nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒10‒16
twelve papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Franchise Contracts with Ex Post Limited Liability By Shane B. Evans
  2. Menus of Linear Contracts in Procurement with Type-Dependent Reservation Utility By Shane B. Evans
  3. Advance-Purchase Programs: When to Introduce and What to Inform Consumers By Zhang, Tianle
  4. Identification strategy : a field experiment on dynamic incentives in rural credit markets By Gine, Xavier; Goldberg, Jessica; Yang, Dean
  5. Stepwise Thinking in Strategic Games with Incomplete Information By Carsten S. Nielsen
  6. An Empirical Study of Online Software Outsourcing: Signals under Different Contract Regimes By Mingfeng Lin; Siva Viswanathan; Ritu Agarwal
  7. Labor Market Signaling with Overconfident Workers By Luis Santos-Pinto
  8. Physicians self selection of a payment mechanism: Capitation versus fee-for-service By Marie Allard; Izabela Jelovac; Pierre-Thomas Léger
  9. Indeterminate credit cycles By Zheng Liu; Pengfei Wang
  10. Innovation Contracts with Leakage Through Licensing By Shane B. Evans
  11. Bargaining or Searching for a Better Price? - An Experimental Study By Francesco Feri; Anita Gantner
  12. Awards as signals By Bruno S. Frey; Susanne Neckermann

  1. By: Shane B. Evans
    Abstract: This paper examines the contracting relationship between a manufacturer and a retailer when the retailer has ex ante private information, and is subject to limited liability. The contract takes place over two periods. In the first period, the retailer can make a report of private information, or take an action, either of which influences the manufacturer's beliefs about the distribution of demand states for a final good in the second period. In the second period, the retailer sells the manufacturers intermediate good into a final output market according to a variable fee schedule. The interaction of the limited liability constraints with incentive compatibility in the second stage gives rise to an expected surplus to the retailer, which the manufacturer can extract with a franchise fee. The franchise fee can also be used as a screening device or a means of eliciting the efficient first stage action from the retailer.
    JEL: D82 D86 L42
    Date: 2010–10
  2. By: Shane B. Evans
    Abstract: This paper examines the influence of type-dependent reservation utility on the optimality of linear contracts in a Principal-Agent model of procurement. Type-dependency of reservation utility, combined with the requirements of individual rationality and incentive compatibility in the principal's contracts induces a countervailing incentive effect, the strength of which depends on an index of quality or degree of competition that the agent would face in an external private market. The results show how the curvature of the reservation utility dictates whether the optimal contracts can be implemented with a menu of linear contracts, and how the magnitude of the private market index influences the net-transfer rule.
    JEL: D82 D86 H57
    Date: 2010–10
  3. By: Zhang, Tianle
    Abstract: We study a two-stage model in which the information processed by consumers at the first stage (advance-purchase stage) is endogenously determined. In the model, the firm decides whether to introduce an advance-purchase program, chooses what attribute information to disclose and determines an advance-purchase price and a retail price. Forward-looking consumers strategically choose, based on the disclosed information, to buy in advance or to make a purchase decision at the second stage (retail stage) when all information is revealed. We characterize the firm's optimal choice on the advance-purchase program and the strategy of information disclosure. In particular, we show that the firm always prefers to introduce the advance-purchase program except when underlying consumer preferences are extremely homogenous. In addition, we find that fully revealing horizontal product information at the advance-purchase stage is never optimal to the firm, but revealing either partial or no product information can be optimal depending on the underlying consumer preferences. Our finding that partial information disclosure is sometimes optimal to the firm is in contrast to the result in the literature of horizontal information provision that a firm maximizes profit by revealing either no or full information to consumers.
    Keywords: advance purchase; information disclosure; dynamic pricing
    JEL: M37 L12
    Date: 2010–10–02
  4. By: Gine, Xavier; Goldberg, Jessica; Yang, Dean
    Abstract: How do borrowers respond to improvements in a lender's ability to punish defaulters? This paper reports the results of a randomized field experiment in rural Malawi that examines the impact of fingerprinting borrowers in a context where a unique identification system is absent. Fingerprinting allows the lender to more effectively use dynamic repayment incentives: withholding future loans from past defaulters while rewarding good borrowers with better loan terms. Consistent with a simple model of borrower heterogeneity and information asymmetries, fingerprinting led to substantially higher repayment rates for borrowers with the highest ex ante default risk, but had no effect for the rest of the borrowers. The change in repayment rates is driven by reductions in adverse selection (smaller loan sizes) and lower moral hazard (for example, less diversion of loan-financed fertilizer from its intended use on the cash crop).
    Keywords: Access to Finance,Debt Markets,Bankruptcy and Resolution of Financial Distress,Microfinance,Economic Theory&Research
    Date: 2010–10–01
  5. By: Carsten S. Nielsen (Department of Economics, University of Copenhagen)
    Abstract: This paper proposes a general incomplete information framework for studying behavior in strategic games with stepwise (viz. `level-k' or `cognitive hierarchy') thinking, which has been found to describe strategic behavior well in experiments involving players' initial responses to games. It is shown that there exist coherent stepwise beliefs, implied by step types, that have the potential to encode all relevant information. In the structure of stepwise beliefs, players are unaware of opponents doing at least as much thinking as themselves. As a result, there exists a Bayesian Nash equilibrium strategy profile in which any player at some step fixes the best responses of opponents at lower steps and then best responds herself.
    Keywords: game theory; interactive epistemology; unawareness; Bayesian Nash equilibrium; bounded rationality; level-k; cognitive hierarchy
    JEL: C70 C72 D80 D82
    Date: 2010–07
  6. By: Mingfeng Lin (Department of Management Information Systems, Eller College of Management, University of Arizona); Siva Viswanathan (Department of Decision, Operations and Information Technologies, R.H. Smith School of Business, University of Maryland, College Park); Ritu Agarwal (Department of Decision, Operations and Information Technologies, R.H. Smith School of Business, University of Maryland, College Park)
    Abstract: We study whether and how contractual arrangements (fixed price vs. time-and-materials contracts) change the effect of reputation, certification, and language characteristics on the chances of winning outsourcing contracts. Using a comprehensive dataset from an online outsourcing marketplace, we model how buyers choose among bidding vendors, and how the effects of these variables change under different contract forms. Our results show that online reputation is an important predictor of success only for fixed-price contracts, but not significant for times-and-materials contracts. In other words, contract forms can mitigate the typical Matthew Effect associated with online reputation systems. Contrary to popular belief, certifications do not increase the chances of winning regardless of the contract forms. Linguistic features of private communications from the vendor to the buyer also affect the chances of winning, and different dimensions have different effects when contract forms change. Our study is one of the first to study the interaction between contract formats and different signals that vendors can reveal to buyers in the competitive bidding process, and is also one of the first to investigate how texts of private communications affect buyers' contracting decisions.
    Keywords: two-sided markets, asymmetric information, contract, outsourcing, offshoring, reputation, certification, text analysis.
    JEL: D02 D82 D83 D86 L14 L86 M51
    Date: 2010–10
  7. By: Luis Santos-Pinto
    Abstract: I extend Spence's (1974) labor market signaling model by assuming some workers are overconfident and some underconfident. Overconfident (underconfident) workers underestimate (overestimate) their marginal cost of acquiring education. Firms cannot observe workers' productive abilities and cannot observe workers' beliefs. However, firms know the fraction of overconfident, underconfident, and high-ability workers in the economy. I find that the presence of overconfident and/or underconfident workers in the labor market compresses wages. I show that workers' biased beliefs reduce welfare when workers are sufficiently different in terms of productivity and cost of education. Finally, I show that if the fraction of overconfident workers is relatively low and workers are sufficiently similar in terms of productivity and cost of education, then biased beliefs improve welfare.
    Keywords: signaling; labor market; behavioral biases; wages; education
    JEL: D82 J24 J31
    Date: 2010–06
  8. By: Marie Allard (HEC Montréal - HEC MONTRÉAL); Izabela Jelovac (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines); Pierre-Thomas Léger (HEC Montréal - HEC MONTRÉAL, CIRANO - Centre interuniversitaire de recherche en analyse des organisations - Université du Québec à Montréal, CIRPEE - Centre interuniversitaire sur le risque, les politiques économiques et l'emploi - Centre Interuniversitaire sur le Risque, les Politiques Economiques et l'Emploi)
    Abstract: The main question raised in this paper is whether GPs should self select their paymentmechanism or not. To answer it, we model GPs' behavior under the most commonpayment schemes (capitation and fee-for-service) and when GPs can select one amongthose. Our analysis considers GPs heterogeneity in terms of both ability and sense ofprofessional duty. We conclude that when savings on specialists costs are the mainconcern of a regulator, GPs should be paid on a fee-for-service basis. Instead, whenfailures to identify severe conditions are the main concern, then payment self selection byGPs can be optimal.
    Keywords: GPs; gatekeeping; payment scheme; self selection; ability; professional duty
    Date: 2010
  9. By: Zheng Liu; Pengfei Wang
    Abstract: We present a model with heterogeneous firms, in which credit constraints may give rise to self-fulfilling, sunspot-driven business cycle fluctuations. We derive optimal incentive-compatible loan contracts, under which a firm’s borrowing capacity is constrained by expected equity value. Interactions between debt and equity value made possible by credit constraints generate a credit externality, which leads to procyclical total factor productivity (TFP) and, with sufficiently high cost of financial intermediation, to equilibrium indeterminacy. At the aggregate level, the credit externality is observationally equivalent to production externality. Aggregate dynamics in our model with credit constraints and constant returns technology at the firm level are isomorphic to those in an aggregate economy with increasing returns, such as that studied by Benhabib and Farmer (1994).
    Keywords: Credit
    Date: 2010
  10. By: Shane B. Evans
    Abstract: In this paper a Developer contracts with a Researcher for the production of a non-drastic innovation. Since effort is non-contractible, the Developer offers an incentive contract dependent on the observed magnitude of the innovation. It is shown that the distribution of intellectual property rights (IPR) ownership does not affect the level of effort exerted for innovations where the Developer would choose to license the innovation to its competitors. This is because the possibility of leakage of the innovation through licensing subsidies the Developer's payment when IPR is delegated to the Researcher, while at the same time eroding its profit.
    JEL: D23 L24
    Date: 2010–10
  11. By: Francesco Feri; Anita Gantner
    Abstract: This experimental study investigates two bargaining games with twosided incomplete information between a seller and a buyer. In the first game with no outside options many subjects do not use the incomplete information to their advantage as predicted. We find that a model with adjusting priors better explains observed behavior. The second game gives the buyer the option to buy via search or return to bargaining. Here many buyers choose a bargaining agreement when a search outcome is predicted. For those who opt out, search outcomes are overall efficient and behavior is relatively close to the optimal search policy.
    Keywords: Bargaining Experiment, Outside Option, Search
    JEL: C91 C78 D83 D82
    Date: 2010–10
  12. By: Bruno S. Frey; Susanne Neckermann
    Abstract: Awards are widespread in all countries and are prevalent both in the public sphere and in the private sector. This paper argues, and empirically supports, that awards serve public functions and economists should take them seriously. Using a unique cross-country data set, we suggest that awards serve as signals. Awards are more prevalent the more difficult the position and status of an individual is to observe due to an anonymous and globalized setting.
    Keywords: Awards, signals, status, anonymity, globalization
    JEL: A13 D63 J33
    Date: 2010–10

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.