Thursday, December 31, 2009

Pay Limits and Adverse Selection

Some AIG executives are quitting over pay limitations imposed by the government. And, who do you think are the most likely people to quit? The better employees, of course.

Wednesday, December 30, 2009

Cut out the middleman

By going straight to a medical lab:
The name of one fast-growing chain of walk-in labs encapsulates the field's business model, Any Lab Test Now. The company says it can generally have testing results within 24 hours and at a cost that is as much as 80 percent less than going through a doctor. The lab franchises offer up to 1,500 tests, from a simple cholesterol check to more sophisticated packages of tests that address complex medical issues.

Tuesday, December 29, 2009

Everyone wants to go to heaven, but no one wants to die

The Secretary of Agriculture is concerned that farmers will respond to the incentives to reduce carbon by--get ready for ths--reducing carbon. 
According to the economic model used by the department and the Environmental Protection Agency, the legislation would give landowners incentives to convert up to 59 million acres of farmland into forests over the next 40 years. The reason: Trees clean the air of heat-trapping gases better than farming does.
"If landowners plant trees to the extent the model suggests, this would be disruptive to agriculture in some regions of the country," he said.

Monday, December 28, 2009

XKCD Learns the One Lesson of Business

The XKCD web comic takes the Spinal Tap "These go to eleven" scene to its logical business conclusion.

Note that the original's alt-text jokes about confusing averages for marginals.

Want to be Happy? Be a Teacher

The the Gallup-Healthways Well-Being Index indicates that teachers score highest "on how they evaluate their lives, access to resources needed to lead a healthy life, emotional health, and their the likelihood of engaging in healthy behaviors."

Tuesday, December 22, 2009

Increasing Incentives to Donate Organs

Continuing our interest in the issue of organ donation, here's some promising news from Israel. The country now gives higher priority in receiving donated organs to those who have volunteered to donate themselves. Close relatives of volunteers also receive higher priority.

The story quotes the head of science and ethics at the British Medical Association, who has some concerns. "Once you start prioritising certain groups, for example those that sign up to the organ register, patients who are really sick and in danger of dying if they don't receive an organ may end up being pushed to the back of the queue".

I think this really misses the point. If you don't do something to increase donation rates, patients who are really sick and dying aren't going to get an organ.

(HT: Marginal Revolution)

Monday, December 21, 2009

Last Minute Gift Idea

Shouldn't everyone have one of these?

Available from the American Economic Association for only $15. Uncle Miltie looks particularly happy.

Thursday, December 17, 2009

Lincoln Electric: how to align the incentives of employees with the goals of the organization

Zoning run amuck

Gallatin Pike is one of the main commercial corridors in Nashville.  It is home to pay day lenders, pawn shops, and used tire stores.  In July 2007, NIMBY residents rezoned it for coffee shops, art cafes, and book stores.  Here is my take on the likely effect of the zoning.
  • The Gallatin SP zoning creates mismatch between (zoned) supply and demand which causes reduced sales, investment, and tax revenue
  • The alternate view, that SP zoning would create new demographics (higher density) to support the zoned uses seems unlikely because the compliance trigger reduces incentive of existing firms to renovate or rebuild

Microfinance Impact

Tim Harford, the Undercover Economist, reviews recent evidence on the value of microfinance programs. The title of the article gives away the punchline: "Perhaps microfinance isn’t such a big deal after all"

Tuesday, December 15, 2009

Why don't bidders like auctions?

In the Berkshire Hathaway Annual report, Warren Buffet tells us how he buys companies.
We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer —customarily within five minutes — as to whether we’re interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don’t participate in auctions.

When participation in an auction is costly, Buffet's dislike of auctions is explained by a recent article by Jeremy Bulow and Paul Klemperer.  They find that auctions are less efficient than sequential bargaining because too many bidders enter auctions.  But it is precisely because of this inefficiency that auctions return higher revenue to the seller, which is why Buffet doesn't participate in them.  And if you do find yourself in a sequential bargaining, try a pre-emptive offer to discourage the seller from searching further.

Harbinger of inflation?

Yield curve is getting steeper. (SOURCE: Laffer Associates)

Monday, December 14, 2009

How the French discourage innovation in winemaking

Incentives Matter - Airline Bathroom Edition

In an interview with the Wall Street Journal, Michael O'Leary, CEO of Ryanair, discusses some "mad ideas" he has for improving his airline's performance. One of them is installing pay toilets on planes.
Now we're looking at charging for toilets on board—not because we want revenue from toilet fees. We'd happily give the money away to some incontinent charity. What it means is, if by charging for toilets on board, more people would use the toilets in the terminals before or after flights, I could take out maybe two of the three toilets on board, add six extra seats and reduce fares across the aircraft by another three or four percent.

So, there's always new ways of lowering costs, but you have to come at it with some imagination and some passion.
Nice to see that someone has passion for toilets.

Price Discrimination is "Unethical?"

MR has a link to a pricing scheme relevant here. A shop owner searches her soul but maximizes profits anyway.
Mata says she knows it's "unethical," but she sizes people up and names a price that she thinks fits the client.
My students like to argue with me about the "fairness" of price discrimination but I try not to take the bait. I would love to debate philosophy with them but have to point out that this is irrelevant. Fair, ethical or otherwise, it is often profitable. Those who eschew the practice will be replaced by those who do not.

Thursday, December 10, 2009

The final victory of form over content

As the season of grading is upon us, I have been reading too many sentences like this one:
To foster cost effective content, failure to enter solution mode requires restructuring the subtle overhaul.  

Generate more than 40 million sentences like this--from real MBA papers--with Mike Shor's MBA writer.  But if you want to learn to think so that you don't have to BS, READ THIS BOOK.

Wednesday, December 9, 2009

Does anyone want a pound cake?

If the cost of a gift to the giver is bigger than the value of the gift to the recipient, then gift-giving is inefficient. Joel Waldfogel estimates that we lose 20% of our $65B annual gift giving this way:
It's bad enough that we buy a lot of stuff that no one wants. It turns out we buy it using money we don't yet have. It wasn't always this way. In the 1930s, almost 10 percent of Christmas spending was financed with money squirreled away into Christmas clubs—bank accounts paying little interest but helping consumers save for the holiday. Participants promised to contribute weekly, frequently as little as $0.25 at a time. These accounts were popular because they helped even unsophisticated consumers—many of whom didn't have another bank account—avoid the temptation to fritter their money away. Since 1970, by contrast, the explosive growth in consumer credit has had the opposite effect, helping consumers fall prey to their lack of self-control when it comes to borrowing. In recent years, one-third of holiday spending is still not paid off two months after Christmas.

Volcker Disses Financial Innovation

Paul Volcker, former chairman of the Federal Reserve and current chairman of the President's Economic Recovery Advisory Board, took a shot at the banking and finance industry yesterday during the Future of Finance Initiative sponsored by the Wall Street Journal: “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”

He wasn't totally critical of the industry, however: "The most important financial innovation I've seen in the last 25 years is the automatic teller machine." Ouch!

Euro dollars, dollar-denominated savings accounts from European banks not subject to US regulation, have allowed lenders and borrowers to by pass usury ceilings on interest rates.   Surely that counts as an unambiguous contributor to economic well being.  --Luke

Tuesday, December 8, 2009

Does extending unemployment benefits...

...lead to longer unemployment duration?

SOURCE:  Laffer Associates

Lincoln Electric headcount reductions

One of the best examples of how to align the incentives of employees with the goals of the organization is Lincoln Electric.  I show a 15 year old video (Lincoln Electric 11-08-92, distributed by Ambrose Video Publishing, Inc., 800-843-0048.), and students invariably ask how they are currently doing. Despite the downturn, their recent financials look great. 
For example, we began to implement headcount reductions and reduced work schedules throughout our global operations in the latter half of 2008, and improved our purchasing practices to take advantage of lower raw material costs. Further, on February 2, 2009, we announced a 10% global workforce reduction for annualized savings of approximately $80 million, a minimum of $20 million reduction in capital expenditures, a freeze on salary increases and external hiring, and a base pay reduction for all executive management. These actions will help to further lower our cost structure and better align our business to the current weak economic conditions.

Monday, December 7, 2009

Incentives Matter – DARPA Balloon Contest Edition

Did you happen to notice any large red balloons in your area this past weekend? The Defense Advanced Research Projects Agency (DARPA) of the Department of Defense held its Network Challenge on Saturday, a competition that challenged participants to find and submit the locations of ten 8-foot red weather balloons across the continental United States. The prize to the winning participant: $40,000. The purpose of the challenge was to:
to explore how broad-scope problems can be tackled using social networking tools. The Challenge explores basic research issues such as mobilization, collaboration, and trust in diverse social networking constructs and could serve to fuel innovation across a wide spectrum of applications. DARPA plans to meet with teams to review the approaches and strategies used to build networks, collect information, and participate in the Challenge.
Well, you might imagine that incentives were a big part of the winning team’s formula. The MIT Red Balloon Challenge Team offered $2,000 to any individual who sent them a correct location of a balloon. But, to exploit the networks of individuals, they offered additional incentives. If you invited someone to participate in the MIT group and that person found a balloon, you would receive $1,000. If someone invited you (and you invited someone who found the balloon), that person would receive $500 and so on.

How effective was the approach? It took the MIT team less than 9 hours to submit the location of all ten balloons.

Thursday, December 3, 2009

How much will students bid for a jar of coins?

If you are behind on your mortgage, try auctioning off a jar of coins in class.  These are the bids from two sections of Managerial Economics (for MBA's) for a jar with $26 in it.  Justify the profit by saying you were only teaching them how to avoid the winner's curse in common value auctions. 

Why can't homeowners walk away from under-water mortgages?

Because they carry too much emotional baggage to make rational decisions:
1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision.

Wednesday, December 2, 2009

All Pay Auctions

The folks over at have implemented something like an all-pay auction. You pay "the house" a small amount with each bid and each bid extends the closing time a bit. This makes all past bids sunk costs and can raise much more money than the object's value. The best strategy is usually not to bid at all.

The Reputation of Business in the Dumps

The Pew Research Center recently released results of a telephone survey of US adults regarding (among other things) their opinions of various professions. Apparently, most people don't share the opinion of Goldman Sachs CEO Lloyd Blankfein who said his firm is doing "God's work" in helping companies grow. Here are the professions ordered by the percent of people who think the profession contributes a lot to the well-being of society.
  • Members of the Military 84%
  • Teachers 77%
  • Scientists 70%
  • Medical Doctors 69%
  • Engineers 64%
  • Clergy 40%
  • Journalists 38%
  • Artists 31%
  • Lawyers 23%
  • Business Executives 21%
Doesn't moving assets to higher-valued uses contribute a lot to the well-being of society? Sad

Tuesday, December 1, 2009

Bargaining exam question

Suppose that a grocery store knows that 50% of its customers are Coke Loyalists (they consume only Coke); 25% are Pepsi Loyalists (they consume only Pepsi); and 25% are Switchers (they will consume either Coke or Pepsi).  If the Grocery store did not carry Pepsi, they would earn $15 million on Coke sales (before payment to Coke);  and if the store did not carry Coke, it would earn $10 million on Pepsi sales (before payment to Pepsi).  Currently the store carries both Coke and Pepsi, and earns 20 million on total soft drink sales (before payment to Coke and Pepsi). 
  1. How is the $20 million profit split between Coke, Pepsi, and the Grocery store?
  2. How would the profit be split if Coke and Pepsi merged and bargained jointly?
HINT:  the alternatives to agreement determine the terms of agreement.

NOTE:  Professors, e mail me for the answer.

REFERENCE:  Werden, Gregory and Luke Froeb, Unilateral Competitive Effects of Horizontal Mergers II: Auctions and Bargaining, Issues in Competition Law and Policy, W. Dale Collins (ed.), ABA Section of Antitrust Law, 2008, vol. 2, 1343. Available at SSRN: