Showing papers in "The American Economic Review in 1995"

Endogenously Chosen Boards of Directors and Their Monitoring of the CEO

Abstract: Author(s): Hermalin, Benjamin E. | Abstract: This paper develops a model in which the effectiveness of a board's monitoring of the CEO depends on the board's independence. The independence of new directors is determined through negotiations (implicit or explicit) between the existing directors and the CEO. The CEO's bargaining position, and thus influence over the board-selection process, depends on an updated estimate of the CEO's ability based on prior performance. Many empirical findings about board structure and performance arise as equilibrium phenomena in this model. We also explore the implications of this model for proposed regulations of corporate governance structures. Please contact the Program in Law and Economics at Boalt Hall School of Law, UC Berkeley, Berkeley, CA 94720 for a copy of this paper.

Cross-Country Evidence on the Link Between Volatility and Growth

Abstract: This paper presents empirical evidence against the standard dichotomy in macroeconomics that separates growth from the volatility of economic fluctuations. In a sample of ninety-two countries as well as a sample of OECD countries, the authors find that countries with higher volatility have lower growth. The addition of standard control variables strengthens the negative relationship. The authors also find that government spending-induced volatility is negatively associated with growth even after controlling for both time- and country-fixed effects. Copyright 1995 by American Economic Association.

Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior

Abstract: This study analyzes the extent to which mutual funds purchase stocks based on their past returns as well as their tendency to exhibit 'herding' behavior (i.e., buying and selling the same stocks at the same time). The authors find that 77 percent of the mutual funds were 'momentum investors,' buying stocks that were past winners; however, most did not systematically sell past losers. On average, funds that invested on momentum realized significantly better performance than other funds. The authors also find relatively weak evidence that funds tended to buy and sell the same stocks at the same time. Copyright 1995 by American Economic Association.

Incumbent behavior: Vote-seeking, tax-setting, and yardstick competition

Abstract: This paper develops a model of the political economy of tax-setting in a multijurisdictional world, where voters' choices and incumbent behavior are determined simultaneously. Voters are assumed to make comparisons between jurisdictions to overcome political agency problems. This forces incumbents into a (yardstick)competition in which they care about what other incumbents are doing. We provide a theoretical framework and empirical evidence using U.S. state data from 1960 to 1988. The results are encouraging to the view that vote-seeking and tax-setting are tied together through the nexus of yardstick competition.

Optimal contracts for central bankers

Abstract: This paper adopts a principal-agent framework to determine how a central banker's incentives should be structured to induce the socially optimal policy. In contrast to previous findings using ad hoc targeting rules, the inflation bias of discretionary policy is eliminated and an optimal response to shocks is achieved by the optimal incentive contract, even in the presence of private central-bank information. In the one-period model that has formed the basis for much of the literature on discretionary monetary policy, it is shown that the optimal contract ties the rewards of the central banker to realized inflation. Copyright 1995 by American Economic Association.

Exchange rates and fundamentals: Evidence on long-horizon predictability

Abstract: Regressions of multiple-period changes in the log exchange rate on the deviation of the log exchange rate from its 'fundamental value' display evidence that long-horizon changes in log nominal exchange rates contain an economically significant predictable component. To account for small-sample bias and size distortion in asymptotic tests, inference is drawn from bootstrap distributions generated under the null hypothesis that the log exchange rate is unpredictable. The bias-adjusted slope coefficients and R[superscript]2's increase with the forecast horizon, and the out-of-sample point predictions generally outperform the driftless random walk at the longer horizons. Copyright 1995 by American Economic Association.

Long-Run Implications of Investment-Specific Technological Change

Abstract: an attempt is made to disentangle its effects from the more traditional Hicksneutral form of technological progress. The balanced growth path for the model is characterized and calibrated to U.S. National Income and Product Account (NIPA) data. The quantitative analysis suggests that investment-specific technological change accounts for the major part of growth. (JEL E13, 030, 041, 047)

The Case of the Missing Trade and Other Mysteries

Abstract: The Heckscher-Ohlin-Vanek (HOV) theorem, which predicts that countries will export products that are made from factors in great supply, performs poorly. However, deviations from HOV follow pronounced patterns. Trade is missing relative to its HOV prediction. Also, rich countries appear scarce in most factors and poor countries appear abundant in all factors, a fact that squares poorly with the HOV prediction that abundant factors are exported. As suggested by the patterns, HOV is rejected empirically in favor of a modification that allows for home bias in consumption and international technology differences. Copyright 1995 by American Economic Association.

Inflation and unemployment

Abstract: The world economy today is vastly different from the 1930s, when Seymour Harris, the chairman of this meeting, infected me with his boundless enthusiasm for economics and his steadfast confidence in its capacity for good works Economics is very different, too Both the science and its subject have changed, and for the better, since World War II But there are some notable constants Unemployment and inflation still preoccupy and perplex economists, statesmen, journalists, housewives, and everyone else The connection between them is the principal domestic economic burden of presidents and prime ministers, and the major area of controversy and ignorance in macroeconomics I have chosen to review economic thought on this topic on this occasion, partly because of its inevitable timeliness, partly because of a personal interest reaching back to my first published work in 1941

Efficiency Wage Models of Unemployment

Abstract: Keynesian economists hold it to be self-evident that business cycles are characterized by involuntary unemployment. But construction of a model of the cycle with involuntary unemployment faces the obvious difficulty of explaining why the labor market does not clear. Involuntarily unemployed people, by definition, want to work at less than the going wage rate. Why don’t firms cut wages, thereby increasing profits?

Does Head Start Make a Difference

Abstract: The impact of participation in Head Start is investigated using a national sample of children. Comparisons are drawn between siblings to control for selection. Head Start is associated with large and significant gains in test scores among both whites and African-Americans. However, among African-Americans, these gains are quickly lost. Head Start significantly reduces the probability that a white child will repeat a grade but it has no effect on grade repetition among African-American children. Both whites and African-Americans who attend Head Start, or other preschools, gain greater access to preventive health services. Copyright 1995 by American Economic Association.

Tastes and technology in a two-country model of the business cycle: Explaining international

Abstract: Trade on international financial markets allows people to insure country-specific risk and smooth consumption intertemporally. Equilibrium models of business cycles with trade on global financial markets typically yield international consumption correlations near one and excessive volatility of investment. The authors incorporate nontraded goods in the model and find that the implications for aggregate consumption, investment, and the trade balance are consistent with business-cycle properties of industrialized countries. However, the model driven by technology shocks alone yields counterfactual implications for comovements between consumption and prices at the sectoral level. Taste shocks produce price-quantity relationships more consistent with the data. Copyright 1995 by American Economic Association.

Output Dynamics in Real-Business-Cycles Models

Abstract: The time-series literature reports two stylized facts about output dynamics in the United States: GNP growth is positively autocorrelated, and GNP appears to have an important trend-reverting component. This paper investigates whether current real-business-cycle (RBC) models are consistent with these stylized facts. Many RBC models have weak internal propagation mechanisms and must rely on external sources of dynamics to replicate both facts. Models that incorporate labor adjustment costs are partially successful. They endogenously generate positive autocorrelation in output growth, but they need implausibly large transitory shocks to match the trend-reverting component in output.

Is there a retirement-savings puzzle?

Abstract: In this paper we ask whether households are saving enough for their retirement. We use data on income, expenditure and expenditure components to analyse patterns of behaviour at and around the time of retirement. For successive date-of-birth cohorts we compare periods of unemployment to periods of retirement and separate expenditures into categories reflecting work-related expenditures, basic necessities and other goods. We find that income typically falls by more at unemployment than retirement, but the reverse is true for expenditure. We observe falls in expenditure at retirement for all expenditure categories. Using a stochastic life-cycle model including mortality rates we assess the anticipated impact of retirement on consumption against that of unemployment. The inter-relationship between goods and leisure explains a large part of the persistent fall in expenditure at retirement. We argue that the only way in which the life-cycle hypothesis could be reconciled with the remaining unanticipated dip in consumption would be with the systematic arrival of unexpected adverse information at the time of retirement.

Ethnicity, Neighborhoods, and Human-Capital Externalities

Abstract: The socioeconomic performance of today's workers depends not only on parental skills but also on the average skills of the ethnic group in the parents' generation (or ethnic capital). This paper investigates the link between the ethnic externality and ethnic neighborhoods. The evidence indicates that residential segregation and the external effect of ethnicity are linked, partly because ethnic capital summarizes the socioeconomic background of the neighborhood where the children were raised. Ethnicity has an external effect, even among persons who grow up in the same neighborhood, when children are exposed frequently to persons who share the same ethnic background. Copyright 1995 by American Economic Association.

Labor-Market Returns to Two- and Four-Year College

Abstract: The paper examines labor-market returns to a two- and four-year college education. Analysis of the 1972 National Longitudinal Survey of Youth; Observation that the average person who attended a two-year college earned about 10-percent more than those without any college education; Comparison with the wages of those who attended a four-year college education.

Race and Gender Discrimination in Bargaining for a New Car

Abstract: More than three hundred paired audits at new-car dealerships reveal that dealers quoted significantly lower prices to white males than to black or female test buyers using identical, scripted bargaining strategies. Ancillary evidence suggests that the dealerships' disparate treatment of women and blacks may be caused by dealers' statistical inferences about consumers' reservation prices, but the data do not strongly support any single theory of discrimination. Copyright 1995 by American Economic Association.

Cooperation in Public-Goods Experiments: Kindness or Confusion?

Abstract: The persistence of cooperation in public-goods experiments has become an important puzzle for economists. This paper presents the first systematic attempt to separate the hypothesis that cooperation is due to kindness, altruism, or warm-glow from the hypothesis that cooperation is simply the result of errors or confusion. The experiment reveals that, on average, about half of all cooperation comes from subjects who understand free-riding but choose to cooperate out of some form of kindness. This suggests that the focus on errors and 'learning' in experimental research should shift to include studies of preferences for cooperation as well. Copyright 1995 by American Economic Association.

Capital Structure and Product-Market Competition: Empirical Evidence from the Supermarket Industry

Abstract: This paper establishes an empirical link between firm capital structure and product-market competition using data from local supermarket competition. First, an event-study analysis of supermarket leveraged buyouts (LBOs) suggests that a LBO announcement increases the market value of the LBO chain's local rivals. Second, the author shows that supermarket chains were more likely to enter and expand in a local market if a large share of the incumbent firms in the local market undertook LBOs. The study suggests that leverage increases in the late 1980s led to softer product-market competition in this industry. Copyright 1995 by American Economic Association.

Biased Judgments of Fairness in Bargaining

Abstract: When court trials (or arbitration) are the mechanisms for resolving bargaining impasses, the costs and risks associated with third-party intervention should motivate settlement (Henry Farber and Harry Katz, 1979) However, empirical evidence suggests that impasses and inefficient settlements are common in the legal system and in contract negotiations For example, one study of asbestos suits found that only 37 cents of every dollar spent by both sides end up in the plaintiffs' hands (James Kakalik et al, 1983)

Homegrown Values and Hypothetical Surveys: Is the Dichotomous Choice Approach Incentive-Compatible?

Abstract: The use of dichotomous choice (DC) methods has become increasingly common in applications of the contingent-valuation method (CVM)1 to elicit the "homegrown value" that an individual might have for nonmarket environmental goods.2 This hypothetical DC method involves a subject responding yes or no to a hypothetical question that asks whether or not he would be willing to make a commitment to pay some stated amount contingent upon the provision of an environmental good. The growing use of this method is primarily based on the assumption that the method yields incentive-compatible results. This implies that subjects will answer the CVM's hypothetical question in the same way as they would answer an identical question asking for a real economic commitment and that, therefore, the hypothetical DC method will result in accurate estimates of true willingness to pay. Explicit or implicit acceptance of this assumption is seen in a number of recent studies. For example, the use of the DC method in CVM studies is strongly recommended by a panel3 convened by the National Oceanic and Atmospheric Administration (NOAA) of the United States Department of Commerce to examine the use of hypothetical CVM survey questions (see NOAA, 1993 pp. 4608, 4608, 4612). The hypothetical DC method has been used by the Attorney General of the State of Alaska in a major application of the CVM to assess damages caused by the Exxon Valdez oil spill of 1989 (see Richard T. Carson et al., 1992). A major CVM study of potential environmental damages due to proposed mining activity in the Kakadu Conservation Zone of Australia employed the DC method with a similar rationale (see David Imber et al., 1991 p. vi). It is clear that if a subject perceives that his expected utility is affected by the possibility of the good actually being provided he has no incentive to misrepresent. We can presume that in an application of a real DC method, where payment and provision of * Cummings: Policy Research Center, College of Business Administration, Georgia State University, Atlanta, GA 30303-3083; Harrison and Rutstr6m: Department of Economics, College of Business Administration, University of South Carolina, Columbia, SC 29208. We are grateful to Peter Bohm, Bengt Kristr6m, and three referees for helpful comments. Ashley Abbott, Lloyd Brown, Colin Day, Tanga McDaniel, Helen Neill, and Melonie Williams provided excellent research assistance. We acknowledge financial support provided by the State of New Mexico's Waste Management Education and Research Consortium and Resources for the Future. We retain responsibility for all errors. 'For a critical review of the debate over the CVM, see Cummings and Harrison (1994) 2"Homegrown value" is a term primarily used in experimental economics. It refers to a subject's value that is independent of the value which an experimenter might "induce" for the good (see Vernon L. Smith, 1976). The idea is that homegrown values are those that the subject brings to an experiment. 3Consisting of Kenneth Arrow (Co-chair), Robert Solow (Co-chair), Paul R. Portney, Edward E. Leamer, Roy Radner, and Howard Schuman.

The International Diversification Puzzle is Worse Than You Think

Abstract: Despite the growing integration of international financial markets, investors do not diversify internationally to any significant extent. The authors show that this 'international diversification puzzle' is deepened once they consider the implications of nontraded human capital for portfolio composition. While growth rates of labor and capital income are not highly correlated within countries, the authors find that the returns to human capital and physical capital are very highly correlated within four OECD countries. Hedging human capital risk therefore involves a substantial short position in domestic marketable assets. A diversified world portfolio will involve a negative position in domestic marketable assets. Copyright 1997 by American Economic Association.

Government Debt, Government Spending, and Private Sector Behavior: Reply

Abstract: Roger Kormendi (1983) presents apparently strong evidence that, in contrast to the standard view, consumption is not reduced by taxes but is reduced by government expenditure. He interprets his results as supporting a "consolidated" approach to private sector behavior in which consumers effectively internalize the government budget constraint. Specifically, he claims that consumers regard government spending as the true measure of the government's claim on private resources, and so do not respond to changes in taxes, given spending. This is basically the approach advocated by Robert Barro (1974) and known also as the Ricardian Equivalence Proposition (hereafter REP). Kormendi's results appears to contradict other empirical work based on the Life Cycle Hypothesis (for example, Martin Feldstein, 1982; Modigliani 1984a; Sterling, 1985) although results similar to his have been reported (see David Aschauer, 1985; John Seater and Roberto Mariano, 1985 and the references in Kormendi). In our view, Kormendi's analysis is seriously flawed. His heuristic derivation of the consumption function leads him to a specification of the aggregate consumption function, which is not consistent with the Life Cycle Hypothesis (LCH) or with REP, and to questionable methods of estimation. Once his conceptual and methodological errors are corrected, his formulation and, more generally, the REP hypothesis are found to receive little empirical support. In the next section we rely on the LCH to derive an aggregate consumption function which shows explicitly how government expenditure and taxes should effect private consumption. This derivation helps to bring out the observable implications of REP, which are shown to be equivalent to a limiting form of the LCH in which the planning horizon is infinite. It also serves to clarify the appropriate specification of the variables appearing in the consumption function. Next, Section II reports our empirical estimates and tests. Section III compares our results with Kormendi's. Finally, Section IV reports the results of endeavors to improve the specification of fiscal variables, notably by distinguishing between permanent and transitory tax changes.

Digging for golden carrots: an analysis of research tournaments

Abstract: Contracting for research is often infeasible because research inputs are unobservable and research outcomes cannot be verified by a court. Sponsoring a research tournament can resolve these problems. A model is presented in which contestants compete to find the innovation of highest value to the tournament sponsor. The winner receives a prespecified prize. The tournament game has a unique subgame-perfect equilibrium. Free entry is not optimal because equilibrium effort by each researcher decreases in the number of contestants. An optimally designed research tournament balances the probability of overshooting the first-best quality level against the probability of falling short. Copyright 1995 by American Economic Association.

Conversation, Information, and Herd Behavior

Abstract: Experimental evidence shows that an important reason why people tend to imitate others, to exhibit "herd behavior" is that they assume that the others have information that justifies their actions. The information cascade models of Banerjee [1992] and Bikhchandani et al. [1992] are significant developments in showing some general equilibrium and welfare effects of such rational imitative behavior. But these models as specified may be of limited applicability since they assert that differences across groups in herd behavior can be attributed to the random decisions of first movers. Differences across groups in herd behavior might be explained more often in terms of different modes of interpersonal information transmission. Patterns of human conversation imply great selectivity to the kinds of information transmitted within groups.(This abstract was borrowed from another version of this item.)

Monetary policy trade-offs and the correlation between nominal interest rates and real output

Abstract: The authors present a structural model of the U.S. economy that combines their price-contracting specification with a term-structure relationship, an aggregate demand curve, and a monetary-policy reaction function. The model matches important features of postwar data well and provides a structural explanation of the correlation between real output and the short-term nominal rate of interest. The authors perform a battery of monetary-policy experiments that show that, as viewed through the lens of this model, monetary policy has struck a good balance recently among competing monetary-policy objectives. Copyright 1995 by American Economic Association.

The design of reform packages under uncertainty

Abstract: The authors present a model of large-scale economic reforms, modeled on the transition process in Eastern Europe, with aggregate and individual uncertainty concerning the outcome of reforms. The government is assumed to choose the speed and sequencing of reforms. The authors compare big-bang strategies with gradualist reform packages. They show that gradualist reform packages may be easier to get started, optimal sequencing of reforms should aim at creating constituencies for further reforms, and gradualism may generate a higher investment response because of a lower option value of waiting than would a big-bang approach. Copyright 1995 by American Economic Association.