Benjamin E. Hermalin

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

Updated August 6, 2014

Short Bio • Contact Information • Publications • Teaching Notes

Working Papers and Teaching Notes

Working Papers

In reverse chronological order.

Why Whine about Wining and Dining?

August 2014
Given potential abuse, conflicts of interest, and other issues, why do companies routinely pay for their managers to entertain the managers of other firms and allow their own managers to be so entertained? An answer that such practices facilitate inter-firm cooperation is incomplete because it fails to address why companies can't or don't induce such cooperation directly via their own incentive systems. This paper addresses these issues. It shows, inter alia, that even when firms can induce cooperation via their own incentive systems, they will do better obtaining that cooperation via cross-firm entertaining and other favor granting. This remains true even if “entertainment” budgets are subject to corruption, including excessive use or potential embezzlement. Furthermore, the results are wholly independent of any favorable tax treatment such practices may receive. Open PDF of paper

When Less is More: The Benefits of Limits on Executive Pay

with Peter Cebon, June 2014
We derive conditions under which limits on executive compensation can enhance efficiency and benefit shareholders (but not executives). Having their hands tied in the future allows a board of directors to credibly enter into relational contracts with executives that are more efficient than performance-contingent contracts. This has implications for the ideal composition of the board. The analysis also offers insights into the political economy of executive-compensation reform. Open PDF of paper

At the Helm, Kirk or Spock? Why Even Wholly Rational Actors May Favor and Respond to Charismatic Leaders

March 2014 [Revised July 2014 (new version corrects an error in Section 8)]
When a leader makes a purely emotional appeal, rational followers realize she is hiding bad news. Despite such pessimism and even though not directly influenced by emotional appeals, rational followers' efforts are nonetheless greater when an emotional appeal is made by a more rather than less charismatic leader. Further, they tend to prefer more charismatic leaders. Although organizations can do better with more charismatic leaders, charisma is a two-edged sword: more charismatic leaders will tend to substitute charm for real action, to the organization's detriment. This helps explain the literature's "mixed report card" on charisma. Open PDF of paper
Response to Tyler Cowen's comments

The Strategic Use of Download Limits by a Monopoly Platform

with Nick Economides, January 2014 (note: currently under revision)
We consider a heretofore unexplored explanation for why platforms, such as Internet service providers, might impose download limits on content consumers: doing so increases the degree to which those consumers view content providers' products as substitutes. This, in turn, intensifies competition among providers, generating greater surplus for consumers. A platform, in turn, can capture this in- creased surplus by charging consumers higher access fees. Even ac- counting for congestion externalities, we show that a platform will tend to set the download limit at a lower level than would be welfare- maximizing; indeed, in some instances, so low that no download limit is welfare superior to the limit the platform would set. Somewhat paradoxically, we show that a platform will install more bandwidth when allowed to impose a download limit than when prevented from doing so. Other related phenomena are explored. Open PDF of paper

Understanding Firm Value and Corporate Governance

August 2010
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.

Network Interconnection with Two-Sided User Benefits

with Michael L. Katz, July 2001
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"