Research Paper Series

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Departments: GREGHEC (CNRS)

Research has suggested that firms may benefit from price uncertainty - about input commodities - because it creates an "option value". We use a stylized mathematical model to explore and generalize this claim and to specify its implications for firms' investment decisions under various setups. In particular, we study firms' motivation for investing in such risk management measures as financial hedging (FH) and technology improvement (TI): technology changes that result in less consumption of an input commodity, fewer waste products and emissions, and lower production costs. We derive a simple expression that explicitly quantities firm's attitude toward input-price risk by considering the firm's (positive or negative) risk premium (i.e., what it would pay to "lock in" the unit input price at its mean) and linking that premium to various firm and industry-level characteristics. Also, we examine the comparative risk management advantages of TI and FH and characterize conditions under which these strategies are complements or substitutes. We find that although input-price uncertainty may be beneficial even for risk-averse firms, they can benefit from investing in risk reduction measures (e.g., TI, FH) because they could increase the option value of that uncertainty. A firm's ability to adjust its price in response to both market competition and input-price variation mediates the benefit of risk-reducing measures and also affects the two strategies' complementarity.

Keywords: Risk Management, Risk Exposure, Technology Improvement, Financial Hedging

Departments: Finance, GREGHEC (CNRS)

Both in the United States and in the Euro Area, bank supervision is the joint responsibility of local and central supervisors. I study a model in which local supervisors do not internalize as many externalities as a central supervisor. Local supervisors are more lenient, but banks also have weaker incentives to hide information from them. These two forces can make a joint supervisory architecture optimal, with more weight put on centralized supervision when cross-border externalities are larger. Conversely, more centralized supervision endogenously encourages banks to integrate more cross-border. Due to this complementarity, the economy can be trapped in an equilibrium with both too little central supervision and too little financial integration, when a superior equilibrium would be achievable.

Keywords: banking union, bank supervision, financial integration

Departments: Finance, GREGHEC (CNRS)

The regulatory use of banks' internal models makes capital requirements more risk-sensitive but invites regulatory arbitrage. I develop a framework to study bank regulation with strategic selection of risk models. A bank supervisor can discourage arbitrage by auditing risk models, and implements capital ratios less risk-sensitive than in the first-best to reduce auditing costs. The optimal capital ratios of a national supervisor can be different from those set by supranational authorities, in which case the supervisor optimally tolerates biased models. I discuss the empirical implications of this "hidden model" problem, and policy answers such as leverage ratios and more reliance on backtesting mechanisms.

Keywords: basel risk-weights, internal risk models, leverage ratio, supervisory audits

Departments: Economics & Decision Sciences, GREGHEC (CNRS)

Stochastic independence has a complex status in probability theory. It is not part of the definition of a probability measure, but it is nonetheless an essential property for the mathematical development of this theory. Bayesian decision theorists such as Savage can be criticized for being silent about stochastic independence. From their current preference axioms, they can derive no more than the definitional properties of a probability measure. In a new framework of twofold uncertainty, we introduce preference axioms that entail not only these definitional properties, but also the stochastic independence of the two sources of uncertainty. This goes some way towards filling a curious lacuna in Bayesian decision theory.

Keywords: Stochastic Independence, Probabilistic Independence, Bayesian Decision Theory, Savage

Departments: Accounting & Management Control, GREGHEC (CNRS)

This paper has three objectives: (1) To introduce a theoretical solution to the issue of non-additivity between assets in place, relying on an accounting-based valuation approach; (2) To explain how such an approach can be implemented empirically by measuring synergies between assets; (3) To present the properties of this non-additive valuation technique. We use Choquet capacities, i.e., non-additive aggregation operators, to measure the interactions between assets and apply our methodology to a sample of U.S. firms from the Capital Goods industry. To operationalize our approach we examine the relationships between synergies – captured by Choquet capacities – and the market-to-book ratio (proxying for growth options), and show how interactions between assets are consistently linked to a firm’s market-to-book ratio. We also measure firm-specific productive efficiency relative to the industry and firm size. For large firms, efficiency, as defined by our approach, is positively associated with higher future operating cash flows. For small firms, efficiency is positively associated with higher future sales growth. We document that the non-additive approach appears to be better to identify expected relationships between efficiency and future performance than a simpler approach based on the market-to-book ratio.

Keywords: Goodwill, Non-additive accounting-based valuation, Synergies, Choquet capacities, Growth options, Productive efficiency

Departments: Tax & Law, GREGHEC (CNRS)

The purpose of this legal memorandum is to provide advice to organisations and individuals interested in submitting a request for public access to documents under Regulation (EC) No 1049/01 (“Regulation 1049/01”) to the European Parliament for documents related to the spending of political groups covered by Budget Item 400 appropriations under Chapter 7.Requests for those documents may face rejection on grounds related to exceptions provided for in Regulation 1049/01, specifically those found in Articles 4(1)b, 4(2), and 4(3) pertaining to privacy and integrity of the individual, commercial interests, and institution’s decision-making process respectively.This legal memorandum addresses the applicability of those exceptions to the documents requested for potential use in a confirmatory request to be submitted to the European Parliament subsequent to the initial rejection in line with Article 7 of Regulation 1049/01. The memo also provides arguments for overcoming these exceptions in light of:1) recent developments in the case law of the Court of Justice of the European Union (“CJEU”) relating to the privacy exception; and2) the strict legal requirements for triggering the commercial interests and institutional decision-making exceptions.The last section of the memo is structured to provide draft responses to the denial of requests for documents and should be tailored to the specific situation in question.

Keywords: Open Government, Transparency, Participation, Civic Empowerment, Legitimacy, Accountability, Civil Society, European Union, Good Governance

Departments: Marketing

We utilize household production theory to address the problem of micro-level demand estimation across complementary goods. According to this theory, consumers buy inputs and combine them to produce final goods from which they derive utility. We use this idea to build a structural model of demand for complements that can be estimated on purchase data in the presence of corner solutions and indivisible packages. We find that, even when reusing the same functional form as some previous models of demand for substitutes, the model can accommodate very different patterns of consumer preferences over complements and lead to a flexible demand system from perfect complementarity to no complementarity. We estimate the model on purchase data from a panel of consumers and show how it can be used to increase the profitability of couponing strategies by taking into account the spillover effect of coupons on demand for complementary categories.

Keywords: Utility Theory, Multicategory Demand Models, Bayesian Estimation

Departments: Strategy & Business Policy, GREGHEC (CNRS)

This article theorizes about and tests the conditions under which firms’ commitment to an industry is influenced by social movement organizations (SMOs) that favor the industry. We argue that the more prominent SMOs are within an industry, the more a firm increases its commitment to that industry by expanding its operations; yet, this main effect should be moderated substantially by a firm’s idiosyncratic characteristics. The current research predicts that a firm’s location, its sensitivity to information about the industry’s potential, and its history of associations with activists determine the magnitude of the effect of SMO prominence on its strategic commitment to the industry. We test and find support for these hypotheses using a longitudinal data set of European manufacturers of solar photovoltaic cells between 1990 and 2011. The findings offer new insights for literature on social movements and organizations, as well as strategic management research.

Keywords: Organization and Management Theory, Strategy and Policy, Sustainability/Corporate Environmentalism, Economic Sociology, Nonmarket/Political Environment

Departments: Marketing, GREGHEC (CNRS)

Empirical demand functions (based on experimental studies, such as Choice Based Conjoint) are critical to many aspects of marketing, such as targeting and segmentation, setting prices and evaluating the potential of new products. While considerable work has been done on developing approaches for ensuring that research subjects are both honest and engaged, the reduced cost associated with collecting data in an online setting has driven many studies to be collected under conditions which leave researchers unsure of the value of the information content provided by each subject. Objective measures related to how the subject completes the study, such as latency (how quickly answers are given), can only be tied to other objective measures (such as the fit of the model or consistency of the answer) and ultimately have questionable relationship to the subject's utility function.In response to this problem, we introduce a mixture modeling framework which clusters subjects based on variances in a choice based setting (multinomial logit models). This model naturally groups subjects based on the internal consistency of their answers, where we argue that a higher level of internal consistence (hence lower variance) reflects more engaged consumers who have sufficient experience with the product category and choice task, to have well-formed utilities. This approach provides an automated way of determining which consumers are relevant. We discuss both the modeling framework and illustrate the methods using data from several commercial conjoint studies.

Keywords: Multinomial Logit, Conjoint Analysis, Data Quality, Finite Mixture Models

Departments: Finance, GREGHEC (CNRS)

Firm political contributions are associated with lower credit default swap spreads for contributing firms. To address endogeneity, we employ novel instruments and use a set of exogenous events on campaign contribution restrictions: (a) the passage of the Bipartisan Campaign Reform Act (BCRA) that banned soft money contributions, (b) the Federal Election Commission decision to interpret the BCRA less strictly, (c) the partial reversal of the BCRA and, (d) the McConnell v. FEC Supreme Court decision, which upheld the BCRA. Overall, the evidence suggests that political contributions are valued by credit market participants.

Keywords: Political Contributions, Credit Risk, CDS, Moral Hazard, Financial Crisis