Working papers

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Departments: Strategy & Business Policy, GREGHEC (CNRS)

Although Strategy research aims to understand how firm actions have differential effects on performance, most empirical research estimates the average effects of these actions across firms. This paper promotes Random Coefficients Models (RCMs) as an ideal empirical methodology to study firm heterogeneity in Strategy research. Specifically, we highlight and illustrate three main benefits that RCMs offer to Strategy researchers—testing firm heterogeneity, predicting firm-specific effects, and estimating trade-offs in strategy—using both synthetic and actual datasets. These examples showcase the potential uses of RCMs to test and build theory in Strategy, as well as to perform exploratory and definitive analyses of firm heterogeneity

Departments: Accounting & Management Control, GREGHEC (CNRS)

While it is generally maintained that earnings management can occur to inform as well as to mislead, evidence that earnings management informs has been scarce, and evidence that credibility increases with signal costliness inexistent. We provide evidence that firms use discretion over financial reporting and real activities to report higher earnings on lower sales from continuing operations. Although these firms defy gravity artificially, we show that the upwards earnings management informs rather than misleads investors. We find that firms that defy gravity (1) report higher future earnings and cash flows, (2) earn higher one-year-ahead abnormal returns, (3) have a positive market reaction to the defying gravity earnings announcement, and (4) their CEOs are more likely to be net buyers in the year preceding the defying gravity event. We also show that the upwards earnings management signal is more credible when it is more costly to achieve: Defying gravity firms perform better when they bear the opportunity loss of not taking a big bath in times of crisis — years where poorer performance can be blamed on economy-wide shocks, and when they have fewer degrees of freedom to report higher earnings.

Keywords: Earnings Management, Signaling, Informativeness, Opportunism, Credibility

Departments: Economics & Decision Sciences, GREGHEC (CNRS)

Few problems in decision theory have raised more persisting interest than the Allais paradox. It appears that sufficiently many brilliant works have addressed it from within decision theory proper for history and philosophy of science now to enter stage.In its historical side, the paper recounts the paradox as it arose, i.e., in 1952, at a Paris conference attended by the main decision theorists of the time. They had drawn renewed confidence in expected utility theory (EUT) from the way von Neumann and Morgenstern had axiomatized it in 1947, and Allais devised his puzzle precisely to shaken their confidence. The issues between the two camps were normative, but they became lost in the developments of the 1980s that belatedly brought fame to the "Allais paradox". These works restricted the paradox to be a straightforward empirical refutation, turning it into a stake of also exclusively empirically oriented non-EU theories.In its philosophical vein, the paper tries to evaluate this shift of interpretation. To an extent, decision theorists were right because their experimental work was thus freed from a major complication and amenable to illuminating results: EUT was empirically refuted, the independence axiom of von Neumann and Morgentern was the main culprit, and the next theoretical stage was to modify this axiom appropriately. However, they were also wrong in not addressing an essential feature of their field, i.e., that observed behaviour is informative only if agents are prepared to endorse it reflectingly, i.e., to endow it with some normative value. As reconstructed here, Allais meant to reserve choice experiments to rational subjects, who were either selected at the outset, or identified as such by the experimental results. The paper tries to flesh out Allais's intuitions by turning to by now little known works of the 1970s, which under his influence provided experimental renderings of rationality, and it eventually suggests that decision theory might diversify its methods by taking inspiration from these original attempts.

Keywords: Allais Paradox, expected utility theory, von Neumann-Morgenstern, positive vs normative, experimental economics of decision, rationality

Departments: Finance, GREGHEC (CNRS)

We investigate how a large-scale French reform to reduce the risk from small business creation for unemployed workers, affects the composition of people who are drawn into entrepreneurship. New firms started in response to the reform are, on average, smaller, but have similar growth expectations and education levels compared to start-ups before the reform. They are also as likely to survive or to hire. However, there are large crowd-out effects: Employment in incumbent firms decreases by a similar magnitude as the number of new jobs created in start-ups. These results point to the importance of Schumpeterian dynamics when facilitating entry

Keywords: Entrepreneurship, Unemployment insurance, Crowding out

Departments: Finance, GREGHEC (CNRS)

We examine the impact of aging on wine prices and the performance of wine as a long-term investment, using a unique historical database for five long-established Bordeaux wines that we construct from auction and dealer prices. We estimate the life-cycle price patterns with a regression model that avoids multicollinearity between age, vintage year, and time by replacing the vintage effects with annual data on production yields and weather quality. In line with the predictions of an illustrative model, we observe the highest rates of appreciation for young high-quality wines that are still maturing. The findings suggest that the non-financial “psychic return” to holding wines that are substantially beyond maturity is at least 1%. Using an arithmetic repeat-sales regression, we estimate an annualized return to wine investments (net of insurance and storage costs) of 4.1%, in real GBP terms, between 1900 and 2012. Wine underperforms equities over this period, but outperforms government bonds, art, and stamps. Wine and equity returns are positively correlated.

Keywords: alternative investments, luxury goods, price indexes, psychic return, consumption, storage

Departments: Finance, GREGHEC (CNRS)

How does underlying knowledge support market development? Our research shows how a knowledge community may be necessary to support the emergence of new categories in markets where products are evaluated before purchase. Using epistemic cultures to frame field growth, we review the development of artwork as a recognizable financial investment category, highlighting institutionalized expectations about evaluation and monitoring of financial assets. We provide a longitudinal study of art investment lexicon (i.e. language) using Google Books data, showing an increasing interest in art investment and the art market. Despite sustained interest, art investments often failed. To explain this we provide a grounded process study of historical data. We find the growth of an epistemic culture around art investing, facilitated by new market actors who met the needs of professional investors for transparency and accountability. Technical knowledge about art investment flowed from economists, art price services, art market analysts, and others, developing alongside practical knowledge about how to structure ventures and profit from art investment. Because empirical investment properties underlie financial market categories, we argue that growth of art investment knowledge — despite venture failures — was just as important for the market development as entrepreneurs and investors willing to enter the area.

Keywords: new field creation; legitimacy; epistemic cultures; institutionalized expectations; investment management; art market

Departments: Finance, GREGHEC (CNRS)

We examine the toxic loans sold by investment banks to local governments. Using proprietary data, we show that politicians strategically use these products to increase chances of being re-elected. Consistent with greater incentives to hide debt, toxic loans are utilized significantly more frequently within highly indebted local governments. Incumbent politicians from politically contested areas are also more likely to turn to toxic loans. Using a difference-in-differences methodology, we show that politicians time the election cycle by implementing more transactions immediately before an election than after. Politicians also exhibit herding behavior. Our findings demonstrate how financial innovation can foster strategic behaviors.

Keywords: Financial innovation, Political cycle, Herding, Structured debt

Departments: Economics & Decision Sciences, GREGHEC (CNRS)

In this paper, we propose a model of discrete time dynamic congestion games with atomic players. This approach allows to give a precise description of the dynamics induced by the individual strategies of players and to study how the steady state is reached, either when players act selfishly, or when the traffic is controlled by a planner. We model also seasonalities by assuming that departure flows fluctuate periodically with time. We focus mostly on simple networks and give closed form formulas for the long-run equilibrium and optimal latencies, as functions of the seasonality. We then derive computations and bounds on the price of anarchy. We also characterize optimal and equilibrium flows and show that, although they produce different costs, they coincide from some time onwards

Keywords: Network games, price of anarchy, dynamic flows

Departments: Economics & Decision Sciences, GREGHEC (CNRS)

This paper considers dynamic implementation problems with evolving private information (according to Markov processes). A social choice function is approximately implementable if there exists a dynamic mechanism such that the social choice function is implemented by an arbitrary large number of times with arbitrary high probability in every communication equilibrium. We show that if a social choice function is strictly efficient in the set of social choice functions that satisfy an undetectable condition, then it is approximately implementable. We revisit the classical monopolistic screening problem and show that the monopolist can extract the full surplus in almost all periods with arbitrary high probability.

Keywords: implementation, Markov Process, undetectability, efficiency

Departments: Finance, GREGHEC (CNRS)

We show how to reverse engineer banks' risk disclosures, such as Value-at-Risk, to obtain an implied measure of their exposures to equity, interest rate, foreign exchange, and commodity risks. Factor Implied Risk Exposures (FIRE) are obtained by breaking down a change in risk disclosure into an exogenous volatility component and an endogenous risk-exposure component. In a study of large US and international banks, we show that (1) changes in risk exposures are negatively correlated with market volatility and (2) changes in risk exposures are positively correlated across banks, which is consistent with banks exhibiting herding behavior in trading.

Keywords: Herding, Risk Disclosure, (Stressed) Value-at-Risk, Regulatory Capital