Optimal Regulation of Cooperative R&D Under Incomplete Information

A regulator offers a cooperation contract to two firms to develop a research project. The contract provides incentives to encourage skill-sharing and coordinate subsequent efforts. Innovators must get informational rents to disclose their privately known skills, which results in distorting R&D efforts with respect to the first-best level. When efforts are strategic complements, both efforts are distorted downwards. By contrast, when efforts are strategic substitutes, the effort of the firm with most valuable skills is distorted downwards (to decrease rents) and the effort of the other firm is distorted upwards (to compensate the previous efficiency loss).     

Incentives through consumer learning about tastes

We consider a long-lived firm that faces an infinite sequence of finitely-lived consumers. In each period, the firm can exert either high or low effort, which is the firm's private information. When consumers learn about the firm's talent from the outcomes of previous transactions, there exists no equilibrium in which the firm always exerts high effort. However, when consumers learn about their own tastes, such an equilibrium can exist. Consumer learning about tastes therefore is an alternative to reputational concerns that produces stable incentives. We discuss the implications of this mechanism for advertising, advertising content, and consumer education.     

AUTHORITY,RISK, AND PERFORMANCE INCENTIVES: EVIDENCE FROM DIVISION MANAGER POSITIONS INSIDE FIRMS*

I show that performance incentives vary by decision‐making authority of division managers. For division managers with broader authority, i.e., those designated as corporate officers, both the sensitivity of pay to global performance measures and the relative importance of global to local measures are larger, relative to non‐officers. There is no difference in sensitivity of pay to local measures by officer status. These results support theories suggesting that authority over project selection combined with incentives designed to maximize firm performance, as well as induce effort for the division, are important in incentive design for division managers. Consistent with earlier findings, the evidence strongly supports one of the main predictions of the principal‐agent model, that is, a negative tradeoff between risk and incentives.     

THE QUALITY OF INFORMATION AND INCENTIVES FOR EFFORT*

We study the relationship between the precision of information about the performance of an agent in a market, and the incentives this agent has for exerting effort to produce high quality. We show that this relationship can be nonmonotonic. There exists an efficient plausible equilibrium that induces a threshold beyond which any further improvement in the precision of information weakens the agent's incentive to produce high quality. Accordingly, both very accurate and very inaccurate signals about the agent's performance may destroy its incentive to exert effort. A few applications of this result are discussed.     

Business groups and corporate transparency in emerging markets: Empirical evidence from India

This study examines the difference in corporate transparency of firms affiliated with business groups and unaffiliated firms in India. Based on previous studies we measured corporate transparency using equity analysts’ forecast error and dispersion. We find that firms affiliated with business groups are less transparent than unaffiliated firms. Lack of transparency leads to higher analyst forecast error and dispersion. This study also finds that business group-affiliated firms with more intra-group capital transactions have higher forecast error and dispersion. The findings of this study suggest that firms affiliated with business groups are less transparent due to their reliance on internal capital markets, and therefore lack incentives to disclose information to market participants. As a result, the information asymmetry between business groups and the capital market is higher, restricting the activities of information intermediaries such as equity analysts, who play an important role in the external capital market.     

Managerial ownership and the role of privatization in transition economies: The case of China

Within transition economies, a popular tactic for revitalizing large and inefficient stateowned enterprises (SOEs) is to privatize them. Unfortunately, the empirical evidence related to this issue is equivocal. This study, therefore, explores more deeply what the relationship may be between privatization efforts of SOEs and their financial performance in transition economies. Specifically, we seek to better understand whether privatization reforms per se, or other corporate governance mechanisms that complement or substitute for this effort, are most effective. Using a panel sample of Chinese state-owned public firms over an eight year period from 1999 to 2006, we find that managerial ownership has a more significant impact on firm performance than privatization does. This finding suggests that internal incentives to managers may be more effective than external market mechanisms in economies transitioning from centralized planning to market control. Our results are robust using a wide variety of performance measures and different model specifications.     

Flexible Wage Contracts,Temporary Jobs,and Firm Performance: Evidence From Italian Firms

This study focuses on the effects of decentralized wage schemes and temporary forms of employment on firm performance. The effect of monetary incentives on workers' effort and firm performance is a central topic in economics. According to the principal‐agent paradigm, firms (the principal) have to link employees' remuneration schemes to any verifiable indicator of performance to avoid opportunistic behavior. The empirical evidence shows that financial incentives have the potential to exert strong effects on indicators of firm performance, such as productivity and worker absenteeism, although the degree of effectiveness of such schemes varies significantly according to the institutional/economic context in which firms operate. From both a theoretical and empirical point of view, the prediction on the effects of temporary types of employment on effort and productivity is less neat. In light of these considerations, this study uses a sample of Italian firms to provide further empirical evidence on whether and to what extent performance‐related pay schemes and contract flexibility affect workers' effort (in terms of absenteeism) and, in turn, firm productivity. These effects are analyzed for different types of workers (white collar vs. blue collar), working in workplaces characterized by a different degree of uncertainty and risk and in firms operating in different economic and institutional settings. Our results show that wage flexibility has a significant effect on effort and then on firm's productivity and that white‐collar workers are more responsive to monetary incentives than blue‐collar workers. Moreover, the presence of a large share of temporary contracts, implying a lower dismissal probability for permanent workers and a deterioration of the working environment, appears to reduce workers' motivation and effort.     

A Note on Quality Disclosure and Competition

Competitive pressure is lower in markets where goods are more differentiated. I analyze how a change in the degree of horizontal product differentiation affects the incentives of duopolists to disclose quality information. If disclosure is costly, then a firm discloses high qualities but conceals low qualities in equilibrium. The higher the disclosure cost, the higher the equilibrium threshold below which firms conceal quality information. I show that the effect of product differentiation on quality disclosure depends on the cost of disclosure. For low (high) disclosure costs, a firm discloses more (respectively, less) quality information if goods become more differentiated.     

Coordination and the provision of incentives to a common regulated firm

This paper considers the problem faced by two regulators in providing incentives to a common (privately informed) regulated firm under various degrees of coordination. In the model, the firm exerts effort toward cost reduction and self-dealing, and incentives can be input-based (monitoring) and output-based (demanded cost targets). Full coordination between the regulators leads to the second best allocation. A setting in which the regulators do not fully coordinate leads to (i) higher overall monitoring (more aggressive input-based incentives) and (ii) higher demanded cost targets (i.e., more lenience in terms of output-based incentives). As a consequence of (i), in all possible equilibria, the effort toward cost reduction will be smaller when the agent reports to two regulators who do not coordinate. (i) and (ii) imply that the impact on the effort toward self-dealing activities is ambiguous. In our leading example, self-dealing will be larger if the regulators coordinate on monitoring levels but smaller if they choose monitoring levels independently.     

Horizontal Product Differentiation: Disclosure and Competition

This paper studies firms' incentives to disclose horizontal product attributes in a competitive environment. With competition, two elements play an important role: whether (i) firms can disclose only their own product characteristics or also those of their competitors, and whether (ii) competitors can react with their pricing decisions to the type of information disclosed. In all possible cases, full revelation is an equilibrium outcome. More importantly, it is generically the unique equilibrium outcome when (i) advertising is comparative and (ii) prices are also advertised, that is, announced simultaneously with the product information. When advertising is noncomparative or prices are not advertised, many nondisclosure equilibria exist.     

The Neoclassical Firm Under Moral Hazard

We develop a model of the neoclassical firm under moral hazard with endogenous capital and employment and perfectly competitive capital, labor and product markets. We assume that effort becomes harder to measure as the firm gets larger and the exogenous parameters are affiliated. The model explains why incentives decline but wages rise with firm size, the mixed evidence on the risk-reward tradeoff, and the positive correlation between wages and profits. In the long run, incentives are increasing in risk via endogenous capital. Finally, the model makes novel predictions about the relationship between incentives and labor market conditions.     

Interplay between internal investment and alliance specialization in R&D and marketing

A firm's efforts to build its technological and marketing capabilities are not limited to internal investments but can be extended to include external knowledge acquisitions. We examine the interaction between a firm's specialization in R&D or marketing through its internal investments and its alliances in two different industrial contexts. Our results, based on secondary data sources such as Compustat and SDC Platinum from 1985 to 2009, show that the interaction effects of internal specialization and alliance specialization are contingent on the types of tasks (i.e., R&D and marketing) and the industrial context (i.e., high- and low-tech industries). Our findings indicate that a firm in a high-tech industry is able to achieve greater gains by complementing its internal focus on R&D with its external focus on marketing or by focusing on R&D both internally and externally. In contrast, a firm in a low-tech industry is able to achieve greater performance when R&D and marketing complement each other, without regard for how they are aligned through internal investments and alliances. The firm is also able to improve its performance by focusing on marketing both internally and externally. These findings provide new insights into the complementarity between internal investments and alliances.     

A positive theory of give-away privatization

We make a first step towards a positive theory of privatization, in a framework similar to the one of Shleifer and Vishny's “Politicians and Firms” (QJE, 1994). In our model, a government may want to privatize because privatization can provide managers with stronger incentives to exert effort and more managerial effort may help to maintain jobs that otherwise would be destroyed. However, the government trades off better managerial incentives with the costs of losing control, here, over funds that the government provides for the restructuring of firms. We also show that if managers care for the size of their firm, privatization may weaken, not strengthen incentives.     

Equity‐based incentives and collaboration in the modern multibusiness firm

Research summary : This paper examines the role of equity‐based incentives in fostering cross‐business‐unit collaboration in multibusiness firms. We develop a formal agency model in which headquarters offers equity and profit incentives to business‐unit managers with the objective of maximizing total expected firm returns. The resulting compensation contract provides a rich mechanism for aggregating value from collaborative interactions across business units, aligning managers' efforts with the firm's growth prospects and organization structure and managing the dual risks in profits and firm market value. The inclusion of equity incentives elicits higher levels of own‐unit and collaborative efforts over the profits‐only contract. Our results suggest that equity‐based incentives are most beneficial when profitability is uncertain relative to long‐term growth prospects, in firms pursuing related diversification strategies, and in periods of rising equity markets. Managerial summary : Equity‐based compensation such as restricted stock grants and options are increasingly common, not only for CEOs and other top executives, but also for business unit managers and other non‐C‐suite employees. The paper studies the role of such “global” incentives in enabling multibusiness firms to benefit from cross‐unit collaboration. Results from our model show that managerial contracts that include appropriate levels of equity incentives, in addition to profit‐based incentives, generate higher own‐unit and collaborative efforts. We also find that equity incentives are likely to be most beneficial for large firms in high‐growth sectors, for firms pursuing a related diversification strategy, and in periods of rising stock markets. The model can also provide useful guidance on designing return‐maximizing compensation contracts for business unit managers in different firm, organizational, and industry contexts. Copyright © 2015 John Wiley & Sons, Ltd.     

Allocation of inventive effort in complex product systems

This paper examines the allocation of inventive effort in complex product systems. I argue that complex product systems, e.g., personal computers (PCs), are distinguished by functional interaction among several components, each guided by a relatively autonomous bundle of technical and economic characteristics. I try to explore whether the dynamics of such interactions between components of complex product systems can help us understand changes in the relative allocation of inventive effort. I advance and empirically test three hypotheses: (1) emergence of component constraints (bottlenecks) in product systems will trigger research and development (R&D) investment to resolve the constraints; (2) slack component firms have a strong incentive to invest in resolving component constraints; and (3) the incentive of slack component firms to invest in resolving component constraints is increasing in their prior sunk R&D investments in slack components. In sum, I argue that interactions between components in a product system conditions the R&D incentives of firms and also that the incentives are increasing in their prior investments or capabilities. Using product reviews from technical journals, I trace the constraint components in the PC from 1981 to 1998 and attempt to predict shifts in the allocation of inventive effort in the subsequent period. The empirical results strongly support all three hypotheses. This study highlights the paradoxical effect of modularity in complex product systems. Modular design architectures, while contributing to accelerating the pace of technical change, also tend to limit the economic benefits of firms' component R&D efforts, especially when different components technologies are progressing at different rates. This often creates an impetus to enlarge the scope of firm R&D activities beyond the component product markets that firms operate in. Other implications for R&D decision making are discussed. Copyright © 2007 John Wiley & Sons, Ltd.     

Alleviating managerial dilemmas in human‐capital‐intensive firms through incentives: Evidence from M&A legal advisors

Research summary: We examine how human‐capital‐intensive firms deploy their human assets and how firm‐specific human capital interacts with incentives to influence this deployment. Our empirical context is the UK M&A legal market, where micro‐data enable us to observe the allocation of lawyers to M&A mandates under different incentive regimes. We find that law firms actively equalize the workload among their lawyers to seek efficiency gains, while “stretching” lawyers with high firm‐specific capital to a greater extent. However, lawyers with high firm‐specific capital also appear to influence the staffing process in their favor, leading to unbalanced allocations and less sharing of projects and clients. Paradoxically, law firms may adopt a seniority‐based rent‐sharing system that weakens individual incentives to mitigate the impact of incentive conflicts on resource deployment. Managerial summary: The study highlights the dilemmas when professional service firms allocate their key individuals to incoming projects, and the role that monetary incentives play in aggravating or alleviating these dilemmas. In the context of UK M&A law firms, we find that partners have a tendency to be attached to too many projects and not to share enough work, which is exacerbated when individual monetary incentives are stronger. Firms adopting a seniority based incentive system (lockstep system) are able to alleviate this effect. This implies that there is a trade‐off between rewarding personal performance versus balancing workloads and fostering collaboration among professionals. Copyright © 2015 John Wiley & Sons, Ltd.     

Manipulation Through Biased Product Reviews*

We study a signal-jamming model of product review manipulation in which rational consumers consult product reviews and price to better estimate a product's quality, and a firm, whose quality is either high or low, chooses its price and how much bias to insert into product reviews. We show that both firm types always exert positive effort to manipulate product reviews, and, depending on the equilibrium price level, one or both of them can increase its sales. When the high-type firm exerts more effort than the low-type, review manipulation benefits consumers by raising [lowering] their demand for the high-quality [low-quality] product.     

Organizing for knowledge generation: internal knowledge networks and the contingent effect of external knowledge sourcing

Research summary : When faced with a new technological paradigm, incumbent firms can opt for internal development and/or external sourcing to obtain the necessary new knowledge. We explain how the effectiveness of external knowledge sourcing depends on the properties of internal knowledge production. We apply a social network lens to delineate interpersonal, intra‐firm knowledge networks and capture the emergence of two important firm‐level properties: the incumbent's internal potential for knowledge recombination and the level of knowledge coordination costs. We rely on firm‐level internal knowledge networks to dynamically track the emergence of these properties across 106 global pharmaceutical companies over a 25‐year time period. We find that a firm's success in developing knowledge in a new technological paradigm using external knowledge sourcing is contingent on these internal knowledge properties . Managerial summary : Incumbent firms in high‐tech industries often face competence‐destroying technological change. In their effort to adapt and develop new knowledge in a novel paradigm, incumbent firms have several corporate strategy options available to them: internal knowledge development and a wide array of external knowledge sourcing strategies, including alliances and acquisitions. In this study, we make an effort to address a critical question: How effective is external knowledge sourcing under different internal knowledge generation regimes? We find that external sourcing strategies are less effective when firms can already internally generate new knowledge or if they have high internal coordination costs. Therefore, when considering external sourcing, managers must carefully weigh the benefits of it vis‐à‐vis its commensurate costs as the benefits of external sourcing may be overstated . Copyright © 2015 John Wiley & Sons, Ltd.     

REIT Auditor Fees and Financial Market Transparency

This article examines the relationship between overinvestment in audit services, abnormal nonaudit fees paid to the auditor and market-based measures of firm transparency. Because real estate investment trusts (REITs) must distribute 90% of their earnings as dividends, many are repeat participants in the seasoned equity market. Thus, REITs have unusually strong incentives to strive for security market transparency. We find that the capital markets reward REITs that overinvest in audit services with better liquidity as measured by bid-ask spreads. However, firms with abnormally high nonaudit expenditures appear to be penalized with wider spreads, consistent with the notion that such fees may compromise auditor independence.     

Biases in the selection stage of bottom‐up strategy formulation

We propose that the failure to adopt an idea or innovation can arise from an in‐group bias among employees within an organizational subunit that leads the subunit's members to undervalue systematically ideas associated with members of the organization outside their subunit. Such biases in internal selection processes can stymie organizational adaptation and therefore depress the performance of the firm. Analyzing data on innovation proposals inside a large, multinational consumer goods firm, we find that evaluators are biased in favor of ideas submitted by individuals that work in the same division and facility as they do, particularly when they belong to small or high‐status subunits. Copyright © 2013 John Wiley & Sons, Ltd