Deadweight Costs Research Articles

‘Trophy Architects’ and Design as Rent‐seeking: Quantifying Deadweight Losses in a Tightly Regulated Office Market

Britain tightly restricts the supply of office space, creating substantial economic rents, but its development restrictions are politically administered and therefore gameable, inducing rent‐seeking activity. We find that ‘trophy architects’ (TAs)—prior winners of a lifetime achievement award—obtain more space on a given site apparently by signalling architectural merit. Analysis of 2039 office buildings shows that TAs build 14 stories taller, thereby increasing a representative site value by 152% and capturing potential economic rents of £148m. However, we argue that this apparent premium is merely compensation for the extra costs, risks and delays of using a TA to game the planning system; it is therefore an indirect measure of the deadweight costs of this form of rent‐seeking.

Immigration Fear Induced Populism and Cross-Border Acquisitions

We examine whether immigration-related fear sentiments (IFS), that escalate support for populist ideologies and policies, affect the flow of inbound cross-border acquisitions (CBA). Economic arguments postulate that IFS-induced populist policies generate economic uncertainty and significant associated deadweight costs for potential international investors. Consistent with this conjecture our results show that intensification of IFS leads to a significant decline in inbound CBA activities (number of CBA, lower likelihood of receiving acquisition bids and deal completion) in major developed economies. The results also indicate that the inverse nexus between IFS and inbound CBA is stronger if the State is run by political parties holding anti-immigrant populist views and, also for the labor-intensive industries.

Liquidation, fire sales, and acquirers’ private information

We develop a dynamic model in which a distressed firm optimizes an exit choice between sell-out and default as well as its timing. We assume that the distressed firm is not informed about the acquirer’s asset valuation. We show that the firm delays liquidation to decrease the acquirer’s information rent. Notably, the firm can change the exit choice from sell-out to default when the screening cost is high. In this case, shareholders declare default regardless of the acquirer’s valuation, which provides the acquirer the maximum information rent. Together with the deadweight costs of bankruptcy, the maximal information rent, which causes a wealth transfer from debt holders of the bankrupt firm to the acquirer, lowers the sales price and debt recovery. This mechanism can explain many empirical findings about fire sales and acquirers’ excess gains. Higher volatility, leverage, and asymmetric information increase the likelihood of a fire sale, but higher bankruptcy costs could play a positive role in preventing a fire sale. With asymmetric information, the firm can reduce debt issuance to avoid the risk of a fire sale.

Liquidity hedging with futures and forward contracts

Purpose This paper aims to develop hedging strategies using both futures and forward contracts and issuing risky debt when financially constrained firms are forced to operate in long horizon. Design/methodology/approach The authors present a model for developing hedging strategies using both futures and forward contracts and issuing risky debt. A theoretical model employing stochastic differential equations for forward hedging is illustrated with a numerical example over parameter values consistent with the literature. Findings A financially constrained firm with limited cash balance must hedge its liquidity with both future and forward contracts and issue risky debt to support its long-term operations. The firm can issue a minimal amount of risky debt by adding forward contracts into hedging and can increase its value higher than that when hedging with only futures contracts. We show numerically that hedging with both futures and forward contracts allows the firm to issue minimal risky debt in increasing its firm value. Practical implications When Metallgesellschaft nearly collapsed in 1993, it offered long-term forward contracts to its customers and attempted to hedge its risk by rolling over series of short-term futures contract. It created the situation of inherent mismatch in maturity structure. A financially constrained firm operating in a long horizon appears to commit its liquidity as long-term forward contracts, which cannot be fully hedged with series of futures contacts. The firm should hedge its liquidity with both futures and forward contracts and avoid liquidation with deadweight costs in its long-term operation. Originality/value This is the first study examining hedging strategies with both futures and forward contracts.

All at Sea: The Misguided War on Offshore Financial Centres

Corporate taxes are inefficient and have disproportionate deadweight costs. The optimal corporate tax rate is zero. Most voters are easily deluded into thinking that corporate taxes impose no cost on them, and politicians around the world have cut corporate tax rates, not because they have decided to put the welfare of the population ahead of electoral self-interest, but due to tax competition. The electoral cost of the economic effects of increased capital flight would outweigh the electoral gains from holding up corporate tax rates. Politicians outside tax havens are reluctant corporate tax-cutters and reluctant participants in tax competition. Ending such competition would suit them better than winning it. Principles that UK and EU politicians claim to support have been abandoned in the war on tax havens, including the sovereignty of third countries in tax policy, the right of law-abiding citizens to keep their financial affairs private, and the rule of law. The war on tax havens is an inherently dirty business. Most tax havens are stable democracies, with the rule-of-law and tax regimes that are superior to the inefficient systems that have become the norm in Western countries. The UK and EU have no proper justification for interfering in their affairs.

Blockchain-Based Settlement for Asset Trading

Can securities be settled on a blockchain and, if so, what are the gains relative to existing settlement systems? We consider a blockchain that ensures delivery-vs-payment by linking transfers of assets with payments and operates via a Proof-of-Work protocol. The main benefit of a blockchain is faster and more flexible settlement, whereas the challenge is to avoid settlement fails when participants fork the chain to get rid of trading losses. To deter forking, the blockchain needs to restrict settlement speed through block size and block time in order to generate sufficient transaction fees which finance costly mining. We show that large enough trading volume, sufficiently strong preferences for fast settlement and limited trade size and risk are necessary conditions for blockchain-based settlement to be feasible. Despite mining being a deadweight cost, our estimates based on the market for US corporate debt show that gains from moving to faster and more flexible settlement are in the range of 1-4 bps relative to existing legacy settlement systems.

Labor and Capital Dynamics under Financing Frictions*

Abstract We assemble a new, quarterly panel dataset that links firms’ investment and financing to their employment and wages. In the data, wages and leverage are negatively related, both cross-sectionally and within firms. This pattern contradicts models in which firms insure workers against unemployment risk. We reconcile this fact with a model that integrates factor adjustment frictions and wage bargaining with costly external financing. In the model, the probability of default rises with debt. Because default incurs deadweight costs, the expected surplus over which firms and workers bargain falls, thus depressing wages. We show that raising financing costs reduces employment and wages, in line with recent reduced-form evidence.

Collateral, rehypothecation, and efficiency

Abstract This paper studies rehypothecation, a practice in which financial institutions re-pledge collateral pledged to them by their clients. Rehypothecation enhances provision of funding liquidity to the economy, but it also incurs deadweight cost by misallocating the asset among the agents when counterparties fail. We examine the possibility of a conflict between the intermediary and its borrower on rehypothecation arrangements. The direction of this conflict depends on haircuts of the contract between them: if the contract involves over-collateralization, there tends to be an excessive use of rehypothecation, and if the contract involves under-collateralization, there tends to be an insufficient use of rehypothecation. This offers an empirical prediction of a link between the size of haircut in collateralized financial contracts, borrower information, and the likelihood of rehypothecation.

Regulatory Remedies to the Common Pool: The Limits to Oil Field Unitization

We examine the potential inability of voluntary unitization to remedy common property losses associated with oil field development. Unlike the traditional literature, we show that if the field contains two (or more) substances that differ in kind (like oil and gas), then it is possible that non-unitized forms of ownership and operation (with conflicted production incentives) may dominate unitized development of the resource. More specifically, it may be impossible to identify any plan of unitized development that is not pareto-dominated by initial endowments or other non-unitized production arrangements which the parties might devise. These results cast the role of the regulatory agency in a new light. Whereas compulsory unitization has tended to be viewed as a uniformly helpful form of outside influence that succeeds by reducing or overcoming the deadweight cost of bargaining, from our perspective it could also be seen as forcing on the parties a solution that unavoidably harms one or more of them.

Can Ownership Restrictions Enhance Security Value? Evidence from a Natural Experiment

This paper examines the role of ownership restrictions in raising capital from niche clienteles. Extant literature suggests that limiting availability of securities to only certain classes of investors constricts demand, and hence decreases prices. We argue that ownership restrictions can have positive implications for prices when viewed in the overall context of security design. We provide empirical evidence through an in-depth analysis of a natural experiment: multiple events of capital raising by an emerging market company with ownership restrictions, namely $4.2 billion and $5.5 billion of bonds offered by India's largest bank, State Bank of India exclusively to Indians living abroad at approximately 150 basis points below comparable benchmarks leading to a bottom line savings of $1.08 billion. This is an intriguing issue because it raises the question, how can an emerging market issuer with junk bond ratings obtain such yields? We argue that ownership restrictions can lead to value enhancement as well as value transfer from holders of other securities. Ownership restrictions can enhance value by circumventing the deadweight costs of prolonged negotiations, particularly when a security is restricted to a homogenous clientele that values the underlying collateral higher than other investors. Restricting the ownership further ensures that investment is limited to a homogenous class of investors that the issuer cares about. It thus serves as a precommitment to ensuring an efficient ex-post renegotiation in the potential default states, resulting in a lower ex-ante offering yield (and a higher offer price). This can result in an implicit seniority of holders of these restricted bonds vis-a-vis holders of unrestricted bonds. We empirically test and find support for both value enhancement as well as for value transfer from ownership restrictions. In particular, we find evidence of a transfer of wealth from existing holders of foreign currency denominated bonds of other Indian firms. However, the implicit seniority accounts for some but not all the difference in yields suggesting that ownership restrictions also enhance value through other avenues such as higher collateral valuation and lower renegotiation costs. Overall, our results suggest that firms with niche clienteles can benefit from designing securities with ownership restrictions, by offering new securities exclusively to investors who value them the most.

Towards the Transatlantic Trade and Investment Partnership (TTIP) between the European Union and United States

In this research work, the author focuses on the analysis of the activity towards the Transatlantic Trade and Investment Partnership (TTIP) between the European Union and United States. It has been emphasized that the talks will reduce regulatory barriers. New agreements to remove trade barriers aim at reducing dead-weight costs and at increasing net social gains from international trade. The article examines the impact of free trade agreements like TTIP and, in particular, investor-state dispute resolution mechanisms in reducing the power of national governments to regulate and eliminate market inequality. The article offers examples of successful regulatory cooperation efforts in the hope that it will shed light on possible approaches to addressing regulatory divergences. Ideally, the best way to address problems arising from regulatory divergence would be on a multilateral basis, while taking into account the relations of the EU and the US with other countries. The main aim of the article is the presentation of the challenges for TTIP negotiations. The particular objective of the research task is the regulatory trade barriers in US-EU foreign trade policy, the nature and the promoters of TTIP, the interrelationship between regulatory standards and international cooperation in TTIP. The general theoretical approach will be of broad interest to economists interested in international questions, especially transatlantic cooperation, as well as to political scientists. The main methods applied in this research were the institutional method, comparative method, documentation method and statistical methods. Additionally, the methods of deductive and inductive forecasting were applied.

SPECYFIKA PROTEKCJONIZMU REGULACYJNEGO WE WSPÓŁCZESNYM HANDLU MIĘDZYNARODOWYM

In this research work, the author focuses on the analysis of the problem of specificity the regulatory protectionism in contemporary foreign trade policy. It has been emphasized that the talks between EU and USA will make reducing regulatory barriers. New agreements to remove trade barriers aim at reducing dead-weight costs and at increasing net social gains from international trade. The article examined the impact of investor-state dispute resolution mechanisms in reducing the power of national governments to regulate and elimination of market inequality. The article offers examples of successful regulatory cooperation efforts in the hope that it will shed light on possible approaches to addressing regulatory divergences. Ideally, the best way to address problems arising from regulatory divergence would be on a multilateral basis. The main aim of the article is the presentation of the specificity of the regulatory protectionism in contemporary foreign trade policy

Novel monolithic pendulum tiltmeter with Nanorad resolution

Abstract Tiltmeters with nanorad resolution in a large measurement range of ±9 mrad (±0.5○) and a very good linearity have been developed at the Technische Universität Ilmenau in the recent years. The working principle bases on the measurement of tilt-dependent lateral forces, which act on a hanging force-compensated weigh cell (precision balance). The disadvantage is the relatively complex design of the weigh cell mechanics, the large dead weight and the high manufacturing costs. For that reason a simplified tiltmeter was developed. It only consists of two components: a monolithic pendulum mechanics and an optical position sensor. State of the art pendulum tiltmeters contain several components that are linked by screwed, clamped or glued connections. This can limit the long-term-, temperature- or humidity stability of the tiltmeter. The position sensor achieves a standard deviation of ∼ 50 pm at a measuring frequency of 10 Hz. The length of the pendulum amounts to 0.1 m, its mass is ∼ 62 g. With this combination, the theoretical standard deviation of the tilt measurement should result to ∼ 0.6 nrad at 10 Hz measuring frequency and was approved by measurements. The measurement range of the new monolithic tiltmeter amounts ∼ ±2 mrad.

Penalties, Manipulation, and Investment Efficiency

In this study, we examine whether imposing a penalty based on an earlier positive signal and a bad realized outcome can be welfare-improving. We find that imposing a penalty helps to improve investment efficiency, but it also brings a deadweight cost of potential penalty for entrepreneurs with good projects. We show that when a good project has a much larger chance to achieve a good outcome than a bad project or when a large proportion of the penalty can be reimbursed to the investor, it is optimal to impose a penalty to deter entrepreneurs with bad projects from reporting positive signals to the greatest degree, as the benefit from reducing the investment inefficiency outweighs the expected deadweight cost. Otherwise, it is optimal not to impose any penalty. We also find that a larger penalty may induce more manipulation by a good entrepreneur. This is because, although a larger penalty directly discourages manipulation for both good and bad types by increasing the expected penalty cost, it also encourages upward manipulation by lowering the implicit financing cost upon a high signal. The encouraging effect is mostly pronounced for the good entrepreneur when the good entrepreneur has a much larger chance of success than the bad entrepreneur or when the reimbursement proportion is very high. This paper was accepted by Shiva Rajgopal, accounting.

One Firm and Two Regulators: The Role of PCAOB Cooperation in Cross-Listing Auditing

This paper examines the impact of regulation cooperation between the Public Company Accounting Oversight Board (PCAOB) and foreign counterparts on U.S.-listed foreign firms’ auditing fees, auditor choice, and auditing efforts. We argue that denying access to auditing inspections and information sharing due to judicial law conflicts between two sovereign states leads to a deadweight cost for non-U.S. firms’ auditing in the form of high legal burdens; however, effective PCAOB cooperation helps solve this issue and reduces auditors’ legal frictions while improving their efforts. Consistent with our argument, after the institution of PCAOB cooperation with a U.S.-listed foreign firm’s home-country regulators, auditors charge lower fees to the firms. This effect is more significant for firms from strong rule of law countries, those that use top 4 auditors, and those that have poor earnings quality. Further, non-U.S. firms — especially poor-quality firms — are more likely to select top 4 auditors. Finally, accounting restatement rates decrease after PCAOB cooperation, and this decline is more pronounced for firms with abnormally high auditing fees.

Collateral, Rehypothecation, and Efficiency

This paper studies rehypothecation, a practice in which financial institutions re-use or re-pledge collateral pledged by their clients for their own purposes. We show that rehypothecation enhances provision of funding liquidity to the economy, but it also incurs deadweight cost by misallocating the asset among the agents when counterparties fail. We also examine the possibility of a conflict between the intermediary and its borrower on rehypothecation arrangements. The direction of this conflict depends on haircuts of the contract between them: if the contract involves over-collateralization, there tends to be an excessive use of rehypothecation, and if the contract involves under-collateralization, there tends to be an insufficient use of rehypothecation. This offers an empirical prediction that if the borrower has imperfect information about the intermediary, she tends to be overly cautious to allow rehypothecation, resulting in reduced occurrence of rehypothecation.

The Impact of Transatlantic Trade and Investment Partnership (Ttip) On the usa and European Union Strategic Cooperation

The main aim of the paper is presentation of the impact of TTIP on the USA and European Unionstrategic cooperation. It has been emphasized that the talks will make reducing regulatory barriers. New agreementsto remove trade barriers aim at reducing dead-weight costs and at increasing net social gains frominternational trade. The paper examined in particular, investor-state dispute resolution mechanisms in reducingthe power of national governments to regulate and elimination of market inequality. The article offers examplesof successful regulatory cooperation efforts in the hope that it will shed light on possible approaches to addressingregulatory divergences. Ideally, the best way to address problems arising from regulatory divergence would be ona multilateral basis. The particulary objective of the research task are the regulatory trade barriers in USA - EUforeign trade policy, the nature an d th e promoters of the TTIP, interrelationship between regulatory standards andinternational cooperation in the TTIP. The general theoretical approach will be of broad interest to economistsinterested in international questions especially transatlantic cooperation as well as to political scientists. It wasused the institutional method, comparative method, the documentation method and statistical methods.Additionally, it used also, the methods of deductive and inductive forecasting.

Optimal Sovereign Default

When is it optimal for a fully committed government to default on its legal repayment obligations? Considering a small open economy with domestic production risk and noncontingent government debt, we show that it is ex ante optimal to occasionally deviate from the legal repayment obligation and to repay debt only partially. This holds true even if default generates significant deadweight costs ex post. A quantitative analysis reveals that default is optimal only in response to persistent disaster-like shocks to domestic output. Applying the framework to the situation in Greece, we find that optimal default policies suggest a considerably larger and more timely default than the one actually implemented in the year 2012. (JEL E23, E62, F41, H63)

Buying High and Selling Low: Stock Repurchases and Persistent Asymmetric Information

We investigate the consequences of allowing for repeated capital market transactions in a model with asymmetric information between a firm and its investors. All firms in the model possess a profitable project that they need to raise cash to undertake. However, equilibria exist in which firms return cash to investors via share repurchases. Consistent with managerial accounts, some firms directly profit from repurchasing their stock. The ultimate source of these profits is that other firms buy “high” in order to improve the terms of subsequent stock issues, which is again consistent with empirical evidence. Only equilibria with repurchases satisfy a mild refinement. Repurchases lower social welfare by reducing the fraction of firms that invest, even though repurchasing itself carries no deadweight cost. Our model generates a number of empirical predictions.

Can REDD+ social safeguards reach the ‘right’ people? Lessons from Madagascar

There is extensive debate about the potential impact of the climate mechanism REDD+ on the welfare of forest-dwelling people. To provide emission reductions, REDD+ must slow the rate of deforestation and forest degradation: such a change will tend to result in local opportunity cost to farmers at the forest frontier. Social safeguard processes to mitigate negative impacts of REDD+ are being developed and can learn from existing safeguard procedures such as those implemented by the World Bank. Madagascar has a number of REDD+ pilot projects with World Bank support including the Corridor Ankeniheny-Zahamena (CAZ). Nearly two thousand households around the corridor have been identified as ‘project affected persons’ (PAPs) and given compensation. We compare households identified as project affected persons with those not identified. We found households with more socio-political power locally, those with greater food security, and those that are more accessible were more likely to be identified as eligible for compensation while many people likely to be negatively impacted by the REDD+ project did not receive compensation. We identify three issues which make it difficult for a social safeguard assessment to effectively target the households for compensation: (a) poor information on location of communities and challenging access means that information does not reach remote households; (b) reluctance of people dependant on shifting agriculture to reveal this due to government sanctions; and (c) reliance by safeguard assessors on non-representative local institutions. We suggest that in cases where the majority of households are likely to bear costs and identification of affected households is challenging, the optimal, and principled, strategy may be blanket compensation offered to all the households in affected communities; avoiding the dead weight costs of ineffective safeguard assessments. The Paris Agreement in December 2015 recognised REDD+ as a key policy instrument for climate change mitigation and explicitly recognised the need to respect human rights in all climate actions. However, safeguards will be prone to failure unless those entitled to compensation are aware of their rights and enabled to seek redress where safeguards fail. This research shows that existing safeguard commitments are not always being fulfilled and those implementing social safeguards in REDD+ should not continue with business as usual.