nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2011‒12‒13
twenty-two papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Decentralization of contracts with interim sidecontracting By Theilen, Bernd, 1965-
  2. Securitization and moral hazard: Does security price matter? By Liu, Luke
  3. Quotient Spaces of Boundedly Rational Types By Davide Cianciaruso; Fabrizio Germano
  4. Managerial incentives under competitive pressure: Experimental investigation By Ahmed Ennasri; Marc Willinger
  5. Management compensation and market timing under portfolio constraints By Agarwal, Vikas; Gómez, Juan-Pedro; Priestley, Richard
  6. The Effect of Bidding Information in Ascending Auctions. By Mun Chuia; David Porter; Stephen Rassenti; Vernon Smith
  7. Cronyism in Business, Public Sector and Politics By Zudenkova, Galina
  8. Endogenous Information Flows and the Clustering of Announcements By Acharya, Viral V.; DeMarzo, Peter; Kremer, Ilan
  9. Seller Reputation and Trust in Pre-Trade Communication By Bruno Jullien; In-Uck Park
  10. Laws and Norms By Bénabou, Roland; Tirole, Jean
  11. Informative Advertising, Consumer Search and Transparency Policy By Wang, Chengsi
  12. On the core and Walrasian expectations equilibrium in infinite dimensional commodity spaces By Bhowmik, Anuj; Cao, Jiling
  13. Price Discrimination in Many-to-Many Matching Markets By Renato Gomes; Alessandro Pavan
  14. Multiple Equilibria in Asymmetric First-Price Auctions By Todd R. Kaplan; Shmuel Zamir
  15. Multiple equilibria in asymmetric first-price auctions By Kaplan, Todd R; Zamir, Shmuel
  16. Regulation of network industries in the European Union and in Central and Eastern Europe By Major, Iván; Kiss, Károly M.
  17. Population Monotonic and Strategy-Proof Mechanisms Respecting Welfare Lower Bounds By Duygu Yengin
  18. A Model of Party Discipline in a Congress By Zudenkova, Galina
  19. Efficient Renegotiation in Search Markets: Theory and Field Experimental Evidence By Bengtsson, Niklas
  20. A Theory of Monitoring and Internal Labor Markets By Gautam Bose; Kevin Lang
  21. Tax Evasion and Presumptive Taxation Methods. A Case Study in Italy: Sector Studies By Giuseppe Pulina
  22. The Social Cost of Blackmail By Oleg Yerokhin

  1. By: Theilen, Bernd, 1965-
    Abstract: This paper gives a new explanation for the phenomena of subcontracting. A model in which a principal contracts two agents who work in a sequence on a project, have soft information and can collude is considered. Side-contracts between agents can be signed at any stage of the game. Due to limited liability and moral hazard agents obtain a rent. The principal’s problem is to find the preferable contracting structure. It is shown that in this setting a decentralized contracting structure can be superior to a centralized structure for the principal. The paper derives the conditions under which this holds. Journal of Economic Literature Classification Numbers: D23, D82, L14, L22. Keywords: Contract delegation, Collusion, Interim side-contracting, Moral hazard.
    Keywords: Subcontractació, 33 - Economia,
    Date: 2011
  2. By: Liu, Luke
    Abstract: This article analyses the effect of security price on the behaviour of bank securitization. We present a model of bank securitization in which security price together with liquid constraints create the incentive for banks to originate and sell assets backed securities to investors. Banks have a comparative advantage in locating and screening projects within their locality. Our results show that under the buyer’s market pricing mechanism the banks with different liquidity constraints can share the risk and the moral hazard problem is not serious; but under the seller’s market pricing mechanism the banks have the incentive to conduct strategic securitization and the moral hazard problem is serious. Our main idea has been supported by the subprime crisis broke in the US in 2007.
    Keywords: Securitization; Security price; Moral hazard
    JEL: C50 C02 G21
    Date: 2011–05–19
  3. By: Davide Cianciaruso; Fabrizio Germano
    Abstract: I analyze common agency games in which the principals, and possibly the agent,have private information. I distinguish between games in which the principals delegate the fi…nal decisions to the agent, and games in which they retain some decision power after offering their mechanisms. I show that,in contrast with mechanism design models with one informed Myerrson's Inscrutability Principle fails when there are many informed principals. I also …find that, in contrast with common agency models with uninformed principals, the Delegation Principle (Menu Theorem) fails when principals are informed. I then focus on Perfect Bayesian Equilibria in which principals offer their mechanisms without randomizing. I characterize the outcomes of arbitrary games with delegation as outcomes of a new game in which principals offer menus and send cheap-talk signals. Next, I characterize the outcomes of arbitrary games without delegation as outcomes of a new game in which principals offer menus of direct revelation mechanisms, to which they truthfully report their types. JEL Code: C72, D03, D83
    Keywords: Incomplete-information games, high-order reasoning, type space, quotient space, hierarchies of beliefs, bounded rationality Principle, menus, signals, direct revelation mechanisms.
    Date: 2011–09–20
  4. By: Ahmed Ennasri; Marc Willinger
    Abstract: We investigate the effects of competition on managerial incentives and effort in a laboratory experiment. Each owner offers compensation to his manager in two different contexts: monopoly and Cournot duopoly. After accepting the compensation, the manager chooses an effort level to increase the probability of reduced costs of his firm. Theory predicts that the entry of a rival firm in a monopolistic industry affects negatively both the incentive compensation and the effort level. Our experimental findings confirm that the entry of a rival firm reduces the incentive compensation but not the manager’s effort level. However, despite the reduction of the incentive compensation, the manager continues to accept the contract offers and exert the same level of effort.
    Keywords: Managerial Incentives, Effort, Competition, Moral hazard, Experiments
    Date: 2011–06
  5. By: Agarwal, Vikas; Gómez, Juan-Pedro; Priestley, Richard
    Abstract: This paper shows that portfolio constraints have important implications for management compensation and performance evaluation. Concretely, in the presence of portfolio constraints, allowing for benchmarking can be beneficial. Benchmark design arises as an alternative effort inducement mechanism vis-a-vis relaxing portfolio constraints. Numerically, we solve jointly for the manager's linear incentive fee and the optimal benchmark. The size of the incentive fee and the risk adjustment in the benchmark composition are increasing in the investor's risk tolerance and the manager's ability to acquire and process private information. --
    Keywords: market timing,incentive fee,benchmarking,portfolio constraints
    JEL: D81 D82 J33
    Date: 2011
  6. By: Mun Chuia (School of Economics and Smith's Center for Experimental Economics Research, Shanghai Jiao Tong University, China); David Porter (Economic Science Institute, Chapman University); Stephen Rassenti (Economic Science Institute, Chapman University); Vernon Smith (Economic Science Institute, Chapman University)
    Abstract: We study the effect of the drop out and reenter information in an environment where bidders' values involve both private and common value components. We find that (1) providing bidding information does not have a significant effect on expected revenue and expected efficiency. (2) The effect of information on winner's expected profit depends on the range of uncertainty of the common value component and the level of Nash profit prediction, which the auctioneer has no a priori knowledge. In our environment, where bidders have a private component to their value and the auction takes place in ascending clock format, (3) bidders do not suffer from the winner's curse when information is not provided. (4) Information substantially increases the variability of revenue and winner?s profit when the range of uncertainty of the common value component is large. (5) Bidders? response to information depends on the range of uncertainty.
    JEL: D44
    Date: 2011
  7. By: Zudenkova, Galina
    Abstract: This paper contrasts the incentives for cronyism in business, the public sector and politics within an agency problem model with moral hazard. The analysis is focused on the institutional differences between private, public and political organizations. In business, when facing a residual claimant contract, a chief manager ends up with a relatively moderate rst-best level of cronyism within a …firm. The institutional framework of the public sector does not allow explicit contracting, which leads to a more severe cronyism problem within public organizations. Finally, it is shown that the nature of political appointments (such that the subordinate's reappointment is conditioned on the chief's re-election) together with implicit contracting makes political cronyism the most extreme case. JEL classifi…cation: D72, D73, D86. Keywords: Cronyism; Meritocracy; Manager; Bureaucrat; Politician.
    Keywords: Clientelisme, Burocràcia, Polítics, 32 - Política,
    Date: 2011
  8. By: Acharya, Viral V.; DeMarzo, Peter; Kremer, Ilan
    Abstract: We consider the strategic timing of information releases in a dynamic disclosure model. Because investors don’t know whether or when the firm is informed, the firm will not necessarily disclose immediately. We show that bad market news can trigger the immediate release of information by firms. Conversely, good market news slows the release of information by firms. Thus, our model generates clustering of negative announcements. Surprisingly, this result holds only when firms can preemptively disclose their own information prior to the arrival of external information. These results have implications for conditional variance and skewness of stock returns.
    Keywords: disclosure dynamics; disclosure timing; disclosure,; earnings announcement; skewness; stochastic volatility; strategic disclosure
    JEL: D82 G14 G30 M41
    Date: 2011–12
  9. By: Bruno Jullien; In-Uck Park
    Abstract: We characterize the unique equilibrium in which high ability sellers always announce the quality of their items truthfully, in a repeated game model of experienced good markets with adverse selection on a seller's propensity to supply good quality items. In this equilibrium a seller's value function strictly increases in reputation and a seller's type is revealed within finite time. The analysis highlights a new reputation mechanism based on an endogenous complementarity the market places between a seller's honesty in pre-trade communication (trust) and his/her ability to deliver good quality (reputation). As maintaining honesty is less costly for high ability sellers who anticipate less “bad news” to disclose, they can signal their ability by communicating in a more trustworthy manner. Applying this model, we examine the extent to which consumer feedback systems foster trust in online markets, including the possibility that sellers may change identities or exit.
    Keywords: cheap talk, consumer rating system, reputation, trust.
    JEL: C73 D82 D83 L14
    Date: 2011–03
  10. By: Bénabou, Roland; Tirole, Jean
    Abstract: This paper analyzes how private decisions and public policies are shaped by personal and societal preferences (values), material or other explicit incentives (laws) and social sanctions or rewards (norms). It first examines how honor, stigma and social norms arise from individuals’ behaviors and inferences, and how they interact with material incentives. It then characterizes optimal incentive-setting in the presence of norms, deriving in particular appropriately modified versions of Pigou and Ramsey taxation. Incorporating agents’ imperfect knowledge of the distribution of preferences opens up to analysis several new questions. The first is social psychologists’ practice of norms-based interventions, namely campaigns and messages that seek to alter people’s perceptions of what constitutes normal behavior or values among their peers. The model makes clear how such interventions operate, but also how their effectiveness is limited by a credibility problem, particularly when the descriptive and prescriptive norms conflict. The next main question is the expressive role of law. The choices of legislators and other principals naturally reflect their knowledge of societal preferences, and these same community standards are also what shapes social judgements and moral sentiments. Setting law thus means both imposing material incentives and sending a message about society’s values, and hence about the norms that different behaviors are likely to encounter. The analysis, combining an informed principal with individually signaling agents, makes precise the notion of expressive law, determining in particular when a weakening or a strengthening of incentives is called for. Pushing further this logic, the paper also sheds light on why societies are often resistant to the message of economists, as well as on why they renounce certain policies, such as "cruel and unusual punishments", irrespective of effectiveness considerations, in order to express their being "civilized".
    Keywords: culture; esteem; expressive content; honor; incentives; law; motivation; norms-based interventions; punishments; reputation; social norms; stigma; taxation
    JEL: D64 D82 H41 K1 K42 Z13
    Date: 2011–11
  11. By: Wang, Chengsi
    Abstract: Information about a new or non-frequently purchased product is often produced by both sides of the market. We construct a monopoly pricing model consisting of both seller's information disclosure and consumer's information acquisition. The presence of consumer search, which lowers the probability of making sales, creates incentive for the monopolist to deter search. In contrast with most previous literature, we show that, partial information disclosure arises in equilibrium when the search cost is low. As the search cost increases to medium level, the monopolist hides information but lowers the price to prevent consumers from searching. When the search cost is very high, the monopolist charges high price and hides all information. The equilibrium price is thus non-monotonic in search cost. Information disclosure and consumer search co-exist only when the search cost is low, and thus complement each other. We show that transparency policies on advertising cannot improve social welfare. Nevertheless, they benefit consumers in a wide range of values of the search costs by improving matching quality and reducing the expense of searching. But for some medium levels of search costs, transparency policies hurt consumers due to the induced high price in equilibrium.
    Keywords: Monopoly Pricing; Information Disclosure; Information Acquisition; Search Cost; Transparency Policy
    JEL: M37 D83 D42
    Date: 2011–10–03
  12. By: Bhowmik, Anuj; Cao, Jiling
    Abstract: In this paper, we establish two different characterizations of Walrasian expectations allocations by the veto power of the grand coalition in an asymmetric information economy having finitely many agents and states of nature and whose commodity space is a Banach lattice. The first one deals with Aubin non-dominated allocations, and the other claims that an allocation is a Walrasian expectations allocation if and only if it is not privately dominated by the grand coalition, by considering perturbations of the original initial endowments in precise directions.
    Keywords: Asymmetric information economy; Aubin non-dominated allocation; Private core; Privately non-dominated allocation; Properness; Walrasian expectations allocation
    JEL: D11 D82 D51
    Date: 2011–06–23
  13. By: Renato Gomes; Alessandro Pavan
    Abstract: We study second-degree price discrimination in markets where the product traded by the monopolist is access to other agents. We derive necessary and sufficient conditions for the welfareand the profit-maximizing mechanisms to employ a single network or a menu of non-exclusive networks. We characterize the optimal matching schedules under a wide range of preferences, derive implications for prices, and deliver testable predictions relating the structure of the optimal pricing strategies to conditions on the distribution of match qualities. Our analysis sheds light on the distortions associated with the private provision of broadcasting, health insurance and job matching services. JEL Code: D82
    Keywords: matching, two-sided markets, networks, adverse selection, incentives, mechanism design
    Date: 2011–09
  14. By: Todd R. Kaplan; Shmuel Zamir
    Abstract: Maskin and Riley (2003) and Lebrun (2006) prove that the Bayes-Nash equilibrium of first-price auctions is unique. This uniqueness requires the assumption that a buyer never bids above his value. We demonstrate that, in asymmetric first-price auctions (with or without a minimum bid), the relaxation of this assumption results in additional equilibria that are "substantial." Although in each of these additional equilibria no buyer wins with a bids above his value, the allocation of the object and the selling price may vary among the equilibria. Furthermore, we show that such phenomena can only occur under asymmetry in the distributions of values.
    Keywords: asymmetric auctions, first-price auctions, multiple equilibria
    JEL: C72 D44
    Date: 2011–11
  15. By: Kaplan, Todd R; Zamir, Shmuel
    Abstract: Maskin and Riley (2003) and Lebrun (2006) prove that the Bayes-Nash equilibrium of …rst-price auctions is unique. This uniqueness requires the assumption that a buyer never bids above his value. We demonstrate that, in asymmetric …rst-price auctions (with or without a minimum bid), the relaxation of this assumption results in additional equilibria that are "substantial." Although in each of these additional equilibria no buyer wins with a bids above his value, the allocation of the object and the selling price may vary among the equilibria. Furthermore, we show that such phenomena can only occur under asymmetry in the distributions of values.
    Keywords: Asymmetric auctions; …first-price auctions; multiple equilibria
    JEL: D44 C72
    Date: 2011–11–21
  16. By: Major, Iván; Kiss, Károly M.
    Abstract: Cost-based pricing has dominated the regulatory regime of network industries - and first of all, the regulation of the infocommunications sector - in the European Union since the early 1990s. When privatization of network industries began in Central and Eastern Europe (CEE), one of the main stumbling blocks on the road toward privately owned telecomm companies and postal services, energy producers and distributors, and other network industries was the lack of efficient and up-to-date industry regulations. From the mid-1990s, accessing countries that later became members of the EU, and other CEE countries that are still waiting for admission swiftly adopted the regulatory framework of the European Union. The EU has been striving for market opening and liberalization in these industries; it abolished industry regulation in several segments of the market of network industries. Now it applies so-called cost-based pricing in areas where regulation is still in place. CEE countries now use the same type of regulation as the advanced member states of the EU. But the regulatory capacity of most CEE countries is still far behind of their West European counterparts. Experts of network industries advocate, and telecommunications, energy and other market regulators in various parts of the world practice, cost-based pricing for inter-firm network access services. Cost-based pricing is carried out under the assumption that the regulator has perfect information regarding the costs of producing the services. We show in this paper that - under fairly general conditions - cost-based pricing creates incentives for regulated firms not to improve their efficiency. We also show that cost-based pricing results in smaller consumer welfare than incentive regulation that takes into account the existence of information asymmetry between the regulator and the firm. A model of interconnection with adverse selection and moral hazard is presented. --
    Keywords: network industries,regulation,incentive contracts
    JEL: D8 L14 L51
    Date: 2011
  17. By: Duygu Yengin (School of Economics, University of Adelaide)
    Abstract: The significance of population monotonicity and welfare bounds is well-recognized in the fair division literature. We characterize population monotonic and incentive compatible mechanisms which allocate the goods efficiently and respect a welfare lower bound chosen in the fair allocation problem of allocating collectively owned indivisible goods or bads when monetary transfers are possible and preferences are private information. We consider the welfare bounds that are central to the fair allocation literature, namely, the identical-preferences lower-bound, individual rationality, the stand-alone lower-bound, and k-fairness. We also compare the strength and associated budget deficits of and the logical relations between the aforementioned lower bounds. JEL Classifications: C79, D61, D63.
    Keywords: welfare bounds, the identical-preferences lower-bound, individual rationality, the stand-alone lower-bound, k-fairness, population monotonicity, collective ownership, allocation of indivisible goods and money, NIMBY problems, imposition of tasks, the Groves mechanisms, strategy-proofness
    JEL: C79 D61 D63
    Date: 2011–12
  18. By: Zudenkova, Galina
    Abstract: This paper studies party discipline in a congress within a political agency framework with retrospective voting. Party discipline serves as an incentive device to induce office- motivated congress members to perform in line with the party leadership's objective of controlling both the executive and the legislative branches of government. I show fi…rst that the same party is more likely to control both branches of government (i.e., uni…ed government) the stronger the party discipline in the congress is. Second, the leader of the governing party imposes more party discipline under uni…ed government than does the opposition leader under divided government. Moreover, the incumbents' aggregate performance increases with party discipline, so a representative voter becomes better off. JEL classi…cation: D72. Keywords: Party discipline; Political agency; Retrospective voting; Office-motivated politicians.
    Keywords: Disciplina de partit, 32 - Política,
    Date: 2011
  19. By: Bengtsson, Niklas (Uppsala Center for Labor Studies)
    Abstract: In this paper, I study the conditions that enable search efficiency in a search market in which the firms advertise incomplete terms of trade. The posted terms give rise to cost incentives so perverse that they could result in no trade at all if they are not renegotiated. I show that the private equilibrium is socially efficient if the customers retain the right to trade at the posted terms. The customers will never execute this right in practice, but the threat of doing so will frame the renegotiation in a socially efficient manner. I confirm the mechanisms in a controlled, randomized eld experiment in the market for metered taxis in Cape Town. Renegotiation is always privately efficient and does not lead to holdup. However, despite the absence of holdup and the availability of Pareto gains, renegotiations occur too seldom, which suggests that the trading parts do not understand the bene ts from renegotiation, or that there are some hidden costs associated with renegotiation.
    Keywords: Matching; Diamond Paradox; Taxi Experiment; Incomplete Contracts; Transaction Costs; Institutions; Natural Field Experiment; Search frictions; Price advertisements; Price Posting
    JEL: C78 C93 L51
    Date: 2011–12–05
  20. By: Gautam Bose; Kevin Lang
    Abstract: We analyze a firm's job-assignment and worker-monitoring decisions when workers face occasional crises. Firms prefer to assign good workers to a difficult task and to not employ bad workers. Firms observe failures but only observe successfully resolved crises if they monitor the worker. If monitoring costs are positive but sufficiently small, for a range of probabilities that the worker is good, the firm assigns the worker to a low task (less sensitive to crises) and monitors her. At probabilities below this range and not too much above it, she is assigned to the low task and not monitored. At high probabilities of being good, she is assigned to the difficult task. We analyze the implications for internal labor markets of the case where a worker has the same ex ante probability of being good at all firms and learning is about ability at this particular firm.
    JEL: J01 J41
    Date: 2011–11
  21. By: Giuseppe Pulina
    Abstract: In this paper we analyze a fiscal mechanism used in Italy, which in Italian is called “Studi di Settore” (Sector Studies). This mechanism relies on information gathered on taxpayers to both partition the population into fairly homogeneous clusters and to determine the presumed income they should declare. When this estimated income is announced, before taxpayers fill out their tax returns, their optimal declaration strategies lead the tax- payer population to be naturally split into three homogeneous groups, one of which pays more taxes than are due, the second group comply but bears the audit cost, while the third evades and it is not audited. This result is close to the Italian situation where the greatest number of taxpayers make a tax declaration according to the announced cluster income, but there are always those who declare less and so are audited.
    Keywords: Tax Evasion; "cut-off" policy; Noncooperative games; Asymmetric Information
    JEL: H26 H32 D82 C72
    Date: 2011
  22. By: Oleg Yerokhin (University of Wollongong)
    Abstract: Despite the fact that blackmail constitutes a voluntary transaction between two parties, it is deemed to be a criminal offence in most legal systems. Traditional economic approach to this so-called ‘paradox of blackmail’ emphasizes welfare loss generated by the costly rentseeking activities of potential blackmailers as the primary justification for its criminalization. This argument however does not extend to cases in which potentially damaging information about the victim was acquired by the blackmailer at no cost. It also does not seem to shed light on a related puzzle: why is it legal for a potential victim to bribe the other party with the purpose of achieving the same final outcome (suppression of information) as in the case of blackmail? This paper addresses these questions in a simple model of bargaining under asymmetric information which is used as a unified framework for studying both blackmail and bribery. Under asymmetric information the bargaining outcome is not efficient regardless of the distribution of the bargaining power. However, when the blackmailer is the monopolist seller of the information inefficiency results from his demands being too high relative to the social optimum, providing justification for the practice of penalizing blackmail. On the other hand, when a victim is the monopolist buyer of the information the equilibrium offer is inefficiently low implying that its punishment would be counterproductive. These arguments provide further support for the claim that under reasonable assumptions criminalization of blackmail can be justified on efficiency grounds.
    Keywords: blackmail, bribery, bargaining
    JEL: D82 K42
    Date: 2011

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