Knowledge that Transforms

As Edwin Leuven and Hessel Oosterbeek (2001) point out, rather than performing the comparative statics analysis on the effect of increasing uncertainty, my original study limited the analysis to degenerate cases and refrained from inferring a possible monotonic relationship between uncertainties and the share ratio (Hashimoto, 1981 pp. 479–80). Leuven and Oosterbeek do not dispute my conclusions for degenerate cases. Donald O. Parsons (1986 p. 826) later asserted such a monotonic relationship without reporting a comparative statics analysis. Leuven and Oosterbeek use a uniform distribution of productivity to dispute Parsons’ assertion. Hashimoto and Jeong-Geon Lee (1994) reached a similar conclusion to theirs. Given the Hashimoto-Lee comparative statics analysis, I view the most significant contribution of Leuven-Oosterbeek to be not so much their comparative statics as their explicit formulation to account for what has become known in the literature as enforceability of contracts. In the 1981 paper I was concerned with the enforceability issues, so I adopted a certaintyequivalent approach to the fixed-wage formulation in the face of double informational asymmetry between the employer and worker. I then focused on the Becker-type share determination of specific human-capital returns (Gary S. Becker, 1962). Leuven and Oosterbeek directly formulate the enforceability of employment contracts in terms of a fixed wage rather than in terms of the sharing ratio. By considering the enforceability (or the incentive compatibility) issues in a fuller perspective, I conclude that the certainty-equivalent formulation I adopted in my 1981 model has an internal infirmity. In my opinion, this infirmity is a point that a serious Comment on Hashimoto (1981) should underscore. I do not think that Leuven and Oosterbeek’s Comment (2001) is sufficiently articulate or structured to highlight this point. Space does not permit a full discussion, so let me remark briefly on an important point that Leuven and Oosterbeek should have highlighted, but did not. The explicit and direct determination of the incentive-compatible fixed wage w leads me to conclude that the joint maximand is not the unconditional expectation Ev (s) 2 Ey(s), as I originally formulated; rather it is the conditional expectation Estay(v (s) 2 y(s)), conditional on both parties not separating. In the latter formulation, the determination of the fixed wage w implies an ex ante determination of the share parameter to be a 5 {Estay(w 2 y(s))}/{Estay(v(s) 2 y(s))}, which is equivalent to Leuven and Oosterbeek’s definition of a. In spite of the difference in formulation between Leuven-Oosterbeek and Hashimoto-Lee, the two studies obtain essentially the same comparative statics results. This is because both formulations rely on incentive-compatibility conditions for separation decisions where the forces at work are basically the same. Thus, Leuven and Oosterbeek confirm the accuracy of the degenerate results reported in Hashimoto (1981). For nondegenerate cases, the comparative statics are generally ambiguous. Using a uniform distribution, Leuven and Oosterbeek do find that the optimal wage decreases with the uncertainty in the market and increases with the uncertainty in the firm (p. 345). These findings are equivalent to what Hashimoto and Lee (1994) found: that the optimal share ratio decreases with the uncertainty in the outside productivity and increases with the uncertainty in the inside productivity. The Leuven-Oosterbeek Comment contributes a technical advance, but it retains the essential economic logic * Department of Economics, 410 Arps Hall, Ohio State University, 1945 North High Street, Columbus, OH 43210. I am grateful to Hajime Miyazaki for extensive discussions that elucidated theoretical issues in modeling information asymmetric employment relations and for improving the exposition, and to Teresa Schoellner for her very competent research assistance. However, I bear full responsibility for any remaining shortcomings. 1 Further analytical details are available upon request.

Exchange-Rate Hedging: Financial versus Operational Strategies by George Allayannis, Jane Ihrig and James P. Weston. Published in volume 91, issue 2, pages 391-395 of American Economic Review, May 2001

Market Structure and Racial Earnings: Evidence from Job-Changers by Jacqueline Agesa, Richard U. Agesa and Gary A. Hoover. Published in volume 91, issue 2, pages 169-173 of American Economic Review, May 2001

There exists by now a burgeoning literature concerned with the consequences of a fixed cost of price adjustment. Due to this cost, a monopolistic firm does not necessarily adjust its price even though the current price deviates from the price that would maximize the firm's current profit. As a result, the production generally differs from what it would be in the absence of a menu cost, with the effect of inflation on the average output and welfare under monopolistic competition being ambiguous and depending in a complicated way on the profit and demand functions. 1 However, one strong result holds unambiguously for all profit and demand functions: at low inflation rates, the average output and welfare are above their levels at full price stability where firms charge the static monopoly price.2 The driving force is that discounting makes a firm more concerned with its real profits earlier in a period with a constant nominal price than with its real profits later in the period. In fact, as the inflation rate approaches zero, the firm's initial real price converges to the profit-maximizing real price, while the terminal real price converges to a smaller real price. At low inflation rates, therefore, a firm's price is most of the time below the price that would maximize the current profit. Since output and welfare under monopolistic competition are inversely related to price, average output and welfare are higher than under full price stability. The inevitable conclusion is that the economy benefits from a little bit of inflation. A critical assumption underlying this result is that firms can continuously adjust their production to satisfy demand. So while the menu-cost literature explicitly assumes that there is a small fixed cost incurred at each price adjustment, it also implicitly assumes that it is costless to continuously adjust the quantity of output.3 This is, however, a questionable assumption. There is some empirical evidence indicating the existence of a cost of quantity adjustment, part of which is fixed in that it does not depend on the size of the adjustment.4 The cost of quantity adjustment stems from the need to rearrange and reorganize the factor inputs for the new level of production and includes managerial time and effort. A fixed cost of quantity adjustment rules out any continuous adjustment of the production to satisfy the increasing demand that results from a decreasing real price within a period with a constant nominal price. Under the reasonable assumption that the menu cost does not exceed the fixed cost of quantity adjustment,5 in an inflationary environment a firm chooses to adjust its nomi-

The connection between obtaining higher paying jobs and undertaking some seemingly irrelevant activity is interpreted as “social culture.” In the context of a society trying to adopt a new technology, I show that by allowing the firms to give preferential treatment to workers based on some “cultural activity,” the society can partially overcome an informational free-riding problem. Therefore, social culture may affect the economic performance by altering the effective production technology of the economy.

Do Explicit Warnings Eliminate the Hypothetical Bias in Elicitation Procedures? Evidence from Field Auctions for Sportscards by John A. List. Published in volume 91, issue 5, pages 1498-1507 of American Economic Review, December 2001

Comparing Apples to Oranges: Productivity Convergence and Measurement across Industries and Countries: Reply by Andrew B. Bernard and Charles I. Jones. Published in volume 91, issue 4, pages 1168-1169 of American Economic Review, September 2001

Growing Up in the Projects: The Economic Lives of a Cohort of Men Who Came of Age in Chicago Public Housing by Steven D. Levitt and Sudhir Alladi Venkatesh. Published in volume 91, issue 2, pages 79-84 of American Economic Review, May 2001

Major technological, regulatory, and institutional changes have made finance more widely available in recent years. The ability of institutions to price a variety of exotic instruments, and to assess and spread risks, has increased. More data on potential borrowers is now available, and it is also more timely. Improvements in accounting disclosure have resulted in greater borrower transparency. Deregulation has resulted in greater competition and better prices in markets. Finally, regulatory barriers protecting the turf of different kinds of institutions have come down, resulting in the emergence of new institutional forms. These changes amount to a bona fide financial revolution. In this article, we focus on the impact the revolution has had on the way firms are (or should be) organized and managed, and on the policy consequences. To do this, we first need to understand what firms are and what drives their organizational structure. A caveat is in order at the outset. Finance is not the only force transforming the nature of firms in the last two decades; deregulation and technological change have also played big roles. These have been explored elsewhere (see e.g., Rajan and Zingales, 2000); hence, our focus. I. Critical Resource Theory