Deadweight Costs Research Articles

Furloughing Employees with Uncertain Return? Management of Labor Frictions and Inventory Under Demand Shock

We assess how a retailer can manage inventories and labor under an extreme condition such as a temporary negative demand shock due to a pandemic or an economic turmoil. This analysis incorporates labor market frictions whereby firms incur deadweight costs associated with hiring and firing employees, as well as the option to furlough labor. We examine the impact of these frictions on a retail firm's optimal operating policies around inventory level, furlough, and layoffs. We find that labor market frictions condition the inventory and the level of employment in two ways. First, they lead to underinvestment in inventories, which limits recovery and employment in the postshock period. Second, high labor market frictions motivate the firm to conservatively downsize workforce during the negative demand period leading to higher employment, when compared to downsizing without friction. A significant contribution of our study lies in delineating the optimal furlough decisions and quantifying the impact of the furlough option on inventory and labor decisions. We demonstrate the conditions under which it is optimal for the retailer to either (i) fully downsize labor and leverage the furlough option in the labor market, or (ii) maintain excess labor while also opting to furlough a portion of the workforce. During an extreme event such as a temporary negative demand shock, our results highlight the need for a coordinated effort when implementing governmental subsidy policies on alleviating labor and inventory reductions by accounting for labor market frictions and furlough support.

Stock liquidity and the signaling value of patents: Evidence from china's national equities exchange and quotations market

Young and technology-oriented firms suffer from asymmetric information in seeking access to finance. An increase in stock liquidity can improve a firm's stock price informativeness and mitigate such information problems. We expect that firms will patent less when they face an increase in liquidity if patenting is used as a costly signal mechanism to demonstrate firm quality. By examining an exogenous policy shock that dramatically improves the stock liquidity of treated firms in China's National Equities Exchange and Quotations (NEEQ) market, we document evidence that treated firms patent less after the shock. Our findings reveal the importance of liquidity in reducing the deadweight costs caused by asymmetric information and the signaling value of patenting, and urge caution regarding the sole use of patent applications to measure innovation performance in entrepreneurial firms.

The Optimal Size and Financing of Government and the Dead-Weight Costs of Debt and Taxes

The Optimal Size and Financing of Government and the Dead-Weight Costs of Debt and Taxes

The effects of accounting comparability, income smoothing and engagement partners on audit risk

This study investigates whether accounting comparability, income smoothing and engagement partners affect audit risk perceived by auditors. We find that both accounting comparability and income smoothing reduce perceived audit risk and that the interaction of these two variables incrementally reduces perceived audit risk. We also find that the interaction of accounting comparability and income smoothing incrementally reduces perceived audit risk when engagement partners exert more effort in auditing. The results imply that when clients exhibit both cross‐sectional and the time‐series informativeness of financial statements, auditors lower their perceived audit risk and reduce risk premium, which decreases deadweight cost to these clients. This is especially the case when engagement partners exert more effort in auditing. To the best of our knowledge, this is the first empirical study to test the interaction effect of accounting comparability, income smoothing and engagement partners on perceived audit risk.

The long-run effects of risk: an equilibrium approach

Advanced economies tend to have large financial sectors which can be vulnerable to crises. We employ a DSGE model with banks featuring limited liability to investigate how risk shocks in the financial sector affect long-run macroeconomic outcomes. With full deposit insurance, banks expand balance sheets when risk increases, leading to higher investment and output. With no deposit insurance, we observe substantial drops in long-run credit provision, investment, and output. Reducing moral hazard by lowering the fraction of reimbursed deposits in case of bank default increases the probability of bank default in equilibrium. The long-run probability of bank default under a regime with no deposit insurance is more than 50% higher than under a regime with full deposit insurance for high levels of risk. These differences provide a novel argument in favor of deposit insurance. Our welfare analysis finds that increased risk always reduces welfare, except when there is full deposit insurance and deadweight costs from default are small.

The income bond puzzle

The income bond puzzle

The Cost of Carbon Leakage: Britain’s Carbon Price Support and Cross-border Electricity Trade

Carbon taxes create global benefits unless offset by increased emissions elsewhere. An additional carbon tax in one country may cause leakage through imports and will also increase costs by creating a wedge between economic marginal costs in different markets, causing an offsetting deadweight loss. We estimate the global benefit, carbon leakage and deadweight cost of the British Carbon Price Support (CPS) on GB’s cross-border electricity trade with France and The Netherlands. Over 2015–2020 the unilateral CPS created €72넠 m/yr deadweight loss, about 31% of the initial economic value created by the interconnector, or 2.5% of the global emissions benefit of the CPS at €2.9±0.1 bn/yr. About 16.3±3.5% of the CO2 emissions reduction is undone by France and The Netherlands, the monetary loss of which is about €584±127 m/yr.

Should bankers pay more taxes? Analysing the UK’s bank payroll tax scheme using efficiency and equity lenses

This article takes a conceptual, tax policy analytical approach towards the 2009–2010 UK bank payroll tax (BPT) — often referred to as the ‘banker’s bonus tax’ — from the tax policy conceptual frameworks of efficiency and equity. The first conceptual tax policy factor relating to efficiency under optimal tax theory is analysed in terms of Pareto optimality (Mirrlees et al., 2011), which seeks minimal distortions and avoidance of deadweight costs (Auerbach, 2013; Stiglitz 1986). The conceptual tax policy factor relating to equity will be analysed in terms of fairness, with a policy focus geared toward formal incidence (Shavrio 2009). Equity-related tax policy concerns as it relates to the UK bank payroll tax also include both the benefits principle and ability-to-pay principle, whilst incorporating vertical and horizontal equity concerns. This article is composed of two main parts. The first part provides a conceptual tax and policy analysis from the perspective of efficiency. The second part provides a conceptual tax and policy analysis from the perspective of equity and fairness. Throughout each part, the analysis is augmented through the utilisation of various graphical visual examples.

Credit Risk Pooling as a Tool to Optimize Deadweight Costs of Regional Banks

Credit Risk Pooling as a Tool to Optimize Deadweight Costs of Regional Banks

Parking Permit Scheme for Morning Commute considering Parking Search

Improving parking efficiency is essential to promoting the reform in urban transportation. But the large amount of deadweight costs caused by the parking is often underestimated because it is difficult to measure. Based on the existing investigations from the small fraction of cruising vehicles, this paper explores the influencing factors of the parking issue and describes it by the user equilibrium model. Then, two types of permit management schemes were proposed, lot-based and spot-based. By analyzing their performance in reducing system cost, three conclusions were drawn. Firstly, parking search leads to traveler’s schedule and location adjustments, raises the trip cost, reduces the parking lot occupancy, and makes the parking issues “invisible.” Secondly, permit scheme levels up managers’ control, and it performs well in reducing deadweight loss, but only by eliminating the search cost, the deadweight loss can be fundamentally reduced. Thirdly, reducing parking search needs information guidance; with the rapid growth of urban parking demand, managers should make a transition to the permit scheme with parking information.

National Conflict in a Federal System

To explore the effect of federal institutions on national political conflict, we develop a model of two-level governance with interstate preference heterogeneity and cross-state externalities. Our analysis calls into question the conventional interpretation of federalism as a conflict-minimizing institution. We show that polarization over national policy may be higher in federal than unitary systems, even holding policy demand constant. We also show that the incentives for low and high demanders to engage in costly conflict are contingent on the status quo national policy, and we identify conditions under which those incentives and the deadweight cost of political conflict are higher under federalism than unitary governance. The model helps account for a number of empirical regularities in US politics and policy making.

No-fault default, chapter 11 bankruptcy, and financial institutions

This paper analyzes the costs and benefits of a no-fault-default debt structure as an alternative to the typical bankruptcy process. We show that the deadweight costs of bankruptcy can be avoided or substantially reduced through no-fault-default debt, which permits a relatively seamless transfer of ownership from shareholders to bondholders in certain states of the world. We show that potential costs introduced by this scheme due to risk shifting can be attenuated via convertible debt, and we discuss the relationship of this to bail-in debt and contingent convertible (CoCo) debt for financial institutions. We then explore how, despite the advantages of no-fault-default debt, there may still be a functional role for the bankruptcy process to efficiently allow the renegotiation of labor contracts in certain cases. In sharp contrast to the human-capital-based theories of optimal capital structure in which the renegotiation of labor contract in bankruptcy is a cost associated with leverage, we show that it is a benefit. The normative implication of our analysis is that no-fault-default debt, when combined with specific features of the bankruptcy process, may reduce the deadweight costs associated with bankruptcy. We discuss how an orderly process for transfer of control and a predetermined admissibility of renegotiation of labor contracts can be a useful tool for resolving financial institution failure without harming financial stability.

Fuze Effect: A Landmine in the Way of Sustainable Development of FinTech—The Lessons from the Peer-To-Peer Risk Outbreak

Based on the data of peer-to-peer (P2P) platforms, employing the ARIMAX model and analyzing the risk outbreak process of P2P platforms, we find that the risk outbreak of P2P is a spreading process from weak to strong along the “qualification chain” of the platforms. This risk outbreak process along the qualification chain is dubbed the “fuze effect” in this paper as the process is similar to that of the fuze detonating explosives. This finding implies that the real risk comes from the uneven quality of P2P platforms, which is different from the dominant opinion that of their “credit enhancement services”. Our further study suggests that the fuze effect comes from deadweight cost caused by market competition. This study is of significance for risk prevention in emerging industries such as FinTech; that is, for the sake of sustainable development of emerging industries, the government must be vigilant about the fuze effect.

Competition and Lending Standards with Multidimensional Private Information

We investigate how loan terms respond to competition between lenders when borrowers have multidimensional private information. In our model, competitive lenders screen borrowers using contracts that consist of an interest rate and a collateral requirement. Compared to a monopolistic lender, a competitive market offers uniformly lower collateral requirements, and a larger share of funded projects are negative-NPV. The competitive market may be more or less efficient than the monopolist, depending on the deadweight cost of collateral and the degree of selection externalities. In principle, efficiency could be greatly improved by an uninformed regulator who completely controls the interest rate schedule. However, simpler policies such as minimum collateral or higher interest rates do little to improve efficiency.

No-fault Default, Chapter 11 Bankruptcy, and Financial Institutions

This paper analyzes the costs and benefits of a no-fault-default debt structure as an alternative to the typical bankruptcy process. We show that the deadweight costs of bankruptcy can be avoided or substantially reduced through no-fault-default debt, which permits a relatively seamless transfer of ownership from shareholders to bondholders in certain states of the world. We show that potential costs introduced by this scheme due to risk shifting can be attenuated via convertible debt, and we discuss the relationship of this to bail-in debt and contingent convertible (CoCo) debt for financial institutions. We then explore how, despite the advantages of no-fault-default debt, there may still be a functional role for the bankruptcy process to efficiently allow the renegotiation of labor contracts in certain cases. In sharp contrast to the human-capital-based theories of optimal capital structure in which the renegotiation of labor contract in bankruptcy is a cost associated with leverage, we show that it is a benefit. The normative implication of our analysis is that no-fault-default debt, when combined with specific features of the bankruptcy process, may reduce the deadweight costs associated with bankruptcy. We discuss how an orderly process for transfer of control and a predetermined admissibility of renegotiation of labor contracts can be a useful tool for resolving financial institution failure without harming financial stability. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

De-risking Renewable Energy Investments in Developing Countries: A Multilateral Guarantee Mechanism

Summary Mitigation of global warming requires substantial investment in electricity generation from renewable sources. A large share of new generation capacity is required in regions with adverse financing conditions. We propose a global guarantee mechanism to reduce risk premia of renewable energy investments by means of risk pooling and increased market efficiency. Policymakers could establish this mechanism by scaling up existing international risk guarantee initiatives. We estimate the net present value of overall savings at US$2018 1.5 trillion globally for investments by 2030, with the largest relative savings (between 20.5% and 22%) in Sub-Saharan Africa and the Maghreb. The savings from such a mechanism outweigh its estimated average yearly operating cost. By lowering the cost of decarbonization in high-risk countries, the proposed mechanism offers policymakers a tool to make current global mitigation pledges more achievable and enables the global community to pursue more ambitious climate action.

Symposium: ethics of economic ordeals

Economic ordeals are allocation mechanisms that impose non-financial ‘deadweight costs to qualify for a transfer’ (Nichols and Zeckhauser 1982: 372). Examples include long waiting times, travel and form-filling as conditions for certain healthcare services. Appropriately designed, ordeals can enhance target efficiency so that the goods being allocated better reach the intended recipients. The logic behind this is simple: ‘Say one welfare eligible would receive 100 utiles from a particular transfer, yet another would receive only 10. Then an ordeal that imposes an 11 utile loss in order to qualify for the transfer will be an effective sorting device’ (Nichols and Zeckhauser 1982: 376). In other words, recipients who would receive smaller benefits are expected to be dissuaded by the ordeal and refrain from requesting the good, whereas recipients who would receive larger benefits from the transfer are expected to seek out the good even if there is a deadweight cost. Moreover, unlike financial participation, which can similarly dissuade users with relatively little to gain from the good in question, ordeals are in no direct way financially regressive: the poor are not necessarily more dissuaded by losing time or by having to fill in a form than the rich are.

Does asset location and concentration explain REIT IPO valuation?

AbstractFollowing recent developments in the asset pricing literature on geographic concentration, we complement classic theories based on information asymmetry and explain the short‐run performance of real estate investment trust (REIT) initial public offerings (IPOs) through an investor base mechanism. We analyze the U.S. market and show that issuers are more likely to underprice when a REIT is more geographically concentrated. In particular, by adopting an identification strategy of pre‐ and post‐IPO returns, we find evidence for an investor base channel rather than a diversification discount channel. In addition, geographic portfolio concentration has a stronger impact on the initial returns of REIT IPOs than property type concentration. Finally, we find that lower deadweight costs at the time of an IPO weaken the influence of geographic concentration on initial returns. Our results are robust to the firm's geographic concentration in economically defined regions, different measures of deadweight costs, the control of information environment of the portfolio and headquarters markets, and to controlling for the REIT's property type focus.

Putting costs and benefits of ordeals together

AbstractThis paper addresses how to think about the permissibility of introducing deadweight costs (so-called ‘ordeals’) on candidate recipients of goods in order to attain better outcomes. The paper introduces some distinctions between different kinds of value dimensions that should be taken into account when such judgements are made and draws from the literature on comparisons across different value dimensions in order to canvas what sort of situations one might arguably face when evaluating ordeals. In light of the distinctions drawn and the possibilities canvassed, the paper proceeds to outline what circumstances indicate which of the possible situations one is in.

Optimal terms of contingent capital, incentive effects, and capital structure dynamics

Contingent Convertible Bonds (CoCos) with conversion ratios that dilute issuer's shareholders generate incentives to preemptively raise equity capital to avoid triggering conversion. Our dynamic model provides an interior solution for the unique optimal conversion ratio and the capital structure policies that maximizes issuer's value net of deadweight costs. Preemptive recapitalization induced by moderately dilutive conversion terms leads to fewer defaults, lower borrowing rates, and higher debt capacity when compared to less dilutive terms. However, highly dilutive conversion ratios do not always enhance efficiency because issuers facing very high dilution risk recapitalize too frequently, generating excessive adjustment costs. Conversely, if CoCo's principal is written-down at the conversion without diluting shareholders, then the issuer will have perverse incentives to destroy a portion of its capital (“burn money”) to force conversion and generate windfall gains for shareholders.