Sequential Decision Problems and Asymmetric Information

The study of sequential decision processes has been important for theories of statistical decisionmaking, dynamic programming, optimal stopping, search, and investment decisions. These literatures have emphasized the benefits of incrementalism and the resulting value of information. However, the costs arising from asymmetries in access to newly-arriving information have been uniformly ignored. This paper presents a preliminary inquiry into the costs of information in sequential economic decisionmaking problems. An investment project with several stages is modeled, in which the project manager and the investors have differential access to new information about project value. An optimal contract is derived specifiying financing terms and project management rules. Two general conclusions are developed: first, asymmetric information in sequential decision problems can be quite costly; second, modeling investment decisions as sequential problems with asymmetric information can lead to optimal contracts that are simple, robust and realistic. Applications to a broad range of economic questions are suggested.Center for Research on Economic and Social Theory, Department of Economics, University of Michiganhttp://deepblue.lib.umich.edu/bitstream/2027.42/100870/1/ECON323.pd

Nonlinear Taxation of Risky Assets and Investment, With Application to Mining

An intertemporal capital asset valuation approach is applied to analyzing the effects of nonlinear taxes on asset values and optimal investment decisions. The method is quite general, and is illustrated both analytically and numerically. The paper studies the effects of nonlinearities in the corporate income tax, including the percentage depletion allowance, on mine values and investment decisions. Although the tax policies are found to have the expected effects on asset values, the effects on investment decisions are sometimes perverse. An increase in the income tax rate may encourage investment; an increase in the depletion allowance subsidy may discourage investment.Center for Research on Economic and Social Theory, Department of Economics, University of Michiganhttp://deepblue.lib.umich.edu/bitstream/2027.42/100869/1/ECON322.pd

Taxes, Information and Corporate Financing Choices

The paper uses a different approach from most capital structure studies, and a large new data set to study many hypotheses of the determinants of financial decisions. We focus on incremental financing choices by firms (new public issues) rather than the debt/assets ratio. We resolve some questions about the role of taxes, by obtaining strong and plausible results after controlling for confounding effects which have been ignored in previous studies. We also find strong support for several predictions of moral hazard and financial distress theories of optimal leverage ratios. Some evidence of signaling costs for equity issues emerges, but the extreme "pecking order" hypothesis (that firms have hierarchical preferences with no optimal debt ratio) is rejected.Center for Research on Economic and Social Theory, Department of Economics, University of Michiganhttp://deepblue.lib.umich.edu/bitstream/2027.42/100871/1/ECON324.pd

System Design, User Cost and Electronic Usage of Journals

Dramatic increases in the capabilities and decreases in the costs of computers and communication networks have fomented revolutionary thoughts in the scholarly publishing community. In one dimension, traditional pricing schemes and product packages are being modified or replaced. We designed and undertook a large-scale field experiment in pricing and bundling for electronic access to scholarly journals: PEAK. We provided Internet-based delivery of content from 1200 Elsevier Science journals to users at multiple campuses and commercial facilities. Our primary research objective was to generate rich empirical evidence on user behavior when faced with various bundling schemes and price structures. In this article we explain the different types and levels of cost that users faced when accessing individual articles, and report on the effect of these costs on usage. We found that both monetary and non-monetary user costs have a significant impact on the demand for electronic access. We also estimate how taking user costs into account would change the optimal (least cost) bundle of access options that an institution should purchase.

How Much Do Taxes Discourage Incorporation.

One of the most basic distortions created by the double taxation of corporate income is the disincentive to incorporate. In this paper, we investigate the extent to which the aggregate allocation of assets and taxable income in the U.S. between corporate vs. noncorporate forms of organization during the period 1959-86 has responded to the size of the tax distortion discouraging firms from incorporating. In theory, profitable firms should shift out of the corporate sector when the tax distortion to incorporating is larger, and conversely for firms with tax losses. Our empirical results provide strong support for these theoretical forecasts, and hold consistently across a wide variety of specifications and measures of the tax variables. Measured effects are small, however, throwing doubt on the economic importance of tax-induced changes in organizational form.

Why Is There Corporate Taxation In a Small Open Economy? The Role of Transfer Pricing and Income Shifting

Several recent papers argue that corporate income taxes should not be used by small, open economies. With capital mobility, the burden of the tax falls on fixed factors (e.g., labor), and the tax system is more efficient if labor is taxed directly. However, corporate taxes not only exist but rates are roughly comparable with the top personal tax rates. Past models also forecast that multinationals should not invest in countries with low corporate tax rates, since the surtax they owe when profits are repatriated puts them at a competitive disadvantage. Yet such foreign direct investment is substantial. We suggest that the resolution of these puzzles may be found in the role of income shifting, both domestic (between the personal and corporate tax bases) and cross-border (through transfer pricing). Countries need cash-flow corporate taxes as a backstop to labor taxes to discourage individuals from converting their labor income into otherwise untaxed corporate income. We explore how these taxes can best be modified to deal as well with cross-border shifting.

Economic FAQs About the Internet

This is a set of Frequently Asked Questions (and answers) about the economic, institutional, and technological structure of the Internet. We describe the history and current state of the Internet, discuss some of the pressing economic and regulatory problems, and speculate about future developments.Internet, telecommunications, congestion pricing, National Information Infrastructure

Effects of the Tax Reform Act of 1986 on Corporate Financial Policy and Organizational Form

We examine the effects of the Tax Reform Act of 1986 on the financial decisions made by firms. We review the theory and empirical predictions of prior literature for corporate debt policy, for dividend and equity repurchase payouts to shareholders, and for the choice of organizational form. We then compare the predictions to post-1986 experience. The change in debt/value ratios has been substantially smaller than expected. Dividend payouts increased as predicted, but stock repurchases increased even more rapidly which was unexpected and is difficult to understand. Based on very scant data, it appears that some activities have shuffled among organizational forms; in particular, loss activities may have been moved into corporate form where they are deducted at a higher tax rate, while gain activities may have shifted towards noncorporate form, to be taxed at the lower personal rates. In addition, several interesting new issues are raised. One concerns previously neglected implications for the effective tax on retained earnings that follow from optimal trading strategies when long- and short-term capital gains are taxed at different rates. Also, new interest allocation rules for multinational corporations provide a substantial incentive for many firms to shift their borrowing abroad.

Do Firms Care Who Provides their Financing?

Several types of evidence are presented to demonstrate that firms are concerned with who provides their financing, not just with the debt/equity distinction. Aggregate and industry trends and patterns in the incremental sources of financial capital are documented, and a large sample of incremental corporate financial decisions is econometrically analyzed. There are large and persistent differences in the patterns of internal and external financing, both in the aggregate and across industries. Individual firms are shown to have distinct preferences for different providers of funds. Several indicators of potentially costly hidden information problems are important and significant determinants of choices between private and publicly-marketed sources, even after controlling for the type of security (debt or equity).