Fighting Fire with Fire: Optimality of Value Destruction to Mitigate Short-Termism

I study a model of short-termism where a firm's value is affected by the actions of an agent, who can represent the manager or the board, as well as an entrepreneur, venture capital, private equity, or activist shareholder. The agent either has a project with positive NPV and can further increase the NPV by exerting effort, or has a project that destroys value. The agent has a stake in the company and can liquidate it before the NPV of his actions is realized by the market. This ability to exit creates short-term incentives for the agent to not exert effort, as well as opportunities for him to profit even if he is destroying value. I find that replacing a fraction of agents that have positive NPV projects with value-destroying agents can increase average firm value, because it motivates the value-creating agents to work harder and this effect can dominate the added value destruction. Moreover, this result also holds under endogenous entry of agents: Reducing the entry or operating costs for the agents can increase average firm value and gross value destruction simultaneously, even though the fraction of agents with positive NPV projects decreases. Therefore, regulations that aim mitigating short-termism by curbing value destruction can actually yield opposite results and reduce average firm value instead.

EQUILIBRIUM INDETERMINACY, ENDOGENOUS ENTRY AND EXIT, AND INCREASING RETURNS TO SPECIALIZATION

This paper systematically examines the interrelations between equilibrium indeterminacy, endogenous entry and exit of intermediate input firms, and increasing returns to specialization within two versions of a parsimonious one-sector monopolistically competitive RBC model. The technology for producing an intermediate good is postulated to display internal increasing returns to scale in our benchmark framework, whereas positive productive externalities are considered in the alternative setting. We analytically show that either formulation will exhibit belief-driven cyclical fluctuations provided the equilibrium wage-hours locus is positively sloped and steeper than the household’s labor supply curve. We also find that ceteris paribus our alternative macroeconomy is more susceptible to indeterminacy and sunspots than the baseline counterpart.

Information Disclosure in Contests with Endogenous Entry: An Experiment

We use a laboratory experiment to study the effects of disclosing the number of active participants in contests with endogenous entry. At the first stage, potential participants decide whether to enter competition, and at the second stage, entrants choose their investments. In a 2[Formula: see text]2 design, we manipulate the size of the outside option, [Formula: see text], and whether the number of entrants is disclosed between the stages. Theory predicts more entry for lower [Formula: see text] and the levels of entry and aggregate investment to be independent of disclosure in all cases. We find empirical entry frequencies decreasing with [Formula: see text]. For aggregate investment, we find no effect of disclosure when [Formula: see text] is low but a strong positive effect of disclosure when [Formula: see text] is high. The difference is driven by substantial overinvestment in contests with a small, publicly known number of players contrasted by more restrained investment in contests in which the number of players is uncertain and may be small. The behavior under disclosure is explained by a combination of joy of winning and entry regret. This paper was accepted by Yan Chen, decision analysis.

PATENT PROTECTION, OPTIMAL LICENSING, AND INNOVATION WITH ENDOGENOUS ENTRY

How does patent policy affect innovation when patent licensing is crucial for firms? To address this question, the present study incorporates voluntary patent licensing between an innovator and followers, as discussed in the literature of industrial organization, into a dynamic general equilibrium model. Unlike previous studies, both the licensing fee and the number of licensees are endogenously determined by the innovator’s maximization and the free-entry condition. Using this model, we show that strong patent protection does not always enhance innovation, economic growth, and welfare. Furthermore, the extended analysis provides the policy implication that the effect of patent policy depends on how difficult further innovation is without patent licensing of the current leading technology.