2010–2011

Do Fixed Patent Terms Distort Innovation? Evidence from Cancer R&D

Eric Budish, Assistant Professor of Economics

Summary: This project investigates whether the current structure of the patent system distorts research away from medical treatments that could prevent early stage diseases from becoming fatal, and towards treatments that provide relatively smaller health benefits to terminally ill patients. Fixed patent terms aim to offer a uniform period of protection to all inventions. However, because the patent term runs from the filing date of a patent, which for many inventions occurs early in product development, the longer it takes to get an invention to market the shorter its effective patent life becomes. This distorts research and development (R&D) incentives away from inventions with long lags between invention and commercialization. In extreme cases where the lag between invention and commercialization is longer than the patent term, the patent system provides no R&D incentives at all. We access the empirical relevance of this distortion in the context of R&D on cancer treatments.

Wireless Carriers’ Exclusive Handset Arrangements: An Empirical Look at the iPhone

Pradeep Chintagunta, Robert Law Professor of Marketing
Ting Zhu, Assistant Professor of Marketing

Summary: Since the Apple iPhone’s first launch in 2007 with an exclusive arrangement with AT&T, it has gained overwhelmingly positive responses from consumers and from the media. With its success, exclusive contracts between handset makers and wireless carriers have come under increasing scrutiny by regulators and lawmakers. Such practices have been criticized by regulators, by the media, and by “locked-out” consumers. A consumer has to subscribe to a particular service provider if he or she overwhelmingly prefers one handset as compared to other phones. In this paper, we empirically examine the impact of handset exclusivity arrangements on consumer welfare. We student consumers’ purchase decisions in mobile services including choices of handsets and service providers. We combine panel data from the Consumer Technographics surveys in 2007 and 2008 with supplemented data on prices and features of the most popular handsets from Consumer Reports. Based on our demand estimation, we will conduct counterfactual experiment assuming that (1) there are no changes in the prices of handsets and service offered by service providers, and (2) both handset manufacturers and service providers respond to the change of channel structure strategically. The results will demonstrate the impact of exclusive arrangements on iPhone’s retail prices and market share, and its impact on consumer welfare.

Estimating the Impact of Policy Changes in the US Kidney Allocation System under Endogenous Patient Choice Behavior

Günter Hitsch, Associate Professor of Marketing
Che-Lin Su, Assistant Professor of Operations Management

Summary: From a policy perspective, comparative effectiveness of any proposed kidney allocation policy depends not only on its impact on the length and composition of national waiting list for kidney transplantation, but also on behavior changes a policy may induce at the patient and clinical level. Failing to account for these factors in evaluating the impact of policy changes can result in untended consequences, such as the unforeseen decline in living donors for pediatric recipients as a result of the pediatric donor policy. In this research, we aim to develop predictive decision model for patients and organ allocation model for policy makers that take into account the complex interaction between the evolution of the waiting list and the patients dynamic decisions. Our models will better inform individual patients with end-stage kidney disease to better inform the comparative effectiveness research of renal replacement therapy option, personalized treatment decisions and organ allocation policy.

Does Price Impact the Experience of a Product?

Emir Kamenica, Assistant Professor of Economics

Summary: Previous work suggests that individuals might experience a product differently if they know the product is particularly expensive. None of the existing evidence on this topic, however, is based on revealed preference. We propose to conduct an experiment that will examine the impact of price on experience through revealed preference. Subjects will taste an unfamiliar Italian and an unfamiliar Belgian chocolate and then choose which one to buy. We will randomize whether the Italian or the Belgian chocolate is cheaper and will randomize whether a subject learns the price before or after (s)he tastes the chocolates. If knowledge of higher price improves the experienced taste of the product, we should find that subjects’ demand is more elastic when they taste the chocolates prior to learning their prices.

Best Prices

Anil K Kashyap, Edward Eagle Brown Professor of Economics and Finance

Summary: We explore the importance of retailer price discrimination strategies for macroeconomic descriptions of price dynamics. The critical observation underpinning our analysis is that some consumers are active shoppers who chase discounts, substitute across products in a narrowly defined product category, and potentially use storage to maintain smooth consumption whilst concentrating their purchases in sale weeks. Other customers are passive, and retailers will employ strategies to charge these two groups different prices. Due to the actions of these strategic consumers, we find that weighted average prices paid differ substantially from posted prices. Moreover, accounting for the price discrimination motive on the retailer's side helps resolve several pricing "puzzles" that arise in the recent macroeconomics literature and provides several new facts about properly measured prices.

Nudging the Economy to Fixed Rate Mortgages? The Welfare Loss of Abolishing Adjustable Rate Mortgages

Gregor Matvos, Assistant Professor of Finance
Amit Seru, Assistant Professor of Finance

Summary: A large part of the blame in the current financial crisis has been placed on banks "duping" borrowers by steering them towards adjustable rate mortgages (ARMs). Several influential policy proposals have suggested that fixed rate mortgage (FRM) contracts be the only ones made available to households - and this is one of the actions that Consumer Protection Agency established under Dodd Frank is evaluating. Our paper challenges this view. We argue that there are substantial welfare gains achieved by a large population of borrowers who optimally choose ARMs over FRMs. We propose a structural model to estimate this gain and argue that the net effect of removing ARMs on overall welfare - after accounting for "duped" population - may be, at best ambiguous and at worst significantly negative.

Duration Dependence in Unemployment: A Field Experiment

Matthew Notowidigdo, Neubauer Family Assistant Professor of Economics

Summary: The recent recession has brought into focus the issue of long-term unemployment. A central idea in labor economics is the theory of duration dependence, which predicts that the longer someone is out of a job, the more difficult it is to find a job. While this theory has influenced both economic models and public policy, there is little credible evidence demonstrating its empirical relevance.

We propose a large-scale resume audit study to estimate the effect of length of unemployment spell on callback rates. By sending fictitious resumes to real help-wanted ads across Chicago, we will measure how callback rates vary across (hypothetical) individuals who differ solely in their length of unemployment spells. The experimental design will allow clean and precise estimation of the effect of unemployment history on callback rates, and the large scale of the study will allow precise estimation of how these effects vary across demographic groups.

Uncertainty about Government Policy and Stock Prices

Lubos Pastor, Charles P. McQuaid Professor of Finance
Pietro Veronesi, Roman Family Professor of Finance

Summary: We analyze how changes in government policy affect stock prices. Our general equilibrium model features uncertainty about government policy and a government that has both economic and noneconomic motives. The government tends to change its policy after performance downturns in the private sector. Stock prices fall at the announcements of policy changes, on average. The price fall is expected to be large if uncertainty about government policy is large, as well as if the policy change is preceded by a short or shallow downturn. Policy changes increase volatility, risk premia, and correlations among stocks. The jump risk premium associated with policy decisions is positive, on average.

Why Has Secured Credit Come Down?

Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance

Summary: We have collected data since the 1920s, which suggests a secular decline in the use of bonds secured by assets in the United States. This pattern does not just exist because of a change in sectoral composition of issuers, but even within manufacturing, and even for the same firm. We would like to (i) put this fact on firmer footing (ii) understand why it has happened.

The main candidate explanations might be (i) learning about the costs and benefits of secured debt, especially during the Depression (ii) substitution of other forms of debt for secured debt - bank loans and leases would be good candidates (iii) changes in bankruptcy law (iv) changes in institutional willingness to hold unsecured bonds (v) change in the attitudes of rating agencies towards them (vi) change in the liquidity of the underlying assets (vii) changes in attractiveness of debt (lower debt may mean less need for secured assets). We will work our way through these explanations, some of which are not mutually exclusive.

Decomposing Costs and Benefits of Internal Capital Markets: A Structural Approach

Amit Seru, Assistant Professor of Finance

Summary: Reduced form evidence on capital allocation in diversified firms has only isolated the “net cost or benefit” of conglomerates. We use a structural model of internal capital markets to decompose the costs and benefits of conglomerates. The cost of conglomerates arises from managerial preferences for corporate socialism while the benefit is that funds can be allocated between divisions without incurring cost of accessing external capital markets. The structural parameters of our model are identified using an oil price based exogenous shifter of diversity in investment opportunities among divisions. The dark side of internal capital markets is that the manager of an average two segment conglomerate values a dollar of cash-flows from the stronger division at $0.92 and those of the weaker division at $1.10. The bright side of a conglomerate is that the marginal cost of raising external financing is lower by about 2% as compared to stand-alone firms. The net conglomerate cost/benefit trade-off is not static—corporate socialism is shown to vary with the condition of external capital markets.

We use our model to examine how the shock of financial market destabilization in the 2007/2008 crisis propagated in conglomerates and stand alone firms and provide evidence that is consistent with this dynamic trade-off.

The Role of Finance and Unemployment: Significantly Revamping Okun’s Law

Amit Seru, Assistant Professor of Finance

Summary: For more than 80 years, since the great depression of the 1920s, one of the key problems of macroeconomics has been the explanation of unemployment. More recently, following the recent financial crisis and economic recession, there has been an increasing interest in understanding the cyclical behavior of unemployment and in particular its relation to financial constraints and the availability of finance. As the national rate of unemployment is crossing 10%, many of them low-wage jobs, there is growing evidence indicating that many of the jobs lost in the last two years have been those of employees in small businesses. While the relation between financial constraints and corporate investment has been studied extensively, little is known about the role that financial constraints and the availability of finance play in the propagation of unemployment and the amplification of business cycles and industry downturns. This aspect of finance is perhaps most important for small and medium business firms where financial constraints likely drive hiring and firing decisions. Lack of systematic understanding of these issues was best seen in the diffused (and so far largely ineffectual) policy response to combat unemployment in the recent financial crisis. This project proposes to study this link and fill this gap.

Housing, Labor Mobility, and Unemployment

Amir Sufi, Bruce Lindsay Professor of Economics and Public Policy

Summary: One of the striking features of the current economic downturn is the increase in long-term unemployment. Our central goal in this research project is to evaluate whether the negative effects of house price declines and mortgage delinquencies on labor mobility is responsible for this trend. We plan on using individual-level credit bureau data which will allow us to measure whether an individual is a homeowner versus a renter, and the degree to which the homeowner is facing house price declines and mortgage debt delinquency. Further, credit bureau data will allow us to measure the original and new zip code of any individual that moves. This data set will allow us to test whether homeowners with underwater homes are less likely to seek better job opportunities elsewhere relative to similarly situated renters.

Advertising and Competition in Privatized Social Security: The Case of Mexico

Chad Syverson, Professor of Economics

Summary: We explore why price competition appears to be so weak in the privatized Mexican social security system. Earlier research has pointed to information frictions as a source of limited price competition in retail financial markets. We explore this issue in this market by estimating the interaction between information, consumer preferences, and advertising. Using participant-level data on workers’ demographics and fund manager choices, we estimate Mexican workers’ choice demand for account management services, allowing demand to be influenced by asset management companies’ advertising choices. We model how asset management firms choose their prices and advertising levels given this demand structure, and then use this model to ask whether market outcomes would be different if advertising were forbidden or otherwise limited in the market.

The Distribution of Talent across Family and Non-family Firms and Its Effect on Wages, Profitability and Growth

Margarita Tsoutsoura, Assistant Professor of Finance

Summary: Our research project aims to study the way talent is allocated across firms and the implications for firm profitability, wages and growth. How is the matching of firms and employees affected by the firm's ownership structure? The existing literature has mainly focused on the incentive provision in firms, while there is relative little evidence on the matching of firms and workers, mainly due to the limited availability of integrated databases that have details on both sides of the match. Furthermore, the existing literature has not been able to fully account for the fact that optimizing firms endogenously choose the best incentive structure for themselves. Our dataset provides us with detailed information, both at the firm and the employee level and will allow us to address the above issues and offer new insights.

The Effect of Shareholder-friendly Activities on the Structure of Debt Convenants

Regina Wittenberg-Moerman, Assistant Professor of Accounting and Neubauer Family Faculty Fellow

Summary: We investigate whether borrowers that engage in shareholder-friendly activities receive stricter covenant structures when they issue new public debt. Our analysis uses novel data to measure both shareholder friendly activities (the views of bond analysts extracted from their research reports) and covenant protection. This analysis contributes to the literature that studies the underlying factors that drive debt contract design. First, we investigate not only the presence of covenants but also their quality, as measured by their restrictiveness. Second, we measure the extent of shareholder-debt holder misalignment by gauging the views of bond analysts, who are important debt market information intermediaries. Our preliminary results provide evidence that when shareholder friendly actions of managers lead (or likely lead) to an increase in leverage, debt holders will impose higher quality covenants that restrict these actions.

How Managerial Bonuses are Determined?

Luigi Zingales

Summary: to be announced.