Meetings: Summer, 2002

Public Economics

The NBER's Program on Public Economics, directed by James M. Poterba of MIT, met in Cambridge on April 5. The following papers were discussed:

• William M. Gentry, NBER and Columbia University, and David M. Schizer, Columbia University Law School, "Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Debt"
• Discussant: Mihir A. Desai, NBER and Harvard University
• Susan Dynarski, NBER and Harvard University, "Loans, Liquidity, and the Market for Higher Education"
• Discussant: Charles T. Clotfelter, NBER and Duke University
• B. Douglas Bernheim and Antonio Rangel, NBER and Stanford University, "Addiction, Cognition, and the Visceral Brain"
• Discussant: Botond Koszegi, University of California, Berkeley
• Mark Duggan, NBER and University of Chicago, "Does Contracting Out Improve the Efficiency of Government Programs? Evidence from Medicaid HMOs"
• Discussant: Katherine Baicker, NBER and Dartmouth College
• Alberto Alesina, NBER and Harvard University, Ignazio Angeloni, European Central Bank, and Federico Etro, Harvard University, "Institutional Rules for Federations" (NBER Working Paper No. 8646)
• Discussant: Roger H. Gordon, NBER and University of California, San Diego
• Daniel Bergstresser, MIT, and James M. Poterba, "Asset Allocation and Asset Location Decisions: Evidence from the Survey of Consumer Finances"
• Discussant: Andrew Samwick, NBER and Dartmouth College

Financial innovation may undermine efforts at taxing capital income; often financial innovations take advantage of the realization-based elements of the tax code. Gentry and Schizer examine one such innovation: publicly traded exchangeable debt issued in the United States between 1992 and 2000. These debt contracts raise cash and allow the issuer to hedge much of the risk of an appreciated position but do not trigger a tax on the capital gain. The authors note that in addition to underwriting fees, typically 3 percent of gross proceeds, financial market frictions create costs of using these securities to avoid taxes. The announcement of these securities is associated with a negative 1.03 percent average abnormal return in the underlying stock. Furthermore, just prior to the execution of the transaction, the underlying stock experiences an abnormal return of negative 2.8 percent. To some extent, the underlying stock rebounds from this later price effect, but the issuer does not participate fully in this rebound because the debt has hedged the issuer from benefiting in the price movements in the underlying stock. In addition to the price effects, the issuance of these debt securities is associated with large abnormal trading volume in the underlying stock, suggestive of arbitrage trading.

During the 1999-2000 school year, students borrowed $36 billion through the federal loan program, double the volume in 1992-3. Despite the large size and rapid growth of the student loan market, it has been the subject of little economic analysis. Does the availability of government loans affect schooling decisions? Identifying the effect of loans is empirically challenging, because eligibility for federal loans is correlated with observed and unobserved determinants of schooling. Dynarski exploits variation in loan eligibility induced by the Higher Education Amendments of 1992, which removed home equity from the set of assets that are taxed by the federal financial aid formula. She finds that loan eligibility has a positive effect on college attendance. Loan eligibility also appears to shift students toward four-year private colleges.

Bernheim and Rangel develop a new model of the consumption of addictive substances. The basic premise of their theory is that environmental cues can trigger states that lead the brain to provide an incomplete characterization of the decision problem; this can lead the decisionmaker to make systematic mistakes. Importantly, cues affect behavior because they influence how the brain characterizes the problem, not because they change the underlying preferences. The authors show that their model: can explain the basic stylized facts associated with addiction; has good foundations in neuroscience and psychology; and generates plausible consumption patterns for different substances. They also use the model to study the welfare properties of six drug policies: laissez-faire; taxation; subsidization of treatment programs; criminalization; regulated dispensation; and "behavioral policies" such as education and "shock-based" marketing campaigns.

State governments contract with health maintenance organizations (HMOs) to coordinate medical care for nearly 20 million Medicaid recipients. Identifying the causal effect of HMO enrollment on government spending and health care quality is difficult if, as is often the case, recipients have the option to enroll in a plan. To estimate the average effect of HMO enrollment, Duggan exploits county-level mandates introduced during the last several years in the state of California requiring most Medicaid recipients to enroll in a managed care plan. His results demonstrate that the resulting switch from fee-for-service to managed care was associated with a substantial increase in government spending but no observable improvement in health outcomes, thus apparently reducing the efficiency of this large government program. The findings cast doubt on the hypothesis that HMO contracting has reduced the strain on government budgets.

Alesina, Angeloni, and Etro study the organization of federations -- or international unions -- which together decide the provision of certain public goods. The authors individuate as an optimal institutional design a form of fiscal federalism based on decentralization of expenditures and a system of subsidies and transfers between countries. Since this solution can be politically unfeasible, they also study institutional compromises between a centralized federation and a decentralized one. "Flexible unions" and federal mandates in which both the state and federal levels are involved in providing public goods typically are superior to complete centralization and are politically feasible. Finally, the authors study the effects of a qualified majority voting rule in a centralized system: they find that it can be a useful device for correcting a bias toward "excessive" union level activism.

The rapid growth of assets in self-directed tax-deferred retirement accounts has generated a new set of financial decisions for many households. In addition to deciding which assets to hold, households with substantial assets in both taxable and tax-deferred accounts must decide where to hold their various assets. Bergstresser and Poterba use data from the 1989-98 Surveys of Consumer Finances to assess how many households have enough assets in both taxable and tax-deferred accounts to face significant choices regarding asset location. As of 1998, 45 percent of households had at least some assets in a tax-deferred account, and more than ten million households had at least $25,000 in their taxable as well as their tax-deferred accounts. Many households hold equities in their tax-deferred accounts, but not in their taxable accounts, while also holding taxable bonds in their taxable accounts. This contradicts the general wisdom that one should locate heavily taxed assets in the tax-deferred account. Asset allocation within tax deferred accounts is quite similar to asset allocation in taxable accounts.

Labor Studies

The NBER's Program on Labor Studies met in Cambridge on April 12. Program Director Richard B. Freeman, and Lawrence F. Katz, both of Harvard University, organized this program:

• Robert A. Margo, NBER and Vanderbilt University, "The North-South Wage Gap, Before and After the Civil War"
• Chinhui Juhn, NBER and University of Houston, and Kevin M. Murphy and Robert H. Topel, NBER and University of Chicago, "U.S. Unemployment in Historical Perspective"
• David Card, NBER and University of California, Berkeley, and Lara D. Shore-Sheppard, NBER and Williams College, "Using Discontinuous Eligibility Rules to Identify the Effects of the Federal Medicaid Expansions"
• Alan B. Krueger, NBER and Princeton University, and Alexandre Mas, Princeton University, "Strikes, Scabs, and Tread Separations: Labor Strife and the Production of Defective Bridgestone/Firestone Tires"
• Roundtable Discussion of Policies Related to 401(K) Plans, ESOPs, and Employer-Provided Retirement Benefits:
• Douglas L. Kruse, NBER and Rutgers University
• David Laibson, NBER and Harvard University
• Olivia S. Mitchell, NBER and University of Pennsylvania
• Edward N. Wolff, NBER and New York University

Using data for a variety of occupations, Margo documents that the Civil War occasioned a dramatic divergence in the regional structure of wages: in particular, wages fell sharply in the South Atlantic and South Central states relative to the North after the War. The divergence was immediate, being apparent as early as 1866. It was persistent: for none of the occupations that Margo examined did the regional wage structure return to its ante-bellum configuration by century's end. The divergence cannot be explained by the changing racial composition of the Southern wage labor force after the War but does appear consistent with a sharp drop in labor productivity in Southern agriculture. He also uses previously neglected data to argue that the South probably experienced a decline in the relative price of non-traded goods after the War.

After two decades of increase, the unemployment rates for prime-age males fell in the 1990s to low levels comparable to those of the late 1960s. Using the March Current Population Survey, Juhn, Murphy, and Topel examine whether trends identified during that period of rising employment have continued or been reversed in the 1990s. They find that labor market participation declined in spite of falling unemployment, leaving the overall employment of prime-age males unchanged between the business cycle peaks of 1988-9 and 1999-2000. They also find that long jobless spells continue to be important, with average durations of both unemployment and non-employment rising in the 1990s. These trends reflect both the low real wages in the 1990s relative to historical standards and the less stringent eligibility rules governing the disability insurance program. While some trends have continued, the decades-long rise in wage inequality finally has run its course and actually reversed in the 1990s. The data on joblessness broadly reflect these changing wage trends, with employment improving the most for the least skilled group.

Card and Shore-Sheppard exploit the discrete nature of the eligibility criteria for two major federal expansions of Medicaid to discern the effects of the expansions on Medicaid coverage, overall health insurance coverage, and coverage by private and other non-Medicaid sources. Using data from the Survey of Income and Program Participation, the authors examine the "133 percent" program, which covered children under the age of six in families with incomes up to 133 percent of the poverty line, and the "100 percent" program, which covered children in poor families born after September 30, 1983. Graphical and conventional differences-in-differences methods suggest that the 100 percent program led to a 10 to 15 percentage point rise in Medicaid coverage among the targeted group, with a small decline in non-Medicaid coverage and a rise in the incidence of dual coverage. The newly covered group includes children in families further from the AFDC income cutoffs and closer to the poverty line than the traditional Medicaid caseload, and includes more children in dual-headed families. By comparison, the authors are unable to find much evidence that the 133 percent program had any effect on Medicaid coverage of children in families with incomes from 100 to 133 percent of the poverty line. This negative finding is confirmed in data from the March Current Population Survey.

Krueger and Mas study the effect of labor relations on product quality. They consider whether a long, contentious strike and the hiring of permanent replacement workers by Bridgestone/Firestone in the mid-1990s contributed to the production of an excess number of defective tires. Using several independent data sources, they find that labor strife in the Decatur plant coincided closely with lower product quality. Their models based on two datasets of tire failures by plant, year, and age show significantly higher failure rates for tires produced in Decatur during the labor dispute than before or after the dispute, or than at other plants. Also, an analysis of internal Firestone engineering tests indicates that P235 tires from Decatur performed less well if they were manufactured during the labor dispute compared with those produced after the dispute, or compared with those from other, non-striking plants. Monthly data suggest that the production of defective tires was particularly high around the time wage concessions were demanded by Firestone in early 1994 and when large numbers of replacement workers and permanent workers worked side by side in 1996.

Monetary Economics

The NBER's Program on Monetary Economics, met in Cambridge on April 12. NBER Research Associates Martin Eichenbaum and Lawrence Christiano, both of Northwestern University, organized this program:

• Michael Woodford, NBER and Princeton University, "Imperfect Common Knowledge and the Effects of Monetary Policy" (NBER Working Paper No. 8673)
• Discussant: V. V. Chari, University of Minnesota
• Nobuhiro Kiyotaki, NBER and London School of Economics, and John Moore, MIT, "Liquidity, Business Cycles, and Monetary Policy"
• Discussant: Harold Cole, University of California, Los Angeles
• George W. Evans, University of Oregon, and Seppo Honkapohja, University of Helsinki, "Monetary Policy, Expectations, and Commitment"
• Discussant: Marco Bassetto, University of Minnesota
• Mark Bils, NBER and University of Rochester, and Yongsung Chang, University of Pennsylvania, "Welfare Costs of Sticky Wages When Effort Can Respond"
• Discussant: Miles S. Kimball, NBER and University of Michigan
• Fernando Alvarez, NBER and University of Chicago; Andrew Atkeson, NBER and University of California, Los Angeles; and Christian Edmond, University of California, Los Angeles, "Can a Baumol-Tobin Model Account for Short-Run Behavior of Velocity?"
• Discussant: Julio J. Rotemberg, NBER and Harvard University
• Harold Cole and Lee Ohanian, University of California, Los Angeles, and Ron Leung, University of Minnesota, "Deflation, Real Wages, and the International Great Depression: A Productivity Puzzle"
• Discussant: Ben S. Bernanke, NBER and Princeton University

Woodford reconsiders the Phelps-Lucas hypothesis, according to which temporary real effects of purely nominal disturbances result from imperfect information. He departs from the assumptions of Lucas (1973) in two crucial respects, though. Because of monopolistically competitive pricing, higher-order expectations are crucial for aggregate inflation dynamics, as Phelps argued (1983). And, decisionmakers' subjective perceptions of current conditions are assumed to be of imperfect precision, because of finite information processing capacity, as Sims argued (2001). The model can explain highly persistent real effects of a monetary disturbance and a delayed effect on inflation.

Kiyotaki and Moore provide a simple framework for modelling differences in liquidity across assets. Their goal is to understand the interaction between asset prices and aggregate economic activity, and to explain liquidity premiums. In so doing, they examine the role of government policy, through open market operations, in changing the mix of assets held by the private sector. They also show that certain anomalies of the real economy, such as low rates of return on liquid assets, volatility of asset prices, and limited participation in asset markets, in fact are normal features of an economy where money is essential for the smooth allocation of resources.

In monetary policy, the equilibriums from full commitment are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules thus have been proposed to implement or approximate full commitment policy. Evans and Honkapohja assess these optimal reaction functions and instrument rules in terms of whether they lead to an equilibrium that is both locally determinate and stable under adaptive learning by private agents. They find that a reaction function that appropriately depends explicitly on private expectations performs best on both counts.

Bils and Chang examine the impact of wage stickiness when employment has an effort as well as an hours dimension. Despite wages being predetermined, the labor market clears through the effort margin. Consequently, welfare costs of wage stickiness are potentially much, much smaller.

Alvarez, Atkeson, and Edmond describe the link between money, velocity, and prices in an inventory-theoretic model of the demand for money. They then explore the extent to which such a model can account for the short-run volatility of velocity, the negative correlation of velocity, the ratio of money to consumption, and the resulting "stickyness" of the aggregate price level as measured by the relative volatility of the ratio of money to consumption and the price level. They find that an inventory-theoretic model of the demand for money is a natural framework for understanding these aspects of the behavior of velocity in the short run.

The high-real-wage story is one of the leading hypotheses for how deflation caused the international Great Depression. Theoretically, world-wide deflation combined with incomplete nominal wage adjustment raised real wages in a number of countries. These higher real wages reduced employment as firms moved up their labor demand curves. This implies a strong negative correlation between deviations in output and real wages, while the correlation in the data is positive. The positive correlation implies the need for another shock to act as a shifter of labor demand. Cole, Ohanian, and Leung assume that the other shock works through productivity. They evaluate the relative contributions of productivity shocks and money shocks (operating through high real wages) to output changes for 17 countries between 1930 and 1933. They estimate that about two-thirds of output changes in the international cross section are explained by a productivity or productivity-like shock which is orthogonal to deflation, and about one-third of output changes are explained by money shocks.

Corporate Finance

The NBER's Program on Corporate Finance, directed by Raghuram G. Rajan, Northwestern University, met in Chicago on April 19. They discussed the following papers:

• Mike Burkart, Stockholm School of Economics; Fausto Panunzi, Università di Bologna; and Andrei Shleifer, NBER and Harvard University, "Family Firms" (NBER Working Paper No. 8776)
• Discussant: Robert Gertner, NBER and University of Chicago
• Allen N. Berger and Nathan H. Miller, Federal Reserve Board of Governors; Mitchell A. Petersen, Northwestern University; Raghuram G. Rajan; and Jeremy C. Stein, NBER and Harvard University; "Does Function Follow Organizational Form? Evidence from the Lending Practices of Large and Small Banks"
• Discussant: David S. Scharfstein, NBER and MIT
• Lucian Bebchuk, NBER and Harvard University, and Alma Cohen, Harvard University, "Firms' Decisions Where to Incorporate"
• Discussant: Roberta Romano, NBER and Yale University
• B. Espen Eckbo and Karin S. Thorburn, Dartmouth College, "Overbidding versus Fire Sales in Bankruptcy Auctions"
• Discussant: Kose John, New York University
• Alexander Dyck, Harvard University, and Luigi Zingales, NBER and University of Chicago, "Private Benefits of Control: An International Comparison" (NBER Working Paper No. 8711)
• Discussant: Rene M. Stulz, NBER and Ohio State University
• Marianne Bertrand, NBER and University of Chicago, and Antoinette Schoar, NBER and MIT, "Managing with Style: The Effect of Managers on Firm Policies"
• Discussant: Kent D. Daniel, NBER and Northwestern University
• Ivo Welch, NBER and Yale University, "Columbus's Egg: Stock Returns Are The Real Determinant of Capital Structure"
• Discussant: Steven N. Kaplan, NBER and University of Chicago

Burkart, Panunzi, and Shleifer present a model of succession in a firm controlled and managed by its founder. The founder decides between hiring a professional manager or leaving management to his heir, as well as on how much, if any, of the shares to float on the stock exchange. The authors assume that a professional is a better manager than the heir, and they describe how the founder's decision is shaped by the legal environment. Specifically, they show that, in legal regimes that successfully limit the expropriation of minority shareholders, the widely held professionally managed corporation emerges as the equilibrium outcome. In legal regimes with intermediate protection, management is delegated to a professional, but the family stays on as large shareholders to monitor the manager. In legal regimes with the weakest protection, the founder designates his heir to manage and the ownership remains inside the family. This theory of separation of ownership from management includes the Anglo-Saxon and the Continental European patterns of corporate governance as special cases, and generates additional empirical predictions consistent with cross-country evidence.

Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. Berger, Miller, Petersen, Rajan, and Stein explore this idea in the context of bank lending to small firms, an activity that is typically thought of as relying heavily on soft information. They find that large banks are less willing than small banks to lend to informationally "difficult" credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact less personally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks.

Bebchuk and Cohen investigate the decisions of publicly traded firms about where to incorporate. They study what makes states more or less attractive to incorporating firms and how firms determine whether they will incorporate outside their state of location. The authors find that states that offer stronger antitakeover protections are significantly more successful in retaining in-state companies and in attracting out-of-state incorporations. Indeed, the market for incorporations has not even penalized the three states that passed severe antitakeover statutes which have been viewed as detrimental to shareholders. The authors also find that there is a big difference between a state's ability to attract incorporations from firms located in it versus from out-of-state firms; they investigate several possible explanations for this home-state advantage. Finally, the authors find that Delaware's dominance is greater than has been recognized and that in the future Delaware's market share can be expected to increase further. These findings have significant implications for the ongoing debates on regulatory competition, takeover law, and corporate governance.

Eckbo and Thorburn analyze the bidding incentives of the main creditor (bank) in Swedish bankruptcy auctions. Without a direct mechanism for enforcing its seller-reservation price, the bank offers financing to a potential bidder in return for a strategy that maximizes the expected profits of the bank-bidder coalition. The coalition overbids (in excess of the coalition's private valuation) by an amount that decreases with the bank's "liquidation recovery": the recovery if the bank were to receive the piecemeal liquidation value announced by the auctioneer at the start of the auction. Since both the liquidation recovery and the final going-concern auction premium can be observed, the overbidding theory can be tested. The authors perform a large-sample, cross-sectional analysis in which overbidding is pitted against asset-fire sale arguments. The latter hold that auctions tend to produce lower going-concern premiums when taking place during industry-wide financial distress, or when the firm is sold back to old owners or to industry outsiders. The evidence is strongly consistent with overbidding but provides little support for asset fire-sale arguments.

Dyck and Zingales construct a measure of the private benefits of control in 39 countries based on 412 transactions between 1990 and 2000. They find that the value of control ranges between negative 4 percent and positive 65 percent, with an average of 14 percent. In countries where private benefits of control are larger, capital markets are less developed, ownership is more concentrated, and privatizations are less likely to take place as public offerings. The authors also analyze what institutions are most important in curbing these private benefits. A high degree of statutory protection of minority shareholders and a high degree of law enforcement are associated with lower levels of private benefits of control, but so are a high level of diffusion of the press, a high rate of tax compliance, and a high degree of product market competition. A crude test suggests that the "non-traditional" mechanisms have at least as much explanatory power as the legal ones commonly mentioned in the literature. In fact, in a multivariate analysis, newspapers' circulation and tax compliance seem to be the dominating factors. The authors advance an explanation of why this might be the case.

Bertrand and Schoar investigate the extent to which heterogeneity in firm policies can be explained by differences in managerial style. They use a firm-manager matched panel data set with which they can track the same managers across different firms over time. They find that manager fixed effects matter for a wide range of corporate decisions. For example, differences in capital expenditures, financial structure, dividend policies, acquisition and diversification policies, and cost-cutting policies are explained to a significant extent by executive fixed effects. Moreover, specific patterns in managerial decisionmaking seem to indicate general differences in "style." Also, style affects performance, and this is reflected in part in managerial compensation levels. In a final step, the authors tie these findings to some observable managerial characteristics, including MBA graduation and birth cohort. They ask whether and how corporate decisions are affected by these managerial characteristics. Executives from earlier birth cohorts overall appear more financially conservative. On the other hand, managers who hold an MBA degree on average seem to follow more financially aggressive strategies.

Welch shows that the typical firm's capital structure is not caused by attempts to time the market, by attempts to minimize taxes or bankruptcy costs, or by any other attempts at firm-value maximization. Instead, firms appear to be passive. Thus, current capital structure is best predicted by (past capital structure adjusted for) intervening stock return appreciation. Consequently, one should conclude that observed U.S. capital structure is determined defacto primarily by external stock market influences and not by deliberate internal corporate decisionmaking.

Behavioral Finance

The NBER's Working Group on Behavioral Finance met in Chicago on April 20. NBER Research Associates Robert J. Shiller, Yale University, and Richard H. Thaler, University of Chicago, organized this program:

• Christopher K. Polk and Paola Sapienza, Northwestern University, "The Real Effects of Investor Sentiment"
• Discussant: Jeremy C. Stein, NBER and Harvard University
• Nicholas C. Barberis, NBER and University of Chicago, Andrei Shleifer, NBER and Harvard University, and Jeffrey Wurgler, New York University, "Comovement"
• Discussant: Robert J. Shiller
• Sendhil Mullainathan, NBER and MIT, "Thinking Through Categories"
• Discussant: Jesus Santos, NBER and University of Chicago
• Tim Loughran, University of Notre Dame, and Jay R. Ritter, University of Florida, "Why has IPO Underpricing Increased Over Time?"
• Discussant: Ivo Welch, NBER and Yale University
• Amiyatosh K. Purnanandam and Bhaskaran Swaminathan, Cornell University, "Are IPOs Underpriced?"
• Discussant: Alon Brav, Duke University
• Mark Grinblatt, NBER and University of California, Los Angeles, and Bing Han, University of California, Los Angeles, "The Disposition Effect and Momentum"
• Discussant: Harrison Hong, Stanford University

Do inefficiencies in the capital markets have real consequences? Or, are they simply wealth transfers from noise traders to arbitrageurs? Polk and Sapienza study firm business investment and find a positive relationship between investment and each of their three measures of mispricing (after controlling for investment opportunities and financial slack.) Consistent with their predictions, they find that firms with higher research and development intensity (suggesting less transparency and longer periods of information asymmetry) have investment that is more sensitive to mispricing.

Barberis, Shleifer, and Wurgler distinguish three views of comovement among different traded securities. The traditional "fundamentals" view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash flows or discount rates. "Category-based" comovement occurs when investors classify different securities into the same asset class and then shift resources in and out of this class in correlated ways. "Habitat-based" comovement arises when a group of investors restricts its trading to a given set of securities, and then moves in and out of that set in tandem. The authors model each type of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock's category and investor clientele (habitat), but do not change its fundamentals. The authors find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results broadly support the category and habitat views of comovement, but not the fundamentals view. More generally, these non-traditional views may help to explain other instances of comovement in the data.

Mullainathan presents a model of human inference in which people use coarse categories to make inferences. "Coarseness" means that, rather than updating continuously as suggested by the Bayesian ideal, people update or change categories only when they see enough data to suggest that an alternative category fits the data better. This simple model of inference generates a set of predictions about behavior. Mullainathan applies this framework to produce a simple model of financial markets which produces straightforward and testable predictions about the predictability of returns, comovement, and volume.

In the 1980s, the average first-day return on initial public offerings (IPOs) was 7 percent. The average first-day return doubled to almost 15 percent during 1990-8, before jumping to 65 percent during the internet bubble years of 1999-2000. Part of the increase can be attributed to changes in the composition of the companies going public. Loughran and Ritter attribute much of the increase in underpricing, though, to previously latent agency problems between underwriters and issuing firms. They argue that the increase in valuations over time has caused issuers to be more complacent about leaving money on the table.

Purnanandam and Swaminathan study the valuation of initial public offerings (IPOs) using comparable firm multiples. In a sample of more than 2000 IPOs from 1980 to 1997, the median IPO is overvalued at the offer by about 50 percent relative to its industry peers, they find. In the cross-section, overvalued IPOs earn 5 percent to 7 percent higher first day returns than undervalued IPOs, but earn 20 percent to 50 percent lower returns over the next five years. Overvalued IPOs temporarily exhibit higher sales growth rates but persistently earn lower profit margins and return on assets than undervalued IPOs over the next five years. This suggests that any projected growth opportunities implicit in the initial valuation fail to materialize subsequently. These results are not consistent with asymmetric information models of IPO pricing and rather support behavioral theories based on investor overconfidence.

Prior research shows that many investors have a lower propensity to sell stocks on which they have a capital loss. This behavioral phenomenon, known as "the disposition effect," has implications for equilibrium prices. Grinblatt and Han investigate the temporal pattern of stock prices in an equilibrium that aggregates the demand functions of both rational and disposition investors. The disposition effect creates a spread between a stock's fundamental value -- the stock price that would exist in the absence of a disposition effect -- and its market price. Even when a stock's fundamental value follows a random walk, and thus is unpredictable, its equilibrium price will tend to underreact to information. Spread convergence, arising from the random evolution of fundamental values and updating of the reference prices, generates predictable equilibrium prices. This convergence implies that stocks with large past price run-ups and stocks on which most investors experienced capital gains have higher expected returns than those that have experienced large declines and capital losses. The profitability of a momentum strategy, which makes use of this spread, depends on the path of past stock prices. The authors find that stocks with large aggregate unrealized capital gains tend to have higher expected returns than stocks with large aggregate unrealized capital losses; this capital gains "overhang" appears to be the key variable that generates the profitability of a momentum strategy. When this capital gains variable is used along with past returns and volume to predict future returns, the momentum effect disappears.

Health Care

The NBER's Program on Health Care met in Cambridge on May 3. Program Director Alan M. Garber of Stanford University organized the meeting. These papers were discussed:

• Dahlia K. Remler and Joshua Graff Zivin, Columbia University, and Sherry A. Glied, NBER and Columbia University, "Modeling Health Insurance Expansions: Effects of Alternate Approaches"
• Frank R. Lichtenberg, NBER and Columbia University, "The Effect of Changes in Drug Utilization on Labor Supply and Per Capita Output"
• Jay Bhattacharya, Stanford University; Darius Lakdawalla, NBER and Rand Corporation; and Michael Schoenbaum, Rand Corporation, "Whom Does Medicare Benefit?"
• Mark Duggan, NBER and University of Chicago, "Does Contracting Out Increase the Efficiency of Government Programs? Evidence from Medicaid HMOs" (For a description of this paper, see "Public Economics" earlier in this issue)
• Mark V. Pauly, NBER and University of Pennsylvania, and Bradley J. Herring, Yale University, "The Demand for Health Insurance in the Group Setting: Can You Always Get What You Want?"
• Nancy D. Beaulieu and David M. Cutler, NBER and Harvard University, and Katherine E. Ho, Harvard University, "Why Quality is So Poor"

Remler, Zivin, and Glied categorize and describe the different methodological approaches used to predict the effects of proposals to increase health insurance coverage; they explain the conceptual theoretical relationships between the of the approaches can yield quantitatively identical predictions Finally, they illustrate the conditions under which these approaches diverge, and the quantitative extent of that divergence. All of the modeling approaches implicitly make assumptions about functional form that impose restrictions on unobservable heterogeneity. Those assumptions can dramatically affect the quantitative predictions made.

Lichtenberg examines the effect of changes in both the average quantity and average vintage ("quality") of drugs consumed on labor supply, using longitudinal, condition-level data. First, he considers the effect of changes during 1996-8 in the average number of prescriptions consumed for a given condition on the probability of missed work days. His estimates indicate that conditions for which there were above-average increases in prescription use tended to have above-average reductions in the probability of missed work days. The estimated value to employers of the reduction in missed work days appears to exceed the employer's increase in drug cost. Using different data, Lichtenberg then examines the effect of changes during 1985-96 in the average vintage of prescriptions consumed for a condition on five different, condition-specific measures of activity limitation, including limits on ability to work. His estimates are consistent with the hypothesis that an increase in a condition's mean drug vintage reduces the probability that people with that condition will experience activity and work limitations, and reduces their average number of restricted-activity days. The estimates imply that activity limitations decline at the rate of about one percent per year of drug vintage, and that the rate of pharmaceutical-embodied technical progress with respect to activity limitations is about 18 percent. Estimates of the cost of the increase in drug vintage necessary to achieve reductions in activity limitations indicate that increases in drug vintage tend to be very "cost-effective."

Bhattacharya, Lakdawalla, and Schoenbaum attempt to construct the rate of return on Medicare for various groups in the population. They focus in particular on how rates of return vary with permanent income and education. This allows them to determine whether Medicare is beneficial for the average person, the average disadvantaged person, or the average advantaged person. Implicitly, they view Medicare taxes as investments in future health benefits. Whether or not Medicare is beneficial depends on the internal rate of return on these investments. The authors find that the internal rate of return is significantly higher for the less educated. Indeed, the internal rate of return is less than the real rate of interest for the most educated groups, but well above it for the least educated. As a result, less educated individuals would willingly choose to invest in Medicare, while more educated individuals would not. This is true in spite of the fact that less educated people do not live as long.

To what extent do health benefits obtained in the employment-based setting reflect individual preferences? Pauly and Herring examine this question by comparing characteristics of plans obtained in this setting to those obtained in the individual insurance market, using data from the 1996-7 Community Tracking Study's Household Survey. They also examine the effect of unions on group choice. Their structural models of the demand for insurance using individual-level demographic characteristics indicate that plans obtained in the group setting generally reflect underlying preferences for insurance, although they do observe significantly different effects of ethnicity and unionization.

Examining quality measures for care of chronically ill patients by Health Maintenance Organizations (HMOs) suggests that there is substantial room for improvement, as well as substantial variation among HMO plans. Beaulieu, Cutler, and Ho hypothesize several factors, both health plan-related and market-related, that could be associated with higher or lower performance on these chronic care measures. They then test these hypotheses in a multivariate model. They find that HMOs in markets characterized by lower competition and a greater presence of large employers score higher on the chronic care quality measures. Also, several health plan characteristics are associated positively with better performance: not-for-profit tax status; tighter physician networks; privately-held ownership; and group-model organizational form. Socio-demographic characteristics of the market in which health plans operate and the method by which health plans compensate their physicians have no significant influence on the quality of care.