nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒04‒29
twelve papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Can information asymmetry cause agglomeration? By Berliant, Marcus; Kung, Fan-chin
  2. Delegation with Incomplete and Renegotiable Contracts By Levent Koçkesen; Emanuele Gerratana
  3. Carrots and Sticks: Prizes and Punishments in Contests By Moldovanu, Benny; Sela, Aner; Shi, Xianwen
  4. How many banks does it take to lend? Empirical evidence from Europe By Christophe J. Godlewski; Ydriss Ziane
  5. Optimal Nonlinear Pricing, Bundling Commodities and Contingent Services By Marion PODESTA; Jean-Christophe POUDOU
  6. Settlement in Merger Cases: Remedies and Litigation By Bertrand Chopard; Thomas Cortade; Andreea Cosnita
  7. Contracting in the Shadow of the Law By Surajeet Chakravarty; W. Bentley MacLeod
  8. Institutions and Contract Enforcement By Armin Falk; David Huffman; W. Bentley MacLeod
  9. Social Preferences and Public Economics: Mechanism Design when Social Preferences Depend on Incentives By Samuel Bowles; Sung-Ha Hwang
  10. Control Rights over Intellectual Property: Corporate Venturing and Bankruptcy Regimes By Sudipto Bhattacharya; Sergei Guriev
  11. On Efficient Trading Mechanisms with Ex-Post Individually Rational Traders By Stefano Galavotti
  12. Endogenous Systemic Liquidity Risk By Cao, Jin; Illing, Gerhard

  1. 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 R12 D82
    Date: 2008–04–22
  2. By: Levent Koçkesen (Koç University); Emanuele Gerratana
    Abstract: It is well known that delegating the play of a game to an agent via incentive contractsmay serveas a commitment device and hence provide a strategic advantage. Previous literature has shown that any Nash equilibrium outcome of an extensive-form principals-only game can be supported as a sequential equilibrium outcome of the induced delegation game when contracts are unobservable and non-renegotiable. In this paper we characterize equilibriumoutcomes of delegation games with unobservable and incomplete contractswith andwithout renegotiation opportunities under the assumption that the principal cannot observe every history in the game when played by her agent. We show that incompleteness of the contracts restricts the set of outcomes to a subset of Nash equilibrium outcomes and renegotiation imposes further constraints. Yet, there is a large class of games in which non-subgame perfect equilibrium outcomes of the principals-only game can be supported even with renegotiable contracts, and hence delegation still has a bite.
    Keywords: Strategic Delegation, Incomplete Contracts, Renegotiation.
    JEL: C72 C78 D86 L13
    Date: 2008–04
  3. By: Moldovanu, Benny; Sela, Aner; Shi, Xianwen
    Abstract: We study optimal contest design in situations where the designer can reward high performance agents with positive prizes and punish low performance agents with negative prizes. We link the optimal prize structure to the curvature of distribution of abilities in the population. In particular, we identify conditions under which, even if punishment is costly, punishing the bottom is more effective than rewarding the top in eliciting effort input. If punishment is costless, we study the optimal number of punishments in the contest.
    Keywords: All-pay auctions; Contests; Order Statistics; Punishments
    JEL: D44 D82 J31 J41
    Date: 2008–04
  4. By: Christophe J. Godlewski (Laboratoire de Recherche en Gestion et Economie, Université Louis Pasteur); Ydriss Ziane (BETA, Université de Nancy)
    Abstract: We provide empirical evidence on the determinants of the number of bank lenders using a sample of more than 3000 loans to firms from 24 European countries. Our testable hypotheses are built upon different theoretical frameworks drawn from the existing literature, referring to firm characteristics, strategic considerations, geographical distances, bank market concentration, efficiency of legal system, and development of alternative sources of funds. Our main results show that the number and the international diversity of lenders is increased by loan and firm characteristics which reduce agency costs, and by financial structure and legal environment characteristics which mitigate expropriation risk.
    Keywords: Lending relationships, number of lenders, bank loans, financial governance, asymmetric information, Europe.
    JEL: G21 G32 G33
    Date: 2008
  5. By: Marion PODESTA; Jean-Christophe POUDOU
    Abstract: In this paper, we propose to analyze optimal nonlinear pricing when a firm offers in a bundle a commodity and a contingent service. The paper studies a mechanism design where all private information can be captured in a single scalar variable in a monopoly context. We show that to propose the package for commodity and service is less costly for the consumer, the firm has lower consumers rent than the situation where it sells their good and contingent service under an independent pricing strategy. In fact, the possibility to use price discrimination via the supply of package is dominated by the fact that it is costly for the consumer to sign two contracts. Bundling energy and a contingent service is a profitable strategy for a energetician monopoly practising optimal nonlinear tariff. We show that the rates of the energy and the contingent service depend to the optional character of the contingent service and depend to the degree of complementarity between commodities and services.
    Keywords: Bundling, Nonlinear pricing, Energy market
    JEL: D42 L12 Q4
    Date: 2008
  6. By: Bertrand Chopard; Thomas Cortade; Andreea Cosnita
    Abstract: This paper performs a pre-trial settlement analysis for the negotiation of asset divestitures in merger control cases. Taking into account the asymmetric information between the competition agency and the merging firms concerning the true competition impact of the merger, we examine the impact on the likelihood of settlement divestiture and the divestiture amount in equilibrium of various factors, such as the transfer rate of the merger’s cost savings, the severity of the appeal court, as well as the bargaining power of the merging partners in the sale of the divested assets.
    Keywords: out-of-court settlement, merger control, divestitures, asymmetric information
    JEL: K21 L41 D82
    Date: 2008
  7. By: Surajeet Chakravarty; W. Bentley MacLeod
    Abstract: Economic models of contract typically assume that courts enforce obligations on the basis of verifiable events. As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies that are enforced by a court of law. This paper shows that standard form construction contracts can be viewed as an optimal solution to this problem. It is shown that a central feature of construction contracts is the inclusion of governance covenants that shape the scope of authority, and regulate the ex post bargaining power of parties. Our model also provides a unified framework for the study of the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley vs. Baxendale.
    JEL: D02 K12 L23
    Date: 2008–04
  8. By: Armin Falk; David Huffman; W. Bentley MacLeod
    Abstract: We provide evidence on how two important types of institutions -- dismissal barriers, and bonus pay -- affect contract enforcement behavior in a market with incomplete contracts and repeated interactions. Dismissal barriers are shown to have a strong negative impact on worker performance, and market efficiency, by interfering with firms' use of firing threat as an incentive device. Dismissal barriers also distort the dynamics of worker effort levels over time, cause firms to rely more on the spot market for labor, and create a distribution of relationship lengths in the market that is more extreme, with more very short and more very long relationships. The introduction of a bonus pay option dramatically changes the market outcome. Firms are observed to substitute bonus pay for threat of firing as an incentive device, almost entirely offsetting the negative incentive and efficiency effects of dismissal barriers. Nevertheless, contract enforcement behavior remains fundamentally changed, because the option to pay bonuses causes firms to rely less on long-term relationships. Our results show that market outcomes are the result of a complex interplay between contract enforcement policies and the institutions in which they are embedded.
    JEL: C9 D01 J3 J41
    Date: 2008–04
  9. By: Samuel Bowles; Sung-Ha Hwang
    Abstract: Social preferences such as altruism, reciprocity, intrinsic motivation and a desire to uphold ethical norms are essential to good government, often facilitating socially desirable allocations that would be unattainable by incentives that appeal solely to self-interest. But experimental and other evidence indicates that conventional economic incentives and social preferences may be either complements or substitutes, explicit incentives crowding in or crowding out social preferences. We investigate the design of optimal incentives to contribute to a public good under these conditions. We identify cases in which a sophisticated planner cognizant of these non-additive effects would make either more or less use of explicit incentives, by comparison to a naive planner who assumes they are absent
    Keywords: Social preferences, implementation theory, incentive contracts, incomplete contracts
    JEL: D52 D64 H21 H41
    Date: 2008–03
  10. By: Sudipto Bhattacharya (NLondon School of Economics, and CEPR); Sergei Guriev (Stockholm School of Economics, Stockholm; Centre for Economic and Financial Research (CEFIR), Moscow, and CEPR)
    Abstract: We develop a theory of control rights in the context of licensing interim innovative knowledge for further development, which is consistent with the inalienability of initial innovator's intellectual property rights (IPR). Control rights of a downstream development unit, a buyer of the interim innovation, arise from his ability to prevent the upstream research unit from forming financial coalitions at the ex interim stage of bargaining, over the amount and structure of licensing fees as well as the mode of licensing, either based on trade secrets or via patenting. We model explicitly the equilibrium choice of the financial structure of licensing fees and show that the innovator's financial constraint is more likely to bind when the value of her innovation is low. By constraining the flexibility of the upstream unit regarding her choice of the mode of licensing of her interim knowledge, the controlling development unit is able to reduce the research unit's payoffs in such contingencies. This incentivises the research unit to expend costly e¤ort ex ante to generate more productive interim innovations. We show that such interim control rights can be renegotiation-proof.
    JEL: D23 K12 O32
    Date: 2008–04
  11. By: Stefano Galavotti (Department of Applied Mathematics, University of Venice)
    Abstract: This paper studies a bilateral trading setting where the two agents are not ex-ante identified, in the sense that each of them may end up being a net buyer or a net seller. We derive a sufficient condition that ensures the existence of an (ex-post) efficient, (ex-post) budget balanced, (interim) incentive compatible trading mechanism that always yields a positive net utility to all agents (ex-post individually rational). This result improves a former existence result based on interim individual rationality showing that the stronger requirement of ex-post individual rationality does not always rule out efficiency.
    JEL: D02 D40 D44 D82
    Date: 2008–04
  12. By: Cao, Jin; Illing, Gerhard
    Abstract: Traditionally, aggregate liquidity shocks are modelled as exogenous events. Extending our previous work (Cao & Illing, 2007), this paper analyses the adequate policy response to endogenous systemic liquidity risk. We analyse the feedback between lender of last resort policy and incentives of private banks, determining the aggregate amount of liquidity available. We show that imposing minimum liquidity standards for banks ex ante are a crucial requirement for sensible lender of last resort policy. In addition, we analyse the impact of equity requirements and narrow banking, in the sense that banks are required to hold sufficient liquid funds so as to pay out in all contingencies. We show that such a policy is strictly inferior to imposing minimum liquidity standards ex ante combined with lender of last resort policy.
    Keywords: Liquidity risk; Free-riding; Narrow banking; Lender of last resort
    JEL: E5 G21 G28
    Date: 2008–04–21

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