How does managed care do it?

Integrating the health services and insurance industries, as health maintenance organizations (HMOs) do, could lower expenditure by reducing either the quantity of services or unit price or both. We compare the treatment of heart disease in HMOs and traditional insurance plans using two datasets from Massachusetts. The nature of these health problems should minimize selection. HMOs have 30% to 40% lower expenditures than traditional plans. Both actual treatments and health outcomes differ little; virtually all the difference in spending comes from lower unit prices. Managed care may yield substantial increases in measured productivity relative to traditional insurance.     

What determines stock option contract design?

We analyze the factors that drive exercise price policy for executive option plans (ESOPs) and their scope in a country where firms are not subject to the tax and accounting considerations that seem to have led to the dominance of at-the-money options in the US Our “unbounded” data for Finland provide us with an excellent opportunity to investigate whether contract design is consistent with compensation theory. Our findings are largely consistent with predictions from the optimal contracting literature. The size of the plan is negatively related to Tobin's Q and firm size and positively related to proxies for monitoring costs, which also influence the probability of launching premium ESOPs. Our results also show that the premium (out-of-the-moneyness) is negatively related to prior stock returns and cash flow-to-assets, which may be an indication of high-water mark contracting, or alternatively, of managerial power. Finally, we also find some support for a positive relation between the premium and the length of the vesting period when maturity is fixed, which indicates an effort to keep the incentives for management from falling over time.     

How do individual investors trade?

This paper examines how high-frequency trading decisions of individual investors are influenced by past price changes. Specifically, we address the question as to whether decisions to open or close a position are different when investors already hold a position compared with when they do not. Based on a unique data set from an electronic foreign exchange trading platform, OANDA FXTrade, we find that investors’ future order flow is (significantly) driven by past price movements and that these predictive patterns last up to several hours. This observation clearly shows that for high-frequency trading, investors rely on previous price movements in making future investment decisions. We provide clear evidence that market and limit orders flows are much more predictable if those orders are submitted to close an existing position than if they are used to open one. We interpret this finding as evidence for the existence of a monitoring effect, which has implications for theoretical market microstructure models and behavioral finance phenomena, such as the endowment effect.     

How do CEO incentives affect corporate tax planning and financial reporting of income taxes?

We examine how different accounting metrics used to evaluate CEO performance for annual bonuses affect the level of corporate tax planning as well as financial reporting for income taxes. We predict and find that firms using cash flow metrics report lower GAAP and cash effective tax rates (ETR) than firms using earnings metrics. We also find that firms using after-tax earnings metrics report lower GAAP ETRs but similar cash ETRs as firms using pre-tax earnings metrics. Further analyses show that firms using after-tax earnings metrics are more likely to designate foreign earnings as permanently reinvested and have lower discretionary reserves for tax uncertainty. Hence, it appears that both types of firms engage in similar levels of tax planning, but firms evaluating CEOs with after tax-earnings metrics incentivize different financial reporting choices.     

How do venture capitalists make decisions?

We survey 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions. Using the framework in Kaplan and Strömberg (2001), we provide detailed information on VCs’ practices in pre-investment screening (sourcing evaluating and selecting investments), in structuring investments, and in post-investment monitoring and advising. In selecting investments, VCs see the management team as somewhat more important than business-related characteristics such as product or technology although there is meaningful cross-sectional variation across company stage and industry. VCs also attribute the ultimate investment success or failure more to the team than to the business. While deal sourcing, deal selection, and post-investment value-added all contribute to value creation, the VCs rate deal selection as the most important of the three. We compare our results to those for chief financial officers (Graham and Harvey, 2001) and private equity investors (Gompers et al., 2016a).     

How do firms adjust director compensation?

This paper examines outside director compensation for a sample of 237 Fortune 500 firms over the 1998–2004 period. We document a trend towards fixed-value equity compensation and away from cash only and fixed-number equity compensation. Adjustments to director compensation are consistent with firms targeting a market level of compensation, and firms that deviate from their market wage symmetrically adjust compensation back toward the market level. We also document the relation between changes in compensation and changes in equity values, and find that upward adjustments begin sooner than downward adjustments. When equity values rise, we find virtually no immediate offset to director compensation. However, when equity values fall, fixed-number equity compensation is adjusted in the same period (by awarding more shares or options) to offset the loss of income by almost one-third. Thus, the magnitude of adjustments towards the market wage level is symmetric, but the timing is not.     

How do investors react under uncertainty?

It has long been accepted that risk plays an important role in determining valuation where risk reflects that investors are unsure of future returns but are able to express their prior expectations by a probability distribution of these returns. Knight (1921) introduced the concept of uncertainty where investors possess incomplete knowledge about this distribution and so are unable to formulate priors over all possible outcomes. One common approach for making uncertainty tractable is to assume that investors faced with uncertainty will base their decisions on the worst case scenario (i.e. follow maxmin expected utility). As a consequence it is postulated that investors will become more pessimistic as uncertainty increases, upgrading bad news and downgrading good news. Using Australian data, we find evidence that investors react to bad news at times of high market uncertainty but largely ignore good news which is consistent with them taking on a pessimistic bias. However, we also find evidence of the reverse when market uncertainty is low with investors taking on an optimistic stance by ignoring bad news but reacting to good news. We also find that the impact that market uncertainty has on the reaction of investors to new information is modified by the prevailing market sentiment at the time of the announcement. Besides throwing light on the question of how uncertainty impacts on investor behaviour, our findings seriously challenge the common assumption made that investors consistently deal with uncertainty by applying maxmin expected utility.     

Politicians and financial supervision unification outside the central bank: Why do they do it?

An increasing number of countries show a trend towards a certain degree of consolidation of powers in financial supervision, which has resulted in the establishment of unified regulators, that are different from the national central banks. By contrast a high involvement of the central bank in supervision seems to be correlated with a multi-authorities regime (central bank fragmentation effect). This paper, using a simple application of a general common agency game, sheds light on which conditions the politicians prefer when implementing an unified sector supervision outside the central bank. From a theoretical point of view the quality of public sector governance plays a crucial role in determining the supervision unification. Focusing on the behaviour of the “good” policymaker (helping hand type), it will prefer a unified financial authority that is different from the central bank if the correspondent welfare gains-linked to at least one of the three effects: moral hazard, conflict of interest, bureaucracy—are considered higher respect to the information losses. The “bad” policymaker (grabbing hand type) will choose the single financial authority if the financial industry likes it, and the central bank is not a captured one. On the other hand, the paper tests the model, confirming the robustness of the institutional position of the central bank in explaining the recent trend in supervision consolidation, with an empirical analysis performed with ordered functions on an updated dataset.     

Do they do it for the money?

Using a sample of all top management who were indicted for illegal insider trading in the United States for trades during the period 1989-2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them). We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other motives.     

How do banks adjust their capital ratios?

We analyze the dynamics of banks’ regulatory capital ratios. Using monthly regulatory data of large German banks, we estimate the target level and the adjustment speed of the capital ratio for each bank separately. There exists a target level for a substantial percentage of banks. Unlike with panel regressions, we can estimate individual adjustment speeds and find large variation across banks. Adjustments on the liability side are most effective, although adjustment rates on the asset side are higher. Private commercial banks (neither state-owned nor cooperative) and banks with a high level of proprietary trading are more likely to adjust their capital ratio tightly. Banks with a target capital ratio compensate for low target ratios with low asset volatilities and high adjustment speeds. They seem to care mainly about the resulting probability to comply with the regulatory minimum. Assuming low variation of this probability explains most of the large cross-sectional variation of bank capital.     

How do share repurchases affect ownership concentration?

We study how share repurchases affect the ownership stake of outside blockholders in 950 publicly-traded US corporations from 1996 through 2001, using a control function approach to address the possible endogeneity of repurchases. We find that share repurchases tend to make outside ownership less concentrated: repurchasing 1% of outstanding common equity decreases the fraction owned by large shareholders by around one and a half percentage points. This may decrease outside shareholders' influence over firm decision-making. Our results are confirmed when we restrict the sample to institutional owners, but not to individual owners.     

How well do investors understand loss persistence?

This paper examines investors’ expectations of loss persistence. I develop a model to forecast loss firms’ future earnings based on Joos and Plesko, The Accounting Review 80: 847–870, (2005). This model produces smaller forecast errors than two random walk models and a model that assumes losses are transitory. The results suggest that investors do not fully distinguish the differences in loss persistence captured by the model and instead appear to assume that all losses are transitory. Consequently, investors are surprised by future announcements of negative earnings for firms with predicted persistent losses, and these firms experience significantly negative abnormal returns over the following four quarters. Additional results indicate that the future negative returns of firms with predicted persistent losses are smaller in magnitude when these firms are followed by analysts. The results are robust to controls for various price anomalies and are not driven by short sale constraints.     

How do mentoring rewards influence experienced auditors?

The benefits of mentoring are well documented, and include lower employee turnover, heightened employee success, and higher employee satisfaction. In an effort to acquire these benefits, audit firms are structuring rewards for mentoring. However, we predict that rewarding mentors can prove problematic, leaving needy young auditors without a mentor or perhaps receiving advice that might prove detrimental. We test our expectations in an experiment with 111 Big 4 auditor participants. As expected, we find that in the presence of mentoring rewards, experienced auditors are less willing to mentor the young auditors who likely would benefit the most. We also find that in the presence of mentoring rewards, experienced auditors are more likely to provide advice that might be counterproductive. Yet interestingly, in our study, when rewards are absent, experienced auditors are more willing to mentor and more likely to provide beneficial advice. Our results inform the audit mentoring literature though our focus on mentor behavior, as opposed to protégé behavior. Our results also have implications for audit firms as they consider the structure of mentoring rewards, training on mentoring advice, and the effects of this advice.     

How do bond investors perceive dividend payouts?

We explore how bond investors view corporate cash distributions through dividends and how that view influences corporate cost of debt. Explaining between 45 and 67 percent of variance in credit spreads at the time of issuance, our model reveals a non-linear association between dividend payouts and investment return expected by bondholders. In particular, while bondholders view cash disbursements in small amounts as a positive signal, large dividend payouts are viewed negatively. Our results thus provide support for both the signaling hypothesis and for the agency-cost-of-debt hypothesis. The results are robust even after controlling for firm size, growth opportunities, profitability, leverage, business risk, asset tangibility, and term structure. Exploiting the 2003 dividend tax cut as an exogenous shock, we demonstrate that our results are not vulnerable to endogeneity problems. Finally, we find no evidence of corporations timing the payouts strategically to influence the cost of debt.     

The fair value of a token: How do markets price cryptocurrencies?

With the rise of cryptocurrency tokens as a new asset class, the question of the fair evaluation of a cryptocurrency token has become a question of increasing importance. We estimate the pricing kernel with which users price factors affecting their token holdings. We investigate how traditional risk factors such as market risk are evaluated, as well as how blockchain specific risk factors are priced in. In order to do so, we introduce an asset pricing model and modify its properties to make it applicable to cryptocurrency markets. We group the risk factors into market related and Bitcoin- and Ethereum blockchain specific risk factors. We find that blockchain specific risk factors are priced in. There is evidence that risk factors have moved from Bitcoin to Ethereum specific risk factors with an increasing importance of market factors, providing evidence for a decoupling of on-chain and off-chain trading activity.     

Firm R&D and financial analysis: How do they interact?

This paper demonstrates, theoretically and empirically, that firms’ research and development (R&D) efforts and investors’ analyses of their prospects are mutually reinforcing. Entrepreneurs attempt more research when financiers are better informed about projects’ profitability because they expect financiers to provide more funding to successful projects. Conversely, financiers collect more information about projects when entrepreneurs undertake more R&D because the opportunity cost of missing out on successful projects is then higher. Two natural experiments confirm that this interaction occurs and suggest that it contributes to about one third of the total effect of a policy designed to stimulate R&D. Overall, the analysis suggests that policies aimed at promoting R&D – such as research subsidies or tax breaks – have a multiplier effect owing to the induced improvement in capital efficiency. As a result, those policies can be rendered more effective by coupling them with other policies designed to increase capital efficiency. The feedback effect that we document also helps explaining why innovative ecosystems such as that in the Silicon Valley are challenging to set up.     

How strong is the macroeconomic case for downward real wage rigidity?

We explore the existence of downward real wage rigidity (DRWR) at the industry level, based on data from 19 OECD countries for the period 1973-1999. The results show that DRWR compresses the distributions of industry wage changes overall, as well as for specific geographical regions and time periods, but there are not many real wage cuts that are prevented. More important, however, DRWR attenuates larger real wage cuts, thus leading to higher real wages. There is stronger evidence for downward nominal wage rigidity than for DRWR. Real wage cuts are less prevalent in countries with strict employment protection legislation and high union density.     

How do commodity futures respond to macroeconomic news?

This paper investigates the impact of seventeen US macroeconomic announcements on two broad and representative commodity futures indices. Based on a large sample from 1989 to 2005, we show that the daily price response of the CRB and GSCI commodity futures indices to macroeconomic news is state-dependent. During recessions, news about higher (lower) inflation and real activity lead to positive (negative) adjustments of commodity futures prices. In contrast, we find no significant reactions during economic expansions. We attribute this asymmetric response to the state-dependent interpretation of macroeconomic news. Our findings are robust to several alternative business cycle definitions.