Joanna Tyrowicz Transaction cost economics

1. Joanna Tyrowicz Transaction cost economics Institutional Economics

2. “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

3. 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 raisestransaction costs of using the market and therefore favours integration - vertical for transactions inintermediate inputs, and horizontal, vertical, or conglomerate for internal financing. • This canexplain the large family-owned conglomerates in LDCs.

4. 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)

5. 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

6. 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

7. 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

8. 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

9. Traditional TC empirics • Evaluate probability that G*will will be be chosen chosen over overalternative 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 thetransaction(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

10. 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; byapp. 12 yearscontracts 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 theduration of franchise agreements are significantly longer the larger franchisee initial investments (specific investment, hold-up problem)

11. 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)

12. 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]

13. 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!!!)

14. I CF CF I ??? DEBT Cash-flow investment sensitivity MILLER-MODIGLIANI, AND SIGNIFICANT CORRELATION? INFORMATION ASYMMETRY (Greenwald, Stiglitz, Weiss; 1984) MANAGERIAL DISCRETION (Jensen; 1986 + Vogt; 1994)

15. 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...

16. 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?

17. Data • Source: WSE • Data: • Market capitalisation • Book value of assets • Sales • Cash flows (not directly!) • State ownership • CEO • Polish? • New? }‘Q’

18. 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

19. Results:

20. 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