An empirical analysis of strategic competition and firm values the case of R&D competition

We operationalize a firm's competitive strategy through a new empirical measure, and develop a framework for empirical analysis of the market value of strategic behavior. Using this framework, we study announcement effects of R&D spending. The announcing firm's stock prices are positively influenced by a change in spending, and negatively by our competitive strategy measure (CSM). Competitors' stock prices are positively influenced by the interaction between the market's reaction to the announcing firm and the CSM. Our results are consistent with positive effects of ‘accommodating’ competition with strategic substitutes, and nonpositive effects of ‘tough’ competition with strategic complements.     

Optimality of project financing: Theory and empirical implications in finance and accounting

During the 1980s a fairly active market developed in the private placement of limited recourse project financing. Although this form of financing is gaining in importance, we know very little about it. This article presents a theoretical analysis of project financing. In the model of the firm presented, outstanding risky debt gives rise to agency costs of underinvestment that are offset by the benefit of debt-related tax shields. The tradeoff specifies the optimal leverage for a firm. Within this framework, we consider the optimality of financing a new project with a nonrecourse project financing arrangement. We derive implications for 1) the characteristics of a new venture that will be project financed, 2) the wealth gains from project financing over that of financing with straight debt, and 3) the optimal allocation of debt across the different assets (the sponsor firm vs. the new venture). It is shown that a project financing arrangement, where the debt is optimally allocated to the sponsor firm and the new venture, increases value by reducing agency costs and increasing the value of tax shields (compared to the case of straight debt financing). The optimal allocation of debt in project financing involves assigning to the sponsor firm and the new venture debt levels equal to their individual optimal capital structures. Several testable empirical implications in finance and accounting are developed.     

Remittances over the business cycle: Theory and evidence

We examine the behaviour of remittances over the business cycle and their potential to act as a ‘stabilizer’ during periods of high business cycle volatility. Two main findings are reported. First, remittances are less volatile than other foreign currency flows and do not appear to systemically comove with business cycle fluctuations. Second, remittances are relatively stable even during episodes of sharp business cycle volatility, such as those associated with sudden stops and financial crises. We also provide an overview of the theoretical literature on the implications of different motives to remit for the cyclical behaviour of remittances.     

Can the standard international business cycle model explain the relation between trade and comovement?

Recent empirical research finds that pairs of countries with stronger trade linkages tend to have more highly correlated business cycles. We assess whether the standard international business cycle framework can replicate this intuitive result. We employ a three-country model with transportation costs. We simulate the effects of increased goods market integration under two asset market structures, complete markets and international financial autarky. Our main finding is that under both asset market structures the model can generate stronger correlations for pairs of countries that trade more, but the increased correlation falls far short of the empirical findings. Even when we control for the fact that most country-pairs are small with respect to the rest-of-the-world, the model continues to fall short. We also conduct additional simulations that allow for increased trade with the third country or increased TFP shock comovement to affect the country-pair's business cycle comovement. These simulations are helpful in highlighting channels that could narrow the gap between the empirical findings and the predictions of the model.     

How do business and financial cycles interact?

This paper analyzes the interactions between business and financial cycles using an extensive database covering 44 countries for the period 1960:1–2010:4. Our analysis shows that there are strong linkages between the different phases of business and financial cycles. In particular, recessions associated with financial disruptions, notably house and equity price busts, tend to be longer and deeper than other recessions. Conversely, while recoveries following asset price busts tend to be weaker, recoveries associated with rapid growth in credit and house prices are often stronger. These findings emphasize the importance of financial market developments for the real economy.     

Understanding the evolution of world business cycles

This paper studies the changes in world business cycles during the period 1960–2003. We employ a Bayesian dynamic latent factor model to estimate common and country-specific components in the main macroeconomic aggregates (output, consumption, and investment) of the G-7 countries. We then quantify the relative importance of the common and country components in explaining comovement in each observable aggregate over three distinct time periods: the Bretton Woods (BW) period (1960:1–1972:2), the period of common shocks (1972:3–1986:2), and the globalization period (1986:3–2003:4). The results indicate that the common (G-7) factor explains, on average, a larger fraction of output, consumption and investment volatility in the globalization period than it does in the BW period.     

Does financial globalization promote risk sharing?

In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. In this paper, we provide an empirical evaluation of the patterns of risk sharing among different groups of countries and examine how international financial integration has affected the evolution of these patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. Even emerging market economies, many of which have reduced capital controls and all of which have witnessed large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which had dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing.     

GLOBAL BUSINESS CYCLES: CONVERGENCE OR DECOUPLING?*

We analyze the evolution of the degree of global cyclical interdependence over the period 1960–2008. Using a dynamic factor model, we decompose macroeconomic fluctuations in output, consumption, and investment into a global factor, factors specific to country groups, and country‐specific factors. We find that during 1985–2008, there is some convergence of business cycle fluctuations among industrial economies and among emerging market economies. Surprisingly, there is a concomitant decline in the relative importance of the global factor. We conclude that there is evidence of business cycle convergence within each of these two groups of countries but divergence (or decoupling) between them.     

Managerial incentives, derivatives and stability

In this paper we model the derivative strategies optimally undertaken by a manager (or head of a profit center in a hedge fund) when the detailed derivative positions taken are not contractible. We show that with commonly-used incentive features in the compensation structure, managers have incentives to implement complex derivative strategies that lead to a slight reduction in default probabilities (or a slight increase in performance measures) with a high probability at the cost of allowing for the possibility of disaster states involving large losses, although with a very small probability. Such disaster states cause systemic instability (similar to the experience of Long-Term Capital Management in September 1998). We discuss possible audit strategies, governance mechanisms and incentive structures that will ameliorate the probability of systemic instability arising from such incentives in a market with a rich enough menu of derivatives. We characterize the optimal intensity of audit effort with and without the presence of such derivative strategies. The dependence of the optimal audit intensity on the legal liability regime and different rules for apportioning the auditor's liability is derived. Our results also relate the optimal audit intensity to the cost and efficiency parameters of the audit firm.