Knowledge that Transforms

We examine legislative policy making in institutions with two empirically relevant features: agenda setting occurs in real time and the default policy evolves. We demonstrate that these institutions select Condorcet winners when they exist, provided a sufficient number of individuals have opportunities to make proposals. In policy spaces with either pork barrel or pure redistributional politics (where a Condorcet winner does not exist), the last proposer is effectively a dictator or near-dictator under relatively weak conditions. Copyright The Econometric Society 2006.

This paper provides a first order asymptotic theory for generalized method of moments (GMM) estimators when the number of moment conditions is allowed to increase with the sample size and the moment conditions may be weak. Examples in which these asymptotics are relevant include instrumental variable (IV) estimation with many (possibly weak or uninformed) instruments and some panel data models that cover moderate time spans and have correspondingly large numbers of instruments. Under certain regularity conditions, the GMM estimators are shown to converge in probability but not necessarily to the true parameter, and conditions for consistent GMM estimation are given. A general framework for the GMM limit distribution theory is developed based on epiconvergence methods. Some illustrations are provided, including consistent GMM estimation of a panel model with time varying individual effects, consistent limited information maximum likelihood estimation as a continuously updated GMM estimator, and consistent IV structural estimation using large numbers of weak or irrelevant instruments. Some simulations are reported. Copyright The Econometric Society 2006.

We characterize, in the Anscombe–Aumann framework, the preferences for which there are a utility functionu on outcomes and an ambiguity indexc on the set of probabilities on the states of the world such that, for all acts f and g, . The function u represents the decision maker's risk attitudes, while the index c captures his ambiguity attitudes. These preferences include the multiple priors preferences of Gilboa and Schmeidler and the multiplier preferences of Hansen and Sargent. This provides a rigorous decision-theoretic foundation for the latter model, which has been widely used in macroeconomics and finance.

We examine experimentally the impact of communication on trust and cooperation. Our design admits observation of promises, lies, and beliefs. The evidence is consistent with people striving to live up to others' expectations so as to avoid guilt, as can be modeled using psychological game theory. When players exhibit such guilt aversion, communication may influence motivation and behavior by influencing beliefs about beliefs. Promises may enhance trustworthy behavior, which is what we observe. We argue that guilt aversion may be relevant for understanding strategic interaction in a variety of settings, and that it may shed light on the role of language, discussions, agreements, and social norms in these contexts.

This paper presents a new approach to estimation and inference in panel data models with a general multifactor error structure. The unobserved factors and the individual-specific errors are allowed to follow arbitrary stationary processes, and the number of unobserved factors need not be estimated. The basic idea is to filter the individual-specific regressors by means of cross-section averages such that asymptotically as the cross-section dimension (N) tends to infinity, the differential effects of unobserved common factors are eliminated. The estimation procedure has the advantage that it can be computed by least squares applied to auxiliary regressions where the observed regressors are augmented with cross-sectional averages of the dependent variable and the individual-specific regressors. A number of estimators (referred to as common correlated effects (CCE) estimators) are proposed and their asymptotic distributions are derived. The small sample properties of mean group and pooled CCE estimators are investigated by Monte Carlo experiments, showing that the CCE estimators have satisfactory small sample properties even under a substantial degree of heterogeneity and dynamics, and for relatively small values of N and T.

We model CEO and director compensation using firm characteristics, CEO characteristics, and governance variables. After controlling for monitoring proxies, we find a significant positive relationship between CEO and director compensation. We hypothesize that this relationship could be due to unobserved firm complexity (omitted variables), and/or to excess compensation of directors and managers. We also find evidence that excess compensation (both director and CEO) is associated with firm underperformance. We therefore conclude that the evidence is consistent with excessive compensation due to mutual back scratching or cronyism. The evidence suggests that excessive compensation has an effect on firm performance that is independent of the poor governance variables discussed by previous studies.

I develop a corporate governance framework, provide a broad overview of recent corporate governance research, and place each of the Special Issue papers within the context of this framework. The papers in the issue contribute to our understanding of a wide range of governance topics including: the role of antitakeover measures, board structure, capital market governance, compensation and incentives, debt and agency costs, director and officer labor markets, fraud, lawsuits, ownership structure, and regulation. In short, the papers span almost every aspect of governance systems.

This paper examines the link between capital market governance (CMG) and several key measures of market performance. Using detailed data from individual stock exchanges, we develop a composite CMG index that captures three dimensions of security laws: the degree of earnings opacity, the enforcement of insider laws, and the effect of removing short-selling restrictions. We find that improvements in the CMG index are associated with decreases in the cost-of-equity capital (both implied and realized), increases in market liquidity (trading volume, market depth, and U.S. foreign investments), and increases in market pricing efficiency (reduced price synchronicity and IPO underpricing). The results are quite consistent across individual components of CMG and over alternative market performance measures.

Our study examines whether ownership structure and boardroom characteristics have an effect on corporate financial fraud in China. The data come from the enforcement actions of the Chinese Securities Regulatory Commission (CSRC). The results from univariate analyses, where we compare fraud and no-fraud firms, show that ownership and board characteristics are important in explaining fraud. However, using a bivariate probit model with partial observability we demonstrate that boardroom characteristics are important, while the type of owner is less relevant. In particular, the proportion of outside directors, the number of board meetings, and the tenure of the chairman are associated with the incidence of fraud. Our findings have implications for the design of appropriate corporate governance systems for listed firms. Moreover, our results provide information that can inform policy debates within the CSRC.

We report a significant positive association between the likelihood of securities fraud allegations and a measure of executive stock option incentives. This relation is robust to the inclusion of other components of the compensation structure and to other possible determinants of fraud allegations. In addition, we find that the positive relation between the likelihood of fraud allegations and option intensity is stronger in firms with higher outside blockholder and higher institutional ownership. These findings support the view that stock options increase the incentive to engage in fraudulent activity and that this incentive is exacerbated by institutional and block ownership.