nep-bec New Economics Papers
on Business Economics
Issue of 2010‒01‒10
sixteen papers chosen by
Christian Calmes
Universite du Quebec en Outaouais

  1. Returns for Entrepreneurs vs. Employees: The Effect of Education and Personal Control on the Relative Performance of Entrepreneurs vs. Wage Employees By van Praag, Mirjam; van Witteloostuijn, Arjen; van der Sluis, Justin
  2. Labor Market Pooling, Outsourcing and Labor Contracts By Pierre M. Picard; David E. Wildasin
  3. Financial leverage, corporate investment, and stock returns By Ali K. Ozdagli
  4. Does Finance Bolster Superstar Companies? Banks, Venture Capital, and Firm Size in Local U.S. Markets. By Alexander Popov
  5. Optimal Lending Contracts with Asymmetric Information and Two-sided Limited Commitment or Impatient Entrepreneur By Shuyun May Li
  6. Tenure, Wage Profiles and Monitoring By Sessions, John; Theodoropoulos, N.
  7. Indeterminacy of competitive equilibrium with risk of default By Gaetano Bloise; Pietro Reichlin; Mario Tirelli
  8. Liquidity constraints of the middle class By Jeffrey R. Campbell; Zvi Hercowitz
  9. The Effect of Adversity on Process Innovations and Managerial Incentives By Benoit Dostie; Rajshri Jayaraman
  10. When liquidity risk becomes a macro-prudential issue: Empirical evidence of bank behaviour By Jan Willem van den End; Mostafa Tabbae
  11. An analytical derivation of the relation between idiosyncratic volatility and expected stock return By Don U.A. Galagedera
  12. Contracting Under Reciprocal Altruism By Shchetinin, Oleg
  13. Taxes on severance pay, corporate governance and golden handshakes. By Fabienne Llense
  14. Stationary equilibrium distributions in economies with limited commitment By Tobias Broer
  15. Illiquidity and Under-Valuation of Firms By Douglas Gale; Piero Gottardi
  16. Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area. By Olli Castrén; Ilja Kristian Kavonius

  1. By: van Praag, Mirjam (University of Amsterdam); van Witteloostuijn, Arjen (University of Antwerp); van der Sluis, Justin (University of Amsterdam)
    Abstract: How valuable is education for entrepreneurs' performance as compared to employees'? What might explain any differences? And does education affect peoples' occupational choices accordingly? We answer these questions based on a large panel of US labor force participants. We show that education affects peoples' decisions to become an entrepreneur negatively. We show furthermore that entrepreneurs have higher returns to education than employees (in terms of the comparable performance measure 'income'). This is the case even when estimating individual fixed effects of the differential returns to education for spells in entrepreneurship versus wage employment, thereby accounting for selectivity into entrepreneurial positions based on fixed individual characteristics. We find these results irrespective of whether we control for general ability and/or whether we use instrumental variables to cope with the endogenous nature of education in income equations. Finally, we find (indirect) support for the argument that the higher returns to education for entrepreneurs is due to fewer (organizational) constraints faced by entrepreneurs when optimizing the profitable employment of their education. Entrepreneurs have more personal control over the profitable employment of their human capital than wage employees.
    Keywords: entrepreneurship, self-employment, returns to education, performance, personal control, locus of control, human capital, wages, incomes
    JEL: J23 J24 J31 J44 M13
    Date: 2009–12
  2. By: Pierre M. Picard; David E. Wildasin (CREA, University of Luxembourg)
    Abstract: Economic regions, such as urban agglomerations, face external demand and price shocks that produce income risk. Workers in large and diversified agglomerations may benefit from reduced wage volatility, while firms may outsource the production of intermediate goods and realize benefits from Chamberlinian externalities. Firms may also protect workers from wage risks through fixed wage contracts. This paper explores the relationships between firms’ risks, workers’ contracts, and the structure of production in cities.
    JEL: R12 R23 J31 J65
    Date: 2009
  3. By: Ali K. Ozdagli
    Abstract: This paper presents a dynamic model of the firm with risk-free debt contracts, investment irreversibility, and debt restructuring costs. The model fits several stylized facts of corporate finance and asset pricing: First, book leverage is constant across different book-to-market portfolios, whereas market leverage differs significantly. Second, changes in market leverage are mainly caused by changes in stock prices rather than by changes in debt. Third, when the model is calibrated to fit the cross-sectional distribution of book-to-market ratios, it explains the return differences across different firms. The model also shows that investment irreversibility alone cannot generate the cross-sectional patterns observed in stock returns and that leverage is the main source of the value premium.
    Keywords: Corporations - Finance ; Stocks - Rate of return
    Date: 2009
  4. By: Alexander Popov (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We study the relative effect of venture capital and bank finance on large manufacturing firms in local U.S. markets. Theory predicts that with venture capital, the firm size distribution should become more stretched-out to the right, but it’s ambiguous on the effect of banks on large firms. The empirical evidence suggests that while the average size of firms in the top bin of the firm size distribution has remained unaffected by banking sector developments, it has increased with venture capital investment. We argue that this is due to the emergence of new corporate giants rather than the growth of existing ones. JEL Classification: G24, J24, L11.
    Keywords: venture capital, banking, firm size.
    Date: 2009–12
  5. By: Shuyun May Li
    Abstract: This paper discusses two ways to amend the optimal lending contract under asymmetric information studied in Clementi and Hopenhayn (2006) to change its long-run implications so that firm growth and exit driven by borrowing constraints exist in the long run. One way assumes that the entrepreneur has a lower discount factor than the bank, and the other assumes the bank has limited commitment. The optimal lending contracts under each variation closely resemble each other.
    Keywords: Optimal lending contract; Borrowing constraints; Asymmetric information; Limited commitment; Impatient entrepreneur
    JEL: G3 L2 D21
    Date: 2009
  6. By: Sessions, John; Theodoropoulos, N.
    Abstract: We undertake the first empirical investigation of the relationship between the slope of the wagetenure profile and the level of monitoring. On the assumption that firms strive for the optimal trade-off between these various instruments, we hypothesise that increased monitoring leads to a decline in the slope of the wagetenure profile. Our empirical analysis, using two cross sections of matched employer-employee British data, provides robust support for this prediction.
    Keywords: Monitoring; tenure; efficiency wages;
    Date: 2009–11
  7. By: Gaetano Bloise; Pietro Reichlin; Mario Tirelli
    Abstract: We prove indeterminacy of competitive equilibrium in sequential economies, where limited commitment requires the endogenous determination of solvency constraints preventing debt repudiation (Alvarez and Jermann [3]). In particular, we show that, for any arbitrary value of social welfare in between autarchy and (constrained) optimality, there exists an equilibrium attaining that value. Our method consists in restoring Welfare Theorems for a weak notion of (constrained) optimality. The latter, inspired by Malinvaud [15], corresponds to the absence of Pareto improving feasible redistributions over nite (though inde nite) horizons.
    Keywords: imited commitment; solvency constraints; Malinvaud efficiency Welfare Theorems; indeterminacy; Welfare Theorems; indeterminacy; Welfare Theorems indeterminacy;financial fragility; market collapse
    JEL: D50 D52 D61 E44 G13
    Date: 2009
  8. By: Jeffrey R. Campbell; Zvi Hercowitz
    Abstract: There is evidence that a household's consumption response to transitory income does not decline, and perhaps increases, with the level of financial assets it holds. That is, middle class households with assets act as if they face liquidity constraints. This paper addresses this puzzling observation with a model of impatient households that face a large recurring expenditure. In spite of impatience, they save as this expenditure draws near. We call such saving made in preparation for a foreseeable event at a given future date.
    Date: 2009
  9. By: Benoit Dostie (HEC Montréal); Rajshri Jayaraman (ESMT European School of Management and Technology)
    Abstract: This paper asks whether adversity spurs the introduction of process innovations and increases the use of managerial incentives by firms. Using a large panel data set of workplaces in Canada, our identification strategy relies on exogenous variation in adversity arising from increased border security along the 49th parallel following 9/11. Our longitudinal difference-in-differences estimates indicate that firms responded to adversity by introducing new or improved processes, but did not change their use of managerial incentives. These results suggest that the threat of bankruptcy may provide impetus for improving efficiency.
    Keywords: process innovation, managerial incentives, efficiency, natural experiment
    JEL: L20 O31 M52 J33
    Date: 2009–06–02
  10. By: Jan Willem van den End; Mostafa Tabbae
    Abstract: This paper provides empirical evidence of behavioural responses by banks and their contribution to system-wide liquidity stress. Using firm-specific balance sheet data, we construct aggregate indicators of macro-prudential risk. Measures of size and herding show that balance sheet adjustments have been pro-cyclical in the crisis, while responses became increasingly dependent across banks and concentrated on certain market segments. Banks' reactions were shaped by decreased risk tolerance and limited flexibility in risk management. Regression analysis confirms that their behaviour contributed to financial sector stress. The behavioural measures are useful tools for monetary and macro prudential analyses and can improve the micro foundations of financial stability models. 
    Keywords: banking; financial stability; stress-tests; liquidity risk.
    JEL: C15 E44 G21 G32
    Date: 2009–12
  11. By: Don U.A. Galagedera
    Abstract: Modelling stock return generating process as a single factor model, we show analytically that the relation between idiosyncratic volatility measured as variance of the residuals and expected stock return in the cross-section may be represented by a parabola that opens to the left and has horizontal axis. This relation is uncovered for stocks of similar volatility and no abnormal return. The sensitivity of the derived relation when these restrictions are relaxed is discussed. Our findings, to a great extent, help uncover the shape of the non-linear inverse relation between idiosyncratic volatility and expected stock return observed in the cross-section in previous empirical studies.
    Keywords: Idiosyncratic volatility, expected return, analytical derivation, cross-sectional analysis
    JEL: C13 G12
    Date: 2009–11
  12. By: Shchetinin, Oleg (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: I show that a simple formal model of reciprocal altruism is able to predict human behavior in contracting situations, puzzling when considered within selfishness assumption. For instance, motivation and performance crowding-out are explained by a signaling mechanism in which provision of an extrinsic incentive signals non-generosity of the Principal and decreases Agent’s intrinsic motivation. The model’s equilibrium predicts behavior in the Control Game of Falk and Kosfeld and in a variant of Trust Game by Fehr and Rockenbach. This suggests that reciprocal altruism modeling could be fruitful more generally in applications of contract theory.<p>
    Keywords: Reciprocal Altruism; Extrinsic and intrinsic motivation; Contract Theory; Behavioral Economics.
    JEL: D82 M54
    Date: 2009–12–09
  13. By: Fabienne Llense (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This paper puts forward an explanation of the rapid increase in golden handshake provision in Europe over the last ten years, based on both enhanced investor protection and attractive tax codes for severance pay. This article takes up a framework in which asymmetric information about the quality of the match between CEO and firm explains the use of golden handshakes for CEOs. It shows how corporate governance and taxation can modify the magnitude and the use of golden handshakes and thus CEO turnover rates. The second-best optimal taxation rate depends on the kind of private benefits accorded to the CEO. I show that golden handshakes should be taxed in the same way as CEO incomes. However, nonpecuniary private benefits strengten the agency cost and require some transfers for firms providing parachute-type contracts. In effect, this means partial exemption. An improvement in the quality of corporate governance should lead to smaller golden handshakes, higher turnover-performance sensitivity and the disappearance of advantageous tax codes for termination pay.
    Keywords: CEOs turnover, corporate governance, golden handshakes, optimal taxation, severance pay.
    JEL: G34 H32 J33 J44
    Date: 2009–11
  14. By: Tobias Broer
    Abstract: Limited commitment to contracts can explain imperfect risk sharing even when individuals have access to complete insurance markets. Past contributions have focused on the resulting cross-sectional distribution of consumption (Cordoba 2008, Krueger and Perri 2006). In contrast, this paper looks at the joint dynamics of income, consumption and wealth implied by the asymmetric nature of partial insurance under limited commitment, where negative income shocks are largely insured but positive shocks can lead to large rises in consumption. A theoretical section proves the existence and uniqueness of equilibrium in a limited commitment continuum economy where incomes follow a standard markov process, and solves analytically for the joint equilibrium distribution of consumption, income and wealth. I show that individual consumption follows, at least locally, a left-skewed geometric distribution. Also, the conditional distributions of consumption and wealth are highly non-linear and have a characteristic form of heteroscedasticity, with declining conditional variances as income increases. In a quantitative part, the paper compares the exact distributions in the Krueger and Perri (2006) model to non-parametric estimates of their counterparts in US micro-data, and in a simple Ayagari economy.
    Keywords: Risk Sharing, Limited Commitment, Inequality, Wealth and Consumption Distribution, Participation Constraints, Default
    JEL: D52 D31 E21 E44
    Date: 2009
  15. By: Douglas Gale; Piero Gottardi
    Abstract: We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature and default may lead to the sale of the firms’ assets at fire sale prices when markets are illiquid. This incompleteness is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort .rms.investment decisions. We characterize the conditions under which fire sales occur in equilibrium and their consequences on firms' investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria.
    Keywords: illiquid markets, default, incomplete markets, price distortions, inefficient investment
    JEL: D5 D8 G1 G33
    Date: 2009
  16. By: Olli Castrén (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Ilja Kristian Kavonius (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The financial crisis has highlighted the need for models that can identify counterparty risk exposures and shock transmission processes at the systemic level. We use the euro area financial accounts (flow of funds) data to construct a sector-level network of bilateral balance sheet exposures and show how local shocks can propagate throughout the network and affect the balance sheets in other, even seemingly remote, parts of the financial system. We then use the contingent claims approach to extend this accounting-based network of interlinked exposures to risk-based balance sheets which are sensitive to changes in leverage and asset volatility. We conclude that the bilateral cross-sector exposures in the euro area financial system constitute important channels through which local risk exposures and balance sheet dislocations can be transmitted, with the financial intermediaries playing a key role in the processes. High financial leverage and high asset volatility are found to increase a sector’s vulnerability to shocks and contagion. JEL Classification: C22, E01, E21, E44, F36, G01, G12, G14.
    Keywords: Balance sheet contagion, financial accounts, network models, contingent claims analysis, systemic risk, macro-prudential analysis.
    Date: 2009–12

This nep-bec issue is ©2010 by Christian Calmes. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.