Toward Choice-Theoretic Foundations for Behavioral Welfare Economics

Interest in behavioral economics has grown in recent years, stimulated largely by accumulating evidence that the standard model of consumer decision making provides an inadequate, positive description of human behavior. Behavioral models are increasingly finding their way into policy evaluation, which inevitably involves welfare analysis. No consensus concerning the appropriate standards and criteria for behavioral welfare analysis has emerged yet. This paper summarizes our effort to develop a unified framework for behavioral welfare economics (for a detailed discussion see Bernheim and Rangel 2007) — one that can be viewed as a natural extension of standard welfare economics. Standard welfare analysis is based on choice, not on utility or preferences. In its simplest form, it instructs the planner to respect the choices an individual would make for himself. The guiding normative principle is an extension of the libertarian deference to freedom of choice, which takes the view that it is better to give a person the thing he would choose for himself rather than something that someone else would choose for him. We show that it is possible to extend the standard choice-theoretic approach to welfare analysis to situations where individuals make inconsistent choices, which are prevalent in behavioral economics

Beyond revealed preference: choice-theoretic foundations for behavioral welfare economics

We propose a broad generalization of standard choice-theoretic welfare economics that encompasses a wide variety of nonstandard behavioral models. Our approach exploits the coherent aspects of choice that those positive models typically attempt to capture. It replaces the standard revealed preference relation with an unambiguous choice relation: roughly, x is (strictly) unambiguously chosen over y (written xP*y) iff y is never chosen when x is available. Under weak assumptions, P* is acyclic and therefore suitable for welfare analysis; it is also the most discerning welfare criterion that never overrules choice. The resulting framework generates natural counterparts for the standard tools of applied welfare economics and is easily applied in the context of specific behavioral theories, with novel implications. Though not universally discerning, it lends itself to principled refinements

A Tax-Based Test of the Dividend Signaling Hypothesis

We propose and implement a new test of the dividend signaling hypothesis that is designed to discriminate between dividend signaling and other theories that would account for the apparent existence of a dividend preference. Our test refines the use of data on stock price responses to dividend announcements. In particular, we study the effect of dividend taxation on the bang-for-the-buck, which we define as the share price response per dollar of dividends. Most dividend signaling models imply that an increase in dividend taxation should increase the bang-for-the-buck. In contrast, other dividend preference theories imply that an increase in dividend taxation should decrease the bang-for-the-buck. Since there have recently been considerable variation in the tax treatment of dividends, we are able to study dividend announcement effects under different tax regimes. Our central finding is that there is a strong positive relationship between dividend tax rates and the bang-for-the-buck. This result supports the dividend signaling hypothesis, and is consistent with alternatives. The paper also provides corroborating evidence based on the relationship between the bang-for-the-buck and bond ratings.

Optimal Money Burning: Theory and Application to Corporate Dividend Policy

We explore signaling behavior in settings with a discriminating signal and several costly nondiscriminating ( money burning ) activities. In settings where informed parties have many options for burning money, existing theory provides no basis for selecting one nondiscriminating activity over another. When senders have private information about the costs of these activities, each sender's indifference is resolved, the taxation of a nondiscriminating signal is Pareto improving, and the use of the taxed activity becomes more widespread as the tax rate rises. We apply this analysis to the theory of dividend signaling. The central testable implication of the model is verified empirically.

Do Real Estate Brokers Add Value When Listing Services Are Unbundled?

This paper measures the effects of real estate brokerage services provided to sellers, other than MLS listings, on the terms and timing of home sales. It is not obvious that sellers benefit from those services. On the one hand, brokers offer potentially useful knowledge and expertise. On the other hand, because the relationship between the homeowner and the broker resembles a classical principal-agent problem, the broker may not deploy services in ways that promote the seller’s interests. Yet as long as valuable MLS listings are bundled with brokerage services, homeowners may use brokers even if the agency costs exceed the benefits of brokers’ knowledge and expertise. Thus, quantification of the net value of brokerage services other than MLS listings bears directly on the recent policy debate over the desirability unbundling of MLS listings. We estimate the effect of a seller’s decision to use a broker on list prices, selling prices, and speed of sale for a real estate market with an unusual and critical characteristic: it has a single open-access listing service that is used by essentially all sellers, regardless of whether they employ brokers. Our central finding is that, when listings are not tied to brokerage services, a seller’s use of a broker reduces the selling price of the typical home by 5.9 to 7.7 percent, which indicates that agency costs exceed the advantages of brokers’ knowledge and expertise by a wide margin.