Benjamin E. Hermalin

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





Updated October 19, 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
Abstract
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
Abstract
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? The Pros and Cons of Charismatic Leadership

March 2014 [major revision October 2014; previously revised July 2014]
Abstract
Charisma is seen as a generally positive attribute for a leader to possess, yet many studies give it a "mixed report card": finding it can have little or no effect, or worse a negative effect. This paper develops a model to explain why. The key insight is that presenting the cold hard truth is often incompatible with simultaneously firing up followers—a tradeoff exists between information and inspiration. In particular, a temptation exists to hide bad news behind upbeat rhetoric. Rational followers understand such appeals conceal bad news. But as long as any followers are swayed by such appeals—respond to the leader's charisma—rational followers' pessimism is tempered, and more so the more charismatic the leader. Hence, a more charismatic leader can generate better responses from all followers with an emotional appeal than can a less charismatic leader. This is a benefit to charisma. But this power has a dark side: a highly charismatic leader is tempted to substitute charm for action—she is less likely to learn relevant information and, on certain margins, works less hard herself—all to her followers' detriment. 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 [major revision October 2014]
Abstract
We consider a heretofore unexplored explanation for why platforms, such as Internet service providers and mobile-phone networks, offer plans with download limits: through one of two mechanisms, doing so causes the providers of the content consumer purchase to either reduce their prices or increase their quality. This, in turn, generates greater surplus for consumers. A platform captures this increased surplus by charging consumers higher access fees. Even accounting for congestion externalities, we show that a platform will tend to restrict downloads more than would be welfare-maximizing; indeed, in some instances, by so much that a complete prohibition on such behavior is welfare superior to the practices the platform would pursue. Somewhat paradoxically, we show that a platform will install more bandwidth when allowed to restrict downloads than when prevented from doing so. Other related phenomena are explored. 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.

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"