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This paper asks to what extent distortions to the adoption of new technology cause income inequality across nations. We work in the framework of embodied technological progress with an individual, C.E.S. production function. We estimate the parameters of this production function from international data and calibrate the model, using U.S. National Income statistics. Our analysis suggests that distortions account for a bigger portion of income inequality than hitherto has been assessed. Download Paper
We develop a model in which the value of a firm’s reputation for quality increases gradually over time. In our model, a firm’s ability to deliver high quality at any given period depends on how much it invests in quality. This investment is the firm’s private information. Also, a firm’s current quality is unobservable. Thus the only observable is a firm’s past performance - the realized quality of the products it delivered. We assume that information about a firm’s past performance diffuses only gradually in the market. Thus, the longer a firm has been delivering high-quality products, the larger the number of potential customers, which are aware of it. We show that in equilibrium, the firm’s investment in quality increases over time, as its reputation - the number of consumers who are aware of its history - increases. This is because the greater its reputation, the more it has to lose from tarnishing it by under-investing and, conversely, the more it has to gain from maintaining it. This is recognized by rational consumers. Therefore, older - and hence larger firms - command higher prices as quality premia. This in turn feeds back into firms’ investment incentives: the fact that they are able to command higher prices motivates older and larger firms to invest and larger a firm is, the more valuable an asset its reputation is. Download Paper
A striking characteristic of high-tech products is the rapid decrease of their quality-adjusted prices. Empirical studies show that the rate of decrease of QAPs is typically not constant over time; QAPs decrease rapidly at early stages of the product and then the rate of decrease tapers off. Studies also suggest that the QAP is positively correlated with the rate of product introductions: The faster new products are introduced, the faster is the rate of decrease in their QAPs. This paper presents a dynamic model of product innovations consistent with these empirical regularities. Download Paper
We compare the rates of product innovation under rental versus sales when the product is durable and the market structure is one of duopoly. Our main conclusion is that sales induce a slower and more efficient rate of product introductions than rentals. The basic reason for this is that under rentals sellers are able to extract a higher surplus from buyers, and this higher surplus is dissipated away through excessive rate of product innovation. Since the exact opposite is true under monopoly market structure this highlights the role of market structure in determining the rate of product innovations when the product is durable. Download Paper
We consider a repeated duopoly game where each firm chooses its investment in quality, and realized quality is a noisy indicator of the firm's investment. We derive reputation equilibria, whereby consumers `discipline' a firm by switching to its rival in case its realized quality is too low. The model predicts that firms with good reputation charge a higher price, sell a bigger quantity and have a higher stock-market capitalization. Every so often, the market is subjected to turnover, whereby the highquality / good reputation firm loses market share, lowers its price and its capitalization suffers, while its rival gains market share, raises its price and enjoys increased capitalization. We examine properties of reputation equilibria. In particular, we show that the equilibrium is not efficient or nearly efficient even as the discount factor goes to 1. Download Paper
We explore entry into a foreign market with uncertain demand growth. A multinational can serve the foreign demand by two modes, or by a combination thereof: it can export its product, or it can create productive capacity via Foreign Direct Investment. The advantage of FDI is that it allows lower marginal cost than exports. The disadvantage is that FDI is irreversible and, hence, entails the risk of creating under-utilized capacity in case the market turns out to be smaller than expected. The presence of demand uncertainty and irreversibility gives rise to an interior solution, whereby the multinational does - under certain conditions - both exports and FDI. We argue that this feature is consistent with observed behavior of multinationals, yet it has not arisen in previous theoretical formulations. Download Paper
We study a dynamic principal-agent problem where social capital is an important part of the system of incentives. In each period the firm chooses an incentive intensity, and its employees allocate effort between individual and cooperative tasks. Cooperative tasks are within bounds -more productive than individual tasks, but employees are not monetarily rewarded for them. Rather, and consistent with recent work in experimental economics, employees allocate effort to cooperative tasks because they derive utility from cooperation. The utility from cooperation is endogenously de-termined, and depends on how much others have cooperated in the past and on the firm's incentive intensity. Consequently, the cooperativeness of the workforce, which we also call the firm's "social capital," follows a dynamic process where the incentive intensity acts as a control variable. We show that the optimal choice of incentives can create cultural differences across firms. Download Paper
We develop a theoretical framework for comparing the style of work in public and private enterprises. We incorporate "socializing," an activity which yields utility for workers and affects a firm's output, into a simple multitask model of work organization. In contrast with previous models, we establish the two following results. First, the optimal workers' compensation policy displays a larger incentive intensity in the private firm than in the public firm. Second, labor productivity in the private firm may be higher or lower than in the public firm. Both results fit well with the findings of empirical work. Download Paper
In this paper, we model the dynamic portfolio choice problem facing banks, calibrate the model using empirical data from the banking industry for 1984-1993, and assess quantitatively the impact of recent regulatory. developments related to bank capital. The model suggests that the new regulatory environment may have the unintended consequence of inducing banks, especially undercapitalized ones, to invest in riskier assets. This holds both under higher capital requirements (even if risk-based) and under capital-based deposit-insurance premia. Download Paper
We develop a model of firm size in which firms are unable to access as many consumers as they want. Newly arrived consumers match randomly with firms. Subsequently, consumers must pay search costs to be able to switch firms. This cost promotes an inertial tendency for consumers to remain with the ̄rm they currently buy from. Consequently, established firms enjoy a proprietary relationship with respect to their old customers while new entrants only have access to first time consumers, who are as yet unattached to any firm. As time goes on, firms acquire successive generations of new consumers, and their stock of loyal customers grows gradually. Thus, more senior firms command higher market shares. We construct an industry model based on this hypothesis and show that the aggregate implications of the model are consistent with empirical facts about industry dynamics (e.g., Dunne, Roberts and Samuelson, (1988, 1989) or Davis and Haltiwanger (1992)): Larger and older firms are less likely to exit than younger and smaller firms. In our model this results from the fact that the option value of remaining operative in the aftermath of a high cost-shock is greater for an older firm than for a younger firm because the value of a cost turnaround is greater for the former (which has already accumulated a large customer-base) than for the latter (which has yet to do so). This enables older (and larger) firms to survive adverse cost-shocks which force the exit of younger (and smaller) firms. For similar reasons, R&D expenditures are larger for larger firms, as per the empirical findings surveyed by Cohen and Lewis (1989). Download Paper
This paper examines the effect of competition on firms’ efforts to experiment and learn about market demand. Consumers are assumed to know prices only at sellers they have actually visited, but must bear search costs to find the prices of other sellers. Under these conditions we show that firms’ incentives to experiment are diluted by comparison with the monopoly case and that this effect is stronger the smaller the search cost. The learning environment we portray gives rise to several time paths which have been empirically documented, including penetration pricing, cream-skimming and cyclical pricing. Download Paper
We develop a theory of the firm in which the willingness of workers to cooperate with each other plays a central role. We study a dynamic principal-agent problem. In each period, the firm (the principal) chooses an incentive intensity (how much to pay workers per-unit of measured output) and the employees (the agents) allocate effort between individual production and tasks that involve cooperating with other employees. Following the literature on organizational behavior, (i) employees are willing to engage in cooperative tasks even when these tasks are less effective at increasing their measured output and (ii) the level of cooperation is increasing in past levels of cooperation in the firm and decreasing in the incentive intensity. Hence, an increase in the incentive intensity does not just increase current effort, it has important dynamic consequences: future employee cooperativeness falls. We show how the firm balances these two effects to maximize its lifetime profits. By extending the set of employee motivators beyond the purely financial, we are able to introduce a precise definition of corporate culture and to show how firms optimally manage their culture. Our theory helps explain why different firms, placed in similar “physical” circumstances, choose different incentive systems. It also helps explain how corporate culture can be a hard-to-imitate asset which yields some firms excess profits. Download Paper