Employee Stock Options and Investment

Exercises of employee stock options generate substantial cash inflows to the firm. These cash inflows substitute for costly external finance in those states of the world in which the demand for investment is high. Using the fact that the proceeds from option exercises exhibit a distinct nonlinearity around the point where options fall out of the money, we estimate that firms increase investment by $0.34 for each dollar received from the exercise of stock options. Firms that face higher external financing costs allocate more of the proceeds from option exercises to investment.     

Analyzing the Tax Benefits from Employee Stock Options

Employees tend to exercise stock options when corporate taxable income is high, shifting corporate tax deductions to years with higher tax rates. If firms paid employees the same dollar value in wages instead of stock options, the average annual tax bill for large U.S. companies would increase by $12.6 million, or 9.8%. These direct tax benefits of options increase in the convexity of the tax function. In addition, profitable firms can realize indirect tax benefits because stock options increase debt capacity. Although tax minimization is probably not the main motive for option grants, firms with larger potential tax benefits grant more options.     

Hedging under Transaction Costs in Currency Markets: a Continuous‐Time Model

We consider a general semimartingale model of a currency market with transaction costs. Assuming that the price process is continuous and the solvency cone is proper we prove a hedging theorem describing the set of initial endowments that allows the investor to hedge a contingent claim in various currencies by a self‐financing portfolio.     

Idiosyncratic Cash Flows and Systematic Risk

We show that unpriced cash flow shocks contain information about future priced risk. A positive idiosyncratic shock decreases the sensitivity of firm value to priced risk factors and simultaneously increases firm size and idiosyncratic risk. A simple model can therefore explain book‐to‐market and size anomalies, as well as the negative relation between idiosyncratic volatility and stock returns. Empirically, we find that anomalies are more pronounced for firms with high idiosyncratic cash flow volatility. More generally, our results imply that any economic variable correlated with the history of idiosyncratic shocks can help to explain expected stock returns.     

Effectiveness of Weighted Majority Rules with Random Decision Power Distribution

There is a large body of research studying the conditions under which majority decisions are best. In particular, in many circumstances, the probability of a group to decide correctly is higher than that of a random subgroup. Moreover, the latter probability increases as the subgroup size grows. Here we generalize those results by showing that, in the same setup, the simple majority rule is the most effective of all weighted majority rules when weights are distributed randomly between group members. For special families of weighted majority rules, rule effectiveness increases as we get “closer” to the simple majority rule.     

Half a Century of Public Software Institutions: Open Source as a Solution to Hold‐Up Problem

We argue that the intrinsic inefficiency of proprietary software has historically created a space for alternative institutions that provide software as a public good. We discuss several sources of such inefficiency, focusing on one that has not been described in the literature: the underinvestment due to fear of hold‐up. An inefficient hold‐up occurs when a user of software must make complementary investments, when the return on such investments depends on future cooperation of the software vendor, and when contracting about a future relationship with the software vendor is not feasible. We also consider how the nature of the production function of software makes software cheaper to develop when the code is open to the end users. Our framework explains why open source dominates certain sectors of the software industry (e.g., programming languages), while being almost non existent in some other sectors (e.g., computer games). We then use our discussion of efficiency to examine the history of institutions for provision of public software from the early collaborative projects of the 1950s to the modern “open source” software institutions. We look at how such institutions have created a sustainable coalition for provision of software as a public good by organizing diverse individual incentives, both altruistic and profit‐seeking, providing open source products of tremendous commercial importance, which have come to dominate certain segments of the software industry.