nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒07‒05
seven papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Secret Contracts for Efficient Partnerships By David Rahman; Ichiro Obara
  2. Optimal Contracts for Lenient Supervisors By Thomas Giebe; Oliver Gürtler
  3. Privatization of Credence Goods:Theory and Evidence from Service Contracting By Lindqvist, Erik
  4. Altruism and Career Concern By Shchetinin, Oleg
  6. Seller Competition by Mechanism Design By Damianov, Damian
  7. The Allocation of Economic Capital in Opaque Financial Conglomerates By Mierzejewski, Fernando

  1. By: David Rahman (Department of Economics, University of Minnesota); Ichiro Obara (Department of Economics, University of Minnesota)
    Abstract: By allocating dierent information to team members, secret contracts can provide better incentives to perform with an intuitive organizational design. For instance, they may help to monitor monitors, and appoint secret principals. Generally, secret contracts highlight a rich duality between detection and enforcement with linear transfers. On the one hand, disobedient deviations must be detectable to enforce a given outcome, but dierent behavior may be used to detect dierent deviations. On the other hand, disobedient deviations must be attributable, i.e., some individual can be identied as innocent, to provide incentives with budget balance.
    Keywords: secret contracts, partnerships, duality, private monitoring.
    JEL: D21 D23 D82
    Date: 2008–06–26
  2. By: Thomas Giebe (Thomas Giebe, Department of Economics, Economic Theory I, Humboldt University Berlin, Spandauer Stra_e 1, D-10178 Berlin, Germany, e-mail:; Oliver Gürtler (Oliver Gürtler, Department of Economics, BWL II, University of Bonn, Adenauerallee 24-42, 53113 Bonn, Germany, e-mail:
    Abstract: We consider a situation where an agent's effort is monitored by a supervisor who cares for the agent's well-being. This is modeled by incorporating the agent's utility into the utility function of the supervisor. The first-best solution can be implemented even if the supervisor's preferences are unknown. The corresponding optimal contract is similar to what we observe in practice: The supervisor's wage is constant and independent of his report. It induces one type of supervisor to report the agent's performance truthfully, while all others report favorably independent of performance. This implies that overstated performance (leniency bias) maybe the outcome of optimal contracts under informational asymmetries.
    Keywords: Subjectiveperformanceevaluation,leniency,supervisor,privateinformation
    JEL: D82 D86 J33 M52
    Date: 2008–06
  3. By: Lindqvist, Erik (Research Institute of Industrial Economics (IFN))
    Abstract: A wide range of services provided by the public sector are credence goods, i.e., services for which the producer has private information whether a certain treatment is needed or not. This paper studies how ownership affects the incentives for producers to reveal such information to public procurers. I develop a model where procurers buy a more extensive treatment in case quality is high. Private firms have strong incentives to reduce cost and must be given rents in order not to shirk on non-contractible quality. The existence of rents makes private firms try to induce demand for unnecessary treatments. Public sector managers have no incentive to cut cost, implying that optimal contracts don't entail rents unless quality is very important. Public sector managers instead use their informational advantage to avoid unpleasant tasks. Empirical evidence from residential care for teenagers with behavioral problems supports the model's predictions. Private ownership prolongs the duration of treatment by more than a year, doubling total cost. Unlike private facilities, public facilities are much more likely to initiate treatment breakdowns for teenagers that are particularly burdensome to treat.
    Keywords: Privatization; Public Sector Contracting; Credence Goods; Incomplete Contracts; Contracting Out; Residential Youth Care; Juvenile Delinquency
    JEL: H11 H40 L32 L33
    Date: 2008–06–04
  4. By: Shchetinin, Oleg
    Abstract: The paper studies the impact of altruism on Agent's motivation in the career concerns model. The main result is that higher altruism can decrease effort though conventional wisdom suggests the opposite should always the case. The key for the result is the distinction between current and anticipated altruism. The current altruism stimulates the Agent because it makes him partially internalize the Principal's benefit from output. More subtle, the anticipated altruism weakens effort because it lessens career concerns. The paper contributes to the literature on interaction between intrinsic and extrinsic motivation. It gives an example when intrinsic motivator (altruism) lessens extrinsic motivation (career concerns). The model has a number of other interesting features. It gives an example of winner's blessing. It shows that if the worker pushes himself too hard trying to pretend more skilled, it can hinder altruistic relationship. Whereas if the worker shirks, his laziness is safe for establishing altruistic relation in the future. The natural interpretation of the model is labor contract between friends, other applications are also discussed.
    Keywords: career concern; altruism; labor contract; intrinsic motivation
    JEL: D86 D64 M50
    Date: 2008–07
  5. By: Steven F. Koch (Department of Economics, University of Pretoria); S. Ssekabira Ntege (Department of Economics, University of Pretoria)
    Abstract: This paper explores the degree to which imperfect information in the labour market regarding worker quality is likely to impact employment opportunities, as well as the wages associated with those opportunities. The primary purpose of this paper is to provide preliminary empirical evidence that market imperfections exist in South Africa's labour market, that those imperfections could be based on asymmetric private information, and that market participants pursue information gathering and revelation strategies to help mitigate the negative effects of the information asymmetries.
    JEL: D81 D82 I21 J23 J24 J31
    Date: 2008–06
  6. By: Damianov, Damian
    Abstract: In the market game presented here, sellers offer trade mechanisms to buyers, and buyers randomize over the sellers they visit. The distribution of buyers across sellers is endogenous and depends on all of the transaction opportunities existing in the market. Sellers choose from a broad class of trade mechanisms; the only constraints imposed on mechanisms is that they are direct, incentive compatible, and anonymous. In the (subgame perfect) equilibrium of this market, sellers hold auctions with an efficient reserve price but charge an entry fee. The entry fee depends on the number of buyers and sellers, the distribution of buyer valuations, and the buyer cost of entering the market. As the size of the market increases, the entry fee decreases and vanishes in the limit. The model sheds light on the endogenous formation of trading institutions in decentralized markets.
    Keywords: competition; mechanism design; auctions
    JEL: D44 D82
    Date: 2008–06–23
  7. By: Mierzejewski, Fernando
    Abstract: The capital structure of firms that face restrictions on liquidity (i.e. that cannot hedge continuously) is affected by the agency costs and moral-hazard implicit in the contracts they establish with stockholders and customers. It is demonstrated in this paper that then an optimal level of capital exists, which is characterised in terms of the actuarial prices of the involved agreements. The capital principle so obtained explicitly depends on risk and expectations and it can be naturally applied to allocate balances inside multidivisiona corporations. In particular, an optimal decentralised mechanism is defined, which stimulates the exchange of information between central and divisional administrations. A novel model of capital is thus formulated, which extends the classic theoretical framework (sustained by the well-known proposition of Modigliani and Miller and the model of deposit insurance of Robert Merton) and integrates the financial and actuarial theoretical settings.
    Keywords: Economic Capital; Capital Allocation; Deposit Insurance; Distorted Risk principle; Value-at-Risk;
    JEL: G32 G30 G10 G20
    Date: 2008–07–03

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