Thesis submitted by Jinrui Pan for the Degree of Doctor of Philosophy in the University of Manchester, and entitled, “Time and Risk Preferences: Theoretical Models and Applications.” Date of submission 2014.This thesis makes contributions to two important areas of behavioural economics, namely individual decision making over time and under risk. Following the Introduction, Chapter 2 presents a new discounting function for analysing intertemporal choice. Liminal discounting, the model developed here, generalises exponential discounting in a parsimonious way. It allows for well-known departures, whilst maintaining its elegance and tractability. It also can be seen as an extension of quasi-hyperbolic discounting to continuous time. A liminal discounter has a constant rate of time preference before and after some threshold time; the liminal point. A preference foundation is provided, showing that the liminal point is derived endogenously from behaviour. Chapter 3 proposes an axiomatic model featuring a differential treatment of attitudes towards risk and time. Such distinction has been strongly suggested by experimental research when studying intertemporal choice, since the future is inherently risky. In the proposed model, non-linear probability distortions are incorporated into a dynamic model with discounted utility. Time is captured by a general discounting function independent of probabilities and outcomes. Utility of outcomes is captured by standard vNM utility independent of time. A two-parameter probability weighting function captures intertemporal probabilistic risk attitudes, with one parameter being constant over time, the other being time-dependent. An index of optimism is derived that depends on both parameters, which allows to model the observed high risk tolerance for delayed lotteries. Further, a preference foundation is provided. Interestingly, the model allows behaviour to be consistent with discounted expected utility, when risk is sufficiently distant from the present.

The question of how to measure and classify people's risk preferences is of substantial importance in the field of economics. Inspired by the multitude of ways used to elicit risk preferences, we conduct a holistic investigation of the most prevalent method, the multiple price list (MPL) and its derivations. In our experiment, we find that revealed preferences differ under various versions of MPLs as well as yield unstable results within a 30-minute time frame. We determine the most stable elicitation method with the highest forecast accuracy by using multiple measures of within-method consistency and by using behavior in two economically relevant games as benchmarks. A derivation of the well-known method by Holt and Laury (American Economic Review 92(5):1644-1655, 2002), where the highest payoff is varied instead of probabilities, emerges as the best MPL method in both dimensions. As we pinpoint each MPL characteristic's effect on the revealed preference and its consistency, our results have implications for preference elicitation procedures in general.

Syfte: Syftet är att beskriva samband av revisorns bakomliggande psykologiska egenskapers påverkan vid värderingen av ett företags varumärke. Metod: Studien utgår ifrån en positivistisk vetenskapssyn där en kvantitativ ansats används. Teoretiskt perspektiv: Uppsatsens teoretiska kapitel utgår ifrån teorier om psykologiska variabler. De psykologiska variabler som i uppsatsen används är femfaktor-teorin samt riskbenägenhet. Empiri: Det empiriska materialet som används i denna studie är insamlat med hjälp av ett modellföretag samt en kompletterande enkät. Resultat: Studien i denna uppsats har visat att inga samband finns mellan revisorns psykologiska egenskaper samt dennes värdering av ett varumärke. Detta berör både faktorerna i femfaktor-teorin samt riskbenägenhet. Ett eventuellt samband finns mellan variablen agreeableness och varumärkesvärderingen,men då signifikans ej finns för hela modellen är det inget som statistiskt kan säkerställas. / Purpose: The purpose of this study is to describe the relationship of the auditor’s underlying psychological characteristics’ effect on the valuation of a brand. Methodology: This study applied a positivist concept of science with a quantitative research approach. Theory: The theoretical chapter is based on theories of psychological factors. The psychological factors in the essay is based on a five factor-model and risk preference. Empirical foundation: The empirical data used in this study was collected by a use of a model company and a supplemental questionnaire. Conclusions: The study in this paper has shown that no connection exists between the auditor's psychological characteristics, and his valuation of a brand. This affects both factors in fivefactor-theory and risk preference. A possible connection between the variable agreeableness and the value of the brand exists, but the significance was not present for the entire model, therefore it is not statistically ensured.

In this thesis we study problems in the context of inventory control and facility location. In chapter 2 we study the competition among risk averse newsvendors. We showed that the well-known result for the single-product monopoly firm, which states higher risk aversion causes the firm to reduce its order quantity, cease to hold under the competition. We concluded that the higher risk aversion does not necessarily cause both firms to reduce their order quantity. We showed that the impact of risk aversion on equilibrium quantities is a trade-off between two effects: (a) Own risk aversion increment which causes that the firm reduces its order quantity and (b) Effect of spillover demand from competitor which causes that the firm increases its order quantity. We also show which firm raises its order quantity as both firms become more risk averse depending on their attributes: profitability ratio (overstocking to understocking ratio), initial risk aversion level and demand characteristic (distribution and substitution). In Chapter 3, we study how the operational decisions of a firm's manager depend on her own incentives, the capital structure, and financial decisions in the context of the newsvendor framework. We showed that in contrast to common practices, tying the manager's compensation to stock price (equity value) may not be optimal for shareholders. We propose to tie the managers' compensation to the firm value or include a debt-like instrument in the compensation package to mitigate the risk taking behaviour of the managers. We also show how the board of directors can modify the compensation structure based on the state of the economy and publicly available information about company's demand. In Chapter 4, we study the effect of risk attitude of decision makers on well-known location problems with uncertain demand. In addition to providing mathematical formulations for those problems, we also discussed how we can solve these problems using linearization techniques. We also shed some light on the importance of considering the volatility and correlation structure. Furthermore, we apply a Bayesian updating method, a useful tool for updating the probability distribution to incorporate the consultants' view about uncertain factors in location problems.

In previous research, aggregation of returns has been found as a way to counteract the risk averse behavior that is the result of investors' myopia. This paper expands the study of aggregation by analyzing its effect on forward looking probabilities. Namely, through the disaggregation of future information, subjects become myopic and trade with varying risk preferences. In an experimental market, subjects trading securities with disaggregated forward looking information are found to 'buy high and sell low', while subjects trading the same securities, but with aggregated information, trade with more consistent risk preferences.

A wager is a one time bet, staking money on one among a collection of alternatives having uncertain reward. Wagers represent a common class of engineering decision, where “bets” are placed on the design, deployment, and/or operation of technology. Often such wagers are characterized by alternatives having value that evolves according to some future cash flow. Here, the values of specific alternatives are derived from a cash flow modeled as a stochastic marked point process. A principal difficulty with these engineering wagers is that the probability laws governing the dynamics of random cash flow typically are not (completely) available; hence, separating the gambler’s preference among wager alternatives is quite difficult. In this dissertation, we investigate a computational approach for separating preferences among alternatives of a wager where the alternatives have values that evolve according to a marked point processes. We are particularly concerned with separating a gambler’s preferences when the probability laws on the available alternatives are not completely specified.

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The budget system is one of the important tools in the management accounting control system. However, in the budget goal setting process, budgeting managers may insert slack into their budgets. Budget slack will erode the effectiveness of the budget system. Agency researchers recognize that well-designed contracts can be used to solve this incentive problem. Therefore, truth-inducing schemes are widely discussed and analyzed. However, many empirical studies report that such schemes can decrease, but not eliminate slack completely. In the meanwhile, they can not increase performance. This study points out that the parameters of the schemes are not well-designed, therefore, the effectiveness to induce subordinates to disclose private information and increase performance is of failure. This paper analyses the relationship among parameters of the truth-inducing pay scheme, risk preference and budget slack by Minimax law under uncertainty, and points that this scheme will lose its effectiveness under some condition. At the meanwhile, this thesis also explains how to design a compensation contract to provide a reference for practical application.

In this thesis we study problems in the context of inventory control and facility location. In chapter 2 we study the competition among risk averse newsvendors. We showed that the well-known result for the single-product monopoly firm, which states higher risk aversion causes the firm to reduce its order quantity, cease to hold under the competition. We concluded that the higher risk aversion does not necessarily cause both firms to reduce their order quantity. We showed that the impact of risk aversion on equilibrium quantities is a trade-off between two effects: (a) Own risk aversion increment which causes that the firm reduces its order quantity and (b) Effect of spillover demand from competitor which causes that the firm increases its order quantity. We also show which firm raises its order quantity as both firms become more risk averse depending on their attributes: profitability ratio (overstocking to understocking ratio), initial risk aversion level and demand characteristic (distribution and substitution). In Chapter 3, we study how the operational decisions of a firm's manager depend on her own incentives, the capital structure, and financial decisions in the context of the newsvendor framework. We showed that in contrast to common practices, tying the manager's compensation to stock price (equity value) may not be optimal for shareholders. We propose to tie the managers' compensation to the firm value or include a debt-like instrument in the compensation package to mitigate the risk taking behaviour of the managers. We also show how the board of directors can modify the compensation structure based on the state of the economy and publicly available information about company's demand. In Chapter 4, we study the effect of risk attitude of decision makers on well-known location problems with uncertain demand. In addition to providing mathematical formulations for those problems, we also discussed how we can solve these problems using linearization techniques. We also shed some light on the importance of considering the volatility and correlation structure. Furthermore, we apply a Bayesian updating method, a useful tool for updating the probability distribution to incorporate the consultants' view about uncertain factors in location problems.

Internal auditing is the auditing performed by companies themselves. Previous research has put forth the idea that female chairmen in audit committees increase the internal auditing. In this study, we examine how levels of risk preference within internal auditing are influenced by the gender of the chairman in an audit committee. We also examine how the independence of a chairman affect internal auditing. We propose two hypothesizes, where the first one considers if the risk preference is affected by the gender of an audit committee chairman. The second hypothesis is stated to further question if the risk preference is affected by the independence of an audit committee chairman. The study is based on 697 observations retrieved from financial reports between the years of 2005-2013. Risk preference is measured as the proportion of audit fees that are under the direct control of an audit committee. Gender is measured through binary variables based on legal gender. Our moderating variable Independence is binary based on full independence. By using regression analysis, we find an association between gender and internal auditing, but we find a weak positive association between lower ratio of non-audit costs and independence. This act as an indication that an independent chairmen lead to an increased internal auditing.