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on Contract Theory and Applications |
| By: | Carlos Carrillo-Tudela (Department of Economics, University of Essex, United Kingdom); Leo Kaas (Department of Economics, University of Konstanz, Germany) |
| Abstract: | We consider a model of on-the-job search where firms offer long-term wage contracts to workers of different ability. Firms do not observe worker ability upon hiring but learn it gradually over time. With sufficiently strong information frictions, low-wage firms offer separating contracts and hire all types of workers in equilibrium, whereas high-wage firms offer pooling contracts designed to retain high-ability workers only. Low-ability workers have higher turnover rates, they are more often employed in low-wage firms and face an earnings distribution with a higher frictional component. Furthermore, positive sorting obtains in equilibrium. |
| Keywords: | Adverse Selection, On-the-job Search, Wage Dispersion, Sorting |
| JEL: | D82 J63 J64 |
| Date: | 2011–08–16 |
| URL: | http://d.repec.org/n?u=RePEc:knz:dpteco:1129&r=cta |
| By: | Martimort, David; Stole, Lars |
| Abstract: | We study games of public delegated common agency under asymmetric information. Us- ing tools from non-smooth analysis and optimal control, we derive best responses and characterize equilibria (both continuous and discontinuous) using self-generating opti- mization programs of which any equilibrium allocation must be a solution. Special atten- tion is given to common agency games in which each principal’s payoff is a linear function of the agent’s action. In such games the self-generating optimization program reduces to the maximization of the principals’ “aggregate” virtual surplus in which the agent’s marginal valuation is replaced by a confluence of “virtual” valuations that reflect com- mon agency problems. One noteworthy subset of equilibrium allocations are “virtually truthful” which are the incomplete-information generalization of Bernheim and Whin- ston’s (1986) “truthful” equilibria. Virtually-truthful equilibria are simple to calculate and illustrate two distinct sources of equilibrium distortion: inefficient contracting by a given coalition of active principals and inefficient participation (insufficient activity) by principals. Our results are illustrated by means of two games: a public goods game in which each player simultaneously offers a menu contract to a common provider of the public good in order to induce greater supply, and a lobbying game between conflicting interest groups in which each group offers a menu of contributions to a common political decision-maker in an attempt to influence policymaking. |
| Keywords: | Common agency; asymmetric information; menu auctions; delegated contracting games; public goods; lobbying; non-smooth analysis; non-smooth control |
| JEL: | D73 D8 C61 C72 |
| Date: | 2011–08–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:32874&r=cta |
| By: | Theodoros M. Diasakos; Kostas Koufopoulos |
| Abstract: | This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz (1976). We propose a simple extension of the game-theoretic structure in Hellwig (1987) under which Nash-type strategic interaction between the informed customers and the uninformed firms results always in a particular separating equilibrium. The equilibrium allocation is unique and Pareto-efficient in the interim sense subject to incentive-compatibility and individual rationality. In fact, it is the unique neutral optimum in the sense of Myerson (1983). |
| Keywords: | Insurance Market; Adverse Selection; Incentive Efficiency |
| JEL: | D86 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:215&r=cta |
| By: | David Gill; Daniel Sgroi |
| Abstract: | We develop a framework in which: (i) a firm can have a new product tested publicly before launch; and (ii) tests vary in toughness, holding expertise fixed. Price flexibility boosts the strong positive impact on consumer beliefs of passing a tough test and mitigates the strong negative impact of failing a soft test. As a result, profits are convex in toughness: the firm selects either the toughest or softest test available. The toughest test is optimal when consumers start with an unfavorable prior and receive sufficiently uninformative private signals (an “innovative” product); the softest test is optimal when signals are sufficiently informative. |
| Keywords: | Tests, reviewers, certification, Bayesian learning, information transmission, marketing, product launch, bias, tough test, soft test |
| JEL: | D82 D83 L15 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:562&r=cta |
| By: | Albagli, Elias; Hellwig, Christian; Tsyvinski, Aleh |
| Abstract: | We study the interplay of share prices and firm decisions when share prices aggregate and convey noisy information about fundamentals to investors and managers. First, we show that the informational feedback between the firm's share price and its investment decisions leads to a systematic premium in the firm's share price relative to expected dividends. Noisy information aggregation leads to excess price volatility, over-valuation of shares in response to good news, and undervaluation in response to bad news. By optimally increasing its exposure to fundamental risks when the market price conveys good news, the firm shifts its dividend risk to the upside, which amplifies the overvaluation and explains the premium. Second, we argue that explicitly linking managerial compensation to share prices gives managers an incentive to manipulate the firm's decisions to their own benefit. The managers take advantage of shareholders by taking excessive investment risks when the market is optimistic, and investing too little when the market is pessimistic. The amplified upside exposure is rewarded by the market through a higher share price, but is inefficient from the perspective of dividend value. |
| Keywords: | information aggregation; managerial incentives; market efficiency |
| JEL: | D82 D84 G14 M52 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8539&r=cta |
| By: | Elias Albagli; Christian Hellwig; Aleh Tsyvinski |
| Abstract: | We study the interplay of share prices and firm decisions when share prices aggregate and convey noisy information about fundamentals to investors and managers. First, we show that the informational feedback between the firm's share price and its investment decisions leads to a systematic premium in the firm's share price relative to expected dividends. Noisy information aggregation leads to excess price volatility, over-valuation of shares in response to good news, and undervaluation in response to bad news. By optimally increasing its exposure to fundamental risks when the market price conveys good news, the firm shifts its dividend risk to the upside, which amplifies the overvaluation and explains the premium. Second, we argue that explicitly linking managerial compensation to share prices gives managers an incentive to manipulate the firm's decisions to their own benefit. The managers take advantage of shareholders by taking excessive investment risks when the market is optimistic, and investing too little when the market is pessimistic. The amplified upside exposure is rewarded by the market through a higher share price, but is inefficient from the perspective of dividend value. |
| JEL: | G10 G12 G30 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17330&r=cta |
| By: | Elias Albagli (USC Marshall); Christian Hellwig (Toulouse School of Economics); Aleh Tsyvinski (Dept. of Economics, Yale University) |
| Abstract: | We study the interplay of share prices and firm decisions when share prices aggregate and convey noisy information about fundamentals to investors and managers. First, we show that the informational feedback between the firm's share price and its investment decisions leads to a systematic premium in the firm's share price relative to expected dividends. Noisy information aggregation leads to excess price volatility, over-valuation of shares in response to good news, and undervaluation in response to bad news. By optimally increasing its exposure to fundamental risks when the market price conveys good news, the firm shifts its dividend risk to the upside, which amplifies the overvaluation and explains the premium. Second, we argue that explicitly linking managerial compensation to share prices gives managers an incentive to manipulate the firm's decisions to their own benefit. The managers take advantage of shareholders by taking excessive investment risks when the market is optimistic, and investing too little when the market is pessimistic. The amplified upside exposure is rewarded by the market through a higher share price, but is inefficient from the perspective of dividend value. |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1816&r=cta |
| By: | Segev, Ella; Sela, Aner |
| Abstract: | We study a sequential all-pay auction with two contestants who are privately informed about a parameter (ability) that affects their cost of effort. In the model, contestant 1 (the first mover) exerts an effort in the first period which translates into an observable output but with some noise, and contestant 2 (the second mover) observes this noisy output. Then, contestant 2 exerts an effort in the second period, and wins the contest if her output is larger than or equal to the observed noisy output of contestant 1; otherwise, contestant 1 wins. We study two variations of this model where contestant 1 either knows or does not know the realization of the noise before she chooses her effort. Contestant 2 does not know the realization of the noise in both variations. For both variations, we characterize the subgame perfect equilibrium and investigate the effect of a random noise on the expected highest effort in this contest. |
| Keywords: | Noisy outputs; Sequential contests |
| JEL: | D44 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8509&r=cta |
| By: | Martimort, David; Stole, Lars |
| Abstract: | This note uses techniques developed for aggregate games to characterize the set of equilib- ria for a beauty contest or prediction game in which the experts’ preferences are quadratic, but with an otherwise unrestricted information structure for private signals and the state variable. We show that, on aggregate, the experts’ collective estimate of the unknown parameter to be estimated is unbiased for every equilibrium. |
| Keywords: | Aggregate games; beauty contests; prediction games |
| JEL: | C8 C72 |
| Date: | 2011–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:32872&r=cta |
| By: | Cerqueiro, G.M.; Ongena, S.; Roszbach, K. (Tilburg University, Center for Economic Research) |
| Abstract: | Collateral is one of the most important features of a debt contract. A substantial theoretical literature motivates the use of collateral as a means to alleviate ex-ante and ex-post information asymmetries between borrowers and lenders and the incidence of credit rationing. Through its seniority effect, collateral may also affect banks’ incentives to monitor borrowers. There is little empirical evidence, however, on the precise workings of collateral, its interaction with other contract terms, and its impact on banks’ monitoring incentives. We study a change in the Swedish law that exogenously reduced the value of all outstanding company mortgages, i.e., a type of collateral that is comparable to the floating lien. We explore this natural experiment to identify how collateral determines borrower quality, loan terms, access to credit and bank monitoring of business term loans. Using a differences-in-differences approach, we find that following the change in the law and the loss in collateral value borrowers pay a higher interest rate on their loans, receive a worse quality assessment by their bank, and experience a substantial reduction in the supply of credit by their bank. Consistent with theories that consider collateral and monitoring to be complements, the reduction in collateral precedes a decrease in bank monitoring intensity and frequency of both collateral and borrower. |
| Keywords: | Collateral;credit rationing;differences-in-differences;floating lien;loan contracts;monitoring;natural experiment. |
| JEL: | D82 G21 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2011087&r=cta |
| By: | Daron Acemoglu; Georgy Egorov; Konstantin Sonin |
| Abstract: | When voters fear that politicians may have a right-wing bias or that they may be influenced or corrupted by the rich elite, signals of true left-wing conviction are valuable. As a consequence, even a moderate politician seeking reelection chooses “populist’ policies - i.e., policies to the left of the median voter - as a way of signaling that he is not from the right. Truly right-wing politicians respond by choosing more moderate, or even left-of-center policies. This populist bias of policy is greater when the value of remaining in office is higher for the politician; when there is greater polarization between the policy preferences of the median voter and right-wing politicians; when politicians are indeed more likely to have a hidden right-wing agenda; when there is an intermediate amount of noise in the information that voters receive; when politicians are more forward-looking; and when there is greater uncertainty about the type of the incumbent. We show that similar results apply when some politicians can be corrupted or influenced through other non-electoral means by the rich elite. We also show that ‘soft term limits’ may exacerbate, rather than reduce, the populist bias of policies. |
| JEL: | C71 D71 D74 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17306&r=cta |
| By: | Soohyung Lee; Muriel Niederle; Hye-Rim Kim; Woo-Keum Kim |
| Abstract: | The large literature on costly signaling and the somewhat scant literature on preference signaling had varying success in showing the effectiveness of signals. We use a field experiment to show that even when everyone can send a signal, signals are free and the only costs are opportunity costs, sending a signal increases the chances of success. In an online dating experiment, participants can attach “virtual roses” to a proposal to signal special interest in another participant. We find that attaching a rose to an offer substantially increases the chance of acceptance. This effect is driven by an increase in the acceptance rate when the offer is made to a participant who is less desirable than the proposer. Furthermore, participants endowed with more roses have more of their offers accepted than their counterparts. |
| JEL: | C78 C93 J0 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17340&r=cta |
| By: | Martimort, David; Stole, Lars |
| Abstract: | An aggregate game is a normal-form game with the property that each player’s payoff is a function only of his own strategy and an aggregate function of the strategy profile of all players. Aggregate games possess a set of purely algebraic properties that can often provide simple characterizations of equilibrium aggregates without first requiring that one solves for the equilibrium strategy profile. The defining nature of payoffs in an aggregate game allows one to project the n-player strategic analysis of a normal form game onto a lower-dimension aggregate-strategy space, thereby converting an n-player game to a simpler object – a self-generating single-person maximization program. We apply these techniques to a number of economic settings including competition in supply functions and multi-principal common agency games with nonlinear transfer functions. |
| Keywords: | Aggregate games; common agency; asymmetric informa- tion; menu auctions |
| JEL: | D8 C72 |
| Date: | 2011–06–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:32871&r=cta |