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Abstract:
We develop a contracting model between shareholders and managers in which managers diversify their firms for two reasons: to reduce idiosyncratic risk and to capture private benefits. We test the comparative static predictions of our model. In contrast to previous work, we find that diversification is positively related to managerial incentives. Further, the link between firm performance and managerial incentives is weaker for firms that experience changes in diversification than it is for firms that do not. Our findings suggest that managers diversify their firms in response to changes in private benefits rather than to reduce their exposure to risk.

Abstract:
We develop a contracting model between shareholders and managers in which optimal incentive contracts mitigate managers' propensity to diversify their firms. In our model, managers may diversify for two reasons: to reduce idiosyncratic risk and to capture private benefits. We derive comparative static predictions for the equilibrium relationships between incentives, diversification, and firm performance. We then test our model. Consistent with prior studies, we find that firm performance is positively related to incentives and negatively related to diversification. We find that diversification is positively related to managerial incentives. We show that the negative relationship between diversification and managerial incentives that has been observed in prior work is the result of omitted variable bias. We also find that the link between firm performance and managerial incentives is weaker for firms that experience changes in diversification than it is for firms that do not experience changes in diversification. These findings suggest that observed changes in diversification, incentives, and firm performance are equilibrium responses to changes in the level of private benefits that managers derive from diversification. Our evidence does not support the idea that managers diversify their firms to reduce their exposure to risk.

Abstract:
Core and Guay (2001) argue that there is an increasing relation between an executive's pay-performance sensitivity (incentives) and firm risk, in contrast to the findings in Aggarwal and Samwick (1999) and the predictions of principal-agent models such as Holmstrom and Milgrom (1987). They claim that including a control variable for firm size in our regression specification reverses the sign of the coefficient on firm risk. We show that their conclusions are based on errors in their empirical work, not the validity of their claim. We re-examine both our original findings and Core and Guay's findings and show that our original findings are quite robust to changes in specification - the relation between pay-performance sensitivity and firm risk is decreasing as predicted by principal-agent theory.

Principal-agent Problem, Incentives, Risk, Insurance

Abstract:
The principal-agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance, yet the existing empirical evidence supporting it is quite weak. The key predication of the model is that the executive's pay-performance sensitivity is decreasing in the variance of the firm's performance. We demonstrate strong empirical confirmation of this prediction using a comprehensive sample of executives at large corporations. In general, the pay-performance sensitivity for executives at firms with the least volatile stock prices is an order of magnitude greater than the pay-performance sensitivity for executives at firms with the most volatile stock prices. This result holds for both chief executive officers and for other highly compensated executives. We further show that estimates of the pay-performance sensitivity that do not explicitly account for the effect of the variance of firm performance are biased toward zero. We also test for relative performance evaluation of executives against the performance of other firms. We find little support for the relative performance evaluation model. Our findings suggest that executive compensation contracts incorporate the benefits of risk-sharing but do not incorporate the potential informational advantages of relative performance evaluation.

Abstract:
The principal-agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance, yet the existing empirical evidence supporting it is quite weak. The key prediction of the model is that the executive's pay-performance sensitivity is decreasing in the variance of the firm's performance. We demonstrate strong empirical confirmation of this prediction using a comprehensive sample of executives at large corporations. In general, the pay-performance sensitivity for executives at firms with the least volatile stock prices is an order of magnitude greater than the pay-performance sensitivity for executives at firms with the most volatile stock prices. This result holds for both chief executive officers and for other highly compensated executives. We further show that estimates of the pay-performance sensitivity that do not explicitly account for the effect of the variance of firm performance are biased toward zero. We also test for relative performance evaluation of executives against the performance of other firms. We find little support for the relative performance evaluation model. Our findings suggest that executive compensation contracts incorporate the benefits of risk-sharing but do not incorporate the potential informational advantages of relative performance evaluation.

Abstract:
The principal-agent model of executive compensation is of central importance to the modern theory of the firm and corporate governance, yet the existing empirical evidence supporting it is quite weak. The key cross-sectional prediction of the model is that the executive's pay-performance sensitivity is decreasing in the variance of the firm's performance. We demonstrate strong empirical confirmation of this prediction using a comprehensive sample of executives at large corporations. In general, the pay-performance sensitivity for executives at firms with the least volatile stock prices is an order of magnitude greater than the pay-performance sensitivity for executives at firms with the most volatile stock prices. This result holds for both chief executive officers and for other highly compensated executives. We show that estimates of the pay-performance sensitivity that do not explicitly account for the effect of the variance of firm performance are biased strongly toward zero. We also test for relative performance evaluation of executives against the performance of other firms. We find little support for the relative performance evaluation model. Our findings suggest that executive compensation contracts are optimal with respect to risk-sharing but do not incorporate the potential informational advantages of relative performance evaluation.

Abstract:
How has the emergence of defined contribution pension plans, such as 401(k)s, affected the financial security of future retirees? We consider this question using a detailed survey of pension formulas in the Survey of Consumer Finances. Our simulations show that average and median pension benefits are higher under defined contribution plans that for defined benefit plans. Defined benefit plans are slightly better at providing minimum benefits, but for plausible values of risk aversion, a defined contribution plan drawn randomly from those available in 1995 is still preferred to a defined benefit plan drawn randomly from those available in 1983. This result is robust to different assumptions regarding the spending of defined contribution balances between jobs, equity rates of return, and the date of retirement. In short, we suggest that defined contribution plans can strengthen the financial security of retirees.

Abstract:
How has the emergence of defined contribution pension plans, such as 401(k)s, affected the financial security of future retirees? We consider this question using a detailed survey of pension formulas in the Survey of Consumer Finances. Our simulations show that average and median pension benefits are higher under defined contribution plans than for defined benefit plans. Defined benefit plans are slightly better at providing minimum benefits; but for plausible values of risk aversion, a defined contribution plan drawn randomly from those available in 1995 is still preferred to a defined benefit plan drawn randomly from those available in 1983. This result is robust to different assumptions regarding the spending of defined contribution balances between jobs, equity rates of return, and the date of retirement. In short, we suggest that defined contribution plans can strengthen the financial security of retirees.

Abstract:
Despite the prominence of management consulting firms, there is little systematic evidence in the finance and economic literature of their impact on corporate performance. This paper assembles a unique dataset of companies that announce their relationships with a management consulting firm between 1991 and 2001. Stock returns fall by an average of 4.3 percentage points relative to the market when an announcement is made. The median price drop is 1.6 percentage points. In a longer-term analysis, the intercepts from a Fama-French four-factor model show that announcing companies earn negative risk adjusted returns prior to their announcements. Risk adjusted returns are significantly higher after the announcement, with the total risk adjusted return peaking at 1.3 percentage points per month approximately three years after the announcement. In addition, we show that the companies that announce a relationship with a management consultant tend to under perform their competitors before hiring and then begin to outperform them after two years. Average employment growth turns sharply negative in the years following the announcement; however, the positive risk-adjusted returns are only weakly correlated with employment contractions in the cross-section of announcement companies.

Consultant, Event study, Multifactor model

Abstract:
This paper simulates a transition from the current pay-as-you-go Social Security system to a prefunded system based on Personal Retirement Accounts (PRAs). Annual PRA contributions of 2 percent of taxable payroll earning the historical return on the corporate sector are sufficient to close the financing gap projected for the Old-Age Survivors and Disability Insurance programs and to provide a modest increase in expected retirement income. Critically, the balance in the Social Security Trust Fund is positive and increasing at the end of the usual 75-year forecasting period, showing that the new system is solvent on a permanent basis. The simulations in this paper update the original plan discussed in Feldstein and Samwick (1998). The paper also discusses issues of portfolio risk, income distribution, and administrative costs of a system of PRAs.

Social Security, Individual Accounts, Personal Retirement Accounts

Abstract:
Among the far-reaching effects of Social Security reform on the rest of the economy is the impact on private pensions. This paper develops a model of pension plan design that incorporates heterogeneity in tastes for saving and sorting of workers in the labor market. The model is used to analyze the likely effects of a range of Social Security reform proposals on the design of employer-provided pensions. Several reform options are shown to change the relative benefits received by high- and low-income workers and to affect the ability of pension plan sponsors to comply with nondiscrimination rules for the distribution of pension contributions and benefits.

Abstract:
In this paper, we analyze the relationship between age and portfolio structure for households in the US. We focus on both the probability that households of different ages own particular portfolio assets and the fraction of their net worth allocated to each asset category. We distinguish between age and cohort effects using data from the repeated cross-sections of the Federal Reserve Board's Surveys of Consumer Finances. We present two broad conclusions. First, there are important differences across asset classes in both the age-specific probabilities of asset ownership and in the portfolio shares of different assets at different ages. The notnion that all assets can be treated as identical from the standpoint of analyzing household wealth accumulation is not supported by the data. Institutional factors, asset liquidity, and evolving investor tastes must be recognized in modeling asset demand. These factors could affect analyses of overall household saving as well as the composition of this saving. Second, there are evident differences in the asset ownership probabilities of different birth cohorts. Currently, older households were more likely to hold corporate stock, and less likely to hold tax-exempt bonds, than younger households at any given age. These differences across cohorts are important to recognize when analyzing asset accumulation profiles.

Abstract:
This paper presents several alternative Social Security reform options in which the projected level of benefits for every future cohort of retirees is as high or higher than the benefits projected in current law. These future benefits can be achieved without any increase in the payroll tax or in other tax rates. Under each option, the Social Security Trust Fund is solvent and ends with a sustainable positive and growing balance. Each option combines the current pay-as-you-go system of defined benefits with an investment-based personal retirement account (PRA). Assets in the PRA can be bequeathed if the individual dies before normal retirement age. We also consider the option in which an individual can take all or part of his accumulated PRA balanced as a lump sum at normal retirement age. The basic plan that we present in greatest detail combines a transfer to the personal retirement account of a portion of the individual's payroll tax equal to 1.5 percent of earnings if the individual agrees to deposit an equal out-of-pocket amount. The additional national saving that results from this option leads to increased business investment and therefore to increased general tax revenue; a portion of that revenue, equal to 1 percent of the PRA balances , is transferred to the Social Security Trust Fund. The other options that we present include plans with no out-of-pocket contributions by individuals and others with no transfer of general revenue to the Trust Fund. We also discuss the implications of different rates of return on the PRA balances and, more generally, the issue of risk, including a market-based method of guaranteeing the real principal of all PRA deposits.

Abstract:
Do firms systematically over- or underinvest as a result of agency problems? We develop a contracting model between shareholders and managers in which managers have private benefits or private costs of investment. Managers overinvest when they have private benefits and underinvest when they have private costs. Optimal incentive contracts mitigate the over- or underinvestment problem. We derive comparative static predictions for the equilibrium relationships between incentives from compensation, investment, and firm performance for both cases. The relationship between firm performance and managerial incentives, in isolation, is insufficient to identify whether managers have private benefits or private costs of investment. In order to identify whether managers have private benefits or costs, we estimate the joint relationships between incentives and firm performance and between incentives and investment. Our empirical results show that both firm performance and investment are increasing in managerial incentives. These results are consistent with managers having private costs of investment. We find no support for overinvestment based on private benefits.

Abstract:
The bull market of the last year has raised the total value of corporate stock in the United States by nearly a trillion dollars. While many analysts have tried to explain or interpret the recent movements of the stock market, there has been less attention to the link between rising stock prices and real economic activity. How are the gains from and increase in share prices distributed across households? What fraction of these gains accrues to a small set of wealthy investors? How do rising stock prices affect consumer spending?

Abstract:
This paper explores the relationship between household marginal income tax rates, the set of assets that households own, and the portfolio shares accounted for by each of these assets. It analyzes data from the 1983, 1989, 1992, and 1995 Surveys of Consumer Finances and develops a new algorithm for imputing federal marginal tax rates to households in these surveys. The empirical findings suggest that a household's marginal tax rate has an important effect its asset allocation decisions. The probability that a household owns tax-advantaged assets is strongly related to its tax rate on ordinary income. In addition, the amount of investment through tax-deferred accounts such as 401(k) plans and IRAs is an increasing function of the household's marginal tax rate. Holdings of corporate stock, which is taxed less heavily than interest bearing assets, and of tax-exempt bonds are also increasing in the household's marginal tax rate. Holdings of heavily taxed assets, such as corporate bonds and interest-bearing accounts, decline as a share of wealth as a household's marginal tax rate increases.

Abstract:
Together, pensions, social security and health insurance account for half of the wealth held by all households in the Health and Retirement Study (HRS), for 60 percent of total wealth of HRS households who are in the 45th to 55th wealth percentiles, and even for 48 percent of wealth for those in the 90th and 95th wealth percentiles. The HRS surveys households aged 51 to 61 in 1992, and obtains pension plan descriptions from respondents' employers. Pension accrual profiles, income and wealth distributions by type, wealth-income ratios and accrued wealth by pension status are also explored.

Abstract:
Together, pensions, social security and health insurance account for half of the wealth held by all households in the Health and Retirement Study (HRS), for 60 percent of total wealth of HRS households who are in the 45th to 55th wealth percentiles, and even for 48 percent of wealth for those in the 90th to 95th wealth percentiles. The HRS surveys households aged 51 to 61 in 1992, and obtains pension plan descriptions from respondents' employers. Pension accrual profiles, income and wealth distributions by type, wealth-income ratios and accrued wealth by pension status are also explored.

Abstract:
This paper analyzes the transition from the existing pay-as-you-go Social Security program to a system of funded Mandatory" Individual Retirement Accounts (MIRAs). Because of the high return on real capital relative to the very low return in a mature pay-as-you-go program, the benefits that can be financed with the existing 12.4 percent payroll tax could eventually be funded with mandatory contributions of only 2.1 percent of payroll. A transition to that fully funded program could be done with a surcharge of less than 1.5 percent of payroll during the early part of the transition. After 25 years, the combination of financing the pay-as-you-go benefits and accumulating the funded accounts would require less than the current 12.4 percent of payroll. The paper also discusses how a MIRA system could deal with the benefits of low income employees and with the risks associated with uncertain longevity and fluctuating market returns.

Abstract:
We show that top management incentives vary by responsibility. For oversight executives, pay-performance incentives are $1.22 per thousand dollar increase in shareholder wealth higher than for divisional executives. For CEOs, incentives are $5.65 higher than for divisional executives. Incentives for the median top management team are substantial at $32.32. CEOs account for 42 to 58 percent of aggregate team incentives. For divisional executives, the pay-performance sensitivity is positive and increasing in the precision of divisional performance and the pay-performance sensitivity is decreasing in the precision of divisional performance. These results support principal-agent models with multiple signals of managerial effort.

Abstract:
Empirical research on executive compensation has focused almost exclusively on the incentives provided to chief executive officers. However, firms are run by teams of managers, and a theory of the firm should also explain the distribution of incentives and responsibilities for other members of the top management team. An extension of the standard principal-agent model to allow for multiple signals of effort predicts that executives who have other, more precise signals of their effort than firm performance will have compensation that is less sensitive to the overall performance of the firm. We test this prediction in a comprehensive panel dataset of executives at large corporations by comparing executives with explicit divisional responsibilities to those with broad oversight authority over the firm and to CEOs. Controlling for executive fixed effects and the level of compensation, we find that CEOs have pay-performance incentives that are $5.85 per thousand dollar increase in shareholder wealth higher than the pay-performance incentives of executives with divisional responsibility. Executives with oversight authority have pay-performance incentives that are $1.26 per thousand higher than those of executives with divisional responsibility. The aggregate pay-performance sensitivity of the top management team is quite substantial, at $30.24 per thousand dollar increase in shareholder wealth for the median firm in our sample. Our work sheds light on the alignment of responsibility and incentives within firms and suggests that the principal-agent model provides an appropriate characterization of the internal organization of the firm.

Abstract:
Empirical research on the principal-agent model has focused almost exclusively on the incentives provided to chief executive officers. However, the model is also directly relevant to the incentives provided to other top executives. Furthermore, the extent to which other executives will be provided with high-powered incentives to maximize firm profits depends critically on the other measures of their performance that are observable to the shareholders. Top managers who have important divisional responsibilities within the firm have more precise signals of their effort than the overall performance of the firm. Consequently, the compensation of this group of executives will be less sensitive to firm performance than will the compensation of top managers with broad oversight authority. We find robust empirical support for this proposition using a comprehensive panel dataset of executives at large corporations. We also show that the aggregate pay-performance sensitivity of the top management team is quite substantial. These findings are consistent with a principal-agent model in which shareholders optimally utilize multiple signals of executive effort in determining compensation. Our results suggest that the principal-agent model is an appropriate characterization of the internal organization of the firm.

Abstract:
In an earlier paper we analyzed a method of combining traditional tax financed pay-as-you-go Social Security benefits with annuities financed by Personal Retirement Accounts. We showed that such a combination could maintain the level of retirement income projected in current Social Security law while avoiding a future increase in the payroll tax rate. The current paper extends the earlier analysis in four ways: (1) We now specify that the funds deposited in the Personal Retirement Accounts come from allocating 2 percent of the 12.4 percent payroll tax instead of being additional funds provided from outside the system. (2) We discuss the effects of the uncertain return on investment based annuities. (3) We provide estimates of the cost of permitting bequests if individuals die either before retirement or during the first twenty years after retirement. (4) We update the statistical basis for our estimates to be consistent with the 2000 Social Security Trustees Report. Our analysis shows that a program of Personal Retirement Accounts funded by allocating 2 percent of the 12.4 percent payroll tax collections can maintain the retirement income projected in current law while avoiding any increase in the 12.4 percent payroll tax. The combination of the higher return on the assets in the Personal Retirement Accounts and the use of the additional corporate profits taxes that result from the increased national saving in Personal Retirement Accounts is sufficient to maintain the solvency of the Social Security Trust Fund even though the tax payments to the fund are reduced from 12.4 percent of taxable payroll to 10.4 percent of taxable payroll. Although there is a period of years when the Trust Fund must borrow, it is able to repay this borrowing with interest out of future tax collections. In the long run, the Trust Fund becomes very large, implying that it would be possible to reduce the payroll tax further or to increase retirement incomes above the levels projected in current law.

Abstract:
A program of Personal Retirement Accounts (PRAs) funded by deposits equal to 2.3 percent of earnings (up to the Social Security maximum) would permit retirees to receive more income in retirement than with the current Social Security program while at the same time making it unnecessary to increase the 12.4 percent payroll tax in response to the aging of the population. The gross cost of these deposits, approximately 0.9 percent of GDP, could be financed for more than a decade out of the budget surpluses currently projected by the Congressional Budget Office. By the year 2030, the additional corporate tax revenue that results from the enlarged capital stock financed by PRA assets would be able to finance fully these personal tax credits. During the intervening years (about 2020 to 2030), a reduction of other government spending or an increase in taxes would be needed if budget deficits are to be avoided. If implemented, the PRA program would not only increase retirement income and stabilize the Social Security payroll tax, but would also substantially increase national saving and GDP. NOTE: This is a revised version of "Two Percent Personal Retirement Accounts: Their Potential Effects on Social Security Tax Rates and National Saving," by Martin Feldstein and Andrew Samwick, issued in April, 1998 as working paper 6540.

Abstract:
As many countries consider the privatization of existing pay-as-you-go Social Security systems, the option to make participation in the new system voluntary may appeal to policy makers who need to obtain the political support of their workers. A critical issue in evaluating such a reform and its economic consequences is the unobserved heterogeneity in households' preferences for consumption. This paper estimates the distribution of rates of time preference from the wealth data in the Survey of Consumer Finances 1992 and a flexible life-cycle model of consumption under income uncertainty. The estimated distribution is then applied to a variety of reform proposals that incorporate a voluntary choice of how much to contribute to a dedicated retirement account and a rebate of the existing payroll tax that increases with the magnitude of the contribution. The main finding is that an appropriate menu of reform plans can induce the voluntary buy out of 84 percent of existing payroll taxes at an immediate cost to national saving of less than 0.25 percentage point.

Abstract:
The precipitous decline in tax sheltered investments after the Tax Reform Act of 1986 (TRA) is widely attributed to the passive loss rules. These rules disallowed losses from activities in which the taxpayer did not materially participate as a current deduction against all sources of income except for other passive activities. This paper demonstrates instead that the role of the passive loss limitations was secondary to that of other reforms enacted by TRA, most importantly the repeal of the investment tax credit and the long-term capital gain exclusion. These other reforms not only lowered after-tax rates of return on tax sheltered investments but also eliminated the positive correlation between the investor's marginal tax rate and the investment's after-tax rate of return. As a result, high income taxpayers ceased to be the natural clientele for legitimate tax shelters after TRA. The passive loss rules were more effective in curtailing the use of 'abusive' tax shelters; however, it is shown that a more narrowly focused restriction on seller financing of tax sheltered investments could have accomplished the same goal with much less scope for discouraging productive economic investments.

Abstract:
We estimate consumers%u2019 valuation of disability insurance using a stochastic lifecycle framework inwhich disability is modeled as permanent, involuntary retirement. We base our probabilities of worklimiting disability on 25 years of data from the Current Population Survey and examine the changes in the disability gradient for different demographic groups over their lifecycle. Our estimates show that a typical consumer would be willing to pay about 5 percent of expected consumption to eliminate the average disability risk faced by current workers. Only about 2 percentage points reflect the impact of disability on expected lifetime earnings; the larger part is attributable to the uncertainty associated with the threat of disablement. We estimate that no more than 20 percent of mean assets accumulated before voluntary retirement are attributable to disability risks measured for any demographic group in our data. Compared to other reductions in expected utility of comparable amounts, such as a reduction in the replacement rate at voluntary retirement or increases in annual income fluctuations, disability risk generates substantially less pre-retirement saving. Because the probability of disablement is small and the average size of the loss %u2014 conditional on becoming disabled %u2014 is large, disability risk is not effectively insured through precautionary saving.

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Abstract:
This paper presents a detailed analysis of the economics of prefunding benefits for the aged, focusing on Social Security but indicating some of the analogous magnitudes for prefunding Medicare Benefits. We use detailed Census and Social Security information to model the transition to a fully funded system based on mandatory contributions to individual accounts. The funded system we examine would permanently maintain the level of benefits now specified in current law and would require no new government borrowing (other than eventually selling the bonds in the Social Security trust fund). During the transition, the combined rate of payroll tax and mandatory saving rises at first by 2 percentage points (to a total of 14.4 percent) and then declines so that in less than 20 years it is less than the current 12.4 percent payroll tax. We estimate the impact of such prefunding on the growth of the capital stock and the level of national income and show that the combination of higher pretax wages and lower payroll taxes could raise wages net of income and payroll taxes by more than 35 % in the long run. We also discuss distributional issues and the way that the poor can be at least as well off as under Social Security. A stochastic simulation shows that a small increase in the mandatory saving rate would reduce the risk of receiving less than the scheduled level to less than one percent. Separate calculations are presented of the value of the 'forward-looking recognition bonds' and 'backward-looking recognition bonds' which the government might issue if it decides not to pay future social security benefits explicitly.

Abstract:
This paper analyzes changes in the progressivity of the Social Security benefit formula as a means of lessening the risk inherent in investment-based Social Security reform. Focusing on a single cohort of workers, it simulates the distribution of benefits subject to both earnings and financial risks in a reformed system in which solvency has been restored and traditional benefits have been augmented by personal retirement accounts (PRAs). The simulations show that some investment in equities is desirable in all cases. However, switching from the current benefit formula to the maximally progressive formula - a flat benefit independent of earnings - improves the welfare of the bottom 30 percent of the earnings distribution even if they reduce their PRA investments in equity to zero. An additional 30 percent of earners can lessen their equity investments without loss of welfare under the maximally progressive formula. Intermediate approaches in which traditional benefit replacement rates for lower earnings are reduced by less than those for higher earnings allow about half of the equity risk to be eliminated for the lowest earnings decile. Sensitivity tests show that these patterns are robust to different assumptions about risk aversion, the equity premium, and the size of the personal retirement accounts established by the reform.

Abstract:
We estimate the fraction of the wealth of a sample of PSID respondents that is held because some households face greater income uncertainty than others. We first derive an equation characterizing the theoretical relationship between wealth and uncertainty in a buffer-stock model of saving. Next, we estimate that equation using PSID data; we find strong evidence that households engage in precautionary saving. Finally, we simulate the wealth distribution that would prevail if all households had the same uncertainty as the lowest-uncertainty group. We find that between 39 and 46 percent of wealth in our sample is attributable to uncertainty differentials across groups.

Abstract:
In this paper we study the transition from a pay-as-you-go system of Social Security pensions to an investment-based system in an economy in which portfolio returns and capital profitability are both uncertain. The paper extends earlier studies by Feldstein and Samwick that modeled the transition process in a nonstochastic environment and by Feldstein and Ranguelova that examined the implication of portfolio risk after the transition to an investment-based system has been completed. We analyze transitions to a mixed system that maintains the current 12.4 percent pay-as-you-go tax rate as well as to a system that is completely investment-based. We model intergenerational guarantees and assess the risk of such guarantees to taxpayers. We find that transitions to either a completely investment-based system or a mixed system that maintains current law benefits can be done with little additional saving in the early years (a maximum of three percent) and substantially lower combinations of taxes and saving deposits in the later years. The extra risk to retirees and/or taxpayers is relatively small, making the investment-based plans preferable to a pure pay-as-you-go system for reasonable degrees of risk aversion.

Abstract:
If the United States switched to a broad-based consumption tax, than all forms of saving would enjoy the tax-preferred status reserved primarily for retirement saving vehicles under the current income tax system. Because pensions have other unique characteristics besides their tax advantage, current results on the effect of pensions on saving may provide an unreliable guide to the saving response to fundamental tax reform. The net effect of reform on saving depends critically on household motives for saving. This paper documents the considerable variation in the reasons why households save and presents a buffer stock model of saving that allows for both life cycle and target saving. To the extent that specific targets that are not currently tax-favored motivate the saving of households in their preretirement years, fundamental tax reform that results in the elimination of current pension plans will reduce saving.

Abstract:
This paper uses the Panel Study of Income Dynamics to provide some of the first direct evidence that wealth is systematically higher for consumers with greater income uncertainty. However, the apparent pattern of precautionary saving is not consistent with a standard parameterization of the life cycle model in which consumers are patient enough to begin saving for retirement early in life: wealth is estimated to be less sensitive to uncertainty in permanent income than implied by that model. Instead, our results suggest that over most of their working lifetime, consumers behave in accordance with the 'buffer-stock' models of saving described in Carroll (1992) or Deaton (1991), in which consumers hold wealth principally to insulate consumption against near term fluctuations in income.

Abstract:
There has been rapid growth in `self-directed' pension programs such as the 401(k) plan. Because such plans are voluntary, there is concern that many workers neglecting to contribute will reach retirement with inadequate pension saving. First, we show that people who are eligible for 401(k)s, do not contribute to them, and have no alternative pension plan make up only 2-4 percent of the workforce. By contrast, nearly 50 percent of workers have no pension coverage at all. Imposing mandatory 3 percent or 5 percent contribution rates will improve retirement prospects among the lowest decile of pension- eligible, but would have small aggregate effects. Finally, restricting 401(k) withdrawals when the worker changes jobs could have a larger impact on retirement pension security.

Abstract:
Both Social Security and private pensions confront older workers with financial incentives to hasten or delay retirement. Depending on the worker's age, employment history, and earnings, there may be large gains or losses in the value of retirement benefits if retirement is delayed. These incentives vary dramatically across pension plans.

Previous studies of retirement have either ignored the financial incentives in pensions or considered the retirement behavior of workers at a limited number firms. This article is the first to estimate the effect of pensions and Social Security on retirement with both detailed pension plan information and a nationally representative cross-section of workers. The main result is that the accrual of retirement wealth from continued work significantly discourages retirement, whereas the level of retirement wealth does not affect the timing of retirement. The option value of retirement developed by Stock and Wise (1990) is shown to be a more reliable measure of retirement incentives than the one-year accrual of retirement wealth.

There are two important implications of these results. First, they show that workers respond to the financial incentives in their retirement plans. Second, the trend in pensions toward large incentives to retire at earlier ages has contributed to lower labor force participation of older workers in the postwar period.

Abstract:
The market value of corporate stock in the United States increased by nearly one trillion dollars between December 1994 and July 1995. This paper explores the distribution of the stock ownership, and hence the gains from the stock price rise, and what the rise in stock prices implies for consumer spending. It begins by noting the substantial change in the pattern of stock ownership during the postwar period. Individual investors, who directly held most corporate stock in the early 1950s, have gradually replaced their direct stock holdings with indirect holdings through mutual funds, pension funds, and other financial intermediaries. It then documents the substantial predictive power of stock price fluctuations for future consumption growth; and considers two potential explanations for this relationship. The first, or "leading indicator," view, holds that the stock market responds to news that suggests consumption will rise in the future. This does not suggest any causality between stock price changes and subsequent consumption movements. An alternative and not necessarily exclusive view, the "wealth effect," holds that higher stock prices raise consumption by raising household net worth, and thereby expanding consumption opportunity sets. We test for the importance of the wealth effect by studying the effect of stock price changes on the share of consumption devoted to luxury items, and we test for effects of changing stock price ownership patterns on the link between stock price fluctuations and consumption growth. We find virtually no evidence to support important wealth effects associated with stock price changes. We also explore whether the source of stock price fluctuations, in particular fluctuations that are related to changes in dividends or earnings rather than to changes in discount rates, affects the predicted change in consumption that follows a stock price change.

Abstract:
We examine compensation contracts for managers in imperfectly competitive product markets. We show that strategic interactions among firms can explain the lack of relative performance-based incentives in which compensation decreases with rival firm performance. The need to soften product market competition generates an optimal compensation contract that places a positive weight on both own and rival performance. Firms in more competitive industries place greater weight on rival firm performance relative to own firm performance. We find empirical evidence of a positive sensitivity of compensation to rival firm performance that is increasing in the degree of competition in the industry.

Abstract:
This paper examines optimal compensation contracts for managers of firms in imperfectly competitive markets. Previous studies have not found convincing evidence of high-powered incentives and relative performance evlauation. We show that strategic interactions among firms can explain this lack of strong performance-based incentives. When managers can be compensated based on their own and their rivals' performance, the need to soften product market competition generates an optimal compensation contract that places a positive weight on both own and rival performance. Across industries, the theory also predicts that firms in more competitive industries place greater weight on rival firm performance relative to own firm performance. We test the predictions empirically using recent data on compensation of executives at large corporations. We find evidence of a positive sensitivity of compensation to rival firm performance which is increasing in the degree of competition in the firm's industry.