nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒01‒23
twelve papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Does private information affect the insurance risk? Evidence from the automobile insurance market. By Arvidsson, Sara
  2. A price uncertainty principle and the existence of sequential equilibrium. By Lionel de Boisdeffre
  3. Informational Barriers to Energy Efficiency – Theory and European Policies By Bleischwitz, Raimund; Andersen, Lars-Morten
  4. Auctioning Process Innovations when Losers’ Bids Determine Royalty Rates By Cuihong Fan; Byoung Heon Jun; Elmar Wolfstetter
  5. Switching Consumers and Product Liability: On the Optimality of Incomplete Strict Liability By Florian Baumann; Tim Friehe; Kristoffel Grechenig
  6. SIGNALING IN AUCTIONS AMONG COMPETITORS By Benedikt von Scarpatetti; Cédric Wasser
  7. Market and Non-Market Mechanisms for the Optimal Allocation of Scarce Resources By Daniele Condorelli
  8. Directed Search in the Housing Market By Albrecht, James; Gautier, Pieter; Vroman, Susan
  9. Optimal Auction Design and Equilibrium Selection in Sponsored Search Auctions By Benjamin Edelman; Michael Schwarz
  10. Screening, Competition, and Job Design Economic Origins of Good Jobs By Björn Bartling; Ernst Fehr; Klaus M. Schmidt
  11. Licensing a common value innovation when signaling strength may backfire By Cuihong Fan; Byoung Heon Jun; Elmar Wolfstetter
  12. Sticks and Carrots in Procurement By Maria Bigoni; Giancarlo Spagnolo; Paola Valbonesi

  1. By: Arvidsson, Sara (VTI)
    Abstract: We empirically investigate the effect of policyholders’ private information of risky traffic behavior on automobile insurance coverage and ex post risk. We combine our insurance company’s information with private information data that is not accessible to the insurance company. We show that being unable to reject the null of zero correlation is not necessarily consistent with symmetric information in the automobile insurance market. Our results are twofold: In contrast to much of the previous work we find a positive significant correlation for three groups of policyholders, consistent with the adverse selection prediction. We furthermore find that private information about risky traffic behavior increases ex post risk while it both increases and decreases the demand for extensive insurance. This supports our hypothesis that adverse and propitious is present simultaneously in this market.
    Keywords: Adverse selection; Moral hazard; Propitious selection; Insurance
    JEL: D82
    Date: 2010–01–12
  2. By: Lionel de Boisdeffre (Centre d'Economie de la Sorbonne)
    Abstract: We consider a pure exchange financial economy, where agents observe private information signals, form private anticipations and face an "exogenous uncertainty" on the future state, and an "endogenous uncertainty", on the future prices. At a sequential equilibrium, all agents expect the "true" price as a possible outcome, and elect optimal strategies, which clear on all markets at every time period. This concept differs from both traditional ones of temporary equilibrium and sequential equilibrium with perfect price foresight. We display on an example a continuum of sequential equilibria, varying with agents' anticipations. We show, when anticipations are private or prone to change, that "correct" price forecasts need always embed a set of "minimum uncertainty", which only depends on the fundamentals of the economy and current period prices. When anticipations are so correct, we prove the existence of a sequential equilibrium is still characterized by the no-arbitrage condition.
    Keywords: Sequential equilibrium, temporary equilibrium, perfect foresight, expectations, incomplete markets, asymmetric information, arbitrage, existence proof.
    JEL: D52
    Date: 2009–12
  3. By: Bleischwitz, Raimund; Andersen, Lars-Morten
    Abstract: This BEER addresses informational barriers to energy efficiency. It is a widely acknowledged result that an energy efficiency gap exists implying that the level of energy efficiency is at an inefficiently low level. Several barriers to energy efficiency create this gap and the presence of asymmetric information is likely to be one such barrier. In this article a theoretical framework is presented addressing the issues of moral hazard and adverse selection related to energy efficiency. Based on the theoretical framework, European policies on energy efficiency are evaluated. The article is divided into two main parts. The first part presents the theory on information asymmetries and its consequences on energy efficiency focusing on the problems of moral hazard and adverse selection. Having established a theoretical framework to understand the agency barriers to energy efficiency, the second part evaluates the policies of the European Union on energy efficiency. The BEER finds that problems of moral hazard and adverse selection indeed can help explain the seemingly low levels of energy. In both presented models the cost to the principal from implementing high energy efficiency outcome is increased with the informational asymmetries. The theory reveals two implications to policies on energy efficiency. First, the development of measures to enable contractual parties to base remuneration on energy performance must be enhanced, and second, the information on technologies and the education of consumers and installers on energy efficiency must be increased. This could be complemented with certification of installers and energy efficiency advisors to enable consumers to select good agents. Finally, it is found that the preferred EU policy instrument on energy efficiency, so far, seems to be the use of minimum requirements. Less used in EU legislation is the use of measuring and verification as well as the use of certifications. Therefore, it is concluded that the EU should consider an increased use of these instruments, and in particular focus on a further development of standards on measurability and verification as well as an increased focus on education of consumers as well as installers and advisors on energy efficiency.
    Keywords: Energy efficiency; Informational barriers; European policies
    JEL: Q56
    Date: 2009–12
  4. By: Cuihong Fan (Shanghai University of Finance and Economics); Byoung Heon Jun; Elmar Wolfstetter (Humboldt University at Berlin)
    Abstract: We consider a licensing mechanism for process innovations that combines a license auction with royalty contracts to those who lose the auction. Firms’ bids are dual signals of their cost reductions: the winning bid signals the own cost reduction to rival oligopolists, whereas the losing bid influences the beliefs of the innovator who uses that information to set the royalty rate. We derive conditions for existence of a separating equilibrium, explain why a sufficiently high reserve price is essential for such an equilibrium, and show that the innovator generally benefits from the proposed mechanism.
    Keywords: Patents, licensing, auctions, royalty, innovation, R&D, mechanism design.
    JEL: D21 D43 D44 D45
    Date: 2010–01
  5. By: Florian Baumann (Eberhard Karls University, Department of Economics); Tim Friehe (University of Konstanz, Department of Economics); Kristoffel Grechenig (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This article shows that it may be socially optimal to grant accident victims less than full compensation. In our framework, firms are liable under product liability but also invest in care to prevent consumers switching to competitors. Affecting the partition of consumers by means of care-taking is not desirable from a social standpoint. Consequently, it may be optimal to reduce liability below full compensation in order to adjust firms’ care incentives.
    Keywords: Tort law; product liability, care level, asymmetric information, switching
    JEL: K13
    Date: 2010–01
  6. By: Benedikt von Scarpatetti (University of Basel); Cédric Wasser (Humboldt University of Berlin)
    Abstract: We consider a model of oligopolistic firms that have private information about their cost structure. Prior to competing in the market a competitive advantage, i.e., a cost reducing technology, is allocated to a subset of the firms by means of a multi-object auction. After the auction either all bids or only the prices to be paid are revealed to all firms. This provides an opportunity for signaling. Whether there exists an equilibrium in which bids perfectly identify the bidders’ costs generally depends on the type and fierceness of the market competition, the specific auction format, and the bid announcement policy.
    Keywords: Auction; Oligopoly; Signaling
    JEL: D44 L13 D43 D82 C72
    Date: 2010–01
  7. By: Daniele Condorelli
    Abstract: Both market (e.g. auctions) and non-market mechanisms (e.g. lotteries and prior- ity lists) are used to allocate a large amount of scarce public resources that produce large private benets and small consumption externalities. I study a model in which the use of both market and non-market mechanisms can be rationalized. Agents are risk neutral and heterogeneous in terms of their monetary value for a good and their opportunity cost of money, which are both private information. The designer wants to allocate a set of identical goods to the agents with the highest values. To achieve her goal, she can screen agents on the basis of their observable characteris- tics, and on the basis of information on their willingness to pay that she can extract using market mechanisms. In contrast to models where willingness to pay and value coincide, a rst best cannot be achieved. My main result is that both market and non-market mechanisms, or hybrid mechanisms, can be optimal depending on the prior information available to the designer. In particular, non-market mechanisms may be optimal if the value is positively correlated with the opportunity cost of money.
    Date: 2009–11
  8. By: Albrecht, James (Georgetown University); Gautier, Pieter (VU University Amsterdam); Vroman, Susan (Georgetown University)
    Abstract: In this paper, we present a directed search model of the housing market. The pricing mechanism we analyze reflects the way houses are bought and sold in the United States. Our model is consistent with the observation that houses are sometimes sold above, sometimes below and sometimes at the asking price. We consider two versions of our model. In the first version, all sellers have the same reservation value. In the second version, there are two seller types, and type is private information. For both versions, we characterize the equilibrium of the game played by buyers and sellers, and we prove efficiency. Our model offers a new way to look at the housing market from a search-theoretic perspective. In addition, we contribute to the directed search literature by considering a model in which the asking price (i) entails only limited commitment and (ii) has the potential to signal seller type.
    Keywords: directed search, housing
    JEL: D83 R31
    Date: 2009–12
  9. By: Benjamin Edelman (Harvard Business School, Negotiation, Organizations & Markets Unit); Michael Schwarz (Yahoo! Research Labs)
    Date: 2010–01
  10. By: Björn Bartling (University of Zurich); Ernst Fehr (University of Zurich); Klaus M. Schmidt (University of Munich)
    Abstract: In recent decades, many firms offered more discretion to their employees, often increasing the productivity of effort but also leaving more opportunities for shirking. These “high-performance work systems” are difficult to understand in terms of standard moral hazard models. We show experimentally that complementarities between high effort discretion, rent-sharing, screening opportunities, and competition are important driving forces behind these new forms of work organization. We document in particular the endogenous emergence of two fundamentally distinct types of employment strategies. Employers either implement a control strategy, which consists of low effort discretion and little or no rent-sharing, or they implement a trust strategy, which stipulates high effort discretion and substantial rent-sharing. If employers cannot screen employees, the control strategy prevails, while the possibility of screening renders the trust strategy profitable. The introduction of competition substantially fosters the trust strategy, reduces market segmentation, and leads to large welfare gains for both employers and employees.
    Keywords: job design, high-performance work systems, screening, reputation, competition, trust, control, social preferences, complementarities
    JEL: C91 D86
    Date: 2009–01
  11. By: Cuihong Fan (Shanghai University of Finance and Economics); Byoung Heon Jun; Elmar Wolfstetter (Humboldt University at Berlin)
    Abstract: This paper reconsiders the licensing of a common value innovation to a downstream duopoly, assuming a dual licensing scheme that combines a first-price license auction with royalty contracts for losers. Prior to bidding firms observe imperfect signals of the expected cost reduction; after the auction the winning bid is made public. Bidders may signal strength to their rivals through aggressive bidding, which may however backfire and mislead the innovator to set an excessively high royalty rate. We provide sufficient conditions for existence of monotone bidding strategies and for the profitability of combining auctions and royalty contracts for losers.
    Keywords: Patents, licensing, auctions, royalty, innovation, R&D, mechanism design.
    JEL: D21 D43 D44 D45
    Date: 2010–01
  12. By: Maria Bigoni (University of Padua); Giancarlo Spagnolo; Paola Valbonesi (University of Padua)
    Abstract: We study differently framed incentives in dynamic laboratory buyer-seller relationships with multi-tasking and endogenous matching. The experimental design tries to mitigate the role of social preferences and intrinsic motivation. Absent explicit incentives, effort is low in both tasks. Their introduction boosts efficiency substantially increasing effort in the contractible task, mildly crowding it out in the non-contractible one, and increasing buyer surplus. Bonuses and penalties are equivalent for efficiency and crowding-out, but dierent in distributional effects: sellers' surplus increases with bonuses as buyers' offers become more generous. Buyers tend to prefer penalties, which may explain why they are dominant in procurement.
    Keywords: bonuses, business-to-business, contract choice, experiment, framing, explicit incentives, incomplete contracts, loss-aversion, motivation, penalties, procurement, multi-tasking, relational contracts, rewards.
    JEL: H57 C92 L14 M52
    Date: 2010–01

This nep-cta issue is ©2010 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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