The Market Mechanism as an Incentive Scheme

Hart, Oliver

doi:10.2307/3003639

Cited by 1,184 publications

(716 citation statements)

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“…First, we examine whether the effect of options trading on innovation depends on product market competition. The quiet life story suggests that the effect of options trading on innovation is weaker in highly competitive environments because stronger competition increases the threat of bankruptcy, which induces the manager to work harder to avoid liquidation and to keep his job (Hart, 1983;Schmidt, 1997). In contrast, if informed agents serve as a "shield" that protects managers, this effect should be more pronounced when the degree of product market competition is higher.…”

Section: Possible Mechanismsmentioning

confidence: 99%

“…The first is that managers prefer the "quiet" life as proposed by Hart (1983), Schmidt (1997) and Bertrand and Mullainathan (2003) and that the increased price informativeness induced by options trading serves as a monitoring mechanism that forces managers to invest in innovation if they are a priori reluctant to do so. Alternatively, the positive association between options trading and innovation can also be attributable to career concerns.…”

Section: Possible Mechanismsmentioning

confidence: 99%

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The bright side of financial derivatives: Options trading and firm innovation

Blanco

Wehrheim

2017

Journal of Financial Economics

102

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Do financial derivatives enhance or impede innovation? We aim to answer this question by examining the relationship between equity options markets and standard measures of firm innovation. Our baseline results show that firms with more options trading activity generate more patents and patent citations per dollar of R&D invested. We then investigate how more active options markets affect firms' innovation strategy. Our results suggest that firms with greater trading activity pursue a more creative, diverse and risky innovation strategy. We discuss potential underlying mechanisms and show that options appear to mitigate managerial career concerns that would induce managers to take actions that boost short-term performance measures. Finally, using several econometric specifications that try to account for the potential endogeneity of options trading, we argue that the positive effect of options trading on firm innovation is causal.

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Section: Possible Mechanismsmentioning

confidence: 99%

Section: Possible Mechanismsmentioning

confidence: 99%

The bright side of financial derivatives: Options trading and firm innovation

Blanco

Wehrheim

2017

Journal of Financial Economics

102

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“…In this case, relative performance evaluation can induce optimal management performance. Hart (1983) compares two situations with independent and with positively correlated cost functions, respectively, showing that, when costs are correlated, competition reduces the amount of managerial slack. However, Scharfstein (1988) shows that Hart's results depend on the extent of managers' assumed risk aversion.…”

Section: Existing Literature On the Determinants Of Firm Productivitymentioning

confidence: 99%

Product market competition, corporate governance and firm performance: an empirical analysis for Germany

Januszewski

Köke

Winter

2002

Research in Economics

138

105

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Productivity growth has been slow in many continental European countries over the last few decades, especially in comparison with the United States. It has been argued that lack of product market competition and poor corporate governance are two of the main reasons for this phenomenon. However, predictions from theoretical models are far from unambiguous, and empirical evidence is sparse, in particular at the level of individual firms. In this paper, we aim to close this gap with an econometric analysis of firm performance in Germany. Based on a unique panel data set with detailed information on almost 400 manufacturing firms over the 1986-94 period, we find that firms operating in industries which are characterized by more intensive product market competition experience higher rates of productivity growth. We also find weak evidence for the notion that in Germany's bank-based system of internal control, ownership concentration is harmful for productivity growth. Keywords Non-technical summaryProductivity growth has been slow in many continental European countries over the last few decades, especially in comparison with the United States. European countries such as Germany and France have low capital performance as measured by capital productivity and various rates of return. Improving productivity is important not only for shareholder value, but also from a public policy perspective: In many countries, social security systems move away from pay-as-you-go systems to more capital-funded systems, and therefore the rate of return on capital will be even more important as a determinant of future generations' welfare than in the past.It has been argued that lack of product market competition and poor corporate governance are the two main reasons for slow productivity growth in continental Europe. However, predictions from theoretical models are far from unambiguous, and empirical evidence is sparse, in particular at the level of individual firms. This study tries to close this gap with an econometric analysis of firm performance in Germany. Using a panel of almost 400 German manufacturing firms that covers the period 1986-94, we analyze how product market competition and corporate governance affect the growth of total factor productivity.Our empirical approach improves on existing empirical studies on corporate governance in Germany in two important respects. First, the data set consists of listed and non-listed firms which also differ in their legal forms. Hence, our analysis is not restricted to public companies with limited liability whose shares are listed (börsennotierte Aktiengesellschaften). Second, we recognize that product market competition and corporate governance are potentially endogenous. To avoid biased regression results, we use an instrumental variables technique.We find that firms which operate in more competitive product markets have a higher growth of total factor productivity. This suggests that an increase in the intensity of competition should result in productivity improvements. Fro...

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“…14 Ghosal and Loungani (1996) find XXXX. In addition, a number of theoretical papers examine the effect of product market competition on managerial incentives [Hart, 1983;Scharfstein, 1988;Schmidt, 1997;Raith, 2003]. While the conclusion is somewhat ambiguous, product market competition can exert a disciplining effect on managers, and could thus act as a substitute for incentive schemes.…”

Section: Product Market Competitionmentioning

confidence: 99%

Investment, Idiosyncratic Risk, and Ownership

Papanikolaou

Panousi

2009

SSRN Journal

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We find a significant negative effect of idiosyncratic stock-return volatility on investment. We address the endogeneity problem of stock return volatility by instrumenting for volatility with a measure of a firm's customer base concentration. We propose that the negative effect of idiosyncratic risk on investment is partly due to managerial risk aversion, and find that the negative relationship between idiosyncratic uncertainty and investment is stronger for firms with high levels of insider ownership. Several mechanisms can mitigate this effect namely the use of option-based compensation and shareholder monitoring. We find that the investment-idiosyncratic relationship is weaker for firms that make use of option-based compensation, and insider ownership does not matter for firms primarily held by institutional investors. * Federal Reserve Board, vasia.panousi@frb.gov, and Kellogg School of Management, d-papanikolaou @kel-logg.northwestern.edu. We would like to thank

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The Market Mechanism as an Incentive Scheme

Cited by 1,184 publications

References 6 publications

The bright side of financial derivatives: Options trading and firm innovation

The bright side of financial derivatives: Options trading and firm innovation

Product market competition, corporate governance and firm performance: an empirical analysis for Germany

Investment, Idiosyncratic Risk, and Ownership

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