Joseph Tzur

Costly diagnosis and price dispersion

Abstract In the standard search model under monopolistic competition, when the consumer encounters a seller he knows the price before purchasing the commodity. Consequently, the price cannot exceed the consumers reservation price. In a market with rational and homogeneous agents the price distribution must therefore be degenerate. In markets for indivisible professional services the consumer does not necessarily know the price of the service when he encounters the seller. This possibility arises when the cost of ascertaining the price (the diagnosis cost) is high and the consumer decides to enter the market without searching. In contrast to the standard model, under monopolistic competition, price dispersion in equilibrium is possible even when fully rational economic agents on both sides of the market are homogeneous. We characterize such equilibria and provide a sufficient condition for their existence. We then study the effect of manipulating the search technology (typically, through a professional code of ethics) on the equilibrium in markets for such professional services.

Microstructure of Firms' Disclosure

Because of imperfections in auditing technology, firms can successfully misrepresent financial reports. We offer a new mechanism, a “sunshine rule,” by which firms are required to publicize a management draft prior to the audited reports. If the final reports are materially different from the managements draft, the market penalizes both the firm and the manager. The proposals effectiveness in eliminating “earnings management,” increasing the quality of the financial reports, and reducing the cost of the managers incentives is illustrated in signaling games with perfect and imperfect information and a principal-agent model with perfect information.

A General Model for Cost Estimation in an Exchange

Current Generally Accepted Accounting Principles (GAAP) state that the cost of an asset acquired for cash is the fair value (FV) of the amount surrendered, and that of an asset acquired in a non-monetary exchange is the FV of the asset surrendered or, if it is more “clearly evident,” the FV of the acquired asset. The measurement method prescribed for a non-monetary exchange ignores valuable information about the “less clearly evident” asset. Thus, we suggest that the FV in any exchange be measured by the weighted average of the exchanged assets’ FV estimations, where the weights are the inverse of the variances’ estimations. This alternative valuation process accounts for the uncertainty involved in estimating the FV of each of the asset in the exchange. The proposed method suits all types of exchanges: monetary and non-monetary. In a monetary transaction, the weighted average equals the cash paid because the variance of its FV is nil.

A Note on the Present Value of a Loan

This paper provides a new and original formula to calculate the present value of a loan that is paid in different installments. The analysis is extended to various topics, such as calculating the duration of a loan and the value of a swap and develops simplified expressions for both. The simplified expressions developed in this paper may be used in a variety of ways to facilitate and simplify the analysis and calculation of the fair value of a financial instrument. Even though computations may be carried out using software, such as Microsoft Excel, there is much to gain from the new analysis, as it provides insight into the relevant relationships and allows efficient ways of setting up the relevant calculations.

An Advanced Present Value Formula

At present, accounting textbooks miss a quick calculation of the present value of an annuity with variable payments. The current approach is to calculate the present value of each payment separately. In this paper, we present different ways to calculate the present value of such an annuity when the differences between successive payments are fixed. We show that the annuity can be broken into two sub-series whose present values are easily calculated, and we then apply this approach to revise the current formula of present value. Because a formula is time-saving and elegant, this paper is valuable to educators and practitioners.

Restricted competition as a reward for public service: The case of auditors

Abstract The main purpose of this paper is to offer a new insight into the problem of rationalizing governmental regulation in the form of protection to particular professions that fulfil auditing or attestation functions. Protection takes the form of licensing exams, restrictive advertising, price-fixing arrangements, etcetera. The basic new idea is that by providing third parties with excess profits, and then threatening to revoke licenses of third parties that ‘misbehave’, the government can fulfil its administrative roles more efficiently. We demonstrate this argument by analyzing a stylized tax evasion game with three types of agents: the government, taxpayers, and auditors. Within our framework, we show that by providing auditors with excess profits, and then threatening to revoke licenses of auditors caught abetting tax evasion, the government can keep taxpayers honest with a low audit rate.

An agency model of search for alternatives

Abstract The agency model of organization is augmented by a sampling process in which the agent continues search as long as the expected marginal benefit exceeds the marginal cost. It is shown that even if the agent is risk neutral in money due to the form of compensation, he may behave either like a risk averter or a risk preferrer. Sufficient conditions are given for the rent contract to be Pareto-optimal in this environment; if the ‘dominant’ factor in the agents utility function is his pecuniary income then the rent contract dominates all the fee functions for which the principals income is not negatively correlated with the agents effort.