Formation and destruction of coalition groups under economic growth

This paper introduces a model economy in which formation of coalition groups under technological progress is generated endogenously. The coalition formation depends crucially on the rate of arrival of new technologies. In the model, an agent working in the saroe technology for more than one period acquires skills, part of which is specific to this technology. These skills increase the agent productivity. In this case, if he has worked more than one period with the same technology he has incentives to construct a coalition to block the adoption of new technologies. Therefore, in every sector the workers have incentives to construct a coalition and to block the adoption of new technologies. They will block every time that a technology stay in use for more than one period.

Evidence on the incentive optimality of share contracts

Ever since Adam Smith, economists have argued that share contracts do not provide proper incentives. This paper uses tenancy data from India to assess the existence of missing incentives in this classical example of moral hazard. Sharecroppers are found to be less productive than owners, but as productive as fixed-rent tenants. Also, the productivity gap between owners and both types of tenants is driven by sample-selection issues. An endogenous selection rule matches tenancy contracts with less-skilled farmers and lower-quality lands. Due to complementarity, such a matching affects tenants’ input choices. Controlling for that, the contract form has no effect on the expected output. Next, I explicitly model farmer’s optimal decisions to test the existence of non-contractible inputs being misused. No evidence of missing incentives is found.

Affirmative action in college admission and the proficiency of high school students

Economic theory suggests that a¢ rmative action can either reduce or enhance incentives to invest in human capital. Empirical evidence on this matter, however, is still lacking. Using di¤erence in di¤er- ence estimates, this paper evaluates the e¤ects of the quota system in the admission to Brazilian public universities on the pro ciency of high school students. Our ndings show that favored groups attained lower scores, suggesting a negative link between a¢ rmative action and incentives for e¤ort and skill acquisition.

Endogenous supply of fiat money

We address whether reputation concerns can discipline the behavior of a self-interested agent who has a monopoly over the provision of fiat money. We obtain that when this agent can commit to a plan of action, there is a monetary equilibrium where it never overissues. We show, however, that such equilibrium is no longer possible when there is no commitment. This happens because the incentives this agent has to maintain a reputation for providing valuable currency disappear once its reputation is high enough. More generally, we prove that there is no monetary equilibrium where overissue happens only infrequently. We conclude by showing that imperfect memory can restore the positive result obtained in the presence of commitment.

The effects of credit risk transfer on bank monitoring and firm financing

This paper examines the efects of the transfer of credit risk associated with bank loans. We are interested in (a) whether the transfer of credit risk has any impact on the intensity with which banks monitor their borrowers and (b) whether credit risk transfer infuences the amount of financing that is provided to firms in an economy. Our model first develops conditions under which bank finance is available to firrms, mainly in the spirit of Holmstrom/Tirole (1997). We then introduce projects with uncorrelated pay-offs and argue that one possible economic rationale for credit risk transfer is diversi¯cation. We analyze whether and how within this scenario the transfer of the credit risk of loans changes a bank's incentives to monitor its debtors. Finally we investigate whether and what kind of impact this may have on the amount of ¯nancing available to firms in an economy. Our results indicate that the monitoring incentives are being eroded indeed and that credit risk transfer can increase the overall amount of obtainable funds in an economy.

Regional subsidies and industrial prospects of lagging regions

Large and sustained differences in economic performance across regions of developing countries have long provided motivation for fiscal incentives designed to encourage firm entry in lagging areas. Empirical evidence in support of these policies has, however, been weak at best. This paper undertakes a direct evaluation of the most prominent fiscal incentive policy in Brazil, the Fundos Constitucionais de Financiamento (Constitutional Funds). In doing so, we exploit valuable features of the Brazilian Ministry of Labor's RAIS data set to address two important elements of firm location decisions that have the potential to bias an assessment of the Funds: (i) firm “family structure” (in particular, proximity to headquarters for vertically integrated firms), and (ii) unobserved spatial heterogeneity (with the potential to confound the effects of the Funds). We find that the pull of firm headquarters is very strong relative to the Constitutional Funds for vertically integrated firms, but that, with non-parametric controls for time invariant spatial heterogeneity, the Funds provide statistically and economically significant incentives for firms in many of the targeted industries.

Workplace diversity and incentive contracts : theory and evidence

This paper presents a simple theory of the provision of incentives in firms in which the principal optimally chooses both compensation contracts and the composition of the work force. Assuming that individuals display group loyalty, a less diverse (more homogeneous) work force will be more cooperative. Simple comparative statics provide some testable implications relating risk, diversity and incentive pay. I also analyze the case in which workers’ characteristics cannot be readily observed ex ante. The theory then predicts that firms are more likely to prevent workers from interacting with each other when workers are expected to have similar characteristics. This shows a surprising effect of diversity in the workplace: more diverse firms will promote more interactions between workers of different types, i.e. they will be less segregated. I test the main predictions of the model using a cross-sectional sample of corporate boards. I use the proportion of women on boards as a measure of diversity. There are three main empirical findings: (1) a significant negative correlation between firm risk and diversity, (2) a significant positive relationship between performance-based compensation and diversity and (3) a significant positive correlation between the number of board meetings (a measure of interactions among directors) and diversity. The evidence is broadly consistent with the implications of the theory.

Credible managerial vision

We develop a model in which managers choose whether or not to reveal their “vision” for the future of their companies. Visionary managers are valuable because they generate incentives for workers to develop profitable innovations for the firm. However, managerial vision is not necessarily credible. After workers have invested in developing ideas, there is no a priori reason for a manager to keep her earlier promises when new contingencies arise and make it profitable to change the firm’s strategic direction. We show that credible managerial vision will arise in equilibrium when managers have career concerns. In order to credibly implement their visions, managers issue public “mission statements” to motivate workers. Mission statements are not legally binding contracts and their value comes solely from their effects on managerial opportunities outside the firm. Among the new implications of the model, we show that managerial vision is more likely to be credible in industries in which managerial turnover is high and in which the managerial skill premium is high. Differently from the related literature that take managerial biases as exogenous, we show not only that biases increase workers’ incentives, but also that the need to provide incentives to workers increases managers’ incentives to become credible visionaries.

Contracting with repeated moral hazard and private evaluations

A repeated moral hazard setting in which the Principal privately observes the Agent’s output is studied. It is shown that there is no loss from restricting the analysis to contracts in which the Agent is supposed to exert effort every period, receives a constant efficiency wage and no feedback until he is fired. The optimal contract for a finite horizon is characterized, and shown to require burning of resources. These are only burnt after the worst possible realization sequence and the amount is independent of both the length of the horizon and the discount factor (δ). For the infinite horizon case a family of fixed interval review contracts is characterized and shown to achieve first best as δ → 1. The optimal contract when δ << 1 is partially characterized. Incentives are optimally provided with a combination of efficiency wages and the threat of termination, which will exhibit memory over the whole history of realizations. Finally, Tournaments are shown to provide an alternative solution to the problem.

Information asymmetry and competition in credit markets: the pricing of overdraft loans in Brazil

This paper evaluates how information asymmetry affects the strength of competition in credit markets. A theory is presented in which adverse selection softens competition by decreasing the incentives creditors have for competing in the interest rate dimension. In equilibirum, although creditors compete, the outcome is similar to collusion. Three empirical implications arise. First, interest rate should respond asymmetrically to changes in the cost of funds: increases in cost of funds should, on average, have a larger effect on interest rates than decreases. Second, aggressiveness in pricing should be associated with a worseing in the bank level default rates. Third, bank level default rates should be endogenous. We then verify the validity of these three empirical implications using Brazilian data on consumer overdraft loans. The results in this paper rationalize seemingly abnormallly high interest rates in unsecured loans.

Rent dissipation, political viability and the strategic adoption of free trade agreements

This paper studies the political viability of free trade agreements (FTAs). The key element of the analysis is the “rent dissipation” that these arrangements induce: by eliminating intra-bloc trade barriers, an FTA reduces the incentives of the local firms to lobby for higher external tariffs, thereby causing a reduction of the rents created in the lobbying process. The prospect of rent dissipation moderates the governments’ willingness to participate in FTAs; they will support only arrangements that are “substantially” welfare improving, and no FTA that reduces welfare. Rent dissipation also implies that the prospects of political turnover may create strategic reasons for the formation of FTAs. Specifically, a government facing a high enough probability of losing power may want to form a trade bloc simply to “tie the hands” of its successor. An FTA can affect the likelihood of political turnover as well. If the incumbent party has a known bias toward special interests, it may want to commit to less distortionary policies in order to reduce its electoral disadvantage; the rent dissipation effect ensures that an FTA can serve as the vehicle for such a commitment. In nascent/unstable democracies, the incumbent government can use a free trade agreement also to reduce the likelihood of a dictatorial takeover and to “consolidate” democracy – a finding that is consistent with the timing of numerous accessions to and formations of preferential arrangements.

Banks, liquidity crises and economic growth

How do the liquidity functions of banks affect investment and growth at different stages of economic development? How do financial fragility and the costs of banking crises evolve with the level of wealth of countries? We analyze these issues using an overlapping generations growth model where agents, who experience idiosyncratic liquidity shocks, can invest in a liquid storage technology or in a partially illiquid Cobb Douglas technology. By pooling liquidity risk, banks play a growth enhancing role in reducing inefficient liquidation of long term projects, but they may face liquidity crises associated with severe output losses. We show that middle income economies may find optimal to be exposed to liquidity crises, while poor and rich economies have more incentives to develop a fully covered banking system. Therefore, middle income economies could experience banking crises in the process of their development and, as they get richer, they eventually converge to a financially safe long run steady state. Finally, the model replicates the empirical fact of higher costs of banking crises for middle income economies.

Co-ordination failure, moral hazard and sovereign bankruptcy procedures

We study a model of sovereign debt crisis that combines problems of creditor coordination and debtor moral hazard. Solving the sovereign debtor's incentives leads to excessive 'rollover failure' by creditors when sovereign default occurs. We discuss how the incidence of crises might be reduced by international sovereign bankruptcy procedures and relate this to the current debate on revising international financial architecture. Paper prepared for Bank of England Conference on "The Role of the Official and Private Sectors in Resolving International Financial Crises", London, and for the Latin American Meeting of the Econometric Society, Sao Paolo, Brazil. (Preliminary draft circulated for comments, please do not cite without reference to the authors).

Endogenous borrowing constraints and default when markets are incomplete

Incomplete markets and non-default borrowing constraints increase the volatility of pricing kernels and are helpful when addressing assetpricing puzzles. However, ruling out default when markets are in complete is suboptimal. This paper endogenizes borrowing constraints as an intertemporal incentive structure to default. It modeIs an infinitehorizon economy, where agents are allowed not to pay their liabilities and face borrowing constraints that depend on the individual history of default. Those constraints trade off the economy's risk-sharing possibilities and incentives to prevent default. The equilibrium presents stationary properties, such as an invariant distribution for the assets' solvency rate.

The long-run economic impact of AIDS

This paper studies the long-run impact of HIV / AIDS on per capita income and education. We introduce a channel from HIV / AIDS to long-run income that has been overlooked by the literature, the reduction of the incentives to study due to shorter expected longevity. We work with a continuous time overlapping generations mo deI in which life cycle features of savings and education decision play key roles. The simulations predict that the most affected countries in Sub-Saharan Africa will be in the future, on average, a quarter poorer than they would be without AIDS, due only to the direct (human capital reduction) and indirect (decline in savings and investment) effects of life-expectancy reductions. Schooling will decline on average by half. These findings are well above previous results in the literature and indicate that, as pessimistic as they may be, at least in economic terms the worst could be yet to come.