nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒12‒23
four papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Great Expectations: Law, Employment Contracts, and Labor Market Performance By MacLeod, W. Bentley
  2. The Effects of Bonus Taxes on Executive Compensation in a Principal-Agent Model By Helmut Dietl; Martin Grossmann; Markus Lang; Simon Wey
  3. Signaling and indirect taxation By Tom TRUYTS
  4. Subscribing to Supplemental Health Insurance in France: A Dynamic Analysis of Adverse Selection By Carine Franc; Marc Perronnin; Aurélie Pierre

  1. By: MacLeod, W. Bentley (Columbia University)
    Abstract: This chapter reviews the literature on employment and labor law. The goal of the review is to understand why every jurisdiction in the world has extensive employment law, particularly employment protection law, while most economic analysis of the law suggests that less employment protection would enhance welfare. The review has three parts. The first part discusses the structure of the common law and the evolution of employment protection law. The second part discusses the economic theory of contract. Finally, the empirical literature on employment and labor law is reviewed. I conclude that many aspects of employment law are consistent with the economic theory of contract – namely, that contracts are written and enforced to enhance ex ante match efficiency in the presence of asymmetric information and relationship specific investments. In contrast, empirical labor market research focuses upon ex post match efficiency in the face of an exogenous productivity shock. Hence, in order to understand the form and structure of existing employment law we need better empirical tools to assess the ex ante benefits of employment contracts.
    Keywords: employment law, labor law, employment contract, employment contract, law and economics
    JEL: J08 J33 J41 J5 K31
    Date: 2010–12
  2. By: Helmut Dietl (Institute for Strategy and Business Economics, University of Zurich); Martin Grossmann (Institute for Strategy and Business Economics, University of Zurich); Markus Lang (Institute for Strategy and Business Economics, University of Zurich); Simon Wey (Institute for Strategy and Business Economics, University of Zurich)
    Abstract: The financial crisis from 2007-2010 was the worst crisis since the Great Depression. Politicians, economists and regulators search for measures to avoid such a crisis to repeat. One prominent proposal is the introduction of bonus taxes for corporate executives. In this paper, we analyze the effects of such a bonus tax on executive compensation in a principal-agent model. Our paper shows that a bonus tax may lead to the unintended result that the effort-based compensation increases at the expense of the fixed salary. The introduction of a bonus tax can further induce the principal to offer higher bonuses even though the agent always reduces his effort. The tax-induced effort reduction by the agent decreases with an increase in the product of risk aversion and uncertainty. Moreover, a bonus tax will decrease social welfare unless the social planner puts a sufficiently high weight on tax revenue. Finally, we present simulation results for two general classes of effort cost functions.
    Keywords: Principal-agent model, bonus tax, labor taxation, executive compensation, financial regulation
    JEL: H24 J30 M52
    Date: 2010–12
  3. By: Tom TRUYTS
    Abstract: Commodities communicate. Consumers choose a consumption bundle both for its intrinsic characteristics and for what this bundle communicates about their qualities (or .identity.) to spectators. We investigate optimal indirect taxation when consumption choices are motivated by two sorts of concerns: intrinsic consumption and costly signaling. Optimal indirect taxes are introduced into a monotonic signaling game with a finite typespace of consumers. We provide sufficient conditions for the uniqueness of the D1 sequential equilibrium in terms of strategies. In the case of pure costly signaling, signaling goods can in equilibrium be taxed without burden and the optimal quantity taxes on these goods are infinite. When commodities serve both intrinsic consumption and signaling, optimal taxes can be characterized by a generalization of the Ramsey rule, which also deals with the distortions resulting from signaling.
    Keywords: Optimal Taxation, Indirect Taxation, Costly Signaling, Identity.
    JEL: C72 H21
    Date: 2010–04
  4. By: Carine Franc (Cermes, Inserm U988, CNRS UMR8211, IRDES); Marc Perronnin (IRDES institut for research and information in health economics); Aurélie Pierre (IRDES institut for research and information in health economics)
    Abstract: Adverse selection, which is well described in the theoretical literature on insurance, remains relatively difficult to study empirically. The traditional approach, which focuses on the binary decision of “covered” or “not”, potentially misses the main effects because heterogeneity may be very high among the insured. In the French context, which is characterized by universal but incomplete public health insurance (PHI), we study the determinants of the decision to subscribe to supplemental health insurance (SHI) in addition to complementary health insurance (CHI). This work permits to analyze health insurance demand at the margin. Using a panelized dataset, we study the effects of both individual state of health, which is measured by age and previous individual health spending, and timing on the decision to subscribe. One striking result is the changing role of health risk over time, illustrating that adverse selection occurs immediately after the introduction of SHI. After the initial period, the effects of health risks (such as doctors’ previous health expenditures) diminish over time and financial risks (such as dental and optical expenses and income) remain significant. These results may highlight the inconsistent effects of health risks on the demand for insurance and the challenges of studying adverse selection.
    Keywords: Supplemental health insurance, adverse selection, health insurance demand, longitudinal analysis.
    JEL: C23 D82 G22 I11
    Date: 2010–12

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