Information Percolation with Equilibrium Search Dynamics

We solve for the equilibrium dynamics of information sharing in a large population. Each agent is endowed with signals regarding the likely outcome of a random variable of common concern. Individuals choose the effort with which they search for others from whom they can gather additional information. When two agents meet, they share their information. The information gathered is further shared at subsequent meetings, and so on. Equilibria exist in which agents search maximally until they acquire sufficient information precision, and then minimally. A tax whose proceeds are used to subsidize the costs of search improves information sharing and can in some cases increase welfare. On the other hand, endowing agents with public signals reduces information sharing and can in some cases decrease welfare

Macroeconomic Risk and Debt Overhang*

Since corporate debt tends to be riskier in recessions, transfers from equity holders to debt holders that accompany corporate decisions also tend to concentrate in recessions. Such systematic risk exposures of debt overhang have important implications for corporate investment and financing decisions, and for the ex ante costs of debt overhang. Using a calibrated dynamic capital structure model, we show that the costs of debt overhang become higher in the presence of macroeconomic risk. We also provide several new predictions on how the cyclicality of a firm's assets in place and growth options affect its investment and capital structure decisions

Obfuscation, Learning, and the Evolution of Investor Sophistication

Investor sophistication has lagged behind the growing complexity of retail financial markets. To explore this, we develop a dynamic model to study the interaction between obfuscation and investor sophistica- tion in mutual fund markets. Taking into account different learning mechanisms within the investor population, we characterize the op- timal timing of obfuscation for financial institutions who offer retail products. We show that educational initiatives that are directed to fa- cilitate learning by investors may induce providers to increase wasteful obfuscation, further disorienting investors and decreasing overall wel- fare. Obfuscation decreases with competition among firms, since the information rents from obfuscation dissipate as each institution attracts a smaller market share

Performance-Sensitive Debt

This paper studies performance-sensitive debt (PSD), the class of debt obligations whose interest payments depend on some measure of the borrower’s performance. For example, step-up bonds compensate credit rating downgrades with higher interest rates, and reward credit rating upgrades with lower interest rates. In an endogenous default setting, we develop an algorithm to value PSD obligations allowing for general payment profiles, and obtain closed-form pricing formulas in important special cases, including step-up bonds. Moreover, we provide a criterion to compare different PSD obligations in terms of their efficiency. In particular, we find that step-up bonds lead to earlier default and lower the market value of the issuing firm’s equity, compared to fixed-coupon bonds of the same market value. Lastly, we analyze the implications of our results for the policy of credit-rating agencies

Performance-Sensitive Debt

This paper studies performance-sensitive debt (PSD), the class of debt obligations whose interest payments depend on some measure of the borrower’s performance. For example, step-up bonds compensate credit rating downgrades with higher interest rates, and reward credit rating upgrades with lower interest rates. In an endogenous default setting, we develop an algorithm to value PSD obligations allowing for general payment profiles, and obtain closed-form pricing formulas in important special cases, including step-up bonds. Moreover, we provide a criterion to compare different PSD obligations in terms of their efficiency. In particular, we find that step-up bonds lead to earlier default and lower the market value of the issuing firm’s equity, compared to fixed-coupon bonds of the same market value. Lastly, we analyze the implications of our results for the policy of credit-rating agencies

The Relative Contributions of Private Information Sharing and Public Information Releases to Information Aggregation

We calculate learning rates when agents are informed through both public and private observation of other agents’ actions. We provide an explicit solution for the evolution of the distribution of posterior beliefs. When the private learning channel is present, we show that convergence of the distribution of beliefs to the perfect-information limit is exponential at a rate equal to the sum of the mean arrival rate of public information and the mean rate at which individual agents are randomly matched with other agents. If, however, there is no private information sharing, then convergence is exponential at a rate strictly lower than the mean arrival rate of public information

Governance Through Trading and Intervention: A Theory of Multiple Blockholders

http://rfs.oxfordjournals.org/content/early/2010/12/13/rfs.hhq145.full.pdf+htmlTraditional theories argue that governance is strongest under a single large blockholder, as she has high incentives to undertake value-enhancing interventions. However, most firms are held by multiple small blockholders. This article shows that, while such a structure generates free-rider problems that hinder intervention, the same coordination difficulties strengthen a second governance mechanism: disciplining the manager through trading. Since multiple blockholders cannot coordinate to limit their orders and maximize combined trading profits, they trade competitively, impounding more information into prices. This strengthens the threat of disciplinary trading, inducing higher managerial effort. The optimal blockholder structure depends on the relative effectiveness of manager and blockholder effort, the complementarities in their outputs, information asymmetry, liquidity, monitoring costs, and the manager's contract.Wharton SchoolRodney L. White Center for Financial Research (Goldman Sachs Research Fellowship

Information Percolation in Segmented Markets

We calculate equilibria of dynamic double-auction markets in which agents are distinguished by their preferences and information. Over time, agents are privately informed by bids and offers. Investors are segmented into groups that differ with respect to characteristics determining information quality, including initial information precision as well as market “connectivity,” the expected frequency of their trading opportunities. Investors with superior information sources attain strictly higher expected profits, provided their counterparties are unable to observe the quality of those sources. If, however, the quality of bidders’ information sources are commonly observable, then, under conditions, investors with superior information sources have strictly lower expected profits.

When Does Libertarian Paternalism Work?

We develop a theoretical model to study the effects of libertarian paternalism on knowledge acquisition and social learning. Individuals in our model are permitted to appreciate and use the information content in the default options set by the government. We show that in some settings libertarian paternalism may decrease welfare because default options slow information aggregation in the market. We also analyze what happens when the government acquires imprecise information about individuals, and characterize its incentives to avoid full disclosure of its information to the market, even when it has perfect information. Finally, we consider a market in which individuals can sell their information to others and show that the presence of default options causes the quality of advice to decrease, which may lower social welfare.

Incentives and Creativity: Evidence from the Academic Life Sciences

Despite its presumed role as an engine of economic growth, we know surprisingly little about the drivers of scientific creativity. In this paper, we exploit key differences across funding streams within the academic life sciences to estimate the impact of incentives on the rate and direction of scientific exploration. Specifically, we study the careers of investigators of the Howard Hughes Medical Institute (HHMI), which tolerates early failure, rewards long-term success, and gives its appointees great freedom to experiment; and grantees from the National Institute of Health, which are subject to short review cycles, pre-defined deliverables, and renewal policies unforgiving of failure. Using a combination of propensity-score weighting and difference-in-differences estimation strategies, we find that HHMI investigators produce high- impact papers at a much higher rate than a control group of similarly-accomplished NIH-funded scientists. Moreover, the direction of their research changes in ways that suggest the program induces them to explore novel lines of inquiry.