nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2012‒02‒20
thirteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Standards and Incentives under Moral Hazard with Limited Liability By Reinshagen, Felix
  2. Laws and Norms By Benabou, Roland; Tirole, Jean
  3. Core-stable rings in second price auctions with common values. By Orzach, Ram; Forges, Françoise
  4. One Person, Many Votes: Divided Majority and Information Aggregation By Micael Castanheira De Moura; Laurent Bouton
  5. Competition for Traders and Risk By Bijlsma, M.; Boone, J.; Zwart, G.
  6. Public Monitoring with Uncertainty in the Time Repetitions By Osório, Antonio
  7. Signalling, Incumbency Advantage, and Optimal Reelection Thresholds By Francesco Caselli; Thomas E. Cunningham; Massimo Morelli; Inés Moreno de Barreda
  8. Trading mechanism selection with budget constraints By Selcuk, Cemil
  9. Do Health Care Report Cards Cause Providers to Select Patients and Raise Quality of Care? By Yijuan Chen; Juergen Meinecke
  10. When organization encounters uncertainty in regulatory times By Xiao, Fenglong
  11. A Folk Theorem for Games when Frequent Monitoring Decreases Noise By Osório, Antonio
  12. Transparency in the banking sector By Broll, Udo; Eckwert, Bernhard; Eickhoff, Andreas
  13. Voting as a Signaling Device By R. Emre Aytimur; Aristotelis Boukouras; Robert Schwager

  1. By: Reinshagen, Felix
    Abstract: We consider a model of moral hazard with limited liability of the agent and effort that is two-dimensional. One dimension of the agent’s effort is observable and the other is not. The principal can thusmake the contract conditional not only on outcome but also on observable effort. The principal’s optimal contract gives the agent no rent and – in contrast to the first-best allocation – uses toomuch observable effort and too little unobservable effort. This distortion in the relative use of the two kinds of effort increases if the agent’s liability becomes more limited.
    Keywords: moral hazard; two-dimensional effort; regulation
    JEL: D82 D86 K32
    Date: 2012–02
  2. By: Benabou, Roland (Princeton University); Tirole, Jean (IDEI)
    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: motivation, incentives, esteem, reputation, honor, stigma, social norms, culture, taxation, law, punishments, norms-based interventions, expressive content
    JEL: D64 D82 H41 K1 K42 Z13
    Date: 2012–01
  3. By: Orzach, Ram; Forges, Françoise
    Abstract: In a commonvalueauction in which the information partitions of the bidders are connected, all rings are core-stable. More precisely, the ex ante expected utilities of rings, at the (noncooperative) sophisticated equilibrium proposed by Einy et al. [Einy, E., Haimanko, O., Orzach, R., Sela, A., 2002. Dominance solvability of second-pricesauctions with differential information. Journal of Mathematical Economics 37, 247–258], describe a cooperative games in characteristic function form, in spite of the underlying strategic externalities. A ring is core-stable if the core of this characteristic function is not empty. Furthermore, every ring can implement its sophisticated equilibrium strategy by means of an incentive compatible mechanism. An example shows that, if the bidders’ information partitions are not connected, rings may no longer be core-stable.
    Keywords: Characteristic function; Partition form game; Core; Collusion; Bayesian game; Auctions;
    JEL: D44 C72 C71
    Date: 2011
  4. By: Micael Castanheira De Moura; Laurent Bouton
    Abstract: This paper shows that information imperfections and common values can solve coordination problems in multicandidate elections. We analyze an election in which (i) the majority is divided between two alternatives and (ii) the minority backs a third alternative, which the majority views as strictly inferior. Standard analyses assume voters have a fixed preference ordering over candidates. Coordination problems cannot be overcome in such a case, and it is possible that inferior candidates win. In our setup the majority is also divided as a result of information imperfections. The majority thus faces two problems: aggregating information and coordinating to defeat the minority candidate. We show that when the common value component is strong enough, approval voting produces full information and coordination equivalence: the equilibrium is unique and solves both problems. Thus, the need for information aggregation helps resolve the majority's coordination problem under approval voting. This is not the case under standard electoral systems.
    JEL: C72 D72 D82 D81
    Date: 2012–01–10
  5. By: Bijlsma, M.; Boone, J.; Zwart, G. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders.
    Keywords: optimal contracts;remuneration policy;imperfect competition;financial institutions;risk.
    JEL: G21 G32 L22
    Date: 2012
  6. By: Osório, Antonio
    Abstract: This paper study repeated games where the time repetitions of the stage game are not known or controlled by the players. We call this feature random monitoring. Kawamori's (2004) shows that perfect random monitoring is always better than the canonical case. Surprisingly, when the monitoring is public, the result is less clear-cut and does not generalize in a straightforward way. Unless the public signals are sufficiently informative about player's actions and/or players are patient enough. In addition to a discount effect, that tends to consistently favor the provision of incentives, we found an information effect, associated with the time uncertainty on the distribution of public signals. Whether payoff improvements are or not possible, depends crucially on the direction and strength of these effects. JEL: C73, D82, D86. KEYWORDS: Repeated Games, Frequent Monitoring, Random Public Monitoring, Moral Hazard, Stochastic Processes.
    Keywords: Teoria de jocs, 33 - Economia, 65 - Gestió i organització. Administració i direcció d'empreses. Publicitat. Relacions públiques. Mitjans de comunicació de masses,
    Date: 2011–12–18
  7. By: Francesco Caselli; Thomas E. Cunningham; Massimo Morelli; Inés Moreno de Barreda
    Abstract: Much literature on political behavior treats politicians as motivated by reelection, choosing actions to signal their types to voters. We identify two novel implications of models in which signalling incentives are important. First, because incumbents only care about clearing a reelection hurdle, signals will tend to cluster just above the threshold needed for reelection. This generates a skew distribution of signals leading to an incumbency advantage in the probability of election. Second, voters can exploit the signalling behavior of politicians by precommitting to a higher threshold for signals received. Raising the threshold discourages signalling effort by low quality politicians but encourages effort by high quality politicians, thus increasing the separation of signals and improving the selection function of an election. This precommitment has a simple institutional interpretation as a supermajority rule, requiring that incumbents exceed some fraction of votes greater than 50% to be reelected.
    JEL: D72 D78 D82
    Date: 2012–02
  8. By: Selcuk, Cemil
    Abstract: We present an equilibrium search model of competing mechanisms where some buyers are budget constrained. Absent budget constraints, the existing literature capitulates that if buyers differ in their valuations then in the unique equilibrium all sellers hold second price auctions (e.g. McAfee (1993)) whereas if buyers are homogeneous then sellers are indifferent across a large number of payoff-equivalent mechanisms (e.g. Eeckhout and Kircher (2010)). We show that these results are not robust to the presence of budget constrained buyers; merely lowering the budgets of a few buyers renders the auction equilibrium as well as payoff equivalence unsustainable. If buyers differ only slightly in terms of their ability to pay then sellers prefer fixed price trading; otherwise they prefer auctions.
    Keywords: Trading Mechanisms; Budget Constraints; Competitive Search
    JEL: C78 D40 D83
    Date: 2011–03–12
  9. By: Yijuan Chen; Juergen Meinecke
    Abstract: We exploit a brief period of asymmetric information during the implementation of Pennsylvania’s “report card” scheme for coronary artery bypass graft surgery to test for improvements in quality of care and selection of patients by health care providers. During the ?rst three years of the 1990s, providers in Pennsylvania had an incentive to bias report cards by selecting patients strategically, with patients having no access to the report cards. This dichotomy enables us to separate providers’ selection of patients from patients’ selection of providers. Using data from the Nationwide Inpatient Sample, we estimate a non–linear difference–in– differences model and derive asymptotic standard errors. The mortality rate for bypass patients decreases by only 0.05 percentage points due to the report cards, which we interpret as evidence that quality of bypass surgery did not improve (at least in the short–term) nor did patient selection by providers occur. Our timing, estimation, and asymptotics are readily applicable to many other report card schemes.
    Keywords: health care report cards; provider moral hazard; quality improvement; difference–in–differences estimation
    JEL: C23 D82 I18
    Date: 2012–01
  10. By: Xiao, Fenglong
    Abstract: Regulatory policy is a considerable factor in organizational business strategy decisions. This article focuses on the organizational adjustment cost under uncertainty brought by regulation from game theory and contract theory perspective. Three conclusions are reached: 1. The cost of adjustment of organizations under regulation in a monopolized industry is only affected by their own risk tolerance of uncertainty and the cost of information; 2. when the regulation is enacted in a more competitive market, the cost of information would raise with a higher expected loss comparing with the same regulation in monopolized market; 3. If the claim of such measurement is true, the net benefit or loss of regulation is exactly the difference between organizational information cost and regulatory benefit. So the policy that guarantees the positive communication and transparent information exchange that helps to reduce the organizational information cost is necessary for an efficient regulatory policy.
    Keywords: Regulation; Organization; Contract; Uncertainty
    JEL: D81 L51 L22
    Date: 2011–05–22
  11. By: Osório, Antonio
    Abstract: This paper studies frequent monitoring in an infinitely repeated game with imperfect public information and discounting, where players observe the state of a continuous time Brownian process at moments in time of length _. It shows that a limit folk theorem can be achieved with imperfect public monitoring when players monitor each other at the highest frequency, i.e., _. The approach assumes that the expected joint output depends exclusively on the action profile simultaneously and privately decided by the players at the beginning of each period of the game, but not on _. The strong decreasing effect on the expected immediate gains from deviation when the interval between actions shrinks, and the associated increase precision of the public signals, make the result possible in the limit. JEL: C72/73, D82, L20. KEYWORDS: Repeated Games, Frequent Monitoring, Public Monitoring, Brownian Motion.
    Keywords: Teoria de jocs, 33 - Economia, 65 - Gestió i organització. Administració i direcció d'empreses. Publicitat. Relacions públiques. Mitjans de comunicació de masses,
    Date: 2011–10–27
  12. By: Broll, Udo; Eckwert, Bernhard; Eickhoff, Andreas
    Abstract: The paper revisits the impact of uncertainty on the decision problem of a bank. The bank extends risky loans to private investors and sells deposits to savers at fixed rates. The uncertainty under which deposit/loan-portfolios are chosen by banks is endogenized through an information system that conveys public signals about the return distribution of bank loans. Transparency in the banking sector is defined in terms of the reliability of these signals. We find that higher transparency always raises expected bank profits, but may lead to a higher or lower expected loan volume. Moreover, higher transparency may reduce economic welfare. --
    Keywords: market transparency,banking firm
    JEL: G21 G32 D81
    Date: 2011
  13. By: R. Emre Aytimur (Georg-August-University Göttingen); Aristotelis Boukouras (Georg-August-University Göttingen); Robert Schwager (Georg-August-University Göttingen)
    Abstract: In this paper, citizens vote in order to influence the election outcome and in order to signal their unobserved characteristics to others. The model is one of rational voting and generates the following predictions: (i) The paradox of not voting does not arise, because the benefit of voting does not vanish with population size. (ii) Turnout in elections is positively related to the size of the local community and the importance of social interactions. (iii) Voting may exhibit bandwagon effects and small changes in the electoral incentives may generate large changes in turnout due to signaling effects. (iv) Signaling incentives increase the sensitivity of turnout to voting incentives in communities with low opportunity cost of social interaction, while the opposite is true for communities with high cost of social interaction. Therefore, the model predicts less volatile turnout for the latter type of communities.
    Keywords: electoral incentives; signaling; voting
    JEL: C70 D72 D80
    Date: 2012–01–26

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