nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2012‒02‒27
fourteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Optimal Obscurity in the Acquisition and Disclosure of Information about a Shock By Masaki Aoyagi
  2. Are you a Good Employee or Simply a Good Guy? Infl?uence Costs and Contract Design. By Brice Corgnet; Ismael Rodriguez-Lara
  3. Credit Markets with Ethical Banks and Motivated Borrowers By Barigozzi, Francesca; Tedeschi, Piero
  4. Dynamic Equilibrium Bunching By Tao Wang
  5. Do We Follow Private Information when We Should? Laboratory Evidence on Naive Herding By Christoph March; Sebastian Krügel; Anthony Ziegelmeyer
  6. On the Equivalence of Bayesian and Dominant Strategy Implementation By Alex Gershkov; Jacob Goeree; Alexey Kushnir; Benny Moldovanu; Xianwen Shi
  7. Job Allocation Rules and Sorting Efficiency: Experimental Outcomes in a Peter Principle Environment By David Dickinson; Marie-Claire Villeval
  8. Competition, loan rates and information dispersion in microcredit markets By Guillermo Baquero; Malika Hamadi; Andréas Heinen
  9. "Do We Follow Others when We Should? A Simple Test of Rational Expectations": Comment By Anthony Ziegelmeyer; Christoph March; Sebastian Krügel
  10. The Firm as the Locus of Social Comparisons: Internal Labor Markets versus Up-or-Out By Auriol, Emmanuelle; Friebel, Guido; Lammers, Frauke
  11. Optimal Unemployment Insurance for Older Workers By Jean-Olivier Hairault; François Langot; Sébastien Ménard; Thepthida Sopraseuth
  12. Private antitrust enforcement revisited: The role of private incentives to report evidence to the antitrust authority By Tim Reuter
  13. Comparing Centralized and Decentralized Banking: A Study of the Risk-Return Profiles of Banks By Holmberg, Ulf; Sjögren, Tomas; Hellström, Jörgen
  14. Brand Management and Strategies Against Counterfeits By Yi Qian

  1. By: Masaki Aoyagi
    Abstract: A principal acquires information about a shock and then discloses it to an agent. After the disclosure, the principal and agent each decide whether to take costly preparatory actions that yield benefits only when the shock strikes. The principal maximizes his expected payoff by controlling the quality of his information, and the disclosure rule. We show that even when the acquisition of perfect information is costless, the principal may optimally acquire imperfect information when his own action eliminates the agent's incentive to take action against the risk.
    Date: 2012–02
  2. By: Brice Corgnet (Economic Science Institute, Chapman University); Ismael Rodriguez-Lara (Dpto. Analisis Economico, Universidad de Valencia, ERICES)
    Abstract: We develop a principal-agent model with a moral hazard problem in which the principal has access to a hard signal (the level of output) and a soft signal (the supervision signal) about the agent?s level of effort. We show that the agent?'s ability to manipulate the soft signal increases the cost of implementing the effcient equilibrium, leading to wage compression when the infl?uence cost is privately incurred by the agent. When manipulation activities negatively affect the agent?s productivity through the level of output, the design of infl?uence-free contracts that deter manipulation may lead to high-powered incentives. This result implies that high-productivity workers face incentive schemes that are more sensitive to hard evidence than those faced by their low-productivity counterparts. In that context, the principal will tolerate infl?uence for low-productivity workers but not for high-productivity workers. We also fi?nd that in the case of productivity-based costs, it may be optimal for the principal not to supervise the agent, even if supervision is costless.
    Keywords: principal-agent model with supervision, contract design, in?uence activities, manipulation, productivity-based in?uence costs, power of incentives
    JEL: D23 D82
    Date: 2012
  3. By: Barigozzi, Francesca (Associazione Italiana per la Cultura della Cooperazione e del Non Profit); Tedeschi, Piero (Associazione Italiana per la Cultura della Cooperazione e del Non Profit)
    Abstract: This paper investigates banks’ corporate social responsibility. Two different competitive credit markets do exist: one for standard projects and one for ethical ones. Ethical projects have also a social profitability, but a lower (positive) expected revenue with respect to standard ones. Ethical projects are financed by ethical banks and undertaken by motivated borrowers. These borrowers obtain additional benefit (a social responsibility premium) from accomplishing ethical projects when trading with ethical banks. If the expected profitability of ethical project is sufficiently close to that of standard ones and/or the social responsibility premium of motivated borrowers is sufficiently high, the market for ethical projects is active and the credit market is fully segmented. This result holds true irrespective of the information structure: only moral hazard on the borrower side, moral hazard and screening on the borrower side, moral hazard on the borrower side and screening on the lender side. The optimal contract in our set-up is always a debt contract. However, its precise form and welfare properties depend on the information structure.
    Keywords: corporate social responsibility; ethical banks; motivated borrowers; microfinance
    JEL: D86 G21 G30
    Date: 2012–01–16
  4. By: Tao Wang (Queen's University)
    Abstract: In this paper, we analyze the asymmetric pure strategy equilibria in a dynamic game of pure information externality. Each player receives a private signal and chooses whether and when to invest. In some of the periods, only a subgroup of the players make decisions, which we call bunching, while the rest of the players do not invest regardless of their signals. Bunching is different from herding; it occurs in the first period and recursively until herding takes place or the game runs out of undecided players. We find that any asymmetric pure strategy equilibrium is more efficient than the symmetric mixed strategy equilibrium. When players become patient enough, herding of investment disappears in the most efficient asymmetric pure strategy equilibrium, while the least efficient asymmetric pure strategy equilibrium resembles those in a fixed timing model, producing an exact match when the discount factor is equal to 1. Bunch sizes are shown to be independent of the total number of players; adding more players to the game need not change early players' behavior. All these are unique properties of the asymmetric pure strategy equilibria. We also show that the asymmetric pure strategy equilibria can accommodate small heterogeneities of the players in costs of acquiring signals, discount factors, or degree of risk aversion. In any of these environments, there exists a unique welfare maximizing equilibrium which provides a natural way for the players to coordinate.
    Keywords: bunching, herding, endogenous timing, asymmetric equilibrium, information externality
    JEL: C73 D82 G01
    Date: 2011–11
  5. By: Christoph March (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Sebastian Krügel (Max Planck Institute of Economics - Max Planck Institute of Economics); Anthony Ziegelmeyer (Max Planck Institute of Economics - Max Planck Institute of Economics)
    Abstract: We investigate whether experimental participants follow their private information and contradict herds in situations where it is empirically optimal to do so. We consider two sequences of players, an observed and an unobserved sequence. Observed players sequentially predict which of two options has been randomly chosen with the help of a medium quality private signal. Unobserved players predict which of the two options has been randomly chosen knowing previous choices of observed and with the help of a low, medium or high quality signal. We use preprogrammed computers as observed players in half the experimental sessions. Our new evidence suggests that participants are prone to a 'social-confirmation' bias and it gives support to the argument that they naively believe that each observable choice reveals a substantial amount of that person's private information. Though both the 'overweighting-of-private-information' and the 'social-con firmation' bias coexist in our data, participants forgo much larger parts of earnings when herding naively than when relying too much on their private information. Unobserved participants make the empirically optimal choice in 77 and 84 percent of the cases in the human-human and computer-human treatment which suggests that social learning improves in the presence of lower behavioral uncertainty.
    Keywords: Information cascades ; Laboratory Experiments ; Naive herding
    Date: 2012–02
  6. By: Alex Gershkov; Jacob Goeree; Alexey Kushnir; Benny Moldovanu; Xianwen Shi
    Abstract: We consider a standard social choice environment with linear utilities and independent, one-dimensional, private types. We prove that for any Bayesian incentive compatible mechanism there exists an equivalent dominant strategy incentive compatible mechanism that delivers the same interim expected utilities for all agents and the same ex ante expected social surplus. The short proof is based on an extension of an elegant result due to Gutmann et al. (Annals of Probability, 1991). We also show that the equivalence between Bayesian and dominant strategy implementation generally breaks down when the main assumptions underlying the social choice model are relaxed, or when the equivalence concept is strengthened to apply to interim expected allocations.
    Keywords: Bayesian Implementation, Dominant Strategy Implementation, Equivalence
    JEL: D82
    Date: 2012–02–16
  7. By: David Dickinson (Department of Economics - Appalachian State University); Marie-Claire Villeval (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure - Lyon)
    Abstract: An important issue in personnel economics is the design of efficient job allocation rules. Firms often use promotions both to sort workers across jobs and to provide them with incentives. However, the Peter Principle states that employees' output tends to fall after a promotion. Lazear (2004) suggests that self-selection may improve job allocation efficiency while preserving incentive effects. We reproduce this Peter Principle in the laboratory and compare the efficiency of a promotion standard with subjects self-selecting their task. We find no evidence of effort distortion, as predicted by theory. Furthermore, we find that when the Peter Principle is not severe, promotion rules often dominate self-selection efficiency of task assignment. Results are consistent with imperfect appraisal of transitory ability and a lack of strategic behavior.
    Keywords: Promotion, Peter Principle, Sorting, Experiment
    Date: 2012
  8. By: Guillermo Baquero (ESMT European School of Management and Technology); Malika Hamadi (Luxembourg School of Finance (LSF)); Andréas Heinen (THEMA, Université de Cergy-Pontoise)
    Abstract: Length: 57 pages
    Keywords: bank competition, microfinance, microcredit, microbank, loan rates, information dispersion, PAR, portfolio quality
    JEL: D4 G21 L1 O1
    Date: 2012–02–16
  9. By: Anthony Ziegelmeyer (Max Planck Institute of Economics, Jena); Christoph March (Paris School of Economics); Sebastian Krügel (Max Planck Institute of Economics, Jena, IMPRS "Uncertainty")
    Abstract: Weizsäcker (2010) estimates the payoff of actions to test rational expectations and to measure the success of social learning in information cascade experiments. He concludes that participants perform poorly when learning from others and that rational expectations are violated. We show that his estimated payoffs rely on estimates of the publicly known prior and signal qualities which may lead the formulated test of rational expectations to generate false positives. We rely on the true values of the prior and signal qualities to estimate the payoff of actions. We confirm that the rational expectations hypothesis is rejected, but we measure a much larger success of social learning.
    Keywords: Information Cascades, Laboratory Experiments, Quantal Response Equilibrium
    JEL: C92 D82
    Date: 2012–02–20
  10. By: Auriol, Emmanuelle (Toulouse School of Economics); Friebel, Guido (Goethe University Frankfurt); Lammers, Frauke (University of Bern)
    Abstract: We suggest a parsimonious dynamic agency model in which workers have status concerns. A firm is a promotion hierarchy in which a worker's status depends on past performance. We investigate the optimality of two types of promotion hierarchies: (i) internal labor markets, in which agents have a job guarantee, and (ii) "up-or-out", in which agents are fired when unsuccessful. We show that up-or-out is optimal if success is difficult to achieve. When success is less hard to achieve, an internal labor market is optimal provided the payoffs associated with success are moderate. Otherwise, up-or-out is, again, optimal. These results are in line with observations from academia, law firms, investment banks and top consulting firms. Here, up-or-out dominates, while internal labor markets dominate where work is less demanding or payoffs are more compressed, for instance, because the environment is less competitive. We present some supporting evidence from academia, comparing US with French economics departments.
    Keywords: status, promotion hierarchies, incentives, sorting
    JEL: J3 M5 L2
    Date: 2012–02
  11. By: Jean-Olivier Hairault (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, IZA - Institute for the Study of Labor); François Langot (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Mans, CEPREMAP - Centre pour la recherche économique et ses applications); Sébastien Ménard (GAINS - Université du Maine); Thepthida Sopraseuth (CEPREMAP - Centre pour la recherche économique et ses applications, GAINS-TEPP - Université du Maine)
    Abstract: This paper studies the optimal unemployment insurance for older workers in a repeated principal-agent model, where the search intensity of risk-averse workers (the agents) is not observed by the risk-neutral insurance agency (the principal). When unemployment benefits are the only available tool, the insurance agency is not able to induce older workers to search for a job. This is because of the short time-horizon of workers close to retirement. We propose to introduce a pension tax dependent on the length of the unemployment spell. We show that this device performs better than a wage tax after re-employment. First, it makes jobs more attractive, as they are free of tax. Second, because re-employment will be short-lived, a pension tax is a more powerful incentive than a wage tax, and provides more substantial fiscal gains to the agency. Finally, a pension tax allows those workers near retirement who still do not exercise job search to smooth their consumption during their unemployment spell, as if they could borrow against their future pension.
    Date: 2012–02–13
  12. By: Tim Reuter (Department of Economics, University of Konstanz, Germany)
    Abstract: It is commonly believed that the possibility to sue privately for antitrust damages decreases the number of type II errors in enforcement at the cost of creating more type I errors. We extend the analysis by taking into account the fact that private parties often submit evidence during public prosecution. Such parties consider private suit as a partial substitute for public prosecution, as both imply desistance of the violation. The trial option might induce these parties to be less willing to contribute evidence to public cases. Private trials crowd out public prosecution and can have ambiguous effects on the number of enforcement errors.
    Keywords: private and public enforcement, damages, antitrust litigation
    JEL: K21 K41 K42 L41
    Date: 2012–02–13
  13. By: Holmberg, Ulf (Department of Economics, Umeå University); Sjögren, Tomas (Department of Economics, Umeå University); Hellström, Jörgen (Department of Business Administration)
    Abstract: This paper studies the risk-return profile of centralized and decentralized banks. We address the conditions that favor a particular lending regime while acknowledging the effects on lending and returns caused by the course of the business cycle. To analyze these issues, we develop a model which incorporates two stylized facts; (i) banks in which lending decisions are decentralized tend to have a lower cost associated with screening potential borrowers and (ii) decentralized decision-making may generate inefficient outcomes because of lack of coordination. Simulations are used to compare the two banking regimes. Among the results, it is found that asymmetric markets (in terms of the proportion of high ability entrepreneurs) tend to favor centralized banking while decentralized banks seem better at lending in the wake of an economic downturn (high probability of a recession). In addition, we find that even though a bank group where decisions are decentralized may end up with a portfolio of loans which is (relatively) poorly diversified between regions, the ability to effectively screen potential borrowers may nevertheless give a decentralized bank a lower overall risk in the lending portfolio than when decisions are centralized.
    Keywords: lending; screening; business cycle; portfolio diversification; risk; organization; simulations
    JEL: C63 E30 G01 G11 G21 G32
    Date: 2012–02–17
  14. By: Yi Qian
    Abstract: In this paper, I provide a theory for the brand-protection strategies to counterfeiting under weak intellectual property rights. My theoretical framework has general implications for endogenous sunk cost investments as a means of deterring counterfeiters. My model incorporates two layers of asymmetric information that counterfeits can incur: counterfeiters fooling consumers, and buyers of counterfeits fooling other consumers. Brands have a number of different tools at their disposal to maintain a separating equilibrium in the face of counterfeits. One of the theoretical predictions of this study is that counterfeit entry would induce incumbent brand to introduce new products. This helps to explain the innovation strategies that authentic firms employ in response to entry by their counterfeiters in the real world. Authentic prices rise if and only if the counterfeit quality is lower than a threshold level. In addition, the model demonstrates how authentic producers could invest in self-enforcement to increase counterfeiters' incentives to separate themselves. Better channel management through company stores and other costly devices are forms of non-price signals and complement a company's own enforcements against counterfeits. These predictions are validated using a unique panel data collected from Chinese shoe companies covering the years 1993-2004. Data further reveal that companies with worse relationships with the government invest more in various self-enforcement strategies, which are effective in reducing counterfeit sales, and that the set of strategies are complements rather than substitutes.
    JEL: D21 D22 D4 K42 L26
    Date: 2012–02

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