Foregone Profits Research Articles

Effects of heterogeneity on bank efficiency scores

Bank efficiency estimates often serve as a proxy of managerial skill since they quantify sub-optimal production choices. But such deviations can also be due to omitted systematic differences among banks. In this study, we examine the effects of heterogeneity on bank efficiency scores. We compare different specifications of a stochastic cost and alternative profit frontier model with a baseline specification. After conducting a specification test, we discuss heterogeneity effects on efficiency levels, ranks and the tails of the efficiency distribution. We find that heterogeneity controls influence both banks’ optimal costs and profits and their ability to be efficient. Differences in efficiency scores are important for more than only methodological reasons. First, different ways of accounting for heterogeneity result in estimates of foregone profits and additional costs that are significantly different from what we infer from our general specification. Second, banks are significantly re-ranked when their efficiency is estimated with a specification other than the preferred, general specification. Third, the general specification gives the most reliable estimates of the probability of distress, although differences to the other specifications are low.

Private Damage Claims and the Passing-On Defense in Horizontal Price-Fixing Cases: An Economist's Perspective

The paper studies the assessment of private damages that the cartelization of a market imposes on buyers in that market and, possibly, on the buyers' own customers in further market downstream. Abstracting from procedural problems and focussing on conceptual issues, the paper argues that damages comprise not just the overcharge on the actual quantity purchased, but also foregone profits on the units that are not purchased because the cartel price is higher than the competitive price. The paper also argues that the passing-on defense against claims by direct buyers is flawed because it neglects the business loss effect that is associated with a direct buyer's raising his own price to pass the higher cartel price on to his own customers. If direct buyers are not in competition with each other, a revealed-preference argument shows that the business loss effect on the direct buyer's profits is necessarily greater than the effect of the increase in revenues per unit that is sold. The overcharge on the actual quantity purchased again is a lower bound for actual damages. The assessment of damages suffered by indirect buyers is independent of this refutation of the passing-on defense. If direct buyers are in competition with each other, there is an additional business gain effect because the cartelization upstream raises rivals' costs and thereby affects the competition between the direct buyers. In this case, the assessment of damages depends on the treatment of causation i.e., to what extent a direct buyer's competitors' price increases are ascribed to the cartelization upstream. Consistency requires that, for claims raised at the level of direct and indirect buyers alike, the same treatment of causation should be used. Either the cartel members should be held responsible for the entire shift in the equilibrium of the strategic game between direct buyers in suits involving indirect buyers, as well as direct buyers, or a ceteris paribus assumption should be applied to the actions of a direct buyer's competitors, which eliminates the business gain effect resulting from their price increases. In the latter treatment, which seems conceptually and procedurally the simplest, the overcharge on the actual quantity purchased is again a lower bound for actual damages.

Customer base analysis: partial defection of behaviourally loyal clients in a non-contractual FMCG retail setting

Customer relationship management (CRM) enjoys increasing attention as a countermeasure to switching behaviour of customers. Because foregone profits of (partially) defected customers can be significant, an increase of the retention rate can be very profitable. In this paper we focus on the treatment of a company's most behaviourally loyal customers in a non-contractual setting. We build a model in order to predict partial defection by behaviourally loyal clients using three classification techniques: Logistic regression, automatic relevance determination (ARD) Neural Networks and Random Forests. Focusing on partial attrition of high-frequency shoppers who exhibit a regular visit pattern may overcome the problem of unidentifiability of total defection in non-contractual settings. Classification accuracy (PCC) and area under the receiver operating characteristic curve (AUC) are used to evaluate classifier performance on a test/hold-out sample. Using real-life data from an FMCG retailer, we show that future partial defection can be successfully predicted, i.e. exceeding the benchmark hurdle of the null model. There are no significant differences in terms of performance among alternative classification techniques. Similar to direct-marketing applications we find that past behavioural variables, more specifically RFM variables (recency, frequency, and monetary value) are the best predictors of partial customer defection. This set of variables complements demographic variables confirming findings by other authors about its importance in predicting churn behaviour. Moreover, additional variables (listed in decreasing order of importance) such as the length of customer relationship, mode of payment, buying behaviour across categories, usage of promotions and brand purchase behaviour are shown to be moderately useful to incorporate in attrition models.

Life-Cycle Maintenance Management of Generating Units in a Competitive Environment

Preventive maintenance of generation assets in a market environment is often subject to a more stringent financial scrutiny as compared to the regulated regime. Gencos have to strike a balance between maintenance costs and foregone profits in the short-term vis-a/spl grave/-vis permanent performance degradation of the assets in the longer run. The present work lays an analytic foundation to assess the maintenance needs in a competitive environment. A stochastic optimization model is proposed that considers the trade-off among short and long-term objectives to determine the optimal maintenance profile for generating units over the life of the assets. The model recognizes the driver of generation and maintenance decisions in a competitive electricity markets namely, spot and contractual revenue, and the technical drivers, such as heat rate degradation, capacity de-rating, and increased risk of forced outages. It is expected that the modeling framework will prove to be a useful analytic first step toward addressing the life-cycle maintenance issues in an electricity market.

Post-TRIPS Options for Access to Patented Medicines in Developing Nations

This article explores the tension between granting patent protection under the TRIPS Agreements and the availability of medicines at affordable prices to developing countries. A crucial consideration under the TRIPS compulsory licensing option is the ‘adequate remuneration’ paid. A theoretical and empirical analysis shows that the royalties set under past compulsory licenses have been much lower than those that would be established under the ‘foregone profits’ standard of US patent law. To respect comparative advantage in the supply of licensed drugs, the TRIPS language requiring that compulsory licensing be predominantly for domestic supply needs clarification. The multinational drug pricing strategy that best combines equity with coverage of R&D costs is a variant of Ramsey pricing, under which prices are much lower in nations with low ability to pay and/or high price elasticities of demand than in wealthy nations. Statistical evidence on the prices of 15 AIDS drugs in 18 low‐ and medium‐income nations reveals that tendencies toward Ramsey pricing were at best weak. To encourage Ramsey pricing, parallel exports should be barred from low‐income nations, and price controls should not benchmark the prices charged in low‐income nations. Outright donation can also enhance the supply of drugs to low‐income nations. A quantitative analysis shows that when the marginal cost of production is low relative to ‘inventoriable’ average cost, donations can actually enhance a drug producer's after‐tax profits under US tax laws. Minor tax law changes to enhance donation incentives are suggested.

Model Selection in an Information Economy: Choosing What to Learn

As online markets for the exchange of goods and services become more common, the study of markets composed, at least in part, of autonomous agents has taken on increasing importance. In contrast to traditional complete–information economic scenarios, agents that are operating in an electronic marketplace often do so under considerable uncertainty. In order to reduce their uncertainty, these agents must learn about the world around them. When an agent producer is engaged in a learning task in which data collection is costly, such as learning the preferences of a consumer population, it is faced with a classic decision problem: when to explore and when to exploit. If the agent has a limited number of chances to experiment, it must explicitly consider the cost of learning (in terms of foregone profit) against the value of the information acquired. Information goods add an additional dimension to this problem; due to their flexibility, they can be bundled and priced according to a number of different price schedules. An optimizing producer should consider the profit each price schedule can extract, as well as the difficulty of learning of this schedule.In this paper, we demonstrate the tradeoff between complexity and profitability for a number of common price schedules. We begin with a one–shot decision as to which schedule to learn. Schedules with moderate complexity are preferred in the short and medium term, as they are learned quickly, yet extract a significant fraction of the available profit. We then turn to the repeated version of this one–shot decision and show that moderate complexity schedules, in particular two–part tariff, perform well when the producer must adapt to nonstationarity in the consumer population. When a producer can dynamically change schedules as it learns, it can use an explicit decision–theoretic formulation to greedily select the schedule which appears to yield the greatest profit in the next period. By explicitly considering both the learnability and the profit extracted by different price schedules, a producer can extract more profit as it learns than if it naively chose models that are accurate once learned.

Unbundled reactive support service: key characteristics and dominant cost component

In this paper, the authors present a systematic exposition of generator-provided reactive support as an unbundled ancillary service under open access transmission. They discuss the nature and salient physical characteristics of reactive support and analyze their implications in acquiring VAr support as one of the ancillary services. The paper provides an analysis of the dominant component in the cost structure of this service. This component is determined from the opportunity costs, which are evaluated from the foregone profits of a generator in making sales in real power markets by providing reactive support instead of real power. They illustrate the combined effects of the voltage set points of the generators and of the generator capability constraints on the transactions in competitive electricity markets, both under normal and contingency operating conditions. They discuss the key role of the grid operator in the provision of the reactive support, and the key considerations in the acquisition and pricing of the reactive support service.

Unbundled Reactive Support Service: Key Characteristics and Dominant Cost Component

In this paper, we present a systematic exposition of generator-provided reactive support as an unbundled ancillary service under open access transmission. We discuss the nature and salient physical characteristics of reactive support and analyze their implications in acquiring var support as one of the ancillary services. The paper provides an analysis of the dominant component in the cost structure of this service. This component is determined from the opportunity costs, which are evaluated from the foregone profits of a generator in making sales in real power markets by providing reactive support instead of real power. We illustrate the combined effects of the voltage set points of the generators and of the generator capability constraints on the transactions in competitive electricity markets, both under normal and contingency operating conditions. We discuss the key role of the grid operator in the provision of the reactive support and the key considerations in the acquisition and pricing of the reactive support service.

Who's minding the store? Motivating and monitoring hired managers at small, closely held commercial banks

Small, closely held corporations must rely disproportionately on managerial shareholdings to mitigate the agency costs associated with hired managers, because market discipline and motivated outside monitors are typically absent for such firms. We study a random sample of 266 small, closely held US commercial banks with a broad range of ownership and management arrangements. Our results suggest that hiring an outside manager can improve profitability, but these gains depend on aligning hired managers with owners via managerial shareholdings. We find that over-utilizing this control mechanism results in entrenchment, while under-utilization is costly in terms of foregone profits.

Who's Minding The Store? Motivating And Monitoring Hired Managers At Small, Closely Held Firms: The Case Of Commercial Banks

We test whether the gains from hiring an outside manager exceed the principal-agent costs of owner-manager separation at 266 small, closely held U.S. commercial banks. Our results suggest that hiring an outside manager can improve a bank's profit efficiency, but that these gains depend on aligning the hired managers with owners via managerial shareholdings. We find that over-utilizing this control mechanism results in entrenchment, while under-utilization is costly in terms of foregone profits. This study provides a relatively unfettered test of mitigating principal-agent costs, because these small banks cannot rely on market forces or blocks of outside investors to monitor managers.

Spatial Competition, Uniform Pricing, and Transportation Efficiency in the California Processing Tomato Industry

AbstractThis study examines the role of spatial pricing in the allocation of processing tomatoes from farms to the thirty‐two processing facilities located in northern and central California. A simple theoretical model illustrates that the industry's uniform pricing policy encourages market overlap and excessive transportation costs relative to FOB pricing. A nonlinear mathematical programming model is developed to determine the optimal allocation of processing tomatoes. This allocation is then compared to the estimated actual allocation. The analysis reveals foregone profits of only 1.9% from inefficient product allocation. Simulation results reveal significant competition among processors despite their separation in many cases by long distances.

Incomplete Markets And The Calculation Of Economic Loss

Abstract No abstract available.

Environmental regulation and profitability: An application to Swedish pulp and paper mills

In this paper we analyze the impact on firm profits of the environmental regulations in the Swedish pulp and paper industry. The approach taken is a non-parametric programming model of the technology. A feature of this industry is that environmental regulations are determined individually for each mill. A question, then, is if these individual regulations have a similar impact on firm profits. The approach in this paper allows us to calculate both the regulated and unregulated profits, which means that the severity of the regulations, in terms of foregone profits, can be calculated for each mill. The empirical result shows that the impact on the mills varies substantially, and that the burden from the regulations is less severe in 1990 than in 1989.

Optimal production with uncertain interruptions in the supply of electricity: Estimation of electricity outage costs

In this paper we develop a model to measure expected electricity outage costs in the industrial and commercial sectors. Four sources contribute to the costs of outage in these sectors: foregone profits (output), possible reduction in productivity due to the outage, damage to materials, and payments to labor during the outage. The beginning and duration of the electricity outage are random variables with known distribution functions. Thus, the business customer maximizes his expected profits, taking into account his ability, or lack of ability, to respond to the random electricity outage. The model is applied, assuming a quadratic production function, to eleven industrial branches in Israel. The estimates indicate a large variation in customer preferences for reliability.

On Comparing Alternative Advertising Policies of Pulsation*

ABSTRACTIn this paper, five alternative advertising policies that belong to the advertising pulsation class are compared analytically for linear and concave response functions using a modified version of the Vidale‐Wolfe model. The results of the research show that (1) For both linear and concave response functions, advertising pulsing/maintenance policy dominates advertising pulsing policy but is dominated by the Uniform Advertising Policy. For convex response functions, the order of dominance is reversed. (2) For linear response functions, uniform advertising policy dominates the impulse advertising policy but is dominated by the chattering advertising policy. (3) For concave response functions, uniform advertising policy dominates both the impulse advertising policy and the chattering advertising policy. (4) For convex response functions, chattering advertising policy dominates both the advertising pulsing policy and the impulse advertising policy.The Vidale‐Wolfe model is estimated using the well‐known Lydia Pinkham data. Optimality analysis shows that the company was overadvertising about half of the time studied. Overadvertising seems to have produced appreciable gain in sales and created significant barriers to competitive entry at a little cost in terms of foregone profits.

Lucrum Cessans, Damnum Emergens and the Market Place

Abstract No abstract available.

A Nonparametric Approach to Expenditure‐Constrained Profit Maximization

AbstractA nonparametric approach to expenditure‐constrained profit maximization is developed. A deterministic frontier profit function is constructed with and without expenditure constraints. Foregone profit is used as dual evidence for the existence of expenditure constraints. Individual evaluations on performance and expenditure constraints are produced. Empirical analysis is based on survey data for California rice farms. Seventeen of the eighty‐two surveyed farms experience profit loss as a result of expenditure constraints.

Risk and investment decisions in non-liner shipping

The investment decisions of non-liner shipping firms based on their behaviour towards risk, stochastic demand for capacity, inelastic supply and foregone profits are discussed. These aspects are formalized in a simple stochastic model, which, together with definitions of two broad categories of risk behaviour, is then used to examine and contrast the investment decisions of the two different strategic groups. The analysis shows that the capacity expansions/investments sought by the risk averter and the risk lover will differ under ‘normal’ circumstances with the risk averter having significantly less capacity than the risk lover. The risk lover will have higher capacity in a volatile market than in a stable market situation. During periods of high capital costs, the investment decisions of the two risk groups tend to be indistinguishable.

“Leveraged” Decision Making in Advertising: The Flat Maximum Principle and Its Implications

The relationship between advertising and sales revenues has been the focus of numerous empirical and conceptual studies. Guided by past empirical works and using calculated values, the authors examine the implications of three advertising-to-sales response functions. The research findings are discussed in terms of advertising budgeting and future research on advertising effects. Noting four qualifications to their findings, the authors suggest that, within the bounds of the normative models and specific parameters examined, overadvertising could cost very little in foregone profit and may result in appreciable sales gains.

On the Diffusion of New Technology: A Game Theoretic Approach

This paper is an attempt at a rigorous (albeit not exceedingly general) analysis of the diffusion of new technology. In particular, consider an industry composed of two firms, each using the current best-practice technology. The firms are assumed to be operating at Nash equilibrium output levels, generating a market price (given demand) and profit allocations. When a cost-reducing innovation is announced, each firm must determine when (if ever) to adopt it, based in part upon the discounted cost of implementing the new technology, and in part upon the behavior of the rival firm. If either firm adopts before the other, it can expect to make substantial profits at the expense of the other firm. On the other hand, the discounted sum of purchase price and adjustment costs may decline with the lengthening of the adjustment period as various quasi-fixed factors become more easily variable. Therefore, although waiting costs the firm more in terms of foregone profits, it may save money on the cost of purchasing the new technology. Thus the firm must weigh the costs and benefits of delaying adoption, as well as take account of its rival's strategic behavior.