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on Contract Theory and Applications |
| By: | Julien Prat; Boyan Jovanovic |
| Abstract: | We analyze a long-term contracting problem involving common uncertainty about a parameter capturing the productivity of the relationship, and featuring a hidden action for the agent. We develop an approach that works for any utility function when the parameter and noise are normally distributed and when the effort and noise affect output additively. We then analytically solve for the optimal contract when the agent has exponential utility. We find that the Pareto frontier shifts out as information about the agent's quality improves. In the standard spot-market setup, by contrast, when the parameter measures the agent's 'quality', the Pareto frontier shifts inwards with better information. Commitment is therefore more valuable when quality is known more precisely. Incentives then are easier to provide because the agent has less room to manipulate the beliefs of the principal. Moreover, in contrast to results under one-period commitment, wage volatility declines as experience accumulates. |
| JEL: | L14 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16649&r=cta |
| By: | Pei, Di |
| Abstract: | This paper provides a new explanation for the relationship between firm scope, agent's effort and corporate risk. I set up a moral hazard in teams model with multiple agents and departments under the assumption that both the principal and the agents are protected by limited liability. Each agent exerts effort to reduce the probability of loss of his department. The two-sided limited liability assumption creates an externality between agents, since the bad performance of an agent could reduce the firm’s expected profit, and decrease the expected payoff of a good performing agent within the same firm. This would lower the incentive for other agents to exert effort, which causes 'Contagious shirking'. I prove for the optimal contract and derive conditions for effort to increase or decrease with scope, and explain why ‘contagious effect’ could better answer this question than diversification when firm scope is large. |
| Keywords: | firm scope; moral hazard in teams; two-sided limited liability |
| JEL: | D21 |
| Date: | 2010–08–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:27416&r=cta |
| By: | Wendelin Schnedler |
| Abstract: | Incentives often fail in inducing economic agents to engage in a desirable activity; implementability is restricted. What restricts implementability? When does re-organization help to overcome this restriction? This paper shows that any restriction of implementability is caused by an identification problem. It also describes organizations that can solve this identfication problem and provides conditions under which such organisations exist. Applying the findings to established and new moral hazard models yields insights into optimal organization design, uncovers the reason why certain organization designs, such as advocacy or specialization, overcome restricted implementability, and formalizes a widespread type of multi-tasking problem. |
| Keywords: | moral hazard, hidden action, implementation, multi-tasking, identification by organisation design |
| JEL: | D86 M52 D82 M41 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:bri:cmpowp:10/250&r=cta |
| By: | F. Balmaceda; S.R. Balseiro; J.R. Correa; N.E. Stier-Moses |
| Abstract: | In this paper we quantify the potential social-welfare loss due to the existence of limited liability in the principal-agent problem. The worst-case welfare loss is defined as the largest possible ratio between the social welfare when the agent chooses the effort that is optimal for the system and that of the sub-game perfect equilibrium of the game. Our main result establishes that under the monotone likelihood-ratio property and a limited liability constraint, the worst-case welfare loss (also known as the Price of Anarchy) is exactly equal to the number of efforts available. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:edj:ceauch:275&r=cta |
| By: | Andrew Metrick; Ayako Yasuda |
| Abstract: | We review the theory and evidence on venture capital (VC) and other private equity: why professional private equity exists, what private equity managers do with their portfolio companies, what returns they earn, who earns more and why, what determines the design of contracts signed between (i) private equity managers and their portfolio companies and (ii) private equity managers and their investors (limited partners), and how/whether these contractual designs affect outcomes. Findings highlight the importance of private ownership, and information asymmetry and illiquidity associated with it, as a key explanatory factor of what makes private equity different from other asset classes. |
| JEL: | G24 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16652&r=cta |
| By: | Winston Buckley; Garfield Brown; Mario Marshall |
| Abstract: | We extend the theory of asymmetric information in mispricing models for stocks following geometric Brownian motion to constant relative risk averse investors. Mispricing follows a continuous mean--reverting Ornstein--Uhlenbeck process. Optimal portfolios and maximum expected log--linear utilities from terminal wealth for informed and uninformed investors are derived. We obtain analogous but more general results which nests those of Guasoni (2006) as a special case of the relative risk aversion approaching one. |
| Date: | 2011–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1101.1148&r=cta |
| By: | Allan Drazen; Ethan Ilzetzki |
| Abstract: | Both conventional wisdom and leading academic research view pork barrel spending as antithetical to responsible policymaking in times of crisis. In this paper we present an alternative view. When agents are heterogeneous in their ideology and in their information about the economic situation, allocation of pork may enable passage of legislation appropriate to a "crisis" that might otherwise not pass. Pork "greases the legislative wheels" not by bribing legislators to accept legislation they view as harmful, but by conveying information about the necessity of policy change, where it may be impossible to convey such information in the absence of pork. Pork may be used for this function in situations where all legislators would agree to forgo pork under full information. Moreover, pork will be observed when the public good is most valuable precisely because it is valuable and the informed agenda setter wants to convey this information. |
| JEL: | D72 E62 H40 |
| Date: | 2011–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16667&r=cta |
| By: | Akiko Maruyama (National Graduate Institute for Policy Studies) |
| Abstract: | This paper is an analysis of a two-sided search model in which agents are vertically heterogeneous and some agents do not know their own types. Agents who do not know their own types update their beliefs about their own types through the offers or rejections that they receive from others. In the belief-updating process, an agent who is unsure of his or her own type frequently behaves as an over- or underconfident agent. In this paper, we show that this apparent over- or underconfidence influences both on the individual’s and other agents’ matching behaviors. We show, especially, that the apparent overconfidence of some agents prevents the lowest-type agents from matching in an equilibrium. |
| Keywords: | two-sided search; imperfect self-knowledge; overconfidence; looking-glass self |
| JEL: | D82 D83 J12 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:ngi:dpaper:10-26&r=cta |
| By: | James W. Roberts; Andrew Sweeting |
| Abstract: | We develop and estimate an entry model for second price and open outcry independent private value auctions where potential bidders receive an imperfectly informative signal about their value prior to deciding whether to pay a sunk entry cost. In this way the model flexibly allows for selection on values, which will affect an entrant's subsequent competitiveness, at the entry stage. As signals become more informative, the entry process exhibits greater selection as firms with higher values are more likely to enter. We allow for asymmetries across bidders and unobserved heterogeneity across auctions, which are important features of most data sets. We show how incorrectly assuming the extremes of either no selection (no signal) or perfect selection (prior knowledge of one's value) - the common alternatives in the literature - can yield incorrect estimates of model primitives and bias the results from counterfactuals. We apply our model to U.S. Forest Service timber auctions and find strong evidence in favor of a selective entry process. We take advantage of the flexible entry model to reevaluate the well known theory result that with fixed participation a seller prefers an extra bidder over the ability to set an optimal reserve price. In our model, the relative value of setting a reserve price and increasing the number of potential entrants to a revenue-maximizing seller will depend on the degree of selection. Our structural estimates imply that, if the USFS wants to maximize revenues, it will benefit more from adding an additional potential entrant than setting an optimal reserve price. |
| JEL: | D44 L20 L44 L73 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16650&r=cta |
| By: | Ojo, Marianne |
| Abstract: | Whilst the predecessor (Part I) to this paper addresses criticisms and challenges which have arisen in response to recent Basel Committee's initiatives aimed at addressing capital and liquidity standards, the present paper highlights further measures which are being introduced by the Basel Committee to address such criticisms and challenges. As well as presenting and drawing attention to proposals which could serve as means of addressing challenges presented by liquidity risks, Part I of the paper concludes with the result that market based regulation is an essential and vital tool in the Basel Committee's efforts to address some of the challenges presented by liquidity risks. The present paper highlights the Basel Committee's acknowledgement of this conclusion. Furthermore, it draws attention to other areas which are considered to constitute fertile substrates for purposes of future research. This paper will also illustrate why the potential of banking regulations and disclosure requirements to impact risk taking levels is not only dependent on certain factors such as the dissemination of information to appropriate recipients, appropriate volume of disseminated information, when to disseminate such information, but also on other factors such as ownership structures and effective corporate governance measures aimed fostering monitoring, supervision and accountability. |
| Keywords: | liquidity risks; systemic risks; capital; standards; Basel III; moral hazard; disclosure; information; Liquidity Coverage Ratio (LCR); Net Stable Funding Ratio (NSFR); accountability; corporate governance |
| JEL: | K2 E32 G3 D8 |
| Date: | 2010–12–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:27778&r=cta |
| By: | Vega, Hugo (Banco Central de Reserva del Perú) |
| Abstract: | Imperfection information models where agents solve some kind of signal extraction problem are multiplying and developing fast. They have commonly been used to study the impact of imperfect information on the business cycle and the importance of news versus noise shocks. This paper attempts to apply the framework to a di¤erent, albeit related, question: that of the e¤ect of volatility (both in news and noise) on the economy, from a long and short run perspective. An RBC model where the agent faces imperfect information regarding productivity is developed and calibrated in order to address the question, coming to the conclusion that the long run e¤ect is insigni cant while further development is required to address the short run conclusively. |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:rbp:wpaper:2010-014&r=cta |
| By: | Eduardo Engel; Ronald Fischer; Alexander Galetovic |
| Abstract: | We examine the economics of infrastructure finance, focusing on public provision and public-private partnerships (PPPs). We show that project finance is appropriate for PPP projects, because there are few economies of scope and assets are project specific. Furthermore, we suggest that the higher cost of finance of PPPs is not an argument in favour of public provision, since it appears to reflect the combination of deficient contract design and the cost-cutting incentives embedded in PPPs. Thus in the case of a correctly designed PPP contract, the higher cost of capital may be the price to pay for the efficiency advantages of PPPs. We also examine the role of government activities in PPP financing (e.g. revenue guarantees, renegotiations) and their consequences. Finally, we discuss how to include PPPs, revenue guarantees and the results of PPP contract renegotiation in the government balance sheet. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:edj:ceauch:276&r=cta |