Department of Economics, UCSC

In this paper, we estimate a VAR model to present an empirical finding that an unexpected rise in the federal funds rate decreases the ratio of sales to stocks available for sales, while it increases finished goods inventories. In addition, dynamic responses of these variables reach their peaks several quarters after a monetary shock. In order to understand the ob- served relationship between monetary policy and finished goods inventories, we allow for the accumulation of finished goods inventories in an optimizing sticky price model, where prices are set in a staggered fashion. In our model, holding finished inventories helps firms to generate more sales at given their prices. We then show that the model can generate the observed relationship between monetary shocks and finished goods inventories. Furthermore, we find that allowing for inventory holdings leads to a Phillips curve equation, which makes the inflation rate dependent on the expected present-value of future marginal cost as well as the current period's marginal cost and the expected rate of future inflation.

Why do firm growth and exit rates decline with size? What determines the size distribution of firms? This paper presents a theory of firm dynamics that simultaneously rationalizes the basic facts on firm growth, exit, and size distributions. The theory emphasizes the accumulation of industry specific human capital in response to industry specific productivity shocks. The theory implies that firm growth and exit rates should decline faster with size, and the size distribution should have thinner tails, in sectors that use human capital less intensively, or correspondingly, physical capital more intensively. In line with the theory, we document substantial sectoral heterogeneity in US firm dynamics and firm size distributions, which is well explained by variation in physical capital intensities.

Employer-provided benefits are a large and growing share of compensation costs. In this paper, I consider three factors that can affect the value created by employer-sponsored benefits. First, firms have a comparative advantage (for example, due to scale economies or tax treatment) in purchasing relative to employees. This advantage can vary across firms based on size and other differences in cost structure. Second, employees differ in their valuations of benefits and it is costly for workers to match with firms that offer the benefits they value. Finally, some benefits can reduce the marginal cost to an employee of extra working time. I develop a simple model that integrates these factors. I then generate empirical implications of the model and use data from the National Longitudinal Survey of Youth to test these implications. I examine access to employer-provided meals, child-care, dental insurance, and health insurance. I also study how benefits are grouped together and differences between benefits packages at for-profit, not-for-profit, and government employers. The empirical analysis provides evidence consistent with all three factors in the model contributing to firms’ decisions about which benefits to offer.

This paper exploits a new source of variation in Head Start funding to identify the program's long-term effects. In 1965 the Office of Economic Opportunity (OEO) provided technical assistance to the 300 poorest counties in the U.S. to develop Head Start funding proposals, but did not provide similar assistance to other counties. We show that the result is a substantial difference in Head Start funding and participation rates in those counties just above and below OEO's poverty-rate cutoff for technical assistance, differences that seem to have persisted through at least the 1970’s. This discontinuity in Head Start funding and participation are associated with discontinuities in educational attainment.

Increasingly, local governments compete by offering substantial subsidies to industrial plants to locate within their jurisdictions. This paper uses a novel research design to estimate the local consequences of successfully bidding for an industrial plant, relative to bidding and losing, on labor earnings, public finances, and property values. Each issue of the corporate real estate journal Site Selection includes an article titled "The Million Dollar Plant" that reports the county where a large plant chose to locate (i.e., the 'winner'), as well as the one or two runner-up counties (i.e., the 'losers'). We use these revealed rankings of profit-maximizing firms to form a counterfactual for what would have happened in the winning counties in the absence of the plant opening. We find that the plant opening announcement is associated with a 1.5% trend break in labor earnings in the new plant's industry in winning counties, as well as increased earnings in the same industry in counties that neighbor the winner. Further, there is modest evidence of increased expenditures for local services, such as public education.

Property values may provide a summary measure of the net change in welfare, because the costs and benefits of attracting a plant should be capitalized into the price of land. If the winners and losers are homogeneous, a simple model suggests that any rents should be bid away. We find a positive, relative trend break of approximately 1.1-1.7% in property values. Since the winners and losers have similar observables in advance of the opening announcement, the property value results may be explained by heterogeneity in subsidies from higher levels of government (e.g., states) and/or systematic underbidding. Overall, the results undermine the popular view that the provision of local subsidies to attract large industrial plants reduces local residents' welfare.

We analyze oligopolistic competition in a multi-period dynamic setting for goods with network effects. Two or more infinitely-lived firms produce incompatible products differentiated in their inherent quality. Consumers live for a single period and receive the network effect of the previous period’s sales. We show existence and characterize Markov perfect equilibria that are unique given market shares at the beginning of time. We find that, generally, small network effects help the higher quality firm realize higher prices, sales, and profits. Intermediate network effects lead eventually to monopoly of the firm that provides the higher inherent quality, irrespective of original market shares. Strong network effects lead to a stable monopoly equilibrium in the long run which is achieved by the firm of sufficiently high starting market share. Although the case of monopoly resulting under strong network effects and determined by original market shares has been understood in the academic literature and drives the traditional theory of “tilting” of networks to monopoly, our finding that, for intermediate network effects, the resulting monopoly is only determined by inherent quality is new and qualitatively different than traditional theories of titling to monopoly. We also find that, in the case of small network effects, the dominance of the high quality firm is accentuated as consumers become more patient. Finally, we analyze the impact of the intensity of network effects on the number of firms that survive at the long run equilibrium.

A well developed financial system enhances competition in the industrial sector by allowing easier entry. The impact varies across industries, however. For some, small changes in financial development quickly induce entry and dissipate incumbents’ rents, generating strong incentives to oppose improvement of the financial system. In other sectors incumbents may even benefit from increased availability of external funds. The relative strength of promoters and opponents determines the political equilibrium level of financial system development. This may be perturbed by the effect of trade liberalization in the strength of each group. Using a sample of 41 trade liberalizers we conduct an event study and show that the change in the strength of promoters vis-à-vis opponents is a very good predictor of subsequent financial development. The result is not driven by changes in demand for external funds, or by the success of the trade policy. The relationship is mediated by policy reforms, the kind that induces competition in the financial sector, in particular. Real effects follow not so much from capital deepening but mainly through improved allocation. The effect is stronger in countries with high levels of governance, suggesting that incumbents resort to this costly but more subtle way of restricting entry where is difficult to obtain more blatant forms of anti-competitive measures from politicians.

We study effects of horizontal integration on firm reputation. In an environment where customers observe only imperfect signals about firms' effort/quality choices, firms cannot maintain reputations of high quality and earn quality premium forever. Even when firms are choosing high quality/effort, there is always a possibility that a bad signal is observed. In this case, firms must give up their quality premium, at least temporarily, as punishment. A firm's integration decision is based on the extent to which integration attenuates this necessary cost of maintaining a good reputation. Horizontal integration leads to a larger market base for the merged firm and may allow better monitoring of the firm's choices, hence improving the punishment scheme for deviations. On the other hand, it gives the merged firm more room for sophisticated derivations. We characterize the optimal level of integration and provide sufficient conditions under which nonintegration dominates integration. We show that the optimal size of the firm is smaller when (1) trades are more frequent and information is disseminated more rapidly; or (2) the deviation gain is smaller than the honesty benefit; or (3) customer information about firm choices is more precise.

This paper argues that when the exchange rate and projected sales in the host country are jointly determined by underlying macroeconomic variables, standard regressions of FDI flows on both exchange rate levels and volatility are subject to bias. The results hinge on the interaction of macroeconomic uncertainty, a sunk cost, and heterogeneous productivity across firms. They indicate that a multinational firm’s response to increases in exchange rate volatility will differ depending on whether the volatility arises from shocks in the firm’s native or host country. It is the first study to depart from the representative-firm framework in an analysis of direct investment behavior with money.