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on Contract Theory and Applications |
| By: | Delacroix, Alain (University of Québec at Montréal); Wasmer, Etienne (Sciences Po, Paris) |
| Abstract: | Wage determination under asymmetric information generates inefficiencies due to excess turnover. Severance pay and layoff taxes can improve efficiency. We show that inefficient separations can even be fully removed with fixed separation taxes in the case where the relevant private information is exponentially distributed. |
| Keywords: | bargaining, asymmetric information, employment protection legislation, inefficient job separations |
| JEL: | J41 J60 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4524&r=cta |
| By: | Piero Gottardi (European University Institute - Department of Economics); Jean-Marc Tallon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Paolo Ghirardato (Collegio Carlo Alberto - Via Real Collegio 30) |
| Abstract: | This paper studies the costs and benefits of delegating decisions to superiorly informed agents relative to the use of rigid, non discretionary contracts. Delegation grants some flexibility in the choice of the action by the agent, but also requires the use of an appropriate incentive contract so as to realign his interests with those of the principal. The parties' understanding of the possible circumstances in which actions will have to be chosen and their attitude towards risk and uncertainty play then an important role in determining the costs of delegation. The main focus of the paper lies indeed in the analysis of these costs and the consequences for whether or not delegation is optimal. We determine and characterize the properties of the optimal flexible contract both when the parties have sharp probabilistic beliefs over the possible events in which the agent will have to act and when they only have a set of such beliefs. We show that the higher the agent's degree of risk aversion, the higher the agency costs for delegation and hence the less profitable is a flexible contract versus a rigid one. The agent's imprecision aversion in the case of multiple priors introduces another, additional agency costs ; it again implies that the higher the degree of imprecision aversion the less profitable flexible contracts versus rigid ones. Even though, with multiple priors, the contract may be designed in such a way that principal and agent end up using "different beliefs" and hence engage in speculative trade, this is never optimal, in contrast with the case where the parties have sharp heterogeneous beliefs. |
| Keywords: | Delegation, flexibility, agency costs, multiple priors, imprecision aversion. |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00429784_v1&r=cta |
| By: | Dur, Robert (Erasmus University Rotterdam); Sol, Joeri (Erasmus University Rotterdam) |
| Abstract: | Social interaction with colleagues is an important job attribute for many workers. To attract and retain workers, managers therefore need to think about how to create and preserve high-quality co-worker relationships. This paper develops a principal-multi-agent model where agents do not only engage in productive activities, but also in social interaction with their colleagues, which in turn creates co-worker altruism. We study how financial incentives for productive activities can improve or damage the work climate. We show that both team incentives and relative incentives can help to create a good work climate. |
| Keywords: | social interaction, altruism, incentive contracts, co-worker satisfaction |
| JEL: | D86 J41 M50 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4532&r=cta |
| By: | Daniel Danau; Annalisa Vinella |
| Abstract: | We consider a principal who deals with two privately informed agents protected by limited liability. Their technologies are such that the fixed costs decline with the marginal costs (the types), which are correlated. Because of these technological features, agents display countervailing incentives to misrepresent type. We show that, with high liability, the first-best outcome can be effected for any type if (1) the fixed cost is non-concave in type, under the contract that yields the smallest feasible loss to agents; (2) the fixed cost is not very concave in type, under the contract that yields the maximum sustainable loss to agents. We further show that, with low liability, the first-best outcome is still implemented for a non-degenerate range of types if the fixed cost is less concave in type than some given threshold, which tightens as the liability reduces. The optimal contract entails pooling otherwise.. |
| Keywords: | Countervailing incentives; Limited liability; Correlation; Pooling |
| JEL: | D82 |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:san:crieff:0911&r=cta |
| By: | Xavier Vives (IESE Business School and UPF) |
| Abstract: | A finite number of sellers (n) compete in schedules to supply an elastic demand. The costs of the sellers have uncertain common and private value components and there is no exogenous noise in the system. A Bayesian supply function equilibrium is characterized; the equilibrium is privately revealing and the incentives to acquire information are preserved. Price-cost margins and bid shading are affected by the parameters of the information structure: supply functions are steeper with more noise in the private signals or more correlation among the costs parameters. In fact, for large values of noise or correlation supply functions are downward sloping, margins are larger than the Cournot ones, and as we approach the common value case they tend to the collusive level. Private information coupled with strategic behavior induces additional distortionary market power above full information levels and welfare losses which can be counteracted by subsidies. As the market grows large the equilibrium becomes price-taking, bid shading is of the order of 1/n, and the order of magnitude of welfare losses is I/n^2. The results extend to demand schedule competition and a range of applications in product and financial markets are presented. |
| Keywords: | Reverse auction, Demand schedule competition, Market power, Adverse selection, Competitiveness, Rational expectations, Collusion, Welfare |
| JEL: | L13 D44 D82 G14 L94 E58 F13 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1736&r=cta |
| By: | Hendrik Hakenes (Institute of Financial Economics, Leibniz University of Hannover); Isabel Schnabel (Department of Law and Economics, Johannes Gutenberg University Mainz) |
| Abstract: | We present a banking model with imperfect competition in which borrowers’ access to credit is improved when banks are able to transfer credit risks. However, the market for credit risk transfer (CRT) works smoothly only if the quality of loans is public information. If the quality of loans is private information, banks have an incentive to grant unprofitable loans in order to transfer them to other parties, leading to an increase in aggregate risk. Nevertheless, the introduction of CRT generally increases welfare in our setup. However, under private information, higher competition induces an expansion of loans to unprofitable firms, which in the limit offsets the welfare gains from CRT completely. |
| Keywords: | access to credit, bank competition, credit derivatives, Credit risk transfer, public and private information |
| JEL: | G13 G21 L11 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2009_33&r=cta |
| By: | Jos Jansen (Max Planck Institute for Research on Collective Goods, Bonn) |
| Abstract: | This paper studies the incentives for production cost disclosure in an asymmetric Cournot duopoly. Whereas the efficient firm (consumers) prefers information sharing (concealment) when the firms choose accommodating strategies in the product market, the firm (consumers) may prefer information concealment (sharing) when it can exclude its competitor from the market. Hence, the rankings of expected profit and consumer surplus can be reversed if exit of the inefficient firm is possible. Although the efficient firm has stronger incentives to share information when it shares strategically, there remain cases in which the firm conceals information in equilibrium to induce exit. |
| Keywords: | cost asymmetry, Cournot duopoly, exit, information disclosure, precommitment |
| JEL: | D82 L13 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2009_32&r=cta |
| By: | Iyer, Rajkamal (MIT); Khwaja, Asim Ijaz (Harvard University); Luttmer, Erzo F. P. (Harvard University); Shue, Kelly (Harvard University) |
| Abstract: | The current banking crisis highlights the challenges faced in the traditional lending model, particularly in terms of screening smaller borrowers. The recent growth in online peer-to-peer lending marketplaces offers opportunities to examine different lending models that rely on screening by multiple peers. This paper evaluates the screening ability of lenders in such peer-to-peer markets. Our methodology takes advantage of the fact that lenders do not observe a borrower's true credit score but only see an aggregate credit category. We find that lenders are able to use available information to infer a third of the variation in creditworthiness that is captured by a borrower's credit score. This inference is economically significant and allows lenders to lend at a 140-basis-points lower rate for borrowers with (unobserved to lenders) better credit scores within a credit category. While lenders infer the most from standard banking "hard" information, they also use non-standard (subjective) information. Our methodology shows, without needing to code subjective information that lenders learn even from such "softer" information, particularly when it is likely to provide credible signals regarding borrower creditworthiness. Our findings highlight the screening ability of peer-to-peer markets and suggest that these emerging markets may provide a viable complement to traditional lending markets, especially for smaller borrowers. |
| JEL: | D53 D80 G21 L81 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:harjfk:rwp09-031&r=cta |
| By: | Michael, Steven C. (University of Illinois at Urbana-Champaign) |
| Abstract: | Agency relationships--where one party (the principal) delegates authority to another (the agent)--are well studied in financial settings but less so in technical settings. The asymmetry of information between the general manager and the technical manager is likely to create the possibility of misdirected effort, an overuse of the agent's human capital, whether the agent is opportunistic or not. Analyzing a dataset of information technology hardware and staff spending by larger multidivisional firms during a growth phase of US IT spending, 1989-1993, results suggest that technical managers significantly overspent on hardware, with deleterious consequences for performance. Chief executive experience significantly altered the effects of overspending. Analysis of the results suggest a solution, a model termed "staged commitment," that can be used to monitor technical agents in many areas of business. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:illbus:09-0103&r=cta |
| By: | Johannes Horner (Cowles Foundation, Yale University); Stefano Lovo (HEC School of Management, Paris and GREGHEC); Tristan Tomala (HEC School of Management, Paris and GREGHEC) |
| Abstract: | We characterize belief-free equilibria in infinitely repeated games with incomplete information with N \ge 2 players and arbitrary information structures. This characterization involves a new type of individual rational constraint linking the lowest equilibrium payoffs across players. The characterization is tight: we define a set of payoffs that contains all the belief-free equilibrium payoffs; conversely, any point in the interior of this set is a belief-free equilibrium payoff vector when players are sufficiently patient. Further, we provide necessary conditions and sufficient conditions on the information structure for this set to be non-empty, both for the case of known-own payoffs, and for arbitrary payoffs. |
| Keywords: | Repeated games with incomplete information, Harsanyi doctrine, Belief-free equilibria |
| JEL: | C72 C73 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1739&r=cta |
| By: | Gilberto Turati (Università di Torino); Luigi Buzzacchi (Politecnico di Torino, DISPEA) |
| Abstract: | In this paper we consider the institutional arrangements needed in a decentralised framework to cope with the potential adverse welfare effects caused by localized negative shocks, that impact on the provision of public services and that can be limited by precautionary investments. We model the role of a public mutual fund to cover these “collective risks”. We first study the under-investment problem stemming from the moral hazard of Local administrations, when investments are defined at the local level and are not observable by the Central government that manages the mutual fund. We then examine the potential role of private insurers in solving the underinvestment problem. Our analysis shows that the public fund is almost always superior to the private insurance solution. |
| Keywords: | intergovernmental transfers, private insurer, collective risks |
| JEL: | H23 H77 G22 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:ieb:wpaper:2009/10/doc2009-21&r=cta |
| By: | Helios Herrera (SIPA, Columbia University); Johannes Horner (Cowles Foundation, Yale University) |
| Abstract: | This paper examines social learning when only one of the two types of decisions is observable. Because agents arrive randomly over time, and only those who invest are observed, later agents face a more complicated inference problem than in the standard model, as the absence of investment might reflect either a choice not to invest, or a lack of arrivals. We show that, as in the standard model, learning is complete if and only if signals are unbounded. If signals are bounded, cascades may occur, and whether they are more or less likely than in the standard model depends on a property of the signal distribution. If the hazard ratio of the distributions increases in the signal, it is more likely that no one invests in the standard model than in this one, and welfare is higher. Conclusions are reversed if the hazard ratio is decreasing. The monotonicity of the hazard ratio is the condition that guarantees the presence or absence of informational cascades in the standard herding model. |
| Keywords: | Informational herds, Cascades, Selection bias |
| JEL: | D82 D83 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1738&r=cta |
| By: | Tianxi Wang |
| Abstract: | The paper shows that the principal can enhance her control over the agent's human capital by acquiring the physical capital that is critical for him to create value. However, the enhancement in the control necessarily reduces his incentive to make human capital investment ex ante and to exert e¤ort ex post. This trade-off between control and incentive thus decides the boundary of the firm. The paper also presents a rationale for M-form firms: centralized ownership of physical capital to facilitate coordination, and dispersed payoff rights to incentivize divisions. |
| Date: | 2009–11–03 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:676&r=cta |
| By: | Johannes Horner (Cowles Foundation, Yale University); Dinah Rosenberg (Dept. of Economics and Decision Sciences, HEC Paris and GREGHEC); Eilon Solan (School of Mathematical Sciences, Tel Aviv University); Nicolas Vieille (Dept of Economics and Decision Sciences, HEC Paris and GREGHEC) |
| Abstract: | We apply the average cost optimality equation to zero-sum Markov games, by considering a simple game with one-sided incomplete information that generalizes an example of Aumann and Maschler (1995). We determine the value and identify the optimal strategies for a range of parameters. |
| Keywords: | Repeated game with incomplete information, Zero-sum games, Partially observable Markov decision processes |
| JEL: | C72 C73 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1737&r=cta |
| By: | Groh, Alexander P. (IESE Business School); Liectenstein, Heinrich (IESE Business School) |
| Abstract: | We contribute to the knowledge about the capital flow from institutional investors, via Venture Capital (VC) funds as intermediaries, to their final destination, entrepreneurial ventures. Therefore, we run a world-wide survey among 1,079 institutional investors to determine the importance of several criteria when they select VC funds. The expected deal flow and access to transactions, a VC fund's historic track record, its local market experience, the match of the experience of team members with the proposed investment strategy, the team's reputation, and the mechanisms proposed to align interest between the institutional investors and the VC funds are the top criteria. The level of fees payable to the funds is not an important selection criterion. The VC relationship is based on a complex structure of (several) principals and agents, and is functional only if the interests of all participants are aligned. Fees are an important element of this alignment. Overall, the sorting criteria of institutional investors are very similar to what we know about the criteria applied by VC funds themselves, when selecting entrepreneurial ventures: the institutions have to mitigate the same kind of agency conflicts that VC funds and entrepreneurs are exposed to. |
| Keywords: | Entrepreneurial Finance; Venture Capital; Asset Allocation Criteria; Institutional Investor; |
| JEL: | G23 G24 |
| Date: | 2009–05–17 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0795&r=cta |
| By: | Besancenot, Damien (University Paris 13 and CEPN (Centre d'Economie de l'université Paris Nord)); Vranceanu, Radu (ESSEC Business School, Department of Economics) |
| Abstract: | Many observers argue that the abnormal accumulation of risk by banks has been one of the major causes of the 2007-2009 financial turmoil. But what could have pushed banks to engage in such a risk race? The answer brought by this paper builds on the classical signaling model by Spence. If banks’ returns can be observed while risk cannot, less efficient banks can hide their type by taking more risks and paying the same returns as the efficient banks. The latter can signal themselves by taking even higher risks and delivering bigger returns. The game presents several equilibria that are all characterized by excessive risk taking as compared to the perfect information case. |
| Keywords: | Banking Sector; Imperfect Information; Risk Strategy; Risk/return Tradeoff; Signaling |
| JEL: | D82 G21 G32 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:essewp:dr-09007&r=cta |
| By: | Lewis, David J. (University of Wisconsin); Plantinga, Andrew J. (Oregon State University); Nelson, Erik (Natural Capital Project, Stanford University); Polasky, Stephen (University of Minnesota) |
| Abstract: | In this paper we analyze the efficiency of voluntary incentive-based land-use policies for biodiversity conservation. Two factors combine to make it difficult to achieve an efficient result. First, the spatial pattern of habitat across multiple landowners is important for determining biodiversity conservation results. Second, the willingness of private landowners to accept a payment in exchange for enrolling in a conservation program is private information. Therefore, a conservation agency cannot easily control the spatial pattern of voluntary enrollment in conservation programs. We begin by showing how the distribution of a landowner's willingness-to-accept a conservation payment can be derived from a parcel-scale land-use change model. Next we combine the econometric land-use model with spatial data and ecological models to simulate the effects of various conservation program designs on biodiversity conservation outcomes. We compare these results to an estimate of the efficiency frontier that maximizes biodiversity conservation at each level of cost. The frontier mimics the regulator's solution to the biodiversity conservation problem when she has perfect information on landowner willingness-to-accept. Results indicate that there are substantial differences in biodiversity conservation scores generated by the incentive-based policies and efficient solutions. The performance of incentive-based policies is particularly poor at low levels of the conservation budget where spatial fragmentation of conserved parcels is a large concern. Performance can be improved by encouraging agglomeration of conserved habitat and by incorporating basic biological information, such as that on rare habitats, into the selection criteria. |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:wisagr:533&r=cta |
| By: | Gabrielle Demange |
| Abstract: | The paper analyzes how uncertainty on traders' participation affects a competitive security market in which there are some informed traders. We show that discontinuities, or "crashes", can arise at equilibrium, even when no investor posts a priori an increasing demand. Because of uncertain participation, the precision of the information brought by a price is endogenous, affected by the size of the trades. As a result, two prices with different volumes and information revelation may clear the market for the same values of the fundamentals. At one price, insurance motives drive the exchanges, noise is large and little information is revealed. At another price, uninformed trades are small, which makes the clearing price much more informative. This multiplicity of prices with different precision of information generates discontinuities. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2009-43&r=cta |
| By: | Timothy W. Guinnane (Yale University, Economic Growth Center); Jochen Streb (University of Hohenheim) |
| Abstract: | This paper studies moral hazard in a sickness-insurance fund that provided the model for social-insurance schemes around the world. The German Knappschaften were formed in the medieval period to provide sickness, accident, and death benefits for miners. By the mid-nineteenth century, participation in the Knappschaft was compulsory for workers in mines and related occupations, and the range and generosity of benefits had expanded considerably. Each Knappschaft was locally controlled and self-funded, and their admirers saw in them the ability to use local knowledge and good incentives to deliver benefits at low cost. The Knappschaft underlies Bismarck’s sickness and accident insurance legislation (1883 and 1884), which in turn forms the basis of the German social-insurance system today and, indirectly, many social-insurance systems around the world. This paper focuses on a problem central to any insurance system, and one that plagued the Knappschaften as they grew larger in the later nineteenth century: the problem of moral hazard. Replacement pay for sick miners made it attractive, on the margin, for miners to invent or exaggerate conditions that made it impossible for them to work. Here we outline the moral hazard problem the Knappschaften faced as well as the internal mechanisms they devised to control it. We then use econometric models to demonstrate that those mechanisms were at best imperfect. |
| Keywords: | sickness insurance, moral hazard, Knappschaft, social insurance |
| JEL: | N33 N43 H55 H53 I18 |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:egc:wpaper:978&r=cta |
| By: | Domenico Colucci (Dipartimento di Matematica per le Decisioni, Universita' degli Studi di Firenze); Nicola Doni (Dipartimento di Scienze Economiche, Universita' degli Studi di Firenze); Vincenzo Valori (Dipartimento di Matematica per le Decisioni, Universita' degli Studi di Firenze) |
| Abstract: | We study a procurement auction recently analysed by Gal-Or et al. (2007). In this auction game the buyer ranks different bids on the basis of both the prices submitted and the quality of each bidder that is her private information. We emphasise the similarity between this model and existing models of competition in horizontally differentiated markets. Finally we illustrate conditions for the existence and the stability of such equilibrium. To this end we extend the model to a dynamic setting in which a sequence of independent auctions takes place. We assume bidders have bounded rationality in a twofold sense. On one hand, they use an underparametrized model of their competitors' behaviour, best responding to expectations on average bids rather than keeping track of the entire vector of competitors' bids. On the other they update expectations adaptively. In a general framework with more than two bidders the system may fail to converge to the steady state, i.e. to the symmetric Nash equilibrium of the original game. |
| Keywords: | Non-binding auctions, Product differentiation, Hotelling Duopoly, Expectations, Stability of steady states |
| JEL: | D43 D44 C62 D83 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:flo:wpaper:2009-06&r=cta |