Corporate managers, bankers, and policy makers alike have expressed concerns that the recent dearth of initial public offerings (IPOs) has caused a breakdown in the engine of innovation and growth. In the paper, Does Going Public Affect Innovation?, which was recently made publicly available on SSRN, I explore whether the transition to public equity markets indeed affects innovation, and if so, how. Theoretically, the effect of IPOs on innovation is ambiguous. On the one hand, going public provides improved access to capital that may allow firms to enhance their innovative activities; on the other hand, market pressures and potential departure of employees following the IPO may lead to opposite results.

To answer this question, I use standard patent-based metrics to capture changes in innovative activity in the years around the IPO and focus on three important dimensions of firms’ innovative activity: internally generated innovation, the productivity and mobility choices of individual inventors, and the acquisition of external innovation.

…continue reading: IPOs and Innovation

In a paper recently published in Fordham Law Review, Corporate Philanthropy as Signaling and Co-optation, I examine a previously unnoticed mechanism through which corporate philanthropy (CP) can enhance company value: signaling.

Current value-enhancing accounts rest on the premise that CP “buys goodwill” for the company: companies, by acting nicely, can increase consumers’ or employees’ willingness to pay. But the necessary conditions underlying this theory are simply too unrealistic. For one, consumers have to be aware of companies’ CP policies and be willing to pay to delegate their philanthropy (that is, pay for someone else’s charitable preferences). We should focus less on charitable preferences and warm-glow concepts, and more on the potential of pro-social sacrifices to convey messages about a firm’s fundamentals. Explicit sacrifices of profits can serve as costly signals. They reliably convey messages about attributes that are important to shareholders, consumers, and employees – who are evaluating whether to invest in, buy products from, or work for those companies (that is, important even to those stakeholders who are strictly profit-minded).

To illustrate, the paper elaborates on the option of CP as a costly signal to investors. An increase in the level of donations could convey messages about financial strength to potential investors, who could infer that future free cash flows are perceived by insiders to be relatively high, that the company is now less financially constrained, or that the riskiness of future cash flows has decreased. Pro-sociality could also bridge asymmetric information between insiders and non-financial stakeholders, such as employees and consumers, by conveying messages about the styles and characteristics of top management and the extent to which they are subject to short-termism.

…continue reading: Corporate Philanthropy as Signaling and Co-optation

In the paper, Regulation and Distrust, which is forthcoming in the Quarterly Journal of Economics, we document and try to explain the strong, negative correlation between government regulation and social capital found in a cross-section of countries. The correlation works for a range of measures of social capital, from trust in others to trust in corporations and political institutions, as well as for a range of measures of regulation, from product markets, to labor markets, to judicial procedures.

We present a simple model explaining this correlation. In the model, people make two decisions: whether or not to become civic (invest in social capital), and whether to become entrepreneurs or choose routine (perhaps state) production. We accept a broad view of civicness or social capital, namely that it is a broad cultural attitude. Those who have not invested in social capital impose a negative externality on others when they become entrepreneurs (e.g., pollute), while those who have invested do not. The community (whether through voting or through some other political mechanism) regulates entry into entrepreneurial activity when the expected negative externalities are large. But regulation itself must be implemented by government officials, who demand bribes if they had not invested in social capital. As a consequence, when entrepreneurship is restricted through regulation, investment in social capital may not pay.

…continue reading: Regulation and Distrust

It looks like the folks at AIG have taken “tone at the top” to heart. Unfortunately, their tone isn’t of the type that is good news for taxpayers, who now own 80% of AIG. As this Washington Post article describes, two former AIG CEOs were grilled during a House Committee on Oversight and Government Reform hearing this week (one of whom received a $5 million performance bonus just before he left – in addition to a $15 million golden parachute – and another AIG executive was fired still receives $1 million per month for consulting services). The former CEOs expressed no remorse for their actions that drove AIG into the arms of the government and didn’t acknowledge making any mistakes. Rather, they blamed the accounting. The House committee members were visibly disturbed by the sheer audacity of these so-called corporate leaders. Given the long list of troubling practices at AIG described in this front-page WSJ article, we may well see these two in pinstripes someday.

The topper is the fact that AIG is now getting an additional $37.8 billion loan from the taxpayers, which is lumped on top of the $80 billion load the government provided last month. This came a day after it was revealed that the company held a junket for sales reps at a resort, spending unbelievable amounts of the taxpayer’s money. How exactly does one spend $23,000 on spa treatments or $5,000 at the bar? The story is outrageous and listening to the radio, it’s fair to say that AIG already has become the posterchild of all that is broken in Corporate America. If this doesn’t get you mad, nothing will.

…continue reading: The Trust Has Left the Building: $23,000 on Spa Treatments