nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2011‒10‒01
nineteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Information revelation in procurement auctions with two-sided asymmetric information By Nicola Doni; Domenico Menicucci
  2. Litigation and Settlement under Judicial Agency By Levent Koçkesen; Murat Usman
  3. Credit Market Consequences of Improved Personal Identification: Field Experimental Evidence from Malawi By Xavier Giné; Jessica Goldberg; Dean Yang
  4. Work for Image and Work for Pay By Dessi, Roberta; Rustichini, Aldo
  5. Collateral Crises By Gary Gorton; Guillermo Ordonez
  6. Make it challenging : motivation through goal setting By Joaquín Gómez Miñambres
  7. See No Evil: Information Chains and Reciprocity in Teams By Eva-Maria Steiger; Ro'i Zultan
  8. Multiple policymakers and the social value of public information By Juan David Prada-Sarmiento
  9. Why do Facebook and Twitter facilitate revolutions more than TV and radio? By Kiss, Hubert Janos; Rosa-García, Alfonso
  10. Tagging with leisure needs By Pierre Pestieau; Maria Racioenero
  11. Multi-Period Contract Problems with Verifiable and Unverifiable Outputs By Kazuya Kamiya; Meg Sato
  12. Firms' Moral Hazard in Sickness Absences By René Böheim; Thomas Leoni
  13. Information provision by regulated public transport companies By De Borger B.; Fosgerau M.
  14. Do Bayesians learn their way out of ambiguity? By Alexander Zimper
  15. Innovation, Spillovers and Venture Capital Contracts By Dessi, Roberta
  16. Asymmetric Information and the Foreign-Exchange Trades of Global Custody Banks By Carol Osler; Thang Nguyen; Tanseli Savaser
  17. Cost Incentives for Doctors: A Double-Edged Sword By Schottmuller, C.
  18. Adverse Selection and Switching Costs in Health Insurance Markets: When Nudging Hurts By Benjamin R. Handel
  19. Costly Contracts and Consumer Credit By Igor Livshits; James MacGee; Michèle Tertilt

  1. By: Nicola Doni (Università degli Studi di Firenze,); Domenico Menicucci (Dipartimento di Matematica per le Decisioni)
    Abstract: A buyer needs to procure a good from either of two potential suppliers offering differentiated products and with privately observed costs. The buyer privately observes the own valuations for the products and (ex ante) decides how much of this information should be revealed to suppliers before they play a first score auction. We show that the more significant is each supplier’s private information on the own cost, the less information the buyer should reveal. Part of our analysis is linked to the comparison between a first and a second price auction in an asymmetric setup with a distribution shift.
    Keywords: Asymmetric auctions
    JEL: D44 D82
    Date: 2011
  2. By: Levent Koçkesen (Koc University); Murat Usman (Koc University)
    Abstract: We model the settlement of a legal dispute where the trial outcome depends on the behavior of a strategically motivated judge. We consider a standard asymmetric information model where the uninformed defendant makes a take it or leave it offer. If the case goes to trial, the judge decides how much effort to exert to learn about the actual damages inflicted on the plaintiff. We show that under very general assumptions the model exhibits multiple equilibria. In equilibria in which the judge exerts less effort more cases settle out of court, and vice versa. The judge is better off in low effort equilibria, with a higher settlement rate. However, the terms of the settlement heavily favor the informed plaintiff, and consequently induce over-investment in ex ante preventive care by the defendant.
    Keywords: Litigation, settlement, trial, judges
    JEL: K00 K41 D82 C78
    Date: 2011–09
  3. By: Xavier Giné; Jessica Goldberg; Dean Yang
    Abstract: We report the results of a randomized field experiment that examines the credit market impacts of improvements in a lender's ability to determine borrowers’ identities. Improved personal identification enhances the credibility of a lender’s dynamic repayment incentives by allowing it to withhold future loans from past defaulters and expand credit for good borrowers. The experimental context, rural Malawi, is characterized by an imperfect identification system. 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).
    JEL: O12 O16
    Date: 2011–09
  4. By: Dessi, Roberta (Toulouse School of Economics (IDEI and GREMAQ), and CEPR); Rustichini, Aldo (University of Minnesota)
    Abstract: Standard economic models with complete information predict a positive, monotonic relationship between pay and performance. This prediction does not always hold in experimental tests: offering a small payment may result in lower performance than not offering any pay- ment. We test experimentally two main explanations that have been put forward for this result: the "incomplete contract" hypothesis views the payment rule as a signal given to subjects on purpose of the activity. The "informed principal" hypothesis views it as a signal concerning the characteristics of the agent or of the task. The incomplete contract view appears to oer the best overall explanation for our results. We also nd that high-powered monetary incentives do not "crowd out" intrinsic motivation, but may elicit "too much" eort when intrinsic motivation is very high.
    Date: 2011–09–10
  5. By: Gary Gorton (Yale University and NBER (e-mail:; Guillermo Ordonez (Yale University (e-mail:
    Abstract: How can a small shock sometimes cause a large crisis when it does not at other times? Financial fragility builds up over time because it is not optimal to always produce costly information about counterparties. Short-term, collateralized, debt (e.g., demand deposits, money market instruments) -private money- is efficient if agents are willing to lend without producing costly information about the value of the collateral backing the debt. But, when the economy relies on this informationally-insensitive debt, information is not renewed over time, generating a credit boom during which firms with low quality collateral start borrowing. During the credit boom output and consumption go up, but there is increased fragility. A small shock can trigger a large change in the information environment; agents suddenly produce information about all collateral and find that much of the collateral is low quality, leading to a decline in output and consumption. A social planner would produce more information than private agents, but would not always want to eliminate fragility.
    Date: 2011–09
  6. By: Joaquín Gómez Miñambres
    Abstract: We study a principal agent model where agents derive a sense of pride when accomplishing production goals. As in classical models, the principal offers a pay-per-performance wage to the agent, determining the agent’s extrinsic incentives. However, in our setting, the principal does also want to set goals that affect the agents’ intrinsic motivation to work. Agents differ in their personal standard which determines what becomes challenging and rewarding to them, and hence the intensity of their intrinsic motivation to achieve goals. We show that, at the optimal contract, the agents’ production, as well as the goals set by the principal, increase with the agents’ personal standards. Thus, although goal setting is payoff irrelevant, since it does not directly affect agents’ wage, it increases agents’ achievement and hence the principal’s profits. Moreover, we show that a mediocre standard agent could end up being the most satisfied one
    Keywords: Intrinsic motivation; Goal-setting; Reference dependent preference
    JEL: D82 D86 M50 Z13
    Date: 2011–08
  7. By: Eva-Maria Steiger (Max Planck Institute of Economics, Jena); Ro'i Zultan
    Abstract: Transparency in teams can induce cooperation. We study contribution decisions by agents when previous decisions can be observed. We find that an information chain, in which each agent directly observes only the decision of her immediate predecessor, is at least as effective as a fully-transparent protocol in inducing cooperation under increasing returns to scale. In a comparable social dilemma, the information chain leads to high cooperation both when compared to a non-transparent protocol for early movers, and when compared to a fully-transparent protocol for late movers. we conclude that information chains facilitate cooperation by balancing positive and negative reciprocity.
    Keywords: team production, public goods, incentives, externality, information, transparency, conditional cooperation
    JEL: C72 C92 D21 J31 M52
    Date: 2011–09–23
  8. By: Juan David Prada-Sarmiento
    Abstract: In most economies, macroeconomic policy is conducted by two or more independent authorities. In general, each policymaker has a different piece of information about the state of the economy, and this information is different from the one held by the private sector. We extend the model of James and Lawler [2011], of asymmetric and imperfect information, to account for the existence of two independent policymakers. The active policymakers can choose optimally what policy rule to follow, what information to share with the other policymakers, and what information to share with the public. This paper studies the social value of public information when the policymakers are active. We find that improving the quality of the signals transmitted to the private sector can increase the expected value of welfare. If both policymakers seek to maximize expected welfare, full information sharing between authorities achieves higher expected welfare than no information sharing at all.
    Date: 2011–09–11
  9. By: Kiss, Hubert Janos; Rosa-García, Alfonso
    Abstract: A distinctive feature of recent revolutions was the key role of social media (e.g. Facebook, Twitter and YouTube). In a simple model we assume that while social media allow to observe all previous decisions, mass media only give aggregate information about the state of a revolt. We show, first, that when individuals' willingness to revolt is publicly known, then both sorts of media foster a successful revolution. However, when willingness to revolt is private information, only social media ensure that a revolt succeeds, with mass media multiple outcomes are possible. This suggests that social media enhance the likelihood that a revolution triumphs more than traditional mass media.
    Keywords: social media; mass media; revolution; coordination game; sequential games
    JEL: D74 D02 C72
    Date: 2011–09–19
  10. By: Pierre Pestieau; Maria Racioenero
    Abstract: We study optimal redistributive taxes when individuals differ in two characteristics - earning ability and leisure needs - assumed to be imperfectly correlated. Individuals have private information about their abilities but needs are observable. With two different levels of observable needs the population can be separated into two groups and needs may be used as a tag. We first assume that the social planner considers individuals should be compensated for their leisure needs and characterize the optimal redistributive policy, and the extent of compensation for needs, with tagging. We also consider an alternative social objective in which individuals are deemed responsible for their needs.
    JEL: H21 H41
    Date: 2011–09
  11. By: Kazuya Kamiya (University of Tokyo - Faculty of Economics); Meg Sato (The Australian National University (ANU) - Crawford School of Economics and Government)
    Abstract: Labour contracts tend to be more complicated than one simple short or long-term contract which is the basis of previous studies. Combinations of different length contracts become essential when principals expect to maximize not only verifiable outputs but also observable but unverifiable outputs, e.g., leadership. This paper is the first to develop a theoretical model of multi-period contracts that combine short-, mid-, and long-term contracts. We show that combinations of different length contracts vary by the relative importance of verifiable and unverifiable outputs and relative efficiency of investments in human capital made for each output. We also determine thresholds where the principal switches from offering one type of contract to the other.
    Keywords: Different Length Contracts, Unverifiable Outputs, Unverifiable Investments, Unverifiable Ability
    JEL: D86 J41 J31
    Date: 2011–04
  12. By: René Böheim (WIFO); Thomas Leoni (WIFO)
    Abstract: Sick workers in many countries receive sick pay during their illness-related absences from the workplace. In several countries, the social security system insures firms against their workers' sickness absences. However, this insurance may create moral hazard problems for firms, leading to the inefficient monitoring of absences or to an underinvestment in their prevention. In the present paper, we investigate firms' moral hazard problems in sickness absences by analysing a legislative change that took place in Austria in 2000. In September 2000, an insurance fund that refunded firms for the costs of their blue-collar workers' sickness absences was abolished (firms did not receive a similar refund for their white-collar workers' sickness absences). Before that time, small firms were fully refunded for the wage costs of blue-collar workers' sickness absences. Large firms, by contrast, were refunded only 70 percent of the wages paid to sick blue-collar workers. Using a difference-in-differences-in-differences approach, we estimate the causal impact of refunding firms for their workers' sickness absences. Our results indicate that the incidences of blue-collar workers' sicknesses dropped by approximately 8 percent and sickness absences were almost 11 percent shorter following the removal of the refund. Several robustness checks confirm these results.
    Keywords: Absenteeism Moral Hazard Sickness Insurance
  13. By: De Borger B.; Fosgerau M.
    Abstract: We study the interaction between pricing, frequency of service and information provision by public transport firms offering scheduled services, and we do so under various regulatory regimes. The model assumes that users can come to the bus stop or rail station at random or they can plan their trips; the fraction of users who plan their trips is endogenous and depends on the frequency of service and on the quality of information provided. Four institutional regimes are considered, reflecting various degrees of government regulation. A numerical example illustrates the theoretical results. Findings include the following. First, fare regulation induces the firm to provide less frequency and less information than is socially optimal. Second, if information and frequency did not affect the number of planning users a higher fare always induces the firm to raise both frequency and the quality of information. With endogenous planning, however, this need not be the case, as the effect of higher fares strongly depends on how frequency and information quality affect the number of planners. Third, a profit-maximizing firm offers more information than a fare-regulated firm. Fourth, if the agency regulates both the fare and the quality of information then more stringent information requirements induce the firm to reduce frequency; this strongly limits the welfare improvement of information regulation. Finally, of all institutional structures considered, socially optimal fares, frequency and quality of information stimulate passengers least to plan their trips, because the high frequency offered reduces the benefits of trip planning.
    Date: 2011–09
  14. By: Alexander Zimper
    Abstract: In standard models of Bayesian learning agents reduce their uncertainty about an eventÂ’s true probability because their consistent estimator concentrates almost surely around this probabilityÂ’s true value as the number of observations becomes large. This paper takes the empirically observed violations of SavageÂ’s (1954) sure thing principle seriously and asks whether Bayesian learners with ambiguity attitudes will reduce their ambiguity when sample information becomes large. To address this question, I develop closed-form models of Bayesian learning in which beliefs are described as Choquet estimators with respect to neo-additive capacities (Chateauneuf, Eichberger, and Grant 2007). Under the optimistic, the pessimistic, and the full Bayesian update rule, a Bayesian learnerÂ’s ambiguity will increase rather than decrease to the effect that these agents will express ambiguity attitudes regardless of whether they have access to large sample information or not. While consistent Bayesian learning occurs under the Sarin-Wakker update rule, this result comes with the descriptive drawback that it does not apply to agents who still express ambiguity attitudes after one round of updating.
    Keywords: Non-additive Probability Measures, Bayesian Learning, Choquet Expected Utility Theory
    JEL: C11 D81 D83
    Date: 2011
  15. By: Dessi, Roberta (IDEI, Toulouse School of Economics)
    Abstract: Innovative start-ups and venture capitalists are highly clustered, benefiting from localized spillovers: Silicon Valley is perhaps the best example. There is also substantial geographical variation in venture capital contracts: California contracts are more "incomplete". This paper proposes an economic explanation for these observations, often attributed to regional cultural differences. In the presence of significant spillovers, it becomes optimal for an innovative start-up and its financier to adopt contracts with fewer contingencies: these contracts maximize their ability to extract (part of) the surplus they generate through positive spillovers. This relaxes ex-ante financing constraints and makes it possible to induce higher innovative effort.
    JEL: D82 D86 G24 L22
    Date: 2011–09–13
  16. By: Carol Osler (Brandeis International Business School); Thang Nguyen (Brandeis International Business School); Tanseli Savaser (Williams College)
    Abstract: This paper provides the first rigorous empirical analysis of markups on custodial foreign exchange trades. It finds that they substantially exceed relevant benchmarks such as interbank half-spreads. We trace this to an information asymmetry -- custodial bank dealers know more about their prices and bid-ask spreads than their client funds. We also examine the asset managers’ continued heavy reliance on this high-cost approach to trading when alternatives are available with lower markups. We provide evidence that this choice does not reflect ignorance of the cost differential. Analysis relies on the complete foreign exchange trading record of a mid-sized global custody bank during calendar year 2006.
    Date: 2011–06
  17. By: Schottmuller, C. (Tilburg University, Center for Economic Research)
    Abstract: Incentivicing doctors to take the costs of treatment into account in their prescription decision could lead to lower health care expenditures and higher welfare. This paper shows that also the opposite effects can result. The reason is a misalignment of doctor and patient incentives: Because of health insurance, the patient does not take the costs of treatment fully into account. This misalignment hampers communication between patient and doctor, e.g. the patient may overstate the intensity of symptoms. It is shown that cost incentives for doctors increase welfare if (i) the doctor's examination technology is sufficiently good or (ii) (marginal) costs of treatment are high enough. Optimal health care systems should implement different degrees of cost incentives depending on type of disease and/or doctor.
    Keywords: cheap talk;communication;health insurance;market design.
    JEL: D82 D83 I10
    Date: 2011
  18. By: Benjamin R. Handel
    Abstract: This paper investigates consumer switching costs in the context of health insurance markets, where adverse selection is a potential concern. Though previous work has studied these phenomena in isolation, they interact in a way that directly impacts market outcomes and consumer welfare. Our identification strategy leverages a unique natural experiment that occurred at a large firm where we also observe individual-level panel data on health insurance choices and medical claims. We present descriptive results to show that (i) switching costs are large and (ii) adverse selection is present. To formalize this analysis we develop and estimate a choice model that jointly quantifies switching costs, risk preferences, and ex ante health risk. We use these estimates to study the welfare impact of an information provision policy that nudges consumers toward better decisions by reducing switching costs. This policy increases welfare in a naive setting where insurance plan prices are held fixed. However, when insurance prices change endogenously to reflect updated enrollee risk pools, the same policy substantially exacerbates adverse selection and reduces consumer welfare, doubling the existing welfare loss from adverse selection.
    JEL: D81 D82 D83 G22 I11 I18
    Date: 2011–09
  19. By: Igor Livshits; James MacGee; Michèle Tertilt
    Abstract: Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.
    JEL: E21 E49 G18 K35
    Date: 2011–09

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