This paper surveys the growing literature on payments. We begin by presenting a simple model that illustrates the essential function of payments and how this may be implemented through various arrangements. We show how the basic models of payments have been used to address a variety of microeconomic and macroeconomic policy issues. We then discuss the links between payments economics and other fields, including monetary theory, corporate finance, and industrial organization. We conclude with an overview of the empirical literature and directions for future research.

This paper investigates whether functional diversification is value-enhancing or value-destroying in the financial services sector, broadly defined. Based on a U.S. dataset comprising approximately 4060 observations covering the period 1985–2004, we report a substantial and persistent conglomerate discount among financial intermediaries. Our results suggest that it is diversification that causes the discount, and not that troubled firms diversify into other more promising areas. In addition, the discount applies to all financial services activity-areas with the exception of investment banking and is stable over different combinations of financial activity-areas with the exception of commercial banking units combined with insurance companies and/or investment banking activities.

Abstract Compensation policy has become one of the most important ingredients of corporate governance. In this paper we take a new look at the issue, by contrasting the use of options with that of stock. We do this by integrating the repricing or resetting aspect of options with that of industrial structure. We show that industry competition may play an important role in dictating which form of compensation is optimal. When aggressive competition for key professional staff is an issue, the flexibility of options may actually become a disadvantage and therefore pure stock compensation may survive as an equilibrium. Thus compensation trends may be partly explained by trends in the nature of the competitive environment.

Size matters in banking. In this paper, we explore whether shocks originating at large banks affect the probability of distress of smaller banks and thus the stability of the banking system. Our analysis proceeds in two steps. In a first step, we follow Gabaix [Gabaix, X., 2008a. The Granular Origins of Aggregate Fluctuations. Available at SSRN: http://ssrn.com/abstract=1111765] and construct a measure of idiosyncratic shocks at large banks, the so-called Banking Granular Residual. This measure documents the importance of size effects for the German banking system. In a second step, we incorporate this measure of idiosyncratic shocks at large banks into an integrated stress-testing model for the German banking system following De Graeve et al. (2008). We find that positive shocks at large banks reduce the probability of distress of small banks.

Financial intermediaries often use stress testing to set risk exposure limits. Accordingly, we examine a model with an agent who faces stress testing constraints and another who does not. Three results are obtained. First, when there are K* binding constraints, the constrained agent's optimal portfolio exhibits (K*+2)-fund separation. Second, the effect of the constraints on the optimal portfolio is identical to that of an adjustment in the expected payoffs of the risky securities that tends to lower them. Third, a security's equilibrium expected return depends on both its systematic risk and its idiosyncratic returns in the states where the constraints bind.

In this discussion, I provide some big picture thoughts on the Collins, Gong and Li (2009) paper (CGL hereafter) entitled: Corporate Governance and Backdating of Executive Stock Options. CGL utilize an estimation algorithm to generate a large sample of potential incidences of grant-level backdating behavior. The conceptual premise of the paper is that the backdating of CEO stock option grants is a direct consequence of “weak ” corporate governance structures. The authors make directional predictions about the relation between firms ’ individual governance structures and the probability that stock option backdating occurs. Each governance structure for a firm is represented by a numerical metric where higher values are interpreted as weaker governance. For example, governance is posited to get weaker as the proportion of inside or gray directors increases. The authors then predict the probability of backdating to be an increasing function of the metric representing each individual governance structure. CGL adds to the stream of papers that empirically examine the backdating issue (e.g., Heron and Lie (2007), Bebchuk, Grinstein and Peyer (2007), and Bizjak et al., (2006)). In some sense, CGL is the culmination of this research line. CGL replicates a number of results spread across the extant literature, and add some twists and turns of their own. The authors do a nice job in the paper of isolating their unique contributions, so I need not repeat any of that here. Overall, this is a very careful piece of empirical research, and I have no intention of nit-picking the empirical analysis. Instead, I offer a critique of the paper that is pertinent to the entire literature on backdating and to empirical corporate governance research in general. In particular, I consider fundamental problems in interpreting statistical associations between corporate behavior and measures of individual corporate governance structures. A large body of corporate governance research, including CGL, regress measures of corporate behavior on metrics of corporate governance attributes. But this design raises a series