nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒04‒17
27 papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Optimal Procurement Contracts with Pre–Project Planning By Daniel Krähmer; Roland Strausz
  2. Information, Authority, and Corporate Hierarchies By Choe, Chongwoo; In-Uck, Park
  3. "Role of Linking Mechanisms in Multitask Agency with Hidden Information" By Hitoshi Matsushima; Koichi Miyazaki; Nobuyuki Yagi
  4. Information acquisition in conflicts By Florian Morath; Johannes Münster
  5. Rent-seeking Contests under Symmetric and Asymmetric Information By Cédric Wasser
  6. Information acquisition during a Dutch auction By Miettinen, Paavo
  7. Optimal Liability Sharing and Court Errors : An Exploratory Analysis By BOYER, Marcel; PORRINI, Donatella
  8. The Efficient and Fair Approval of “Multiple-Cost-Single-Benefit” Projects Under Unilateral Information By Nava Kahana; Yosef Mealem; Shmuel Nitzan
  9. Quadratic hedging in an incomplete market derived by an influent informed investor By Anne Eyraud-Loisel
  10. Asymmetric Information and Bank Runs By Chao Gu
  11. A Sticky-Dispersed Information Phillips Curve: A model with partial and delayed information By Marta Areosa; Waldyr Areosa; Vinicius Carrasco
  12. Equilibrium Corporate Finance By Alberto Bisin; Piero Gottardi; Guido Ruta
  13. Cheap Talk with an Informed Receiver By Junichiro Ishida; Takashi Shimizu
  14. Information Asymmetry in Pricing of Credit Derivatives By Caroline Hillairet; Ying Jiao
  15. The information revolution and small business lending: the missing evidence By Robert DeYoung; W. Scott Frame; Dennis Glennon; Peter Nigro
  16. Does Trade Credit Provides Favorable Information to Banks? Evidence from Japan By Takanori Tanaka
  17. Perfect Implementation By Sergei Izmalkov; Matt Lepinski; Silvio Micali
  18. Can Incomplete Information Lead to Under-exploitation in the Commons By Ana Espinola-Arredondo; Felix Munoz-Garcia
  19. Memory in Contracts: The Experience of the EBRD (1991-2003) By Lionel Artige; Rosella Nicolini
  20. Tests of ex ante versus ex post theories of collateral using private and public information By Allen N. Berger; W. Scott Frame; Vasso Ioannidou
  21. Capital Structure, Risk and Asymmetric Information: Theory and Evidence By M. V. Ibrahimo; C. P. Barros
  22. Centralizing Information in Networks By Jeanne Hagenbach
  23. A dynamic auction for multi-object procurement under a hard budget constraint By Ludwig Ensthaler; Thomas Giebe
  24. Financial safety nets, bailouts and moral hazard By Jaime Hurtubia Torres; Claudio Sardoni
  25. Irreversible Games with Incomplete Information: The Asymptotic Value By Rida Laraki
  26. "Incentives in Hedge Funds" By Hitoshi Matsushima
  27. Soft budget constraints in a dynamic general equilibrium model By Enrique Guilles

  1. By: Daniel Krähmer (University of Bonn); Roland Strausz (Humboldt University Berlin)
    Abstract: The paper studies procurement contracts with pre–project investigations in the presence of adverse selection and moral hazard. To model the procurer’s problem, we extend a standard sequential screening model to endogenous information acquisition with moral hazard. The optimal contract displays systematic distortions in information acquisition. Due to a rent effect, adverse selection induces too much information acquisition to prevent cost overruns and too little information acquisition to prevent false project cancelations. Moral hazard mitigates the distortions related to cost overruns yet exacerbates those related to false negatives. The optimal mechanism is a menu of option contracts that achieves the dual goal of providing incentives for information acquisition and truthful information revelation.
    Keywords: Information acquisition, procurement, dynamic mechanism design
    JEL: D82 H57
    Date: 2010–01
  2. By: Choe, Chongwoo; In-Uck, Park
    Abstract: In a typical corporate hierarchy, the manager is delegated the authority to make strategic decisions, and to contract with other employees. By studying a model with one principal and two agents where one agent can gather information that is valuable for the principal's project choice and the other agent provides effort to the chosen project, we study when the principal can benefit from such delegation relative to centralization. We show that beneficial delegation is possible when complete contracts cannot be written, and delegation of authority should necessarily be to the information gatherer. The benets of delegation stem from either efficiency gains or reduction in rent to the information gatherer.
    Keywords: Corporate hierarchies; information gathering; delegation; centralization.
    JEL: D21 D82 L22 C72
    Date: 2010–01–10
  3. By: Hitoshi Matsushima (Faculty of Economics, University of Tokyo); Koichi Miyazaki (Department of Economics, Pennsylvania State University); Nobuyuki Yagi (Graduate School of Economics, University of Tokyo)
    Abstract: We investigate the adverse selection problem where a principal delegates multiple tasks to an agent. We characterize the virtually implementable social choice functions by using the linking mechanism proposed by Jackson and Sonnenschein (2007) that restricts the message spaces. The principal does not require any incentive wage schemes and can therefore avoid any information rent and welfare loss. We show the resemblance between the functioning of this message space restriction and that of incentive wage schemes. We also extend the results of the single-agent model to the multi-agent model.
    Date: 2010–03
  4. By: Florian Morath (Max Planck Institute for Intellectual Property, Competition and Tax Law); Johannes Münster (Free University of Berlin)
    Abstract: This paper considers incentives for information acquisition ahead of conflicts. First, we characterize the (unique) equilibrium of the all-pay auction between two players with one-sided asymmetric information where one player has private information about his valuation. Then, we use ou rresults to study information acquisition prior to an all-pay auction. If the decision to acquire information is observable, but not the informatio nreceived, one-sided asymmetric information can occur endogenously in equilibrium. Moreover, the cutoff values of the cost of information that determine equilibrium information acquisition are higher than in the first best. Thus, information acquisition is excessive. Incontrast, with open or covert information acquisition, the equilibrium cut-off values are as in the first best.
    Keywords: All-payauctions; Conflicts; Contests; Information acquisition; Asymmetric information
    JEL: D72 D74 D82 D83
    Date: 2010–03
  5. By: Cédric Wasser (Humboldt University of Berlin)
    Abstract: We consider a variant of the Tullock rent-seeking contest. Under symmetric information we determine equilibrium strategies and prove their uniqueness. Then, we assume contestants to be privately informed about their costs of effort. We prove existence of a pure-strategy equilibrium and provide a sufficient condition for uniqueness. Comparing different informational settings we find that if players are uncertain about the costs of all players, aggregate effort is lower than under both private and complete information. Yet, under additional assumptions, rent dissipation is still smaller in the latter settings. Numerical examples illustrate that there is no general ranking between private and complete information. The results depend on the distribution costs are drawn from and on the exact specification of the contest success function.
    Keywords: Rent-seeking, Contest, Asymmetric Information, Private values
    JEL: D72 D74 D82 C72
    Date: 2010–03
  6. By: Miettinen, Paavo (Bank of Finland)
    Abstract: In this paper we consider equilibrium behavior in a Dutch (descending price) auction where the bidders are uninformed of their valuations with probability 1-q and can acquire information about their valuation at a positive cost during the auction. We assume that the information acquisition activity is covert. We characterize the equilibrium behavior in a setting where bidders are ex ante symmetric and have independent private values. We show that, if the number of bidders is large, the Dutch auction produces more revenue than would a first price auction.
    Keywords: auctions; information acquisition
    JEL: D44 D82 D83
    Date: 2010–02–22
  7. By: BOYER, Marcel; PORRINI, Donatella
    Abstract: We focus in this paper on the effects of court errors on the optimal sharing of liability between firms and financiers, as an environmental policy instrument. Using a structural model of the interactions between firms, financial institutions, governments and courts we show, through numerical simulations, the distortions in liability sharing between firms and financiers that the imperfect implementation of government policies implies. We consider in particular the role played by the efficiency of the courts in avoiding Type I (finding an innocent firm guilty of inappropriate care) and Type II (finding a guilty firm innocent of inappropriate care) errors. This role is considered in a context where liability sharing is already distorted (when compared with first best values) due not only to the courts’ own imperfect assessment of safety care levels exerted by firm but also to the presence of moral hazard and adverse selection in financial contracting, as well as of noncongruence of objectives between firms and financiers on the one hand and social welfare maximization on the other. Our results indicate that an increase in the efficiency of the court system in avoiding errors raises safety care levels, thereby reducing the probability of accident, and allowing the social welfare maximizing government to impose a lower liability [higher] share for firms [financiers] as well as a lower standard level of care.
    Keywords: Environmental Policy, Court Efficiency, Liability Sharing, Regulation, Incomplete Information
    JEL: D82 G32 K13 K32 Q28
    Date: 2010
  8. By: Nava Kahana (Department of Economics, Bar Ilan University,IZA, Bonn); Yosef Mealem (Netanya Academic College, The School of Banking & Finance Netanya, Israel); Shmuel Nitzan (Department of Economics, Bar Ilan University)
    Abstract: This paper focuses on indivisible multiple-cost–single-benefit projects that must be approved by the government. A simple mechanism is proposed that ensures an efficient and fair implementation of such projects. The proposed mechanism is appropriate for a unilateral information structure: the single beneficiary has complete information on the cost and benefit of the project while the government official has no such information and the cost bearers have information only on each other's costs.
    Keywords: indivisible project; single beneficiary; multiple-cost bearers; unilateral information; efficient and fair implementation
    JEL: D61 D62 D78
    Date: 2009–05
  9. By: Anne Eyraud-Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: In this paper a model with an influent and informed investor is presented. The studied problem is the point of view of a non informed agent hedging an option in this influenced and informed market. Her lack of information makes the market incomplete to the non informed agent. The obtained results, by means of Malliavin calculus and Clark-Ocone Formula, as well as Filtering Theory are the expressions and a comparison between the strategy of the non informed trader, and the strategy of the informed agent. An expression of the residual risk a non informed trader keeps by detaining an option in this influenced and informed market is derived using a quadratic approach of hedging in incomplete market. Finally, the analysis leads to a measure of the lack of information that makes the incompleteness of the market. The financial interpretation is explained throughout the theoretical analysis, together with an example of such influenced informed model.
    Keywords: Enlargement of filtration; FBSDE; quadratic hedging; risk minimization; insider trading; influent investor; asymmetric information; martingale representation; Clark-Ocone formula.
    Date: 2009–10–31
  10. By: Chao Gu (Department of Economics, University of Missouri-Columbia)
    Abstract: In the existing literature, panic-based bank runs are triggered by a commonly acknowledged and observed sunspot signal. There are only two equilibrium realizations resulting from the commonly observed sunspot signal: Everyone runs or no one runs. I consider a more general and more realistic situation in which consumers observe noisy private sunspot signals. If the noise in the signals is sufficiently small, there exists a proper correlated equilibrium for some demand deposit contracts. A full bank run, a partial bank run (in which some consumers panic whereas others do not), or no bank run occurs, depending on the realization of the sunspot signals. If the probabilities of runs are small, the optimal demand deposit contract tolerates full and partial bank runs.
    Keywords: sunspot equilibrium, correlated equilibrium, imperfect coordination, imperfect information.
    JEL: D82 G21
    Date: 2010–02–11
  11. By: Marta Areosa (Banco Central do Brasi); Waldyr Areosa (Banco Central do Brasil); Vinicius Carrasco (Department of Economics PUC-Rio)
    Abstract: We study the interaction between dispersed and sticky information by assuming that firms receive private noisy signals about the state in an otherwise standard model of price setting with sticky-information. We show that there exists a unique equilibrium of the incomplete information game induced by the firms’ pricing decisions, and derive the resulting Sticky-Dispersed Information (SDI) Phillips curve. The (equilibrium) aggregate price level and the inflation rates we derive depend on all values they have taken in the past. We perform several numerical simulations to evaluate how the Sticky-Dispersed Phillips curve we derive respond to changes in the main parameters of the model.
    Keywords: Sticky information, dispersed information, Phillips curve JEL Codes: D82, D83, E31
    Date: 2010–03
  12. By: Alberto Bisin; Piero Gottardi; Guido Ruta
    Abstract: We study a general equilibrium model with production where financial markets are incomplete. At a competitive equilibrium firms take their production and financial decisions so as to maximize their value. We show that shareholders unanimously support value maximization. Furthermore, competitive equilibria are constrained Pareto efficient. Finally the Modigliani-Miller theorem typically does not hold and the firms’ corporate financing structure is determined at equilibrium. Such results extend to the case where informational asymmetries are present and contribute to determine the firms’ capital structure.
    Keywords: capital structure, competitive equilibria, incomplete markets, asymmetric information
    Date: 2010
  13. By: Junichiro Ishida; Takashi Shimizu
    Abstract: This paper examines the effectiveness of cheap talk when the receiver is imperfectly informed. We show that the receiver's prior knowledge becomes an impediment to efficient communication in a model with the discrete state space: in general, the more the receiver is informed, the less information she can extract from the sender. In fact, when the receiver is as informed as the sender, no information can be conveyed via cheap talk for an arbitrarily small preference bias. This draws sharp contrast to the conventional setup where there is always a fully separating equilibrium as long as the preference bias is sufficiently small. We relate this result to issues that are critical for organizational design, such as the allocation of decision-making authority and the span of control.
    Date: 2009–06
  14. By: Caroline Hillairet (CMAP - Centre de Mathématiques Appliquées - CNRS : UMR7641 - Polytechnique - X); Ying Jiao (PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII)
    Abstract: We study the pricing of credit derivatives with asymmetric information. The managers have complete information on the value process of the firm and on the default threshold, while the investors on the market have only partial observations, especially about the default threshold. Different information structures are distinguished using the framework of enlargement of filtrations. We specify risk neutral probabilities and we evaluate default sensitive contingent claims in these cases.
    Date: 2010–02–17
  15. By: Robert DeYoung; W. Scott Frame; Dennis Glennon; Peter Nigro
    Abstract: This paper provides empirical confirmation for Petersen and Rajan's (2002) widely accepted conjecture that information technology was the primary driver of the observed increase in small business borrower-lender distances in the United States in recent years. Using a different data source for small business loans, we show that annual increases in borrower-lender distances were slow and steady prior to 1993 (the end point in Petersen and Rajan's data) but accelerated rapidly after that. Importantly, we are able to assign at least half of this acceleration to the adoption of credit scoring technologies by the lending banks. Our tests also reveal strong statistical associations between lending distances and borrower characteristics, lender characteristics, market conditions, regulatory constraints, moral hazard incentives, and principal-agent incentives.
    Date: 2010
  16. By: Takanori Tanaka (Institute of Social and Economic Research, Osaka University)
    Abstract: This paper examines whether trade credit as a credible signal about firmfs creditworthiness to banks facilitates provision of bank credit to the firms receiving trade credit. Using data on Japanese manufacturing firms over the period 1990-1995, we find that firms receiving trade credit are provided short-term credit by less-informed banks. Consequently, in the firms that have armfs-length relations with banks, trade credit plays an important role in mitigating asymmetric information problems between firms and banks, thereby facilitating extension of bank credit.
    Keywords: Trade Credit; Bank Credit
    JEL: G32
    Date: 2009–07
  17. By: Sergei Izmalkov (New Economic School); Matt Lepinski; Silvio Micali
    Abstract: Privacy and trust aect our strategic thinking, yet they have not been precisely modeled in mechanism design. In settings of incomplete information, traditional implementations of a normal-form mechanism - by disregarding the players' privacy, or assuming trust in a mediator - may fail to reach the mechanism's objectives. We thus investigate implementations of a new type. We put forward the notion of a perfect implementation of a normal-form mechanism M: in essence, a concrete extensive-form mechanism exactly preserving all strategic properties of M, without relying on a trusted mediator or violating the privacy of the players. We prove that any normal-form mechanism can be perfectly implemented by a verifiable mediator using envelopes and an envelope-randomizing device (i.e., the same tools used for running fair lotteries or tallying secret votes). Differently from a trusted mediator, a veriable one only performs prescribed public actions, so that everyone can verify that he is acting properly, and that he never learns any information that should remain private
    Date: 2010–01
  18. By: Ana Espinola-Arredondo; Felix Munoz-Garcia (School of Economic Sciences, Washington State University)
    Abstract: This paper analyzes the protection of a common pool resource (CPR) through the manage- ment of information. Speci?cally, we examine an entry deterrence model between an incumbent perfectly informed about the initial stock of a CPR and an uninformed potential entrant. In our model, the appropriation of the CPR by the incumbent reduces both players?future pro?ts from exploiting the resource. In the case of complete information, we show that the incumbent operating in a high-stock common pool overexploits the CPR during the ?rst period since it does not internalize the negative external e¤ect that its ?rst-period exploitation imposes on the en- trant?s future pro?ts. This ine¢ ciency, however, is absent when the common totally regenerates across periods. Under incomplete information, we identify an additional form of ine¢ ciency. In particular, the incumbent operating in a low-stock CPR underexploits the resource in order to signal the low available stock to potential entrants, deterring entry. When the common fully regenerates, we show that such underexploitation becomes more signi?cant since the low-stock incumbent aims to protect its larger monopoly pro?ts.
    Keywords: Common Pool Resources; Signaling games; Externalities
    JEL: L12 D82 Q20 D62
    Date: 2010–04
  19. By: Lionel Artige (HEC-Department of Economics, Université de Liège.); Rosella Nicolini (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: The objective of this paper is to identify the role of memory as a screening device in repeated contracts with asymmetric information in financial intermediation. We use an original dataset from the European Bank for Reconstruction and Development. We propose a simple empirical method to capture the role of memory using the client’s reputation. Our results unambiguously isolate the dominant effect of memory on the bank’s lending decisions over market factors in the case of established clients.
    Keywords: Financial contract,Empirical contract theory,Reputation,Asymmetric
    JEL: D21 D82 G21 L14 P21
    Date: 2010–03
  20. By: Allen N. Berger; W. Scott Frame; Vasso Ioannidou
    Abstract: Collateral is a widely used, but not well understood, debt-contracting feature. Two broad strands of theoretical literature explain collateral as arising from the existence of either ex ante private information or ex post incentive problems between borrowers and lenders. However, the extant empirical literature has been unable to isolate each of these effects. This paper attempts to do so using a credit registry that is unique in that it allows the researcher to have access to some private information about borrower risk that is unobserved by the lender. The data also include public information about borrower risk, loan contract terms, and ex post performance for both secured and unsecured loans. The results suggest that the ex post theories of collateral are empirically dominant although the ex ante theories are also valid for customers with short borrower-lender relationships that are relatively unknown to the lender.
    Date: 2010
  21. By: M. V. Ibrahimo; C. P. Barros
    Abstract: This paper proposes a principal-agent model between banks and firms with risk and asymmetric information. A mixed form of finance to firms is assumed. The capital structure of firms is a relevant cause for the final aggregate level of investment in the economy. In the model analyzed, there may be a separating equilibrium, which is not economically efficient, because aggregate investments fall short of the first-best level. Based on European firm-level data, an empirical model is presented which validates the result of the relevance of the capital structure of firms. The relative magnitude of equity in the capital structure makes a real difference to the profits obtained by firms in the economy.
    Keywords: Risk, asymmetric information, credit and capital structure.
    JEL: D81 D82 G21 G32
    Date: 2010–01
  22. By: Jeanne Hagenbach (University of Mannheim)
    Abstract: In the dynamic game we analyze, players are the members of a fixed network. Everyone is initially endowed with an information item that he is the only player to hold. Players are offered a finite number of periods to centralize the initially dispersed items in the hands of any one member of the network. In every period, each agent strategically chooses whether or not to transmit the items he holds to his neighbors in the network. The sooner all the items are gathered by any individual, the better it is for the group of players as a whole. Besides, the agent who first centralizes all the items is offered an additional reward that he keeps for himself. In this framework where information transmission is strategic and physically restricted, we provide a necessary and suffcient condition for a group to pool information items in every equilibrium. This condition is independent of the network structure. The architecture of links however affects the time needed before items are centralized in equilibrium.
    Keywords: communication network, communication dilemma, dynamic network game, strategic communication, war of attrition
    JEL: D83 C72 L22
    Date: 2010–04
  23. By: Ludwig Ensthaler (Humboldt University at Berlin); Thomas Giebe (Humboldt University at Berlin)
    Abstract: We present a new dynamic auction for procurement problems where payments are bounded by a hard budget constraint and money does not enter the procurer’s objective function.
    Keywords: Auctions, Mechanism Design, Knapsack Problem, Dominant Strategy, Budget, Procurement
    JEL: D21 D44 D45 D82
    Date: 2010–03
  24. By: Jaime Hurtubia Torres; Claudio Sardoni (Department of Economics,Sapienza University of Rome)
    Abstract: The paper argues that policymakers bail out banks with financial problems to avoid the costs of financial repression. After financial liberalization and when risk is verifiable, in some circumstances policymakers can commit to policies that discipline banks ex-ante and ex-post, by providing bailout to conservative banks and threatening the takeover of risky banks. When these policies are time consistent, regulatory policies to deal with moral hazard ex-ante, like for example prudential regulation, become redundant and policymakers refrain from implementing them.
    JEL: G21 G28
    Date: 2010
  25. By: Rida Laraki (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: Les jeux irréversibles sont des jeux stochastiques où une fois un état est quitté, il n'est plus jamais revisité. Cette classe contient les jeux absorbants. Cet article démontre l'existence et une caractérisation de la valeur asymptotique pour tout jeu irréversible fini à information incomplète des deux côtés. Cela généralise Mertens et Zamir 1971 pour les jeux répétés à information incomplète des deux côtés et Rosenberg 2000 pour les jeux absorbants à information incomplète d'un côté.
    Keywords: Jeux stochastiques; jeux répétés; information incomplète; valeur asymptotique; principe de comparaison; inégalités variationelles
    Date: 2010–04–06
  26. By: Hitoshi Matsushima (Faculty of Economics, University of Tokyo)
    Abstract: We investigate a game of delegated portfolio management such as hedge funds featuring risk-neutrality, hidden types, and hidden actions. We show that capital gain tax plays the decisive role in solving the incentive problem. We characterize the constrained optimal fee scheme and capital gain tax rate; the fee after taxation must be linear and affected by gains and losses in a low-powered and symmetric manner. We argue that high income tax incentivizes managers to select this scheme voluntarily. The equity stake suppresses the distortion caused by solvency.
    Date: 2010–02
  27. By: Enrique Guilles
    Abstract: This paper considers an overlapping generations model in which capital investment is financed in a credit market with adverse selection. Lenders’ inability to commit ex-ante not to bailout ex-post, together with a wealthy position of entrepreneurs gives rise to the soft budget constraint syndrome, i.e. the absence of liquidation of poor performing firms on a regular basis. This problem arises endogenously as a result of the interaction between the economic behavior of agents, without relying on political economy ex- planations. We found the problem more binding along the business cycle, providing an explanation to creditors leniency during booms in some Latin- American countries in the late seventies and early nineties.
    Date: 2010–02–28

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