Serious Business

Kevin Lewis

March 04, 2010

How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systemically Important?

Julapa Jagtiani & Elijah Brewer
Federal Reserve Bank Working Paper, December 2009

This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991-2004, we find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. We estimate at least $14 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, we find that both the stock and bond markets reacted positively to these deals. Our estimated TBTF subsidy is large enough to create serious concern, since recent assisted mergers have allowed TBTF organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.


Family Values and the Regulation of Labor

Alberto Alesina, Yann Algan, Pierre Cahuc & Paola Giuliano
NBER Working Paper, February 2010

Flexible labor markets require geographically mobile workers to be efficient. Otherwise, firms can take advantage of the immobility of workers and extract monopsony rents. In cultures with strong family ties, moving away from home is costly. Thus, individuals with strong family ties rationally choose regulated labor markets to avoid moving and limiting the monopsony power of firms, even though regulation generates lower employment and income. Empirically, we do find that individuals who inherit stronger family ties are less mobile, have lower wages, are less often employed and support more stringent labor market regulations. There are also positive cross-country correlations between the strength of family ties and labor market rigidities. Finally, we find positive correlations between labor market rigidities at the beginning of the twenty first century and family values prevailing before World War II, which suggests that labor market regulations have deep cultural roots.


CEO decision horizon and firm performance: An empirical investigation

Murad Antia, Christos Pantzalis & Jung Chul Park
Journal of Corporate Finance, forthcoming

We investigate the effect of top managers' myopia on firms' market valuation. We devise a measure of expected CEO tenure as a proxy for the length of CEO decision horizon. After accounting for the endogenous nature of CEO horizon, our empirical tests show that shorter CEO horizon is associated with more agency costs, lower firm valuation and higher levels of information risk. The results are consistent with the notion that a short CEO decision horizon is indicative of preference for investments that offer relatively faster paybacks at the expense of long-term value creation.


The Efficient Markets Hypothesis: The Demise of the Demon of Chance?

Stephen Brown
NYU Working Paper, January 2010

Many commentators have suggested that economists in general and financial economists in particular have some responsibility for the recent global financial crisis. They were blinded by an irrational faith in a discredited Efficient Markets Hypothesis and failed to see the bubble in asset prices and to give due warning of its collapse. There is considerable confusion as to what this hypothesis is and what it says. The irony is that the strong implication of this hypothesis is that nobody, no practitioner, no academic and no regulator had the ability to foresee the collapse of this most recent bubble. While few economists believe it is literally true, this hypothesis is considered a useful benchmark with some important practical implications. Indeed, a case can be made that it was the failure to believe in the essential truth of this idea which was a leading factor responsible for the global financial crisis.


Learning About Policy from Federal Reserve History

Allan Meltzer
Carnegie Mellon University Working Paper, February 2010

The paper summarizes some of the main findings about domestic monetary policy from my three volume history. It finds that the Federal Open Market Committee concentrates excessively on the very near-term and rarely discusses medium or long-term implications. Also it has never agreed on a model and does not try to get agreement. These and other problems and achievements are summarized.


Regulating Misinformation

Edward Glaeser & Gergely Ujhelyi
Journal of Public Economics, April 2010, Pages 247-257

Governments have responded to misleading advertising by banning it, engaging in counter-advertising and taxing and regulating the product. In this paper, we consider the welfare effects of those different responses to misinformation. While misinformation lowers consumer surplus, its effect on social welfare is ambiguous. Misleading advertising leads to over-consumption but that may be offsetting the under-consumption associated with oligopoly outputs. If all advertising is misinformation then a tax or quantity restriction on advertising maximizes welfare, and other policy interventions are inferior. If firms undertake quality improving investments that are complementary to misinformation, then combining taxes or bans on misleading advertising with other policies can increase welfare.


Financialisation and the dynamics of offshoring in the USA

William Milberg & Deborah Winkler
Cambridge Journal of Economics, March 2010, Pages 275-293

Imports are linked to higher cost mark-ups and firm profits, and the gains from such non-competitive imports - the result of offshoring - are increasingly associated with the reinvestment of these higher profits. Our regression analysis of 35 US manufacturing and service industries over the period 1998-2006 supports aggregate and firm-level studies showing that offshoring is associated with a higher share of corporate profit in total value added. But the 'dynamic' gains from offshoring have not been fully realised because firms have purchased financial assets - especially share buybacks and higher dividend payments - to raise shareholder value, rather than investing in productive assets that raise productivity, growth, employment and income. Despite the corporate sector's contribution to national savings over the past decade, the offshoring-financialisation linkage reduces the capacity of non-financial corporations to act as a driver of the recovery from the economic crisis that emerged in 2008.


The Costs and Benefits of Benefit-Cost Analysis

Graciela Chichilnisky
Columbia University Working Paper, December 2009

Among the tools of the economic trade, cost-benefit analysis is the most widely used in policy circles. Asking whether there is a role for cost-benefit analysis is like asking whether there is a role for the weatherman. Of course there is. The analogy is not idle. We need to know the weather, for it causes some of the worst uncertainties known to humans. But it is at least as important to know that the weather service makes errors. We need to know its limitations to take precautions. Errors can be costly. Think of cyclones, droughts and floods. Few of us would fly an airplane in possibly dangerous weather conditions if we did not know the margin of error. Like weather prediction, cost-benefit analysis can be useful but it can also go wrong. Erroneous cost-benefit analysis can be as damaging as erroneous weather prediction. Both fail when concerned with larger issues. Weather predictions for large areas and for large timescales are unreliable and could be dangerous if taken too seriously. The same holds true with cost-benefit analysis. Climate change is a global version of this problem, and illustrates it well.


Negative Freedom and Death in the United States

Leland Ackerson & S.V. Subramanian
American Journal of Public Health, forthcoming

Personal freedoms have been characterized as "positive" (freedom to pursue opportunities) and "negative" (freedom from external constraints on decision making). An ecological analysis of US data revealed a strong positive association (r=0.41; P=.003) between state-level negative personal freedom (defined in terms of regulation of personal behavior) and state-level age-adjusted rates of unintentional injury. A conceptual emphasis on positive freedom construed as freedom to pursue a life without risk of unintentional injury could help motivate a conversation to improve public health.


CFOs and CEOs: Who has the most influence on earnings management?

John (Xuefeng) Jiang, Kathy Petroni & Isabel Yanyan Wang
Journal of Financial Economics, forthcoming

This study examines the association between chief financial officer (CFO) equity incentives and earnings management. Chief executive officer (CEO) equity incentives have been shown to be associated with accruals management and the likelihood of beating analyst forecasts (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005). Because CFOs' primary responsibility is financial reporting, CFO equity incentives should play a stronger role than those of the CEO in earnings management. We find that the magnitude of accruals and the likelihood of beating analyst forecasts are more sensitive to CFO equity incentives than to those of the CEO. Our evidence supports the Securities and Exchange Commission's (SEC) new disclosure requirement on CFO compensation.


Does Product Market Competition Lead Firms to Decentralize?

Nicholas Bloom, Raffaella Sadun & John Van Reenen
Harvard Working Paper, January 2010

There is a widespread sense that over the last two decades firms have been decentralizing decisions to employees further down the managerial hierarchy. Economists have developed a range of theories to account for delegation, but there is less empirical evidence, especially across countries. This has limited the ability to understand the phenomenon of decentralization. To address the empirical lacuna we have developed a research program to measure the internal organization of firms - including their decentralization decisions - across a large range of industries and countries. In this paper we investigate whether greater product market competition increases decentralization. For example, tougher competition may make local manager's information more valuable, as delays to decisions become more costly. Since globalization and liberalization have increased the competitiveness of product markets, one explanation for the trend towards decentralization could be increased competition. Of course there are a range of other factors that may also be at play, including human capital, information and communication technology, culture and industrial composition. To tackle these issues we collected detailed information on the internal organization of firms across nations. The few data-sets that exist are either from a single industry or (at best) across many firms in a single country. We analyze data on almost 4,000 firms across twelve countries in Europe, North America and Asia. We find that competition does indeed seem to foster greater decentralization.

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