Feature Articles
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Volume 26, Issue 3, Fall 2017

Targeted advertising, platform competition, and privacy

Henk Kox, Bas Straathof, and Gijsbert Zwart

Targeted advertising can benefit consumers through lower prices for access to web sites. Yet, if consumers dislike that web sites collect their personal information, their welfare may go down. We study competition for consumers between web sites that can show targeted advertisements. We find that more targeting increases competition and reduces the web sites’ profits, but yet in equilibrium web sites choose maximum targeting as they cannot credibly commit to low targeting. A privacy protection policy can be beneficial for both consumers and web sites. If consumers are heterogeneous in their concerns for privacy, a policy that allows choice between two levels of privacy will be better. Optimal privacy protection takes into account that the more intense competition on the high-targeting market segment also benefits consumers on the less competitive segment. Consumer surplus is maximized by allowing them a choice between a high-targeting regime and a low-targeting regime which affords more privacy.

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The effects of major U.S. domestic airline code sharing and profit sharing rule

Caixia Shen

This paper presents a structural model of code sharing among major U.S. domestic airlines and estimates a profit-sharing rule. The profit-sharing rule between partner firms in code sharing is estimated at 0.92, which suggests that the operating carrier acquires around 92% of profits from a round-trip, and the marketing carrier retains 8% as a commission fee. Meanwhile, the economies of code sharing reduces marginal cost, and firms are able to price at higher markups. This implies that demand increases and consumers have larger surplus if code sharing creates new products.

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Recently Published Articles

Volume 26, Issue 2, Summer 2017

Privacy Is Precious: On the Attempt of Lifting Anonymity on the Internet to Increase Revenue

Tobias Regner and Gerhard Riener
We investigate the effect of a reduction of anonymity on consumers' purchase decisions (whether to buy, and if so how much to pay) at an online music store with Pay-What-You-Want (PWYW)-like pricing and in an Internet experiment mimicking the real world situation. Our results suggest that the positive effect of reduced anonymity, previously established for donation or public goods contexts, does not extend to a consumption environment.

A Map of Markups: Why We Observe Mixed Behaviors of Markups

Seong-Hoon Kim and Seongman Moon
This paper proposes an explanation for mixed evidence on the behaviors of markups. The key mechanism consists of two complementary channels through which firms handle uninsurable business losses.

Punishment Motives for Small and Big Lies

Gerald Eisenkopf, Ruslan Gurtoviy, and Verena Utikal
Corporate fraud typically involves deceptive financial statements that are harmful for some stakeholders. We analyze how preferences for honesty and economic fairness shape the punishment of such untruthful statements. Our results suggest that popular demand for punitive measures in case of financial scandals reflects a genuine interest in the enforcement of social norms.

Honest versus Misleading Certification

Philippe Mahenc
This paper questions the honesty of third-party certification in the market for a good whose environmental quality is not observable by consumers. I show that certification can only be honest when the certifier is driven more by social welfare than by profit. In the reverse case, the certifier cannot help jamming the price signal, thereby granting unreliable labels.

Optimal Loyalty-Based Management

Dongsoo Shin
This paper studies an agency model in which an entrepreneur selects a manager from a candidate set. The selected manager's effort improves the project's potential environment, and is a hidden action. The realized project environment is the entrepreneur's private information.

Bailing on the Car That Was Not Bailed Out: Bounding Consumer Reactions to Financial Distress

Cristian Huse, Nikita Koptyug
This paper examines how consumers react to the financial distress of durable goods manufacturers by studying the Swedish new car market.

Vertical Integration and Firm Productivity

Hongyi Li, Yi Lu, Zhigang Tao
This paper uses three cross-industry datasets from China and other developing countries to study the effect of vertical integration on firm productivity. Our findings suggest that vertical integration has a negative impact on productivity, in contrast to recent studies based on U.S. firms. We argue that in settings with poor corporate governance, vertical integration reduces firm productivity because it enables inefficient rent-seeking by insiders.

The Quality of Institutions and Organizational Form Decisions: Evidence from Within the Firm

Francine Lafontaine, Rozenn Perrigot, Nathan E. Wilson
We use data on the operations of a multinational, multibrand hotel company to show that in environments where local institutions are weaker—as proxied mainly by the World Bank's Checks index—the company eschews direct ownership. Rather than increasing its reliance on franchising, as predicted by some models, the company relies more on another form of organization commonly used in this industry, namely management contracts.

Measuring Consumer Preferences for Video Content Provision Via Cord-Cutting Behavior

Jeffrey Prince, Shane Greenstein
The television industry is undergoing a generational shift in structure; however, many demand-side determinants are still not well understood. We model how consumers choose video content provision among over-the-air (OTA), paid subscription to cable or satellite, and online streaming (also known as over-the-top, or OTT).

Volume 26
Issue 1

Volume 26, Issue 1, Spring 2017

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Input Hedging, Output Hedging, and Market Power

David De Angelis, S. Abraham Ravid
We argue that commodity input hedging is different from commodity output hedging. Output hedging can be detrimental to “sector play.” Furthermore, firms with market power that hedge outputs have incentives to over-produce and distort market prices. In rational markets, such hedging will be expensive and we expect to see a negative relationship between hedging and market power in “output industries” but not in “input industries.” We test these predictions on a sample of S&P500 firms from 2001 to 2005. Our results support both hypotheses. Placebo tests show that the same empirical regularities do not apply to currency hedging. Finally, our empirical framework, which differentiates between hedging inputs and hedging outputs, can also help in reconciling conflicting results in prior studies.
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Firm-Driven Management of Longevity Risk: Analysis of Lump-Sum Forward Payments in Japanese Nursing Homes

Shinya Sugawara
This study analyzes a unique economic circumstance of longevity risk management in the Japanese private nursing home market. This circumstance takes the form of a lump-sum forward payment of lifetime rent by residents, which leaves most longevity risk to be covered by homes. To analyze this circumstance, I construct a structural econometric model of industrial organization for this market. For the underlying structure of longevity risk, I assume that both individual consumers and nursing homes utilize the subjective evaluation. My empirical analysis detects excess payments that can be compensated for only by an unrealistically long stay in nursing homes. This finding implies the existence of the exaggerated evaluation of longevity by economic agents. Thus, appropriate government intervention to help hedge longevity risk might improve social welfare.
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Selective Hearing: Physician-Ownership and Physicians’ Response to New Evidence

David H. Howard, Guy David, Jason Hockenberry
Physicians, acting in their role as experts, are often faced with situations where they must trade off personal and patient welfare. Physicians’ incentives vary based on the organizational environment in which they practice. We use the publication of a major clinical trial, which found that a common knee operation does not improve outcomes for patients with osteoarthritis, as an “informational shock” to gauge the impact of physicians’ agency relationships on treatment decisions. Using a 100% sample of procedures in Florida from 1998 to 2010, we find that publication of the trial reduced procedure volume, but the magnitude of the decline was smaller in physician-owned surgery centers. Incentives affected physicians’ reactions to evidence.
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Competition with Aftermarket Power When Consumers Are Heterogeneous

Dainis Zēgners, Tobias Kretschmer
We study a model of competitive foremarkets and partly monopolized aftermarkets. We show that high aftermarket power prompts firms to engage in inefficiently aggressive below-cost pricing in the foremarket. This inefficiency is driven by the presence of consumers with valuations below marginal cost. While for intermediate aftermarket power their presence leads to a competition-softening effect, for high aftermarket power firms attract increasing numbers of unprofitable consumers by aggressively pricing below cost. For high aftermarket power, firms' equilibrium profits can therefore be decreasing in aftermarket power but are always higher than for low aftermarket power. If firms engage in price discrimination by bundling the foremarket and aftermarket goods or by reducing their aftermarket power, they avoid selling to unprofitable consumers but also reduce the competition-softening effect. This decreases firms' equilibrium profits but increases consumer and social welfare.
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Do Dominant Firms Provide More Training?

Christos Bilanakos, Colin P. Green, John S. Heywood, and Nikolaos Theodoropoulos
A canonical Cournot competition model shows that the profitability of training can increase as the number of competitors decreases. British establishment evidence from 1998, 2004, and 2011 confirms that firms in less competitive markets provide more formal training. This persists within three separate cross-sections and in two separate panel estimates. It persists with alternative measures of training, with alternative measures of market competition and in estimates designed to account for endogeneity. These results suggest that a dominant product market position, indeed, increases the incentives to invest in training.
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Information Acquisition and the Equilibrium Incentive Problem

Alice Peng-Ju Su
I study the optimal incentive provision in a principal–agent relationship with costly information acquisition by the agent. I emphasize that adverse selection or moral hazard is the principal's endogenous choice by inducing or deterring information acquisition. The principal designs the contract not only to address an existing incentive problem but also to implement its presence. Implementation of adverse selection relies on a steeper information rent to the agent than the standard menu, such that the agent is motivated to distinguish the efficient state of nature from the inefficient. Moral hazard is implemented by replacing the benchmark debt contract with a debt-with-equity-share contract, such that the agent does not attempt to acquire information to either avoid debt or to extract rent.
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Taking the Leap: The Determinants of Entrepreneurs Hiring Their First Employee

Robert W. Fairlie and Javier Miranda
Job creation is one of the most important aspects of entrepreneurship, but we know relatively little about the hiring patterns and decisions of start-ups. Longitudinal data from the Integrated Longitudinal Business Database (iLBD), Kauffman Firm Survey (KFS), and the Growing America through Entrepreneurship (GATE) experiment are used to provide some of the first evidence in the literature on the determinants of taking the leap from a nonemployer to employer firm among start-ups. Several interesting patterns emerge regarding the dynamics of nonemployer start-ups hiring their first employee. Hiring rates among the universe of nonemployer start-ups are very low, but increase when the population of nonemployers is focused on more growth-oriented businesses such as incorporated and employer identification number businesses. If nonemployer start-ups hire, the bulk of hiring occurs in the first few years of existence. After this point in time, relatively few nonemployer start-ups hire an employee. Focusing on more growth- and employment-oriented start-ups in the KFS, we find that Asian-owned and Hispanic-owned start-ups have higher rates of hiring their first employee than white-owned start-ups. Female-owned start-ups are roughly 10 percentage points less likely to hire their first employee by the first, second, and seventh years after start-up. The education level of the owner, however, is not found to be associated with the probability of hiring an employee. Among business characteristics, we find evidence that business assets and intellectual property are associated with hiring the first employee. Using data from the largest random experiment providing entrepreneurship training in the United States ever conducted, we do not find evidence that entrepreneurship training increases the likelihood that nonemployers hire their first employee.
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Venture Capital Investments in Europe and Portfolio Firms' Economic Performance: Independent Versus Corporate Investors

Massimo G. Colombo and Samuele Murtinu
Using a new European Commission-sponsored longitudinal dataset—the VICO dataset—we assess the impact of independent (IVC) and corporate venture capital (CVC) investments on the economic performance of European high-tech entrepreneurial firms during the period 1992–2010. After controlling for potential sources of endogeneity and selection bias, our results indicate that both IVC and CVC investments boost portfolio firms' economic performance. These effects are mostly due to an increase in real sales value. Moreover, the dynamics of the impact of VC investments on firms’ overall economic performance and its components—real sales value, real fixed assets, and real labor costs—differs depending on the type of investor. Finally, we do not detect any impact related to the syndication of investments by both IVC and CVC investors.
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Voluntary Assurance of Voluntary CSR Disclosure

Mark Bagnoli and Susan G. Watts
We study a firm's decisions to engage in socially responsible activities, voluntarily report on them, and purchase external assurance of the report. In our signaling model, neither firm type nor the level of activity is observed. We show that if voluntary assurance is not too expensive, the firm that engages in more socially responsible activities purchases external assurance and thus “selects” a separating equilibrium. As a result, CSR reports can be used to infer the level of activity and this causes all firms to engage in more socially responsible activity. Further, when voluntary assurance is required to support a separating equilibrium, greater monitoring by social activists increases the chosen quality of voluntary assurance—voluntary assurance and monitoring by social activists are complements, not substitutes.

Volume 25
Issue 4

Volume 25, Issue 4, Winter 2016

The Effect of Performance Standards on Health Care Provider Behavior: Evidence from Kidney Transplantation

Sarah S. Stith, Richard A. Hirth
Performance standards are designed to ensure a basic level of quality, and through public reporting of firm performance, encourage firms to compete on quality thus allowing the market to determine the optimal level of quality. In a context of excess demand induced by price controls, we show that information alone has no impact and enforcement may actually increase market inefficiencies; firms respond to costly quality requirements, not by improving quality, but by reducing supply, which exacerbates the disequilibrium between supply and demand, and by cream-skimming, which reduces access to transplantation among sicker patients.

Bargains Followed by Bargains: When Switching Costs Make Markets More Competitive

Jason Pearcy
In markets where consumers have switching costs and firms cannot price-discriminate, firms have two conflicting strategies. A firm can either offer a low price to attract new consumers and build future market share or a firm can offer a high price to exploit the partial lock-in of their existing consumers. This paper develops a theory of competition when overlapping generations of consumers have switching costs and firms produce differentiated products. Unlike previous studies, this paper demonstrates that the number of firms also determines whether switching costs are pro- or anticompetitive, and with a sufficiently large (small) number of firms switching costs are pro- (anti-) competitive.

When Does Aftermarket Monopolization Soften Foremarket Competition?

Yuk-fai Fong, Jin Li, Ke Liu
This paper investigates firms' abilities to tacitly collude when they each monopolize a proprietary aftermarket. When firms' aftermarkets are completely isolated from foremarket competition, they cannot tacitly collude more easily than single-product firms. However, when their aftermarket power is contested by foremarket competition as equipment owners view new equipment as a substitute for their incumbent firm's aftermarket product, profitable tacit collusion is sustainable among a larger number of firms. Conditions under which introduction of aftermarket competition hinders firms' ability to tacitly collude are characterized.

Advertising Media Planning, Optimal Pricing, and Welfare

Lola Esteban, José M. Hernández
This paper analyzes optimal media planning strategies in a pricing-advertising competition model where firms can use mass and specialized advertising. We find that although targeted advertising avoids the wasting of ads, firms might find it optimal to mix specialized advertising with the mass media. We also show that the characteristics of the specialized media available crucially affect the outcome of price competition between firms, which can range from a full fragmentation of the market into local monopolies to lower average prices (compared to the case where firms had only mass advertising available). Regarding welfare, we prove that although the use of specialized advertising can lower consumer surplus and drive a fragment of consumers out of the market, this advertising technology is welfare-improving, and can be Pareto superior.

Autonomy and Monitoring

Marco a. Barrenechea-méndez, Pedro Ortín-Ángel, Eduardo C. Rodes
This paper provides a theoretical and empirical analysis of an under-explored consequence of granting autonomy to workers: monitoring. In the principal-agent model that we develop, granting autonomy allows workers to carry out innovative tasks in the workplace. Given that innovative tasks are more difficult to monitor, the model predicts a positive relationship between autonomy and monitoring. Relying on information about blue-collar workers coming from a dataset of Spanish industrial plants, we provide strong support for this prediction.

Role of Information Rents in Relational Contracts

Akifumi Ishihara
We study a repeated contracting model in which the agent has private information and the performance measure is unverifiable. In an optimal stationary contract, when the discount factor is not high, the principal's objective shifts from purely reducing the information rent toward increasing the total surplus to sustain the relational contract. As a result, the total surplus is not monotonically increasing in the discount factor and could decrease when the unverifiable performance measure becomes verifiable.

Team Incentives and Reference-Dependent Preferences

Kohei Daido, Takeshi Murooka
We investigate a multi-agent moral-hazard model where agents have expectation-based reference-dependent preferences à la Kőszegi and Rabin (2006, 2007). We show that even when each agent's probability of success in a project is independent, a principal may employ team incentives. Because the agents are loss averse, they have first-order risk aversion to wage uncertainty. This causes the agents to work harder when their own failure is stochastically compensated through other agents' performance. In the optimal contract, agents with high performance are always rewarded, whereas agents with low performance are rewarded if and only if other agents' performance is high.

The Role of Public Information in Corporate Social Responsibility

Aleix Calveras, Juan-José Ganuza
Many of the attributes that make a good “socially responsible” (SR) are credence attributes that cannot be learned by consumers either through search or experience. We show both that in more transparent markets a larger number of firms will be SR, and that in a market with more intense competition, a higher degree of transparency is required in order to sustain a given number of SR firms.

Imminent Entry and the Transition to Multimarket Rivalry in a Laboratory Setting

Charles F. Mason, Owen R. Phillips
In this paper we study the behavior of rivals when there is a known probability of imminent entry. Experimental markets are used to collect data on pre- and postentry production when there is an announced time of possible entry; some markets experience entry and other do not. In all preentry markets competition is more intense. Postentry behavior in all markets is more competitive compared to a baseline that had no threat. There is evidence that postentry multimarket contact raises outputs in those markets that did not experience entry, behavior we generally refer to as a conduit effect.