Trade, Technologies, and the Evolution of Corporate Governance

Abstract:

Do international trade and technological change influence how firms create incentives for human capital? I present a model that incorporates agency problems into a framework with firm heterogeneity and human capital. My model indicates that trade liberalizations and skill-biased technological change alter the way how the largest firms in an economy incentivize their managers. Increases in managerial reservation wages lead to a reduction in corporate governance investments and a rise in performance compensation since monitoring managers becomes less efficient. Using data on CEO compensation and entrenchment opportunities in public industrial firms in the U.S., I document strong empirical regularities in support of the model predictions. Firms allow for more managerial entrenchment and offer larger CEO compensation when their industries become more open to trade or when production becomes more I.T. intensive.

JEL classification: F1, F16, G34, J33, L22, O33
Keywords: International Trade and Firm Organization, Agency Problems in International Trade, Endogenous Managerial Entrenchment, Corporate Governance and CEO Compensation

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525SFB.pdf

Trade in Tasks and the Organization of Firms

Abstract:

We incorporate trade in tasks à la Grossman and Rossi-Hansberg (2008) into a small open economy version of the theory of firm organization of Marin and Verdier (2012) to examine how offshoring affects the way firms organize. We show that the offshoring of production tasks leads firms to reorganize with a more decentralized management, improving the competitiveness of the offshoring firms. We show further that the offshoring of managerial tasks relaxes the constraint on managers but toughens competition, and thus has an ambiguous impact on the level of decentralized management and CEO wages of the offshoring firms. In sufficiently open economies, however, managerial offshoring unambiguously leads to more decentralized management and to larger CEO wages. We test the predictions of the model based on original firm level data we designed and collected of 660 Austrian and German multinational firms with 2200 subsidiaries in Eastern Europe. We find that offshoring firms are 33.4% more decentralized than non-offshoring firms. We find further that the average fraction of managers offshored reduces the level of decentralized management by 3.1%, but increases the level of decentralized management by 4% in industries with a level of openness above the 25th percentile of the openness distribution. Lastly, we find that one additional offshored manager lowers CEO wages relative to workers by 4.9%.

Keywords: international trade with endogenous organizations, the rise of human capital, theory of the firm, multinational firms, CEO pay

JEL classification: F12, F14, L22, D23

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482.pdf

Affirmative Action: One Size Does Not Fit All

Abstract:

This paper identifies a new reason for giving preferences to the disadvantaged using a model of contests. There are two forces at work: the effort effect working against giving preferences and the selection effect working for them. When education is costly and easy to obtain (as in the U.S.), the selection effect dominates. When education is heavily subsidized and limited in supply (as in India), preferences are welfare reducing. The model also shows that unequal treatment of identical agents can be welfare improving, providing insights into when the counterintuitive policy of rationing educational access to some subgroups is welfare improving.

Keywords: contests; educational quotas; private benefits; social welfare.

JEL classification: D61, I23

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407.pdf

Trade Costs, Conflicts, and Defense Spending

Abstract:

This paper develops a quantitative model of trade, military conflicts, and defense spending. Trade liberalization between two countries reduces probability of an armed conflict between them, causing both to cut defense spending. This in turn causes a domino effect on defense spending by other countries. As a result, both countries and the rest of the world are better off. We estimate the model using data on trade, conflicts, and military spending. We find that, after reduction of costs of trade between a pair of hostile countries, the welfare effect of worldwide defense spending cuts is comparable in magnitude to the direct welfare gains from trade.

Keywords: general equilibrium, gains from trade, defense spending

JEL Codes: C5, C6, F13, F51, H56

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404.pdf

Trade Openness and Cross-country Income Differences

Abstract:

Development accounting literature usually attributes the observed cross-country variation in per capita income to differences in countries' factor endowments and total factor productivity (the Solow residual). While the former can be relatively straightforward interpreted and measured, the latter remains at least partly a black box. In this paper, we provide a structural interpretation for differences in total factor productivity across countries and quantitatively explore the role of trade barriers in explaining cross-country income differences. In particular, we find that giving all countries the same market entry costs or giving all country-pairs the same variable trade costs reduces inequality by around 13%.

Keywords: General equilibrium, market access costs, development accounting, experiments

JEL Classification: F11, F12, O10, O40

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402.pdf

Do Multinationals Transplant their Business Model?

Abstract:

What determines whether or not multinational firms transplant their mode of organisation to other countries? We embed the theory of knowledge hierarchies in an industry equilibrium model of monopolistic competition to examine how the economic environment may affect the decision of a multinational firm about transplanting its business organisation to other countries. We test the theory with original and matched parent and affiliate data on the internal organisation of 660 Austrian and German multinational firms and 2200 of their affiliate firms in Eastern Europe. We find that three factors stand out in promoting the multinational firm’s decision to transplant the business model to the affiliate firm in the host country: a competitive host market, the corporate culture of the multinational firm, and when an innovative technology is transferred to the host country. These factors increase the respective probabilities of organisational transfer by 18.5 percentage points, 37, and 31 percentage points.

JEL Codes: D23 F12 F23 F61

Keywords: organisational economics of multinational firms, trade and organisations, the theory of the firm, organisational transfer between countries

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398.pdf

What explains the rise in CEO pay in Germany? A Panel Data Analysis for 1977-2009

Abstract:

The compensation of executive board members in Germany has become a highly controversial topic since Vodafone's hostile takeover of Mannesmann in 2000 and it is again in the spotlight since the outbreak of the financial crisis of 2009. Based on unique panel data evidence of the 500 largest firms in Germany in the period 1977-2009 we test two prominent hypothesis in the literature on executive pay: the manager power hypothesis and the efficient pay hypothesis. We find support for the manager power hypothesis for Germany as executives tend to be rewarded when the sector is doing well rather than the firm they work for. We reject, however, the efficient pay hypothesis as CEO pay and the demand for managers increases in Germany in difficult times when the typical firm size shrinks. We find further that domestic and global competition for managers has contributed to the rise in executive pay in Germany. Lastly, we show that CEOs in the banking sector are provided with incentives for performance and that the great recession of 2009 acted as a disciplining devise on CEO pay in Germany.
JEL classification: F23, J3, M12, M52.

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374.pdf

The Theory of the Firm goes Global

Abstract:

What insights can be gained from bringing the theory of the firm to the global economy? I discuss several new features of the world economy that can be explained by incorporating the theory of the firm into the theory of international trade. Among the new features I discuss are the move to flatter corporate hierarchies and the decentralization of authority in firms, the “war for talent”, the rise of CEO pay in rich countries, organizational convergence across countries, and firm heterogeneity.

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370_01.pdf

The Organization of European Multinationals

Abstract:

Recent literature on international trade has established that the most productive rms become multinationals. But our data reveal a startling variation in productivity levels of foreign aliates across the countries in Eastern Europe of the same European multinational parent rms suggesting that not all multinationals transplant their home productivity advantage to the new EU Member States and Emerging Europe. One candidate for this startling difference in productivity levels among foreign aliates is the ability of European multinationals to transport their business model abroad. This paper examines the conditions under which European multinationals give autonomy to their subsidiaries and delegate authority to them. We also analyse the conditions under which European multinationals transplant their business model to Eastern Europe. We collect original and unique matched parent and aliate data on the internal organization of 660 German and Austrian parent rms and 2200 of their subsidiaries in Eastern Europe including the former Soviet Union. We test the hypothesis that the ability of European multinationals to transplant their business model to foreign aliates is determined by the organization of European multinationals on the one hand and the market environment their aliate rms face in Eastern Europe on the other hand. We show that the business culture of parent rms accounts for about 50 percent of the variation of the organization of subsidiaries, while the market environment of subsidiaries contributes the rest.

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367_01.pdf

Exports Versus FDI Revisited: Does Finance Matter?

Abstract:

This paper explores the impact of financial constraints on the  internationalization strategies of firms. It contributes to the literature by focusing on three aspects: First, the paper studies the impact of financial constraints on exporting relative to FDI. Consistent with theory, the empirical results confirm  that the impact of financial constraints is stronger for FDI than for exporting. Second, the paper analyzes the extensive and the intensive margins and finds that financial frictions matter for  both. Third, the paper explores the impact on manufacturing as compared to service industries and shows that firms in service industries are affected more than firms in manufacturing. The paper also identifies a threshold effect: Financial constraints do not matter  for small firms whose productivity seems to be too low to consider international expansions.

Keywords: Multinational firms, exports versus FDI, financial constraints,
heterogeneity, productivity 

JEL Classification: F2, G2

November 2010

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340.pdf

Exports and Productivity: An Empirical Analysis of German and Austrian Firm-Level Performance

Abstract:

This paper studies the relationship between export activities and firm-level productivity. Unique matching of German and Austrian micro data from 1994 to 2003 suggests that exporters are more productive by around 40 percent compared with non-exporters. Moreover, beside other analysis techniques,
instrumental variable estimations suggest that exporting causes a rise in firm-level productivity. That is, the annual average growth rate of an exporting firm's productivity is between about 1 and 1.5 percent higher than that of non-exporters. It allows the conclusion that, against other findings of existing studies, both directions hold: more productive firms self-select themselves into export markets and being active in foreign markets boosts firm-level productivity.

JEL Classification: D24; F13; F23; L22; L23; O47

April 2010

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317.pdf

Tariff Rates, Offshoring and Productivity: Evidence from German and Austrian Firm-Level Data

Abstract:

This paper studies the impact of trade liberalization in terms of tariff cuts within the Eastern European enlargement on German and Austrian firm productivity. Unique matching of data from 1994 to 2003 suggests that tariff reductions raise parent firm productivity significantly. A ten percentage point decrease in tariff rates can lead to total factor productivity gains of up to 2 percent. The data allow distinction between three types of tariffs: output, intra-firm and input tariff rates. The size of the results strongly depends on the type of tariff and country analyzed.

JEL Classification: F12; F13; F23; L22; L23; O14

April 2010

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316.pdf

Innovation and the International Firm Structure: Theory and Evidence from German Firm-Level Data

Abstract:

This paper studies the impact of innovation on the organizational structure. The theoretical framework predicts that a larger parental pool of knowledge raises the probability of offshoring. This holds in a national as well as an international context. However, when the producer loses territorial protection, the changeover from non-integration to integration is delayed. Employing data on German firms investing in Eastern Europe finds empirical evidence for the theoretical predictions. The results are robust to different measurements and an instrumental variable regression.

JEL Classification: D23; D51; F23; L14; L21; L22; L23

April 2010

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315.pdf

Creditor Rights and Debt Allocation within Multinationals

Abstract:

We analyze the optimal debt structure of multinational corporations choosing between centralized or decentralized borrowing. We identify how this choice is affected by creditor rights and bankruptcy costs, taking into account managerial incentives and coinsurance considerations. We find that partially centralized borrowing structures are optimal with either weak or strong creditor rights. For intermediate levels of creditor rights fully decentralized (centralized) borrowing structures are optimal if managers have strong (weak) empire building dencies. Decentralized borrowing is more attractive for companies focussing on short-term profitability. Credits are rather taken in countries with better creditor rights and more efficient insolvency systems.

Keywords: Multinational corporations, capital structure, creditor rights, coinsurance, internal capital markets

JEL Classification: G32, F23

November 2009

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304.pdf

Group Lending versus Individual Lending in Microfinance

Abstract:

Microfinance is typically associated with joint liability of group members. However, a large part of microfinance institutions rather offers individual instead of group loans. We analyze the incentive mechanisms in both individual and group contracts. Moreover, we show that microfinance institutions offer group loans when the loan size is rather large, refinancing costs are high, and competition between microfinance institutions is low. Otherwise, individual loans are offered. Interestingly, our analysis predicts that individual lending in microfinance will gain in importance in the future if microfinance institutions continue to get better access to capital markets and if competition further rises.

Keywords: microfinance, group loans, individual loans

JEL Classification: G21, L13, O16

August 2009

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299.pdf

On the Use of Information in Repeated Insurance Markets

Abstract:

We analyze the use of information in a repeated oligopolistic insurance market. To sustain collusion, insurance companies might refrain from changing their pricing schedules even if new information about risks becomes available. We therefore provide an explanation for the existence of "unused observables" that is information which

a) insurance companies collect or could collect,

b) is correlated with the risk experience, but

c) is not used by companies to set prices.

Furthermore, the existence of bulk discounts becomes rationalizable. These results also obtain if we include communication among companies and market entry to our framework.

Keywords: repeated games, insurance markets, oligopoly, unused observables

JEL Classification:C72, G22, L13

October 2009

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280.pdf

Financial Constraints and Foreign Direct Investment: Firm-Level Evidence

Abstract:

Recent literature on multinational firms has stressed the importance of low productivity as a barrier to the cross-border expansion of firms. But firms may also need external finance to shoulder the costs of entering foreign markets. We develop a model of multinational firms facing real and financial barriers to foreign direct investment (FDI), and we analyze their impact on the FDI decision (the extensive margin) and foreign affiliate sales (the intensive margin). We provide empirical evidence based on a detailed dataset of German multinationals which contains information on parent-level and affiliate-level financial constraints as well as on the location the foreign affiliates. We find that financial factors constrain firms’ foreign investment decisions, an effect  felt in particular by large firms. Financial constraints at the parent level matter for the extensive, but less  so for the intensive margin. For the intensive margin, financial constraints at the affiliate level are relatively more important.

Keywords: multinational firms, heterogeneity, productivity, financial constraints
JEL Classification: F2, G2

September 2009

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272.pdf

Integrating with Their Feet: Cross-Border Lending at the German-Austrian Border

Abstract:

The current economic policy discussion on financial integration in the European Union concentrates on cross-border mergers. We study the impact of cross-border lending in a theoretical model where banks acquire either hard or soft information on borrowing firms and predict that the closer firms are to the border the more likely banks are to offer them cross-border loans. This hypothesis is confirmed in the ifo Business Climate Survey that reports the perceptions of German firms on banks lending behavior between 2003 and 2006. In contrast to the policy of harmonization, differences in bank regulations may provide incentives for cross-border lending. Thus, we show that financial integration may take place from the bottom up.

Keywords: Financial Integration, SMEs, Banking Supervision, Business Surveys, Threshold Analysis
JEL Classification: TG18, G21, C25
August 2008

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248.pdf

Bank Competition - When is it Good?

Abstract:

The effects of bank competition and institutions on credit markets are usually studied separately although both factors are interdependent. We study the effect of bank competition on the choice of contracts (screening versus collateralized credit contract) and explicitly capture the impact of the institutional environment. Most importantly, we show that the effects of bank competition on collateralization, access to finance, and social welfare depend on the institutional environment. We predict that firms' access to credit increases in bank competition if institutions are weak but bank competition does not matter if they are well-developed.

Keywords: Bank competition, collateralization, screening, incentives
JEL Classification: D82, G21, K00
July 2008

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244.pdf

A Model of Vertical Oligopolistic Competition

Abstract:

This paper develops a model of successive oligopolies with endogenous market entry, allowing for varying degrees of product differentiation and entry costs in both markets. Our analysis shows that the downstream conditions dominate the overall profitability of the two-tier structure while the upstream conditions mainly affect the distribution of profits. We compare the welfare effects of upstream versus downstream deregulation policies and show that the impact of deregulation may be overvalued when ignoring feedback effects from the other market. Furthermore, we analyze how different forms of vertical restraints influence the endogenous market structure and show when they are welfare enhancing.

Keywords: Deregulation, Free Entry, Price Competition, Product Differentiation, Successive Oligopolies, Two-Part Tariffs, Vertical Restraints
JEL Classification: L13, D43, L40, L50
February 2008

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228.pdf

Corporate Hierarchies and the Size of Nations: Theory and Evidence

Abstract:

Corporate organization varies within a country and across countries with country size. The paper starts by establishing some facts about corporate organization based on unique data of 660 Austrian and German corporations. The larger country (Germany) has larger firms with flatter and more decentralized corporate hierarchies compared to the smaller country (Austria). Firms in the larger country change their organization less fast than firms in the smaller country. Over time firms have been introducing less hierarchical organizations by delegating power to lower levels of the corporation. We develop a theory which explains these facts and which links these features to the trade environment that countries and firms face. We introduce firms with internal hierarchies in a Krugman (1980) cum Melitz and Ottaviano (2007) model of trade. We show that international trade and the toughness of competition in international markets induce a power struggle in firms which eventually leads to decentralized corporate hierarchies. We offer empirical evidence which is consistent with the models predictions.

Keywords: international trade with endogenous firm organizations, endogenous congruence in the firm, corporate organization in similar countries, empirical test of the theory of the firm
JEL Classification: F12, F14, L22, D23
February 2008

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227.pdf

The Politician and his Banker

Abstract:

Should the European Union grant state aid through an institution like the European Investment bank? This paper evaluates the efficiency of different measures for granting state aid. We use a theoretical model with firms that differ in their creditworthiness and compare different types of subsidies with indirect subsidization through public banks. We find that, in a large parameter range, the politician prefers public banks to direct subsidies because they avoid windfall gains to entrepreneurs and they economize on screening costs. For similar reasons, they may increase social welfare relative to subsidies. One important prerequisite for this result is that public banks must not be allowed to fully compete with private banks. However, from a welfare perspective, a politician uses public banks inefficiently often.

Keywords: public bank, development bank, state aid, subsidies, governance
JEL Classification: G21, G38, H25
November 2007

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222.pdf

The Effect of Bank Competition on the Bank’s Incentive to Collateralize

Abstract:

It has been argued that competing banks make inefficiently frequent use of collateralization in situations where they are better able to evaluate a project’s risk than entrepreneurs. We study the bank’s choice between screening and collateralization in a model where banks do not have this superior screening skill. In particular, we study the effect of bank competition on this choice. We find that competing banks use collateral less often than a monopolistic bank because competition will intensify if both banks collateralize. Moreover, bank competition is welfare improving if collateralization is rather costly.

Keywords: collateralization, screening, incentives, bank competition
JEL Classification: D82, G21, K00
September 2007

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216.pdf

Who is Afraid of Political Risk? Multinational Firms and their Choice of Capital Structure

Abstract:

This paper investigates how multinational firms choose their capital structure in response to political risk. We focus on two choice variables, the leverage and the ownership structure of the foreign affiliate, and we distinguish different types of political risk, like expropriation, corruption and confiscatory taxation, and In our theoretical analysis we find that as political risk increases the ownership share always decreases whereas leverage can both increase or decrease, depending on the type of political risk. Using the Microdatabase Direct Investment of the Deutsche Bundesbank, we find supportive evidence for these different effects.

Keywords: multinational Terms, political risk, capital structure, leverage, ownership structure
JEL Classification: F23, F21, G32
August 2007

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213.pdf

FDI and Domestic Investment: An Industry-Level View

Abstract:

Previous empirical work on the link between domestic and foreign investment provides mixed results which partly depend on the level of aggregation of the data. We argue that the aggregated home country implications of foreign direct investment (FDI) cannot be gauged using firm-level data. Aggregated data, in turn, miss channels through which domestic and foreign activities interact. Instead, industry-level data provide useful information on the link between domestic and foreign investment. We theoretically show that the effects of FDI on the domestic capital stock depend on the structure of industries and the relative importance of domestic and multinational firms. Our model allows distinguishing intra-sector competition from inter-sector linkage effects. We test the model using data on German FDI. Using panel cointegration methods, we find evidence for a positive long-run impact of FDI on the domestic capital stock and on the stock of inward FDI. Effects of FDI on the domestic capital stock are driven mainly by intrasector effects. For inward FDI, inter-sector linkages matter as well.

Keywords: foreign direct investment, domestic capital stock
JEL Classification: F21, F23, E22
July 2007

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212.pdf

Allocation of Authority when a Person is not a Robot

Abstract:

We formalize a conception of authority, which is commonly defined as the right of controlling a person’s actions embedded in human assets in sociology. Due to the inalienable property of human assets, the contractible formal authority is hard to verify and enforce, while real authority usually diverges from formal authority. Inefficiency tends to arise when a task is not routine or can not be done by a robot. Using a framework of incomplete contract, we show that allocation of formal authority, as an instrument to mitigate the inefficiency, is determined by features of tasks and specificity of assets, and the relationship between the resources. Monitoring is then introduced to fine tune value of delegation.

Keywords: Transaction of human assets, real authority, formal authority, delegation, monitor
JEL Classification: D23, J24, J41, L22.
July 2007

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211.pdf

Power in the Multinational Corporation in Industry Equilibrium

Abstract:

Recent theories of the multinational corporation introduce the property rights model of the firm and examine whether to integrate our outsource firm activities locally or to a foreign country. This paper focus instead on the internal organization of the multinational corporation by examining the power allocation between headquarters and subsidiaries. We provide a framework to analyse the interaction between the decision to serve the local market by exporting or FDI, market acces and the optimal mode of organization of the multinational corporation. We find that subsidiary managers are given most autonomy in their decision how to run the firm at intermediate levels of local competition. We then provide comparative statics for changes in fixed FDI entry costs and trade costs, information technology, the number of local competitors, and in the size of the local market.

Keywords: foreign direct investment, power allocation in the firm, international trade and the organization of production
JEL Classification: D23; F1; F2
May 2007

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209.pdf

Competing in Organizations: Firm Heterogeneity and International Trade

Abstract:

This paper develops a theory which investigates how firms’ choice of corporate organization is affecting firm performance and the nature of competition in international markets. We develop a model in which firms’ organisational choices determine heterogeneity across firms in size and productivity in the same industry. We then incorporate these organisational choices in a Krugman cum Melitz and Ottaviano model of international trade. We show that the toughness of competition in a market depends on who - headquarters or middle managers - have power in firms. Furthermore, we propose two new margins of trade adjustments: the monitoring margin and the organizational margin. International trade may or may not lead to an increase in aggregate productivity of an industry depending on which of these margins dominate. Trade may trigger firms to opt for organizations which encourage the creation of new ideas and which are less well adapt to price and cost competition.

Keywords: international trade with endogenous firm organizations and endogenous toughness of competition, firm heterogeneity, power struggle in the firm
JEL Classification: F12, F14, L22, D23
May 2007

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207.pdf

Project Finance as a Risk-Management Tool in International Syndicated Lending

Abstract:

We develop a double moral hazard model that predicts that the use of project finance increases with both the political risk of the country in which the project is located and the influence of the lender over this political risk exposure. In contrast, the use of project finance should decrease as the economic health and corporate governance provisions of the borrower’s home country improve. When we test these predictions with a global sample of syndicated loans to borrowers in 139 countries, we find overall support for our model and provide evidence that multilateral development banks act as “political umbrellas”.

Keywords: project finance, syndicated loans, political risk, double moral hazard
JEL Classification: D82, F34, G21, G32
December 2006

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183.pdf

Acquisition versus greenfield: The impact of the mode of foreign bank entry on information and bank lending rates

Abstract:

Policy makers often decide to liberalize foreign bank entry but at the same time restrict the mode of entry. We study how different entry modes affect the interest rate for loans in a model in which domestic banks possess private information about their incumbent clients but foreign banks have better screening skills. Our model predicts that competition is stronger if market entry occurs through a greenfield investment and therefore domestic banks' interest rates are lower. We find empirical support for our results for a sample of banks from ten Eastern European countries for the period 1995-2003.

Keywords: banking, foreign entry, mode of entry, interest rate, asymmetric information
JEL Classification: G21, D4, L31
November 2006

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182.pdf

Migration and the Welfare State: The Economic Power of the Non-Voter?

Abstract:

This paper investigates the impact of emigration on the political choice regarding the size of the welfare state. Mobility has two countervailing effects: the political participation effect and the tax base effect. With emigration, the composition of the constituency changes. This increases the political influence of the less mobile part of the population. The new political majority has to take into account that emigration reduces tax revenues and thereby affects the feasible set of redistribution policies. The interaction of the two effects has so far not been analyzed in isolation. We find that the direction of the total effect of migration depends on the initial income distribution in the economy. Our results also contribute to the empirical debate on the validity of the median-voter approach for explaining the relation between income inequality and redistribution levels.

Keywords: migration, redistribution, voting
JEL Classification: F22, H50, D31, D72
July 2005

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154.pdf

Entry of Foreign Banks and their Impact on Host Countries

Abstract:

Foreign bank entry is frequently associated with spillover effects for local banks and increasing competition in the local banking market. We study the impact of these effects on host countries. In particular, we ask how these effects interact and how they depend on the competitive environment of the host banking market. An increasing number of banks is more likely to have positive welfare effects the more competitive the market environment, whereas spillovers are less likely to have positive welfare effects the stronger competition. Hence, competitive effects seem to reinforce each other, while spillovers and competition tend to weaken each other.

Keywords: foreign bank entry, multinational bank, competition in banking, spillover effects
JEL Classification: F37, G21, L13, O16
June 2006

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152.pdf

The Political Economy of Corruption and the Role of Financial Institutions

Abstract:

In many developing countries, we observe rather high levels of corruption. This is surprising from a political economy perspective, as the majority of people generally suffers from high corruption levels. We explain why citizens do not exert enough political pressure to reduce corruption if financial institutions are missing. Our model is based on the fact that corrupt officials have to pay entry fees to get lucrative positions. The mode of financing this entry fee determines the distribution of the rents from corruption. In a probabilistic voting model, we show that a lack of financial institutions can lead to more corruption as more voters are part of the corrupt system. Thus, the economic system has an effect on political outcomes. Well-functioning financial institutions, in turn, can increase the political support for anti-corruption measures.

Keywords: Corruption, Financial Markets, Institutions, Development, Voting
JEL Classification: D73, D72, O17
June 2006

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135.pdf

Private Provision of a Complementary Public Good

Abstract:

For several years, an increasing number of firms are investing in Open Source Software (OSS). While improvements in such a non-excludable public good cannot be appropriated, companies can benefit indirectly in a complementary proprietary segment. We study this incentive for investment in OSS. In particular we ask how (1) market entry and (2) public investments in the public good affects the firms' production and profits. Surprisingly, we find that there exist cases where incumbents benefit from market entry. Moreover, we show the counter-intuitive result that public spending does not necessarily lead to a decreasing voluntary private contribution.

Keywords: Open Source Software, Private Provision of Public Goods, Cournot-Nash Equilibrium, Complements, Market Entry
JEL Classification: C72, L13, L86
June 2006

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134.pdf

Two-Sided Markets with Pecuniary and Participation Externalities

Abstract:

The existing literature on "two-sided markets" addresses participation externalities, but so far it has neglected pecuniary externalities between competing platforms. In this paper we build a model that incorporates both externalities. In our setup differentiated platforms compete in advertising and offer consumers a service free of charge (such as a TV program) that is financed through advertising. We show that advertising can exhibit the properties of a strategic substitute or complement. Surprisingly, there exist cases in which platforms benefit from market entry. Moreover, we show that from a welfare point of view perfect competition is not always desirable.

Keywords: two-sided markets, broadcasting, advertising, market entry, digital television.
JEL Classification: D43, L13, L82

June 2006

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133.pdf

When is FDI a Capital Flow?

Abstract:

In this paper we analyze the conditions under which a foreign direct investment (FDI) involves a net capital flow across countries. Frequently, foreign direct investment is financed in the host country without an international capital movement. We develop a model in which the optimal choice of financing an international investment trades off the relative costs and benefits associated with the allocation and effectiveness of control rights resulting from the financing decision. We find that the financing choice is driven by managerial incentive problems and that FDI involves an international capital flow when these problems are not too large. Our results are consistent with data from a survey on German and Austrian investments in Eastern Europe.

Keywords: Multinational firms, Firm specific capital costs, Internal capital markets, International capital flows
JEL Classification: F23, F21, G32, L20, D23
June 2006

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126.pdf

Business Groups in Emerging Markets - Financial Control and Sequential Investment

Abstract:

Business groups in emerging markets perform better than unaffiliated firms. One explanation is that business groups substitute some functions of missing institutions, for example, enforcing contracts. We investigate this by setting up a model where firms within the business group are connected to each other by a vertical production structure and an internal capital market. Thus, the business group’s organizational mode and the financial structure allow a self-enforcing contract to be designed. Our model of a business group shows that only sequential investments can solve the ex post moral hazard problem. We also find that firms may prefer not to integrate.

Keywords: Business groups, self-enforcing contract, institutions, internal capital market
JEL Classification: G31, G32, G34, K49, L22
June 2006

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124.pdf

Power Inside the Firm and the Market: A General Equilibrium Approach

Abstract:

Recent years have witnessed an enormous amount of reorganization of the corporate sector in the US and in Europe. This paper examines the role of market competition for this trend in corporate reorganization. We find that at intermediate levels of competition the CEO of the corporation decides to have less power inside the firm and to delegate control to lower levels of the firms’ hierarchy. Thus, workers empowerment and the move to flatter firm organizations emerge as an equilibrium when competition is not too tough and not too weak. The model predicts merger waves or waves of outsourcing when countries become more integrated into the world economy as the corporate sector reorganizes in response to an increase in international competition.

Keywords: monopolistic competition, international trade, corporate reorganisation, flattening firm hierarchies
JEL Classification: F12, D23, L22, L1
March 2006

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109.pdf

Organization of Multinational Activities and Ownership Structure

Abstract:

We develop a model in which multinational investors decide about the modes of organization, the locations of production, and the markets to be served. Foreign investments are driven by market-seeking and cost-reducing motives. We further assume that investors face costs of control that vary among sectors and increase in distance. The results show that (i) production intensive sectors are more likely to operate a foreign business independent of the investment motive, (ii) that distance may have a non-monotonous effect on the likelihood of horizontal investments, and (iii) that globalization, if understood as reducing distance, leads to more integration.

Keywords: Multinational firms, Joint ventures, Distance, Technology spillovers, Ownership structure
JEL Classification: F23, L24, L22, L23, D23
February 2006

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Foreign Banks in Eastern Europe: Mode of Entry and Effects on Bank Interest Rates

Abstract:

Credit markets in many Eastern European countries are now dominated by foreign-owned banks. We analyze the development for foreign ownership and its impact on lending rate in ten Eastern European countries between 1995 and 2003. Currently, the majority of loans from foreign banks is granted by acquired banks. The presence of foreign acquired banks as measured by their relative number among the banks in our dataset increased somewhat slower than that of foreign de novo banks. However, since market entry through acquisition allows acquiring a credit portfolio and a customer base, acquired banks were able to expand their market share much faster than the foreign de novo banks. Our results also show that the interest rate decreased after foreign bank entry. Moreover, while the reduction in interest rates of domestic banks is more pronounced in the case of foreign entry through a de novo investment, foreign de novo banks charge higher interest rates than foreign acquired banks.

Keywords: SME, Banking, Foreign Entry, Mode of Entry, Interest Rate
JEL Classification: D4, G21
February 2006

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Technology Transfer and Spillovers in International Joint Ventures

Abstract:

It is often argued that multinationals are reluctant to transfer technology due to the fear of spillovers. We show that this need not be the case if host country policies like taxation are taken into account. Furthermore, we examine the incentives the multinational and the host country have to engage in an international joint venture. We show why a multinational may agree to enter a joint venture even though this gives rise to spillovers. Surprisingly, we find that a joint venture is sometimes not in the interest of a host country, despite the prospect of spillovers.

Keywords: Foreign Direct Investment, International Joint Ventures, Technology Transfer, Technology Spillovers, Multinational Firms
JEL Classification: D43, F21, F23, L13, P31, O12
October 2005

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The Vanishing Barter Economy in Russia: A Test of the Virtual Economy Hypothesis? Reply to Barry Ickes

Abstract:

This paper is a reply to Barry Ickes' critique of my paper “Trust versus Illusion: What is Driving Demonetization in Russia?” in which I show that the data reject Barry Ickes' Virtual Economy explanation of barter in Russia in favor of an institutional explanation based on the lack of trust.

Keywords: imperfect input and capital markets, the virtual economy, trade credit, trust, contract enforcement
JEL Classification: D20, G30, O10, P30
November 2004

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A New International Division of Labor in Europe: Outsourcing and Offshoring to Eastern Europe

Abstract:

Europe is reorganizing its international value chain. I document these changes in Europe’s international organization of production with new survey data of Austrian and German firms investing in Eastern Europe. I show estimates of the share of intrafirm trade between Austria or Germany on the one hand and Eastern Europe on the other. Furthermore, I present empirical evidence of the drivers of the new division of labor in Europe. I find among other things that falling trade costs and reduced levels of corruption as well as improvements in the contracting environment in Eastern Europe are affecting the level of intrafirm imports from that region. These factors also favor outsourcing over offshoring. In contrast, low organizational costs of hierarchies and large costs of holdup (when there are no alternative investors in Old Europe or no alternative suppliers in Eastern Europe) favor offshoring over outsourcing. Tax holidays granted by host countries in Eastern Europe also mildly affect the organizational choice.

Keywords: the empirics of global sourcing, intrafirm trade, contract enforcement, comparative advantage in Eastern Europe, empirical test of the theory of the firm
JEL Classification: D23, D51, F11, L14, O11
September 2005

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Financial Crisis, Economic Recovery, and Banking Development in Russia, and other FSU Countries

Abstract:

This paper provides a unified analysis for the onset of the 1998 financial crisis and the strong economic recovery afterward in Russia and other former Soviet Union countries. Before the crisis a banking failure arose owing to the coexistence of a lemons credit market and high government borrowing. In a lemons credit market low credit risk firms switched from bank to nonbank finance, including trade credits and barter trade, generating an externality on banks’ interest rates. The collapse of the treasury bills market in the financial crisis triggered a change in banks’ lending behavior, providing initial conditions for banking development.

Keywords: banking development, institutional trap, financial crisis
JEL Classification: G3, G21, P34, O16, D82
June 2004

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Law in Transition and Development: The Case of Russia

Abstract:

The rise of barter and non-cash payments has become a dominant feature of the Russian transition to a market economy. This paper confronts with empirical evidence two approaches to explain barter in Russia: the ’illusion view’ and the ’trust view’ of barter. The ’illusion view’ suggests that barter allows the parties to pretend that the manufacturing sector in Russia is producing value added by enabling this sector to sell its output at a higher price than its market value. The ’trust view’ sees barter as an institution to deal with the absence of trust and liquidity in the Russian economy. We confront the prediction of both explanations with actual data on barter in Ukraine in 1997. The data reject the ’illusion view‘ in favor of the ‘trust view‘ of barter.

Keywords: imperfect input and capital markets, the virtual economy, trade credit, trust, contract enforcement
JEL Classification: D20, G30, O10, P30
April 2004

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‘A Nation of Poets and Thinkers’ - Less So with Eastern Enlargement? Austria and Germany

Abstract:

Many people in the European Union fear that Eastern Enlargement will lead to major job losses. More recently, these fears about job losses have extended to high skill labor and IT jobs. The paper examines with new firm level data whether these fears are justified for the two neighboring countries of Eastern Enlargement Austria and Germany. I find that Eastern Enlargement leads to surprising small job losses, because jobs in Eastern Europe do not compete with jobs in Austria and Germany. Low cost jobs of affiliates in Eastern Europe help Austrian and German firms to stay competitive in an increasingly competitive environment. However, I also find that multinational firms in Austria and Germany are outsourcing the most skill intensive activities to Eastern Europe taking advantage of cheap abundant skilled labor in Eastern Europe. I find that the firms’ outsourcing activities to Eastern Europe are a response to a human capital scarcity in Austria and Germany which has become particularly severe in the 1990s. Corporations’ outsourcing of skill intensive firm activity to Eastern Europe has helped to ease the human capital crisis in both countries. I find that high skilled jobs transferred to Eastern Europe account for 10 percent of Germany’s and 48 percent of Austria’s supply of university graduates in the 1990s. I then discuss what can be done to address the skill exodus to Eastern Europe. I show that R&D subsidies do not work in economies with a skill crisis and I suggest to liberalize the movement of high skill labor with Eastern Enlargement.

Keywords: human capital, intra-firm trade, multinationals and jobs, out-sourcing to Eastern Europe, R&D policy
JEL Classification: F21, F23, J24, J31, L24, O3, P33
March 2004

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Is Human Capital Losing From Outsourcing? Evidence for Austria and Poland

Abstract:

Feenstra and Hanson (1997) have argued in the context of the North American Free Trade Agreement that US outsourcing to Mexico leads to an increase in the skill premium in both the US and Mexico. In this paper we show on the example of Austria and Poland that with the new international division of labor emerging in Europe Austria, the high income country, is specializing in the low skill intensive part of the value chain and Poland, the low income country, is specializing in the high skill part. As a result, skilled workers in Austria are losing from outsourcing, while gaining in Poland. In Austria, relative wages for human capital declined by 2 percent during 1995-2002 and increased by 41 percent during 1994-2002 in Poland. In both countries outsourcing contributes roughly 35 percent to these changes in the relative wages for skilled workers. Furthermore, we show that Austria’s R&D policy has contributed to an increase in the skill premium there.

Keywords: foreign direct investment, wage inequality, transition economy
JEL Classification: F21, F23, J31, P45
October 2005

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Globalization and the Empowerment of Talent

Abstract:

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004

Globalization has been identified by many experts as a new way firms organize their activities and as the emergence of talent as the new stakeholder in the firm. This paper examines the role of trade integration for the changing nature of the corporation. International trade leads to a ’war for talent’ which makes it more likely that an organizational equilibrium emerges in the integrated world economy in which control is delegated to lower levels of the firms’ hierarchy empowering human capital. Furthermore, trade integration is shown to lead to waves of outsourcing and to convergence in corporate cultures across countries.

Keywords: international trade with endogenous organizations, the rise of human capital, theory of the firm, Rybczynski Theorem of firm organization
JEL Classification: F12, F14, L22, D23
July 2004

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