Persuasion in Finance

Persuasion is a fundamental part of social activity, yet it is rarely studied by economists. We compare the traditional economic model, in which persuasion is communication of objectively valuable information, with a behavioral model, in which persuasion is an effort to fit the message into the audience's already held beliefs. We present a simple formalization of the behavioral model, and compare the two models using data on financial advertising in Money and Business Week magazines over the course of the internet bubble. The evidence on the content of the persuasive messages is broadly consistent with the behavioral model of persuasion.

Profitable Investments or Dissipated Cash?: Evidence on the Investment-Cash Flow Relationship From Oil and Gas Lease Bidding

Both agency- and non-agency-based interpretations have been proposed to explain the strong positive empirical relationship between corporate cash flow and corporate investment. In this paper, we attempt to distinguish between these different interpretations using project-level data in the oil and gas industry. The specific projects we consider are mineral exploration leases on tracts of land. The standard positive relationship between investment and cash flow holds for these projects, in that we find that positive shocks to residual cash flow (netting out firm and time effects) are associated with higher spending on these projects. Interestingly, the increased investment comes from an increase in the price paid per tract with little to no change in the total number of tracts or total acreage of land bought. The positive association between price and cash flow holds even after controlling for a set of tract and firm characteristics that might be ex-ante related to expected return on a given tract. This data is most useful, however, because we can directly observe the eventual productivity of the projects undertaken. We find that the variation in bid price induced by higher cash flow is, if anything, negatively related to tract productivity. More importantly, the overall number of productive tracts does not increase with the cash flow in the year these tracts were bought. In other words, while higher cash flow is associated with higher spending on these projects, higher cash flow does not lead to higher revenues from these projects. Combining this finding with the lack of a quantity response, we conclude that our results are best described by an agency model where managers use cash flow to simplify their job (or live a “quiet life”) rather than “empire-build. ”

Do Cigarette Taxes Make Smokers Happier?

To measure how policy changes affect social welfare, economists typically look at how policies affect behavior, and use a formal model to infer welfare consequences from the behavioral responses. But when different models can map the same behavior to very different welfare impacts, it becomes hard to draw firm conclusions about many policies. An excellent example of this conundrum is the taxation of addictive substances such as cigarettes. Existing empirical evidence on smoking is equally consistent with two models that have radically different welfare implications. Under the rational addiction model, cigarette taxes make time consistent smokers worse off. But, under alternative time inconsistent models, smokers are made better off by taxes, as they provide a valuable self-control device. We therefore propose an alternative approach to assessing the welfare implications of policy interventions: examining directly the impact on subjective well-being. We do so by matching information on cigarette excise taxation to separate surveys from the U.S. and Canada that contain data on self-reported happiness. And we model the differential impact of excise taxes on those predicted to be likely to be smokers, relative to others, in order to control for omitted correlations between happiness and excise taxation. We find consistent evidence in both countries that excise taxes make predicted smokers happier. This evidence suggests that the time inconsistent model of smoking is more appropriate, and that as a result welfare is improved by higher cigarette taxes.

Sticking with Your Vote: Cognitive Dissonance and Voting

In traditional models, votes are an expression of preferences and beliefs. Psychological theories of cognitive dissonance suggest, however, that behavior may shape preferences. In this view, the very act of voting may influence political attitudes. A vote for a candidate may lead to more favorable interpretations of his actions in the future. We test the empirical relevance of cognitive dissonance in US Presidential elections. The key problem in such a test is the endogeneity of voter choice which leads to a mechanical relationship between voting and preferences. We use the voting age restrictions to help surmount this difficulty. We examine the Presidential opinion ratings of nineteen and twenty year olds two years after the President's election. Consistent with cognitive dissonance, we find that twenty year olds (who were eligible to vote in the election) show greater polarization of opinions than comparable nineteen year olds (who were ineligible to vote). We rule out that aging drives these results in two ways. First, we find no polarization differences in years in which twenty and nineteen year olds would not have differed in their eligibility to vote in the prior Presidential election. Second, we show a similar effect when we compare polarization (for all age groups) in opinions of Senators elected during high turnout Presidential campaign years with Senators elected during low turnout non-Presidential campaign years. Thus we find empirical support for the relevance of cognitive dissonance to voting behavior. This finding has at least three implications for the dynamics of voting behavior. First, it offers a new rationale for the incumbency advantage. Second, it suggests that there is an efficiency argument for term limits. And finally, our results demonstrate that efficiency may not be increasing in turnout level.

Profitable Investments or Dissipated Cash? Evidence on the Investment-Cash Flow Relationship From Oil and Gas Lease Bidding

The strong positive relationship between corporate cash flow and investment has been interpreted through the lens of both agency- and non-agency-based models. In this paper, we distinguish between these two interpretations using project-level data in the oil and gas industry. The specific projects we consider are auctioned-off leases that give mineral exploration rights to tracts of federal land. We find the standard positive relationship between investment and cash flow in this data, in that positive shocks to residual cash flow (netting out firm and time effects) are associated with higher spending on these leases. Interestingly, the increased investment comes from an increase in the price paid per tract with little to no change in the total number of tracts or total acreage of land bought. The positive association between price and cash flow holds even after controlling for a set of tract and firm characteristics that might be ex-ante related to expected return on a given tract. This data is most useful, however, because we can directly observe the eventual productivity of each of these projects. We find that the increase in price induced by higher cash flow is associated with lower average productivity. In fact, the total number of productive tracts does not increase with cash flow. In other words, while higher cash flow is associated with higher spending on these projects, higher cash flow does not lead to higher revenues from these projects. Combining this finding with the lack of a quantity response, we conclude that our results are best described by an agency model where managers use cash flow to simplify their job (or live a ``quiet life'') rather than ``empire-build.''

Media Bias

There are two different types of media bias. One bias, which we refer to as ideology, reflects a news outlet's desire to affect reader opinions in a particular direction. The second bias, which we refer to as spin, reflects the outlet's attempt to simply create a memorable story. We examine competition among media outlets in the presence of these biases. Whereas competition can eliminate the effect of ideological bias, it actually exaggerates the incentive to spin stories.