nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2011‒01‒30
fifteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Incentives in Development Lending: Technical Cooperation By Josepa Miquel-Florensa
  2. Endogenous Market Structures and Contract Theory. Delegation, principal-agent contracts, screening, franchising and tying By Etro Federico
  3. Oligopolistic Screening and Two-way Distortion By Michela Cella; Federico Etro
  4. Information Sharing and Cross-border Entry in European Banking By Caterina Giannetti; Nicola Jentzsch; Giancarlo Spagnolo
  5. Moral hazard in the credit market when the collateral value is stochastic By Niinimäki, Juha-Pekka
  6. Using or Hiding Private Information ? An experimental Study of Zero-Sum Repeated Games with Incomplete Information. By Nicolas Jacquemet; Frédéric Koessler
  7. Bilateral and Community Enforcement in a Networked Market with Simple Strategies By Itay P. Fainmesser; David A. Goldberg
  8. Sustainable Reputations with Rating Systems By Mehmet Ekmekci
  9. Corporate Leniency with Private Information: The Push of Prosecution and the Pull of Pre-emption By Joseph E. Harrington, Jr.
  10. The Design of Performance Pay in Education By Derek Neal
  11. Adverse Selection and Liquidity Distortion in Decentralized Markets By Briana Chang
  12. Voting in Corporate Boards with Heterogeneous Preferences By Paolo Balduzzi; Clara Graziano; Annalisa Luporini
  13. Privately informed parties and policy divergence By Kikuchi, Kazuya
  14. Voting in Small Committees By Paolo Balduzzi; Clara Graziano; Annalisa Luporini

  1. By: Josepa Miquel-Florensa (Toulouse School of Economics (ARQADE), Toulouse, France)
    Abstract: This paper models incentives and information asymmetries between the different participants in multilateral development banks' decision process, namely borrowing countries, managers and the board of governors (with borrower and non-borrower members). We propose technical cooperation requirements as instruments for the board of governors to solve the moral hazard and adverse selection problems. We assume technical cooperation makes the probability of success not to depend on the agent's effort choice, as long as he provides effort, but on the principal's distribution of resources, and may also provide private benefits to the recipients. Moreover, the outcome of the agent's investment is a "public good" since is enjoyed in a non-rival fashion by both Board and agents. Using data on project performance reports from the IADB, we show that technical cooperation does have an impact on project results. Furthermore, we are able to differentiate for which projects, contract and recipients technical cooperation is more effective and relate the reported problems to the information asymmetries.
    Keywords: Information assymetry, multilateral development, IDB, IADB, Moral Hazzard, Governance, Latin America
    JEL: D82 F35 F53
    Date: 2011–01
  2. By: Etro Federico (Department of Economics, University Of Venice Cà Foscari)
    Abstract: I study the role of unilateral strategic contracts for firms active in markets with price competition and endogenous entry. Traditional results change substantially when the market structure is endogenous rather than exogenous. They concern 1) contracts of managerial delegation to non-profit maximizers, 2) incentive principal-agent contracts in the presence of moral hazard on cost reducing activities, 3) screening contracts in case of asymmetric information on the productivity of the managers, 4) vertical contracts of franchising in case of hold-up problems and 5) tying contracts by monopolists competing also in secondary markets. Firms use always these contracts to strengthen price competition and manage to obtain positive profits in spite of free entry.
    Keywords: Strategic delegation, Incentive contracts, Screening contracts, Franchising, Tying, Endogenous market structures
    JEL: L11 L13 L22 L43
    Date: 2010
  3. By: Michela Cella (Department of Economics, University Of Milan, Bicocca); Federico Etro (Department of Economics, University Of Venice, Ca’ Foscari)
    Abstract: We analyze the choice of incentive contracts by oligopolistic firms that compete on the product market. Managers have private information and in the first stage they exert cost reducing effort. In equilibrium the standard "no distortion at the top" property disappears and two way distortions are optimal. We extend our analysis to other informational, contractual and competitive settings.
    Keywords: Oligopoly, screening, two way distortion, incentives, RD investment
    JEL: D21 D82 D86 L13 L22
    Date: 2010
  4. By: Caterina Giannetti (GSBC Jena, University of Siena, ECRI); Nicola Jentzsch (DIW Berlin); Giancarlo Spagnolo (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: Information asymmetries can severely limit cross-border border expansion of banks. When a bank enters a new market, it has incomplete information about potential new clients. Such asymmetries are reduced by credit registers, which distribute financial data on bank clients. We investigate the interaction of credit registers and bank entry modes (in form of branching and M&A) by using a new set of time series cross-section data for the EU-27 countries. We study how the presence of public and private credit registers and the type of information exchanged affect bank entry modes during the period 1990-2007. Our analysis shows that the existence of both types of registers increases the share of branching in the overall entries. Additionally, the establishment of public registers reduces concentration ratios, and some banking competition indicators (such as overhead costs/assets). The introduction of a private credit bureau, on the other hand, has no effect on concentration ratios, but positively contributes to competition (by decreasing interest rate margins). This suggests that credit registers facilitate direct entry through a reduction of information asymmetries, which in turn intensifies competition.
    Keywords: credit registries, foreign entry, asymmetric information
    JEL: F37 G21 G34 L13 O16
    Date: 2010–12–21
  5. By: Niinimäki, Juha-Pekka (Bank of Finland Research)
    Abstract: This theoretical paper explores the effects of costly and non-costly collateral on moral hazard, when collateral value may fluctuate. Given that all collateral is costly, stochastic collateral will entail the same positive incentive effects as nonstochastic collateral, provided the variation in collateral value is modest. If it is large, the incentive effects are smaller under stochastic collateral. With non-costly collateral, stochastic collateral entails positive incentive effects or no effects, if the variation in collateral value is modest. If it is large, the incentive effects may be positive or negative. Thus, collateral can increase moral hazard. The findings are related to the topical subprime crisis and the fluctuating value of real estate collateral.
    Keywords: banking; collateral; moral hazard; subprime lending
    JEL: G21 G22 G28
    Date: 2010–12–21
  6. By: Nicolas Jacquemet (Centre d'Economie de la Sorbonne - Paris School of Economics); Frédéric Koessler (Paris-Jourdan Sciences Economiques)
    Abstract: This paper studies experimentally the value of private information in strictly competitive interactions with asymmetric information. We implement in the laboratory three examples from the class of zero-sum repeated games with incomplete information on one side and perfect monitoring. The stage games share the same simple structure, but differ markedly on how information should be optimally used once they are repeated. Despite the complexity of the optimal strategies, the empirical value of information coincides with the theoretical prediction in most instances. In particular, it is never negative, it decreases with the number of repetitions, and it is nicely bounded below by the value of the infinitely repeated game and above by the value of the one-shot game. Subjects are unable to completely ignore their information when it is optimal to do so, but the use of information in the lab reacts qualitatively well to the type and length of the game being played.
    Keywords: Concavification, laboratory experiments, incomplete information, value of information, zero-sum repeated games.
    JEL: C72 D82
    Date: 2011–01
  7. By: Itay P. Fainmesser; David A. Goldberg
    Abstract: We present a model of repeated games in large buyer-seller networks in the presence of reputation networks via which buyers share information about past transactions. The model allows us to characterize cooperation networks - networks in which each seller cooperates (by providing high quality goods) with every buyer that is connected to her. To this end, we provide conditions under which: [1] the incentives of a seller s to cooperate depend only on her beliefs with respect to her local neighborhood - a subnetwork that includes seller s and is of a size that is independent of the size of the entire network; and [2] the incentives of a seller s to cooperate can be calculated as if the network was a random tree with seller s at its root. Our characterization sheds light on the welfare costs of relying only on repeated interactions for sustaining cooperation, and on how to mitigate such costs.
    Keywords: Networks, moral hazard, graph theory, repeated games
    Date: 2011
  8. By: Mehmet Ekmekci
    Abstract: In a product choice game played between a long lived seller and an infnite sequence of buyers, we assume that buyers cannot observe past signals. To facilitate the analysis of applications such as online auctions (e.g. eBay), online shopping search engines (e.g. and consumer reports, we assume that a central mechanism observes all past signals, and makes public announcements every period. The set of announcements and the mapping from observed signals to the set of announcements is called a rating system. We show that, absent reputation effects, information censoring cannot improve attainable payoffs. However, if there is an initial probability that the seller is a commitment type that plays a particular strategy every period, then there exists a finite rating system and an equilibrium of the resulting game such that, the expected present discounted payoff of the seller is almost his Stackelberg payoff after every history. This is in contrast to Cripps, Mailath and Samuelson (2004), where it is shown that reputation effects do not last forever in such games if buyers can observe all past signals. We also construct .nite rating systems that increase payoffs of almost all buyers, while decreasing the seller’s payoff.
    Keywords: Reputations, Rating Systems, Online Reputation Mechanisms, Disappearing Reputations, Permanent Reputations. JEL Classification Numbers: D82
    Date: 2010–03–01
  9. By: Joseph E. Harrington, Jr.
    Abstract: A corporate leniency program provides relief from government penalties to the first member of a cartel to come forward and cooperate with the authorities. This study explores the incentives to apply for leniency when each cartel member has private information as to the likelihood that the competition authority will be able to convict them without a cooperating firm. A firm may apply for leniency because it fears being convicted or because it fears another firm will apply. Policies by the competition authority to magnify concerns about pre-emption - and thereby induce greater use of the leniency program - are explored.
    Date: 2011–01
  10. By: Derek Neal
    Abstract: This chapter analyzes the design of incentive schemes in education while reviewing empirical studies that evaluate performance pay programs for educators. Several themes emerge. First, it is difficult to use one assessment system to create both educator performance metrics and measures of student achievement. To mitigate incentives for coaching, incentive systems should employ assessments that vary in both format and item content. Separate no-stakes assessments provide more reliable information about student achievement because they create no incentives for educators to take hidden actions that contaminate student test scores. Second, relative performance schemes are rare in education even though they are more difficult to manipulate than systems built around psychometric or subjective performance standards. Third, assessment-based incentive schemes are mechanisms that complement rather than substitute for systems that promote parental choice, e.g. vouchers and charter schools.
    JEL: I20 I28
    Date: 2011–01
  11. By: Briana Chang
    Abstract: Why do some markets remain liquid even when there is a positive gain from trade? In order to understand the real determinants of market liquidity in decentralized markets, we are going to analyze this question in a competitive market setting when both search frictions and adverse selection play roles. In a dynamic environment with heterogeneous sellers and buyers, we investigate the role of market frictions and how adverse selection leads to the distortion of equilibrium market liquidity. The resulting friction therefore prohibits resources from reallocating efficiently. In the application of capital reallocation, we further show that this trading friction can generate significant economic fluctuations.
    Keywords: Liquidity; Search frictions, Adverse selection; Uncertainty; Capital Reallocation JEL Classification Numbers: D82, G1
    Date: 2010–11–02
  12. By: Paolo Balduzzi (Università Cattolica Milano); Clara Graziano (Università degli Studi di Udine); Annalisa Luporini (Università degli Studi di Firenze, Dipartimento di Scienze Economiche)
    Abstract: We analyze the voting behavior of a board of directors that has to approve (or reject) an investment proposal with uncertain return. We consider three types of directors: insiders, who are biased toward acceptance of the project, independent outsiders who want to maximize the firm's profit and independent outsiders who care about their reputation. We show that the presence of members with heterogeneous preferences can be beneficial and that the partisan behavior of insiders can be used as a sort of coordinating device by uninformed outsiders. Provided that the size of the board is optimal, there is no gain from increasing the number of outsiders above the strict majority despite the fact that each outsider is informed with positive probability. Substituting profit-maximizing directors with directors concerned about their reputation is not an obstacle to profit maximization provided that an appropriate sequential voting protocol is followed. We also show that a proper board composition makes communication between directors irrelevant in the sense that the same outcome is obtained with and without communication. Finally, as information is costly, our model provides some suggestions on the optimal size of boards.
    Keywords: Board of directors, Voting, Corporate Governance
    JEL: G30 D71
    Date: 2011
  13. By: Kikuchi, Kazuya
    Abstract: This paper presents a Downsian model of political competition in which parties have incomplete but richer information than voters on policy effects. Each party can observe a private signal of the policy effects, while voters cannot. In this setting, voters infer the policy effects from the party platforms. In this political game with private information, we show that there exist weak perfect Bayesian equilibria (WPBEs) at which the parties play different strategies, and thus, announce different platforms even when their signals coincide. This result is in contrast with the conclusion of the Median Voter Theorem in the classical Downsian model. Our equilibrium analysis suggests similarity between the set of WPBEs in this model and the set of uniformly perfect equilibria of Harsanyi and Selten (1988) in the model with completely informed parties which we studied in a previous paper (Kikuchi, 2010).
    Date: 2011–01
  14. By: Paolo Balduzzi (Università Cattolica Milano); Clara Graziano (Università degli Studi di Udine); Annalisa Luporini (Università degli Studi di Firenze, Dipartimento di Scienze Economiche)
    Abstract: We analyze the voting behavior of a small committee that has to approve or reject a proposal whose return is uncertain. Members have heterogenous preferences: some members want to maximize the expected value while other members have a bias toward project approval and ignore their private information. We analyze different voting games when information is costless and communication is not possible, and we provide insights on the optimal composition of these committees. Our main result is that the presence of biased members can improve the voting outcome by simplifying the strategies of unbiased members. Thus, committees with heterogeneous members can function at least as well as homogeneous committees and in some cases they perform better. In particular, when value-maximizing members hold 51% of votes, the socially optimal equilibrium becomes unique.
    Keywords: Voting, Small committees.
    JEL: D71 D72
    Date: 2011
    Abstract: We use an incentive model in which improvements to fundamentals boost the ability of leveraged financial firms (banks) to expand the balance sheet (as in Adrian and Shin 2010). The rise in asset prices due to the amplified response of procyclical systems distorts bankers' incentives in providing (costly and non observable) monitoring effort. On the one hand, the fundamental value of assets positively affects the optimal effort of the banker, thus allowing supervisory authorities to relax incentive-compatible capital requirements and boosting asset demand and prices. On the other hand, in a macro perspective, high prices positively affect the banker's payoff in the bad state of asset liquidation (via asset prices), jeopardizing incentives. This type of externality follows from a purely “macro” phenomenon à la Borio (2003) and should be taken into account by the regulatory authority in designing capital requirements. In procyclical and advanced (low agency costs and highly liquid) financial systems, incentive compatibility requires a higher capital requirement in the face of an improvement to fundamentals. Our results provide a theoretical foundation to the countercyclical buffer provided for by the Basel Committee.
    Keywords: Macroprudential regulation; financial stability; capital requirement.
    JEL: D86 G18 E44
    Date: 2011–01–17

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