nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2008‒10‒07
fifteen papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Relative Performance Pay, Bonuses, and Job-Promotion Tournaments By Matthias Kräkel; Anja Schöttner
  2. How Ego-threats Facilitate Contracts Based on Subjective Evaluations By Alexander Sebald; Markus Walzl
  3. Uberrimae Fidei and Adverse Selection: the equitable legal judgment of Insurance Contracts By Strauss, Jason David
  4. Crowding Out Wasteful Activities by Wasteful Activities By Amihai Glazer
  5. Mechanism Design and Communication Networks By Ludovic Renou; Tristan Tomala
  6. Comparing Certification and Self-regulation By Jan Myslivecek
  7. Point-record incentives, asymmetric information and dynamic data By Jean Pinquet; Georges Dionne; Charles Vanasse; Mathieu Maurice
  8. Bidding and Drilling on O®shore Wildcat Tracts By Nicolas Melissas
  9. Obtaining information by diversifying projects or why specialization is inefficient By Amihai Glazer; Stef Proost
  10. Asymmetric Information and the Signaling Role of Prices By Wassim Daher; Leonard J. Mirman; Marc Santugini
  11. Outsourcing, Complementary Innovations and Growth By Alireza Naghavi; Gianmarco I.P. Ottaviano
  12. Beyond the Cartel Law Handbook: How Corruption, Social Norms and Collectivist Business Cultures can Undermine Conventional Enforcement Tools By Andreas Stephan
  13. Combatant Recruitment and the Outcome of War By Ahmed Saber Mahmud; Juan F. Vargas
  14. Strategic Informative Advertising in a Horizontally Differentiated Duopoly By Levent Çelik
  15. Taxes Versus Quantities for a Stock Pollutant with Endogenous Abatement Costs and Asymmetric Information By Larry Karp; Jiangfeng Zhang

  1. By: Matthias Kräkel; Anja Schöttner (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany; University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany)
    Abstract: Several empirical studies have challenged tournament theory by pointing out that (1) there is considerable pay variation within hierarchy levels, (2) promotion premiums only in part explain hierarchical wage differences and (3) external recruitment is observable on nearly any hierarchy level. We explain these empirical puzzles by combining job-promotion tournaments with higher-level bonus payments in a two-tier hierarchy. Moreover, we show that under certain conditions the firm implements first-best effort on tier 2 although workers earn strictly positive rents. The reason is that the firm can use second-tier rents for creating incentives on tier 1. If workers are heterogeneous, the firm strictly improves the selection quality of a job-promotion tournament by employing a hybrid incentive scheme that includes bonus payments.
    Keywords: bonuses, external recruitment, job promotion, limited liability, tournaments
    JEL: D82 D86 J33
    Date: 2008–09
  2. By: Alexander Sebald (Department of Economics, University of Copenhagen); Markus Walzl (Department of Economics, University of Maastricht)
    Abstract: We show that individuals’ desire to protect their self-esteem against ego-threatening feedback can mitigate moral hazard in environments with purely subjective performance evaluations. In line with evidence from social psychology we assume that agents’ react aggressively to evaluations by the principal which do not coincide with their own positive self-perceptions and thereby generate costs of conflict for the principal. We identify conditions for a positive welfare effect of increasing costs of conflict or increasing sensitivity to ego-threats, and a negative welfare effect of a more informative information technology. As a consequence, principals may choose imperfect information technologies in equilibrium even if the signal quality is costless.
    Keywords: contracts; Subjective evaluations; self-esteem; ego-threats
    JEL: D01 D02 D82 D86 J41
    Date: 2008–09
  3. By: Strauss, Jason David
    Abstract: This paper examines uberrimae fidei (utmost good faith) with adverse selection in an insurance market. If consumers know their risk type (they know their expected loss), and if they understand the concept of uberrimae fidei, adverse selection is completely eliminated. However, if uberrimae fidei is strictly enforced by the courts, insurers have no incentive to do any underwriting whatsoever. Therefore, whether consumers know their risk type or not, and whether they understand uberrimae fidei, is of paramount importance. If consumers don’t know their risk type or don’t understand uberrimae fidei, then the (equitable) non-strict enforcement (judicial ruling) of contracts of insurance can be efficiency enhancing as it can create an ex-ante incentive for insurers to underwrite. With an ex-ante positive probability that a court may rule equitably in favor of the insured, the insurer engages in underwriting as part of its profit maximization objective, helping insureds to discover their risk type and/or educating potential insureds on the requirements of a contract of uberrimae fidei. This paper therefore contributes a new theory of underwriting.
    Keywords: Insurance; Uberrimae Fidei; Utmost Good Faith; Adverse Selection; Contract Theory; Equity; Equitable Law; Institutions; Insurance Cycle
    JEL: D86 G22 D82
    Date: 2008–10–02
  4. By: Amihai Glazer (Department of Economics, University of California-Irvine)
    Abstract: A seller can benefit from information about the valuation a potential buyer places on the good. Under some circumstances, improved information raises social welfare. But under other circumstances, the information has private value but no social value, so that agents may spend too much on collecting information. A government which collects and disseminates some information about valuations can limit spending by private agents on data collection, thereby increasing social welfare. That is, governmental provision of information may be useful not because information is socially useful, but because it limits the amount private agents spend on collecting information.
    Keywords: Information; Rent seeking
    JEL: D61 D82 D83
    Date: 2008–09
  5. By: Ludovic Renou; Tristan Tomala
    Abstract: This paper characterizes the class of communication networks for which, in any environment (utilities and beliefs), every incentive-compatible social choice function is (partially) implementable. Among others, in environments with either common and independent beliefs and private values or a bad outcome, we show that if the communication network is 2-connected, then any incentive-compatible social choice function is implementable. A network is 2-connected if each player is either directly connected to the designer or indirectly connected to the designer through at least two disjoint paths. We couple encryption techniques together with appropriate incentives to secure the transmission of each player’s private information to the designer.
    Keywords: Mechanism design; incentives; Bayesian equilibrium; communication networks; encryption; secure transmission; coding
    JEL: C7
    Date: 2008–09
  6. By: Jan Myslivecek
    Abstract: I compare certification and self-regulation, two widely used quality assurance mechanisms in markets where consumers do not observe the quality of goods. Certification is a mechanism in which an external firm oers a certificate to producers who undergo a testing procedure, issues the certificate if they meet the certifier's standards and collects the certification fee. Self-regulation is a mechanism in which a club of firms in the industry adhere (or not) to a self-imposed code of conduct and benefit from the club's reputation. I show that if the testing technology is perfect and costless, the choice of standards and fees by the certifying organization (CO) is welfare inferior, while the self-regulatory organization (SRO) chooses a welfare optimal fee, and I identify conditions under which the SRO also chooses optimal standards. If the testing technology is costly and imperfect, this result is not necessarily valid and depends on the dierence between the costs of the testing technology available to the CO and SRO.
    Keywords: Quality assurance, asymmetry of information, certication, self-regulation.
    JEL: D02 D45 D71 D72 D82 L14 L15 L21 L38 L43 L51
    Date: 2008–09
  7. By: Jean Pinquet (LEEP - Laboratoire d'econometrie de l'école polytechnique - CNRS : UMR7657 - Polytechnique - X); Georges Dionne (HEC Montréal -); Charles Vanasse (TD Asset Management -); Mathieu Maurice (HEC Montréal -)
    Abstract: Les politiques de sécurité routière utilisent souvent des mécanismes incitatifs basés sur les infractions pour améliorer le comportement des conducteurs. Ces mécanismes sont soit monétaires (amendes, primes d'assurance), soit non monétaires (permis à points). Nous utilisons des données québécoises couvrant une période allant de 1983 à 1996 pour analyser l'efficacité incitative de ces mécanismes. Nous analysons leurs propriétés théoriques par rapport au nombre de points associés aux infractions et par rapport au temps contrat. Ces propriétés sont ensuite testées empiriquement. Nous comparons l'efficacité globale des différents mécanismes incitatifs et nous relions les résultats obtenus avec les propriétés de la relation entre l'effort de conduite prudente et le risque d'infractions. Nous concluons à la présence d'aléa moral dans les données. Par ailleurs, la prime indicée sur les points introduite en 1992 a réduit de 15% la fréquence d'infractions.
    Date: 2007
  8. By: Nicolas Melissas (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))
    Abstract: I study a game in which ¯rms ¯rst bid on wildcat tracts and then time their drilling decisions. In an equilibrium bids are used as a coordination device: if player i bid low while player ¡i bid high, player i waits while player ¡i drills. This equilibrium is consistent with the empirical ¯ndings of Hendricks and Porter (1996). Firms know that by bidding \low" they can be allocated the right to free-ride. This induces \optimistic" ¯rms to submit \low" bids. Nonetheless, this equilibrium need not reduce expected revenues as compared to the benchmark case in which one abstracts from signalling issues.
    Keywords: Information externality, auctions, oil exploration
    JEL: D44 D82 C72 Q49
    Date: 2008–09
  9. By: Amihai Glazer; Stef Proost
    Abstract: We examine how diversification of projects assigned to an agency can enhance efficiency by informing a principal of the agency’s quality. Projects that appear inefficient in isolation may be justified when assigned to the same agency. Assigning different tasks to different special purpose governments, though allowing for technical efficiency in the management of each project, may nevertheless reduce overall efficiency.
    Keywords: Special purpose governments, Asymmetric information, Bureaucracy, Project evaluation
    JEL: D73 D83 H43
    Date: 2008–06
  10. By: Wassim Daher; Leonard J. Mirman; Marc Santugini (IEA, HEC Montréal)
    Abstract: We study asymmetric information and the signaling role of prices in a noiseless and imperfectly competitive environment. Here, the price is determined by market forces. After describing the general model, we study information flows in applications of industrial organization and finance: a quantity-setting monopoly, Cournot oligopoly, and a model of choice and allocation of a risky asset. For each application, there is a unique signaling equilibrium in which the price conveys all the information. Moreover, the signaling equilibrium differs from the full information equilibrium..
    Date: 2008–09
  11. By: Alireza Naghavi; Gianmarco I.P. Ottaviano
    Abstract: This paper studies the parallel creation of complementary upstream and downstream innovations by independent labs to shed light on the impact of outsourcing on R&D when supply contracts are incomplete. In particular, we argue that outsourced upstream production contributes to the emergence of innovation networks by creating a demand for upstream R&D. We then analyze under which conditions this leads to faster innovation than in the case of vertically integrated production relying on integrated R&D. In the presence of incomplete supply contracts, the ex-post bargaining power of upstream and downstream parties feeds back to innovation. This determines whether outsourcing decisions leading to static gains from specialized production generate or not also dynamic gains in terms of faster innovation.
    Keywords: outsourcing, complementary innovations, incomplete contracts, organization of firms
    JEL: L14 L23 O32 D91
    Date: 2008–05
  12. By: Andreas Stephan (Centre for Competition Policy, University of East Anglia)
    Abstract: The combination of leniency programmes, high sanctions, complaints from customers and private actions for damages, has proven very successful at uncovering and punishing cartel agreements in the US. Countless jurisdictions are being encouraged to adopt these ‘conventional’ enforcement tools, in the absence of an international competition authority. The purpose of this paper is to widen the debate on cartel enforcement by identifying three issues which can undermine their effectiveness in some jurisdictions: (1) Corruption and organised crime; (2) Social norms that are sympathetic to collusive practices; (3) Collectivist business cultures built on personal relationships.
    Keywords: cartels, leniency programmes, enforcement, corruption, organised crime, social norms, collectivism
    JEL: D21 K21 K42 L40 Z1
    Date: 2008–09
  13. By: Ahmed Saber Mahmud; Juan F. Vargas
    Abstract: Why do some civil wars terminate soon, with victory of one party over the other? What determines if the winner is the incumbent or the rebel group? Why do other conflicts last longer? We propose a simple model in which the power of each armed group depends on the number of combatants it is able to recruit. This is in turn a function of the relative 'distance' between group leaderships and potential recruits. We emphasize the moral hazard problem of recruitment: …ghting is costly and risky so combatants have the incentive to defect from their task. They can also desert alto- gether and join the enemy. This incentive is stronger the farther away the …ghter is from the principal, since monitoring becomes increasingly costly. Bigger armies have more power but less monitoring capacity to prevent defection and desertion. This general framework allows a variety of interpretations of what type of proximity matters for building strong cohesive armies ranging from ethnic distance to geographic dispersion. Di¤erent assumptions about the distribution of potential …ghters along the relevant dimension of con‡ict lead to di¤erent equilibria. We characterize these, discuss the implied outcome in terms of who wins the war, and illustrate with historical and contemporaneous case studies.
    Date: 2008–09–23
  14. By: Levent Çelik
    Abstract: When firms possess information about their competitors’ products, their advertisements may leak extra information. I analyze this within a duopoly television market that lasts for two periods. Each station may advertise its upcoming program by airing a tune-in during the first program. Viewers may alternatively sample a program. I find that each station’s equilibrium tune-in decision depends on both upcoming programs - thereby revealing more information than the actual content - when the sampling cost is sufficiently low. Otherwise, tune-in decisions are made independently. It is welfare improving to ban tune-ins in the latter case but not in the former.
    Keywords: Informative advertising, Tune-ins, Sampling, Information disclosure, Signaling.
    JEL: D83 L13 M37
    Date: 2008–09
  15. By: Larry Karp (University of California, Berkeley and Giannini Foundation); Jiangfeng Zhang (Asian Development Bank)
    Abstract: Non-strategic firms with rational expectations make investment and emissions decisions. The investment rule depends on firms' beliefs about future emissions policies. We compare emissions taxes and quotas when the (strategic) regulator and (nonstrategic) firms have asymmetric information about abatement costs, and all agents use Markov Perfect decision rules. Emissions taxes create a secondary distortion at the investment stage, unless a particular condition holds; emissions quotas do not create a secondary distortion. We solve a linear-quadratic model calibrated to represent the problem of controlling greenhouse gasses. The endogeneity of abatement capital favors taxes, and it increases abatement.
    Keywords: Pollution control; Investment, asymmetric information, rational expectations, choice of instruments,
    Date: 2008–07–21

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.