nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2009‒06‒17
fifteen papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. To Trust or to Monitor: A Dynamic Analysis By Fali Huang
  2. Search of Prior Art and Revelation of Information by Patent Applicants By Langinier, Corinne; Marcoul, Phillipe
  3. How does Investors' Legal Protection affect Productivity and Growth? By Berdugo, Binyamin; Hadad, Sharon
  4. Evaluating information in zero-sum games with incomplete information on both sides. By Bernard De Meyer; Ehud Lehrer; Dinah Rosenberg
  5. Need I Remind You? Monitoring with Collective Memory By David A. Miller; Kareen Rozen
  6. The Lifecycle of the Financial Sector and Other Speculative Industries By Bruno Biais; Paul Woolley; Jean-Charles Rochet
  7. The Evolution and Utilization of the GATT/WTO Dispute By Pao-Li Chang
  8. Inefficient Worker Turnover By Nicolas L. Jacquet
  9. Repeated games with asymmetric information and random price fluctuations at finance markets : the case of countable state space. By Victor C. Domansky; Victoria L. Kreps
  10. Need I remind you? Monitoring with collective memory By David A. Miller; Kareen Rozen
  11. Information Transmission and Micro-structure rents in Emerging Markets By Siddiqi, Hammad
  12. Employee Screening: Theory and Evidence By Fali Huang; Peter Cappelli
  13. Monetary and Implicit Incentives of Patent Examiners By Langinier, Corinne; Marcoul, Phillipe
  14. With a little help from my enemy: comparative advertising as a signal of quality By Francesca BARIGOZZI; Paolo Giorgio GARELLA; Martin PEITZ
  15. Generalized Agency Problems By Randall Morck

  1. By: Fali Huang (School of Economics, Singapore Management University)
    Abstract: In a principal?agent framework, principals can mitigate moral hazard problems not only through extrinsic incentives such as monitoring, but also through agents intrinsic trustworthiness. Their relative usage, however, changes over time and varies across societies. This paper attempts to explain this phenomenon by endogenizing agent trustworthiness as a response to potential returns. When monitoring becomes relatively cheaper over time, agents acquire lower trustworthiness, which may actually drive up the overall governance cost in society. Across societies, those giving employees lower weights in choosing governance methods tend to have higher monitoring intensities and lower trust. These results are consistent with the empirical evidence.
    Keywords: Monitoring , Trustworthiness , Trust , Screening , Economic Governance
    JEL: D2 J5 L2 M5 Z13
    Date: 2007–09
  2. By: Langinier, Corinne (University of Alberta, Department of Economics); Marcoul, Phillipe (Department of Rural Economy, University of Alberta)
    Abstract: We examine the strategic non-revelation of information by patent applicants. In a model of a bilateral search of information, we show that patent applicants may conceal information, and that examiners make their screening intensity contingent upon the received information. We then analyze the effects of a double review policy and a policy in which examiners ex ante commit to screening efforts. The implementation of the former policy reduces strategic non-revelation, but its overall implication remains unclear. The latter policy involves equal screening intensity across all applications, requires a limited commitment power and induces truthful revelation.
    Keywords: patents; information; incentives
    JEL: D83 O31 O34
    Date: 2009–05–30
  3. By: Berdugo, Binyamin; Hadad, Sharon
    Abstract: This paper analyzes the implications of investors' legal protection on aggregate productivity and growth. We have two main results. First, that better investors' legal protection can mitigate agency problems between investors and innovators and therefore expand the range of high-tech projects that can be financed by non-bank investors. Second, investors' legal protection shifts investment resources from less productive (medium-tech) to highly productive (high-tech) projects and therefore enhances economic growth. These results stem from two forces. On one hand, private investors' moral hazard problems (in which entrepreneurs shift investors' resources to their own benefit), and on the other hand innovators' risk of project termination by banks due to wrong signals about projects' probability of success. Our results are consistent with recent empirical studies that show a high correlation between legal investors' protection and the structure of the financial system as well as the economic performance at industry and macroeconomic levels.
    Keywords: Banks; private investors protection; growth
    JEL: G38 D10 G10 G33
    Date: 2009–05–31
  4. By: Bernard De Meyer (Centre d'Economie de la Sorbonne); Ehud Lehrer (School of Mathematical Sciences - Tel Aviv University); Dinah Rosenberg (LAGA Institut Galilée - Université Paris 13)
    Abstract: In a Bayesian game some players might receive a noisy signal regarding the specific game actually being played before it starts. We study zero-sum games where each player receives a partial information about his own type and no information about that of the other player and analyze the impact the signals have on the payoffs. It turns out that the functions that evaluate the value of information share two property. The first is Blackwell monotonicity, which means that each player gains from knowing more. The second is concavity on the space of conditional probabilities.
    Keywords: Value of information, Blackwell monotonicity, concavity.
    JEL: C72 C73 D80 D82 D83
    Date: 2009–05
  5. By: David A. Miller (University of California, San Diego); Kareen Rozen (Cowles Foundation, Yale University)
    Abstract: We consider a team setting where forgetful players with limited memories have costly but socially efficient tasks to complete. Each teammate promises to complete some subset of the tasks, and strategically memorizes her own promises as well as a subset of her teammates' promises. She can be contractually punished for an unfulfilled promise only if another player remembers it. Hence the team's collective memory serves as a costly monitoring device. We show that linear contracts are the optimal way to ensure that a player completes as many promises as she remembers, and characterize the optimal linear contract when players' memories differ in size and quality. Linear contracts are indeed optimal if players are not very forgetful. However, when players are more forgetful, an optimal equilibrium has empty promises; these are promises a player might not complete even if she remembers them. The corresponding optimal non-linear contract will "forgive" some failures. As players become more forgetful, they make more empty promises and devote more of their memories to monitoring.
    Keywords: Bounded memory, Costly monitoring, Team production, Empty promises, Collective memory, Cross-cueing, Transactive responsibility, Optimal contracts
    JEL: D86
    Date: 2009–06
  6. By: Bruno Biais; Paul Woolley; Jean-Charles Rochet
    Abstract: Speculative industries exploit novel technologies subject to two risks. First, there is uncertainty about the fundamental value of the innovation: is it strong or fragile? Second, it is difficult to monitor managers, which creates moral hazard. Because of moral hazard, managers earn agency rents in equilibrium. As time goes by and profits are observed, beliefs about the industry are rationally updated. If the industry is strong, confidence builds up. Initially this spurs growth. But increasingly confident managers end up requesting very large rents, which curb the growth of the speculative sector. If rents become too high, investors may give up on incentives, and risk and failure rates rise. Furthermore, if the innovation is fragile, eventually there is a crisis, and the industry shrinks. Our model thus captures important stylized facts of the financial innovation wave which took place at the beginning of this century.
    Date: 2009–05
  7. By: Pao-Li Chang (School of Economics, Singapore Management University)
    Abstract: This paper provides a theoretical framework of dispute settlement to explain the surge in blocking incidence of GATT panel reports during the 1980s and the variations in withdrawn incidence versus total disputes across di®erent decades of the GATT regime. The study first suggests the role of the degree of legal controversy over a panel ruling in determining countries' incentives to block (appeal) a panel report under the GATT (WTO) regime. The study then analyzes the effects of political power on countries' incentives to use, and their interactions in using, the dispute settlement mechanism, when two-sided asymmetric information exists regarding panel judgement.
    Keywords: dispute settlement; legal controversy; block; appeal; two-sided asymmetric information; political cost
    JEL: F02 F13 K33 K41 K42
    Date: 2007–07
  8. By: Nicolas L. Jacquet (School of Economics, Singapore Management University)
    Abstract: This paper considers the efficiency properties of risk-neutral workers’ mobility decisions in an equilibrium model with search frictions, but no search externalities, when the rent accruing to a match is split through bargaining. Matches are ex ante homogeneous and their true productivity is learnt after the match is formed. It is shown that the efficiency of worker turnover depends on contract enforceability, and that in the absence of complete enforceability the equilibrium fails to be efficient. This is because without complete enforceability firms cannot credibly offer workers contracts that will guarantee them the entire future of all potential future matches.
    Keywords: On-the-Job Search; Learning; Bargaining; Contracts; Enforceability
    JEL: J30 J6
    Date: 2007–09
  9. By: Victor C. Domansky (St. Petersburg Institute for Economics and Mathematics - Russian Academy of Sciences); Victoria L. Kreps (St. Petersburg Institute for Economics and Mathematics - Russian Academy of Sciences)
    Abstract: This paper is concerned with multistage bidding models introduced by De Meyer and Moussa Saley (2002) to analyze the evolution of the price system at finance markets with asymmetric information. The zero-sum repeated games with incomplete information are considered modeling the bidding with countable sets of possible prices and admissible bids. It is shown that, if the liquidation price of a share has a finite variance, then the sequence of values of n-step games is bounded and converges to the value of the game with infinite number of steps. We construct explicitly the optimal strategies for this game. The optimal strategy of Player 1 (the insider) generates a symmetric random walk of posterior mathematical expectations of liquidation price with absorption. The expected duration of this random walk is equal to the initial variance of liquidation price. The guaranteed total gain of Player 1 (the value of the game) is equal to this expected duration multiplied with the fixed gain per step.
    Keywords: Multistage bidding, asymmetric information, repeated games, optimal strategy.
    JEL: C73 D82 D44
    Date: 2009–01
  10. By: David A. Miller; Kareen Rozen
    Date: 2009–06–01
  11. By: Siddiqi, Hammad
    Abstract: This paper offers a first ever theoretical study of a unique financing instrument associated with prominent emerging equity markets in South Asia. The instrument known as badla, in local parlance, has two interesting aspects, which have been ignored thus far. Firstly, it may serve as an information transmission mechanism and can be thought of as an institutional response to information gaps in the emerging markets. Secondly, it creates new types of rents, called “market microstructure” rents for certain market players. These rents are then exploited to gain control of the governing boards of equity markets. Consequently, institutional inertia is created which hinders the badly needed reform process.
    Keywords: Information transmission; Signaling; Microstructure rents; Linked games; Institutional inertia
    JEL: D02 K42 D80 G10
    Date: 2009–02–10
  12. By: Fali Huang (School of Economics, Singapore Management University); Peter Cappelli (The Wharton School, University of Pennsylvania)
    Abstract: Arguably the fundamental problem faced by employers is how to elicit effort from employees. Most models suggest that employers meet this challenge by monitoring employees carefully to prevent shirking. But there is another option that relies on heterogeneity across employees, and that is to screen job candidates to find workers with a stronger work ethic who require less monitoring. This should be especially useful in work systems where monitoring by supervisors is more difficult, such as teamwork systems. We analyze the relationship between screening and monitoring in the context of a principal-agent model and test the theoretical results using a national sample of U.S. establishments, which includes information on employee selection. We find that employers screen applicants more intensively for work ethic where they make greater use of systems such as teamwork where monitoring is more difficult. This screening is also associated with higher wages, as predicted by the theory: The synergies between reduced monitoring costs and high performance work systems enable the firm to pay higher wages to attract and retain such workers. Screening for other attributes, such as work experiences and academic performance, does not produce these results.
    Keywords: Employee Screening, Monitoring, Work Ethic, High Performance Work Practices, Principal-Agent Model.
    JEL: M51 M54 J30
    Date: 2007–09
  13. By: Langinier, Corinne (University of Alberta, Department of Economics); Marcoul, Phillipe (Department of Rural Economy, University of Alberta)
    Abstract: Patent examiners, who are often accused of granting questionable patents, might lack proper incentives to carefully scrutinize applications. Furthermore, they have outside options and leave the patent office. It is thus interesting to investigate whether their granting behavior is affected by career concerns. In a simple setting, we analyze different incentive schemes that reward examiners on the basis of rejected and/or accepted patents. We then study the effect of career concerns on the granting behavior of examiners. We find that a reward based on rejection gives more incentives to search for relevant information, and career concerns increase these incentives. Besides, the information provided by the applicant has an impact on the examiners incentive to search for information.
    Keywords: patent examiners; career concerns
    JEL: J60 O34
    Date: 2009–05–30
  14. By: Francesca BARIGOZZI; Paolo Giorgio GARELLA; Martin PEITZ
    Abstract: We extend the theory of advertising as a quality signal, using a model where an entrant can choose to advertise by comparing its product to that of an established incumbent. Comparative advertising, comparing quality of one’s own product to that of a rival’s, empowers the latter to file for court intervention if it believes the comparison to be false or misleading. We show that comparative advertising can be a signal in instances where generic advertising is not viable.
    Keywords: Advertising, Quality, signaling, Entry, Competition
    JEL: L15 M37 L13
    Date: 2008–10–16
  15. By: Randall Morck
    Abstract: Agency problems in economics virtually always entail self-interested agency exhibiting "insufficient" loyalty to principal. Social psychology also has a literature, mainly derived from work by Stanley Milgram, on issues of agency, but this emphasizes excessive loyalty -- people undergoing a so-called "agentic shift" and forsaking rationality for loyalty to a legitimate principal, as when "loyal" soldiers obey orders to commit atrocities. This literature posit that individuals experience a deep inner satisfaction from acts of loyalty -- essentially a "utility of loyalty" -- and that this both buttresses institutions organized as hierarchies and explains much human misery. Agency problems of excessive loyalty, as when boards kowtow to errant CEOs and controlling shareholders, may be as economically important in corporate finance as the more familiar problems of insufficient loyalty of corporate insiders to shareholders. Overt conflict between rival authorities is shown to reverse the "agentic shift" -- justifying institutions that formalize argumentation such as the adversary system in Common Law courts; the Official Opposition in Westminster democracies; discussants and referees in academia; and independent directors, non-executive chairs, and proxy contests in corporate governance.
    JEL: D02 D72 D87 G3 K0 P37
    Date: 2009–06

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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