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Why Economics Cannot Explain the Modern World

Why Economics Cannot Explain the Modern World

Deirdre Nansen McCloskey University of Illinois at Chicago – Department of Economics

June 2013
Economic Record, Vol. 89, pp. 8-22, 2013

Abstract: 
Why indeed? Because the Great Fact, 1800 to the present, incomes rising by a factor of a factor of 30, and higher if quality is acknowledged, cannot be explained by piling brick on brick, or BA on BA, in the absence of new ideas. As Keynes said, the marginal product of capital would be driven quickly down to zero. If the key were accumulation, which economists love, the Great Fact of modern growth would have happened earlier, or in China. Only ideas, in an environment of liberty and dignity for ordinary people, historically unique to northwestern Europe, work.

Embracing Co-Creation Thinking in Economics

Embracing Co-Creation Thinking in Economics

Avik Chakrabarti University of Michigan – Stephen M. Ross School of Business

Venkatram Ramaswamy Stephen M. Ross School of Business at the University of Michigan

June 2013
Ross School of Business Paper No. 1188

Abstract: 
Economics without the lens of co-creation, in the new evolving economy, blurs visibility. We provide a framework that can reshape economic thinking with co-creation at the core. In particular, an individual’s experience from co-creation is at the foundation of our economic apparatus. This is consistent with the mounting evidence on the new evolving economy where the conventional firm-centric view is of little relevance. We compare and contrast key elements of our co-creation thinking with conventional economic thinking. We show how fundamental economic concepts, such as surplus and efficiency, must be modified in order to incorporate co-creation experiences. We also posit a principle of co-creative advantage to guide efficient co-creation.

The Network Origins of Large Economic Downturns

The Network Origins of Large Economic Downturns

Daron Acemoglu Massachusetts Institute of Technology (MIT) – Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Asuman E. Ozdaglar Massachusetts Institute of Technology (MIT) – Department of Electrical Engineering and Computer Science

Alireza Tahbaz-Salehi Columbia Business School – Decision Risk and Operations

June 13, 2013
Columbia Business School Research Paper

Abstract: 
This paper shows that large economic downturns may result from the propagation of microeconomic shocks over the input-output linkages across different firms or sectors within the economy. Building on the framework of Acemoglu et al. (2012), we argue that the economy’s input-output structure can fundamentally reshape the distribution of aggregate output, increasing the likelihood of large downturns from infinitesimal to substantial. More specifically, we show that an economy with non-trivial intersectoral input-output linkages that is subject to thin-tailed productivity shocks may exhibit deep recessions as frequently as economies that are subject to heavy-tailed shocks. Moreover, we show that in the presence of input-output linkages, aggregate volatility is not necessarily a sufficient statistic for the likelihood of large downturns. Rather, depending on the shape of the distribution of the idiosyncratic shocks, different features of the economy’s input-output network may be of first-order importance. Finally, our results establish that the effects of the economy’s input-output structure and the nature of the idiosyncratic firm-level shocks on aggregate output are not separable, in the sense that the likelihood of large economic downturns is determined by the interplay between the two.

Governance Through Threat: Does Short Selling Improve Internal Governance?

Governance Through Threat: Does Short Selling Improve Internal Governance?

Massimo Massa INSEAD – Finance

Bohui Zhang The University of New South Wales – School of Banking and Finance; Financial Research Network (FIRN)

Hong Zhang INSEAD – Finance

July 9, 2013
INSEAD Working Paper No. 2013/83/FIN

Abstract: 
We explore the relationship between internal governance and the disciplining mechanisms created by the threat of short selling (i.e. “short-selling potential”). We argue that the presence of short selling increases the cost of agency problems for shareholders and incentivizes them to improve internal governance. Our stock-level tests across 23 developed countries during 2003-2009 confirm that the threat of short selling significantly enhances the quality of internal governance. This effect is stronger for financially constrained firms and more pronounced in countries with weak institutional environments. The governance impact of short selling leads to an improvement in firms’ operating performance.

Investor Awareness and PSY-chology Surrounding ‘Gangnam Style’

Investor Awareness and PSY-chology Surrounding ‘Gangnam Style’

Y. Han (Andy) Kim Nanyang Technological University (NTU)

Ho Sung Jung Bank of Korea

July 11, 2013

Abstract: 
The historically unprecedented success of “Gangnam Style,” the 18th K-pop single by the South Korean rapper musician PSY that went global in 2012, was an exogenous shock to investor awareness and enthusiasm about DI Corp., the company founded by the Korean rapper’s father. Equipped with Korean microstructure data that identifies non-resident foreign individual investors by their country of origin, we study the impact of investor awareness and enthusiasm about DI Corp.’s stock and related individual investor behavior. We find that the number of unique countries where non-resident foreign institutional investors place orders for the DI Corp. stock (excluding offshore Koreans) more than doubled after “Gangnam Style” was released, which supports Merton (1987). In addition, using the count of parody videos and flash mobs uploaded on YouTube from each country as a proxy for the enthusiasm of individual investors about DI Corp., we find that non-resident (resident) foreign individual investors become net buyers (sellers) when the count of the uploads increases in their country. In contrast, we find that non-resident foreign institutional investors short sell the stock after the release of the song, except for a period of excessive cost of arbitrage.

The Twilight Zone: OTC Regulatory Regimes and Market Quality

The Twilight Zone: OTC Regulatory Regimes and Market Quality

Ulf Brüggemann Humboldt University of Berlin – School of Business and Economics

Aditya Kaul University of Alberta – Department of Finance and Statistical Analysis

Christian Leuz University of Chicago – Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania – Wharton Financial Institutions Center; CESifo Research Network

Ingrid M. Werner The Ohio State University – Fisher College of Business

July 9, 2013
Fisher College of Business Working Paper No. 2013-03-09
Charles A. Dice Center Working Paper No. 2013-09

Abstract: 
We analyze a comprehensive sample of more than 10,000 U.S. stocks in the OTC market. As little is known about this market, we first characterize OTC firms by trading venue and provide evidence on survival, success, frequency of venue changes, reporting status, and trading activity. A large number of new firms appear on the OTC market each year. With few exceptions, these new firms exhibit poor performance and rarely rise to trade on traditional exchanges. We analyze how market liquidity, price efficiency and crash risk, all of which capture aspects of market quality, differ across OTC venues and firms subject to different regulatory regimes, including federal securities and state blue sky laws. We show that OTC firms that are subject to stricter regulatory regimes have higher market liquidity and price efficiency, and lower return skewness. We also analyze OTC market features that are potential substitutes for SEC registration, such as publication in a securities manual or state merit reviews, and provide evidence on their capital-market effects. This evidence is relevant in light of the JOBS Act and the ensuing relaxation of SEC registration requirements. Overall, our results suggest that investors consider information and regulatory differences when trading OTC stocks.

Enforcement of Accounting Standards in Germany: The Pre- and Post-Misstatement Development of Censured Firms

Enforcement of Accounting Standards in Germany: The Pre- and Post-Misstatement Development of Censured Firms

Manuel Strohmenger University of Wuerzburg

June 20, 2013

Abstract: 
This paper focuses on implementation of a two-tiered external financial reporting enforcement mechanism in Germany 2004. The first objective of the study is the systematically evaluation of the information contained in 151 disclosed error announcements. I find that error announcement on average contain 3.64 single errors and 77% affect the reported profit. Small, high levered and relatively unprofitable firms are overrepresented by the sample of misstatement firms. In a second step, I investigate the development of censured firms over time; I track the pre- and post-misstatement development of the firms in terms of balance sheet data, financial ratios and (real) earnings management. The analysis detects increasing leverage ratios and a decline in profitability overtime. In the year of misstatement firms report large total and discretionary accruals, indicating earnings management. Compared to matched control firms, significant differences in profitability, market valuation, earnings management and real activities manipulations are observable. A major contribution of this study is the examination of trends in financial data and (real) earnings management over a number of years round misstatement as well as the elaboration of the distinction to non-misstating firms. My results show the meaning of the enforcement of IFRS for the quality of financial reporting to standard setters, policy makers, and investors in Germany.

Executive Compensation and Corporate Fraud in China

Executive Compensation and Corporate Fraud in China

Martin J. Conyon University of Pennsylvania – The Wharton School; European Corporate Governance Institute (ECGI)

Lerong He SUNY College at Brockport; University of Pennsylvania – The Wharton School

July 11, 2013

Abstract: 
This study investigates the relation between CEO compensation and corporate fraud in China. We document a significantly negative correlation between CEO compensation and corporate fraud using data on publicly traded firms between 2005 and 2010. Our findings are consistent with the hypothesis that the firm’s owners and the board of directors penalize CEOs for fraud by awarding lower pay. We also find that executive compensation is lower in firms that commit more severe frauds. Panel data fixed effects and propensity score methods are used to demonstrate these effects. We also show that CEOs of privately controlled firms, firms that split the posts of CEO and chairman, and CEOs of firms located in developed regions, suffer larger compensation penalties for committing financial fraud. Finally, we show that CEOs at firms that commit fraud are more likely to be replaced (lose their jobs) compared to non-fraud firms.

Discretionary Disclosure of Customer Information and Average Stock Returns

Discretionary Disclosure of Customer Information and Average Stock Returns

Li-Wen Chen National Chung Cheng University

Hsin-Yi Yu National University of Kaohsiung

Chia-Tien Kelly Hsieh Durham Business School

July 1, 2013

Abstract: 
Firms with lower levels of disclosure hold more private information and thereby generate undiversified risk. This paper investigates the effect of discretionary disclosure of customer identities on average stock returns. Using a data set of firms’ principal customers, we find a negative relationship between the disclosure level of customer information and the cross-section of returns, after controlling for size, book-to-market ratio, momentum, and other return determinants. We also observe that individual investors are inclined to buy stocks that report more customer information. Overall, poor information on customer identity has higher costs of capital than do firms with good information quality.