Issue 3

Volume 24 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Fall 2015

Product Unbundling in the Travel Industry: The Economics of Airline Bag Fees

Jan K. Brueckner, Darin N. Lee, Pierre M. Picard, and Ethan Singer
This paper provides theory and evidence on airline bag fees, offering insights into a real-world case of product unbundling. The theory predicts that an airline's fares should fall when it introduces a bag fee, but that the full-trip price (the bag fee plus the new fare) could either rise or fall. The empirical evidence presented in the paper provides strong confirmation of the first prediction. The data also suggest that the average fare falls by less than the bag fee itself so that the full price of a trip rises for passengers who choose to check bags.

Altruism and Relational Incentives in the Workplace

Robert Dur and Jan Tichem
This paper studies how altruism between managers and employees affects relational incentive contracts. To this end, we develop a simple dynamic principal–agent model where both players may have feelings of altruism or spite toward each other. The contract may contain two types of incentives for the agent to work hard: a bonus and a threat of dismissal. We find that altruism undermines the credibility of a threat of dismissal but strengthens the credibility of a bonus. Among others, these two mechanisms imply that higher altruism sometimes leads to higher bonuses, whereas lower altruism may increase productivity and players' utility in equilibrium.

Management Changes, Reputation, and “Big Bath”—Earnings Management

Petra Nieken and Dirk Sliwka
We study the effects of managerial turnover on earnings management activities in a model in which managers care about their external reputation. We develop an overlapping generations model showing that both outgoing and incoming managers bias reported earnings such that typically very low returns are reported in the first period after a manager has been replaced. Outgoing managers shift earnings forward to their last period in office as they will not benefit from earnings realized after that. Incoming managers can have an incentive to shift earnings to the second period in office as reported earnings will, immediately after a management change, only be partly attributed to their own ability. Deferred compensation can reduce incentives for earnings management.

Price Discrimination under Customer Recognition and Mergers

Rosa-Branca Esteves and Helder Vasconcelos
This paper studies the interaction between horizontal mergers and price discrimination by endogenizing the merger formation process in the context of a repeated purchase model with two periods and three firms wherein firms may engage in behavior-based price discrimination (BBPD). From a merger policy perspective, this paper's main contribution is twofold. First, it shows that when firms are allowed to price discriminate, the (unique) equilibrium merger gives rise to significant increases in profits for the merging firms (the ones with information to price discriminate), but has no ex-post effect on the outsider firm's profitability, thereby eliminating the so-called (static) “free-riding problem.” Second, this equilibrium merger is shown to increase industry profits at the expense of consumers' surplus, leaving total welfare unaffected. This then suggests that competition authorities should scrutinize with greater zeal mergers in industries where firms are expected to engage in BBPD.

Consumer Standards as a Strategic Device to Mitigate Ratchet Effects in Dynamic Regulation

Raffaele Fiocco and Roland Strausz
Strategic delegation to an independent regulator with a pure consumer standard improves dynamic regulation by mitigating ratchet effects associated with short-term contracting. A pure consumer standard alleviates the regulator's myopic temptation to raise output after learning the firm is inefficient. Anticipating this tougher regulatory behavior, efficient firms find it less attractive to exaggerate costs. This reduces the need for long-term rents and mitigates ratchet effects. A welfare standard biased toward consumers entails, however, allocative costs arising from partial separation of the firms' cost types. A trade-off results, which favors strategic delegation when efficient firms are relatively likely.

Information Sharing in Contests

Dan Kovenock, Florian Morath and Johannes Münster
We study the incentives to share private information ahead of contests, such as markets with promotional competition, procurement contests, or research and development (R&D). We consider the cases where firms have (i) independent values and (ii) common values of winning the contest. In both cases, when decisions to share information are made independently, sharing information is strictly dominated. With independent values, an industry-wide agreement to share information can arise in equilibrium. Expected effort is lower with than without information sharing. With common values, an industry-wide agreement to share information never arises in equilibrium. Expected effort is higher with than without information sharing.

Endowment Origin, Demographic Effects, and Individual Preferences in Contests

Curtis R. Price and Roman M. Sheremeta
In modern firms the use of contests as an incentive device is ubiquitous. Nonetheless, experimental research shows that in the laboratory subjects routinely make suboptimal decisions in contests even to the extent of making negative returns. The purpose of this study is to investigate how earning the endowment, demographic differences, and individual preferences impact behavior in contests. To this end, we conduct a laboratory experiment in which subjects expend costly resources (bids) to attain an award (prize). In line with other laboratory studies of contests, our results show that subjects overbid relative to theoretical predictions and incur substantial losses as a result. Making subjects earn their initial resource endowments mitigates overbidding and thus increases efficiency. Overbidding is linked to gender, with women bidding higher than men and having lower average earnings. Other demographic information, such as religiosity, and individual preferences, such as preferences toward winning and risk, also influence behavior in contests.

Vertical Foreclosure Using Exclusivity Clauses: Evidence from Shopping Malls

Itai Ater
Exclusive contracts are one of the most controversial topics in the economic analysis of antitrust. Yet, very few empirical papers analyze the determinants and the consequences of exclusive contracts. In this paper, I study exclusive contracts between hamburger restaurants and Israeli shopping malls, in which mall owners commit to prohibiting additional hamburger restaurants from entering their malls. I investigate the determinants of these exclusive contracts and examine how such contracts affect the number of hamburger restaurants and their sales. I show that exclusive contracts are less likely to be adopted in larger malls, in malls that face more competition from other malls, and in malls that opened before 1993, when McDonald's and Burger King entered the Israeli market. I then use the mall's opening year—before or after 1993—as an instrumental variable to estimate a negative effect of exclusive contracts on the number of restaurants and on total mall hamburger sales. My findings are generally consistent with anti-competitive vertical foreclosure models.

Doing Well by Doing Good? Community Development Venture Capital

Anna Kovner and Josh Lerner
This paper examines the investments and performance of community development venture capital (CDVC). We find substantial differences between CDVCs and traditional VCs: CDVC investments are far more likely to be in nonmetropolitan regions and in regions with little prior venture activity. CDVC investments are likely to be in earlier stage investments and in industries outside the venture capital mainstream that have lower probabilities of successful exit. Even after controlling for this unattractive transaction mixture, the probability of a CDVC investment being successfully exited is lower. One benefit of CDVCs may be their effect in bringing traditional VCs to underserved regions—controlling for the presence of traditional VC investments, each additional CDVC investment results in an additional 0.06 new traditional VC firms in a region.

Odd Prices at Retail Gasoline Stations: Focal Point Pricing and Tacit Collusion

Matthew S. Lewis
This study empirically investigates the theory that odd-numbered pricing points can be used as focal points to facilitate tacit collusion. Like other retailers, gasoline stations in the United States disproportionately sell at prices ending in odd digits. I show that station prices are higher and change less frequently in locations using more odd prices (particularly those ending in 5 or 9), even after controlling for other market characteristics. The evidence suggests that the use of pricing points can be an effective mechanism for tacitly coordinating prices, providing an alternative explanation for the widespread use of odd prices in retail markets.