Signaling, Instrumentation, and CFO Decision-Making

Abstract

Building parable economies embedding econometricians, we view alternative estimators (IV, fuzzy RD, natural experiments, OLS, event studies) from the perspective of privately-informed decision-makers, e.g. CFOs. IV estimates can be misleading since randomization through observable instruments eliminates signal content arising from discretion. If the goal is informing discretionary decisions, rather than predicting outcomes after forced/mistaken actions, instrumentation is problematic, whereas OLS or event studies can be sufficient. The analysis shows the utility of alternative estimators hinges upon oft-neglected assumptions about agent/econometrician information sets, as distinct from exclusion restrictions. We recommend parable economy estimation as precursor to real-world IV estimation.

Keywords: signal, selection, IV, fuzzy RDD, experiments, corporate finance, CFO, government policy

JEL Classification: D82, G14, G18, G28, G3, E6, J24