Benjamin E. Hermalin

Thomas and Alison Schneider Distinguished Professor of Finance
  and Professor, Department of Economics





Updated November 5, 2012

Short Bio • Contact Information • Publications • Teaching Notes

Working Papers and Teaching Notes

Working Papers

In reverse chronological order.

The Relational Underpinnings of Formal Contracting
and the Welfare Consequences of Legal System Improvement

with Larry Li and Tony Naughton, November 2012
Abstract
We consider how parties' formal contracts are underpinned by their ongoing relationship and how welfare changes as the legal system improves. Regardless of impatience, the parties write formal contracts they wouldn't honor--despite stipulated penalties--were interaction one shot. The change in welfare with an improvement in the legal system can be ambiguous and even non-monotonic. [Note: a longer, earlier version of this paper circulated as "The Welfare Consequences of Legal System Improvement."] Open PDF of paper.

Understanding Firm Value and Corporate Governance

August 2010
Abstract
An impressive volume of careful empirical studies finds evidence that the strength of firms' corporate governance tends to be positively correlated with their financial performance; that is, firms that score higher on some measure of governance tend to outperform those which score worse. These findings are a puzzle insofar as we expect those who decide how a firm is organized, including its corporate governance, to do so in a manner that maximizes firm value subject to the relevant constraints. If the governance we observe is constrained optimal, then why, in equilibrium, should any correlation---positive or negative---exist between it and firm performance? This paper offers an answer. In doing so, the paper also makes predictions about the correlation between firm size and strength of governance, provides new explanations for the correlation between firm size and executive compensation, and provides insights into why empirical estimates of managerial incentives are often deemed too low. Open PDF of paper
Mathematica programs: Simulation in text; Simulation in appendix.

Unobserved Investment, Endogenous Quality, and Trade

June 2010 [November 2011]
Abstract
A seller can make investments that affect a tradable asset's future returns. The potential buyer of the asset cannot observe the seller's investment prior to trade, nor does he receive any signal of it, nor can he verify it in anyway after trade. Despite this severe moral hazard problem, this paper shows the seller will invest with positive probability in equilibrium and that trade will occur with positive probability. The outcome of the game is sensitive to the distribution of bargaining power between the parties, with a holdup problem existing if the buyer has the bargaining power. A consequence of the holdup problem is surplus-reducing distortions in investment level. Perhaps counterintuitively, in many situations, this distortion involves an increase in the expected amount invested vis-à-vis the situation without holdup. Open PDF of paper

Leadership and Corporate Culture

August 2007 draft of chapter for forthcoming Handbook of Organization (Gibbons & Roberts, eds.)
Abstract
Much of the economics of organization deals with the formal rights and rules that govern organizations. But, importantly, the operation of organizations is also determined by informal means as well. Two such means are leadership, a concept distinct from authority, and corporate culture, a broad concept covering the informal rules and expectations that affect operations. This chapter surveys the literature on these informal aspects of organization. Because, until recently, they received attention almost exclusively from the non-economic social sciences, this chapter will necessarily be eclectic with respect to the disciplines from which it draws. On the other hand, because this handbook is intended primarily for economists and there has been growing attention to these topics within economics, much of the focus will be economic analyses of leadership and corporate culture. Open PDF of paper

Network Interconnection with Two-Sided User Benefits

with Michael L. Katz, July 2001
Abstract
Previous work on network interconnection has tended to overlook that both the sender and receiver of an electronic message take actions, bear costs,and derive benefits from the message exchange. In a simple model with two-sided benefits and fixed network architectures, we find that the socially optimal interconnection charge is independent of the “direction” of the message and is used to induce optimal end-user prices for sending and receiving messages that account for demand conditions. These optimal retail prices depend solely on the sum of the marginal costs of exchanging a message across the two networks, not the specific marginal costs of the individual networks. Optimal interconnection pricing with endogenous network investment is also explored. Open PDF of paper

Teaching Notes

  1. "Hidden-Information Agency" (An introduction to mechanism design written with Bernard Caillaud.)
  2. "Hidden Action and Incentives" (An introduction to agency written with Bernard Caillaud.)
  3. "Lecture Notes for Economics" (Notes on pricing, mechanism design, and agency at the Ph.D. level.) Revised 1/9/09
  4. "Second-degree Price Discrimination with a Continuum of Types"