Eugene Kandel

Peer Pressure and Partnerships

Partnerships and profit sharing are often claimed to motivate workers by giving them a share of the pie. But in organizations of any significant size, the free-rider effects would seem to choke off any motivational forces. This analysis explores how peer pressure operates and how factors such as profit sharing, shame, guilt, norms, mutual monitoring, and empathy interact to create incentives in the firm. The argument that Japanese firms enjoy team spirit because compensation is linked to overall profitability is analyzed. An explanation for the prevalence of partnerships among individuals in similar occupations is provided.

Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks

The relative merits of dealer versus auction markets have been a subject of significant and sometimes contentious debate. On January 20, 1997, the Securities and Exchange Commission began implementing reforms that would permit the public to compete directly with Nasdaq dealers by submitting binding limit orders. Additionally, superior quotes placed by Nasdaq dealers in private trading venues began to be displayed in the Nasdaq market. We measure the impact of these new rules on various measures of performance, including trading costs and depths. Our results indicate that quoted and effective spreads fell dramatically without adversely affecting market quality. Copyright The American Finance Association 1999.

The Right to Return

This article studies the allocation of responsibility for unsold inventory, provision for which is made in practically every distribution contract. The two extreme cases are the consignment contract, which allocates all the burden to the manufacturer, and the no-return contract, in which retailers purchase the merchandise outright and assume responsibility for unsold inventory. Contract choices are shown to vary across countries, industries, products and types of transactions. The article identifies six main factors affecting this choice: optimal inventory policy in a stochastic retail demand environment, relative advantage in disposing of the unsold inventory, optimal risk allocation, incentives to invest in promotions and provide services to increase consumer demand, information asymmetry, and costs associated with the consignment contract per se. Several testable implications are presented, and the choice of contracts in the publishing industry is shown to be consistent with the predictions of the model.

Nasdaq market structure and spread patterns

This paper argues that the standard competitive equilibrium result that prices will be driven down to the level of marginal cost cannot be routinely applied to the NASDAQ market without explicitly taking into account the institutional features of this market. We show that price competition among a large number of liquidity-providing dealers does not necessarily reduce spreads below the marginal cost of trading plus twice the exogenously set minimum tick size. We also discuss the existing explanations for the phenomenon of the odd-eighths avoidance documented in Christie and Schultz (1994) and provide an alternative explanation based on the concept of focal-point equilibria. The proposed explanation does not rule out the possibility of overt collusion, but shows that a simple coordination device may allow market makers to select the largest competitive equilibrium spread and thus attain profits similar to those possible with a formal collusive arrangement. We show that a different coordination device may be required for low-priced stocks because of their smaller tick size. Finally, we examine one month of data on NASDAQ quotes to illustrate the ideas of the paper. In particular we show that the frequency of odd-eighths avoidance increases dramatically as the minimum tick size declines. We also document that in our sample complete odd-eighths quotes avoidance tends to significantly increase the spread for otherwise comparable stocks.

Payments for Order Flow on Nasdaq

We present a model of Nasdaq that includes the two ways in which marketmakers compete for order flow: quotes and direct payments. Brokers in our model can execute small trades through a computerized system, preferencing arrangements with marketmakers, or vertical integration into market making. The comparative statics in our model differ from those of the traditional model of dealer markets, which does not capture important institutional features of Nasdaq. We also show that the empirical evidence is inconsistent with the traditional model, which suggests that preferencing and vertical integration are important components in understanding Nasdaq. Copyright The American Finance Association 1999.

Option Value, Uncertainty, and the Investment Decision

The options-based approach to studying irreversible investment under uncertainty emphasizes that the opportunity cost of investment includes the value of the option to wait that is extinguished when an investment is undertaken. Thus, the investment decision is affected by the determinants of the value of this option. We extend and generalize a standard model of irreversible investment by introducing a second fully reversible technology, and also incorporate partial reversibility by allowing capital to be abandoned at a cost. As in the existing literature, we find that the threshold value of the “underlying asset” (in our case, demand) at which investment takes place is increasing in the uncertainty of demand. We also find that the value of the option and thus the threshold value of the option value multiple at which investment takes place may be either increasing or decreasing in the uncertainty of demand. In addition, we find that for the case in which capital is used to replace the reversible technology, the threshold value of the option value multiple is insensitive to the degree of reversibility of capital.

DIFFERENTIAL INTERPRETATION OF INFORMATION IN INFLATION FORECASTS

We test the hypothesis associated with a standard assumption in the theoretical literature on learning: that economic agents interpret information identically. We use a data set based on a survey of Israeli business executives forecasting future inflation. One of the main advantages of using this data is that a major change in the inflation regime in 1985 can be treated as a natural experiment in new beliefs formation. We develop a methodology for testing this hypothesis and find evidence that is inconsistent with the identical-interpretation hypothesis, but is consistent with the proposed alternative.

VC Funds: Aging Brings Myopia

We study the conflict of interests between the limited partners (LPs) and the general partner (GP) in a venture capital (VC) fund with a limited life span. LPs commit money, while the GP selects and monitors projects. Midway into the project, the GP privately observes the project’s quality and the estimated time to exit. The fund’s limited time horizon and the GP’s informational advantage lead to inefficient decisions at this stage. First, the GP continues bad projects. Second, he may stop monitoring good, but delay-prone projects. We provide empirical predictions and illustrative evidence that the magnitude of the effect is significant.

Odd-eighth avoidance as a defense against SOES bandits

An earth boring bit having a cone rotatably secured to a cantilevered bearing shaft and a nozzle that discharges a jet stream of fluid having a high velocity core and a lower velocity skirt. The high velocity core is fully contained in a space bounded by the backside of the cone, bit leg, borehole wall and a radial plane tangent to the tips of the heel teeth and intermittently strikes the exposed ends of the erosion and wear resistant teeth when the cone rotates the teeth on the trailing side in and out of the jet stream. Less than half of the fluid in the lower velocity skirt strikes the surface of the cone, while the remainder continues on a path toward the wall and the borehole bottom. The centerline of the high velocity core is aimed no lower than the corner of the borehole. The jet stream is confined on more than about 75 percent of its periphery by either the cone, bit leg or the wall of the borehole, reducing undesirable recirculation and turbulence and opening a large return flow area unobstructed by a high velocity jet stream.

Demand for the Immediacy of Execution: Time is Money

Recent interest in the time-to-execution as a measure of market quality in order driven markets coincides with the emerging empirical research on this topic. We build on recent theoretical models of dynamic limit order book to construct an estimation procedure that tests the effect of the expected time-to-executionen on the order aggressiveness, taking into account the simultaneous determination of the two variables in equilibrium, the selection bias, and the censoring of the time variable. Using very detailed data from the Tel Aviv Stock Exchange, we show that the reduction in the expected time-to-execution is an important determinant of order aggressiveness, and may account for over 50% of the spread. Moreover, we obtain qualitatively similar results for stocks and government bonds that are traded on the same platform, which suggests that immediacy considerations have a significant effect on the high frequency price dynamics regardless of the degree of information asymmetry. We also show that the expected time-to-execution explains the choice of order strategy better than the probability of execution, which was traditionally used in the literature. Finally, our results corroborate predictions of several theoretical models of order driven markets.