Endogenous Investment Research Articles

How much does a single graduation cohort from further education colleges contribute to an open regional economy?

ABSTRACTHow much does a single graduation cohort from further education colleges contribute to an open regional economy? Spatial Economic Analysis. This paper combines elements of growth accounting and numerical general equilibrium analysis to produce an alternative micro-to-macro modelling approach. This is used to evaluate the macroeconomic impact on the Scottish economy of the human capital generated by a single graduation cohort from further education colleges. The macroeconomic impact is found to be significant and larger than growth accounting would suggest due to the associated endogenous investment, employment and competitiveness effects. From a policy perspective this identifies the importance of the conventional teaching role of education institutions and the key function played by further education colleges in this process.

The Economic Consequences of Expanding Accounting Recognition

This article investigates the economic consequences of including more hard-to-measure future activities in a firm’s accounting measurements. Using a simple model of endogenous investment in which payoffs are measured by either a restrictive or expanded recognition rule, we show that, in the process of expanding accounting recognition, firms’ internal investment efficiency and external share-price risk premium may not necessarily be a trade-off. In particular, we show that the consequences of an accounting scope expansion depend on the investment environment (e.g., growth prospects) and the inherent measurement characteristics (e.g., measurement noise). For example, even with a higher measurement noise, an expanded accounting recognition may generate a lower risk premium in the share price. More surprisingly, it may lead to a higher investment efficiency and a lower risk premium at the same time. The underlying driving force is that different accounting regimes can affect the risk premium indirectly through their impacts on the investment level, beyond directly through the different measurement noise levels they bring.

Endogenous Real Estate Investment Cycle the Collateral Effect in Emerging Market: Evidence from China

This paper proposes a dualism of hypothesis derived from dynamic Cournot competition on whether house building is driven by credit constraint corresponding to collateral value. Using monthly data from Jan 2004 to May 2016 of 26 Chinese provinces and 4 direct-controlled municipalities, the empirical test suggests that collateral value do drive house building.

The Evolution of Culture and Institutions: Evidence From the Kuba Kingdom

We use variation in historical state centralization to examine the long-term impact of institutions on cultural norms. The Kuba Kingdom, established in Central Africa in the early 17th century by King Shyaam, had more developed state institutions than the other independent villages and chieftaincies in the region. It had an unwritten constitution, separation of political powers, a judicial system with courts and juries, a police force, a military, taxation, and significant public goods provision. Comparing individuals from the Kuba Kingdom to those from just outside the Kingdom, we find that centralized formal institutions are associated with weaker norms of rule following and a greater propensity to cheat for material gain. This finding is consistent with recent models where endogenous investments to inculcate values in children decline when there is an increase in the effectiveness of formal institutions that enforce socially desirable behavior. Consistent with such a mechanism, we find that Kuba parents believe it is less important to teach children values related to rule-following behaviors.

Pre-Distribution: A Model of Equity Bargaining with Endogenous Investments

This article sets forth a model of multilateral negotiations with alternating offers and voting in which members bargain over the distribution of equity shares prior to making investment decisions that determine the surplus to distribute. We challenge the classical assumption embedded in the divide-the-dollar setting that the fund to distribute is exogenoulsy given. Bargaining over productive incentives is fundamentally a different problem that yields a distinct set of equilibrium payoffs. The proposer faces a trade-off between rent-sharing and rent-generation subject to the constraint of receiving a majority vote. If he attempts to offer small equity shares to coalition partners, the size of the pie might shrink, rendering his large ownership percentage unfruitful. In equilibrium, the proposer forms a minimum winning coalition by offering two types of shares. Some members are incentivized to invest in the common project and they receive a share that yields a payoff greater than the ex ante value of the game, thus the proposer's rent-seeking incentives are mitigated by the production constraints. The remaining coalition partners are offered a share that buys their vote without inducing investment. We provide a new view on efficiency in bargaining games which relates to the approved incentive scheme, and not only the timing of the approval.

Fairness Ideals in Distribution Channels

The authors analytically and experimentally evaluate how firms make decisions in a two-stage dyadic channel, in which firms decide on investments in the first stage and then on prices in the second stage. They find that firms’ behavior differs significantly from the predictions of the standard economic model and is consistent with the existence of fairness concerns. Using a quantal response equilibrium model, in which both manufacturer and retailer make noisy best responses, the authors show that fairness significantly affects channel pricing decisions. In addition, they investigate what affects the perceptions of fairness. More specifically, they analyze whether the notion of fairness is influenced by social norms of strict equality, by endogenous investments and contributions that are affected by players’ decisions, or by the exogenous game structure. To do so, the authors compare four principles of distributive fairness: strict egalitarianism; liberal egalitarianism; libertarianism; and a sequence-aligned ideal, which is studied for the first time in the literature. Surprisingly, the exogenous game structure reflected by the new ideal, whereby the sequence of moving determines the equitable payoff for players, significantly outperforms other fairness ideals, suggesting that equity in distribution channels can arise even in contests in which channel members have fairly different payoffs.

Sourcing Co-Created Products: Should Your Suppliers Collaborate?

We investigate the phenomenon of sourcing co-created products. Specifically, we study how a multi-product downstream firm should source from the upstream market, that is single-source versus multi-source, in a situation where the products are co-created with the suppliers. In business-to-business markets it is increasingly common for downstream firms to co-create the products with the help of their suppliers, and we contribute to the literature on sourcing strategies by incorporating product co-creation. We also model whether the downstream firm should establish a collaborative environment for it suppliers, and this is novel to the literature. Finally, we compare the sourcing strategies for co-created products with the case when the downstream firm makes a straight purchase.We find that the downstream firm may be worse off when the upstream suppliers collaborate, unless the cross-effect of its and its suppliers’ investments is very large. Importantly, we derive this result for a completely general cost function. We have considered a very rich strategy space for the firm’s sourcing strategy, which includes, (a) co-creation or straight purchase, (b) single-sourcing or multi-sourcing, and (c) collaboration or no collaboration in the case of multi-source co-creation. We find that for an additively separable cost function, the downstream firm’s optimal strategy is multi-source co-creation without collaboration. An important economic force that our analysis has uncovered is that single-sourcing of co-created products completely destroys the downstream firm’s incentives to invest in co-creation. This result too has been derived for a completely general cost function, and thus we also contribute to the economics literature on holdup, which has not considered co-created products. This economic force is instrumental in ensuring that multi-sourcing dominates single-sourcing. Finally, we find that the incentives of the downstream firm to multi-source are stronger for co-created products than for straight purchase of standard products. Since the downstream firm internalizes some of the production in the case of co-created products, reducing its dependence on suppliers, one might speculate that the incentives to multi-source may be less for co-created products. Counter-intuitively, we show that the incentives to multi-source are even stronger, and are driven by endogenous investments of the firms.

Testing Supply-Side Climate Policies for the Global Steam Coal Market - Can They Curb Coal Consumption?

The achieved international consensus on the 1.5‐2°C target entails that most of current fossil fuel reserves must remain unburned. Currently, a majority of climate policies aiming at this goal are directed towards the demand side. In the absence of a global carbon regime these polices are prone to carbon leakage and other adverse effects. Supply‐side climate policies present an alternative and more direct approach to reduce the consumption of fossil fuels by addressing their production. Here, coal as both, the most abundant and the most emission-intensive fuel, plays a pivotal role. In this paper, I employ a numerical model of the international steam coal market (COALMOD‐World) to examine two alternative supply‐side policies: 1) a production subsidy reform introduced in major coal producing countries, in line with the G20 initiative to reduce global fossil fuel subsidies; 2) a globally implemented moratorium on new coal mines. The model is designed to replicate global patterns of coal supply, demand and international trade. It features endogenous investments in production and transportation capacities in a multi‐period framework and allows for substitution between imports and domestic production of steam coal. Hence, short‐run adjustments (e.g. import substitution effects) and long‐run reactions (e.g. capacity expansions) of exporting and importing countries are endogenously determined. Results show that a subsidy removal, while associated with a small positive total welfare effect, only leads to an insignificant reduction of global emissions. By contrast, a mine moratorium induces a much more pronounced reduction in global coal consumption by effectively limiting coal availability and strongly increasing prices. Depending on the specification of reserves, the moratorium can achieve a coal consumption path consistent with the 1.5‐2°C target.

Factor income taxation, growth, and investment specific technological change

Why do countries with different tax arrangements exhibit the same growth rate? We refer to this as a growth-tax puzzle. To explain the puzzle, we construct a tractable endogenous growth model with endogenous investment specific technological change (ISTC). Public and private capital stock externalities are assumed to augment ISTC. A specialized labor input exerts a positive externality in final good production. Our primary interest is to highlight the role of such externalities in explaining the puzzle. We show that the competitive equilibrium growth rate can be decomposed into a labor factor and a capital factor. Changes in factor income taxes, by affecting these factors, can have opposing effects leading to constancy in growth. Our model builds on the existing endogenous growth literature by providing an alternative, but compatible explanation for the offsetting growth effects of fiscal policy on growth observed in the data.

Living Up to Expectations: Corporate Reputation and Persistence of Firm Performance

I develop a theory of corporate reputation as a source of persistence in firm performance. I show how a relatively simple and reasonable assumption regarding the dynamics of corporate reputation leads to a self-reinforcing process whereby cross-firm differences in corporate reputation (and performance) are significant and relatively permanent. Numerical simulations suggest that persistence in cross-firm differences is largely due to endogenous investment incentives: firms with higher corporate reputations invest more in corporate reputation. I provide a series of examples consistent with the model’s prediction.

Rethinking Macroeconomic Policy within a Simple Dynamic Model

We propose a simple macrodynamic model to rethink some standard policy prescriptions. Our model includes exogenous growth, endogenous investment, demand-driven production and employment, a dynamic Phillips curve, and fiscal and monetary policy instruments. The model has multiple steady states with different stability properties, and it is analytically tractable to a significant extent. Given the nonlinear nature of the model, we complete the analytical results with simulations. The model generates different growth patterns, endogenous fluctuations, and demand-driven level effects even in the long-run. It also reveals saddle-path type instabilities in which seemingly stable paths suddenly give way to increasing volatility. These results lead us to reflect on fiscal and monetary policy standards, and suggest new interpretations for the “Great Recession”.

A Dynamic Approach to the Dividend Discount Model

We derive a dynamic model of the firm with endogenous investment and leverage ratio within the framework of the dividend discount model (DDM). Our valuation model incorporates two relevant components, namely, managerial flexibility and long-run growth. We dispense with any utility specification capturing the preferences of shareholders and obtain closed-form solutions for the firm problem. A standard parameterization suggests that the value of the real options and long-run growth opportunities can easily represent more than 8% and 10% of share price, respectively. We also find that these two components of the stock price are both complements and countercyclical. We finally identify industries where valuation models that do not incorporate these features can lead to considerable underpricing of securities.

The market (in-)stability reserve for EU carbon emission trading: Why it might fail and how to improve it

The EU parliament has accepted a proposal of the EU commission on the backloading of EU emission allowances (EUA), where the auctioning of EUAs is postponed to future time periods. The EU commission has also proposed a market stability reserve (MSR), which is a quantity-based stabilisation policy that is aimed at controlling the volume of EUAs in circulation.Using an agent-based electricity market simulation with endogenous investment and a CO2 market (including banking), we analyse the backloading reform and the proposed MSR. We find backloading to only have a short-term impact of CO2 prices; regardless, there is a significant risk of high CO2 prices and volatility in the EU ETS.Our simulations indicate that the triggers of the proposed MSR appear to be set too low for the hedging need of power producers, effectively leading to a stricter cap in its initial 10–15 years of operation. While the current proposal may be improved by choosing different triggers, a reserve that is based on volume triggers is likely to increase price volatility, contrary to its purpose. Additional problems are the two-year delay in the response time and the abruptness of the response function, combined with the difficulty of estimating future hedging behaviour.

Horizontal Mergers and Innovation in Concentrated Industries

An open question in antitrust economics is whether allowing rival firms to merge increases or decreases incentives to invest and innovate? I examine this in a dynamic oligopoly model with endogenous investment, entry, exit and horizontal mergers. Firms produce differentiated goods and may merge with rival firms to gain market power and increase the quality of their product. I extend previous work on dynamic mergers by allowing for differentiated goods with competition in prices, more than 2 firms in the market, and an endogenous long run rate of innovation. In equilibrium, horizontal mergers are mostly harmful to consumers in the short run, but the prospect of a buyout creates a powerful incentive for firms to enter the industry and invest to make themselves an attractive merger partner. The result is significantly higher total innovation with mergers than without and significantly higher long-run consumer welfare as well. This result also helps shed light on the larger question of the relationship between the competition and innovation. Further results show that long run welfare is increased most by mergers in industries with low consumer switching costs or brand loyalty, as well as in industries where large and rapid innovation is possible.

Older female little penguins Eudyptula minor adjust nutrient allocations to both eggs

How individuals allocate resources to reproduction is a fundamental concept in animal life history theory. While it is crucial to quantify the relative allocation of somatic reserves to reproduction by avian females; variation at the individual and intra-clutch level has generally been neglected. We investigated nutrient allocation to eggs of little penguins (Eudyptula minor, Forster, 1781) using automated body-mass recording and natural δ13C and δ15N values for plasma and blood cells of incubating females, and down feathers of their chicks. Further, we evaluated the role of female age (a proxy for experience or senescence) and condition as drivers of individual strategies within this population. Little penguins increased their body masses during a short period prior the onset of reproduction, suggesting that they were accumulating resources to cope with reproductive requirements. Estimated endogenous contribution to eggs was relatively low (~20%), and female age was revealed as a major factor modulating individual variations in resource allocation strategies. Older females accumulated larger amounts of reserves before laying (up to 40% body mass increases) and relied more on endogenous resources (up to 45%) for clutch production than younger females. Our findings suggest that females were able to adjust their endogenous investment between their two chicks, with somatic reserve inputs to heavier siblings showing a bimodal distribution (mean±SD; 16.7±5.9% and 36.5±4.4%) that contrasted with the unimodal distribution observed for lighter siblings (17.8±8.7%). Here, we provide evidence pointing to age and age-related changes as major factors modulating individual decisions on the amount of somatic reserves allocated to eggs. We additionally identified two distinct allocation strategies at the intra-clutch level that may favour siblings with greater chances to fledge, revealing a novel clutch size reduction strategy in seabirds that produce two eggs of similar size but involving a differential nutrient investment in eggs.

Explaining the Financial Instability Hypothesis with Endogenous Investment: A Nonlinear Model Predictive Control Approach

This study reveals endogenous instability in the financial market based on the dynamic interaction between endogenous investment behavior and debt in a nonlinear framework, by using a nonlinear model predictive control (NMPC) approach. It is found that when the debt ratio is below a critical threshold, increased debt has a positive effect on investment. On the other hand, when the debt ratio is above that threshold, growing financial stress and greater debt become a drag on investment, leading to an economic downturn and an outbreak of financial crisis. The paper provides theoretical support for Minsky’s financial instability hypothesis.

Waves in Ship Prices and Investment *

Abstract We study the link between investment boom and bust cycles and returns on capital in the dry bulk shipping industry. We show that high current ship earnings are associated with high used ship prices and heightened industry investment in new ships, but forecast low future returns. We propose and estimate a behavioral model of industry cycles that can account for the evidence. In our model, firms overextrapolate exogenous demand shocks and partially neglect the endogenous investment response of their competitors. As a result, firms overpay for ships and overinvest in booms and are disappointed by the subsequent low returns. Formal estimation of the model suggests that modest expectational errors can result in dramatic excess volatility in prices and investment.

Accounting Information Quality, Interbank Competition, and Bank Risk-Taking

ABSTRACT We study the interaction between interbank competition and accounting information quality and their effects on banks' risk-taking behavior. We identify an endogenous false-alarm cost that banks incur when forced to sell assets to meet capital requirements. We find that when the interbank competition is less intense, an improvement in the quality of accounting information encourages banks to take more risk. Keeping the banks' investments in loans constant, the provision of high-quality accounting information reduces the false-alarm cost of assets sales and improves the discriminating efficiency of the capital requirement policy. When considering the banks' endogenous investment decisions, however, this improvement in discriminating efficiency causes excessive risk-taking, because banks respond by competing more aggressively in the deposit market, and the increase in deposit costs motivates banks to take more risk. Our paper shows that improving information quality increases risk-taking with mild competition, but has no effect under fierce competition.

Evolution and market behavior with endogenous investment rules

In a repeated market for short-lived assets, we investigate wealth-driven selection among investment rules that depend on endogenous market variables, such as current and past prices. We study the random dynamical system describing prices and wealth dynamics and characterize local stability of the long-run equilibria in which one or a group of traders dominate. Multiplicity of stable and unstable equilibria, leading to path dependency and persistent heterogeneity, turns out to be a common phenomenon generated by two different mechanisms. Firstly, conditioning investment decisions on endogenous market variables implies that the relative performance of investment rules, in terms of average growth rates, may be different for different prevailing prices, so that the market may fail to select a global winner. Secondly, the feedback existing between past asset prices and current investment decisions can lead to a form of deterministic overshooting.

Pollution Havens, Endogenous Environmental Policy and Foreign Direct Investment

In an increasingly integrated world economy, countries may have greater incentives to weaken environmental policy as disguised protection intended to give a competitive edge to local firms. This may generate pollution havens as firms relocate in response to different environmental policies. Foreign direct investment (FDI) weakens profit-shifting policy considerations while increasing environmental damages but, at the same time, may provide external benefits. We derive conditions under which the FDI-recipient country has an incentive to manipulate its environmental standard to prevent or attract FDI, potentially eliminating or creating pollution havens, in addition to examining the impact of FDI on the equilibrium state of the environment.