Showing papers in "The RAND Journal of Economics in 1993"
TL;DR: In this paper, the authors present new tests for finance constraints on investment by emphasizing the often-neglected role of working capital as both a use and a source of funds, and find that the coefficient of endogenous working capital investment is negative in a fixed-investment regression.
Abstract: This article presents new tests for finance constraints on investment by emphasizing the often-neglected role of working capital as both a use and a source of funds. The coefficient of endogenous working capital investment is negative in a fixed-investment regression, as expected if working capital competes with fixed investment for a limited pool of finance. This finding addresses a criticism of previous research on finance constraints, that cash flows may simply proxy shifts in investment demand. In addition, previous studies may have underestimated the impact of finance constraints on growth and investment because firms smooth fixed investment in the short run with working capital.
891 citations
TL;DR: In this article, the authors developed a model of two-dimensional auctions, where firms bid on both price and quality, and bids are evaluated by a scoring rule designed by a buyer.
Abstract: This article studies design competition in government procurement by developing a model of two-dimensional auctions, wherefirms bid on both price and quality, and bids are evaluated by a scoring rule designed by a buyer Three auction schemes-first score, second score, and second preferred offer-are introduced and related to actual practices If the buyer can commit to a scoring rule in his best interest, -the resulting optimal scoring rule underrewards quality relative to the buyer's utility function and implements the optimal outcome for the buyer underfirst- and second-score auctions Absent the commitment power, the onlyfeasible scoring rule is the buyer's utility function, under which (1) all three schemes yield the same expected utility to the buyer, and (2) first- and second-score auctions induce the first-best level of quality, which turns out to be excessive from the buyer's point of view
841 citations
TL;DR: In this paper, the authors evaluate the effects on corporate profitability of producing a major innovation and find that innovation can have a direct but transitory effect on profitability associated with the production of new products or the use of a new process, and innovations can have an indirect effect on how firms generate profits.
Abstract: This article seeks to evaluate the effects on corporate profitability of producing a major innovation. We examine two types of effect: innovations can have a direct but transitory effect on profitability associated with the production of a new product or the use of a new process, and innovations can have an indirect effect on how firms generate profits because they signal the transformation of a firm's internal capabilities associated with the process of innovating. Positive direct effects on the order of [[sterling]]2.1 million spread over seven years are observed for a sample of 721 large, quoted U.K. firms. More fundamentally, large indirect effects are also observed, not least because innovating firms seem to be more able to benefit from spillovers and are relatively insensitive to adverse macroeconomic shocks. These indirect effects associated with the transformation of a firm's internal capabilities may be as much as three times larger than the direct effects of innovation.
816 citations
TL;DR: In this article, the authors examine the incentives of contractual parties to design agreements that are left intentionally incomplete with regard to future duties or contingencies, and conclude that the degree of contractual incompleteness chosen in practice reflects a desire by the parties to minimize the economic costs associated with contractual exchange.
Abstract: This article examines the incentives of contractual parties to design agreements that are left intentionally incomplete with regard to future duties or contingencies. More complete contracts mitigate ex post opportunism and the associated distortions in unobservable investment, but at the cost of additional resources expended in ex ante design. The optimal degree of contractual incompleteness involves a tradeoff between these opposing forces, the magnitudes of which may be predicted based on observable characteristics of the transactors and of the exchange environment. The resulting hypotheses are tested using panel data on the pricing procedures using in Air Force engine procurement contracts. We conclude that the degree of contractual completeness chosen in practice reflects a desire by the parties to minimize the economic costs associated with contractual exchange.
563 citations
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TL;DR: In this paper, it was shown that a middleman can be welfare improving in all equilibria in a quite general bargaining model when adverse selection is present, and conditions were determined for when the middleman is most likely to be in a market.
Abstract: I show that a middleman can be welfare improving in all equilibria in a quite general bargaining model when adverse selection is present. Conditions are determined for when a middleman is most likely to be in a market. Examples of the theory are also presented.
508 citations
TL;DR: This paper examined the stock market response to acquisition announcements during and immediately after the conglomerate merger wave of the late 1960s and found that acquirer shareholders benefited from diversification acquisitions, which implies that diversification was not driven by managerial objectives.
Abstract: This article examines the stock market response to acquisition announcements during and immediately after the conglomerate merger wave of the late 1960s. The main finding is that acquirer shareholders benefited from diversification acquisitions, which implies that diversification was not driven by managerial objectives. It is also shown that the market responded positively to bidders who retained the management of target companies and negatively to bidders who replaced target management. This is consistent with the hypothesis that the market favored acquisitions intended to exploit managerial synergies. It suggests that the market disliked takeovers that were motivated to discipline target management. Evidence on buyer and target price-earnings ratios is presented that is inconsistent with the conjecture that conglomerates were able to mislead investors by earnings-per-share manipulation.
402 citations
TL;DR: In this article, a general duration model of technology adoption that incorporates the main factors discussed in different theories of diffusion of new process technologies is presented. But, there seems to be little evidence in support of the stock and order effects.
Abstract: In this article we construct a general duration model of technology adoption that incorporates the main factors discussed in different theories of diffusion of new process technologies. The model is applied to data on diffusion of CNC in the UK engineering industry. Although we find strong evidence in support of rank and endogenous learning effects, there seems to be little evidence in support of the stock and order effects. The main factors affecting the diffusion of CNC are found to be endogenous learning, firm size, industry growth rates, the cost of the technology, and expected changes in the cost of the technology.
386 citations
TL;DR: In this article, the authors investigate how information asymmetries affect the organization of markets in which sellers are also experts who determine customers' needs and examine how customers' search for multiple opinions and reputation considerations each play a role in disciplining experts.
Abstract: This article investigates how information asymmetries affect the organization of markets in which sellers are also experts who determine customers' needs. It examines how customers' search for multiple opinions and reputation considerations each play a role in disciplining experts. It shows that customer search may give rise to an equilibrium in which experts specialize in different levels of the service. It discusses the effect of the search-cum-diagnosis costs on the market's organization. experts are more likely to be disciplined by customer search or by reputation according to whether these costs are lower or higher. It also shows that when experts are liable to make diagnosis errors, there is a negative search externality that tends to raise prices.
311 citations
TL;DR: In this article, a principal-agent analysis of the manufacturer-retailer relationship is tested using microdata on contractual form, retail outlet characteristics, and retail prices for gasoline stations in eastern Massachusetts.
Abstract: Predictions from a principal-agent analysis of the manufacturer-retailer relationship are tested using microdata on contractual form, retail outlet characteristics, and retail prices for gasoline stations in eastern Massachusetts. The empirical results are consistent with upstream firms choosing contracts with strong incentives but less direct control when outlet characteristics make unobservable effort by downstream agents important. Manufacturers trade off incentive power for more direct control when observable effort is relatively more important. There is some evidence that the retail prices of some gasoline products are lower when the upstream firm is allowed to control the retail price directly.
310 citations
TL;DR: In this paper, the authors test whether the degree to which firms internalize their externalities depends on the ability of affected communities to engage in collective action and find that firms processing hazardous waste, when deciding where to expand capacity, do take into account variations in the potential for collective action to raise their costs.
Abstract: Firms that generate negative externalities may consider the effects of their location on the surrounding environment because of the right of their prospective neighbors to demand compensation for pollution and raise the transaction costs of location. Since communities vary both in the value individuals place on the environment and in the ability of residents to organize politically, locations that generate the least political opposition may not be the locations that result in the lowest externalities. This article tests whether the degree to which firms internalize their externalities depends on the ability of affected communities to engage in collective action. The results indicate that firms processing hazardous waste, when deciding where to expand capacity, do take into account variations in the potential for collective action to raise their costs.
261 citations
TL;DR: The authors examined the relative strength and significance of the status of "incumbent contractor" in federal computer procurement and found that the (in)compatibility between a buyer's installed base and a potential system also influences the vendor choice.
Abstract: This research examines the relative strength and significance of the status of "incumbent contractor" in federal computer procurement. One finding, as expected, is that an agency is likely to acquire a system from an incumbent vendor. Another finding, perhaps more interesting, is that the (in)compatibility between a buyer's installed base and a potential system also influences the vendor choice; a result that may be the first econometric measurement of the competitive effects of incompatibility. An illustration of this thesis comes from IBM's experience. New evidence shows, however, that IBM's apparent disadvantage with government agencies is largely due to incompatibilities in IBM's product line.
TL;DR: In this article, the authors explain modern cropshare contracts using a model in which agents are risk neutral and contract rules are chosen to maximize expected joint wealth, where the farmer either bears the entire cost of inputs or shares the costs with the landowner in the same proportion as the output.
Abstract: Modern cropshare contracts are explained using a model in which agents are risk neutral and contract rules are chosen to maximize expected joint wealth. It is shown that the farmer either bears the entire cost of inputs or shares the costs with the landowner in the same proportion as the output. The incentives of altering the cropshare percentage are examined and are used to derive implications about the portion of the crop that will be owned by the farmer. The model is tested and supported using data from a 1986 survey offarmers and landowners in Nebraska and South Dakota.
TL;DR: In this article, the authors investigate a spatial duopoly in which the firms simultaneously select locations at the beginning of time; once chosen, the locations are fixed forever, but the firms will choose prices in each of a countably infinite succession of time periods.
Abstract: We investigate a spatial duopoly in which the firms simultaneously select locations at the beginning of time; once chosen, the locations are fixed forever, but the firms will choose prices in each of a countably infinite succession of time periods. We are interested in equilibrium behavior when the firms will collusively arrange a trigger strategy equilibrium in prices, and will select their locations knowing that a particular such trigger strategy price equilibrium will ensue. Specifically, we restrict our attention to prices that support an outcome on the profit possibility frontier at which the ratio of firm 1's profits to those of firm 2 is positively related to the similar ratio of profits at the single-shot noncooperative equilibrium. For these profit-sharing rules the resulting location equilibrium is unique and involves the pairing of firms at the market center.
TL;DR: In this article, the authors introduce a mechanism through which the firm will, in its own best interest, reveal the true value of its private information, even though outside verification is impossible.
Abstract: While under some circumstances information sharing in oligopoly may be beneficial, the literature ignores the possibility of strategic information sharing by assuming verifiability of data. I endogenize the incentives for truthful information sharing and prove that if firms have the ability to send misleading information, they will always do. To overcome this problem I introduce a (costly) mechanism through which the firm will, in its own best interest, reveal the true value of its private information, even though outside verification is impossible. I show that in some cases benefits from information sharing exceed the signalling costs, while in other cases the reverse is true. The fact that I model a two-sided signalling enables me to mitigate the signalling-cost problem. Rather than burning money, oligopolistic rivals may exchange transfer payments, thereby significantly reducing signalling costs.
TL;DR: In contrast, a well-informed client who has a high-quality case will be willing to pay a relatively high fixed fee and a relatively low contingency percentage, while a client with a low quality case will prefer a low fixed fee, and a high contingency percentage as mentioned in this paper.
Abstract: When there is asymmetric information, contingent fees can allow clients to signal the qualities of their cases and attorneys to signal the quality of their advice. Thus, a well-informed client who has a high-quality case will be willing to pay a relatively high fixed fee and a relatively low contingency percentage, while a client with a low-quality case will prefer a low fixed fee and a high contingency percentage. In contrast, a well-informed high-quality attorney will signal her ability by working for a relatively high contingency percentage.
TL;DR: In this article, the authors compare the operating performance of light water Reactor (LWR) power plants in the United States and France and find that the relationship between experience and performance has been strongly influenced by industrial structure.
Abstract: Learning from experience in the nuclear industry has had a significant impact on the operating performance of light water reactor (LWR) power plants. Performance comparisons between the United States and France indicate that the relationship between experience and performance has been strongly influenced by industrial structure. In the United States, a sizable operating performance penalty has been paid both as a result of the diffusion of several types of LWR technology and because of the relative scarcity of multiunit sites caused by the fragmented structure of the electric utility industry. In France, by contrast, performance has benefited from the very high degree of plant design standardization and the prevalence of multiunit siting. These results suggest both short-term and long-term opportunities for improvement in the performance of the American nuclear industry.
TL;DR: In this article, the role of noise in a multidimensional signalling game is investigated and it is shown that when the advertising channel is noisy there is no separating equilibrium where the monopolist will simultaneously employ both signalling mechanisms.
Abstract: This article investigates the role of noise in a multidimensional signalling game. A monopolist that offers a high- or low-quality product can signal its quality to consumers through its selection of price and advertising. It is shown that when the advertising channel is noisy there is no separating equilibrium where the monopolist will simultaneously employ both signalling mechanisms. Advertising will take place only when price is uncorrelated to quality. Furthermore, the noise complicates the process of consumer inference. This enables a low-quality firm to take advantage of consumer ignorance by partially mimicking the strategy of the high-quality firm.
TL;DR: In this paper, the authors present a positive model of investment choices by regulated firms that offers rational explanations for electric utilities' recent behavior of delaying investment and choosing smaller, shorter-lead-time technologies.
Abstract: This article presents a positive model of investment choices by regulated firms that offers rational explanations for electric utilities' recent behavior of delaying investment and choosing smaller, shorter-lead-time technologies. The model assumes thatfirms' capital investments require long lead times, during which the value of the completed project is uncertain. Firms anticipate regulatory profit and loss restrictions, but expectations about the value of a completed project change over time. Firms' decisions are modelled using an option pricing approach that incorporates the value of flexibility to delay or abandon projects. The article shows why rational firms invest in smaller, shorter-lead-time plants, or delay investment when faced with uncertain and asymmetric profit and loss restrictions. It also looks at decisions to abandon partially completed plants, and shows that the static result that a higher cost allowance on abandoned projects increases the incentive for investment is not generally true in a dynamic model.
TL;DR: In this article, the authors consider the incentives for oligopolistic manufacturers to adopt exclusive dealing and find cases in which nonexclusive dealing is a dominant strategy, and also show that even if adoption of exclusive dealing by all manufacturers is the equilibrium, it can arise from a prisoner's dilemma in that each manufacturer would prefer nonexclusive deals.
Abstract: We consider the incentives for oligopolistic manufacturers to adopt exclusive dealing Manufacturers producing differentiated brands can choose to distribute through exclusive retail dealerships or nonexclusive dealerships With nonexclusive dealing, manufacturers face an interbrand externality because brand-enhancing investments made by one manufacturer may benefit the brands of other manufacturers Although exclusive dealing eliminates this externality, oligopolistic manufacturers may not choose exclusive dealing Exclusive dealing enhances the incentive to invest, but the promotional investments are a form of competition between manufacturers Thus, manufacturers might earn higher profits with nonexclusive dealing making lower promotional investments We find cases in which nonexclusive dealing is a dominant strategy We also find cases in which some, but not all, manufacturers adopt exclusive dealing Moreover, even if adoption of exclusive dealing by all manufacturers is the equilibrium, it can arise from a prisoner's dilemma in that each manufacturer would prefer nonexclusive dealing
TL;DR: In this article, the authors examined whether or not cable systems' increased market power, or their increased exercise of market power explains these price increases, and concluded that this 18% real price increase is due to greater exercise of existing market power made possible by the elimination of price regulation.
Abstract: Since the deregulation of rates for basic cable television service, increases in price have outpaced the rate of inflation. This article examines whether or not cable systems' increased market power, or their increased exercise of market power, explains these price increases. An estimated "quasi-supply"function for cable systems before and after deregulation implies that real basic cable prices increased 18% since deregulation, holding quality and other costs constant, accounting for 43% of the total real price increase. A demand equation is also estimated, and the estimated demand elasticity of basic cable does not change after deregulation, implying that this 18% real price increase is due to greater exercise of existing market power, made possible by the elimination ofprice regulation, rather than to an increase in market power caused by a change in the demand elasticity for cable.
TL;DR: This paper showed that the role of equity in sharing aggregate risks leads to the prediction that firms' dividends should vary with macroeconomic conditions, after controlling for the effects of relevant firm-level variables.
Abstract: This article formalizes the intuition that equity provides firms with a cushion against aggregate fluctuations. We show that equity allows a firm to share aggregate risks with its creditors, minimizing the chance that a recession could push it into financial distress. The tax bias against equity finance reduces the extent to which firms insulate themselves against aggregate risks. The role of equity in sharing aggregate risks leads to the prediction that firms' dividends should vary with macroeconomic conditions, after controlling for the effects of relevant firm-level variables. We present empirical evidence in support of this prediction.
TL;DR: In this article, the optimal level of collusion is often less collusive than Cournot duopoly in Bertrand industries, while in perfectly collusive industries, too many firms invest when a project has medium to high chances of success.
Abstract: Anticipated postinnovation collusion encourages RD sometimes they do not. Both usually outperform perfectly collusive industries. The optimal level of collusion is often less collusive than Cournot duopoly. In Bertrand industries, too few firms do R&D. The same goes for long-shot or high-cost projects in all industries. However, in perfectly collusive industries, too many firms invest when a project has medium to high chances of success. Investment by Cournot industries is often close to optimal.
TL;DR: In this article, an overlapping-generations model of saving, investment, and product innovation is presented, which shows that a long duration of patents results in a high aggregate value of monopoly firms that compete for the younger generation's savings with investment in new product development.
Abstract: In this article we demonstrate how a long duration of patents affects investment in new product development. We construct an overlapping-generations model of saving, investment, and product innovation and show that a long duration of patents results in a high aggregate value of monopoly firms that compete for the younger generation's savings with investment in new product development. We analyze the crowding-out effects of long duration of patents and their implications for individuals' welfare under different patent regimes. * It is widely accepted that the patent system is useful for encouraging new product development despite the market distortion it creates by granting temporary monopoly rights to new firms. Thus, the patent system is essential to growing economies. It is commonly believed that a long duration of patents (long duration of monopolies) increases the incentives for firms to engage in product development and therefore increases the rate of product development in the economy. The purpose of this article is to show that when one takes into account the effects of an increase in the number of monopoly firms on savings, this is not necessarily the case. We develop a multiproduct, general-equilibrium, overlapping-generations model of product innovation, in which the savings of the young can be used to purchase monopoly firms from older generations and/or can be allocated to the process of innovation, which involves the construction of new firms (new products). A long duration of patents is associated with monopoly firms that maintain their monopoly rights for many generations. Thus, an increase in the patent life increases the number of existing monopoly firms sold by the old to the young each period, and therefore it increases the fraction of the young's savings allocated to purchasing existing monopoly firms from the old and decreases the fraction of savings allocated to the construction of new firms (the development of new products) .' We define the concept of the "crowding-out effect" as a situation where part of
TL;DR: In this paper, the authors model the managerial bounded rationality by using the concept of strategic complexity as measured by afinite automaton, and show that market behavior can be considerably altered once there is a limit on the complexity of strategies.
Abstract: The article is concerned with market behavior when firms have limited ability to handle effectively the complexity of changing market conditions and strategic interaction. Modelling the managerial bounded rationality by using the concept of strategic complexity as measured by afinite automaton, we show that market behavior can be considerably altered once there is a limit on the complexity ofstrategies. In particular, we demonstrate that when an incumbent firm operates in several markets, an entry to one market may induce the incumbent to exit from another market (divestiture) in order to "concentrate" on the competition it faces. For different parameters the incumbent may react to such an entry by exit from the same market, creating specialization. We also demonstrate that bounded complexity can serve as an entry barrier, giving an advantage to the established incumbent firm.
TL;DR: The authors showed that unless a restrictive and unappealing assumption is made about demand, there is no equilibrium in which both firms adopt most-favored-customer (MFC) policies in a two-period differentiated products duopoly model.
Abstract: In a two-period differentiated products duopoly model, most-favored-customer (MFC) pricing policies allow firms to commit to prices above the Bertrand prices. It is shown here, however, that unless a restrictive and unappealing assumption is made about demand, there is no equilibrium in which both firms adopt MFC policies. The restrictive assumption is that at least one firm's demand is more responsive to changes in its opponent's price than to changes in its own price; otherwise, firms have an incentive to deviate from a greater-than-Bertrand price in the first period.
TL;DR: In this article, a model of the demand for short (intraLATA) long distance calling was proposed, and the economic welfare effects of the adoption of extended area service (EAS) in four metropolitan areas were investigated.
Abstract: Although telephone pricing has received increasing attention in recent years, the geographic patterns of telephone pricing and the corresponding economic consequences of those patterns have remained perplexing to consumers and policymakers and largely unaddressed by economists. In this article we first specify a model of the demand for short (intraLATA) long distance calling. We then draw upon data made available by the recent adoption of extended area service (EAS) in four metropolitan areas to empirically measure the structure of inter-exchange telephone demand. Given these estimates, and a conceptual framework for analyzing the economic welfare effects, we were able to quantify the consumer-surplus effects of alternative pricing policies. The empirical results indicate that consumer surplus is noticeably enhanced by adopting EAS. But the net economic welfare effects are shown to be sensitive to, among other things, the level of price-cost margins prevailing prior to the implementation of EAS.
TL;DR: In this article, a nonlinear variant of the model studied by Freixas, Guesnerie, and Tirole (1985) on the dynamic regulation of a firm with adverse selection and no commitment is introduced.
Abstract: A concept of coordination costs is incorporated into a nonlinear variant of the model studied by Freixas, Guesnerie, and Tirole (1985) on the dynamic regulation of a firm with adverse selection and no commitment (the ratchet effect). Greater coordination costs give rise to two opposing effects. First, the value to the center of obtaining information increases, since this information can be used to eliminate coordination costs. Second, due to the nature of incentive-compatibility constraints, the costs of inducing revelation also increase. It is shown that the second effect always dominates. Greater coordination requirements increase the relative social costs of inducing separation (revelation) as opposed to pooling over and above any additional value of information to the center. A possible application of this theory to the experience of the Soviet economy is discussed.
TL;DR: In this paper, the authors consider a two-stage model of duopolistic capacity choice and subsequent price competition, where consumers' residual demand functions are aggregated from the firm-selection decisions of individual consumers.
Abstract: In a two-stage model of duopolistic capacity choice and subsequent price competition, consumer switching costs can deter some consumers from seeking service at a low-price firm that lacks sufficient capacity to serve the entire market. In this setting, firms' residual demand functions are aggregatedfrom thefirm-selection decisions of individual consumers based on firms' prices and their induced degrees of service reliability. If consumers are approximately risk neutral with respect to service reliability, then capacity-constrained duopoly competition has a unique, subgame-perfect equilibrium in which firms choose Cournot capacities and prices. The equilibrium robustness of Cournot behavior extends to duopoly markets in which consumer switching costs are induced by subscription pricing.
TL;DR: In this paper, it was shown that if the distribution of quality follows some standard distribution, then a unique equilibrium will result, and it is shown that this is the case for all markets with adverse selection.
Abstract: The nature of equilibrium in markets with adverse selection evoked considerable interest following George Akerlof's seminal article on the market for lemons. Akerlof argued that markets with adverse selection may yield no equilibrium. Charles Wilson has subsequently argued that multiple equilibria may result. In this article it is shown that if the distribution of quality follows some standard distribution, then a unique equilibrium will result.
TL;DR: In this article, the authors examined aircraft engine histories to determine if deregulation affected the maintenance of aircraft engines and found that there was a significant increase in the number of engine hours between major overhauls in the period following deregulation.
Abstract: This paper examines aircraft engine histories to determine if deregulation affected the maintenance of aircraft engines. The examination shows that there was a significant increase in the number of engine hours between major overhauls in the period following deregulation. Parametric analysis of time between overhauls, which controls for other variables affecting the length of the shop visit cycle, suggest that deregulation is a significant factor in the change. Logit analysis shows that engine failures, as measure by in-flight shutdowns, have not increased following deregulation. These results indicate that airlines have optimized scheduled service times and possibly improved the quality of service while paying less attention to minor problems between scheduled service dates.