CESifo Economic Studies - recent issues

Introduction to the Symposium on Executive Pay

Englmaier, F., Illing, G., Sadka, E. — Wed, 07 Oct 2009 23:31:55 PDT

In Search of Reasonable Executive Compensation

Kandel, E. — Wed, 07 Oct 2009 23:31:55 PDT

This article makes several observations on the extent of executive compensation and the forms it takes, relating these to the recent literature. I argue that the magnitude of executive compensation seems excessive in light of a wide range of academic studies. I then propose specific regulatory measures that make compensation transparent and predictable for shareholders. Next, a simple taxation of executive compensation above a certain threshold is proposed; I argue that it is a much more efficient way to deal with the issue, than the current legislation in the United States. Turning to the ‘pay for performance’ paradigm, I argue that it must be applied with great care, as, along with the incentives to exert effort it also provides powerful perverse incentives, which are not immediately obvious, may vary dramatically across firms, and may not be well understood by the compensation committees and academics. I outline the design of several generic contracts appropriate for different environments. Finally, I stipulate that the downside of providing too much ‘pay for performance’ is especially evident in financial industry, which is opaque and subject to contagion, thus compensation contract should play a more important role in financial regulation. (JEL codes: G30, K22, M50)

How Much Sunlight Does it Take to Disinfect a Boardroom? A Short History of Executive Compensation Regulation in America

Dew-Becker, I. — Wed, 07 Oct 2009 23:31:55 PDT

This article reviews the history of executive compensation regulation in America and surveys the literature on the effects of these policies. CEOs are almost exclusively in the top 1% of the pay distribution, and regulation of their pay is seen as a well-targeted way of reducing income inequality. Mandatory disclosure of executive compensation has increased nearly uniformly since 1933. A number of other regulations, including special taxes on CEO pay and rules regarding votes on some pay packages have also been introduced, particularly in the last 20 years. However, there is little solid evidence that any of these policies have had any substantial impact on pay. I also review limited evidence from overseas on ‘Say on Pay’, recently proposed in the US, which would allow nonbinding shareholder votes on CEO compensation. The experiences of other countries have been positive, with tighter linkages between pay and performance and improved communication with investors. Mandatory say on pay would be beneficial in the United States, both increasing shareholder value and making CEO pay fairer, thus reducing the likelihood of passage of other legislation to reduce income inequality, such as higher taxes on the rich. (JEL-codes: J01, J08, J33, K22)

Learning from the Past: Trends in Executive Compensation over the 20th Century

Frydman, C. — Wed, 07 Oct 2009 23:31:56 PDT

In recent years, a large academic debate has tried to explain the rapid rise in CEO pay experienced over the past three decades. In this article, I review the main proposed theories, which span views of compensation as the result of a competitive labor market for executives to theories based on excess of managerial power. Some of these hypotheses have found support in cross-sectional evidence, but it has proven more difficult to determine which factors have caused the observed changes in pay over time. An alternative strategy is to evaluate the fit of plausible explanations out of sample by contrasting them with the evolution in executive pay and the market for managers during earlier time periods. A case study of General Electric suggests that evidence for earlier decades can speak of the recent trends and reveals the limitations of current explanations to address the long-run data. (JEL codes: G30, J33, M52, N82)

Strong Managers, Weak Boards?

Adams, R. B., Ferreira, D. — Wed, 07 Oct 2009 23:31:56 PDT

Many governance reform proposals are based on the view that boards have been too friendly to executives, for example, by awarding them excessive pay. Although boards are often on friendly terms with executives, it is less clear that they have systematically failed to function in the interests of shareholders. Understanding board monitoring requires a theory of boards that takes into account how firms provide incentives for their Chief Executive Officer's (CEOs) through other means. We develop a model in which a CEO's ownership stake and private benefits have opposite effects on his willingness to share private information with an independent board of directors. To encourage the CEO to communicate, the board may optimally commit to a low monitoring intensity when either CEO ownership is low or private benefits are high. Our model suggests that the existing cross-section evidence on the correlation between board composition and CEO ownership and tenure needs re-evaluation. Using a new proxy for board monitoring, we provide new evidence that this cross-sectional correlation appears to be non-monotonic, with board independence first decreasing and then increasing in CEO ownership and tenure. We discuss the implications of our model for the design and evaluation of governance structures. (JEL codes: G34, L22, J41, J44)

Insider Information and Performance Pay

Gayle, G.-L., Miller, R. A. — Wed, 07 Oct 2009 23:31:56 PDT

This article provides evidence that managers have private information they exploit for financial gain at the expense of shareholders. It develops a model of optimal contracting to show that moral hazard, hidden actions taken by agents, can rationalize why a principal would optimally induce agents to benefit from their private information. Estimates from a structural model shows that moral hazard is an important economic factor. This leads to the conclusion that, in practice, shareholders and managers might optimally agree upon an arrangement where managers systematically exploit their private information about the firm. (JEL codes: J3, K2, G3 and C5).

Taxes and Executive Compensation: Evidence from the 1990s

Katuscak, P. — Wed, 07 Oct 2009 23:31:57 PDT

This article analyzes the effect of personal income taxation on the pay-to-stock-price sensitivity of executive compensation contracts generated by stock option and restricted stock grants. Using Execucomp data for 1992–1996 and variation in the ordinary income marginal tax rate of top earners in the same time period, I find that an increase in the tax rate decreases the pre-tax pay-to-performance sensitivity generated by option grants, whereas stock grant sensitivity is found to be unresponsive to the same change. Even though these results can be explained by joint tax optimization of executives and their employers, they suggest that after-tax incentive provision for executives is quite sensitive to variation in the ordinary income tax rate. (JEL codes: D21, H24)

Bonus Payments and Fund Managers' Behavior: Transatlantic Evidence

Gehrig, T. P., Lutje, T., Menkhoff, L. — Wed, 07 Oct 2009 23:31:57 PDT

This questionnaire survey of fund managers in USA, Germany, and Switzerland documents a distinctly positive influence of bonus payments on investment behavior on both sides of the Atlantic. Higher bonus payments are significantly related to higher working effort but not to risk-taking. They also seem to induce fund managers to rely more on fundamental information. Findings within regions are confirmed by Transatlantic evidence as US fund managers receive larger bonuses but also show the effects to a higher degree. The effects documented are stronger for relative than for absolute performance assessment. (JEL-Codes: G23, G14)

Introduction to the Symposium on Poverty and Inequality in China

Whalley, J. — Wed, 07 Oct 2009 23:31:57 PDT

What Lies behind Rising Earnings Inequality in Urban China? Regression-based Decompositions

Deng, Q., Li, S. — Wed, 07 Oct 2009 23:31:58 PDT

Coupled with advances in enterprise reform and changes in the wage structure, earnings inequality in urban China has been increasing, and this has contributed significantly to rising income inequality. Using urban household survey data from the 1988, 1995 and 2002 waves of the China Household Income Project, in this article, we decompose earnings inequality in urban China by using the recently developed regression-based decomposition methods. The decomposition results indicate that the effects of gender and membership of the Communist Party of China on earnings inequality have changed little. While work experience had a reduced effect on earnings inequality, the effects of education and occupation have increased. The contributions of ownership status and industry to earnings inequality have increased. Regional effects have been the largest recent contributor to earnings inequality. (JEL codes: D31, J31, O53)

Power as a Driving Force of Inequality in China: How Do Party Membership and Social Networks Affect Pay in Different Ownership Sectors?

Li, S., Lu, M., Sato, H. — Wed, 07 Oct 2009 23:31:58 PDT

Party membership and social networks, as two forms of nonmarket power, have significant effects on personal income and act as driving forces of inequality in China. Do the effects vary across different ownership sectors (suoyouzhi xingshi)? Using a nationally representative survey of urban households (China Household Income Project surveys in 1995 and 2002), we find that (i) party membership can significantly increase personal income, but this effect does not significantly differ between different ownership sectors or between the years 1995 and 2002 and (ii) social networks are insignificant in state-owned enterprises (SOEs), while they contribute significantly to personal income in non-SOE sectors. Our finding does not predict a smaller inequality through lower returns to power during privatization in Chinese economy. (JEL codes: J40, O15, P26, Z13)

Rural Income Volatility and Inequality in China

Whalley, J., Yue, X. — Wed, 07 Oct 2009 23:31:58 PDT

Current literature based on analyses of rural income volatility in China decompose poverty into chronic and transient components using longitudinal survey data and assesses the fraction of the Foster, Greer, and Thorbecke poverty gap attributable to mean income over time being below the poverty line. Resulting estimates of 40–50% transient poverty point to the policy conclusion that poverty may be a less serious social problem than it appears in annual data due to rural income volatility. Here, we instead use a direct method to adjust rural income for volatility using a certainty equivalent income measure and recomputed summary statistics for the distribution of volatility corrected incomes, including the urban–rural income gap on which much of current poverty debate in China focuses. Available data indicate a growing urban–rural income gap (the ratio of mean urban to rural incomes) with a significant increase from around 1.8 in the late-1980s to over three today. These estimates do not take into account the higher volatility of rural incomes in China. Since an uncertain income stream is worth less in utility terms than a certain income stream, we argue that heightened rural volatility increases the effective urban–rural income gap and intensifies not weakens poverty concerns. Using Chinese longitudinal rural survey data for which current decompositions can be replicated, we make adjustments for certainty equivalence of rural household income streams, which not only widen the urban–rural income gap in China but also increase other distributional summary statistics. Depending upon values used for the coefficient of relative risk aversion, the measured urban–rural income gap increases by 20–30% using a certainty equivalent measure to adjust rural incomes for volatility. We also conduct similar analysis using consumption data, for which similar (but slightly larger) increases occur. (JEL codes: D00, D31, D81,G11, N55, O12; O15; R20)

CESifo Symposium on the Economics of Climate Change: Introduction

Whalley, J. — Fri, 29 May 2009 05:20:46 PDT

Climate Policy after 2012

Bosetti, V., Carraro, C., Tavoni, M. — Fri, 29 May 2009 05:20:46 PDT

Discussion over post-2012 climate policy is now entering a crucial phase. Despite the potential great risks of prolonged global warming, the success of an international climate stabilization agreement hinges to a great extent on its economic feasibility. This article makes precise the assumptions that underpin current mainstream estimates of the costs of controlling climate change and provides quantitative estimates of cost differentials under different scenarios. In particular, the article analyses the role of three utmost factors in the economic cost of a climate treaty: energy technology development; the participation rate of developing countries; and the timing of global action. We show that all three factors have a major impact on policy macroeconomic costs. Addressing them effectively is therefore indispensable in ensuring the feasibility of any international agreement to control global warming. Therefore, we propose a series of policy recommendations that can help addressing the issues of technology, timing and participation, and that represent key policy implications for a post-2012 climate policy. (JEL codes: C72, H23, Q25, Q28)

Bringing the Copenhagen Global Climate Change Negotiations to Conclusion

Whalley, J., Walsh, S. — Fri, 29 May 2009 05:20:46 PDT

In this article we discuss the global negotiations now underway and aimed at achieving new climate change mitigation and other arrangements after 2012 (the end of the Kyoto commitment period). These were initiated in Bali in December 2007 and are scheduled to conclude by the end of 2009 in Copenhagen. As such, this negotiation is effectively the second round in ongoing global negotiations on climate change and further rounds will almost certainly follow. We highlight both the vast scope and vagueness of the negotiating mandate, the many outstanding major issues to be accommodated between negotiating parties, the lack of a mechanism to force collective decision making in the negotiation, and their short time frame. The likely lack of compliance with prior Kyoto commitments by several OECD countries (some to a major degree), the effective absence in Kyoto of compliance/enforcement mechanisms, and growing linkage to non-climate change areas (principally trade) all further complicate the task of bringing the negotiation to conclusion. The major clearage we see that needs to be bridged in the negotiations is between OECD countries on the one hand, and lower wage, large population, rapidly growing countries (China, India, Russia, Brazil) on the other. (JEL codes: F33, F51, F53, Q54, Q56, P28)

Technology, Unilateral Commitments and Cumulative Emissions Reduction

Chatterji, S., Ghosal, S. — Fri, 29 May 2009 05:20:46 PDT

In this article, we argue that weak property rights over transnational pollution and the limited threat of retaliatory punishments blunts the effectiveness of a broad-based multilateral agreement to deliver the emission reductions required to mitigate climate change. Instead, we propose a policy framework that builds on unilateral commitments, endogenous innovation and technology transfer that could lead to cumulative emissions reduction by altering the participation constraints of nations over time. (JEL codes: Q54, F53, Q50)

On the Impact of Digital Music Distribution

Ahn, I., Yoon, K. — Fri, 29 May 2009 05:20:46 PDT

We present a framework to evaluate the impact of digital music distribution. We set up a representative model that enables the comparative static analysis. We then interpret two empirical observations about the music industry, the sales decline and the price constancy, and fit the model to these observations. We find that, while the impact of digitalization on the producers’ profits is probably negative, it may not be as severe as the observed impact on the quantity. On the other hand, the impact of digitalization on the consumer surplus is unambiguously positive. The impact on the social welfare is rather ambiguous in general, but the social welfare may increase for plausible parameter values. (JEL codes: K11, L86, O34)

What Can We Learn from Empirical Studies About Piracy?

Dejean, S. — Fri, 29 May 2009 05:20:46 PDT

The purpose of this article is to make an assessment of the empirical literature dedicated to the consequences of piracy on the cultural industry. The diversity of data collected and methodologies used by empirical studies make it difficult to compare the literature results. On the one hand, some studies seem to have overestimated the impact of digital piracy which may be due, for example, to the use of Internet access as a proxy for piracy. On the other hand, the problem of finding a good instrument to avoid the endogeneity between files illegally downloaded and purchased goods, has probably led to an underestimation of the impact of piracy. As a result, the major finding of empirical works about piracy could be the change in the role of industry stakeholders as well as the way cultural goods are distributed and consumed. We also discuss the different evolutions of the music and the movie industries revenues since the appearance of the first P2P network. (JEL codes: L82, L86, K42)

A Review of Financial Stability Instruments for Emerging Market Economies

Mendoza, R. U. — Fri, 29 May 2009 05:20:46 PDT

Graduating from their checkered histories of financial instability and debt-related problems is a key policy objective in many emerging market economies. The global financial turmoil that erupted in 2008 underscores the importance of this issue once again. This article maps out some of the key factors that contribute to this challenge, and then uses this map to develop a possible taxonomy for the array of proposed (and some already existing) policy instruments designed to respond to them. By relating each instrument to the particular aspect(s) of the broader policy challenge, the taxonomy helps to clarify some of the differences, similarities, as well as the potential value-added of these instruments. The analysis herein suggests that instruments that could help increase the efficiency of risk management strategies (such as growth- or GDP-indexed bonds) and enhance the effectiveness of debt management, growth and development policies (such as a stability and social investment facility or SIF) deserve further consideration in order to promote more sustained financial stability and enhanced debt tolerance in the emerging markets.

Reinventing Europe: Introduction

Bordignon, M., Buettner, T., van der Ploeg, F. — Thu, 19 Feb 2009 05:57:28 PST

Given the enlargement of the European Union, the fall-back in productivity growth and the lack of success in implementing further structural reforms, this special issue highlights the political economy in the European Union and discusses the role of the Maastricht Treaty as an impediment or a catalyst for reform. It also sheds light on the empirical characteristics of the voting behaviour of Members of the European Parliament and shows that they vote more along party lines than national lines and pays due attention to allegiance and party discipline. It offers a game-theoretic analysis of why the Lisbon Treaty will not strengthen the European Parliament versus the Council as much as expected and how the old bigger Member States strengthen their grip on the political decision-making process. There is discussion of the ratification of European legislation in the Member States. Finally, the crucial question of how European politics can be made more attractive is addressed. (JEL codes: F55, H11, P16)

Legislative Behavior in the European Parliament

Roland, G. — Thu, 19 Feb 2009 05:57:28 PST

This article summarizes research on the analysis of roll call votes in the European Parliament since the European Parliament was elected by universal suffrage and draws lessons about legislative behavior in the European Parliament. The research shows that voting in the European Parliament occurs along supranational party lines and not along geographical lines. Party cohesion has increased with the powers of the European Parliament. This increased cohesion is the reflection of European party discipline based on cohesion of national party groups. Moreover, coalition frequency is related mostly to ideological closeness between party groups. (JEL codes: D72, F53, P 16)

The Impact of Council Voting Rules on EU Decision-Making

Widgren, M. — Thu, 19 Feb 2009 05:57:29 PST

This article deals with the design of voting rules in the European Union (EU) Council. Both internal and external impact of the voting rules are examined. Internal impact affects the distribution of power among the Member States, and external impact affects power relations between the main decision-making bodies in the EU. One of the main lessons of the analysis is that voting rules matter. This clearly explains why the design of Council voting rules has required so much bargaining and cumbersome marathon negotiations. The internal decision-making rules in the Council have substantial impact on both the national distribution of power in the Council and inter-institutional power between the EU's; decision-making bodies. (JEL codes: C70, D71, D71, H77).

Reforming the EU Budgetary Procedure: Is Codecision a Step Forward?

Giuriato, L. — Thu, 19 Feb 2009 05:57:29 PST

Codecision is the main European Union legislative procedure and the 2007 Reform Treaty draft has adopted it to improve the budgetary process. However, at close examination, codecision and the current budgetary process show an identical structure. Both are designed as non-cooperative alternating offers bargaining games between institutions and both, although in different measure, have gone through periods of interinstitutional deadlocks and conflicts, which can be ascribed to the insufficiency of the non-cooperative bargaining setup with respect to the task of providing for joint-decision making by the Parliament and the Council of Ministers: in particular, the opportunistic interpretation of the Treaty provisions by the Parliament in the 1980s was one of the consequences of the strict bargaining design. The article argues that the lacking elements for joint decision making have been gradually inserted in the procedures by means of informal negotiation institutions, which are not only mechanisms for equilibrium selection but also corrective devices to strict non-cooperative procedures. Informal institutions will play a fundamental role also in the change from the current budgetary procedure to the one designed in the 2007 Reform Treaty, where the Parliament does not seem to gain a ‘dominant position’, the Commission improves its scope for action and the Council consolidates its role. (JEL codes: D73, D78, H77)

Zooming in on Transposition: National Execution Measures for EU Directives 1986-2002

Treutlein, D. — Thu, 19 Feb 2009 05:57:29 PST

This study empirically investigates the transposition patterns of European Union EU directives in 15 Member States and in 5 major sectors of the economy with a view to analysing the political–economic reasons behind sector and national differences in national execution measures. Specifically, we analyse whether, in the course of transposition, EU directives pass the respective national parliaments or not. Neglected in the scientific literature so far, this question is highly relevant from a normative political perspective and complements the debate on the EU's; democratic deficit by focusing on the national implementation of EU law. Based on information contained in CELEX and EUR-lex, our newly constructed dataset allows us to analyse Member States' transposition performances in a novel fashion, namely across time, Member States as well as policy areas. Our empirical analysis reveals generally low primary transposition ratios. Put differently, most of EU directives are transposed by national executives rather than national legislators. Further, remarkable differences in primary transposition ratios are detected along all three data dimensions. We hypothesize that national political-institutional constellations, economic sector characteristics and EU membership benefits are the main explanatory factors behind these differences. (JEL codes: D70, D78, F50, F53, H77)

Home Bias and Market Integration in the EU

Balta, N., Delgado, J. — Thu, 19 Feb 2009 05:57:29 PST

The Single Market has been one of the core policies of the European Union. Twenty years after the launch of the Single Market Programme national borders still matter in Europe. Consumption baskets and investment portfolios of European countries still contain a predominant share of home products and equity. This article evaluates the success of integration policies in the European Union by assessing the magnitude and evolution of home bias across Europe in goods and services markets and in equity portfolio holdings. There are large differences in the degree of home bias across European countries. More worrisome is that home bias in goods and services has barely changed in recent years. This might indicate that traditional integration policies are no longer effective and need to be transformed to continue delivering. (JEL Codes: D78, F15, F21, F36)

Why Lisbon Fails

Ruta, M. — Thu, 19 Feb 2009 05:57:29 PST

This article looks at the political economy of structural reforms and growth in the European Union. As the EU's; economy approaches the world technology frontier, structural reforms that increase competition in intermediate goods sectors are necessary to boost innovation and productivity growth—the main objective of the Lisbon Agenda. Such reforms, however, raise the opposition of incumbents and, therefore, are politically difficult to implement. When there are important policy spillover effects, national governments are more easily captured by vested interests, as they fail to internalize the benefits of reforms on the rest of the Union. This suggests that the weak political governance of the Lisbon Agenda, which is centred on the peer pressure of national governments, and the ensuing inability to complete the single market in non-manufacturing sectors, explains the Lisbon failure. (JEL classification: D72, F42, O30, O40)

Is Lisbon Far from Maastricht? Trade-offs and Complementarities between Fiscal Discipline and Structural Reforms

Buti, M., Roger, W., Turrini, A. — Thu, 19 Feb 2009 05:57:29 PST

While according to the so-called ‘Brussels-Frankfurt consensus’, sound fiscal policies and structural reforms support each other, it is often claimed that the EU fiscal framework, by reducing the budgetary room for manoeuvre and the political capital of governments, may deter reforms. The aim of this article is to explore which factors determine the relationship between fiscal discipline and reforms. By means of a simple model we show that, depending on the time horizon of the government, structural reforms may either be complementary to, or a substitute for, fiscal discipline. If governments are forward-looking, substitution is more likely; if governments are short-sighted, reforms and fiscal discipline may become complementary. We provide empirical evidence supporting this argument. In a sample of EU-15 countries over the past three decades, the introduction of the Maastricht constraints at the beginning of the 1990s does not seem to have affected the probability of labour market reforms on average, but had a positive and significant impact on countries with governments facing elections in the current or forthcoming year (which are hence assumed to behave myopically). Our results suggest that if governments are short-sighted, then the expectation that relaxing fiscal constraints may help to boost structural reforms may not be well-founded. (JEL codes: E62, H50, H55, H62, J58, L50)

The European Union and the Member States: An Empirical Analysis of Europeans' Preferences for Competences Allocation

Cerniglia, F., Pagani, L. — Thu, 19 Feb 2009 05:57:29 PST

In this article, we empirically study the preferences of European citizens concerning the allocation of powers between the European Union (EU) and the Member States using Eurobarometer data from 1995 to 2003. Both descriptive and econometric analysis highlights a ranking of countries according to the number of issues citizens want to delegate to EU (which we call Europeanism). More specifically, the more pro-European countries are those from Southern Europe while the less pro-European countries are those in Scandinavia, Denmark, and Luxemburg. Econometric analysis shows that this country effect is largely linked to the quality of the countries’ national government institutions. We find also a positive relationship between Europeanism and education, the degree of information of citizens, and left wing affiliation. For some policy domains, we also estimate probit equations for citizens’ preferred allocation of powers and we find that the countries’ Europeanism ranking varies with the area considered. (JEL codes: H11, H77)