Bargaining for power and information : an experimental and theoretical analysis of the interaction between institutions, externalities and adverse selection

Bargaining is the building block of many economic interactions, ranging from bilateral to multilateral encounters and from situations in which the actors are individuals to negotiations between firms or countries. In all these settings, economists have been intrigued for a long time by the fact that some projects, trades or agreements are not realized even though they are mutually beneficial. On the one hand, this has been explained by incomplete information. A firm may not be willing to offer a wage that is acceptable to a qualified worker, because it knows that there are also unqualified workers and cannot distinguish between the two types. This phenomenon is known as adverse selection. On the other hand, it has been argued that even with complete information, the presence of externalities may impede efficient outcomes. To see this, consider the example of climate change. If a subset of countries agrees to curb emissions, non-participant regions benefit from the signatories’ efforts without incurring costs. These free riding opportunities give rise to incentives to strategically improve ones bargaining power that work against the formation of a global agreement. This thesis is concerned with extending our understanding of both factors, adverse selection and externalities. The findings are based on empirical evidence from original laboratory experiments as well as game theoretic modeling. On a very general note, it is demonstrated that the institutions through which agents interact matter to a large extent. Insights are provided about which institutions we should expect to perform better than others, at least in terms of aggregate welfare. Chapters 1 and 2 focus on the problem of adverse selection. Effective operation of markets and other institutions often depends on good information transmission properties. In terms of the example introduced above, a firm is only willing to offer high wages if it receives enough positive signals about the worker’s quality during the application and wage bargaining process. In Chapter 1, it will be shown that repeated interaction coupled with time costs facilitates information transmission. By making the wage bargaining process costly for the worker, the firm is able to obtain more accurate information about the worker’s type. The cost could be pure time cost from delaying agreement or cost of effort arising from a multi-step interviewing process. In Chapter 2, I abstract from time cost and show that communication can play a similar role. The simple fact that a worker states to be of high quality may be informative. In Chapter 3, the focus is on a different source of inefficiency. Agents strive for bargaining power and thus may be motivated by incentives that are at odds with the socially efficient outcome. I have already mentioned the example of climate change. Other examples are coalitions within committees that are formed to secure voting power to block outcomes or groups that commit to different technological standards although a single standard would be optimal (e.g. the format war between HD and BlueRay). It will be shown that such inefficiencies are directly linked to the presence of externalities and a certain degree of irreversibility in actions. I now discuss the three articles in more detail. In Chapter 1, Olivier Bochet and I study a simple bilateral bargaining institution that eliminates trade failures arising from incomplete information. In this setting, a buyer makes offers to a seller in order to acquire a good. Whenever an offer is rejected by the seller, the buyer may submit a further offer. Bargaining is costly, because both parties suffer a (small) time cost after any rejection. The difficulties arise, because the good can be of low or high quality and the quality of the good is only known to the seller. Indeed, without the possibility to make repeated offers, it is too risky for the buyer to offer prices that allow for trade of high quality goods. When allowing for repeated offers, however, at equilibrium both types of goods trade with probability one. We provide an experimental test of these predictions. Buyers gather information about sellers using specific price offers and rates of trade are high, much as the model’s qualitative predictions. We also observe a persistent over-delay before trade occurs, and this mitigates efficiency substantially. Possible channels for over-delay are identified in the form of two behavioral assumptions missing from the standard model, loss aversion (buyers) and haggling (sellers), which reconcile the data with the theoretical predictions. Chapter 2 also studies adverse selection, but interaction between buyers and sellers now takes place within a market rather than isolated pairs. Remarkably, in a market it suffices to let agents communicate in a very simple manner to mitigate trade failures. The key insight is that better informed agents (sellers) are willing to truthfully reveal their private information, because by doing so they are able to reduce search frictions and attract more buyers. Behavior observed in the experimental sessions closely follows the theoretical predictions. As a consequence, costless and non-binding communication (cheap talk) significantly raises rates of trade and welfare. Previous experiments have documented that cheap talk alleviates inefficiencies due to asymmetric information. These findings are explained by pro-social preferences and lie aversion. I use appropriate control treatments to show that such consideration play only a minor role in our market. Instead, the experiment highlights the ability to organize markets as a new channel through which communication can facilitate trade in the presence of private information. In Chapter 3, I theoretically explore coalition formation via multilateral bargaining under complete information. The environment studied is extremely rich in the sense that the model allows for all kinds of externalities. This is achieved by using so-called partition functions, which pin down a coalitional worth for each possible coalition in each possible coalition structure. It is found that although binding agreements can be written, efficiency is not guaranteed, because the negotiation process is inherently non-cooperative. The prospects of cooperation are shown to crucially depend on i) the degree to which players can renegotiate and gradually build up agreements and ii) the absence of a certain type of externalities that can loosely be described as incentives to free ride. Moreover, the willingness to concede bargaining power is identified as a novel reason for gradualism. Another key contribution of the study is that it identifies a strong connection between the Core, one of the most important concepts in cooperative game theory, and the set of environments for which efficiency is attained even without renegotiation.

Capital Accumulation in the Presence of Informal Credit Contracts: Does the Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information?

Credit markets with asymmetric information often prefer credit rationing as a profit maximizing device. This paper asks whether the presence of informal credit markets reduces the cost of credit rationing, that is, whether it can alleviate the impact of asymmetric information based on the available information. We used a dynamic general equilibrium model with heterogenous agents to assess this. Using Indian credit market data our study shows that the presence of informal credit market can reduce the cost of credit rationing by separating high risk firms from the low risk firms in the informal market. But even after this improvement, the steady state capital accumulation is still much lower as compared to incentive based market clearing rates. Through self revelation of each firm's type, based on the incentive mechanism, banks can diversify their risk by achieving a separating equilibrium in the loan market. The incentive mechanism helps banks to increase capital accumulation in the long run by charging lower rates and lending relatively higher amount to the less risky firms. Another important finding of this study is that self-revelation leads to very significant welfare improvement, as measured by consumptiuon equivalence.

An empirical analysis on the efficiency of the microfinance investment market

This paper empirically analyzes the market efficiency of microfinance investment funds. For the empirical analysis, we use an index of the microfinance investment funds and apply two kinds of variance ratio tests to examine whether or not this index follows a random walk. We use the entire sample period from December 2003 to June 2010 as well as two sub-samples which divide the entire period before and after January 2007. The empirical evidence demonstrates that the index does not follow a random walk, suggesting that the market of the microfinance investment funds is not efficient. This result is not affected by changes in either empirical techniques or sample periods.

Neutrality in the choice of number of firms or level of fixed costs in calibrating an Armington-Krugman-Melitz encompassing module for applied general equilibrium models

This paper shows how an Armington-Krugman-Melitz encompassing module based on Dixon and Rimmer (2012) can be calibrated, and clarifies the choice of initial levels for two kinds of number of firms, or parameter values for two kinds of fixed costs, that enter a Melitz-type specification can be set freely to any preferred value, just as the cases we derive quantities from given value data assuming some of the initial prices to be unity. In consequence, only one kind of additional information, which is on the shape parameter related to productivity, just is required in order to incorporate Melitz-type monopolistic competition and heterogeneous firms into a standard applied general equilibrium model. To be a Krugman-type, nothing is needed. This enables model builders in applied economics to fully enjoy the featured properties of the theoretical models invented by Krugman (1980) and Melitz (2003) in practical policy simulations at low cost.

Overview of the project. Sector analysis: Search market.

Which is the economic value of personal information? -How the exchange of information is benefiting society and the economy -How companies create value from personal information (by providing new services or servicing better an existing need). -The mechanisms by which personal information exchange creates economic value - How the level of privacy protection influences value creation in different markets

The Economics of EU Railway Reform. Bruges European Economic Policy (BEEP) Briefing 8/2004

The EU began railway reform in earnest around the turn of the century. Two ‘railway packages’ have meanwhile been adopted amounting to a series of directives and a third package has been proposed. A range of complementary initiatives has been undertaken or is underway. This BEEP Briefing inspects the main economic aspects of EU rail reform. After highlighting the dramatic loss of market share of rail since the 1960s, the case for reform is argued to rest on three arguments: the need for greater competitiveness of rail, promoting the (market driven) diversion of road haulage to rail as a step towards sustainable mobility in Europe, and an end to the disproportional claims on public budgets of Member States. The core of the paper deals respectively with market failures in rail and in the internal market for rail services; the complex economic issues underlying vertical separation (unbundling) and pricing options; and the methods, potential and problems of introducing competition in rail freight and in passenger services. Market failures in the rail sector are several (natural monopoly, economies of density, safety and asymmetries of information), exacerbated by no less than 7 technical and legal barriers precluding the practical operation of an internal rail market. The EU choice to opt for vertical unbundling (with benefits similar in nature as in other network industries e.g. preventing opaque cross-subsidisation and greater cost revelation) risks the emergence of considerable coordination costs. The adoption of marginal cost pricing is problematic on economic grounds (drawbacks include arbitrary cost allocation rules in the presence of large economies of scope and relatively large common costs; a non-optimal incentive system, holding back the growth of freight services; possibly anti-competitive effects of two-part tariffs). Without further detailed harmonisation, it may also lead to many different systems in Member States, causing even greater distortions. Insofar as freight could develop into a competitive market, a combination of Ramsey pricing (given the incentive for service providers to keep market share) and price ceilings based on stand-alone costs might be superior in terms of competition, market growth and regulatory oversight. The incipient cooperative approach for path coordination and allocation is welcome but likely to be seriously insufficient. The arguments to introduce competition, notably in freight, are valuable and many e.g. optimal cross-border services, quality differentiation as well as general quality improvement, larger scale for cost recovery and a decrease of rent seeking. Nevertheless, it is not correct to argue for the introduction of competition in rail tout court. It depends on the size of the market and on removing a host of barriers; it requires careful PSO definition and costing; also, coordination failures ought to be pre-empted. On the other hand, reform and competition cannot and should not be assessed in a static perspective. Conduct and cost structures will change with reform. Infrastructure and investment in technology are known to generate enormous potential for cost savings, especially when coupled with the EU interoperability programme. All this dynamism may well help to induce entry and further enlarge the (net) welfare gains from EU railway reform. The paper ends with a few pointers for the way forward in EU rail reform.

Energy efficiency: the ever neglected priority of the European energy strategy. Egmont Paper No. 66, June 2014

Summary. Energy saving has been a stated policy objective of the EU since the 1970s. Presently, the 2020 target is a 20% reduction of EU energy consumption in comparison with current projections for 2020. This is one of the headline targets of the European Energy Strategy 2020 but efforts to achieve it remain slow and insufficient. The aim of this paper is to understand why this is happening. Firstly, this paper examines the reasons why public measures promoting energy efficiency are needed and what form these measures should optimally take (§ 1). Fortunately, over the last 20 years, much research has been done into the famous ‘energy efficiency gap’ (or ‘the energy efficiency paradox’), even if more remains to be done. Multiple explanations have been given: market failures, modelling flaws and behavioural obstacles. Each encompasses many complex aspects. Several types of instruments can be adopted to encourage energy efficiency: measures guaranteeing the correct pricing of energy are preferred, followed by taxes or tradable white certificates which in turn are preferred to standards or subsidies. Information programmes are also necessary. Secondly, the paper analyzes the evolution of the different programmes from 2000 onwards (§ 2). This reveals the extreme complexity of the subject. It deals with quite diverse topics: buildings, appliances, public sector, industry and transport. The market for energy efficiency is as diffuse as energy consumption patterns themselves. It is composed of many market actors who demand more efficient provision of energy services, and that suppliers of the necessary goods and know-how deliver this greater efficiency. Consumers in this market include individuals, businesses and governments, and market activities cover all energy-consuming sectors of the economy. Additionally, energy efficiency is the perfect example of a shared competence between the EU and the Member States. Lastly, the legal framework has steadily increased in complexity, and despite the successive energy efficiency programmes used to build this framework, it has become clear that the gap between the target and the results remains. The paper then examines whether the 2012/27/EU Directive adopted to improve the situation could bring better results. It briefly describes the content of this framework Directive, which accompanies and implements the latest energy efficiency programme (§ 3). Although the Directive is technically complex and maintains nonbinding energy efficiency targets, it certainly represents an improvement in several aspects. However, it is also saddled with a multiplicity of exemption clauses and interpretative documents (with no binding value) which weaken its provisions. Furthermore, alone, it will allow the achievement of only about 17.7% of final energy savings by 2020. The implementation process, which is essential, also remains fairly weak. The paper also gives a glimpse of the various EU instruments for financing energy efficiency projects (§ 4). Though useful, they do not indicate a strong priority. Fourthly, the paper tries to analyze the EU’s limited progress so far and gather a few suggestions for improvement. One thing seems to remain useful: targets which can be defined in various ways (§ 5). Basically, all this indicates that the EU energy efficiency strategy has so far failed to reach its targets, lacks coherence and remains ambiguous. In the new Commission’s proposals of 22 January 2014 – intended to define a new climate/energy package in the period from 2020 to 2030 – the approach to energy efficiency remains unclear. This is regrettable. Energy efficiency is the only instrument which allows the EU to reach simultaneously its three targets: sustainability, competitiveness and security. The final conclusion appears thus paradoxical. On the one hand, all existing studies indicate that the decarbonization of the EU economy will be absolutely impossible without some very serious improvements in energy efficiency. On the other hand, in reality energy efficiency has always been treated as a second zone priority. It is imperative to eliminate this contradiction.

Audit of consultant physicians' reply letters for referrals to clinics in a tertiary teaching hospital

Background: Doctors referring patients to consultant physicians seek reply letters which both educate and assist in ongoing patient management. Highly desirable attributes in specialist letters include clearly stated and justified: (i) diagnostic formulations, (ii) management regimens, (iii) use of clinical investigations, (iv) prog-nostic statements, (v) contingency plans and (vi) follow-up arrangements. Aim: To explicitly evaluate the quality of reply letters for new patients referred to clinics at a tertiary teaching hospital. Methods: Letters were sampled from outpatient clinics of 10 different medical specialties at Princess Alexandra Hospital in Brisbane, Australia. Reply letters for new patient referrals between 1 August 2000 and 31 October 2000 were retrieved, from which data were abstracted to calculate the proportion of letters satisfying prespecified quality attributes. Results: Of 297 new patient referrals, reply letters were retrieved for 204 (69%). Of these, 147 (72%) referrals were accompanied by a referral letter, mostly (113/147; 77%) from general practitioners. For 120 referrals involving diagnostic issues, 69 (56%) letters stated a diagnostic formulation. Of 114 letters recommending further clinical investigations, 61 (53%) described a rationale for such testing. In 125 cases where therapy was a key issue, 83 (66%) letters recommended changes to current treatment for which reasons were specified in 46 (55%) cases, and contingency plans provided in 13 (16%). Prognosis was mentioned in only 18 (9%) cases. Follow-up arrangements were detailed in 123 (60%) letters. Assessments of patient understanding and likely adherence to therapy were stated in less than 15% of -letters. Conclusions: Opportunities exist for improving quality of consultant physicians' reply letters in terms of greater use of problem lists, contingency plans, prognostic statements and patient-centred assessments, as well as more frequent enunciation of consultants' reasoning behind requests for further tests and changes to current management. Use of structured letter templates may facilitate more consistent inclusion of key information to referring doctors.

Auditor's engagement risk and audit fees:the role of the audit firm alumni

This study explores the effect of the association of audit firm alumni with their alma mater on audit prices. The tests indicate that there is a moderate reduction of up to 21% in the level of audit fee when alumni (i.e., former employees) of the incumbent audit firm sit on the client board of directors which is consistent with the engagement risk theory. This suggests that there is an 'alumni effect' in the market for audit services. The findings hold only in the large company segment of the market. The results are robust to different model specifications and alternative samples. The sample comprises all executive and non-executive directors who run the UK quoted companies and are simultaneously ICAEW qualified chartered accountants. The study's implications for the accounting profession and the regulators are also discussed. © 2007 The Author Journal compilation © 2007 Blackwell Publishing Ltd.

The market for professional services in Indonesia

This paper reports the results of a study which investigates the market for professional services in Indonesia, a country which has not been investigated in the by audit fee literature prior. A well-developed research model used in the prior literature has also been applied in this study, and the empirical findings suggest broad similarities in the pricing of professional services in Indonesia and other countries previously studied. In addition to extending the results of prior research to a country not previously studied, this paper examines whether the large auditors fee premium documented in other countries exists in Indonesia, especially after the major Asian financial crisis of 1997/98, since then almost all companies in this geographical area exercise tight budget controls. The results suggest that no audit fee premium is accrued to Indonesian Big 5 auditors, in contrast to the large audit firm fee premium documented in many other countries.

Testing for market segmentation in the A and B share markets of China

Recent research has suggested that the A and B share markets of China may be informationally segmented. In this paper volatility patterns in the A and B share market are studied to establish whether volatility changes to the A and B share markets are synchronous. A consequence of new information, when investors act upon it is that volatility rises. This means that if the A and B markets are perfectly integrated volatility changes to each market would be expected to occur at the same time. However, if they are segmented there is no reason for volatility changes to occur on the same day. Using the iterative cumulative sum of squares across the different markets. Evidence is found of integration between the two A share markets but not between the A and B markets. © 2005 Taylor & Francis Group Ltd.

The relationship between market share and information in a high-tech industry

The role of information in high-technology markets is critical (Dutta, Narasimhan and Rajiv 1999; Farrell and Saloner 1986; Weiss and Heide 1993). In these markets, the volatility and volume of information present managers and researchers with the considerable challenge of monitoring such information and examining how potential customers may respond to it. This article examines the effects of the type and volume of information on the market share of different technological standards in the Local Area Networks (LAN) industry. We identify three different types of information: technological, availability and adoption. Our empirical application suggests that all three types of information have significant effects on the market share of a technological standard, but their direction and magnitude differ. More specifically, technology-related information is negatively related to market share as it demonstrates that the underlying technology is immature and still evolving. Both availability and adoption-related information have a positive effect on market share, but the former is larger than the latter. We conclude that high-tech firms should emphasize the dissemination of information, especially availability-related, as part of their promotional strategy for a new technology. Otherwise, they may risk missing an opportunity to achieve a higher share and establish their market presence.

A study of new product market search and user adoption

The research was carried out in the Aviation Division of Dunlop Limited and was initiated as a search for more diverse uses for carbon/carbon composites. An assumed communication model of adoption was refined by introducing the concept of a two way search after making cross industry comparisons of supplier and consumer behaviour. This research has examined methods of searching for new uses for advanced technology materials. Two broad approaches were adopted. First, a case history approach investigated materials that had been in a similar oosition to carbon/carbon to see how other material producing firms had tackled the problem. Second, a questionnaire survey among industrialists examined: the role and identity of material decision makers in different sized firms; the effectiveness of various information sources and channels; and the material adoption habits of different industries. The effectiveness of selected information channels was further studied by monitoring the response to publicity given to carbon/carbon. A flow chart has been developed from the results of this research which should help any material producing firm that is contemplating the introduction of a new material to the world market. Further benefit to our understanding of the innovation and adoption of new materials would accrue from work in the followino areas: "micro" type case histories; understanding more fully the role of product champions or promoters; investigating the phase difference between incremental and radical type innovations for materials; examining the relationship between the adoption rate of new materials and the advance of technology; studying the development of cost per unit function methods for material selection; and reviewing the benefits that economy of scale studies can have on material developments. These are all suggested areas for further work.

Regulating audit beyond the crisis:a critical discussion of the EU green paper

With the European Commission making global leadership claims in the field of audit regulation, the content of its 2010 Green Paper on ‘Audit Policy: Lessons from the Crisis’ warrants careful scrutiny. Important issues raised in the Green Paper include regulatory oversight, competition in the audit market, the dangers of having very few firms with the capacity to audit global transnational corporations, professional judgement, innovative audit practices and, last but not least, social responsibility. This article analyses the principal perspectives and assumptions underpinning the construction of the Green Paper. The aims are threefold: to enhance understanding of the contemporary regulatory mindset of the European Commission, contribute to policy debate and inspire future research.

Interactive data in financial reporting:the construction of the non-professional investor

The Securities and Exchange Commission (SEC) in the United States and in particular its immediately past chairman, Christopher Cox, has been actively promoting an upgrade of the EDGAR system of disseminating filings. The new generation of information provision has been dubbed by Chairman Cox, "Interactive Data" (SEC, 2006). In October this year the Office of Interactive Disclosure was created(http://www.sec.gov/news/press/2007/2007-213.htm). The focus of this paper is to examine the way in which the non-professional investor has been constructed by various actors. We examine the manner in which Interactive Data has been sold as the panacea for financial market 'irregularities' by the SEC and others. The academic literature shows almost no evidence of researching non-professional investors in any real sense (Young, 2006). Both this literature and the behaviour of representatives of institutions such as the SEC and FSA appears to find it convenient to construct this class of investor in a particular form and to speak for them. We theorise the activities of the SEC and its chairman in particular over a period of about three years, both following and prior to the 'credit crunch'. Our approach is to examine a selection of the policy documents released by the SEC and other interested parties and the statements made by some of the policy makers and regulators central to the programme to advance the socio-technical project that is constituted by Interactive Data. We adopt insights from ANT and more particularly the sociology of translation (Callon, 1986; Latour, 1987, 2005; Law, 1996, 2002; Law & Singleton, 2005) to show how individuals and regulators have acted as spokespersons for this malleable class of investor. We theorise the processes of accountability to investors and others and in so doing reveal the regulatory bodies taking the regulated for granted. The possible implications of technological developments in digital reporting have been identified also by the CEO's of the six biggest audit firms in a discussion document on the role of accounting information and audit in the future of global capital markets (DiPiazza et al., 2006). The potential for digital reporting enabled through XBRL to "revolutionize the entire company reporting model" (p.16) is discussed and they conclude that the new model "should be driven by the wants of investors and other users of company information,..." (p.17; emphasis in the original). Here rather than examine the somewhat illusive and vexing question of whether adding interactive functionality to 'traditional' reports can achieve the benefits claimed for nonprofessional investors we wish to consider the rhetorical and discursive moves in which the SEC and others have engaged to present such developments as providing clearer reporting and accountability standards and serving the interests of this constructed and largely unknown group - the non-professional investor.