Growing out of the Crisis through Prudential Regulation of Large Financial Institutions and Redefined Government Responsibilities

I consider in this paper the challenges and pitfalls we must face to grow out for good of the recent and latent financial crisis and economic recession. I consider a brief history of the crisis and insist on the loss of confidence within the banking and financial sector, which propagated later to the real sector. I discuss ways to rebuild confidence and move out of a stable bad economic equilibrium, due in part to inefficiently designed bonus systems. Considering data on gross job creation and loss in the private sector, I challenge the sorcerer’s apprentices in reforming capitalism and I recall the role of creative destruction. I show that government deficits and economic growth are not good friends and I offer a reference to the Canadian experience of the two decades 1985-2005. Finally, I discuss fiscal reforms and renewed roles for governmental and competitive sectors in generating a more prosperous economy as well as some specific challenges we are facing today, in particular to redesign the regulatory framework of the financial sector Je considère ici certains défis et écueils auxquels nous devons faire face pour sortir pour de bon des récentes et rampantes crise financière et récession économique. Je considère un bref historique de la crise et insiste sur la perte de confiance dans le secteur bancaire et financier, qui s’est propagé plus tard au secteur réel. Je discute des moyens de rétablir la confiance et de se sortir d'un équilibre économique mauvais mais stable, dû en partie à des systèmes incitatifs mal conçus. Considérant les données sur la création et la perte brutes d'emplois dans le secteur privé, je nous mets en garde contre les apprentis-sorciers en mal de réformer le capitalisme et je rappelle le rôle important et trop souvent oublié de la destruction créatrice. Je montre que les déficits publics et la croissance économique ne sont pas de bons comparses donnant en référence l'expérience canadienne des deux décennies 1985-2005. Enfin, je discute des réformes fiscales et des rôles renouvelés des secteurs gouvernemental et concurrentiel dans la génération d’une économie plus prospère, ainsi que certains défis spécifiques auxquels nous sommes confrontés aujourd'hui.Financial crisis, confidence, creative destruction, fiscal reforms, prudential regulation, competitive social-democracy., Crise financière, confiance, destruction créatrice, réforme fiscale, réglementation prudentielle, social-démocratie concurrentielle

Where do we stand in the theory of finance? : a selective overview with reference to Erich Gutenberg

For the past 20 years, financial markets research has concerned itself with issues related to the evaluation and management of financial securities in efficient capital markets and with issues of management control in incomplete markets. The following selective overview focuses on key aspects of the theory and empirical experience of management control under conditions of asymmetric information. The objective is examine the validity of the recently advanced hypothesis on the myths of corporate control. The present overview is based on Gutenberg's position that there exists a discrete corporate interest, as distinct from and separate from the interests of the shareholders or other stakeholders. In the third volume of Grundlagen der BWL: Die Finanzen, published in 1969, this position of Gutenberg's is coupled with an appeal for a so-called financial equilibrium to be maintained. Not until recently have models grounded in capital market theory been developed which also allow for a firm's management to exercise autonomy vis-à-vis its stakeholder. This paper was prepared for the Erich Gutenberg centenary conference on December 12 and 13, 1997 in Cologne

Occupational Choice and the Private Equity Premium Puzzle

This paper suggests a solution to what has become known as the "private equity premium puzzle" (Moskowitz and Vissing-Jorgensen (2002)). We interpret occupational choice as a dynamic portfolio choice problem of a life-cycle investor facing a liquidity constraint and imperfect information about the profitability of potential businesses. In this setting, becoming an entrepreneur is equivalent to investing in non-traded private equity capital subject to transaction costs. We model the return on private equity as the sum of two components, the individual ability of the entrepreneur and idiosyncratic business risk. Information is imperfect, because only entrepreneurs observe their own business risk realizations. Using numerical techniques we find that the model generates the observed return structure for private equity using standard CRRA-preferences and fully rational expectations.Portfolio choice, Life-cycle models, Private equity

Project selection, income smoothing, and Bayesian learning

Capital rationing is an empirically well-documented phenomenon. This constraint requires managers to make investment decisions between mutually exclusive investment opportunities. In a multiperiod agency setting, this paper analyses accounting rules that provide managerial incentives for efficient project selection. In order to motivate a shortsighted manager to expend unobservable effort and to make efficient investment decisions, the principal sets up an incentive scheme based on residual income (e.g. EVATM). The paper shows that income smoothing generates a trade-off between agency costs resulting from differences in discount rates and the costs associated with the "congruity" of residual earnings

The ignored performance measure

This paper studies a setting in which a risk averse agent must be motivated to work on two tasks: he (1) evaluates a new project and, if adopted, (2) manages it. While a performance measure which is informative of an agent´s action is typically valuable because it can be used to improve the risk sharing of the contract, this is not necessarily the case in this two-task setting. I provide a sufficient condition under which a performance measure that is informative of the second task is worthless for contracting despite the agent being risk averse. This shows that information content is a necessary but not a sufficient condition for a performance measure to be valuable

Corporate governance

Governance is largely about the decision-making process in a complex organization Shareholders (owners) delegate authority to professionals who have the managerial skills to increase shareholders’ wealth. As a consequence the contributors of a firm's capital base are usually different from the contributors of its management base. This separation of ownership from control has led to organizations establishing a system of corporate governance controls designed to discourage managers from pursuing objectives that fail to maximize shareholder wealth. These controls constitute the firm's corporate governance framework. Corporate governance controls are designed to monitor managers behavior or align the goals of management with the goals of shareholders. In this chapter, a corporate governance framework is developed that outlines the roles and responsibilities of participants involved in governing the organization and portraying information to the capital market

Foundational Economic Theories for Political-Scientific Inter-Branch Studies

Economic theories are increasingly popular in political science, and in particular in research on the relations between the legislative, the executive, and the judicial branches of government. Among these theories, principal-agent (´PA´) and transaction cost economics (´TCE´) feature particularly high in our research agenda. Yet, pushed by the view that "the content of ´science´ is primarily the methods and rules" (King et al. 1994: 9), and working with limited resources, political scientists have tended to neglect careful theorizing. PA and TCE are taken off-the-shelf without much prior scrutiny, and past conceptual mistakes are perpetuated. This paper aims at introducing and explaining the real PA, positive agency, TCE, and incomplete contracts theories for the purposes of political analysis. In a companion paper, I show the serious mistakes perpetuated by political scientists, and I argue that, faced with a choice between those four economic theories, we should place our bets on a revised version of TCE.Theory of delegation, political science, principal-agent models, transaction costs economics

Crown Financial Asset Management: Objectives and Practice

This paper analyses key issues that may be relevant to setting the Crown's overall objectives and practices for financial asset and liability management. It examines implications of the nature of the Crown's balance sheet for asset and liability management and investigates the appropriate approach of the Crown towards managing risk (concluding that a risk averse approach is warranted). The issue of centralisation versus decentralisation of Crown asset and liability management is analysed both from a portfolio management perspective and from an organisational design perspective. Insights from private sector financial conglomerates are also incorporated. The paper concludes that individual Crown financial entities should each continue to be responsible for setting their own strategic asset allocation, after taking into account the nature of their liabilities. A central Crown body should, however, monitor and aggregate information from each of these entities and be delegated the responsibility and power to manage risks to the overall Crown balance sheet.Crown balance sheet; Public debt management

Liquidity when it matters : QE and Tobin’s q

When financial markets freeze in fear, borrowing costs for solvent governments may fall towards zero in a flight to quality – but credit-worthy private borrowers can be starved of external funding. In Kiyotaki and Moore (2008), where liquidity crisis is captured by the effective rationing of private credit, tightening credit constraints have direct effects on investment. If prices are sticky, the effects on aggregate demand can be pronounced – as reported by FRBNY for the US economy using a calibrated DSGE-style framework modified to include such frictions. In such an environment, two factors stand out. First the recycling of credit flows by central banks can dramatically ease credit-rationing faced by private investors: this is the rationale for Quantitative Easing. Second, revenue-neutral fiscal transfers aimed at would-be investors can have similar effects. We show these features in a stripped- down macro model of inter-temporal optimisation subject to credit constraints