Joanna Tyrowicz

Transaction cost economics

Institutional Economics

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“But I thought you were going to talk about econometrics?!”

TC empirics as opposed to AP empirics First generation of TC empirics

Methods Limits Examples

Second generation of TC empirics Methods Future outlooks Examples [see the list]

AP empirics Methods Limitations Examples – agency theory of dividend taxation

Conclusions

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Formal and informal agreements The concept of governance has exploded into fashion over the

last three decades.

Papers that mention it in the title or abstract (data from EconLit): 1970-79: 3, 1980-89: 112, 1990-99: 3825, 2000-05: 7948

For example, if governance of arm’s length contracts is poor, that raises transaction costs of using the market and therefore favours integration - vertical for transactions in intermediate inputs, and horizontal, vertical, or conglomerate for internal financing.

This can explain the large family-owned conglomerates in LDCs.

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Formal and informal agreements Formal –

Constitution, legislation, policing, courts, regulatory agencies, ...

Informal Social networks for search and information Norms of behavior, and sanctions for enforcement

against violations of norms Private adjudication and enforcement (non-profit or

for-profit)

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Categories of situations needing governance

Predation. One-sided, involuntary. Pertains mostly to property rights. Not just theft but other violations of property rights,

especially intellectual property. Special problem – government or its agents may

themselves be the predators. Mutual insurance and gift-exchange.

Transfer in one direction at one time, with non-specific obligation to reciprocate.

Non-specificity makes these hard to govern; need very close relation or a dominant party.

Example – Don Corleone’s gift to the undertaker

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Categories of situations needing governance

Borrowing and lending, selling for delayed payment, selling experience goods. Transfer occurs in one direction at one time, with specific

obligation to reciprocate. This is the classic one-sided prisoner’s dilemma – Hobbes,

Williamson, Greif etc. Trade, exchange of goods or services for other goods or

services or money. Transfer in both directions, so two-sided prisoners'

dilemma, matched from population. Exists in all economic transactions except purely spot

exchanges. Example – Gambetta’s cattle rancher and butcher

Contribution to provision of public goods, or preservation of common property resources. Multi-person prisoners’ dilemmas. Examples – Elinor Ostrom’s case studies

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TC empirics and AP empirics Basic TC empirics

Contracting decision To contract or not to contract

G* = GC if VC>Valternative

Galternative otherwise VC =f(X, eC), Valternative=f(X, ealternative), X = conditioning variables, βX and αX = conditioning

sets Pr(G* = GC) = Pr(VC > Valternative) = Pr(ealternative-eC < (β-

α)X) Typically, a probit/logit approach, sometimes OLS

How long should the contract last? max VC(t) + Valternative(T-t) VC (t , X, e) = β0 + β1t + β2 X + e Valternative (t , X, e) = α0 + α1t + α2X + e Predict optimal t (contract duration) Typically, left-censored, MLE, problem with unobserved

heteroscedasticity

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TC empirics and AP empirics Basic AP empirics

Any transaction is a contract => no sense to ask why they emerge

Contracts are by assumption complete (every contingency, best outcome given the ex ante information, always enforceable)

Receipt: Optimise the behaviour of each party, play a game, choose PBNE or any other E, Optimality arises from risk sharing and alignment of

incentives Test

To get testable implications, introduce TC Typically, try to estimate the size of agency problem

consequences => any suitable econometric method

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Traditional TC empirics Evaluate probability that G* will will be be chosen chosen

over over alternative alternative governance governance forms forms

Investigate whether evidence is consistent with TCE predictions (G*), i.e. whether the chosen GS is ALIGNED with the characteristics of the transaction(s).

Indirect testing of the propositions! Many testable propositions

Make-or-Buy issues, contractual choices: duration price schemes etc…

More than 600 empirical studies of TCE’s predictions

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Traditional TC empirics Examples:

Allen and Lueck (1992) examined the use of written versus oral leases for farmland => lands requiring investment had written contracts,

Lyons (1994) for UK engineering subcontractors => the more (customer) specific the production, the higher the prob. of formal contract

Joskow (1987) for coal mines-electricity plants contracts => duration of app. 11Y greater in Western states (coal heterogeneous, mines larger, distances greater, transportation alternatives fewer), than in the eastern U.S.(opposite), with Midwestern coal contracts intermediate; by app. 12 years contracts longer for coal supplied at mouth of mine; contract duration increased by an additional 13 years for additional million tons of coal

Bercovitz (1998) finds that the duration of franchise agreements are significantly longer the larger franchisee initial investments (specific investment, hold-up problem)

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Shortcomings of traditional TC empirics

Shows conformity with predictions, but not, that it matters (performance)

What is lost due to „second-best”? If performance evaluated on contractual agreements,

Heckman selection bias Two-stage procedure requires variables linked to

contractual choice, but not to performance (any ideas?) Any solutions?

Try to estimate MISALIGNMENT (Gobserved-Gpredicted), see if it matters in the performance equation (still selection bias, but ...)

Use of natural experiments (like deregulation)

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Modern TC empirics Static prediction: the more misaligned you are, the poorer the

performance All the statistical problems require specific data (if available,

possible) Generally empirics in line with predictions [see the list]

Dynamic prediction: the more misaligned you are, the more likely your GS to change Since dynamic, use diff-in-diff estimator (no endogeneity problems) Either firm survival... [see the list] ... or modification of structure... [see the list] ... or modification of contractual agreement [see the list]

Structural prediction: the type of misalignment matters more than misalignment itself Positive (contracts too long, too much inhouse) Negative (contracts too short, too little inhouse) Explore contermporaneous differentiation and varied impact

measures (innovation or head count instead of profit, etc.) [see the list]

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AP empirics „An agency theory of dividend taxation”, Chetty, Saez

(2007) Managers and shareholders have conflicting interests Efficiency cost of divident taxation If the contract is efficient (second best), distortion

small If the contract inefficient (second best), distortion

large efficiency cost Contracts likely to be inefficient with dispersed

shareholders (small bargaining power, large free riding incentives)

Calibrate to changes in US legal framework in 2003 and find that efficiency cost was comparable in size to taxes raised (strong redistribution!!!)

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MILLER-MODIGLIANI, AND SIGNIFICANT CORRELATION?

INFORMATION ASYMMETRY

(Greenwald, Stiglitz, Weiss; 1984)

MANAGERIAL DISCRETION

(Jensen; 1986 + Vogt; 1994)

I CF

DEBT

I CF

???

Cash-flow investment sensitivity

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What is GOOD investment?

Value to the shareholders! Q theory of investment Tobin’s q: discounted marginal returns Q: marginal versus average (MVA/BVA)

So we get a testable specification:

I/BVA = α + βControlVariables + γCashFlow + μ

But what about AI vs. MD?

Vogt (1994)

FHP contra KZ – a hot debate...

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GPW versus RoW Age impossible Size makes little sense Industry too The role of the banks... Foreign ownership?

SO? Standard AI vs. MD Some other measures of corporate governance? Changes within companies REAL QUESTION: What about state ownership?

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Data Source: WSE Data:

Market capitalisation Book value of assets Sales Cash flows (not directly!) State ownership CEO

Polish? New?

} ‘Q’

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Methodology

In 2004: Maximum 7 years of data (1994 opening of WSE) Maximum of 158 companies Many missing and inconsistent

What if systematic???

Panel data, but which way? Year as a grouping variable Company as a grouping variable

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Results:

INVESTMENT

‘STRAIGHT’ STANDARDISED

COMPANY YEAR COMPANY YEAR

Q 0.18 *** 0.11 *** 0.50 *** 0.29 ***

Sales 0.006 *** 0.07 *** 0.14 *** 0.15 ***

CashFlows 0.45 *** 0.54 *** 0.14 *** 0.15 ***

CashFlows * Q - 0.87 *** - 0.89 *** - 0.77 *** - 0.42 ***

State 0.21 *** 0.13 *** 0.76 *** 0.39 ***

State * Q - 0.10 ** - 0.11 ** - 0.07 - 0.13*

NewCEO - 0.03 ** - 0.03 - 0.12 ** - 0.03 *

ForeignCEO - 0.007 - 0.12 ** - 0.02 - 0.21 *No. of observations

510 (158 g) 510 (6 g) 510 (158 g) 510 (6 g)

R2 0.39 0.21 0.40 0.20

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Overinvestment?

The role of financial institutions (inter alia): Optimal (=> only one!) level of investment Optimal (=> the right one!) investors

What this model shows:

Overinvestment

Wrong investors

=> Institutional failure