Behavioral Economics.

The NBER's Working Group on Behavioral Economics met at the University of Chicago on March 31. The group's directors, NBER Research Associates Robert Shiller of Yale University and Richard H. Thaler of the University of Chicago, organized this program:

George A. Akerlof, University of California, Berkeley, "The Missing Motivation in Macroeconomics"

Discussant: Steven N. Kaplan, University of Chicago and NBER

Roni Michaely and William C. Weld, Cornell University; Shlomo Benartzi, University of California, Los Angeles; and Richard H. Thaler, "A Nominal Stock Price Puzzle"

Discussant: Markus K. Brunnermeier, Princeton University and NBER

Henrik Cronqvist and Angie Low, Ohio State University, and Mattias Nillson, Worcestor Polytechnic Institute, "Does Corporate Culture Matter for Firm Policies?"

Discussant: Malcolm Baker, Harvard University and NBER

Sumit Agarwal, Federal Reserve Bank of Chicago; John C. Driscoll, Federal Reserve Board; Xavier Gabaix, NBER and Princeton University; and David Laibson, NBER and Harvard University, "The Age of Reason: Financial Decisions Over the Lifecycle"

Discussant: Ulrike Malmendier, University of California, Berkeley and NBER

Valentin Dimitrov, Rutgers University; Prem C. Jain, Georgetown University; and Shed Tice, Tulane University, "Sell on the News: Differences of Opinion and Returns around Earnings Announcements"

Discussant: Charles M.C. Lee, Barclay Global Investors

Robert S. Chirinko, Emory University, and Hundey Schaller, Carleton University, "Fundamentals, Misvaluation, and Investment: The Real Story"

Discussant: Joshua Rauh, University of Chicago and NBER

The discovery of five neutralities surprised the economics profession and forced the re-thinking of macroeconomic theory. Those neutralities are: the independence of consumption and current income (given wealth); the independence of investment and finance decisions (the Modigliani-Miller theorem); inflation stability only at the natural rate of unemployment; the ineffectiveness of macro stabilization policy with rational expectations; and Ricardian equivalence. However, each of these surprise results occurs because of missing motivation. The neutralities no longer occur if decisionmakers have natural norms for how they should behave. Akerlof suggests a new agenda for macroeconomics with inclusion of those norms.

Nominal prices of common stocks have remained constant at around $30 per share since the Great Depression as a result of firms splitting their stocks. It is surprising that firms actively maintained constant nominal price for their shares while general prices in the economy went up more than ten fold. This is especially puzzling given that commissions paid by investors on trading ten $30 shares are about ten times those paid on a single $300 share. Michaely, Weld, Benartzi, and Thaler estimate, for example, that had share prices of General Electric kept up with inflation, investors in that stock would have saved $100 million in commissions in 2005. They review potential explanations, including signaling and optimal trading range, and find that none of the existing theories are able to explain the observed constant nominal prices. They suggest that the evidence is consistent with the idea that Norms (for example, Akerlof, 2006) can explain the nominal price puzzle.

Economic theories suggest that a firm's corporate culture matters for its policy choices. Cronqvist, Low, and Nillson construct a parent-spinoff-firm panel dataset that allows them to identify culture effects in firm policies from behavior that is inherited by a spinoff firm from its parent after the firms split up. They find positive and significant relations between spinoff firms' and their parents' choices of investment, financial, and operational policies. Consistent with predictions from economic theories of corporate culture, they find that the culture effects are long-term and stronger for internally grown business units and older firms. Their evidence also suggests that firms preserve their cultures by selecting managers who fit into their cultures. Finally, they find a strong relation between spinoff firms' and their parents' profitability, suggesting that corporate culture ultimately also affects economic performance. These results are robust to a series of robustness checks, and cannot be explained by alternatives such as governance or product market links. The contribution of this paper is to introduce the notion of corporate culture in a formal empirical analysis of firm policies and performance.

The sophistication of financial decisions varies with age: middle-aged adults borrow at lower interest rates and pay fewer fees than both younger and older adults. Agarwal, Driscoll, Gabaix, and Laibson document this pattern in ten financial markets, The measured effects cannot be explained by observed risk characteristics. The sophistication of financial choices peaks at about age 53 in this cross-sectional data. The results are consistent with the hypothesis that financial sophistication rises and then falls with age, although the patterns observed represent a mix of age effects and cohort effects.

Dimitrov, Jain, and Tice present strong evidence that high differences-of-opinion stocks earn lower returns around earnings announcements. The evidence is similar across six different proxies for differences of opinion (earnings volatility, return volatility, dispersion of analysts' earnings forecasts, number of analysts, firm age, and share turnover). The three-day hedge returns (returns on low minus high differences-of-opinion stocks) around earnings announcements are equivalent to annualized returns of 14 percent to 60 percent depending upon the proxy used. The results are even stronger for firms that are more difficult to short. These findings are consistent with Miller's (1977) hypothesis that stock prices contain an optimistic bias and that resolution of uncertainty results in downward price corrections. The conclusions are not affected when the researchers control for size, book-to-market, post-earnings-announcement drift, leverage, price momentum, and price reversals. Their conclusions also are not affected when they control for the return premium around earnings announcements.

Is real investment fully determined by fundamentals or is it sometimes affected by stock market misvaluation? Chirinko and Schaller introduce three new tests that: measure the reaction of investment to sales shocks for firms that may be overvalued; use Fama-MacBeth regressions to determine whether "overinvestment" affects subsequent returns; and analyze the time path of the marginal product of capital in reaction to fundamental and misvaluation shocks. Besides these qualitative tests, they introduce a measure of misvaluation into standard investment equations to estimate the quantitative effect of misvaluation on investment. Overall, the evidence suggests that both fundamental and misvaluation shocks affect investment.