Bunching Flashcards
What is the basic idea of bunching in economic models?
Bunching refers to the clustering of outcomes around specific thresholds where incentives change, such as tax notches or earnings forecasts.
Why do companies care about meeting earnings forecasts?
Meeting earnings forecasts prevent stock price drops, as negative earnings surprises usually lead to negative reactions in the stock market.
What is an earnings surprise?
The difference between a company’s actual earnings and the consensus forecast. Positive surprises generally increase stock prices, while negative surprises lower them.
What behavior do managers exhibit when their company’s earnings are just below the consensus forecast?
Managers may manipulate earnings to boost them just enough to meet or exceed the forecast, leading to bunching at the threshold.
How does the bunching approach differ from Regression Discontinuity Design (RDD)?
RDD assumes no manipulation around the cutoff, whereas bunching specifically studies manipulation around thresholds.
Give an example of bunching due to a tax notch?
If a higher rate applies to income over Z, individuals just above Z may reduce their earnings to just below the threshold to avoid the higher tax rate, causing bunching at Z.
What are three steps to estimate bunching?
- Fit a flexible polynomial to the distribution (excluding the range around the threshold).
- Extrapolate the fitted distribution to the threshold.
- Measure excess bunching as the difference between the observed and counterfactual distribution.
What does excess bunching represent?
It represents the distortion caused by the discontinuity in incentives, showing how behavior is affected by thresholds like tax notches.
What is the implication of large bunching around a tax threshold?
Large bunching suggests that the tax system is creating significant distortions, affecting people’s financial decisions.
What is a density hole in the context of bunching?
A density hole refers to the missing mass of observations just above the threshold where bunching occurs, as individuals or firms adjust their behavior to stay below the cutoff.
How does bunching manifest in earnings management by firms?
Firms manipulate their earnings to just meet or exceed forecasts, leading to a spike in the number of companies reporting zero or small positive earnings surprises.
How can bunching analysis provide visual evidence of behavior?
By plotting the distribution of outcomes, you can visually see spikes around thresholds, making it easy to identify behavioral responses to incentives.
What are the strengths of bunching analysis?
Bunching provides clear, visual evidence of how people or firms react to discontinuities in incentives, making it useful in policy evaluation and behavioral economics.
What is a key limitation of bunching analysis?
It requires large sample sizes and free from measurement error to detect the distortions accurately.
