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Volume 17, Number 2, Spring 2003
Symposium: Enron and Conflict of Interest
The Fall of Enron by Paul M. Healy and Krishna G. Palepu
The financial reporting and disclosure problems at Enron, as well as the high market valuations for its stock raise troubling questions about the functioning of capital market intermediaries, regulators and governance experts whose are supposed to ensure the effective functioning of the stock market. This paper examines the functions of key capital market intermediaries and analyzes how their own governance and incentive problems may have contributed to Enron’s rise and fall. We conclude by proposing system modifications to resolve the observed problems.
Corporate Earnings: Facts and Fiction by Baruch Lev
Manipulated earnings played a central role in the slew of corporate scandals which surfaced during the last three years. This article focuses on the vulnerability of earnings to manipulation by managers: it surveys the empirical record of manipulation, their major objectives, and the means of manipulation. It then focuses on the major source of earnings manipulation--the multitude of estimates and subjective judgments underlying the comutation of earnings. The article accordingly concludes with a proposal to curb manipulation by requiring managers to routinely compare key estimates with ex post realizations, and revise earnings in case of large deviations.
Corporate Conflicts of Interest by Joel S. Demski
This paper surveys conflicts of interest in the corporate governance arena, with emphasis on auditors, boards of directors, analysts and investment bankers, regulators, management, attorneys and investors. Enron provides a host of examples as well. I stress the multifaceted nature of these conflicts, and the fact most research looks at some conflicts, such as auditor independence, absent the larger setting and potential interactions among various players. I further speculate herding behavior is an important explanatory device in understanding periodic failures.
Symposium: Cultural Economics
Contracts Between Art and Commerce by Richard E. Caves
Contract structures used in the arts and entertainment industries are central to understanding their economic organization. The structures spring from common bedrock traits of these industries—pervasive product differentiation, all costs sunk, consumers’ valuations unpredictable, artists having tastes for how creative work is done. Joint-venture structures are commen, with revenue (not profit) shared. Advances to artists help bring incentive and distributive goals into consistency, as do long-term contracts covering successive cycles of the artist’s output. Real option contracts allow the efficient allocation of decision rights in a project on which collaborators work successively.
Some Economics of Ticket Resale by Pascal Courty
A large number of brokers and scalpers resell a significant fraction of event tickets at substantial markups and they manage to do so despite the fact that promoters and ticketing agencies do not support resell for profits and often attempt to block secondary market. Why can’t promoters capture the profits from secondary markets or at least deter brokers from doing so? I present a simple explanation that borrows from the literature on airline ticket pricing and draw parallels with that literature. I review some evidence consistent with this explanation.
Awards, Success and Aesthetic Quality in the Arts by Victor Ginsburgh
The role of experts is dramatically increasing in our societies, where sorting information about quality is becoming more and more difficult. This paper looks at expertise in the arts (movies, novels and musical interpretation) and shows that expert opinion given shortly after the work has been produced (Oscars, prizes, rankings in musical competitions) may influence success, though it does not always recognize talent and does often not survive the “test of time,” considered by many art philosophers, since Hume, as one of the possible measures of fundamental aesthetic quality.
Indirect Liability of Copyright Infringement: Napster and Beyond by William Landes and Douglas Lichtman
When individuals infringe copyright, they often use tools, services, and venues provided by other parties. An enduring legal question asks to what extent those other parties should be held liable for the resulting infringement. For example, should a firm that produces photocopiers be required to compensate authors for any unauthorized copies made on that firm’s machines? What about firms that manufacture personal computers or offer Internet access; should they be held liable, at least in part, for online music piracy? In this essay, we examine how modern copyright law addresses these questions and we evaluate the resulting system on economic grounds.
Articles
Health Care Costs: On the Rise Again by Sherry Glied
Since 1999, health care costs have been growing faster than national income. This rapid growth has occurred as the ability of private and public purchasers to reduce service utilization and bargain for lower prices has fallen, insurers have recouped lost profits through higher premiums, and new technologies have driven up costs throughout the sector. Private insurance market responses to these rising costs may lead to reductions in the number of people with insurance and to increased fragmentation of the insurance market. Over time, technological change in medicine both increases costs and improves the quality of care. The challenge for public policy is to maintain insurance and some degree of equity in the face of these rising costs.
Perspectives from the President's Commission on Social Security Reform by John F. Cogan and Olivia S. Mitchell
Recently we were asked to serve on the President's Commission to Strengthen Social Security (CSSS) along with 14 other members drawn equally from both major political parties. The Commission's charge was to provide recommendations to modernize the Social Security system, restore its fiscal soundness, and develop a workable system of Personal Retirement Accounts. This paper explains how the Commission arrived at some of its recommendations and the role that economics played in contributing to these recommendations. We describe the key institutional constraints confronting efforts to reform Social Security and how these constraints influenced Commission decisions. We also illustrate how economics research influenced the Commission's analysis of how to structure personal accounts, ways to enhance traditional Social Security program finances, and means of measuring the extent of financial progress achieved through reform.
Policy Watch: Unintended Consequences Run Amok — The Individual Alternative Minimum Tax by Leonard E. Burman, William G. Gale and Jeffrey Rohaly
The individual alternative minimum tax (AMT) was designed in 1970 to apply reduce aggressive tax sheltering, but under current law will grow to cover tens of millions of households in the next decade. The growth occurs because the AMT is not indexed for inflation and the 2001 tax cut reduced regular income taxes but not the AMT. AMT growth is troubling because the tax has questionable effects on equity and efficiency and is inordinately complex. This paper describes the AMT, discusses economic issues related to the alternative minimum tax, and examines options for reform.
History Lessons: Sanctions — Neither War nor Peace by Lance Davis and Stanley Engerman
This paper surveys the increasing international use of sanctions over the past century. Sanctions are a form of action taken by one state or by collective action to influence another state to change its behavior, as a substitute for welfare. They generally involve restrictions on foreign trade, either of all goods or of specific commodities. Sanctions have generally been imposed by larger countries on smaller countries. Sanctions have had a mixed success rate, depending on the costs imposed on the targeted nation, their response to these costs, and the impact on the economy and public opinion in other nations.
Features
Recommendations for Further Reading
Comments: Werner Neu, Jon D. Harford, Arthur J. Robson, Alexander J. Field, Theodore Bergstrom
Notes