product market competition and managerial slack this article analyzes the effect of product market competition on managerial incentives in contrast to hart 1983a i show that competition may actually exacerbate the incentive problem the difference in results derives from our different assumptions about managerial preferences the importance of assumptions about preferences suggests that we do not yet understand the precise mechanism through which competition affects incentives

tax asymmetries the cost of capital and investment some evidence from united kingdom panel data a measure of the cost of capital is developed that incorporates the dynamic effects of tax changes and tax asymmetries estimates of the cost of capital are made using an unbalanced panel of 1987 u k quoted companies over the period 1971 to 1984 there is wide cross sectional variation in the cost of capital the measure is used in estimating an equation where this cross sectional variation is found to be a significant determinant of the level of company investment copyright 1989 by royal economic society

reinsurance under conditions of capital market equilibrium a note having accepted a contingent liability under an insurance contract the insurer has an insurable interest in the subject of the insurance policy and can insure all or part of that liability with a second insurer this reinsurance agreement protects the first insurer known as the primary or ceding insurer against unusually large claims since it permits the risk to be broken down into smaller units which can be absorbed easily by individual insurers these agreements are commonly placed with other direct insurers and with specialist reinsurance companies usually holding internationally diversified portfolios the reinsurance agreement affects the risk return structure of the insurer s liability portfolio and consequently affects the risk return characteristics of the insurer s common stock the insurance literature has long assumed such reinsurance is an important procedure and much attention has been devoted to analyzing its use explicit statements of the objectives of reinsurance can be found in most insurance texts these texts commonly stress the portfolio risk effects of reinsurance that is the reduction in the probability of the failure or ruin of the insurance fund and the stabilization of returns to its owners 2 the subdivision of policies and the spreading of risk between insurers permits each insurer to hold a more completely diversified portfolio of liabilities than would be available without reinsurance apart from explicit statements the bulk of analytical literature on optimal reinsurance agreements has assumed risk reduction to be the objective in earlier works such as vajda 15 and ohlin 11 the benefits of reinsurance were identified in the reduction of the variance of the insurer s loss distribution subsequently writers such as borch 3 chs 1 11 buhlmann and jewell 5 du mouchel 6 and gerber 7 have used utility analysis to isolate the effects of reinsurance and to identify the properties of the optimal reinsurance treaty here reinsurance is studied as a bilateral risk reducing device arranged between two or more risk averse insurers the pareto condition has been evoked to define the optimality of a reinsurance treaty and not surprisingly it is shown to depend upon the form and parameters of the participating insurers utility functions the equilibrium conditions for reinsurance have also been established by borch 3

competition privatisation and productive efficiency evidence from the airline industry we use data from the airline industry to examine the extent to which the costs of airline operations are affected by rents accruing to workers and the extent to which these rents depend inter alia upon the degree of competition in the industry our empirical results based on a panel of twelve european and seven major united states airlines confirm that state ownership substantially increases rents to labour while the effects of competition are more subtle and ambiguous airline profits tend to be associated with higher rents to employees the gains from further privatisation and liberalisation may be quite large does competition have significant effects on productive as well as allocative efficiency convincing empirical answers to this question have been hard to find for two reasons first data of the quality required for robust estimation of productive efficiency are only rarely available secondly there is frequently no convincing standard against which the efficiency of an industry or a firm may be compared since when the degree of competition varies many other things such as technology network structures and firm sizes typically vary as well these problems do not automatically make comparison impossible but they compound the need for high quality data one industry which is likely to be well suited to investigating questions of this kind is the international airline industry the industry contains a large number of firms thus ensuring at least enough potential competition to make questions about the effects of competition interesting but the scope for these firms to compete with one another has been influenced to varying degrees over the years by different national and international regulatory regimes in particular deregulation of the united states industry in 1978 provided a kind of natural experiment that has led not only to comparisons of the before and after variety but also to comparisons between the united states industry and that of other global regions notably europe such comparisons are far from straightforward but they are facilitated by the fact that the technology of civil aviation is more or less internationally standardised and by the relatively high quality of available data in the industry

deregulating european airlines deregulating european airlines francis mcgowan and paul seabright one of the industries with the greatest potential to benefit from the single european market is civil aviation which has been highly regulated by european governments the deregulation of civil aviation in the us since the late 1970s has provided valuable evidence about the nature of the airline industry and its response to the liberalization of conditions of entry by new carriers we examine the us experience and look at the changing regulatory framework for the european industry we also consider the main sources of market failure in air transport the lessons of the us experience are threefold first deregulation can in principle produce major gains to consumers without damaging the long run profitability of carriers by reducing the high costs of operation of european airlines second congestion problems especially the availability of landing slots at airports need to be managed effectively to prevent incumbent carriers squeezing out new entrants we recommend a system of slot auctions to achieve this third in spite of relatively low sunk costs of entry to the industry there remain significant opportunities for the exercise of market power by incumbent carriers deregulation of entry needs therefore to be supplemented by a vigorous competition policy especially with regard to the approval of mergers

rent sharing in the european airline industry abstract to the extent that product market competition affects managerial incentives to control costs price cost margins offer a poor guide to the evaluation of market power we propose a method to evaluate simultaneously both market power and its pass through on cost we focus on rent sharing between unions and management as a mechanism through which costs are endogenised we develop and estimate a structural model of competition where wages are endogenously determined in the first stage with a price setting market game following in the second stage this structural model is then estimated using data for 8 european airlines from 1976 1990 we find a strong support for the hypothesis that lax competition induces extensive rent sharing through excessive wages

the impact of regulation on bank equity infusions abstract this article examines the extent to which regulatory capital standards influence infusions of external equity into commercial banks while such infusions occur infrequently they result in large adjustments to overall bank capital and provide important signals to regulators of managerial intent using a sample of 753 equity capital issues occurring during 1986 and 1987 we find evidence that regulatory minimum capital constraints are instrumental in influencing the financing decisions made by a significant subset of banks

predicting catastrophe risk evidence from catastrophe bond markets abstract compared to the past literature on prediction markets that uses small scale observational field data or experiments this present research examines the efficiency of such markets by studying catastrophe cat bonds we collect actual catastrophe loss data match them with the defined trigger events of each cat bond contract and then employ an empirical pricing framework to obtain the excess cat premiums in order to represent the market based forecasts our results indeed show that market based forecasts have more significant predictive content for future cat losses than professional forecasts that use natural catastrophe risk models although the predictive information for cat events is specialized and complex our evidence supports that cat bond markets are successful prediction markets that efficiently aggregate information about future cat losses our resultsalso highlight that actual cat losses in future periods can explain the excess cat bond spreads in the primary market and provide support for market efficiency when pricing cat risk

can insurers pay for the big one measuring the capacity of the insurance market to respond to catastrophic losses abstract this paper presents a theoretical and empirical analysis of the capacity of the us property liability insurance industry to finance catastrophic property losses in the 100 billion range in our theoretical analysis we show that the sufficient condition for capacity maximization given a level of total resources in the industry is for all insurers to hold a net of reinsurance underwriting portfolio which is perfectly correlated with aggregate industry losses this result leads to a natural definition of industry capacity as the amount of industry resources that are deliverable conditional on an industry loss of a given size estimating capacity using insurer financial statement data we find that the industry could adequately fund a 100 billion event however such an event would cause numerous insolvencies and severely destabilize insurance markets

corporation tax asymmetries and investment evidence from uk panel data theoretical work has emphasised the potentially powerful impact of corporation tax asymmetries on investment behaviour but empirical work has mainly been confined to the measurement of effective tax rates this paper uses panel data from 597 u k companies to ask are tax asymmetries important to understanding observed investment behaviour an optimising investment model is developed and estimated both as a q equation and a euler equation in which the cost of capital appears careful modelling of asymmetries does not noticeably improve the empirical performance of these equations possible explanations are discussed

price regulation in property liability insurance a contingent claims approach a discrete time option pricing model is used to derive the fair rate of return for the property liability insurance firm the rationale for the use of this model is that the financial claims of shareholders policyholders and tax authorities can be modeled as european options written on the income generated by the insurer s asset portfolio this portfolio consists mostly of traded financial assets and is therefore relatively easy to value by setting the value of the shareholders option equal to the initial surplus an implicit solution for the fair insurance price may be derived unlike previous insurance regulatory models this approach addresses the ruin probability of the insurer as well as nonlinear tax effects

adverse selection private information and lowballing in insurance markets recent contributions to the adverse selection literature have focused on a multiperiod competitive environment in this setting a clean distinction arises between the predictions of competing models cooper and hayes extend the model of rothschild and stiglitz to multiple periods the result is a self selecting equilibrium characterized by price highballing or systematically overcharging new business kunreuther and pauly suggest that information asymmetries between competing insurance firms render such price quantity policies infeasible their model results in a pooling equilibrium that is characterized by price lowballing or systematically undercharging new business our evidence is consistent with the kunreuther and pauly model and reveals the persistence of adverse selection in the automobile insurance market copyright 1990 by the university of chicago

price cutting in liability insurance markets this article analyzes alleged underpricing of general liability insurance prior to the mid 1980s liability insurance crisis the theoretical analysis considers whether moral hazard and or heterogeneous information for forecasting claim costs can cause some firms to price too low and depress other firms prices cross sectional analysis of insurer loss forecast revisions which should be greater for firms with low prices caused by moral hazard or heterogeneous information and premium growth provides evidence consistent with low pricing due to moral hazard but not heterogeneous information the evidence also implies that shifts in the loss distribution produced large industrywide forecast errors copyright 1994 by university of chicago press

the bank capital decision a time series cross section analysis this paper seeks to explain the dramatic decline in capital to asset ratios in u s commercial banks during the last two decades it is hypothesized that the rise in nominal interest rates during this period might have contributed substantially to the fall in capital ratios time series cross section estimation supports the hypothesis regarding the interest rate bank capital is the sum of equity plus debt subordinated to deposits capital provides a cushion that protects the bank from insolvency when the value of its assets falls a bank can meet its obligations to depositors as long as losses on its asset portfolio do not exceed its capital the ratio of capital to total assets in u s commercial banks has fallen dramatically in the last two decades dropping from 11 7 percent in 1961 to 5 7 percent in 1978 the lowest level since world war ijj1 figure 1 shows the decline in the ratio of capital to noncash assets these figures suggest that the federal deposit insurance corporation fdic and uninsured depositors are being exposed to increased probabilities of losses from bank insolvencies however relatively little empirical research has been devoted to the determinants of the bank capital decision further the existing work see for example peltzman 24 mingo 20 or mayne 17 18 uses only cross sectional data and therefore does not necessarily explain the decline in capital to asset ratios over time previous empirical research has also focused on book values rather than market values of debt and equity although market values provide better estimates of the protection afforded by capital this practice might be partly justified by the attention paid to book values by bank regulators however the increasing use of qualitative factors as well as book ratios in capital regulation indicates that regulators are aware of the deficiencies in book values many of the so called qualitative considerations are precisely the factors that distinguish market from book value 6 pp 78 80 finally difficulties arise over the proper measure of capital the empirical studies cited above treat equity and debt capital symmetrically both equity and assistant professor of finance economics boston university school of management this paper was originally written as part of a doctoral dissertation at m i t helpful suggestions from robert mcdonald richard schmalensee larry summers and edward j kane are gratefully acknowledged l these statistics are based on the market values of capital and assets the methods used to construct the market value series are described in the appendix capital asset ratios based on book values also have fallen over the period in question although not as severely

a reexamination of mean variance analysis of bank capital regulation abstract the mean variance framework has been used to analyze the effects of bank capital regulation on the asset and bankruptcy risk of insured utility maximizing banks this literature claims that more stringent capital regulation will increase asset risk and can increase bankruptcy risk these conclusions are notable because they are opposite to those obtained for insured value maximizing banks in this paper we show that the utility maximization literature does not support its conclusions regarding the effects of bank capital regulation because it has mischaracterized the bank s investment opportunity set by neglecting the option value of deposit insurance

taxation and the cost of capital the uk experience since the 1960s the uk has witnessed a series of reforms to its corporation tax system these include the creation of corporation tax as an independent tax in 1965 the gradual introduction of generous capital allowances in the early 1970s the introduction of the partial imputation system in 1973 and stock relief in 1975 and the 1984 reforms which reduced the tax rate and capital allowances and abolished stock relief a number of these reforms were designed with the specific intention of influencing company decisions regarding investment and finance through the real cost of capital

risk based capital adequacy standards for a sample of 43 major banks abstract the paper extends the option theoretic framework for the estimation of risk adjusted deposit premiums to the calculation of risk based capital adequacy standards based on market data for equity and the book value of debt the model solves for the market value of the capital infusion required to lower the implied deposit premium to acceptable levels of risk this capital infusion can then be translated into market value capital adequacy standards and book value capital asset ratios the determination of which is within the current statutory discretion of regulatory agencies the model is empirically applied to a sample of 43 major u s banks

regulation and incentives in european aviation we study the effect of liberalization on costs and competition in the european airline industry we construct and estimate a model that includes demand capacity and cost equations the latter accounts for inefficiency and cost reducing effort we show that failure to account for the choice of effort would lead to biased estimates of efficiency and competition in the industry we also find that the last european union package of deregulatory measures has led to significant efficiency improvements and has fostered competition

capital and risk in property liability insurance markets abstract this paper investigates the capital and portfolio risk decisions of property liability insurance firms a theoretical model based on option pricing theory is developed which predicts a positive relationship between insurer capital and risk as firms balance these two factors to achieve their desired overall insolvency risk the implications of the model are then tested empirically using a simultaneous equations methodology the results support the predictions of the model they also provide evidence that managerial incentives play a role in determining capital and risk in insurance markets the findings have significant implications for insurance solvency regulation

corporate tax incentives and capital structure new evidence from uk firm level tax returns abstract we investigate how companies capital structure is affected by corporate income taxes using confidential company level tax returns for a large sample of uk firms exploiting variation in companies marginal tax rates we find a positive and substantial long run tax effect on leverage leverage responds more to decreases in the marginal tax rate and it responds to changes in the marginal rather than the average tax rate most importantly we find that the marginal tax rate based on tax returns has greater explanatory power for companies leverage than the marginal tax rate based on financial statements our study suggests that errors in the measurement for tax incentives using financial statements could lead to underestimation of the tax effects on capital structure

investment behaviour of dutch industrial firms a panel data study abstract this study describes a putty clay model of investment for a monopolistic firm in which factor price movements also affect expected output the specifications are tested on a set of panel data for individual dutch industrial firms factor prices are significant and expected output effects of factor prices dominate substitution effects in investment demand corrections are made for attrition and for measurement errors correction for attrition does not make an important difference but correction for measurement errors does

capital controls and bank risk abstract we analyze the effects of deposit guarantees on banks loan portfolio in contrast to earlier work we view bank loans net of evaluation and monitoring costs as non zero npv investments e g market securities deposit guarantees lead to inefficient investment and under plausible circumstances capital requirement increases lead banks to increase asset risk the risk increase reduces the beneficial effects of capital increases on the probability of default and on the economic efficiency of bank lending in some cases a tightening of the capital constraint even leads to an increase in the probability of default and financial instability and to higher expected costs of transferring assets to regulatory agencies increases in bank capital are not a substitute for risk monitoring and control and may imply an increased need for such surveillance

capacity and product market competition measuring market power in a puppy dog industry abstract in this paper we specify and estimate a structural model which accounts for competition in two variables capacity and prices the model has a two stage setup in the first stage firms make capacity decisions followed by a product differentiated price setting game in the second stage since costs are endogenized through the first stage this has important implications for the measurement of market power in the product market in particular simpler one stage specifications would result in a bias in the measurement of market power which can be linked to the taxonomy for two stage games given in fudenberg and tirole 1984 fudenberg d tirole j 1984 the fat cat effect the puppy dog ploy and the lean and hungry look american economic review paper and proceedings 74 361 366 we then estimate this model demand cost short and long run and conduct for the european airline industry using data for the period of 1976 1990 we perform a number of specification tests and reject a simple one stage specification in favor of our two stage set up in particular we find that some degree of market power in the product market exists however market conduct in the two stage set up is significantly less collusive than in the more widely employed one stage specification which is consistent with the direction of bias in puppy dog games this illustrates that collusiveness of firms market conduct in the product market is significantly overestimated whenever capacity competition is not accounted for

capital regulation and bank risk taking a note abstract this paper examines theoretically the effects of more stringent capital regulation on bank asset portfolio risk the analysis shows that for a value maximizing bank incentives to increase asset risk decline as its capital increases thus as long as regulatory efforts to contain asset risk and size are not reduced more stringent capital regulation unambiguously reduces the expected liability of the deposit insurance system

endogenous costs and price cost margins an application to the european airline industry this paper allows for endogenous costs in the estimation of price cost margins in particular we estimate price cost margins when firms bargain over wages we extent the standard two equation set up demand and first order condition in the product market to include a third equation which is derived from bargaining over wages in this way price cost margins are determined by wages and vice versa we implement the model using data for eight european airlines from 1976 1994 and show that the treatment of endogenous costs has important implications for the measurement of price cost margins and the assessment of market power our main result is that observed prices in europe are virtually identical to monopoly prices even though observed margins are consistent with nash behavior apparently costs had been inflated to the point that the european consumers were faced with a de facto monopoly prices

the allocation of catastrophe risk the potential losses from catastrophes have led financial researchers to address the following questions 1 to what extent is catastrophe risk being shared insured and is the allocation of catastrophe risk consistent with notions of optimal risk sharing 2 if not what market imperfections hinder the efficient allocation of catastrophe risk and 3 are there government policies or private market solutions that could lead to a more efficient allocation of catastrophe risk this paper summarizes the research that has been conducted on these questions 2002 elsevier science b v all rights reserved

on the implications of introducing cross border loss offset in the european union abstract this article investigates a tax competition model where countries compete for capital and profits of multinational enterprises mnes through statutory tax rates and cross border loss offset provisions which allow a transfer of foreign subsidiaries losses to the parent company a joint implementation of full cross border loss relief is welfare maximizing because it ensures production efficiency and no profit shifting in equilibrium local governments choose zero level of the loss relief in a noncooperative equilibrium if only capital is mobile and relax the loss offset when mnes engage in profit shifting therefore allowing multinationals to undertake international tax planning activities may be welfare improving in our model

the effects of competition on executive behavior economists presume that competition spurs a firm to be more efficient by forcing it to reduce its agency problems this article investigates this presumption it finds that the effects of competition on executive behavior can be decomposed into four effects each of which is of potentially ambiguous sign theory thus offers no definitive defense of this presumption this article also derives sets of conditions under which increased competition has the presumed effect of reducing agency problems in some sets important conditions are that increased competition reduce the executive s expected income and that agency goods e g shirking be normal goods for the executive the article shows that an increase in the shareholder bargaining strength can both reduce the agency problem and make it more sensitive to competition