nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒03‒25
fourteen papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. From Pigou to Extended Liability: On the Optimal Taxation of Externalities under Imperfect Financial Markets By TIROLE, Jean
  2. Learning about compliance under asymmetric information By Carmen Arguedas; Sandra Rousseau
  3. Collateral Pricing By Efraim Benmelech; Nittai K. Bergman
  4. Persistent Private Information By Noah Williams
  5. Information Independence and Common Knowledge By Olivier Gossner; Ehud Kalai; Robert Weber
  6. Long-Term Contracting in a Changing World By Alessandro Pavan
  7. Sequential Contracting with Multiple Principals By Giacomo Calzolari; Alessandro Pavan
  8. Truthful Revelation Mechanisms for Simultaneous Common Agency Games By Giacomo Calzolari; Alessandro Pavan
  9. Defense Policies Against Currency Attacks: on the Possibility of Predictions in a Global Game with Multiple Equilibria By George-Marios Angeletos; Alessandro Pavan; Christian Hellwig
  10. Multidimensional communication mechanisms: cooperative and conflicting designs By Frédéric Koessler; David Martimort
  11. Information and Human Capital Management By Heski Bar-Isaac; Ian Jewitt; Clare Leaver
  12. The Hedge Fund Game: Incentives, Excess Returns, and Piggy-Backing By Dean P. Foster; H. Peyton Young
  13. Governing the Governors: A Clinical Study of Central Banks By Frisell, Lars; Roszbach, Kasper; spagnolo, giancarlo
  14. Are eBay auctions efficient? A model with buyer entries By Huang, Ching-I

  1. By: TIROLE, Jean
    JEL: D62 D82 H23 J65
    Date: 2008–02
  2. By: Carmen Arguedas; Sandra Rousseau
    Abstract: Over time, inspection agencies gather information about firms that cause harmful externalities. This information may allow agencies to differentiate their monitoring strategies in the future, since inspections can be influenced by firms' past performance relative to other competitors in the market. If a firm is less successful than it peers in reducing the externality, if faces the risk of being targeted for increased inspections in the next period This risk of stricter monitoring might induce high cost firms to mimic low cost firms, while the latter might try to avoid being mimicked We show that under certain circumstances, mimicking, or even the threat of mimicking, might reduce socially harmful activities and thus be welfare improving.
    Keywords: monitoring and enforcement, externalities, learning, mimicking
    JEL: D82 H83 K42
    Date: 2008–03
  3. By: Efraim Benmelech; Nittai K. Bergman
    Abstract: We examine how collateral affects the cost of debt capital. Theories based on borrower moral hazard and limited pledgeable income predict that collateral increases the availability of credit and reduces its price. Testing these theories is complicated by the very selection problem which they imply: creditors will demand collateral precisely from those borrowers who are riskier. This selection problem leads to a positive relation in the data between the presence of collateral and the loan yield. Analyzing the extensive margin of collateral use, therefore, masks the hypothesized negative impact that collateral exhibits on debt yields. In this paper, we alleviate this problem by focusing on a particular industry and examining its intensive, rather than extensive, margin of collateral use. Using a novel data set of secured debt issued by U.S. airlines, we construct industry-specific measures of collateral redeployability. We show that debt tranches that are secured by more redeployable collateral exhibit lower credit spreads, higher credit ratings, and higher loan-to-value ratios -- an effect which our estimates show to be economically sizeable. Our results suggest that the ability to pledge collateral, and in particular redeployable collateral, lowers the cost of external financing and increases debt capacity.
    JEL: G12 G24 G32 G33 L93
    Date: 2008–03
  4. By: Noah Williams
    Abstract: This paper studies the design of optimal contracts in dynamic environments where agents have private information that is persistent. In particular, I focus on a continuous time version of a benchmark insurance problem where a risk averse agent would like to borrow from a risk neutral lender to stabilize his income stream. The income stream is private information to the borrower and is persistent. I find that the optimal contract conditions on the agent's reported endowment as well as two additional state variables: the agent's utility and marginal utility under the contract. I show how persistence alters the nature of the contract, and consider an exponential utility example which can be solved in closed form. Unlike the previous discrete time models with i.i.d. private information, the agent's consumption under the contract may grow over time. Furthermore, in my setting the efficiency losses due to private information increase with the persistence of the endowment, and the distortions vanish as I approximate an i.i.d. endowment.
    JEL: D82 D86 E21
    Date: 2008–03
  5. By: Olivier Gossner; Ehud Kalai; Robert Weber
    Abstract: Conditions of information independence are important in information economics and game theory. We present notions of partial independence in Bayesian environments, and study their relationships to notions of common knowledge.
    Keywords: Bayesian games, independent types, common knowledgees
    Date: 2007–10
  6. By: Alessandro Pavan
    Abstract: I study the properties of optimal long-term contracts in an environment in which the agents type evolves stochastically over time. The model stylizes a buyer-seller relationship but the results apply quite naturally to many contractual situations including regulation and optimal income-taxation. I …rst show, through a simple example, that distortions need not vanish over time and need not be monotonic in the shock to the buyers valuation. These results are in contrast to those obtained in the literature that assumes a Markov process with a binary state space e.g. Battaglini, 2005. I then show that when the sets of possible types in any two adja- cent periods satisfy a certain overlapping condition (which is always satis…ed with a continuum of types), then the dynamics of the optimal mechanism can be signi…cantly simpli…ed by as- suming the shocks are independent over time. Under certain regularity conditions, the optimal mechanism is then the same irrespective of whether the shocks are the buyers private informa- tion or are observed also by the seller. These conditions are satis…ed, for example, in the case of an AR(1) process, a Brownian motion, but also when shocks have a multiplicative e¤ect as it is often the case in …nancial applications. Furthermore, the distortions in the optimal quantities are independent of the distributions of the shocks and, when the buyers valuation is additively separable, they are also independent of whether the shocks are transitory or permanent. Finally, I show that assuming the shocks are independent not only greatly simpli…es the analysis but is actually without loss of generality with a continuum of types.
    Keywords: asymmetric information, stochastic process, dynamic mechanism design, long-term contracting
    JEL: D82 C73 L1
    Date: 2007–12
  7. By: Giacomo Calzolari; Alessandro Pavan
    Abstract: This paper considers dynamic games in which multiple principals contract sequentially and non-cooperatively with the same agent and provides characterization results useful for applications. Our benchmark model is one of private contracting in which downstream principals do not observe upstream mechanisms, nor the decisions taken in these mechanisms. We show that any equilibrium outcome that can be sustained with any arbitrary strategy space for the principals can also be sustained by restricting the principals to offer excended direct mechanisms. In these mechanisms, the agent first reports his extended type (i.e. his exogenous private information along with the endogenous payoff-relevant decisions contracted upstream), the principal then responds by offering the agent a (possibly degenerate) menu of contracts that are payoff-equivalent for that extended type, and finally the agent selects a contract from this menu and the contract is executed. We also show that characterizing equilibria through extended direct mechanisms is facilitated by the fact that (i) each principal can be restricted to offer a single mechanism; (ii) when the agent's strategy is Markov (i.e. it depends only on payoff-relevant information), each mechanism can be restricted to offer a single contract to each extended type; and (iii) restricting the agent's strategy to be Markov is without loss in the case of deterministic decisions, e.g. when the contracts are deterministic and the agent does not mix over effort. We finally show how the aforementioned results must be adjusted to occommodate alternative assumptions on the observability of upstream histories and/or the sequence of contracting examined in the literature.
    Keywords: Sequential common agency, mechanism design, contracts, endogenous types.
    JEL: D82 C73 L1
    Date: 2007–04
  8. By: Giacomo Calzolari; Alessandro Pavan
    Abstract: In games in which multiple principals contract simultaneously and non-cooperatively with the same agent, standard direct revelation mechanisms in which the agent reports his type(i.e. his exogenous private information) have been proven inadequate to characterize the entire set of equilibrium outcomes. This paper introduces a more general class of revelation mechanisms in which the agent reports also the contractual decisions he is inducing with the principals. We …rst show that such a class has the same nice properties as the class of all unrestricted menus: (i) for any equilibrium of any indirect game with arbitrary communication space for the principals, there exists a truthful equilibrium in the game in which the principals are restricted to o¤er revelation mechanisms that sustains the same outcomes; (ii) any truthful equilibrium is robust in the sense that it remains an equilibrium in any game in which the principalsstrategy space is enlarged. We next show how revelation mechanisms can be put to work in applications such as menu auctions, moral hazard settings, and competition in non-linear tari¤s to identify necessary and su¢ cient conditions for the sustainability of outcomes as common agency equilibria.
    Keywords: mechanism design, contracts, Revelation Principle.
    JEL: D89 C72
    Date: 2007–07
  9. By: George-Marios Angeletos; Alessandro Pavan; Christian Hellwig
    Abstract: This paper studies defense policies in a global-game model of speculative currency attacks. Although the signaling role of policy interventions sustains multiple equilibria, a number of novel predictions emerge which are robust across all equilibria. (i) The central bank intervenses by raising domestic interest rates, or otherwise raising the cost of speculation, only when the value it assigns to defending the peg - its "type" - is intermediate. (ii) Devaluation occurs only for low types. (iii) the set of types who intervene shrinks with the precision of market information. (iv) A unique equilibrium policy survives in the limit as the noise in market information vanishes, whereas the devaluation outcome remains indeterminate. (v) The payoff of the central bank is monotonic in its type. (vi) The option to intervene can be harmful only for sufficiently strong types; and when this happens, weak types are necessarily better off. While these predictions seem reasonable, none of them would have been possible in the common-knowledge version of the model. Combined, these results illustrate the broader methodological point of the paper: global games can retain significant selection power and deliver useful predictions even when the endogeneity of information sustains multiple equilibria.
    Keywords: global games, robust predictions, signaling, currency crises, regime change, multiple equilibria.
    JEL: C7 D8 E5 E6 F3
    Date: 2007–08
  10. By: Frédéric Koessler; David Martimort
    Abstract: This paper investigates optimal communication mechanisms with a two-dimensional policy space and no monetary transfers. Contrary to the one-dimensional setting, when a single principal controls two activities undertaken by his agent (cooperative design), the optimal communication mechanism never exhibits any pooling and the agent's ideal policies are never chosen. However, when the conflicts of interests between the agent and the principal on each dimension of the agent's activity are close to each other, simpler mechanisms that generalize those optimal in the one-dimensional case perform quite well. These simple mechanisms exhibit much pooling. When each activity of the agent is controlled by a different principal (non-cooperative design) and enters separately into the agent's utility function, optimal mechanisms under private communication take again the form of simple delegation sets, exactly as in the one-dimensional case. When instead the agent finds some benefits in coordinating actions, a one-sided contractual externality arises between principals under private communication. Under public communication instead, there does not exist any pure strategy Nash equilibrium with continuous and piecewise differentiable communication mechanisms. Relaxing the commitment ability of the principals restores equilibrium existence under public communication and yields partitional equilibria. Compared with private communication, public communication generates discipline or subversion effects among principals depending on the profile of their respective biases with respect to the agent's ideal policies.
    Date: 2008
  11. By: Heski Bar-Isaac; Ian Jewitt; Clare Leaver
    Abstract: An increasingly important organisational design problem for many firms is to recoup general human capital rents while maintaining the attractive career prospects for workers. We explore the role of information management in this context. In our model, an information management policy determines the statistic of worker performance that will be available to outside recruiters. Choosing different statistics affects the extent of regression to the mean which, we show, in turn affects the incidence of adverse selection among retained and released workers. Using this observation, we detail how optimal information management policies vary across firms with different human capital management priorities. This view of human capital management via information management has strong implications for labour market outcomes. We discuss the impact on average wages, wage inequality, wage skewness and labour turnover rates.
    Keywords: Human Capital, Information Disclosure, Regression to the Mean, Adverse Selection, Turnover, Wage Distribution, Human Resource Management
    JEL: D82 J24 L21
    Date: 2007
  12. By: Dean P. Foster; H. Peyton Young
    Abstract: We show that it is very difficult to structure incentive schemes that distinguish between unskilled hedge fund managers, who cannot generate excess returns, and highly skilled managers who can consistently deliver such returns. Under any incentive scheme that does not levy penalties for underperformance, managers with no investment skill can "game" the system to earn expected fees that are at least as high, relative to expected gross returns, as they are for the most skilled managers. Various ways of eliminating this "piggy-back problem" are examined, but the nature of the derivatives market means that it cannot be eliminated entirely.
    Keywords: Incentive Contract, Excess Return, Tail Event
    JEL: G32 D86
    Date: 2008
  13. By: Frisell, Lars (Financial Stability Department, Central Bank of Sweden); Roszbach, Kasper (Research Department, Central Bank of Sweden); spagnolo, giancarlo (University of Rome)
    Abstract: We study the specific corporate governance problems of central banks in their complex role of inflation guardians, bankers’ banks, financial industry regulators/supervisors and, in some cases, competition authorities and deposit insurance agencies. We review the current institutional arrangements of a number of central banks, e.g. formal objectives, ownership, board and governor appointment rules, term limits and compensation, using both existing surveys and newly collected information. Research on central bank governance appears to have focused almost only on their monetary policy task. As shown by the sub-prime loan market turmoil, central banks play a crucial role in financial markets not only in setting monetary policy, but also in ensuring their stability. In this paper, we contrast the current governance practices at central banks with the structures suggested in the corporate governance literature. Our analysis highlights a number of specific issues that appear to have been unsatisfactorily addressed by existing research, such as the incentive structure for governors and board members, the balance between central banks’ multiple objectives and the need for term limits.
    Keywords: accountability; bank regulation; board structure; central banks; corporate governance; central bank independence; governor remuneration; term limits
    JEL: E58 G18 G34 G38
    Date: 2008–03–01
  14. By: Huang, Ching-I
    Abstract: I use a sequential-auction model to mimic the environment of Internet auction sites, such as eBay. For a sequence of auctions, new buyers may enter the auction site after some of the auctions has completed and only bid for the remaining auctions. Because an incumbent buyer may have revealed their own valuation in earlier auctions while a new entrant do not, their expectations about the future are asymmetric. As a result, a buyer with a lower valuation may win an auction while a buyer with a higher valuation may restrain from bidding higher, resulting an inefficient allocation. On the contrary, selling the multiple items in a single simultaneous auction results in an efficient outcome. The profit from selling all items together in one simultaneous auction is less than that from selling them sequentially.
    Keywords: Internet auction; sequential auctions; affiliated private values
    JEL: D44 D82
    Date: 2008–03–14

This nep-cta issue is ©2008 by Simona Fabrizi. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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