nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒03‒08
nine papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Job Assignments, Intrinsic Motivation and Explicit Incentives By Julia Nafziger
  2. Belief-free equilibria in games with incomplete information By Stefano, LOVO
  3. Endogenous Verifiability and Optimality in Agency: A non-contingent approach By Manuel Willington; Roy Costilla
  4. Collusion in a One-Period Insurance Market with Adverse Selection By Alexander Alegria; Manuel Willington
  5. Aid and Corruption: Do Donors Use Development Assistance to Provide the Right Incentives? By ISOPI ALESSIA; MATTESINI FABRIZIO
  6. Product market efficiency: The bright side of myopic, uninformed, and passive external finance By Thomas H. Noe; Michael J. Rebello; Thomas A. Rietz
  7. Tunnel-proofing the executive suite: temptation, and the design of executive compensation By Thomas H. Noe
  8. Auctions in which Losers Set the Price By Mezzetti, Claudio; Tsetlin, Ilia
  9. Can Information Asymmetry Cause Agglomeration? By Berliant, Marcus; Kung, Fan-chin

  1. By: Julia Nafziger
    Abstract: This paper considers the interplay of job assignments with the intrinsic and extrinsic motivation of an agent. Job assignments influence the self confidence of the agent, and thereby his intrinsic motivation. Monetary reward allow the principal to complement intrinsic motivation with extrinsic incentives. The main result is that the principal chooses an inefficient job assignment rule to enhance the agent's intrinsic motivation even though she can motivate him with monetary rewards. This shows that, in the presence of intrinsically motivated agents, it is not possible to separate job assignment decisions from incentive provision.
    Keywords: Intrinsic and Extrinsic Motivation, Job Assignments
    JEL: D82 J31 J33 M12
  2. By: Stefano, LOVO
    Abstract: We de ne belief-free equilibria in two-player games with incomplete information as se- quential equilibria for which players' continuation strategies are best-replies, after every history, independently of their beliefs about the state of nature. We characterize a set of payos that includes all belief-free equilibrium payos. Conversely, any payo in the interior of this set is a belief-free equilibrium payo
    Keywords: repeated game with incomplete information; Harsanyi doctrine; belief-free equilibria
    JEL: C72 C73
    Date: 2007–12–01
  3. By: Manuel Willington (ILADES-Georgetown University, Universidad Alberto Hurtado); Roy Costilla
    Abstract: In the context of a principal-agent model where verification of an agent’s effort is endogenously determined through strategic interactions between contracting parties, we derive a necessary and suficient condition to achieve the first best with a non-contingent or incomplete contract. These conditions relate the Principal’s benefit, the Agent’s cost, the probability of winning and the cost of litigation. Also, these conditions are found to be more general than the ones established in Ishiguro (2002) within a similar setup.
    Keywords: incomplete contracts, endogenous verifiability, expectation damages.
    JEL: D20 D86 K41 M52
    Date: 2007–09
  4. By: Alexander Alegria (Facultad de Ciencias Económicas y Administrativas, Ponti?cia Universidad Javeriana de Cali, Colombia); Manuel Willington (ILADES-Georgetown University, Universidad Alberto Hurtado)
    Abstract: We show how collusive outcomes may arise as equilibrium in a one-period competitive insurance market characterized by adverse selection. We build on Inderst and Wambach (2001) model ?they show that the Rothschild and Stiglitz separating equilibrium always exists when there are capacity constraints? and assume that insurees must pay a minimum premium; which is a common feature on many health systems. In this setup, we show that there is a range of equilibria from the zero profit one in which low-risks implicitly subsidize high risks to one where firms obtain profits with both types of consumers. Moreover, we show that rents only partially dissipate if we assume free entry. Along these equilibria, high risks always obtain full insurance while low risks’ coverage decrease as the firms profits increase. Recently the Chilean antitrust authority (Fiscalía Nacional Económica) accused five of the largest private health insurers of collusion after they reduced the coverage offered to their customers and significantly raised their profits. Our model is consistent with this accusation.
    Keywords: adverse selection, collusion, insurance, capacity constraints
    JEL: L41 I11
    Date: 2007–12
    Abstract: In this paper, we focus on the determinants of the relationship between aid and corruption. We propose a static principal-agent model where a donor faces the problem of giving aid to a recipient country in which the phenomenon of corruption is widely spread. We distinguish among two different types of corruption: one, labeled endemic, that depends on the political and institutional environment of the recipient and that donors feel they can hardly affect from the outside; the other, labeled aid dependent, that is the consequence of moral hazard arising from the ability of corrupt burocracies to divert resources from their intended use. Designing contracts that can induce the right incentives, donors can act on the second type of corruption, contributing to reduce the entity of the phenomenon. We use the restrictions implied by our theoretical framework to test a model of aid allocation. Only for three countries (UK, Norway and Spain), we find some clear indication that efficiency consideration are taken into account in allocating aid. For the other donors, aid allocation depends on a mix of altruistic motives and strategic/economic interests with, however, a prevalence of the latter over the first.
    Date: 2008–01
  6. By: Thomas H. Noe; Michael J. Rebello; Thomas A. Rietz
    Abstract: We show that introducing an external capital market with information asymmetry into a product market model reduces opportunistic substitution of sub-standard goods and encourages producers to concentrate on long-run reputation building. We test this result with a laboratory experiment. We find that, when the problem of product market opportunism is moderate, i.e., reputation formation equilibria exist when firms raise external funds but not when they rely on internal funds, external financing results in much higher (roughly double) economic surplus. This external finance premium results primarily from higher levels of output caused by the reduced likelihood or market failure.
    Keywords: adverse selection, financing, reputation
    JEL: C91 D82 G31 G32 L15
    Date: 2008
  7. By: Thomas H. Noe
    Abstract: This paper considers optimal compensation for a CEO who is entrusted with administering corporate assets honestly. Optimal compensation designs maximize integrity at minimum cost. These designs are very ‘low powered,’ i.e., while specifying a lower bound for performance and increasing pay with performance, they increase compensation at a rapidly decreasing rate. Thus, integrity considerations engender optimal compensation packages that closely resemble the very pervasive 80/120 bonus plans, exactly the sort of compensation which Jensen (2003) argues should compromise integrity. Under optimal designs, expected compensation increases linearly with firm size, and increases in the market/book ratio. Moreover, given optimal compensation, CEO asset diversion is limited to high market-to-book firms that have received negative productivity shocks.
    Keywords: incentives, managerial compensation, agency
    Date: 2008
  8. By: Mezzetti, Claudio (Department of Economics, University of Warwick); Tsetlin, Ilia (INSEAD, Singaport)
    Abstract: We study auctions of a single asset among symmetric bidders with affiliated values. We show that the second-price auction minimizes revenue among all efficient auction mechanisms in which only the winner pays, and the price only depends on the losers' bids. In particular, we show that the k-th price auction generates higher revenue than the second-price auction, for all k > 2. If rationing is allowed, with shares of the asset rationed among the t highest bidders, then the (t + 1)-st price auction yields the lowest revenue among all auctions with rationing in which only the winners pay and the unit price only depends on the losers' bids. Finally, we compute bidding functions and revenue of the k-th price auction, with and without rationing, for an illustrative example much used in the experimental literature to study first-price, second-price and English auctions.
    Keywords: Auctions ; Second-Price Auction ; English Auction ; k-th Price Auction ; Affiliated Values ; Rationing ; Robust Mechanism Design
    JEL: D44 D82
    Date: 2008
  9. By: Berliant, Marcus; Kung, Fan-chin
    Abstract: The modern literature on city formation and development, for example the New Economic Geography literature, has studied the agglomeration of agents in size or mass. We investigate agglomeration in sorting or by type of worker, that implies agglomeration in size when worker populations differ by type. This kind of agglomeration can be driven by asymmetric information in the labor market, specifically when firms do not know if a particular worker is of high or low skill. In a model with two types and two regions, workers of different skill levels are offered separating contracts in equilibrium. When mobile low skill worker population rises or there is technological change that favors high skilled workers, integration of both types of workers in the same region at equilibrium becomes unstable, whereas sorting of worker types into different regions in equilibrium remains stable. The instability of integrated equilibria results from firms, in the region to which workers are perturbed, offering attractive contracts to low skill workers when there is a mixture of workers in the region of origin.
    Keywords: Adverse Selection; Agglomeration
    JEL: R13 D82 R12
    Date: 2008–03–02

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