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on Contract Theory and Applications |
| By: | Pradeep Dubey (Center for Game Theory, Department of Economics, Stony Brook University); Siddhartha Sahi (Dept. of Mathematics, Rutgers University, New Brunswick) |
| Abstract: | Consider agents who undertake costly effort to produce stochastic outputs observable by a principal. The principal can award a prize deterministically to the agent with the highest output, or to all of them with probabilities that are proportional to their outputs. We show that, if there is sufficient diversity in agents' skills relative to the noise on output, then the proportional prize will, in a precise sense, elicit more output on average, than the deterministic prize. Indeed, assuming agents know each others' skills (the complete information case), this result holds when any Nash equilibrium selection, under the proportional prize, is compared with any individually rational selection under the deterministic prize. When there is incomplete information, the result is still true but now we must restrict to Nash selections for both prizes. We also compute the optimal scheme, from among a natural class of probabilistic schemes, for awarding the prize; namely that which elicits maximal effort from the agents for the least prize. In general the optimal scheme is a monotonic step function which lies "between" the proportional and deterministic schemes. When the competition is over small fractional increments, as happens in the presence of strong contestants whose base levels of production are high, the optimal scheme awards the prize according to the "log of the odds," with odds based upon the proportional prize. |
| Keywords: | Deterministic/proportional/optimal prizes, Games of complete/incomplete information, Nash equilibrium, Individually rational strategies |
| JEL: | C70 C72 C79 D44 D63 D82 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1858&r=cta |
| By: | Gropp, R.; Grundl, C.; Guttler, A. (Tilburg University, Center for Economic Research) |
| Abstract: | In this paper we analyze whether discretionary lending increases bank risk. We use a panel dataset of matched bank and borrower data. It offers the chief advantages that we can directly identify soft information in banks’ lending decisions and that we observe ex post defaults of borrowers.Consistent with the previous literature, we find that smaller banks use more discretion in lending. We also show that borrowers self-select to banks depending on whether their soft information is positive or negative. Financially riskier borrowers with positive soft information are more likely to obtain credit from relationship banks. Risky borrowers with negative soft information have the same chance to receive a loan from a relationship or a transaction bank. These selection effects are stronger in more competitive markets, as predicted by theory. However, while relationship banks have financially riskier borrowers, ex post default is not more probable compared to borrowers at transaction banks. As a consequence, relationship banks do not have higher credit risk levels. Loan officers at relationship banks thus do not use discretion in lending to grant loans to ex post riskier borrowers. |
| Keywords: | soft information;discretionary lending;relationship bank;bank risk. |
| JEL: | G21 G28 G32 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2012030&r=cta |
| By: | Vera Angelova (Max Planck Institute of Economics, Jena, Germany); Giuseppe Attanasi (Toulouse School of Economics, Toulouse, France); Yolande Hiriart (Universite de Franche-Comte (CRESE), Besancon, France) |
| Abstract: | We compare the performance of liability rules for managing environmental disasters when third parties are harmed and cannot always be compensated. A firm can invest in safety to reduce the likelihood of accidents. The firm's investment is unobservable to authorities. Externality and asymmetric information call for public intervention to define rules aimed at increasing prevention. We determine the investment in safety under No Liability, Strict Liability and Negligence, and compare it to the first best. Additionally, we investigate how the (dis)ability of the firm to fully cover potential damages affects the firm's behavior. An experiment tests the theoretical predictions. In line with theory, Strict Liability and Negligence are equally effective; both perform better than No Liability; investment in safety is not sensitive to the ability of the firm to compensate potential victims. In contrast with theory, prevention rates absent liability are much higher and liability is much less effective than predicted. |
| Keywords: | Risk Regulation, Liability Rules, Incentives, Insolvency, Experiment |
| JEL: | D82 K13 K32 Q58 |
| Date: | 2012–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-012&r=cta |
| By: | Maik Dierkes (Finance Center Mnster, University of Mnster); Carsten Erner (Finance Center Mnster, University of Mnster); Thomas Langer (Finance Center Mnster, University of Mnster); Lars Norden (Rotterdam School of Management, Erasmus University) |
| Abstract: | We investigate whether and how business credit information sharing helps to better assess the default risk of private firms. Private firms represent an ideal testing ground because they are smaller, more informationally opaque, riskier, and more dependent on trade credit and bank loans than public firms. Based on a representative panel dataset that comprises private firms from all major industries, we find that business credit information sharing substantially improves the quality of default predictions. The improvement is stronger for older firms and those with limited liability, and depends on the sharing of firms' payment history and the number of firms covered by the local credit bureau office. The value of soft business credit information is higher for smaller and less distant firms. Furthermore, in spatial and industry analyses we show that the higher the value of business credit information the lower the realized default rates. Our study highlights the channel through which business credit information sharing adds value and the factors that influence its strength. |
| Keywords: | Asymmetric information, Credit bureau, Credit risk, Hard and soft information, Private firms |
| JEL: | D82 G21 G32 G33 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:anc:wmofir:64&r=cta |
| By: | Douglas Gale; Tanju Yorulmazer |
| Abstract: | Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planners problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash. |
| Date: | 2011–06 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp682&r=cta |
| By: | Mike Burkart; Samuel Lee |
| Abstract: | In many bilateral transactions, the seller fears being underpaid because its outside option is better known to the buyer. We rationalize a variety of observed contracts as solutions to such smart buyer problems. The key to these solutions is to grant the seller upside participation. In contrast, the lemons problem calls for o¤ering the buyer downside protection. Yet in either case, the seller (buyer) receives a convex (concave) claim. Thus, contracts commonly associated with the lemons problem can equally well be manifestations of the smart buyer problem. Nevertheless, the infor- mation asymmetries have opposite cross-sectional implications. To avoid underestimating the empirical relevance of adverse selection problems, it is therefore critical to properly identify the underlying information asym- metries in the data. |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp696&r=cta |
| By: | Matthieu Bouvard; Pierre Chaigneau; Adolfo de Motta |
| Abstract: | The paper presents a theory of optimal transparency in the nancial system when nancial institutions have short-term liabilities and are exposed to rollover risk. Our analysis indicates that transparency enhances the stability of the - nancial system during crises but may have a destabilizing eect during normal economic times. Thus, the optimal level of transparency is contingent on the state of the economy, with the regulator increasing disclosure in times of crises. Under this policy, however, an increase in disclosure signals a deterioration of the economy's fundamentals, so the regulator has incentives to withhold information ex-post. In that case, the regulator may have to commit ex-ante to a degree of transparency which trades o the frequency and magnitude of nancial crises. The analysis also considers the possibility that nancial institutions, in an attempt to deal with rollover risk, either diversify their risks or increase the liquidity of their balance sheets. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp700&r=cta |
| By: | Christopher L. House; Jing Zhang |
| Abstract: | We develop a dynamic equilibrium model of labor demand with adverse selection. Firms learn the quality of newly hired workers after a period of employment. Adverse selection makes it costly to hire new workers and to release productive workers. As a result, firms hoard labor and under-react to labor demand shocks. The adverse selection problem also creates a market for temporary workers. In equilibrium, firms hire a buffer stock of permanent workers and respond to changing business conditions by varying their temp workers. A hiring subsidy or tax can improve welfare by discouraging firms from hoarding too many productive workers. |
| JEL: | D82 E24 J23 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17962&r=cta |
| By: | Pierre Chaigneau |
| Abstract: | It is established that the standard principal-agent model cannot explain the structure of commonly used CEO compensation contracts if CRRA preferences are postulated. However, we demonstrate that this model has potentially a high explanatory power with preferences with decreasing relative risk aversion, in the sense that a typical CEO contract is approximately optimal for plausible preference parameters. |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp693&r=cta |
| By: | Steven Grenadier; Andrey Malenko; Ilya A. Strebulaev |
| Abstract: | We provide a dynamic model of an industry in which agents strategically time liquidation decisions in an effort to protect their reputations. As in traditional models, agents delay liquidation attempting to signal their quality. However, when the industry faces a common shock that indiscriminately forces liquidation of a subset of projects, agents with bad enough projects choose to liquidate even if their projects are unaffected by the shock. Such "blending in with the crowd" creates an additional incentive to delay liquidation, further amplifying the shock. As a result, even minuscule common shocks can be evidenced by massive liquidations. As agents await common shocks, the industry accumulates "living dead" projects. Surprisingly, the potential for moderate negative common shocks often improves agents values. |
| JEL: | G01 G24 G31 G32 G33 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17945&r=cta |