Copyright (c) 2009 All rights reserved. http://works.bepress.com/michael_raith Recent documents in Michael Raith en-us Wed, 02 Sep 2009 07:17:26 PDT 3600 http://works.bepress.com/michael_raith/14 http://works.bepress.com/michael_raith/14 Thu, 26 Mar 2009 10:56:54 PDT This paper argues that accrual-based financial accounting, including the conservative recognition of anticipated cash flows, mimics the properties of an optimal multi-period incentive contract between a firm and a manager. I study a two-period principal-agent model in which a manager can be compensated based on an early signal of a future outcome of his action, or (later) based on the outcome itself. In this dynamic setting it is optimal to use both performance measures even if the signal is strictly noisier than the outcome. Accrual accounting enables the firm and the manager to "settle up" in each period, which is optimal if the manager cannot commit to a long-term contract. Conservative accruals attribute to a period only the portion of expected cash flows that is explained, in a Bayesian sense, by information available in that period. I relate these results to conventional accounting rules and the literature on conservatism. Michael Raith Organizational Economics http://works.bepress.com/michael_raith/13 http://works.bepress.com/michael_raith/13 Thu, 26 Mar 2009 10:54:57 PDT In many occupations, the consequences of an agent's actions become known only over time. Should a principal then compensate an agent based on early but noisy information about performance, or later but more accurate information, or both? To answer this question, I study a two-period model in which a principal can pay a risk-averse agent based on both true output, which is realized with delay, and an early signal of output. The agent can borrow against future income, and can commit to a long-term contract. I show that under very general conditions the optimal wage contract depends on the early signal as well as on output even if the signal is merely a noisy version of output; that is, if the signal is uninformative of effort, given output. Specifically, for given output levels, better signals are on average associated with higher wages. Thus, an important characteristic of any performance measure is the time at which it is generated, which expands the range of signals useful for contracting well beyond that implied by the classic Informativeness Principle. The results also shed light on the use of forward-looking performance measures such as stock returns in managerial incentive contracts. Michael Raith Organizational Economics http://works.bepress.com/michael_raith/12 http://works.bepress.com/michael_raith/12 Thu, 26 Mar 2009 10:48:49 PDT We develop a theory of firm scope and structure in which merging two firms allows the integrated firm's top management to allocate resources that are costly to trade. However, information about their use resides with division managers. We show that establishing truthful upward communication raises the cost of inducing managerial effort compared with stand-alone firms; this effect dominates a positive effect on effort driven by competition for the firm's resources. We derive predictions about optimal firm scope and structure. In particular, we show why it is optimal to separate the tasks of allocating resources and running a division. Michael Raith Organizational Economics http://works.bepress.com/michael_raith/10 http://works.bepress.com/michael_raith/10 Thu, 26 Mar 2009 10:30:14 PDT The conventional view that product heterogeneity limits the scope for collusion among oligopolists has been challenged in recent theoretical work. This paper provides an argument in support of the conventional view by emphasising the role of uncertainty. I introduce the idea that, with stochastic demand, an increase in the heterogeneity of products leads to a decrease in the correlation of the firms' demand shocks. With imperfect monitoring, this makes collusion more difficult to sustain, as discriminating between random demand shocks and marginal deviations from the cartel strategy becomes more difficult. These effects are illustrated within a Hotelling-type duopoly model. Michael Raith Industrial Organization http://works.bepress.com/michael_raith/9 http://works.bepress.com/michael_raith/9 Thu, 26 Mar 2009 10:05:46 PDT In this paper we analyse a model of spatial competition with commuting consumers due to Claycombe (1991, International Journal of Industrial Organization 9, 303-313). We show that results different from Claycombe's are obtained if a rigorous game-theoretic analysis is applied to the model. Our results provide a theoretical basis for a later study carried out by Claycombe and Mahan (1993, International Journal of Industrial Organization 11,283-291) and lead to predictions which are in line with the empirical results of that later study. For small commuting distances (relative to the distance between firms), there exists a symmetric equilibrium in which the price is continuous and decreasing in both the commuting distance and the proportion of commuting consumers. For intermediate distances, however, a symmetric price equilibrium in pure strategies in general does not exist. Only if all consumers commute and the commuting distance is large, perfect competition prevails. Michael Raith Industrial Organization http://works.bepress.com/michael_raith/8 http://works.bepress.com/michael_raith/8 Thu, 26 Mar 2009 09:56:42 PDT Under which conditions do oligopolists have an incentive to share private information about a stochastic demand or stochastic costs? We present a general model which encompasses virtually all models of the existing literature on information sharing as special cases. Within this unifying framework we show that in contrast to the apparent inconclusiveness of previous results some simple principles determining the incentives to share information can be obtained. Existing results are generalized, some previous interpretations are questioned, and new explanations offered, leading to a single general theory for a large class of models. Journal of Economic Literature Classification Numbers C72, C73, D82, L13. Michael Raith Industrial Organization http://works.bepress.com/michael_raith/7 http://works.bepress.com/michael_raith/7 Thu, 26 Mar 2009 09:37:47 PDT This paper examines how the degree of competition among firms in an industry affects the optimal incentives that firms provide to their managers. A central assumption is that there is free entry and exit in the industry, which implies that changes in the nature of competition lead to changes in the equilibrium market structure. The main result is that as the intensity of product market competition increases (as a result of greater product substitutability or greater market size), principals unambiguously provide stronger incentives to their agents to reduce costs. At the same time, more intense competition also leads to more volatile firm-level profits. Consequently, managers' incentives are positively correlated with firm-level risk, consistent with empirical evidence. A decrease in the cost of entering the market has the opposite effect on incentives, but still induces a positive correlation between risk and incentives. Michael Raith Organizational Economics Industrial Organization http://works.bepress.com/michael_raith/6 http://works.bepress.com/michael_raith/6 Thu, 26 Mar 2009 09:29:08 PDT If managers and their subordinates have the same basic qualifications, organizations can benefit from replacing unproductive superiors with more productive subordinates. This threat may induce superiors to deliberately recruit unproductive subordinates, or abuse their personnel authority in other ways, to protect themselves. We show that requiring intrafirm communication to pass through a "chain of command" can be an effective way to provide superiors with an incentive to recruit the best possible subordinates.We discuss alternative ways to prevent the abuse of authority and general implications of our analysis for organizational design. We also present supporting evidence from the literature on human resource management and organizational behavior.One of your jobs as a manager is to identify and promote newmanagers. Ideally, each newmanager should be less qualified than you. Otherwise that new manager will try to take your job or make you look dumb. It's in your best interest to keep the talent pool as thin as possible, just as the people who promoted you have done.Dogbert's Top Secret Management Handbook (Adams, 1996, Ch. 1, p.15) Guido Friebel Organizational Economics http://works.bepress.com/michael_raith/5 http://works.bepress.com/michael_raith/5 Thu, 26 Mar 2009 09:14:56 PDT This paper analyzes the interaction of financing and output market decisions in a duopoly in which one firm is financially constrained and can borrow funds to finance production costs. Two ideas have been separately analyzed in previous work: Some authors argue that debt strategically affects a firm's output market decisions, typically making it more aggressive; others argue that the threat of bankruptcy makes debt financing costly, typically making a firm less aggressive. Our model integrates both ideas; moreover, unlike most previous work, we derive debt as an optimal contract. Compared with a situation in which both firms are unconstrained, the constrained firm produces less, while its unconstrained rival produces more; prices are higher for both firms. Both firms' outputs depend on the constrained firm's internal funds; the relationship is U-shaped for the constrained firm and inversely U-shaped for its unconstrained rival. The unconstrained rival has a higher market share, not because of predation but because of the cost disadvantage of the financially constrained firm. Michael Raith Industrial Organization Corporate Finance http://works.bepress.com/michael_raith/4 http://works.bepress.com/michael_raith/4 Thu, 26 Mar 2009 09:09:01 PDT We study financial contracting when both an entrepreneur's investment and the resulting revenue are unobservable to an outside investor.We show that a debt contract is always optimal; repayment is induced by a liquidation threat that increases with the extent of default. Moreover, when the entrepreneur's decision concerns the scale of his project, a contract that minimizes liquidation losses is optimal. When the decision concerns managerial effort or project risk, however, it may be optimal to write a contract with a greater threat of liquidation, to induce the entrepreneur to exert more effort or to choose a less risky project. Michael Raith Corporate Finance