Lower Payoffs Research Articles

Capital Structure and Earnings Manipulation

We consider an optimal contract between an entrepreneur and an investor, where the entrepreneur is subject to a double moral hazard problem (one being the choice of production effort and the other being earnings manipulation). Since the entrepreneur cannot completely capture the results of his effort, investment is below the optimal level and production effort is socially inefficient. The opportunity to manipulate earnings protects the entrepreneur against the risk of a low payoff when the results of production are low. Ex-ante, this provides an incentive for the entrepreneur to increase investment and improve effort. Based on this insight we make several empirical predictions regarding earnings manipulations. In particular we argue that earnings manipulation should be more frequently observed in industries characterized by a high degree of contract incompleteness.

A Gender Analysis of Bank Loan Negotiations in Uganda

This paper highlights the differences between men and women in bank loan negotiations. It presents findings of an ex post facto design study that involved administering questionnaires to 289 respondents who had ever applied for a loan from a Ugandan commercial bank from 1999 through 2005. Results showed that male and female respondents differed in their negotiation behavior and outcomes. Female respondents scored higher than male respondents on self-enhancement and yielding. Male respondents scored higher than female respondents on inaction. Results further showed that female respondents receive lower payoff than male respondents from bank loan negotiations, and that both male and female respondents encounter problems in mixed gender negotiations.

The Compromise Game: Two-Sided Adverse Selection in the Laboratory

We analyze a game of two-sided private information where players have privately known “strengths” and can decide to fight or compromise. If either chooses to fight, the stronger player receives a high payoff and the weaker player receives a low payoff. If both choose to compromise, each player receives an intermediate payoff. The only equilibrium is for players to always fight. In our experiment, we observe frequent compromise, more fighting the lower the compromise payoff and less fighting by first than second movers. We explore several theories of cognitive limitations in an attempt to understand these anomalous findings. (JEL C91, D82)

Market Volatility and Momentum

This paper investigates time-series predictability of momentum. Taking a hint from the drastic 2008-2009 episode, we examine whether market volatility is linked to momentum. We find that market volatility indeed has significant and robust predictive power for momentum profits, especially in negative market states. In contrast to the cross-sectional relation that momentum profitability is higher among firms with higher information uncertainty or higher default risk, our tests show that volatile down markets forecast low momentum payoffs. The time-series predictability of momentum is asymmetric, which arises from loser stocks. Jointly, these new findings raise a tough challenge to the existing theories on momentum. We explore whether default risk in down markets is related to the predictive power of market volatility and find supportive evidence.

An Explanation for the Lower Payoff to Schooling for Immigrants in the Canadian Labour Market

This paper examines the difference between the payoffs to schooling for immigrants and the native born in Canada, using 2001 Census data. Analyses are presented for males and females. Comparisons are offered with findings for the US. The paper uses the Overeducation/Required education/Undereducation framework (Hartog, 2000) and a decomposition developed by Chiswick and Miller (2008). This decomposition links overeducation to the less-than-perfect international transferability of immigrants' human capital, and under-education to favourable selection in immigration. The results show that immigrants have a lower payoff to schooling because of the different effects under-education and over-education have on their earnings. The effects of under-education, or selection in immigration, are, however, twice as large as the effects of over-education, or limited international transferability of human capital. Favourable selection in immigration appears to be less important in Canada than in the US, where it predominates among the least educated.

ORU Analyses of Immigrant Earnings in Australia, with International Comparisons

This paper examines the way immigrant earnings are determined in Australia. It uses the overeducation/required education/undereducation (ORU) framework (Hartog, 2000) and a decomposition of the native-born/foreign-born differential in the payoff to schooling developed by Chiswick and Miller (2008). This decomposition links overeducation to the less-than- perfect international transferability of immigrants' human capital, and undereducation to favorable selection in immigration. Comparisons are offered with findings from analyses for the US and Canada to enable assessment of the relative impacts of favorable selection and the limited international transferability of human capital to the lower payoff to schooling for the foreign born. The sensitivity of the results of the decomposition to several measurement issues is assessed.

Long-term relationships as safeguards

We analyze a repeated prisoners’ dilemma game played in a community setting with heterogeneous types. The setting is such that individuals choose whether to continue interacting with their present partner, or separate and seek a new partner. Players’ types are not directly observed, but may be imperfectly inferred from observed behavior. We focus on a class of equilibria that satisfy zero tolerance and fresh start. We find that the punishment for defecting and the reward for cooperating are driven by the formation and the dissolution of long-term, high-paying relationships: an individual who defects, aborts a long-term relationship that he is in, or that he might have entered into, is thrown into short-term interactions with individuals who are likely to defect and, consequently, receives low payoffs. On the flip side, an individual who cooperates, enters into or prolongs a long-term interaction with a partner who cooperates and, consequently, receives high payoffs.

Evolutionary stability of altruism and envy in Tullock contests

This paper considers Tullock contests with altruistic and envious individuals as players. Altruism (envy) is beheld as another motivation for low (high) dissipation rates in contests. A pure population of altruists has higher payoffs than a purely envious population, but the altruist has a lower payoff if he is confronted with an envious individual. In an evolutionary approach in which the population share of the type with the higher material payoff rises, it can be shown that there is a possibility of either envy or altruism becoming extinct. Furthermore, we find an advantage of envy in such a manner that very altruistic individuals always die out, but very envious ones only do so under certain conditions.

Partisan politics and election failure with ignorant voters

We analyze candidate competition when some voters do not observe a candidate's policy choice. Voters have a personality preference when both candidates offer the same policy. In equilibrium, the candidate with a personality advantage may get elected with a partisan policy even though his opponent's policy is preferred by all voters. The departure from the Downsian prediction is most pronounced when candidates have a weak policy preference and care mostly about winning the election. In that case, uninformed voters choose the candidate with the preferred personality even if electing this candidate implies a lower payoff on average.

The Curse of Competitiveness: How Advice from Experienced Colleagues and Training Can Hurt Marketing Profitability

The literature suggests that mangers are overly competitive and overemphasize competitors’ payoffs in making decisions. The authors demonstrate how two seemingly innocuous but common decision inputs that mid- and entry-level managers use—(1) advice from colleagues and (2) training—could propagate this bias. The authors conduct an experiment in which one generation of participants plays a noncooperative game and then passes on advice on how to play the same game to the second generation. The authors find that the second generation is more likely to accept decisions that negatively impact the competitor's profits, even when those decisions result in lower payoffs. The results suggest that the advice of the first generation causes the second generation to be more sensitive to relative performance. In a second experiment, the authors show that training films that create negative feelings toward competitors can have adverse effects on managers’ decisions. The training increases the willingness of managers to sacrifice own profits to reduce competitor profitability. These findings have important implications for managers in competitive markets. This research suggests that standard training materials that emphasize beating competitors should be carefully assessed for their unintentional but potentially damaging effects. In particular, training designed to evoke affective responses toward competitors must be used judiciously. Firms that give junior managers more autonomy and responsibility should also be cognizant that the advice these managers get and the information they share may propagate a competitive bias. To mitigate this problem, an option is to devote resources to better understand the content and nature of advice that managers share with one another.

The Curse of Competitiveness: How Advice from Experienced Colleagues and Training Can Hurt Marketing Profitability

Abstract The literature suggests that mangers are overly competitive and overemphasize competitors' payoffs in making decisions. The authors demonstrate how two seemingly innocuous but common decision inputs that mid- and entry-level managers use–(1) advice from colleagues and (2) training–could propagate this bias. The authors conduct an experiment in which one generation of participants plays a noncooperative game and then passes on advice on how to play the same game to the second generation. The authors find that the second generation is more likely to accept decisions that negatively impact the competitor's profits, even when those decisions result in lower payoffs. The results suggest that the advice of the first generation causes the second generation to be more sensitive to relative performance. In a second experiment, the authors show that training films that create negative feelings toward competitors can have adverse effects on managers' decisions. The training increases the willingness of mana...

An investment game with third-party intervention

This paper explores the effect of the possibility of third-party intervention on behavior in a variant of the Berg et al. [Berg, J., Dickhaut, J., McCabe, K., 1995. Trust, reciprocity and social history. Games and Economic Behavior 10, 122–142] “Investment Game”. A third-party's material payoff is not affected by the decisions made by the other participants, but this person may choose to punish a responder who has been overly selfish. The concern over this possibility may serve to discipline potentially selfish responders. We also explore a treatment in which the third party may also choose to reward a sender who has received a low net payoff as a result of the responder's action. We find a strong and significant effect of third-party punishment in both punishment regimes, as the amount sent by the first mover is more than 60% higher when there is the possibility of third-party punishment. We also find that responders return a higher proportion of the amount sent to them when there is the possibility of punishment, with this proportion slightly higher when reward is not feasible. Finally, third parties punish less when reward is feasible, but nevertheless spend more on the combination of reward and punishment when these are both permitted than on punishment when this is the only choice for redressing material outcomes.

Machiavellian Denigration and the Shifting Base of Organisational Power

A game-theoretic model of reputation destruction (denigration) engineered by one party to serve empire-building of another is presented and subgame perfect Nash equilibria (SPE) established. Player 1 can acquire power by denigrating the reputation of player 3 and acquiring his followers. Players 2 may or may not join him in this enterprise, being initially unaware of whether 1 is telling the truth. If they join 1, and the latter is lying, to prevent ultimate denunciation he will offer each a commitment action that promises a bonus over non-commitment but which also gives them a lower payoff in the event of denunciation, once the truth is revealed. 2's can learn the truth only by performing this action. Denunciation by 2's is possible even in the absence of such knowledge but lacks force. It is shown that the primary SPE equilibrium of this game involves certain lying by 1 with no denunciation. Agent 1 eventually takes over the organisation by locking the unwitting 2's into his corrupt empire. However, if agents 2 have dispersed preferences for denunciation independently of prison sentences flowing from revealed commitment actions, the best strategy for 1 is to always tell the truth since sooner or later he will be exposed. This finding suggests that lying might well dominate truth-telling in situations where the cost of arranging commitment action is not too high and preferences of coalition partners are closely aligned with those of the empire-builder.

The Option Value of Delay in Health Technology Assessment

Processes of health technology assessment (HTA) inform decisions under uncertainty about whether to invest in new technologies based on evidence of incremental effects, incremental cost, and incremental net benefit monetary (INMB). An option value to delaying such decisions to wait for further evidence is suggested in the usual case of interest, in which the prior distribution of INMB is positive but uncertain. of estimating the option value of delaying decisions to invest have previously been developed when investments are irreversible with an uncertain payoff over time and information is assumed fixed. However, in HTA decision uncertainty relates to information (evidence) on the distribution of INMB. This article demonstrates that the option value of delaying decisions to allow collection of further evidence can be estimated as the expected value of sample of information (EVSI). For irreversible decisions, delay and trial (DT) is demonstrated to be preferred to adopt and no trial (AN) when the EVSI exceeds expected costs of information, including expected opportunity costs of not treating patients with the new therapy. For reversible decisions, adopt and trial (AT) becomes a potentially optimal strategy, but costs of reversal are shown to reduce the EVSI of this strategy due to both a lower probability of reversal being optimal and lower payoffs when reversal is optimal. Hence, decision makers are generally shown to face joint research and reimbursement decisions (AN, DT and AT), with the optimal choice dependent on costs of reversal as well as opportunity costs of delay and the distribution of prior INMB.

Residential Peer Effects in Higher Education: Does the Field of Study Matter?

Economists have a poor understanding of the mechanisms underlying reduced-form college peer effects. In this paper we explore a candidate mechanism, the provision of school effort. We show that, when earnings reflect individual educational performance as well as the field of study selected at college, and individual effort is a function of expected earnings, the size of the peer effect varies by field. Using data from a middle-sized public university located in Southern Italy and exploiting the random assignment of first year students to college accommodation, we find evidence that peer effects are positive and statistically significant for students enrolled in the fields of Engineering, Maths and Natural Sciences – which are expected to generate higher earnings after college – and not different from zero for students enrolled in the Humanities, Social and Life Sciences, which give access to lower payoffs. An implication of our model is that shocks affecting college wage premia may alter the size of peer effects.

Core and periphery in networks

We study a model of network formation where the benefits from connections exhibit decreasing returns and decay with network distance. We show that the unique equilibrium network is a periphery-sponsored star, where one player, the center, maintains no links and earns a high payoff, while all other players maintain a single link to the center and earn lower payoffs. Both the star architecture and payoff inequality are preserved in an extension of the model where agents can make transfers and bargain over the formation of links, under the condition that the surplus of connections increases in the size of agents’ neighborhoods. Our model thus generates two common features of social and economic networks: (1) a core-periphery structure; (2) positive correlation between network centrality and payoffs.

Payments for environmental services as an alternative to logging under weak property rights: The case of Indonesia

Decentralization reforms in Indonesia have led to local communities negotiating logging agreements with timber companies for relatively low financial payoffs and at high environmental cost. This paper analyzes the potential of payments for environmental services (PES) to provide an alternative to logging for these communities and to induce forest conservation. We apply a game-theoretical model of community–firm interactions that explicitly considers two stylized conditions present in the Indonesian context: (i) community rights to the forest remain weak even after decentralization, and (ii) the presence of logging companies interested in the commercial exploitation of the forest. Intuition may suggest that PES design should focus on those communities with the lowest expected payments from logging deals. However, we show that these communities may not be able to enforce a PES agreement, i.e., they may not be able to prevent logging activities by timber companies. Moreover, some communities would conserve the forest anyway; in these cases PES would not lead to additional environmental gains. Most important, the introduction of PES may increase a community's expected payoff from a logging agreement. A failure to consider this endogeneity in expected payoffs could lead to communities opting for logging agreements despite PES, simply allowing communities to negotiate better logging deals. Our results indicate that PES design is a complex task, and that the costs of an effective PES system could potentially be much higher than expected from observing current logging fees. Using data collected in Indonesia on actual logging fees received by communities, we illustrate how the theoretical results could be used in empirical analysis to guide PES design. Our results are likely to be useful in other cases where local people make resource use decisions but have weak property rights over these resources, and where external commercial forces are present. The results highlight the importance of understanding the details of the local context in order to design PES programs appropriately.

How much is information worth? Willingness to pay for expert and non-expert informational goods compared to material goods in lay economic thinking

Economists consider information a paradoxical good of uncertain value. This experimental study compares the valuation of economic information to the valuation of material goods when subjects possess perfect information so that uncertainty about the outcome of the transaction is eliminated. It also aims to study the participants' justifications of their valuations, in order to examine the underlying cognitive processes. The main hypotheses were that: (a) even if subjects deal with perfect information they will underestimate its value compared to the value of material goods; (b) underestimation of the value of information will be greater in conditions of high involvement, that is when expected payoff and therefore investment and risk are high; and (c) expert information will be valued more highly than non-expert information, since it should be regarded as more reliable. In the main study, two groups of students in the same university were asked to value and justify their valuation of material goods, under conditions of certain low (1000) and high (100,000) payoffs, respectively. Two other groups were asked to value and to justify their valuation of non-expert information under the same conditions of profit. Finally, two more groups of students were asked to value and justify their valuation of expert information, again under conditions of low or high expected profit. The findings of the study show that under all conditions subjects underestimate the value of information both absolutely and relatively in comparison to material goods, especially under conditions of high involvement. The participants' justifications of their own valuations are heuristics which seem to take into account the uncertain character of informational goods.

Risk-prone hunting by chimpanzees (Pan troglodytes schweinfurthii) increases during periods of high diet quality

Most studies suggest that during times of nutritional stress, an animal faced with two foraging choices should follow a risk-prone strategy, choosing the option with highest payoff variance. This “scarcity/risk” hypothesis was developed to account for the foraging patterns of small animals with high metabolic rates susceptible to the threat of starvation. In this paper, we propose that animals should also be risk-prone when their diet quality is particularly high, far exceeding that which is needed to survive. Under these circumstances, the costs of experiencing a low or negative payoff can easily be recouped. We suggest that large-bodied omnivores are most likely to adopt this “abundance/risk” strategy. We investigate this question among wild chimpanzees (Pan troglodytes) that choose between a risk-averse strategy of feeding on plant material and a risk-prone strategy of hunting red colobus monkeys. Using 14 years of data on the Kanyawara chimpanzees of Kibale National Park, Uganda, we find strong evidence that chimpanzees follow the “abundance/risk” strategy. Both hunting rate (hunts/100 observation hours) and the probability of hunting upon encountering red colobus monkeys were positively correlated with seasonal consumption of ripe drupe fruits, a class of preferred food associated with elevated reproductive performance by females. Critically, these results remained statistically significant after controlling for the potentially confounding effects of male chimpanzee party size and the presence of sexually receptive females. These findings suggest that the relationship between risk-sensitive foraging and diet quality depends upon the daily probability of starvation, the number of alternative foraging strategies, and the degree to which diet quality satisfies an animal’s nutritional requirements.

An investment contest to influence environmental policy

In an investment contest for environmental policy, polluters and victims of pollution invest in an increase of their marginal benefits of pollution and environmental quality, respectively. These investments influence time-consistent environmental policy. Investments will exceed their optimal level. The more victims there are, the lower aggregate investment, the lower payoffs for the victims and the higher payoffs for the polluters. The more polluters there are, the higher aggregate investment and the lower payoffs for polluters and victims. Asymmetries between polluter and victim result in less overinvestment and bias environmental policy in favour of the less productive side.