nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2009‒04‒13
ten papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. “Managing Banks’ Optimal Debt Contracts under Costly Enforcement” By Celli, Gian Luca
  2. Leveraged Buy Out: Dynamic agency model with write-off option By Ouidad Yousfi
  3. Optimal Unemployment Insurance for Older Workers By Hairault, Jean-Olivier; Langot, François; Ménard, Sébastien; Sopraseuth, Thepthida
  4. Outside and Inside Liquidity By Patrick Bolton; Tano Santos; Jose A. Scheinkman
  5. Emotional Decision-Makers and Anomalous Attitudes towards Information By Francesca Barigozzi; Rosella Levaggi
  6. The Evolutionary Game of Poverty Traps By Edgar Sanchez Carrera
  7. Incomplete Regulation, Asymmetric Information and Collusion-Proofness By Marco Meireles; Paula Sarmento
  8. Genetic Information: Comparing Alternative Regulatory Approaches when Prevention Matters By Francesca Barigozzi; Dominique Henriet
  9. Face Value: Information and Signaling in an Illegal Market By Trevon Logan; Manisha Shah
  10. Procurement Contracting with Time Incentives: Theory and Evidence By Patrick Bajari; Gregory Lewis

  1. By: Celli, Gian Luca
    Abstract: The proposed research model from “Optimal Debt Contracts under Costly Enforcement” alters the original Costly State Verification (CSV) model introduced by Townsend (1979) by assuming that monitoring is non-contractible and non-deterministic. It emerges, from my analysis, that there are technical problems with the entrepreneur participation constraint. Particularly, the authors did not frame the principal optimization problem taking in to account a type-dependent participation constraint. To correct for this errors, I developed an adverse selection model that integrates the agent out-side opportunity utility. This approach opens up in to an interesting research turf on hypothetical creditors and debt market segmentation.
    Keywords: Agency Costs, Debt Management, Debt Contract, Costly Enforcement, Adverse Selection Models, Debt Tiers, Investor Heterogeneity
    JEL: D86
    Date: 2008–05–28
  2. By: Ouidad Yousfi
    Abstract: We present a dynamic agency model in which the LBO fund may write the entrepreneur's project off at the end of the starting stage to invest in a competitive project. The two partners provide unobservable efforts in both stages to enhance the productivity of the acquired company. We show that under restrictive conditions, the debt-equity contracts induce the entrepreneur and the LBO fund to provide the first best efforts under restrictive conditions in the two stages. Moreover, the write-off threat boosts the incentives of the entrepreneur and the LBO fund such that they provide high efforts. If the compensation cost is exogenous, the sharing rule of this cost depends on the quality of the competitive project. The entrepreneur and the bank share the amount of compensation if it is not very profitable. Otherwise, the whole amount of compensation is pledged to the entrepreneur. If the compensation's amount is endogenous, in order to induce the entrepreneur to provide high effort, the optimal financial contracts must give her the entire compensation's revenue.
    Keywords: Leveraged Buy Out, incentives, exit, write-off option, double moral hazard
    JEL: D82 D92 G32 G33
    Date: 2009
  3. By: Hairault, Jean-Olivier (University of Paris 1); Langot, François (University of Le Mans); Ménard, Sébastien (GAINS, Université du Maine); Sopraseuth, Thepthida (GAINS, Université du Maine)
    Abstract: This paper shows that optimal unemployment insurance contracts are age-dependent. Older workers have only a few years left on the labor market prior to retirement. This short horizon implies a more digressive replacement ratio. However, there is a sufficiently short distance to retirement for which flat unemployment benefits can be the optimal contract as the nearly retired unemployed workers rationally expect never to suffer from the punishment. This is why imposing a tax on the future job is particularly efficient in the context of older workers because the agency can now reward the job search by present employment subsidies. Moreover, we propose adopting a global approach to unemployment insurance by determining an optimal contract that integrates unemployment insurance and retirement pension systems.
    Keywords: unemployment insurance, retirement, recursive contracts, moral hazard
    JEL: C61 J64 J65
    Date: 2009–03
  4. By: Patrick Bolton; Tano Santos; Jose A. Scheinkman
    Abstract: We consider a model of liquidity demand arising from a possible maturity mismatch between asset revenues and consumption. This liquidity demand can be met with either cash reserves (inside liquidity) or via asset sales for cash (outside liquidity). The question we address is, what determines the mix of inside and outside liquidity in equilibrium? An important source of inefficiency in our model is the presence of asymmetric information about asset values, which increases the longer a liquidity trade is delayed. We establish existence of an immediate-trading equilibrium, in which asset trading occurs in anticipation of a liquidity shock, and sometimes also of a delayed-trading equilibrium, in which assets are traded in response to a liquidity shock. We show that, when it exists, the delayed-trading equilibrium is Pareto superior to the immediate-trading equilibrium, despite the presence of adverse selection. However, the presence of adverse selection may inefficiently accelerate asset liquidation. We also show that the delayed-trading equilibrium features more outside liquidity than the immediate-trading equilibrium although it is supplied in the presence of adverse selection. Finally, long term contracts do not always dominate the market provision of liquidity.
    JEL: G2 G21
    Date: 2009–04
  5. By: Francesca Barigozzi; Rosella Levaggi
    Abstract: We use a simple version of the Psychological Expected Utility Model (Caplin and Leahy, QJE, 2001) to analyze the optimal choice of information accuracy by an individual who is concerned with anticipatory feeling. The individual faces the following trade-off: on the one hand information may lead to emotional costs, on the other the higher the information accuracy, the higher the efficiency of decision-making. We completely and explicitly characterize how anticipatory utility depends on information accuracy, and study the optimal amount of information acquisition. We obtain simple and explicit conditions under which the individual prefers no-information or partial information gathering. We show that anomalous attitudes towards information can be more articulated than previously thought.
    Keywords: Psychological expected utility, Information gathering, Bayesian updating
    JEL: D81 D83
    Date: 2008–09
  6. By: Edgar Sanchez Carrera
    Abstract: We study an evolutionary game in which the individual behavior of the economic agents can lead the economy either into a low-level or a high-level equilibrium. The model represents two asymmetric populations, “leaders and followers”, where in each round an economic agent of population 1 is paired with a member of population 2. Our evolutionary game is a signaling game in which only the leader has private information. The leader moves first; the follower observes the leader's action, but not the leader's type, before choosing her own action. We found the equilibria both as self-confirming and evolutionarily stable strategies. Furthermore, considering an imitative behavior of the followers, we show that to overcome the poverty trap there exists a threshold value equals to the ratio "education costs-efficiency wages" of the number of high-profile economic agents
    Keywords: Evolutionary games, imitation rule, poverty traps, replicator dynamics, signaling games, strategic complementarities
    JEL: C70 C72 C73 I30 O10 O40
    Date: 2009–02
  7. By: Marco Meireles (Faculdade de Economia, Universidade do Porto); Paula Sarmento (CEF.UP, Faculdade de Economia, Universidade do Porto)
    Abstract: In an incomplete regulation framework the Regulator cannot replicate all the possible outcomes by himself since he has no influence on some firms present in the market. When facing asymmetric information regarding the regulated firm’s costs, it may be better for the Regulator to allow the other competitors to extract a truthful report from her through side-payments in a collusion and therefore the “Collusion-Proofness Principle” may not hold. In fact, by introducing an exogenous number of unregulated competitors, Social Welfare differences seem to favour a Collusion-Allowing equilibrium. However, such result will strongly depend on the relative importance given by the Regulator to the Consumer Surplus.
    Keywords: Incomplete Regulation, Asymmetric Information, Collusion, Market Competition
    JEL: L41 L51 D82
    Date: 2009–04
  8. By: Francesca Barigozzi; Dominique Henriet
    Abstract: We compare the alternative approaches for regulating genetic information in the health insurance market when prevention measures are available. In the model, firms offer insurance contracts to consumers who are initially uninformed of their risk type but can obtain such information by performing a costless genetic test. A crucial ingredient of our analysis is that information has decision-making value since it allows for optimal choice of a self-insurance action (secondary prevention). We focus on the welfare properties of market equilibria obtained under the different regulatory schemes and, by using an intuitive graphical analysis, we rank them unambiguously. Our results show that Disclosure Duty weakly dominates the other regulatory schemes and that Strict Prohibition represents the worst regulatory approach.
    Keywords: health insurance markets, information gathering, discrimination risk, classification risk, self-insurance
    JEL: D82 D83 G22 L52
    Date: 2008–12
  9. By: Trevon Logan; Manisha Shah
    Abstract: Economists argue that rich information environments and formal enforcement of contracts are necessary to prevent market failures when information asymmetries exist. We test for the necessity of formal enforcement to overcome the problems of asymmetric information by estimating the value of information in an illegal market with a particularly rich information structure: the online market for male sex work. We assemble a rich dataset from the largest and most comprehensive online male sex worker website to estimate the effect of information on pricing. We show how clients of male sex workers informally police the market in a way that makes signaling credible. Using our institutional knowledge, we also identify the specific signal male sex workers use to communicate quality to clients: face pictures. We find that the premium to information is large and that it is due entirely to face pictures. More importantly, the premium is in the range of premiums to information estimated for legal markets. We also show that the evidence is inconsistent with alternative explanations such as beauty premiums. The findings provide novel evidence on the ability of rich information environments to overcome the problems of asymmetric information without formal enforcement, and show that the value of information in illegal markets is similar to its value in legal markets.
    JEL: D4 D8 J4 K4 L8
    Date: 2009–04
  10. By: Patrick Bajari; Gregory Lewis
    Abstract: In public sector procurement, social welfare often depends on the time taken to complete the contract. A leading example is highway construction, where slow completion times inflict a negative externality on commuters. Recently, highway departments have introduced innovative contracting methods that give contractors explicit time in­centives. We characterize equilibrium bidding and efficient design of these contracts. We then gather a unique data set of highway repair projects awarded by the Minnesota Department of Transportation that includes both innovative and standard contracts. Descriptive analysis shows that for both contract types, contractors respond to the incentives as the theory predicts, both at the bidding stage and after the contract is awarded. Next we build a structural econometric model that endogenizes project completion times, and perform counterfactual policy analysis. Our estimates suggest that switching from standard contracts to designs with socially efficient time incentives would raise commuter surplus relative to the contractor’s costs by 19% of the contract value; or in terms of the 2009 Mn/DOT budget, $290 million.
    JEL: D02 D21 D44 H57 L0 L74 L78
    Date: 2009–04

This nep-cta issue is ©2009 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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