Why do firms get merged or acquired? In the end, the hope is that it increases firm value, although the stock market response is often negative. It may also be for (anti-)competitive reasons, as firm try to buy the challengers. Or it may be to acquire a patent portfolio, technology, or access to a client list or new markets. I may forget some other good reasons.
Paige Ouimet and Rebecca Zarutskie show that mergers and acquisitions can also be the result of a drive to get access to the other firm's pool of workers. This is particularly true when the labor market is tight and the workers carry high human capital. Interestingly, wage tend to increase and turnover tends to decrease after such mergers. Thus not all employees should be afraid of M&As.
Wednesday, November 9, 2011
Tuesday, November 8, 2011
Why is funeral insurance so popular in Africa?
Probably the oldest form of insurance is existence is funeral insurance, which takes cares of burial (and now cremation) costs at death. In developed economies, its popularity has vanished, while it is still very common in Africa. One reason could be that when life insurance is available, people believe it is sufficient to cover funeral costs, and the beneficiaries are committed to take care of this. When life insurance is not available or when not commitment can be elicited from descendants, then funeral insurance ensure your body is properly disposed of.
Erlend Berg writes a model along those lines and finds that only middle income should favor funeral insurance. The rich do not face a tight budget constraint and the poor cannot afford it. Then using a marketing survey conducted in South Africa finds results that are consistent with the model. This lack of commitment in Africa for financial matters is pervasive. It is, for example, at the heart of the strange institution that ROSCAs are.
Erlend Berg writes a model along those lines and finds that only middle income should favor funeral insurance. The rich do not face a tight budget constraint and the poor cannot afford it. Then using a marketing survey conducted in South Africa finds results that are consistent with the model. This lack of commitment in Africa for financial matters is pervasive. It is, for example, at the heart of the strange institution that ROSCAs are.
Monday, November 7, 2011
Why top MBA programs do not disclose grades
I have always been puzzled by the policy of many top MBA programs not to disclose the grades of their students. Even more puzzling is that they by and large manage to enforce this policy even from their top students, who should obviously want to signal that they are at the top of their class.
Daniel Gottlieb and Kent Smetters wondered about this as well. Such policies are voted by the students (who in the US own the grades) on the argument that it allows them to take more difficult classes without adverse consequences. Yet the evidence is that they learn less when such a policy is in place, which explains the general opposition to it from faculty. So, one can conclude that students are lazy (nothing new here), but is such a policy limited to top MBA programs? Why not in lesser programs, or other professional schools?
Gottlieb and Smetters point out that students have two signals for potential employers: their grades and the selectivity of the program. They are also risk averse, and at the start of their studies do not know how well they will do. In top schools, the selectivity signal is very strong and the students rely on it, while the "average" grade is superior in expected terms. In lesser schools, the selectivity signal is much weaker, and hence students try to distinguish themselves on the labor market in other ways, for example with grades.
To some extend, the same is happening on the Economics PhD market. When you look at the recommendation letters form the top schools, all candidates are the best in a generation in their field (I am exaggerating on a little). Thus the letter looses a lot of its value, and all that remains is the entrance selectivity of the PhD program. Lower ranked programs are much keener to differentiate their students and push the particularly good ones.
Daniel Gottlieb and Kent Smetters wondered about this as well. Such policies are voted by the students (who in the US own the grades) on the argument that it allows them to take more difficult classes without adverse consequences. Yet the evidence is that they learn less when such a policy is in place, which explains the general opposition to it from faculty. So, one can conclude that students are lazy (nothing new here), but is such a policy limited to top MBA programs? Why not in lesser programs, or other professional schools?
Gottlieb and Smetters point out that students have two signals for potential employers: their grades and the selectivity of the program. They are also risk averse, and at the start of their studies do not know how well they will do. In top schools, the selectivity signal is very strong and the students rely on it, while the "average" grade is superior in expected terms. In lesser schools, the selectivity signal is much weaker, and hence students try to distinguish themselves on the labor market in other ways, for example with grades.
To some extend, the same is happening on the Economics PhD market. When you look at the recommendation letters form the top schools, all candidates are the best in a generation in their field (I am exaggerating on a little). Thus the letter looses a lot of its value, and all that remains is the entrance selectivity of the PhD program. Lower ranked programs are much keener to differentiate their students and push the particularly good ones.
Friday, November 4, 2011
Adaptive versus rational expectations
There was a time where macroeconomics was ruled by adaptive (or backward-looking) expectations, like the much-ridiculed chartists. Then there was a revolution and rational (typically forward-looking) expectations were widely adopted, realizing that people are not stupid and will try to use the available information, including what other agents may do, to figure out what the future holds. Rationality, and in particular rational expectations, has recently come under attack because models failed to predict recent bubbles and crashes. I think this is mistaken, as detailed on several occasions on this blog.
Gregory Chow, however, longs for a return to adaptive expectations for three other reasons. The first is that it is empirically more plausible. Exhibit A is a regression of the stock prices of 50 blue chips in Taiwan on current dividends and past dividend growth. Despite a lowly R2 of 0.111, the fact that the coefficient on dividend growth is positive and significant is taken as evidence of adaptive expectations. I do not find this convincing, as a similar result could emerge with rational expectations if the dividend growth process is persistent.
The second reason is that "there is no reason to believe that the expected values [computed from an econometric model of the rational expectations] will have a sum, after discounting, which equals the actual current price." I think the underlying reasoning is that a statistician can only use a linear combination of past observations, thus economic agents will, too, and this all looks like adaptive expectations. But economic agents, and nowadays statisticians, are more sophisticated than that, and a gigantic literature in finance has shown that, for example, non-linearities and endogenous volatility, too name a few, are important. Even though statisticians have become much more sophisticated, they are still running behind economic agents and are far removed from being linearly backward-looking.
The third reason is that macroeconomists started using rational expectations simply because it was required to deal with the Lucas Critique, empirical evidence be damned. While I can be sympathetic to the argument that rational expectations was adopted without much direct empirical evidence, I also believe that economic agents do try and avoid systematic mistakes and that their expectations contain at least some rationality. And as much literature has shown, a modicum of rationality can bring markets darn close to prices that look like perfectly rational ones.
Gregory Chow, however, longs for a return to adaptive expectations for three other reasons. The first is that it is empirically more plausible. Exhibit A is a regression of the stock prices of 50 blue chips in Taiwan on current dividends and past dividend growth. Despite a lowly R2 of 0.111, the fact that the coefficient on dividend growth is positive and significant is taken as evidence of adaptive expectations. I do not find this convincing, as a similar result could emerge with rational expectations if the dividend growth process is persistent.
The second reason is that "there is no reason to believe that the expected values [computed from an econometric model of the rational expectations] will have a sum, after discounting, which equals the actual current price." I think the underlying reasoning is that a statistician can only use a linear combination of past observations, thus economic agents will, too, and this all looks like adaptive expectations. But economic agents, and nowadays statisticians, are more sophisticated than that, and a gigantic literature in finance has shown that, for example, non-linearities and endogenous volatility, too name a few, are important. Even though statisticians have become much more sophisticated, they are still running behind economic agents and are far removed from being linearly backward-looking.
The third reason is that macroeconomists started using rational expectations simply because it was required to deal with the Lucas Critique, empirical evidence be damned. While I can be sympathetic to the argument that rational expectations was adopted without much direct empirical evidence, I also believe that economic agents do try and avoid systematic mistakes and that their expectations contain at least some rationality. And as much literature has shown, a modicum of rationality can bring markets darn close to prices that look like perfectly rational ones.
Thursday, November 3, 2011
Is index-based weather insurance useful?
Whenever you are facing a risk, you want to be able to hedge against it (at least if you are risk averse). For this, there are all sorts of insurance policies. There are also markets in all sorts of instruments that allow you to find the right contingent claim for your situation. This includes farmers (and others) who want to hedge against meteorological risks. If you crop yields depend on weather patterns, you are looking for securities that pay out depending on some weather statistic. And they are available and have been heavily pushed by aid agencies in developing countries.
Chiratan Banerjee and Ernst Berg say they may not be such a great idea. They take the examples of rice farmers in the Philippines who bought wind-speed based indexes on the hypothesis that rice yields are lower when there are typhoons. But rice is remarkably resistant to typhoons and wind in general, the reason why it is so popular in the region in the first place. This means that rice farmers are heavily over-insured. That is especially bad and farmers are now confused about the concept of insurance as it looks like they face more risk than before.
Chiratan Banerjee and Ernst Berg say they may not be such a great idea. They take the examples of rice farmers in the Philippines who bought wind-speed based indexes on the hypothesis that rice yields are lower when there are typhoons. But rice is remarkably resistant to typhoons and wind in general, the reason why it is so popular in the region in the first place. This means that rice farmers are heavily over-insured. That is especially bad and farmers are now confused about the concept of insurance as it looks like they face more risk than before.
Tuesday, November 1, 2011
Unemployment insurance in developing economies?
There is no doubt that absent moral hazard, insuring against unemployment shocks is welfare improving. But moral hazard, either through the unemployed not searching hard enough or rejecting job offers, can have a vicious effect on welfare if it is sufficiently widespread and successful. In addition, as unemployment insurance contributions typically do not depend on unemployment risk, only bad risks want to participate, and the insurance collapses without mandatory participation. With all this in mind, does it make sense to implement unemployment insurance in developing economies, where there is a large informal sector that makes mandatory contributions difficult to enforce and where moral hazard is, of course, rampant?
David Bardley and Fernando Jaramillo show that introducing unemployment insurance actually makes the formal sector more attractive and that we should thus not worry that much about the current level of informality. The presented model, however, does not allow for someone to collect UI benefits while working in the informal sector, a very real possibility that could easily overturn the results.
David Bardley and Fernando Jaramillo show that introducing unemployment insurance actually makes the formal sector more attractive and that we should thus not worry that much about the current level of informality. The presented model, however, does not allow for someone to collect UI benefits while working in the informal sector, a very real possibility that could easily overturn the results.
Monday, October 31, 2011
Religion as an insurance mechanism against aggregate shocks
I have never been fond of the claims that the world is better with religion. The principal claim is that religion gives hope for people in dire circumstances, and thus in Economic terms increases their utility despite having hit the budget constraint. But one could also argue that these people are being mislead, as religion provides them with subjective probabilities that are far off the objective ones, all the while making the budget constraint even tighter because of the tithe and other material donations.
Olga Popova studies whether this effect of religion on happiness not only applies to individual circumstances, but also for aggregate shocks. Looking at the transition countries, which each suffered through substantial falls in GDP after the collapse of the Soviet rule, more religious people suffered, in terms of happiness, less than others from the large economic reforms. Of course, it is easy to understand that for most, they were happier than circumstances would indicate because it was rather obvious that things would eventually improve, likely a lot. The question is why religious would believe this more? Because they are easily indoctrinated, and it is certainly true that there was a lot of excessive pro-market rhetoric at the time. Non-religious people were probably more among the skeptics. And they were also more likely to be among those who benefited from the previous regime, which definitely oppressed religion. Unfortunately, this study does not take (previous) party affiliation into account, which is likely very (negatively) correlated with religiosity. Too bad.
Olga Popova studies whether this effect of religion on happiness not only applies to individual circumstances, but also for aggregate shocks. Looking at the transition countries, which each suffered through substantial falls in GDP after the collapse of the Soviet rule, more religious people suffered, in terms of happiness, less than others from the large economic reforms. Of course, it is easy to understand that for most, they were happier than circumstances would indicate because it was rather obvious that things would eventually improve, likely a lot. The question is why religious would believe this more? Because they are easily indoctrinated, and it is certainly true that there was a lot of excessive pro-market rhetoric at the time. Non-religious people were probably more among the skeptics. And they were also more likely to be among those who benefited from the previous regime, which definitely oppressed religion. Unfortunately, this study does not take (previous) party affiliation into account, which is likely very (negatively) correlated with religiosity. Too bad.
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