empirical evidence on the relation between stock option compensation and risk taking abstract we examine whether executive stock options esos provide managers with incentives to invest in risky projects for a sample of oil and gas producers we examine whether the coefficient of variation of future cash flows from exploration activity our proxy for exploration risk increases with the sensitivity of the value of the ceo s options to stock return volatility eso risk incentives both eso risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach we find evidence that eso risk incentives has a positive relation with future exploration risk taking additional tests indicate that eso risk incentives exhibits a negative relation with oil price hedging in a system of equations where eso risk incentives and hedging are allowed to be endogenously determined overall our results are consistent with esos providing managers with incentives to mitigate risk related incentive problems

pricing and patents of hiv aids drugs in developing countries this article provides empirical evidence on the impact of patents on drug prices across developing countries it uses sales data on human immunodeficiency virus hiv acquired immuno deficiency syndrome aids drugs in a sample of 34 low and middle income countries between 1995 and mid 2000 the main findings are that patents do shift drug prices up drug prices are correlated to per capita income levels and drug firms follow a skimming strategy when pricing new hiv aids drugs that is there is across country and intertemporal price discrimination in the global drug markets

the measurement of retail output and the retail revolution the computerization of retailing has made price dispersion a norm in the united states so that any given list price or transactions price is an increasingly imperfect measure of a product s resource cost as a consequence measuring the real output of retailers has become increasingly difficult food retailing is used as a case study to examine data problems in retail productivity measurement crude direct measures of grocery store output suggest that the cpi for food at home may have been overstated by 1 4 percentage points annually from 1978 to 1996 this abstract was borrowed from another version of this item

on the application of mathematics to political economy the edgeworth walras bortkievicz controversy 1889 1891 in the period of the first spread and consolidation of mathematical economics there was impotant debate on walras s theory of exchange involving edgeworth walras and bortkievicz directly and marshall indirectly the dispute may be traced back to issues involving the role of abstract reasoning and the use of mathematics in economics the discussion reveals the clash of different methodological requirements on the one hand there is walras s requirement of rigour and simplicity allowed by the reduction of economics to mathematical treatment on the other hand there is edgeworth s requirement of greater realism in the model copyright 2007 oxford university press

human capital bankruptcy and capital structure we derive a firm s optimal capital structure and managerial compensation contract when employees are averse to bearing their own human capital risk while equity holders can diversify this risk away in the presence of corporate taxes our model delivers optimal debt levels consistent with those observed in practice it also makes a number of predictions for the cross sectional distribution of firm leverage consistent with existing empirical evidence it implies persistent idiosyncratic dierences in leverage across firms an important new empirical prediction of the model is that ceteris paribus firms with more leverage should pay higher wages

group cost of living indexes when households have different consumption patterns whose cost of living should an actual price index represent this issue was first raised by j l nicholson and s j prais in the 1950 s both made essentially the same point official price indexes give each household s consumption pattern an implicit weight proportional to its total expenditures see nicholson p 540 prais calls such an index plutocratic and both nicholson and prais suggest an alternative democratic price index which gives all households equal weight a group cost of living index is an index that measures the impact of price changes on the welfare of a group or population of households to define such an index requires an explicit or implicit concept of the welfare of a group and hence requires interpersonal comparison and distributional judgments since group indexes such as the consumer price index play an important role in our perception of inflation and the formation of macro economic policy and are used to escalate wages and social security benefits they have significant effects on government decisions and economic welfare despite their intellectual interest and practical importance however until recently they have been virtually ignored by index number theorists the theory of the cost of living index cli provides a generally accepted framework for measuring the impact of price changes on the welfare of a particular household this paper extends the cli concept to groups and discusses which questions require group indexes and which do not i begin by introducing some notation and terminology in the context of household clis a household s cli is the ratio of the expenditures required to attain a particular base indifference curve in two price situations suppose there are n goods and s households and denote the preference ordering of the rth household by r r the base indifference curve can be identified by a goods collection xro which lies on it the expenditure function er p xr rr shows the minimum expenditure required to attain the base indifference curve at prices p the cli of the rth household ir pa pb xrorr is the ratio of the minimum expenditure required to attain the base indifference curve at prices pa comparison prices to that required at prices pb reference prices except in very special cases the value of the cli depends on the base indifference curve at which it is evaluated as successively higher base indifference curves are specified one would expect the prices of luxuries to become more important relative to the prices of necessities hence it is convenient to regard the cli as a function of the base indifference curve rather than as a single number corresponding to a particular base thus instead of offering guidance in choosing an appropriate base indifference curve theory suggests that there is no need to choose to construct the exact cli an investigator needs to know the household s preferences lacking this knowledge he rnust fall back on indexes which require less information and which are upper bounds on the exact index the laspeyres index jr papbxrb is the ratio of the cost of purchasing the reference period consumption basket at comparison prices to its cost

managerial incentives risk aversion and debt we investigate the risk choices of risk averse ceos following recent theoretical work we expect ceo risk aversion to be more pronounced in firms with high leverage or high default probability we find that the ceos of these firms reduce firm risk even in the presence of strong risk taking incentives our results are robust to controls for the sensitivity of ceo wealth to stock price changes firm risk determinants the endogenous feedback effects of firm risk on ceo incentives unobserved firm and market effects and debt governance the impact of ceo risk aversion is economically significant

leverage decision and manager compensation with choice of effort and volatility abstract we study the incentive effects of granting levered or unlevered stock to a risk averse manager the stock is granted by risk neutral shareholders who choose leverage and compensation level the manager applies costly effort and selects the level of volatility both of which affect expected return the results are driven by the attempt of the risk neutral shareholders to maximize the value of their claims net of the compensation package we consider a dynamic setting and find that levered stock is optimal for high type managers firms with high momentum large firms and firms for which additional volatility only implies a modest increase in expected return

the volatility and price sensitivities of managerial stock option portfolios and corporate hedging we use estimates of the black scholes sensitivity of managers stock option portfolios to stock return volatility and the sensitivity of managers stock and stock option portfolios to stock price to test the relationship between managers risk preferences and hedging activities we find that as the sensitivity of managers stock and stock option portfolios to stock price increases firms tend to hedge more however as the sensitivity of managers stock option portfolios to stock return volatility increases firms tend to hedge less one of the agency costs associated with the corporate form of ownership comes from the risk aversion of the firm s managers the typical corporate manager has a significant portion of his or her wealth invested in the corporation both through portfolio holdings and the value of firm specific human capital as a result managers have an incentive to reduce firm risk more than may be desirable from the perspective of an unaffiliated diversified shareholder one way to mitigate managerial risk aversion is to provide the manager with contracts that have a payoff structure that is a convex function of the firm s stock price smith and stulz 1985 guay 1999 finds that stock options are an important way in which convexity is added to managers portfolios however as recognized by carpenter 2000 and lambert larcker and verrecchia 1991 stock options create two opposing effects on managerial incentives the first effect is sensitivity to stock return volatility due to the convex payoff structure of options the value of a manager s stock option portfolio increases with the volatility of the firm s stock returns this sensitivity to stock return volatility should ceteris paribus give the manager an incentive to take more risk the second effect is sensitivity to stock price this effect comes from the direct link between the payoff of an option and

medical care costs how much welfare loss hardly a week goes by without a front page newspaper article on rising health care costs and the uninsured in this article i focus mainly on costs arguing that the issue has been somewhat misconceived while the level of medical care spending in the u s is a cause for concern the welfare losses associated with rises in that level of spending may not be as large as the public rhetoric can make them seem in fact cost containment may not be as urgent as is widely supposed and some proposed cost containment policies may result in welfare losses for the insured and even increase the number of uninsured

the sensitivity of ceo wealth to equity risk an analysis of the magnitude and determinants abstract to control risk related incentive problems equity holders are expected to manage both the convexity and slope of the relation between firm performance and managers wealth i find stock options but not common stockholdings significantly increase the sensitivity of ceos wealth to equity risk cross sectionally this sensitivity is positively related to firms investment opportunities this result is consistent with managers receiving incentives to invest in risky projects when the potential loss from underinvestment in valuable risk increasing projects is greatest firms stock return volatility is positively related to the convexity provided to managers suggesting convex incentive schemes influence investing and financing decisions

are medical prices declining evidence from heart attack treatments we address long standing problems in measuring medical inflation by estimating two types of price indices the first a service price index prices specific medical services as does the current cpi the second a cost of living index measures a quality adjusted cost of treating a health problem we apply these indices to heart attack treatment between 1983 and 1994 more frequent reweighting and accounting for price discounts lowers the measured price change for heart attacks by three percentage points annually accounting for quality change lowers it further we estimate that the real cost of living index fell about 1 percent annually

the match between ceo and firm we investigate the role of job match heterogeneity in the ceo labor market we document a high percentage of ceo turnovers in the early years of tenure as illustrated by the hazard that increases until the fifth year of ceo tenure and then decreases evidence suggests that a good match is more likely if the new ceo performs better than the previous ceo the best matches tend to occur when inside outside ceos follow previous ceos who quit are dismissed evidence consistent with match theory in the ceo labor market suggests factors that influence the likelihood of observing a good match

the impact of performance based compensation on misreporting abstract this paper examines the effect of ceo compensation contracts on misreporting we find that the sensitivity of the ceo s option portfolio to stock price is significantly positively related to the propensity to misreport we do not find that the sensitivity of other components of ceo compensation i e equity restricted stock long term incentive payouts and salary plus bonus have any significant impact on the propensity to misreport relative to other components of compensation stock options are associated with stronger incentives to misreport because convexity in ceo wealth introduced by stock options limits the downside risk on detection of the misreporting

between berlin and cambridge classical conceptions of the general economic equilibrium in the late 1920s this paper deals with some contributions to the debate on general economic equilibrium between the two world wars originating in cambridge and berlin they differed from the viennese contributions of the walrasian perspective traditionally considered by the literature they can be defined to represent the classical approach to general equilibrium the authors considered are the italian born economist piero sraffa the german mathematician robert remak and the russian born economist wassily leontief the paper focuses in particular on the intellectual origins of their contributions in the russian german theoretical debate of the period 1890 1910 involving classical economists marx and walras these connections emerge clearly in the contributions of the german russian mathematical school between the end of the nineteenth and the beginning of the twentieth centuries

executive compensation and the maturity structure of corporate debt executive compensation influences managerial risk preferences through executives portfolio sensitivities to changes in stock prices delta and stock return volatility vega large deltas discourage managerial risk taking while large vegas encourage risk taking theory suggests that short maturity debt mitigates agency costs of debt by constraining managerial risk preferences we posit and find evidence of a negative positive relation between ceo portfolio deltas vegas and short maturity debt we also find that short maturity debt mitigates the influence of vega and delta related incentives on bond yields overall our empirical evidence shows that short term debt mitigates agency costs of debt arising from compensation risk

endogenously chosen boards of directors and their monitoring of the ceo author s hermalin benjamin e abstract this paper develops a model in which the effectiveness of a board s monitoring of the ceo depends on the board s independence the independence of new directors is determined through negotiations implicit or explicit between the existing directors and the ceo the ceo s bargaining position and thus influence over the board selection process depends on an updated estimate of the ceo s ability based on prior performance many empirical findings about board structure and performance arise as equilibrium phenomena in this model we also explore the implications of this model for proposed regulations of corporate governance structures please contact the program in law and economics at boalt hall school of law uc berkeley berkeley ca 94720 for a copy of this paper

pareto and political economy as a science methodological revolution and analytical advances in economic theory in the 1890s it is argued that schumpeter s widely accepted judgment that pareto s work is completely rooted in walras s system constitutes a misreading of pareto in fact already during the period 1892 1900 pareto traces the methodological outlines of an economic science profoundly different from that of walras it is maintained that his methodological contribution represents an attempt to define the conditions for political economy to be a science in this context pareto examines the theoretical premises of economic theories and questions the hypotheses of perfect foresight and rationality the ordinalist hypothesis is also shown to be a consequence of these methodological reflections

ceo compensation in financially distressed firms an empirical analysis this paper studies senior management compensation policy in 77 publicly traded firms that filed for bankruptcy or privately restructured their debt during 1981 to 1987 almost one third of all ceos are replaced and those who keep their jobs often experience large salary and bonus reductions newly appointed ceos with ties to previous management are typically paid 35 less than the ceos they replace in contrast outside replacement ceos are typically paid 36 more than their predecessors and are often compensated with stock options on average ceo wealth is significantly related to shareholder wealth after firms renegotiate their debt contracts however managers compensation is sometimes explicitly tied to the value of creditors claims

aggregate price indices new goods and generics this paper examines the appropriate treatment in the cost of living index of the appearance of new varieties of old goods existing theory here applies to individual households thus we first show in what sense laspeyres and paasche indices for groups of households can be considered approximations to theoretically desirable group indices and then go on to the case of new goods we apply our results to the case of the introduction of generics in pharmaceuticals and show that proper treatment can make a considerable difference

generics and new goods in pharmaceutical price indexes drug prices and their rate of inflation are a major focus of current policy debates on u s health care in this paper we show that where patent expiration and generic entry are significant as they are for many important classes of drugs movements in the official price indexes may be poor indicators of the actual prices paid and the resulting changes in consumer welfare when a drug goes off patent those consumers who regard the branded and generic versions as more or less perfect substitutes experience a substantial price decline and concomitant welfare gain which the current methods used by the statistical agencies fail to capture we suggest a number of alternative ways of proceeding although our computations are based on a limited number of cases they imply that the overall rate of inflation in drug prices may be quite seriously overstated while generic pharmaceuticals are the topic of our calculations the problem discussed is also of wider importance generic drugs are a special and possibly easy case

estimating the value of employee stock option portfolios and their sensitivities to price and volatility the costs associated with compiling data on employee stock option portfolios is a substantial obstacle in investigating the impact of stock options on managerial incentives accounting choice financing decisions and the valuation of equity we present an accurate method of estimating option portfolio value and the sensitivities of option portfolio value to stock price and stock return volatility that is easily implemented using data from only the current year s proxy statement or annual report this method can be applied to either executive stock option portfolios or to firm wide option plans in broad samples of actual and simulated ceo option portfolios we show that these proxies capture more than 99 of the variation in option portfolio value and sensitivities sensitivity analysis indicates that the degree of bias in these proxies varies with option portfolio characteristics and is most severe in samples of ceos with a large proportion of out of the money options however the proxies explanatory power remains above 95 in all subsamples

top management compensation and capital structure the interrelationship between top management compensation and the design and mix of external claims issued by a firm is studied the optimal managerial compensation structures depend on not only the agency relationship between shareholders and management but also the conflicts of interests which arise in the other contracting relationships for which the firm serves as a nexus we analyze in detail the optimal management compensation for the cases when the external claims are 1 equity and risky debt and 2 equity and convertible debt in addition to the role of aligning managerial incentives with shareholder interests managerial compensation in a levered firm also serves as a precommitment device to minimize the agency costs of debt the optimal management compensation derived has low pay performance sensitivity with convertible debt instead of straight debt the corresponding optimal managerial compensation has high pay to performance sensitivity a negative relationship between pay performance sensitivity and leverage is derived our results provide a reconciliation of the puzzling evidence of jensen and murphy 1990 with agency theory other testable implications include 1 a relationship between the risk premium in corporate bond yields and top management compensation structures and 2 the announcement effect of adoption of executive stock option plans on bond prices the model yields implications for management compensation in banks and federal deposit insurance reform our results explain the dynamics of top management compensation in firms going through financial distress and reorganization

valuing morbidity an integration of the willingness to pay and health status index literatures placing dollar values on human health has long been a controversial aspect of policy analysis and remains difficult given the relatively small number of morbidity valuation studies available by combining both the economic and health literature this paper offers an alternative approach to morbidity valuation and provides estimates for a wide range of short term health conditions

lower salaries and no options on the optimal structure of executive pay we estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 us ceos the model is widely used in the compensation literature but it predicts that almost all of the ceos in our sample should hold no stock options instead ceos should have lower base salaries and receive additional shares in their companies for a typical value of relative risk aversion almost half of the ceos in our sample would be required to purchase additional stock in their companies from their private savings the model predicts contracts that would reduce average compensation costs by 20 while providing the same incentives and the same utility to ceos we investigate a number of extensions and modi cations of the standard model but nd none of them to be satisfactory we conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts one reason may be that executive pay contracts are suboptimal

compensation incentives and the duality of risk aversion and riskiness the common folklore that giving options to agents will make them more willing to take risks is false in fact no incentive schedule will make all expected utility maximizers more or less risk averse this paper finds simple intuitive necessary and sufficient conditions under which incentive schedules make agents more or less risk averse the paper uses these to examine the incentive effects of some common structures such as puts and calls and it briefly explores the duality between a fee schedule that makes an agent more or less risk averse and gambles that increase or decrease risk with the growing interest in executive compensation and agency problems

enrollee mix treatment intensity and cost in competing indemnity and hmo plans abstract why do indemnity insurance plans cost substantially more per capita 77 more in our study than hmos we answer this question using data from a large organization s insurance pool covering 215 000 lives we decompose cost differences for eight major medical conditions into four sources demographics incidence within demographic groups treatment intensity and prices per service greater incidence of disease in the indemnity plan both from demographics themselves and within demographic groups and higher prices each explain nearly 50 of the difference contrary to conventional wisdom indemnity plans do not have greater treatment intensity

too much of a good incentive the case of executive stock options abstract using a utility maximization framework i show that the incentive to increase stock price does not always increase as more options are granted keeping the total cost of his compensation fixed granting more options creates greater incentives to increase stock price only if option wealth does not exceed a certain fraction of total wealth beyond this critical level granting more options actually reduces incentive effects and becomes counterproductive in addition stock options also create incentive to reduce increase idiosyncratic systematic risk these incentive effects are sensitive to the choice of exercise price

getting prices right what should be done much of the profession accepts that the cpi likely overstates the rate of increase of the cost of living it is less clear that there are sound and feasible steps that the bls can adopt to improve matters in the short run there are unresolved conceptual and identification problems in the measurement of quality superlative price indexes are not feasible and feasible approximations are not superlative and may not even be better the need for a single index that aggregates over heterogeneous consumers with different incomes tastes and needs casts serious doubt on the cost of living approach

does option compensation increase managerial risk appetite this paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls under the manager s optimal policy the option ends up either deep in or deep out of the money as the asset value goes to zero volatility goes to infinity however the option compensation does not strictly lead to greater risk seeking sometimes the manager s optimal volatility is less with the option than it would be if he were trading his own account furthermore giving the manager more options causes him to reduce volatility managers with convex compensation schemes play an important role in financial markets this paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls the paper focuses on how the option compensation impacts the manager s appetite for risk when he cannot hedge the option position on one hand the convexity of the option makes the manager shun payoffs that are likely to be near the money under the optimal policy the manager either significantly outperforms his benchmark or else incurs severe losses furthermore in examples of optimal trading strategies asset volatility goes to infinity as asset value goes to zero yet option compensation does not strictly lead to greater risk seeking as asset value grows large or if the evaluation date is far away the manager moderates asset risk for example if the manager has constant relative risk aversion crra asset volatility converges to the merton constant as asset value goes to infinity in some situations the manager actually chooses a lower asset volatility than he would if he were investing on his own because the leverage inherent in his option magnifies his exposure to the asset volatility in addition with all constant or decreasing absolute risk averse utility functions from the hyperbolic absolute risk averse hara class giving the manager more options causes him to reduce asset volatility in the crra case for example the manager targets a fixed volatility for his personal

managerial incentives and capital management the paper shows how career concerns rather than effort aversion can induce a natural incongruity in risk preferences between managers and superiors a model based on learning about managerial talent is developed to study second best contractual remedies we show that the optimal wage contract is an option of the value of the manager s human capital for insurance reasons and that consequently rationing of capital is often required to counterbalance the manager s resulting incentive to overinvest rationing is strictly superior to price decentralization offering one reason for the prevalence of centralized capital budgeting procedures