Showing papers in "The Journal of Business in 1985"

Evaluating Natural Resource Investments

Abstract: Notwithstanding impressive advances in the theory of finance over the past 2 decades, practical procedures for capital budgeting have evolved only slowly. The standard technique, which has remained unchanged in essentials since it was originally proposed (see Dean 1951; Bierman and Smidt 1960), derives from a simple adaptation of the Fisher (1907) model of valuation under certainty: under this technique, expected cash flows from an investment project are discounted at a rate deemed appropriate to their risk, and the resulting present value is compared with the cost of the project. This standard textbook technique reflects modern theoretical developments only insofar as estimates of the discount rate may be obtained from crude application of single period asset pricing theory (but see Brennan 1973; Bogue and Roll 1974; Turnbull 1977; Constantinides 1978). The inadequacy of this approach to capital budgeting is widely acknowledged, although not widely discussed. Its obvious deficiency is its The evaluation of mining and other natural resource projects is made particularly difficult by the high degree of uncertainty attaching to output prices. It is shown that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such projects but also to determine the optimal policies for developing, managing, and abandoning them. The approach may be adapted to a wide variety of contexts outside the natural resource sector where uncertainty about future project revenues is a paramount concern.

International Portfolio Diversification with Estimation Risk

Abstract: International portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign securities. This proposition, however, relies on the assumption that the required inputs to the classical mean-variance analysis are known with certainty. Typically, expected returns, variances, and covariances are simply replaced by their ex post sample values and the optimal portfolio is derived without mentioning the uncertainty inherent in these parameter values. But the rational investor should take this uncertainty into account when forming expectations, and probably will consider estimators that are less subject to estimation error than the classical sample mean. This paper investigates alternative estimators of expected returns and their implications for the alleged gains from diversification. An important observation is the crucial influence that errors in estimating expected returns have on portfolio analysis. A closer examiPrevious studies of international portfolio diversification have relied on ex post meanvariance analysis without considering the problem of estimation risk. Typically, past averages are substituted for expected returns and no allowance is made for the uncertainty inherent in these parameter values. First I demonstrate the shortcomings of such an approach, and second I investigate another method of estimating expected returns initially proposed by Stein. By shrinking the sample averages toward a common mean, I find that the out-of-sample performance of the optimal portfolio is substantially increased. One of the implications of this method is that the classical conclusions vastly overestimate the possible gains in average returns; instead, benefits from diversification are more likely to accrue from a reduction in risk. * This paper draws on part of my dissertation at the University of Chicago. I am grateful to Arnold Zellner, Michael Mussa, George Constantinides, and especially John Bilson, for useful discussions and comments. Numerous improvements were also suggested by the referee. This research received the generous financial support of the College Interuniversitaire d'Etudes Doctorales dans les Sciences du Management.

Stock Prices and Economic News

Abstract: This paper examines the daily response of stock prices to announcements about the money supply, inflation, real economic activity, and the discountrate. Except for the discount rate, survey data on market participants' expectations of these announcements are used to identify the unexpected component of the announcements in order to test the efficient markets hypothesis that only the unexpected part of any announcement, the surprise,moves stock prices. The empirical results support this hypothesis and indicate further that surprises related to monetary policy significantly affect stock prices. There is only limited evidence of an impact from inflation surprises and no evidence of an impact from real activity surprises on the announcement days. There is also only weak evidence of stock price responses to surprises beyond the announcement day.(This abstract was borrowed from another version of this item.)

Insider Trading and the Exploitation of Inside Information: Some Empirical Evidence

Abstract: Rule lOb-5 of the Securities Exchange Act of 1934 prohibits the exploitation of inside information by corporate officers, directors, and large stockholders, usually referred to as insiders. The empirical analysis of insider trading has been the subject of several studies (see, e.g., Finnerty 1976b; Jaffe 1974a, 1974; Lorie and Niederhoffer 1968). The focus of most of these studies is whether insiders obtain trading gains from use of inside information. The answer to this question has clear implications for market efficiency: under the semistrong form of the efficient market hypothesis, all public information is fully reflected in prices. Under the strong form of that hypothesis securities prices reflect all relevant information, regardless of what information is publicly available, with the implication that no abnormal profits could be made through the use of inside information (see Fama [1970] for an extensive exposition and discussion of the efficient markets hypothesis).

Measuring Investment Performance in a Rational Expectations Equilibrium Model

Abstract: Much research has been concerned with evaluating the performance of managed portfolios (e.g., mutual funds) and examining whether portfolio managers display, in some sense, "superior performance." Superior performance would seemingly turn on the possession of superior information that is utilized in managing portfolios. In general, a fund's asset holdings (or portfolio weights) might not be observable to an outsider. Whether they are or not, however, they are likely to change over time. This happens especially when better performance is a result of superior information, since managers will change their portfolio composition on obtaining private information. Since such changes must be taken into account, the problem of measuring performance of managed portfolios is inherently different from that of evaluating the performance of individual assets, groups of assets, or, generally, portfolios with constant and known composition.

Mergers and the Market Concentration Doctrine: Evidence from the Capital Market

Abstract: The last 3 decades of vigorous enforcement of U.S. antimerger laws is based on the market concentration doctrine, one of the oldest and most controversial propositions in industrial economics. This doctrine, which is an implication of oligopoly models in the tradition of Cournot ([1838] 1927) and Nash (1950), holds that the level of industry concentration is a reliable index of the industry's market power. The empirical implication is that a relatively high level of industry concentration, which in the presence of entry barriers is believed to facilitate intraindustry collusion or dominant-firm pricing, should be associated with relatively large industrywide monopoly rents.' Following Bain (1951), numerous The market concentration doctrine predicts that a horizontal merger is more likely to have collusive, anticompetitive effects the greater the merger-induced change in industry concentration. Since a collusive, anticompetitive merger generates an increase in the industry's quality-adjusted product price (or a decrease in factor prices), it also follows from the doctrine that the mergerinduced expected benefits to the product market rivals of the merging firms should be an increasing function of the concentration change. The empirical results of this paper, which are based on the industry wealth effect of a large sample of horizontal mergers, including cases found in violation of antimonopoly laws, fail to support this prediction. This conclusion is robust with respect to assumptions concerning the probability that a proposed merger will be prevented by the law enforcement agencies, and it continues to hold after transforming the industry wealth effect into a hypothetical, constant expected change in the industry's product price. The results imply that the levels of concentration and market shares found in the Department of Justice's merger guidelines are unlikely to identify truly anticompetitive mergers. * I wish to thank Paul Asquith, Gregg Jarrell, Rex Thompson, Walter Vandaele, the participants of the economics workshop at the Antitrust Division of the U.S. Department of Justice, and a referee of this Journal for helpful comments. Earlier drafts were presented at the 1983 meetings of the European Association for Research in Industrial Economics and at the 1984 meetings of the Western Finance Association. Financial support from the Social Sciences and Humanities Research Council of Canada (grant no. 494-83-0091) and the U.S. Federal Trade Commission is also gratefully acknowledged. 1. A closely related but somewhat less general prediction is that high levels of concentration should be associated with relatively high, supracompetitive product prices. Although

Market Structure and Market Value

Abstract: While the use of market models to determine the sources of economic profits is quite new, at least two empirical studies considering the market structure and market value relation have appeared to date. Interestingly, they conflict. Thomadakis (1977) found a close positive relation between the four-firm concentration ratio and relative excess valuation, measured as the difference between the market value of the firm and the book value of tangible assets, all normalized by sales. As a result, Thomadakis argued that "industry concentration plays a role in the determination of excess profits from currently held assets and those expected from the firm's investment options" (p. 185). In contrast, Lindenberg and Ross (1981) reported no significant relation between concentration and Tobin's Q ratio, measured as the ratio of the market value of the firm to the replacement cost of tangible assets. This result disputes Thomadakis's findings and a purely structuralist interpretation of economic profits. According to Lindenberg and Ross, market power may or may not be evident in highly concentrated markets since "high Q's can occur in concentrated or unconcentrated markets and, conversely, low Q's, indicating no significant market power, can occur in markets that have high degrees of concentration" (p. 28).

Dealing-Temporary Price Cuts-By Seller as a Buyer Discrimination Mechanism

Abstract: This paper is concerned with temporary price cuts ("deals," "sales," and "specials") as a mechanism for the seller to price-discriminate between buyers with different intensities of demand. We analyze why a seller offers such price cuts, which buyers take advantage of them, and what the parameters are that determine the amount and frequency of the discount offered. In the remainder of this section, we briefly review the literature on price deals. 1 In section II, simple models of buyer and seller behavior are developed, and we show why and how a seller adopts a dealing strategy. Section III summarizes the key implications of the model and indicates how the price discrimination hypothesis could be tested in practice. Section IV suggests possible extensions of the model. Finally, Section V gives our conclusions. In the marketing literature, the issue of who is "deal prone" has been extensively researched An explanation for temporary price cuts, usually called "deals," "sales," or "specials," is provided. We hypothesize that they are a mechanism that discriminates between more intense and less intense demanders. We further hypothesize a positive relationship between demand elasticity and holding costs. Buyers with more intense demand, with high holding costs, are those who will be buying the product at its regular price. The low-holdingcost buyers take advantage of deals by forward buying. The model is applicable to three relationships: (1) manufacturer-reseller, where the reseller may be a wholesaler or a retailer; (2) resellerreseller, for example, wholesaler-retailer; and (3) retailer-consumer. * We are grateful to Michael Mussa and Albert Madansky for their comments. We also benefited from comments made by the marketing faculty of the Wharton School at a seminar where an earlier version of this paper was presented. Neil Beckwith in particular is acknowledged. 1. For a more detailed review of deals and similar pricecutting mechanisms, e.g., mail-in rebates, cents-off labels, coupons. etc.. see Narsimhan (1982, chan. 2). (Journal of Business, 1985, vol. 58, no. 3) ? 1985 by The University of Chicago. All rights reserved. 0021-9398185/5803-0004$01 .50

"Sales-at-Risk": A Test of the Mutual Forbearance Theory of Conglomerate Behavior

Abstract: In seeking to understand the implications of the large amount of diversification and conglomeration that has occurred in the United States since the mid-1960s, some economists have revived the "mutual forbearance" hypothesis first presented by Edwards (1955). Several papers have attempted to formalize or test this hypothesis, which states that multimarket contacts (MMCs) among firms have the potential for facilitating collusion in one or more of the markets where these contacts occur.' Using 1976 data from the Federal Trade Commission's Line of Business study, an earlier paper (Feinberg 1982) developed a framework for evaluating MMCs and inThis paper tests the mutual forbearance theory of conglomerate behavior at both company and industry levels, using 1976 data from the Federal Trade Commission's Line of Business program. This theory states that companies meeting rivals in more than one market will be able to facilitate collusion in one or all of those markets. At the company level the evidence supports the theory, showing salesat-risk, a measure of the importance of multimarket contacts, to increase price-cost margins in the moderate range of concentration where collusion is feasible but difficult to achieve without mutual forbearance. The industry-level results are weaker, casting some doubt on the hypothesis. * Associate professor of economics, Pennsylvania State University. This paper was begun while I was a consultant to the Line of Business program at the Federal Trade Commission. The Manager of the Line of Business program has certified that he has reviewed and approved the disclosure avoidance procedures used by the staff of the Line of Business program to insure that the data included in this paper do not identify individual company line-of-business data. Views expressed here are my own and not necessarily those of the Federal Trade Commission. I would like to thank William Long, George Pascoe, David Ravenscraft, Melvin Reder, and an anonymous referee for their help on this project. 1. These studies often refer to terms other than mutual forbearance (e.g., "spheres of influence," "extended interdependence"). They include Adams (1974), Reynolds (1976), Heggestad and Rhoades (1978), Areeda and Turner (1979), Strickland (1980), Feinberg (1982, 1984), Scott (1982), and Feinberg and Sherman (1985).

Observability and the payback criterion

Abstract: Among the enigmas of corporate finance theory that have received little attention is the puzzling use of the payback method as a capital budgeting tool. Although the payback method has many drawbacks, it is widely used in industry (see Klammer 1972; Fremgren 1973; Schall, Sundem, and Geijsback 1978).1 Gordon (1955) attempted to explain this anomaly by observing that the inverse of the payback period is an approximation for the internal rate of return. But as Sarnat and Levy (1969) point out, the accuracy of the approximation depends on the life of the project and its IRR. For low values of IRR the inverse of payback is a very poor approximation. Moreover, it is difficult to believe that corporations that use complex and sophisticated technologies need a rule of thumb to approximate something as simple to compute as the IRR. In fact, empirical evidence shows that most firms compute both the IRR and the payback period (see Schall The payback criterion continues to be widely used in industry, although there is little support for it among the academicians. This paper attempts to find an economic rationale for it by using an incentive model with asymmetric information. It argues that when the managers possess private information regarding projects selected for implementation, it is in their interest to choose, ceteris paribus, projects that pay back faster. Since manager's wages depend on output (because their productivity is unknown), by choosing projects that pay back fast they hope to improve their reputations. * I wish to thank Milton Harris and an anonymous referee for their helpful suggestions, while I retain the responsibility for any remaining errors. 1. It has been found that payback is rarely used as a primary capital budgeting method. It is used as a secondary criterion to a discounted cash-flow method such as NPV (net present value) or IRR (internal rate of return).

To Brand or Not to Brand? A Theoretical and Empirical Question

Abstract: A firm's brand name is a valuable asset that can greatly enhance the demand for its products. This fact is widely recognized in both the economics and marketing literatures. Surprisingly, though, little rigorous analysis has been devoted by either of these literatures to the question of when a firm will identify one of its new products with an established brand name. It is on this question that our research is focused. The economics literature in this general area has focused on issues that are related to but quite distinct from the issue we examine. The "traditional" industrial organization literature discusses and attempts to capture empirically the relationships among advertising, brand names, and market power. (For some representative work We develop and test a model that predicts (1) whether a multiproduct firm will brand a new product with the established company name and (2) where the new product will be "located" in relation to the reputation estabished by the firm in other markets. Hotelling's (1929) model of spatial location serves as the basis for our theoretical investigation. However, we extend Hotelling's model to the case of "experience goods" whose qualities can only be known with certainty after the product is purchased and consumed. The logic that underlies our model is tested on a sample of firms from the U.S. liquor industry. We employ a mixed logit approach to capture the simultaneous decisions that are made by the firms in our sample. * The views expressed in this paper are our own, and not necessarily those of the Bell System. We are grateful to 0. Gur-Arie, the Michigan Liquor Control Commission, Peter Ochshorn, and Srinivasan Balakrishnan for valuable assistance with data collection and programming, and to the National Science Foundation for support through grant IST 8315690. The helpful comments of Roger Klein, Pablo Spiller, and an anonymous referee are also gratefully acknowledged. Any errors are, of course, our responsibility.

Tax, Incentive, and Risk-Sharing Issues in the Allocation of Property Rights: The Generalized Lease-or-Buy Problem

Abstract: The lease-versus-buy question has captured the attention of accountants and financial economists for many years.1 The analyses to date have adopted a traditional neoclassical perspective: markets are complete, information is symmetric among agents, and contracts are costlessly enforceable. Alternatives are compared on the basis of their future cash flows. When taxes are factored into the analysis, they are typically shown to have a first-order effect on the decision. Miller and Upton (1976) represent the best work in the area to date, although they discuss some ways in which their analysis is restrictive. I wish to focus on their assumption that future maintenance costs and asset values are the same whether the asset is leased or owned:

The Value of the Tax Subsidy on Risky Debt

Abstract: The effect of corporate taxes on the market value of a levered firm continues to be a central issue in recent contributions in finance theory (e.g., Miller 1977; DeAngelo and Masulis 1980; Kim 1982; Modigliani 1982). In these and other studies (e.g., Krause and Litzenberger 1973; Scott 1976; Brennan and Schwartz 1978; Kim 1978), the relationship between market value and capital structure is established by formulating a tax subsidy function that specifies the partial effect of debt on the expected tax savings at the corporate level under the existing U.S. tax code. A working assumption in most of these studies is that both principal and interest are tax deductible. This assumption is made in the spirit of the original Modigliani and Miller (1963) formulation in which debt is taken to be perpetual and riskless. Indeed, it is well known that the tax shield provided by the deduction of principal in a singleperiod framework has the same value as the tax shield from interest deductions in the case of perpetual and riskless debt. Under this assumption, it is shown that in the absence of non-debtThis paper examines the relationship between leverage and the value of the firm, when non-debt-related tax shields are available and the corporate tax is levied as an income tax. In a previous paper, De Angelo and Masulis argue that, in the presence of nondebt-related tax shields, the relationship between debt and firm value is concave, resulting in an interior optimal capital structure when there is a tax-induced differential in the cost of corporate debt. Their result derives from the fact that they assume the payment of debt principal and non-debt-related depreciation charges are deductible. However, the former deduction is consistent with a wealth tax, while the latter is consistent only with an income tax. We show that if the interest alone is deductible, the debt-firm value function is convex, resulting in corner solutions to the capital structure problem. * The authors wish to thank Richard Castanias, Richard Green, Lemma Senbet, and especially an anonymous referee for helpful comments, and Richard Green and Robert Dammon for computational assistance.

A Reappraisal of Interpreting Rising Concentration: The Case of Beer

Abstract: There has been a tremendous amount of change in the structure and conduct of the post-World War II brewing industry. Most important, concentration has risen, scale economies have increased, and advertising intensity, especially television advertising, has changed.' In a recent article in this Journal William J. Lynk (1984) attempted to determine empirically how changes in concentration and technology affected brewing industry performance between 1974 and 1980.2 He found support for the "competition hypothesis" that cost reductions (due to cost superiority or the exploitation of scale economies) have dominated the possible market power effect of rising concentration and have caused output to increase and prices to fall. Thus the alternative, or the "exclusion hypothesis" that large brewers have squeezed smaller rivals out of In contrast to the finding of William J. Lynk that rising concentration in the U.S. brewing industry caused industry output to expand (and by his presumption, prices to fall), the results of this study show that concentration had no significant direct impact on post-World War II beer prices. Estimates from a reduced-form price equation reveal that advertising and costs have had a significant positive effect on beer prices. These results provide evidence that the rising concentration, scale economies, and advertising expenditures in the U.S. brewing industry generated higher beer prices between 1950 and 1971. * I would like to thank William Hallagan for bringing Lynk's paper to my attention and James F. Ragan, Jr., Carol Horton Tremblay, and an anonymous referee for their helpful comments on earlier drafts. Any remaining errors are my responsibility. 1. For example, the number of firms declined from 386 to 37 and the five-firm concentration ratio increased from 23% to 71% between 1950 and 1978. See Elzinga (1973, 1982), Keithahn (1978), Ornstein (1981), and Greer (1971a, 1981) for excellent industry studies. 2. In this paper industry performance is evaluated from the consumer's point of view. For a given level of product quality, if structure and conduct changes are beneficial to consumers by causing the market price to fall, then industry performance has improved.

Interest Rates and Investment Spending: Some Empirical Evidence for Postwar U.S. Producer Equipment, 1947-1980

Abstract: The empirical evidence on the effect of interest rates on aggregate investment behavior is ambiguous. The early neoclassical models of investment (e.g., Hall and Jorgenson 1967; Jorgenson and Stephenson 1967) and the putty clay extensions (e.g., Bischoff 1969, 1971) imposed various nonlinear restrictions on demand shifters and the user cost of capital. Some studies use the nominal interest rate in constructing user cost whereas others use a proxy for the real rate. Given these restrictions and different definitions of user cost of capital, it is difficult to distinguish the interest rate effect, nominal or real, from other effects on investment behavior. Moreover, some writers (e.g., Eisner and Nadiri 1968; Eisner 1978; Clark 1979) concluded that interest rates are not empirically relevant. The latter authors' empirical findings point to the accelerator effect to be the most critical determinant of investment spending. This paper explores the dynamic effect of interest rates on investment spending utilizing vector autoregressions. Nominal interest rate innovations have a strong and persistent effect on investment, overshadowing "animal spirit" or own-investment innovations and GNP innovations. This result is robust to different ordering of the contemporary innovations. By imposing cross-equation restrictions, we test the Fama-Litterman-Weiss hypothesis that nominal yields affect investment since they provide information on future GNP. This hypothesis cannot be rejected at high significant levels. The strong and persistent nominal interest rate effect on investment is eliminated when we include a rational expectations predictor of future GNP in the VAR system. The results therefore support the accelerator model of investment. * We acknowledge financial assistance from NSF grant no. SES-84-11396 and Columbia Business School. We are indebted to Joe Altonji, Robert B. Litterman, Laurence Weiss, James Poturba, and an anonymous referee for their valuable comments. We would also like to thank participants at workshops at Columbia, Minnesota, Princeton, CUNY, NYU, Queens, Carleton, and Montreal for helpful suggestions.

Taxes, Capital Structure, and Bondholder Clienteles

Abstract: Despite much recent progress, financial theory has yet to explain the connection, if any, between the U.S. tax code and many observed characteristics of corporate bonds.' Empirically, why is there no single tax rate equating yields on corporate bonds with yields on tax-exempt municipal bonds of apparently identical risks and maturities?2 Specifically, why does the spread in yields between corporate and municipal bonds divided by the yield on corporates, a conventional measure of the marginal tax rate on corporates, decrease with increasing risk and maturity? More generally, why are different types of bonds evidently held by clienteles of investors in Tax clienteles for corporate bonds are identified in a competitive financial equilibrium. Under an asymmetric corporate income tax with interest preceding principal, state-contingent bonds with higher coupon yields are issued by firms with higher pretax cash inflows per dollar of nondebt tax shield, purchased by investors in lower tax brackets, and implicitly priced at lower marginal tax rates. On these bonds all investors earn tax-induced 'surpluses. By contrast, all other bonds have implicit tax rates typically equal to the corporate rate and yield for many investors no tax-induced surpluses. * We gratefully acknowledge the helpful comments of George Constantinides, Kose John, Merton Miller, Jim Scott, Marti Subrahmanyam, and participants in seminars at Baruch, Chicago, Columbia, Houston, Michigan, NYU, Rutgers, USC, Washington, Wharton, the American Finance Association, the Western Finance Association, and the Johnson Symposium on Taxes and Finance at Wisconsin. George Constantinides was especially helpful. 1. The most notable contribution is Miller (1977). Other recent papers include Chen and Kim (1979); Kim, Lewellen, and McConnell (1979); DeAngelo and Masulis (1980a, 1980b); Taggart (1980); Kim (1982); Auerbach and King (1983); and Talmor, Haugen, and Bornea (1985). Black (1971) anticipates an equilibrium with clienteles. 2. Schaefer (1982a) identifies tax-induced clienteles of bondholders in the British gilt market. Van Horne (1982) reports that implicit tax rates vary over time as the supply of discount bonds changes. Additional evidence is cited in Trczinka (1982).

The Price and Output of Beer Revisited

Abstract: In an earlier article (Lynk 1984) I discussed several hypotheses about the interpretation of rising industry concentration and concluded essentially that the phenomenon, standing alone, was consistent with both the ordinary competitive process and with various (successful) anticompetitive practices. I focused on the brewing industry for an empirical investigation of this phenomenon because it has had an unusually high rate of increase in concentration and has attracted a correspondingly high level of antitrust and merger scrutiny. Noting a number of basic ambiguities with the use of average prices (competing brands may sell at different prices, as may competing package types), I shifted the test of the competitive consequences of rising concentration from price effects to output effects (see Posner 1981). I found that as concentration grew through the continued expansion of the larger U.S. brewers (over time and in different parts of the country), output expanded rather than contracted. This finding, I concluded, was consistent with growing concentration as an effect of the competitive process and inconsistent with the contraction of output we associate with increasing market power. Victor Tremblay's (in this issue) paper considers Rising concentration may often result from an efficient reorganization of an industry's assets, but it may also create market power. I found earlier that the efficiency effects dominate in the brewing industry. In related research, Tremblay discusses some policy implications of my finding, noting that greater concentration may result in more advertising rather than lower prices. I argue here that a higher level of competitive advertising does not have the adverse welfare implications that Tremblay suggests and that, in any case, Tremblay's tests are biased against finding an inverse relationship between retail prices and either advertising or concentration. I note also that, despite these biases, Tremblay's findings confirm and extend my earlier results: higher concentration has led to lower prices as well as higher output. (Journal of Business, 19,85, vol. 58, no. 4) ? 1985 by The University of Chicago. All rights reserved. 0021-939818515804-0002$01 .50

Advertising and the Residential Demand for Electricity

Abstract: Following the oil embargo in late 1973, a variety of programs were implemented to reduce the rate of increase of electricity consumption, including advertisements to inform consumers of the cost savings available through conservation measures.' Serious doubts have been raised concerning the likely effectiveness of such advertisements in reducing demand. Two basic issues lie at the heart of these doubts. First, since most of these advertising programs were administered by companies that supply electricity, it is difficult to see the incentive of these firms to cooperate in the administration of such programs. Second, no empirical evidence has yet been presented regarding the sensitivity of electricity demand to conservational advertising. Given this lack of evidence, some doubt exists whether demand responds to such efforts at all. Both of these issues are addressed in this paper. In Section 1I we present a simple theoretical model that demonstrates the conditions under which the regulated firm will have a profit incenRecently, considerable effort has been made to reduce the growth rate of electricity consumption in the residential sector through conservational advertising. This paper presents a simple theoretical model of the regulated firm's incentive to reduce the demand for its product through such advertising. An indirect test of this model is provided by estimating a residential electricitydemand equation with utility company advertising included as an independent variable. The empirical results support the theory. Moreover, they indicate that advertising is a statistically significant determinant of the level of electricity demand, but that the advertising elasticity of demand is quite low. * The authors wish to thank William Fox, Richard Tepel, and an anonymous referee for helpful comments on earlier drafts of this paper. At the same time, we alone are responsible for any errors that may remain. 1. Two such programs are the Residential Conservation Service of the U.S. Department of Energy, which performs home energy audits to inform consumers of the relatively more profitable measures available for reducing electricity use, and conservation advertising programs mandated in several states by public service commissions.

Waiting for Physicians' Services: Model and Evidence

Abstract: Full prices of physicians' services include time as well as money price components. Time is spent in the acquisition of market information on alternative sources of care, prices, and the nature of services available at alternative sites. Physician visits often require substantial travel time expenditures. One source of time costs that has received considerable attention is the time patients spend waiting in physicians' offices. Findings from the National Medical Care Expenditure Survey indicate that in 1977 the average office wait for an appointment visit was approximately 18 minutes (Kasper and Berk 1981). If average hourly earnings for workers in private industry are used to impute a value for the opportunity cost of this time, the price of waiting was over 21% of the price of a routine office visit before deducting third-party reimbursements. ' The waiting time cost component of full price can be expected to increase with future increases in When services are distributed by appointment, consumers often incur costs of waiting beyond scheduled appointment times. A model of the physician's office is developed that recognizes that physicians jointly produce office services and accessibility. Testable implications of the model are generated, and estimates of reduced-form waiting time and money-price equations are presented. Results suggest that waiting times are responsive to demand and supply-side factors Estimates are consistent with the theory of the allocation of time and suggest that lower waits will accompany growth in the supply of physicians. * I completed this work while at Syracuse University. I thank an anonymous referee for helpful comments. The views expressed in this paper are mine, and no official endorsement by either the National Center for Health Services Research or Department of Health and Human Services is intended or should be inferred. 1. In 1976, average hourly earnings for workers in private industry were $4.87 (U.S. Department of Commerce 1978); the average price of a routine office visit was $10.65 for general practitioners (Gaffney 1979).

Fair Pricing of Unemployment Insurance Premiums

Abstract: The unemployment insurance (UI) system in the United States differs from a standard competitive insurance market in at least two ways. First, because workers and firms can influence the probability of an adverse event (unemployment), there is a moral hazard problem. Consequently, an optimal insurance program would require coinsurance of unemployment risk.1 A second difference, which has received less attention than the first (in the recent UI literature), is the fact that much of unemployment risk is undiversifiable aggregate risk.2 If shareholders of firms are averse to aggregate risk, an optimal UI program will require coinsurance of aggregate risk.

A Note on Purchased Power Adjustment Clauses

Abstract: A recent series of papers has examined some of the economic effects of automatic fuel adjustment clauses on the behavior of the regulated firm (see Baron and DeBondt 1979; Gallop and Karlson 1978; Cowing and Stevenson 1979; Atkinson and Halvorsen 1980; Isaac 1982; Kaserman and Tepel 1982). For the most part, these papers have analyzed the implications of profit maximization under two alternative regulatory regimes-one in which the firm's output price is determined by the terms of an adjustment clause formula and one in which it is not. 1 Today, virtually all electric utilities are subject to some sort of fuel cost adjustment mechanism.2 Since the specific formulas embodied in these mechanisms exhibit considerable variation across regulatory Virtually all electric utilities are subject to some sort of fuel cost adjustment mechanism. One way in which these formulas differ is in their treatment of purchased power. This paper examines the effect that alternative treatments of purchased power have on the incentive of the regulated firm to minimize short-run costs through its choice of purchased versus owngenerated power. The theoretical model indicates that excluding purchased power from the formula creates an economic incentive to overutilize the firm's own generating equipment. Based on data for 113 privately owned U.S. electric utilities, the empirical analysis confirms the theoretical prediction. * We gratefully acknowledge the financial support provided by the Public Policy Research Center and the Public Utilities Research Center at the University of Florida and a grant from Resources for the Future. Without implicating them in what follows, we also acknowledge the helpful comments on an earlier draft provided by John Mayo and especially by two anonymous referees. 1. The study by Gollop and Karlson (1978) is an exception. They create an index that varies directly with the value of the adjustment clause formula to the firm. 2. Fuel adjustment clauses were in effect in 43 states in 1976. See Isaac (1982, p. 159).