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on Contract Theory and Applications |
| By: | Shingo Ishiguro (Graduate School of Economics, Osaka University) |
| Abstract: | In this paper we present an axiomatic approach to characterize the optimal contracts, which we call gfair contracts,h in the general moral hazard model. The two main axioms we employ are incentive efficiency and no-envyness. The incentive efficiency requires that agents of organization select the Pareto efficient contracts among all possible incentive compatible contracts. No-envyness is equity requirement to ensure that each agent does not envy contracts of others in the same organization. We then show that, due to the tension between incentive efficiency and no-envyness, fair contracts have the very simple feature that risk averse agents are offered the fixed wage to choose only the least costly action. |
| Keywords: | Moral Hazard, Incentive Contracts, Fairness. |
| JEL: | D82 D86 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1130&r=cta |
| By: | Bourjade, Sylvain; Schindele, Ibolya |
| Abstract: | This paper focuses on the role of managerial agency costs in financial conglomeration. We model conglomeration as the integration of commercial and investment banking in one organizational unit where bank managers accomplish both activities. We assume that managers differ in their abilities to undertake the individual tasks. The higher is a manager's ability in undertaking one task, the lower is her disutility of effort for that activity and the higher is her disutility of effort for the other task. When there is no managerial moral hazard, it is not optimal for the bank to form a conglomerate. We show that under managerial moral hazard, forming a conglomerate may be in the bank's interest because it may entail lower agency costs and a larger group of borrowers to fund. |
| Keywords: | Financial Conglomerates; Commercial Banking; Investment Banking; Banking Organization; Multi-task; Moral Hazard |
| JEL: | D82 G24 G21 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34815&r=cta |
| By: | Georges Dionne; Casey G. Rothschild |
| Abstract: | Risk classification refers to the use of observable characteristics by insurers to group individuals with similar expected claims, compute the corresponding premiums, and thereby reduce asymmetric information. An efficient risk classification system generates premiums that fully reflect the expected cost associated with each class of risk characteristics. This is known as financial equity. In the health sector, risk classification is also subject to concerns about social equity and potential discrimination. We present different theoretical frameworks that illustrate the potential trade-off between efficient insurance provision and social equity. We also review empirical studies on risk classification and residual asymmetric information. |
| Keywords: | Adverse selection, classification risk, diagnostic test, empirical test of asymmetric information, financial equity, genetic test, health insurance, insurance rating, insurance pricing, moral hazard, risk classification, risk characteristic, risk pooling, risk separation, social equity |
| JEL: | D80 D82 D86 G22 I11 I18 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1137&r=cta |
| 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 payment. 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 offer the best overall explanation for our results. We also find that high-powered monetary incentives do not "crowd out" intrinsic motivation, but may elicit "too much" effort when intrinsic motivation is very high. |
| Date: | 2011–09–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:24943&r=cta |
| By: | Auriol, Emmanuelle (TSE, ARQADE and IDEI); Picard, Pierre (CREA, University of Luxembourg and CORE, Université Catholique de Louvain) |
| Abstract: | In this paper, we discuss the choice for build-operate-and-transfer (BOT) concessions when governments and rm managers do not share the same information regarding the operation characteristics of a facility. We show that larger shadow costs of public funds and larger information asymmetries entice governments to choose BOT concessions. This result stems from a trade-o¤ between the government’s shadow costs of nancing the construction and the operation of the facility and the excessive usage price that the consumer may face during the concession period. The incentives to choose BOT concessions increase as a function of ex-ante informational asymmetries between governments and potential BOT concession holders and with the possibility of transferring the concession cost characteristics to public rms at the termination of the concession. |
| Keywords: | Public-private-partnership, privatization, adverse selection, regulation, natural monopoly, infrastructure, facilities |
| JEL: | L43 L51 D83 L33 |
| Date: | 2011–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:24307&r=cta |
| By: | Martimort, David; Sand-Zantman, Wilfried |
| Abstract: | We analyze environmental agreements in contexts with asymmetric information, voluntary participation by sovereign countries and possibly limited enforcement. Taking a mechanism design perspective, we study how countries can agree on effort levels and compensations to take into account multilateral externalities. We delineate conditions for efficient agreements and trace out possible inefficiencies to the conjectures that countries hold following disagreement. We show how optimal mechanisms admit simple approximations with attractive implementation properties. Finally, we also highlight how limits on commitment strongly hinder performances of optimal mechanisms. |
| JEL: | D82 |
| Date: | 2011–08–31 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:24932&r=cta |
| By: | Bourjade, Sylvain; Schindele, Ibolya |
| Abstract: | This paper focuses on the size of the borrower group in group lending. We show that, when social ties in a community enhance borrowers' incentives to exert effort, a profit-maximizing financier chooses a group of limited size. Borrowers that would be fundable under moral hazard but have insufficient social ties do not receive funding. The result arises because there is a trade-off between raising profits through increased group size and providing incentives for borrowers with less social ties. The result may explain why many micro-lending institutions and rural credit cooperatives lend to groups of small size. |
| Keywords: | Group Lending; Moral Hazard; Social Capital |
| JEL: | D82 G21 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34817&r=cta |
| By: | Michael Keane (School of Economics, University of New South Wales); Olena Stavrunova (Economics Discipline Group, University of Technology, Sydney) |
| Abstract: | The size of adverse selection and moral hazard effects in health insurance markets has important policy implications. For example, if adverse selection effects are small while moral hazard effects are large, conventional remedies for inefficiencies created by adverse selection (e.g., mandatory insurance enrolment) may lead to substantial increases in health care spending. Unfortunately, there is no consensus on the magnitudes of adverse selection vs. moral hazard. This paper sheds new light on this While both adverse selection and moral hazard effects of Medigap have been studied separately, this is the first paper to estimate both in an unified econometric framework. We develop an econometric model of insurance demand and health care expenditure, where adverse selection is measured by sensitivity of insurance demand to expected expenditure. The model allows for correlation between unobserved determinants of expenditure and insurance demand, and for heterogeneity in the size of moral hazard effects. Inference relies on an MCMC algorithm with data augmentation. Our results suggest there is adverse selection into Medigap, but the effect is small. A one standard deviation increase in expenditure risk raises the probability of insurance purchase by 0.037. In contrast, our estimate of the moral hazard effect is much larger. On average, Medigap coverage increases health care expenditure by 32%. |
| Keywords: | health insurance; adverse selection; moral hazard; health care expenditure |
| JEL: | D82 C34 C35 |
| Date: | 2011–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:wpaper:167&r=cta |
| By: | Bourjade, Sylvain; Jullien, Bruno |
| Abstract: | We analyze situations in which an expert is biased toward some decision but cares also about his reputation in the market for experts. The information the expert reveals decreases as his bias moves toward stronger preference for the status quo. We show that it is optimal to publicly disclose both the expert's contribution and his identity. Surprisingly, revealing the intensity of the expert's bias doesn't always improve the information he reveals in equilibrium. The presence of a second expert raises the first expert's incentives to report truthfully when reports are public, but reduces them when they are secret. In particular, having an option to call another expert may be detrimental in terms of information production if reports are not public. Finally, sequential consultation of experts reduces the information obtained when reports are public, but raises it when they are secret. |
| Keywords: | Experts; Bias; Reputation |
| JEL: | D82 L40 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34813&r=cta |
| By: | Ana Espinola-Arredondo; Felix Munoz-Garcia (School of Economic Sciences, Washington State University) |
| Abstract: | This paper evaluates the welfare benefits of introducing environmental regulation in a market that is subject to the threat of entry. We consider complete and incomplete information settings, where potential entrants use the regulator’s tax policy and the incumbent’s output decisions in order to infer the incumbent’s cost structure. When the regulator is absent, we show that firms? entry-deterring practices increase pollution relative to complete information. Hence, under certain conditions, environmental regulation becomes more beneficial in incomplete than in complete information contexts. Our results, therefore, identify under which cases an under-or over-estimation of the welfare benefits of environmental regulation arises from ignoring the information setting in which firms interact. We also examine how this estimation error increases as firms become more symmetric in their production costs. |
| Keywords: | Entry deterrence; Signaling; Emission fees; Welfare Benefits |
| JEL: | D82 H23 L12 Q5 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:wsu:wpaper:espinola-11&r=cta |
| By: | Ufuk Akcigit; Qingmin Liu |
| Abstract: | Technological progress is typically a result of trial-and-error research by competing firms. While some research paths lead to the innovation sought, others result in dead ends. Because firms benefit from their competitors working in the wrong direction, they do not reveal their dead-end findings. Time and resources are wasted on projects that other firms have already found to be dead ends. Consequently, technological progress is slowed down, and the society benefits from innovations with delay, if ever. To study this prevalent problem, we build a tractable two-arm bandit model with two competing firms. The risky arm could potentially lead to a dead end and the safe arm introduces further competition to make firms keep their dead-end findings private. We characterize the equilibrium in this decentralized environment and show that the equilibrium necessarily entails significant efficiency losses due to wasteful dead-end replication and a flight to safety – an early abandonment of the risky project. Finally, we design a dynamic mechanism where firms are incentivized to disclose their actions and share their private information in a timely manner. This mechanism restores efficiency and suggests a direction for welfare improvement. |
| JEL: | D83 D92 O31 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17602&r=cta |
| By: | Bourjade, Sylvain; Germain, Laurent |
| Abstract: | The aim of this paper is to study what is the best structure of a Board of Directors when collusive aspects between the Board and the CEO are taken into account. We analyze how shareholders should select the members of the Board in a framework with asymmetric information and uncertainty about the optimal projects for the firm. In particular, we examine the optimal degree of independence of the Board from a shareholders perspective. This allows us to state when it is beneficial for shareholders to have an insider-oriented board or an outsider oriented board with a majority of independent directors when collusion is a major threat. |
| Keywords: | Collusion; Corporate Governance; Asymmetric Information; Uncertainty |
| JEL: | D81 G34 D82 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34814&r=cta |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:24944&r=cta |
| By: | Bernhard Ganglmair (Jindal School of Management, University of Texas at Dallas); Emanuele Tarantino (Department of Economics, University of Bologna) |
| Abstract: | We present a model of industry standard setting with two-sided asymmetric information about the existence of intellectual property. We provide an equilibrium analysis of (a) firms' incentives to communicate ideas for improvements of an industry standard, and (b) firms' decisions to disclose the existence of intellectual property to other participants of the standardization process. |
| Keywords: | patent holdup; patent disclosure; standard setting organizations; industry standards; disclosure rules; conversation; asymmetric information; Bertrand competition. |
| JEL: | D71 L15 O34 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:net:wpaper:1115&r=cta |
| By: | Alex Edmans; Itay Goldstein; John Y. Zhu |
| Abstract: | This paper studies optimal contracting under synergies. We define influence as the extent to which effort by one agent reduces a colleague's marginal cost of effort, and synergy to be the sum of the (unidimensional) influence parameters across a pair of agents. In a two-agent model, effort levels are equal even if influence is asymmetric. The optimal effort level depends only on total synergy and not individual influence parameters. An increase in synergy raises total effort and total pay, consistent with strong equity incentives in small firms, including among low-level employees. The influence parameters matter only for individual pay. Pay is asymmetric, with the more influential agent being paid more, even though the level and productivity of effort are both symmetric. With three agents, effort levels differ and are higher for more synergistic agents. An increase in the synergy between two agents can lead to the third agent being excluded from the team, even if his productivity is unchanged. This has implications for optimal team composition and firm boundaries. Agents that influence a greater number of colleagues receive higher wages, consistent with the salary differential between CEOs and divisional managers. |
| JEL: | D86 J31 J33 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17606&r=cta |
| By: | Sung-Ha Hwang (Department of Economics, Sogang University, Seoul); Samuel Bowles (Santa Fe Institute, U.S.A. and Dipartimento di Economia Politica, Univerity of Siena, Italy) |
| Abstract: | In both experimental and natural settings incentives sometimes under-perform, generating smaller eects on the targeted behaviors than would be predicted for entirely self-regarding agents. A parsimonious explanation is that incentives that appeal to payo maximizing mo- tives may crowd out non-economic motives such as altruism, reciprocity, intrinsic motivation and other social preferences, leading to disappointing and sometimes even counter-productive incentive eects. Evidence from behavioral experiments indicates that crowding may take two forms: categorical (the eect on preferences depends only on the presence or absence of the incentive) or marginal (the eect depends on the extent of the incentive). We extend an earlier contribution to this journal (Bowles and Hwang, 2008) providing a more general framework for the study of optimal incentives when crowding out results from framing and information eects including (with evidence for ) categorical crowding, and as a result, an expanded range of situations for which the sophisticated planner will make greater use of incentives when incentives crowd out social preferences than when motivational crowding is absent. |
| Keywords: | Social preferences, public goods, motivational crowding out, explicit incentives, framing, endogenuous preferences |
| JEL: | D64 H41 D78 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:sgo:wpaper:1118&r=cta |
| By: | Jeitschko, Thomas D.; Normann, Hans-Theo |
| Abstract: | We contrast a standard deterministic signaling game with one where the signal-generating mechanism is stochastic. With stochastic signals a unique equilibrium emerges that involves separation and has intuitive comparative-static properties as the degree of signaling depends on the prior type distribution. With deterministic signals both pooling and separating configurations occur. Laboratory data support the theory: In the stochastic variant, there is more signaling behavior than with deterministic signals, and less frequent types distort their signals relatively more. Moreover, the degree of congruence between equilibrium and subject behavior is greater in stochastic settings compared to deterministic treatments. -- |
| Keywords: | experiments,learning,noise,signaling,stochastic environments |
| JEL: | C7 C9 D8 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:dicedp:35&r=cta |
| By: | R. AEBERHARDT (Insee); I. BUONO (Banca d'italia); H. FADINGER (Department of Economics,University of Vienna) |
| Abstract: | We consider a model where exporting requires finding a local partner in each market. Contracts are incomplete and exporters must learn the reliability of their partners through experience. In the model, export behavior is state-dependent due to matching frictions, although there are no sunk costs. Better legal institutions alleviate contracting frictions especially in sectors with large contracting problems. Thus, measures of legal quality help reduce the risk that a match between an exporter and a local distributor splits, and they are all the more effective in sectors that are more exposed to hold-up problems. Moreover, the breaking risk declines with the age of the relationship, as unreliable partners are weeded out. We find strong evidence in favor of the model's predictions when testing them with a French dataset that includes information on firm-level exports by destination country. |
| Keywords: | Trade Dynamics, Learning, Incomplete Contracts, State dependence, Firm-level Trade Data |
| JEL: | F12 F14 L14 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpdeee:g2011-16&r=cta |
| By: | Ufuk Akcigit; Qingmin Liu |
| Date: | 2011–11–21 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000321&r=cta |