysts' earnings forecasts underreact to both types of information, and the underreaction increases with the forecast horizon. The paper also develops a theoretical model that explains this horizon‐dependent analyst underreaction as a rational response to an asymmetric loss function. The model assumes that, for a given level of inaccuracy, analysts' reputations suffer more (less) when subsequent information causes a revision in investor expectations in the opposite (same) direction as the analyst's prior earnings‐forecast revision. Given this asymmetric loss function, underreaction increases with the risk of subsequent disconfirming information and with the disproportionate cost associated with revision reversal. Assuming that market frictions prevent prices from immediately unraveling these analyst underreac‐tion tactics, investors buying (selling) stock on the basis of analysts' positive (negative) earnings‐forecast revisions also benefit from analyst underreaction. Therefore, the asymmetric cost of forecast inaccuracy could arise from rational investor incentives consistent with a preference for analyst underreaction. Our incentives‐based explanation for underreaction provides an alternative to psychology‐based explanations and suggests avenues for further research.     

The Incremental Informativeness of Stock Prices for Future Accounting Earnings*

This study extends previous research that documents a stock price reaction leading accounting earnings. The primary issue is that prior studies use a naive earnings expectation model (random walk) as the benchmark for the information content of lagged returns and do not adequately address the “incremental” information content of lagged returns. This study identifies and estimates firm-specific models of earnings to control directly for the autocorrelation in earnings. The explanatory power of lagged prices with respect to this earnings residual is investigated using both a multiple regression model of lagged returns and a multiple time-series vector autoregressive model. In-sample estimation of the models provides clear evidence that stock prices impound information about future earnings incremental to the information contained in historical earnings data. Holdout period analysis of the earnings forecasts from these lagged return models finds that both models outperform the naive seasonal random walk expectation, but neither model outperforms the more sophisticated Box-Jenkins forecasts. On an individual firm basis, earnings forecasts supplemented with the lagged return data tend to be less precise than the Box-Jenkins forecasts, but the price-based models demonstrate an ability to rank the earnings forecast errors from the time-series models. The analysis helps to characterize the limitations of lagged returns as a means of predicting future earnings innovations.     

The urban informal sector

On the basis of available information, this paper debunks some of the conventional wisdom concerning the informal sector. This sector is not the major point of entry for fresh migrants from rural areas and there exist large variations in earnings within it. A disproportionately large number of informal-sector workers are (i) very young or very old, (ii) females, (iii) limited in education and (iv) not the primary household earners. Finally, the paper confronts the predictions of a dualistic urban labour market model for trends over time in output, employment, productivity and earnings with the results of a case study of Peru by Richard Webb.     

Distinguishing between individual‐and household‐level poverty

Drawing on survey data from 1995, this article shows that the level of aggregation is an important component in the analysis of poverty. Utilising the Headcount Index and cumulative distribution functions, the article examines earnings among individuals and households. Specifically, it is shown that poverty measures at the individual level, compared with estimates at the household level, will transmit differential rankings of indigence. Both are important predictors of poverty and hence should be coupled when trying to understand low earnings in a society.     

Inter-industry labor reallocation and task distance

This paper investigates factors preventing inter-industry labor reallocation by estimating the determinants of inter-industry worker flow and earnings change after a job change. We find that the difference in required tasks is an important reason for earnings reduction after an inter-industry job change, and thus, workers may hesitate to move to industries requiring a different set of tasks for fear of losing the wage premium acquired by task-specific human capital. In addition, more workers switch to industries with which their previous industry had larger transactions, although it affects earnings changes only marginally. On the other hand, industry performance does not affect labor inflow or wage changes significantly for inter-industry job changes. Young men, less educated women, and those quitting previous jobs for family or health reasons are more likely to move to industries requiring a different set of tasks, and young individuals who lost their jobs involuntarily are less likely to do so. Individuals more likely to move are not necessarily those whose earnings loss associated with the move is small: earning losses associated with task distance are relatively small among younger and less educated workers and are uncorrelated with the reasons for quitting the previous job.     

PROMOTIONS, JOB SENIORITY, AND PRODUCT DEMAND EFFECTS ON EARNINGS

This paper investigates the relationship between promotion status,job tenure, product demand, and earnings utilising a matchedemployer-employee sample which gives direct information on individuals'promotion prospects. Promotion status is modelled as an endogenousvariable, subject to an initial job choice. Then the effectof job tenure and product demand on earnings level is investigated.It is found that the earnings of the individuals employed injobs with promotion prospects are not only higher compared withthe remainder but also unaffected by any decrease in productdemand.     

Equilibrium Earnings Management,Incentive Contracts,and Accounting Standards*

In this paper, we model earnings management as a consequence of the interaction among self‐interested economic agents ‐ namely, the managers, the shareholders, and the regulators. In our model, a manager controls a stochastic production technology and makes periodic accounting reports about his or her performance; an owner chooses a compensation contract to induce desirable managerial inputs and reporting choices by the manager; and a regulatory body selects and enforces accounting standards to achieve certain social objectives. We show that various economic trade‐offs give rise to endogenous earnings management. Specifically, the owner may reduce agency costs by designing a compensation contract that tolerates some earnings management because such a contract allocates the compensation risk more efficiently. The earnings‐management activity produces accounting reports that deviate from those prescribed by accounting standards. Given such reports, the valuation of the firm may be nonlinear and s‐shaped, thereby recognizing the manager's reporting incentives. We also explore policy implications, noting that (1) the regulator may find enforcing a zero‐tolerance policy ‐ no earnings management allowed ‐ economically undesirable; and (2) when selecting the optimal accounting standard, valuation concerns may conflict with stewardship concerns. We conclude that earnings management is better understood in a strategic context that involves various economic trade‐offs.     

An Analysis of Historical and Future-Oriented Information in Accounting-Based Security Valuation Models*

The Ohlson (1995) and Feltham and Ohlson (1995) valuation model provides a rigorous framework for summarizing the information in expected future earnings and book values. However, the model provides little guidance on selecting an empirical proxy for expected future earnings. We examine whether and under what circumstances historical earnings and analyst earnings forecasts offer comparable explanation of security prices. This issue is of particular interest because analyst forecasts are less readily available than historical data. Under appropriate circumstances, historical data may allow wider use of the Feltham-Ohlson valuation model by researchers and investors. A related issue is the incremental explanatory power of historical earnings and realized future earnings (perfect-foresight forecasts) for security prices beyond analyst forecasts. If historical earnings are incrementally informative, that would suggest that analyst forecasts do not fully reflect price-relevant information in past earnings. If future earnings are incrementally informative, that would suggest that security prices reflect investors' implicit earnings forecasts beyond analyst forecasts. We examine these issues using a historical model (based on past earnings), a perfect-foresight model (based on realized future earnings), and a forecast model (based on Value Line earnings forecasts). All three models provide significant explanatory power for security prices, and each set of earnings data provides incremental explanatory power for prices when used with the other sets of earnings data. We estimate the models separately for firms with moderate and extreme earnings-to-price (E/P) ratios, a proxy for earnings permanence. For moderate-E/P firms, the historical model's explanatory power exceeds that of the perfect foresight model, and is indistinguishable from that of the analyst forecast model. In contrast, for extreme-E/P firms, the perfect-foresight model offers greater explanatory power than the historical model, but lower explanatory power than analyst forecasts. Our results suggest that financial analysts' forecasting efforts are best focused on firms whose earnings contain large temporary components (extreme E/P firms). However, in general, both historical data and analyst forecasts are complementary information sources for security valuation.     

Earnings Performance of African Immigrants: Evidence from the American Community Survey

Although the number of African immigrants in the U.S. has increased rapidly in recent decades, relatively little regarding their economic performance and assimilation appears in the economics literature. We use pooled cross-sectional data (2011–2015) from the American Community Survey to explore the effects on African immigrant earnings of immigrant characteristics such as degrees attained, type of major, years in the U.S., citizenship status, English-speaking abilities, and country of origin. We also use earnings functions to analyze the earnings assimilation of African immigrants with natives over the past decade. The results show that college-educated African immigrants have experienced some earnings convergence with natives between 2005 and 2015. Surprisingly, the assimilation analysis of non-college graduate African immigrants shows that they have achieved an earnings advantage over native non-college graduates.     

A test of the signalling hypothesis

Education may enhance earnings either because of human capitalincreases or by signalling unobservable worker attributes. Previoustests of these alternatives relied on ad hoc distinctions betweenthem. Our theoretical model provides a direct signal measureas the difference between required and necessary qualifications,forming the basis for an ordered-probit model of discrete differencesbetween required and necessary qualifications that depend onfirm, job, and worker attributes. Estimates support the model'spredictions, providing a continuous, predicted signal measurefor second-stage earnings equations. These results provide thefirst formal evidence of a significant, positive, gender-specificreturn to a signal and indicate a downward bias in the returnto education from excluding the signal measure.     

Aggregation,Dividend Irrelevancy,and Earnings‐Value Relations*

In this paper I show that the aggregation of operating and financial income imposes three conditions on earnings‐based value functions. These three conditions provide a shortcut way to identify dividend irrelevant value functions. For example, consider any value function V_t of book value b_t, earnings x_t, and dividends d_t. The aggregation conditions imply that V_t must be of the form V_t = (1 ? k)bt + k [f xt ? dt]. f is the permanent earnings capitalization factor and undetermined weight k may be any function of Δ_t ≡[φx_t ? d_t] ? b_t. The Ohlson 1995 model is the special case when k is constant. But generally k does not have to be constant to maintain dividend irrelevancy. Whenk varies with Δ_t, V_t is nonlinear in earnings. Hence, this result specifies how V_t may be nonlinear in earnings in settings with limited liability or production or abandonment options and still be dividend‐irrelevant. An even more remarkable feature of this result is that it holds whether accounting is clean surplus or not. One must conclude that accounting‐based valuation properly builds from accounting aggregation and Δ_t, and not from the clean surplus relation and abnormal earnings as many now believe.     

The Difference between Earnings and Operating Cash Flow as an Indicator of Financial Reporting Fraud*

This paper examines the relation between earnings and operating cash flow to derive and test an indicator of financial statement fraud. Accrual measurement concepts indicate that financial statement fraud should be associated with high levels of earnings relative to operating cash flow. We demonstrate that the excess of earnings over operating cash flow is extreme in most fraud cases in years immediately prior to the fraud discovery based on a sample of 56 fraud cases from 1978 to 1991. We compare the distribution of the earnings minus operating cash flow variable for fraud firms with that for a sample of 60,453 firm-years for firms listed on COMPUSTAT. We test a logistic regression model in which the discovery/nondiscovery of fraud is the dependent variable, and earnings minus operating cash flow is the explanatory variable. Other control variables are included in the model based on prior studies. Results are consistent with expectations derived from accrual measurement theory. We then examine the predictive ability of the model using our sample of fraud firms and a sample of nonfraud firms in the same four-digit SIC code industries. Observations for the fraud firms are for the fiscal year prior to the discovery of fraud. Observations for the nonfraud firms are for the same fiscal years as the fraud firms in the same industries. The predictive ability of the model, including the excess of earnings over operating cash flow, is substantially higher than the predictive ability of the model omitting this variable. We conclude that the earnings-operating cash flow relation provides important information for those interested in identifying financial statement fraud, especially when considered in conjunction with other factors associated with fraud risk.     

Equity,efficiency, and labor-market reforms in urban China: the impact of bonus wages on the distribution of earnings

Economic reforms in China have led to a shift in emphasis away from equity towards greater efficiency with a consequent increase in income inequality. In this paper, we focus on the causes of the rising inequality of individual earnings and the link with the reform program by analyzing the components of individual earnings (i.e. standard and bonus wages) separately. Increasing inequality is seen to reflect a rising share and inequality of bonus wages. This, in turn, predominantly reflects the unequal distribution of enterprise profitability combined with labor immobility across enterprises, rather than increasing returns to personal characteristics, such as human capital or gender. Based on these results, we argue that the future evolution of earnings inequality will be determined by the sequence of reforms in, for example, capital and labor markets.     

Estimating the Effects of Earnings Uncertainty on Families' Saving and Insurance Decisions

This paper investigates whether families save partially to self-insure against uncertain future earnings and estimates the extent to which pooled insurance substitutes for saving as a precaution against earnings risk. An econometric model is estimated using unique household survey data from the nineteenth century to examine families' joint saving and insurance decisions. The historical microdata are of interest because they predate widespread social insurance programs, which may stunt self-insurance through private saving among contemporary families. The econometric results imply that two independent measures of idiosyncratic earnings risk matter for families' saving decisions. Additionally, families whose primary wage earners belong to labor unions significantly save less frequently than others, all else being equal, but this tendency is not apparent among members of private benevolent societies.     

On Constructing an EPS Measure: An Assessment of the Properties of Dilution*

This paper evaluates the information content of the treasury stock method for computing diluted earnings per share (EPS). We demonstrate that the treasury stock method decreases the annual association between earnings changes and stock returns and explain why this is the case. Further, we show that the treasury stock method leads to a dilutive adjustment that biases the random walk model of annual earnings in a predictable direction. Finally, we demonstrate that using the treasury stock method appears to confuse both analysts and investors: analysts' forecast errors increase with the size of the dilutive adjustment, and the association between unexpected earnings and stock returns at the earnings announcement date weakens as the dilutive adjustment increases.     

Inequality of opportunity in earnings in rural China

This paper explores the role of ‘inequality of opportunity’ in individual earnings in rural China, which is attributed to ‘circumstantial’ factors over which individuals have no control, including family background, gender, ethnic minority status and region of birth. These circumstances are contrasted with ‘efforts’ or choices that individuals make, which also impact on their individual earnings. Utilising the China Labour-force Dynamics Survey (CLDS) 2014, I measure the share of inequality of opportunity in the overall inequality of individual annual earnings for the entire sample and for each of four ten-year birth cohorts in rural China. The empirical results revealed that the share of inequality of opportunity in individual earnings for the full sample is 20.4% of the GE(0) coefficient. The adoption of machine learning methods provides a wide range of estimates between 16.4% (regression tress) and 25.4% (forests). Across all birth cohorts, gender is consistently the largest single contributor to inequality of opportunity, while family background is relatively more important for younger cohorts. A closer investigation indicates that those who find themselves in the worst circumstances are likely to exert lower level of effort, not because they don’t want to try harder, but because their circumstances prevent them from doing so.     

Temporary Help Service Firms' Use of Employer Tax Credits: Implications for Disadvantaged Workers' Labor Market Outcomes

Temporary help services (THS) firms are increasing their hiring of disadvantaged individuals while also increasing their use of employment subsidies for doing so. Do these subsidies—the Work Opportunity Tax Credit (WOTC) and Welfare-to-Work Tax Credit (WtW)—create incentives that improve employment outcomes for THS workers? We examine the distinct effects of THS employment and WOTC/WtW subsidies on earnings and job duration using new survey and administrative data. We find that, even controlling for a broad range of worker and firm characteristics, some important differences persist between THS workers, WOTC/WtW-certified workers, and those who are both THS and WOTC/WtW certified. THS workers who are WOTC certified have similar job duration to eligible unsubsidized workers but much higher quarterly earnings. Among WOTC-certified workers, those in THS firms have similar quarterly earnings to those in other industries but much shorter average job duration. Panel estimates suggest that these effects do not persist over time.     

Earnings Quality and the Equity Risk Premium: A Benchmark Model*

This paper solves a model that links earnings quality to the equity risk premium in an infinite‐horizon consumption capital asset pricing model (CAPM) economy. In the model, risk‐averse traders hold diversified portfolios consisting of risk‐free bonds and shares of many risky firms. When constructing their portfolios, traders rely on noisy reported earnings and dividend payments for information about the risky firms. The main new element of the model is an explicit representation of earnings quality that includes hidden accrual errors that reverse in subsequent periods. The model demonstrates that earnings quality magnifies fundamental risk. Absent fundamental risk, poor earnings quality cannot affect the equity risk premium. Moreover, only the systematic (undiversified) component of earnings‐quality risk contributes to the equity risk premium. In contrast, all components of earnings‐quality risk affect earnings capitalization factors. The model ties together consumption CAPM and accounting‐based valuation research into one price formula linking earnings quality to the equity risk premium and earnings capitalization factors.     

The Relation between Aggregate Earnings and Security Returns over Long Intervals*

This paper provides a theoretical explanation and consistent empirical evidence for the increase in the contemporaneous correlation between returns and aggregate earnings as the return interval is lengthened. Consistent with intuition and with Easton, Harris, and Ohlson 1992, the analysis shows that aggregation over time renders the lag in accounting recognition relatively less important and thus improves the returns‐earnings R². Interestingly, the analysis also reveals that aggregating earnings over longer periods increases the positive covariance between aggregate earnings and the accounting lag, which may further increase the R². This positive covariance can lead to an earnings coefficient greater than one over some range of aggregation, which is consistent with the findings of Easton et al. that over the 10‐year interval the returns‐earnings regression slope coefficient is greater than one (1.7). The empirical results highlight the fact that the slope coefficient, which is greater than one and increasing with the interval, accounts for much of the increment to the returns‐earnings R². In fact, constraining the slope coefficient to be one results in an R² of 11 percent for the 10‐year interval, which is considerably lower than the R² of 47 percent when the regression is unconstrained. Hence, the positive covariance between current earnings and the accounting lag, rather than the diminishing effect of the accounting lag, appears to be the dominant explanation for the observed high R² over long intervals.