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on Contract Theory and Applications |
| By: | Philippon, Thomas; Schnabl, Philipp |
| Abstract: | We analyze public interventions to alleviate debt overhang among private firms when the government has limited information and limited resources. We compare the efficiency of buying equity, purchasing existing assets, and providing debt guarantees. With symmetric information, all the interventions are equivalent. With asymmetric information between firms and the government, buying equity dominates the two other interventions. We solve for the optimal intervention, and show how it can be implemented with subordinated loans and warrants. |
| Keywords: | bailout; capital; financial crisis; moral hazard |
| JEL: | G3 G34 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7516&r=cta |
| By: | Florence TOUYA |
| Abstract: | Tax Interactions with Asymmetric Information and Nonlinear Instruments |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:tac:wpaper:9&r=cta |
| By: | Edmans, Alex; Gabaix, Xavier; Sadzik, Tomasz; Sannikov, Yuliy |
| Abstract: | Contracts in a dynamic model must address a number of issues absent from static frameworks. Shocks to firm value may weaken the incentive effects of securities (e.g. cause options to fall out of the money), and the impact of some CEO actions may not be felt until far in the future. We derive the optimal contract in a setting where the CEO can affect firm value through both productive effort and costly manipulation, and may undo the contract by privately saving. The optimal contract takes a surprisingly simple form, and can be implemented by a "Dynamic Incentive Account." The CEO’s expected pay is escrowed into an account, a fraction of which is invested in the firm’s stock and the remainder in cash. The account features state-dependent rebalancing and time-dependent vesting. It is constantly rebalanced so that the equity fraction remains above a certain threshold; this threshold sensitivity is typically increasing over time even in the absence of career concerns. The account vests gradually both during the CEO’s employment and after he quits, to deter short-termist actions before retirement. |
| Keywords: | Contract theory; executive compensation; incentives; manipulation; principal-agent problem; private saving; vesting |
| JEL: | D2 D3 G34 J3 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7497&r=cta |
| By: | Masazumi Hattori (Institute for Monetary and Economic Studies, Bank of Japan (E-mail: masazumi.hattori@boj.or.jp)); Kazuhiko Ohashi (Professor, Hitotsubashi University (E-mail: kohashi@ics.hit-u.ac.jp)) |
| Abstract: | We consider an economy in which a lender finances loans to borrowers by issuing a securitized product to investors and in which the credit quality of the product can depend on whether the lender screens borrowers. In the presence of asymmetric information between the lender and investors regarding the credit quality of potential borrowers, overvaluation from the lender's perspective can occur for low-quality securitized products, which inefficiently induces the lender not to screen borrowers and hence to issue the securitized products of low credit quality. This is likely to occur when the probability of being in a bad state (i.e., the presence of low-quality borrowers) is low, or when the seeds of recession begin emerging in a booming economy. |
| Keywords: | Originate-to-distribute, Securitization, Asymmetric information, Screening, Verification |
| JEL: | G14 G21 G24 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:09-e-26&r=cta |
| By: | Keuschnigg, Christian; Ribi, Evelyn |
| Abstract: | In the absence of financing frictions, profit taxes reduce investment by their effect on the user cost of capital. With finance constraints due to moral hazard, investment becomes sensitive to cash-flow and own equity of firms. We propose a corporate finance model of investment and derive three central results: (i) Even small taxes impose first order welfare losses on financially constrained firms; (ii) ACE and cash-flow tax systems, which are investment neutral in the neoclassical model, are no longer neutral when firms are finance constrained. (iii) When banks are active and provide external finance together with monitoring services, the two systems not only reduce investment, but are also no longer equivalent. With active banks, investment is subject to double moral hazard and the timing of tax payments becomes important. The ACE system gives tax relief at the return stage and provides better incentives than a cash-flow tax which gives tax relief upfront. |
| Keywords: | ACE tax; cash-flow tax; Finance constraints; profit tax |
| JEL: | G38 H25 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7433&r=cta |
| By: | Menapace, Luisa; Moschini, GianCarlo |
| Abstract: | This paper studies firm reputation as a mechanism to assure product quality in perfectly competitive markets in a context in which both certification and trademarks are available. Shapiro’s (1983) model of reputation is extended to reflect both collective and firm-specific reputations, and this framework is used to study certification and trademarks for food products with a regional identity, known as Geographical Indications (GIs). Our model yields two primary results. First, in markets with asymmetric information and moral hazard problems, credible certification schemes reduce the cost of establishing reputation and lead to welfare gains compared to a situation in which only private trademarks are available. Hence, certification improves the ability of reputation to operate as a mechanism for assuring quality. Second, the actual design of the certification scheme plays an important role in mitigating informational problems. From a policy perspective, our results have implications for the current debate and negotiations on GIs at the World Trade Organization and the ongoing product quality policy reform within the European Union. With regard to the instrument of choice to provide intellectual property protection for GIs, our model favors a sui generis scheme based on appellations over certification marks. Finally, our model supports the introduction of a scheme for “traditional products,” based exclusively on quality (rather than on geographical) requirements, the feasibility of which is currently being investigated by the European Union. |
| Keywords: | Asymmetric Information, Certification, Geographical Indications, Quality, Reputation |
| Date: | 2009–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:13126&r=cta |
| By: | Huffman, Wallace |
| Abstract: | This paper reviews and synthesizes the theory of information economics and empirical evidence on how information changes the behavior of consumers, households and firms. I show that consumers respond to new information in food experiments but perhaps not in retirement account management. Some seeming perverse consumer/investor decision making may be a result of a complex decision with a low expected payoff. |
| Keywords: | information economics, consumer behavior, behavioral economics, moral hazard, adverse selection. |
| JEL: | A0 |
| Date: | 2009–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:13128&r=cta |
| By: | Marialaura Pesce; Nicholas C Yannelis |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:man:sespap:0922&r=cta |
| By: | Fender, Ingo; Mitchell, Janet |
| Abstract: | This paper examines the power of different contractual mechanisms to influence an originator's choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a "vertical slice", or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism, and the equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. If the choice of how much and what form to retain is left up to the originator, the retention mechanism may lead to low screening effort, suggesting a potential rationale for government intervention. |
| Keywords: | Borrower screening; Retention requirements; Securitisation; Tranching |
| JEL: | D82 D86 G21 G28 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7483&r=cta |
| By: | Dessí, Roberta |
| Abstract: | Contractual execution generates hard information, available to the contracting parties, even when contracts are secretly executed. Building on this simple observation, the paper shows that incomplete contracts can be preferred to complete contracts. This is because (i) execution of incomplete contracts reveals less information to outside parties, giving rise to strategic gains; (ii) secretly executed complete contracts could not do better, given the possible strategic uses of the hard information generated by execution of the contract. The key effects at work are explored in the case of financial contracts for innovative start-up companies, providing a rationale for the observed differences in the extent to which venture capital contracts include a variety of contingencies, and for how this varies across industries and geographically. |
| Keywords: | competition; contingencies; execution; hard evidence; incomplete contracts; venture capital |
| JEL: | D82 D86 G24 L22 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7413&r=cta |
| By: | Peng, Lin; Röell, Ailsa A |
| Abstract: | This paper presents a rational expectations model of optimal executive compensation in a setting where managers are in a position to manipulate short-term stock prices, and managers' propensity to manipulate is uncertain. Stock-based incentives elicit not only productive effort, but also costly information manipulation. We analyze the tradeoffs involved in conditioning pay on long- versus short-term performance and characterize a second-best optimal compensation scheme. The paper shows manipulation, and investors' uncertainty about it, affects the equilibrium pay contract and the informational efficiency of asset prices. The paper derives a range of new cross-sectional comparative static results and sheds light on corporate governance regulations. |
| Keywords: | corporate governance; Executive compensation; long- versus short-term; manipulation uncertainty |
| JEL: | D8 G30 G34 J33 J41 K2 |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7442&r=cta |
| By: | Allenspach, Nicole (Swiss National Bank) |
| Abstract: | This paper shows that transparency in banking can be harmful from a social planner’s point of view. According to our model, enhancing transparency above a certain level may lead to the inefficient liquidation of a bank. The reason lies in the nature of a standard deposit contract: its payoff scheme has limited upside gains (cap) but leaves the depositor with the downside risk. Accordingly, depositors will not take into account possible future upside gains of the bank when deciding whether or not to withdraw their deposits. Our result points towards a trade-off the regulator faces: while enhancing transparency may be useful to reduce incentives for excessive risk-taking (moral hazard), it may also increase the risk of inefficient bank runs. |
| Keywords: | banking; transparency; financial stability; bank run |
| JEL: | D82 G21 G28 |
| Date: | 2009–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:ris:snbwpa:2009_011&r=cta |
| By: | Christopher Cotton (Department of Economics, University of Miami) |
| Abstract: | A decision maker must divide a prize between multiple agents. The prize may be divisible (e.g., a budget, pork-barrel spending) in which case he prefers to award larger shares of the prize to relatively more-qualified agents, or it may be non-divisible (e.g., jobs, college admissions) in which case he prefers to award the limited number of prizes to the most-qualified agents. He is, however, ex ante uncertain about agent qualications. Agents may directly reveal verifiable evidence about their qualifications to the decision maker only if the decision maker grants them \access" (e.g., he takes time to review their applications, hold interviews, or conduct an investigation). The time-constrained decision maker must decide which agents receive access, as he cannot grant access to everyone. One way to award access is through a competition, where agents submit payments (e.g., time, money) and higher payments correspond to a greater likelihood of receiving access. The analysis shows that there always exists competition for access mechanisms in which the decision maker becomes fully informed about the qualifications of all agents (even though only some agents reveal their qualifications through access). That is, the decision maker can award access in such a way that he always becomes fully informed and chooses his preferred prize allocation. The paper derives such full-revelation mechanisms, and determines when awarding access through a traditional all-pay auction is sufficient for full revelation. |
| Keywords: | Verifiable evidence disclosure, hard information, all-pay auction, handicap auction, access, lobbying |
| JEL: | D44 D78 D82 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:mia:wpaper:2010-12&r=cta |
| By: | Emir Kamenica; Matthew Gentzkow |
| Abstract: | When is it possible for one person to persuade another to change her action? We take a mechanism design approach to this question. Taking preferences and initial beliefs as given, we introduce the notion of a persuasion mechanism: a game between Sender and Receiver defined by an information structure and a message technology. We derive necessary and sufficient conditions for the existence of a persuasion mechanism that strictly benefits Sender. We characterize the optimal mechanism. Finally, we analyze several examples that illustrate the applicability of our results. |
| JEL: | D83 K41 L15 M37 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15540&r=cta |
| By: | Siegfried Berninghaus (Institut für Wirtschaftstheorie und Operations Research, University of Karlsruhe); Sabrina Bleich (Institut für Wirtschaftstheorie und Operations Research, University of Karlsruhe); Werner Güth (Max Planck Institute of Economics, Jena) |
| Abstract: | If the future market wage is uncertain, engaging in long-term employment is risky, with the risk depending on how regulated the labor market is. In our experiment long-term employment can result either from offering long-term contracts or from repeatedly and mutually opting for rematching. Treatments differ in how regulations restrict the employer's flexibility in adapting the employment contract to changes of the market (wage). All treatments allow for longer contract duration as well as for mutually opting to be rematched. Effort is chosen by employees after a contract is concluded. Treatments vary from no flexibility to no restriction at all. Will more (downward) flexibility be used in ongoing employment but reduce efficiency? If so, deregulation may weaken rather than promote labor market efficiency. And will regulation crowd out long-term employment, either in the form of long-term contracts or voluntary rematching? |
| Keywords: | deregulation, employment contracts, wage flexibility, principal-agent theory, experimental economics, repeated interaction |
| JEL: | C72 C90 F16 J21 J24 L10 |
| Date: | 2009–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2009-094&r=cta |
| By: | Thorsten Koeppl (Queen's University); Cyril Monnet (Federal Reserve Bank of Philadelphia); Ted Temzelides (Rice University) |
| Abstract: | Clearinghouses support financial trades by keeping records of transactions and by providing liquidity through short-term credit that is periodically cleared by participants. We study efficient clearing arrangements for formal exchanges, where traders must clear with a clearinghouse, and for over-the-counter (OTC) markets, where trades can be cleared bilaterally. When clearing is costly, we show that it can be efficient to subsidize the clearing process for OTC transactions by charging a higher price for the clearing of transactions in exchanges. This necessitates a clearinghouse that operates across both markets. As a clearinghouse offers credit, intertemporal incentives are needed in order to ensure settlement. An increase in the costs of liquidity provision worsens the incentives to settle. Hence, when liquidity costs increase, concerns about default must lead to a tightening of liquidity provision. |
| Keywords: | Clearing, OTC vs Exchanges, Private Information, Liquidity Costs, Default |
| JEL: | G14 G23 E42 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1222&r=cta |
| By: | Agur, Itai |
| Abstract: | How damaging is competition between bank regulators? This paper models regulators that compete because they want to supervise more banks. Both banks' risk profiles and their access to wholesale funding are endogenous, leading to rich interactions. The sensitivity of regulatory standards to bank moral hazard, adverse selection, liquidity risk and the degree of regulatory bias is investigated. A calibration suggests that regulatory reform can halve bank default rates. The paper also shows how a decline in regulators' monitoring capacity gives rise to a gradual rise in bank risk, followed by a sudden interbank crisis. |
| Keywords: | Arbitrage; Bank default; Interbank market; Moral hazard; Supervision |
| JEL: | G21 G28 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7524&r=cta |
| By: | Tim Grebe; Radosveta Ivanova-Stenzel; Sabine Kröger |
| Abstract: | This article is an experimental investigation on decision making in online auction markets. We focus on a widely used format, the Buy-It-Now auction on eBay, where sellers post prices at which buyers can purchase a good prior to an auction. Even though, buyer behavior is well studied in Buy-It-Now auctions, up to date little is known about the behavior of sellers. In this article, we study how sellers set Buy-It-Now prices by combining the use of a real online auction market (the eBay platform and eBay traders) with the techniques of lab experiments. We find a striking relation between information about agents provided by eBay and their behavior. Information about buyers is correlated with their deviation from true value bidding. Sellers respond strategically to this information when deciding on their Buy-It-Now prices. Our results highlight consequences of information publicly available in (online) markets and underline the crucial role of institutional details. |
| Keywords: | Electronic markets, experience, online auctions, BIN price, buyout price, risk, single item auction, private value, experiment |
| JEL: | C72 C91 D44 D82 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0950&r=cta |
| By: | Brocas, Isabelle; Camerer, Colin; Carrillo, Juan D; Wang, Stephanie W. |
| Abstract: | In experiments, people do not always appear to think very strategically or to infer the information of others from their choices. To understand this thinking process further, we use "Mousetracking" to record which game payoffs subjects look at, for how long, in games of private information with three information states, which vary in strategic complexity. Subjects often deviate from Nash equilibrium choices, converge only modestly toward equilibrium across 40 trials, and often fail to look at payoffs which they need to in order to compute an equilibrium response. Theories such as QRE and cursed equilibrium, which can explain non-equilibrium choices, are not well supported by the combination of both choices and lookups. When cluster analysis is used to group subjects according to lookup patterns and choices, the clusters appear to correspond approximately to level-3, level-2 and level-1 thinking in level-k cognitive hierarchy models. The connection between looking and choices is strong enough that the time durations of looking at key payoffs can predict choices, to some extent, at the individual level and at the trial-by-trial level. |
| Keywords: | asymmetric information; attention; laboratory experiment; mousetracking |
| JEL: | C92 D82 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7529&r=cta |
| By: | Julia Cagé |
| Abstract: | Official Development Aid allows are volatile, non-predictable and not delivered in a transparent way. All these features reinforce asymmetric information between the citizens and the recipient government about the amount of aid flows received by developing countries. This article uses a political economy model of rent extraction to show how this asymmetry (i) encourages rent extraction by kleptocratic regimes, thus reducing aid efficiency, and (ii) increases the negative impact of aid volatility. It identifies a new channel - the "asymmetric information" channel - through which aid volatility is costly for recipient countries. The empirical relevance of the model is confirmed on a panel data of developing countries. Using various specifications and econometric methods, and developing new yearly estimates of aid volatility, I show that (i) introducing more information increases aid efficiency, that (ii) the negative impact of aid volatility on aid efficiency vanishes once one controls for information, and that (iii) this positive impact of information does not come from the fact that more transparent countries tend to have better institutions. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2009-45&r=cta |