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on Contract Theory and Applications |
| By: | Emanuele Gerratana (SIPA, Columbia University); Levent Kockesen (Koç University) |
| Abstract: | This paper characterizes the equilibrium outcomes of two-stage games in which the second mover has private information and can sign renegotiable contracts with a neutral third-party. Our aim is to understand whether renegotiation-proof third-party contracts can confer a strategic advantage on the second mover. We first analyze non-renegotiable contracts and show that a “folk theorem” holds: Any outcome in which the second mover best responds to the first mover’s action and the first mover obtains a payoff at least as large as his “individually rational payoff” can be supported. Renegotiation-proofness imposes some restrictions, which is most transparent in games with externalities, i.e., games in which the first mover’s payoff increases (or decreases) in the second mover’s action. In such games, a similar folk theorem holds with renegotation-proof contracts as well, but the firstmover’s individually rational payoff is in general higher. |
| Keywords: | Third-Party Contracts, Strategic Delegation, Renegotiation, Asymmetric Information, Renegotiation-Proofness, Durability. |
| JEL: | C72 D80 L13 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:koc:wpaper:1208&r=cta |
| By: | Francesc Dilmé (Department of Economics, University of Pennsylvania) |
| Abstract: | Asymmetric information is an important source of inefficiency when assets (like firms) are transacted. The two main sources of this asymmetry are unobserved idiosyncratic characteristics of the asset (for example, quality) and unobserved idiosyncratic choices (actions done by the current owners). We introduce moral hazard in a dynamic signaling model where heterogeneous sellers exert effort to affect the distribution of a stochastic signal (for example sales or profits) of their firms. Buyers observe the signal history and make price offers to the sellers. High-quality sellers try to separate themselves from the less quality ones in order to receive high price offers, while the latter try to pool with the first group to avoid receiving a low price. We characterize the competitive equilibria of the model, and we propose an adaptation of existing refinements to the incorporation of moral hazard in dynamic signaling that implies uniqueness of equilibria. We find that similar individual characteristics across types of sellers make everyone worse off, since competition increases signaling waste. Also, due to the new intensive margin (effort), non-trivial signaling will take place even when the cost of signaling is large. In particular cases, we find analytical solutions, that allow transparent comparative statics analysis. The model can be applied to education where grades depend not only on the students’ skills, but also on their effort. |
| Keywords: | Dynamic Signaling, Dynamic Moral Hazard, Endogenous Effort |
| JEL: | D82 D83 C73 J24 |
| Date: | 2012–03–19 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:12-012&r=cta |
| By: | Andriy Zapechelnyuk (Queen Mary, University of London) |
| Abstract: | The paper addresses the mechanism design problem of eliciting truthful information from a committee of informed experts who collude in their information disclosure strategies. It is shown that under fairly general conditions full information disclosure is possible if and only if the induced outcome is Pareto undominated for the committee members. |
| Keywords: | Communication, Multidimensional mechanism design, Experts, Collusion, Axiomatic bargaining, Closed rule |
| JEL: | D82 C78 D72 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp692&r=cta |
| By: | Ching-to Albert MA (Department of Economics, Boston University.); Ingela Alger (TSE (LERNA, CNRS) and Economics Department, Carleton University); Regis Renault (Universite de Cergy-Pontoise, THEMA, Cergy-Pontoise Cedex FRANCE, and Institut Universitaire de France;) |
| Abstract: | A principal chooses between in-house production and outsourcing. An agent will be hired when production is in-house. An agent will be contracted upon when production is outsourced. In each case, the agent earns experience benefits: future monetary returns from managing production, reputation, and enjoyment. The principal would like to extract experience benets. He can do so when production is outsourced. But the external agent earns information rent from private information about production costs. The principal cannot fully extract experience benets when production is in-house because the internal agent must receive a minimum income, although the principal has full information on production costs. Our theory proposes a new trade-off, between information rent under outsourcing, and experience rent under in-house production. The principal chooses outsourcing when experience benefits are high. The principal's organizational choice may be socially inefficient. |
| Keywords: | vertical integration, experience benets, experience rents, informational rents. |
| JEL: | D23 L22 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2012-007&r=cta |
| By: | Kyungmin Kim; Antonio Penta |
| Abstract: | We study the problem of efficient auction design in environments with interdependent values, under arbitrary common knowledge assumptions. We propose a simple mechanism and show that, under a rather mild condition, it "robustly" achieves efficiency. Our mechanism consists in a standard Vickrey auction, preceded by one round of communication, where agents report their private signals and receive transfers from the designer. We interpret the transfers as the cost for the designer to robustly achieve efficiency. We introduce a notion of robust informational size and show that the transfers are small if agents are informationally small in our sense. Furthermore, the transfers are decreasing in the amount of information available to the designer and in the strength of the common knowledge assumptions. In other words, the more robust the efficient implementation result, the higher the cost of achieving efficiency. We thus formalize the intuitive idea of a trade-off between robustness and efficient implementation and analyze the determinants of the "cost of robustness". |
| Keywords: | Cost of robustness; efficient auctions; informational size; interdependent values; robust mechanism design |
| JEL: | C72 D82 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:248&r=cta |
| By: | Frank Schmielewski (Leuphana University of Lüneburg, Germany); Thomas Wein (Leuphana University of Lueneburg, Germany) |
| Abstract: | In this study, we propose our hypothesis that the distinguishable principal-agent relationships of German banks are significantly influencing the risk-taking attitudes of bank managers. Particularly, we intend to substantiate the theory that banks owned by dispersed shareholders or federal state authorities face a higher relevance of principal-agent problems than other banking sectors due to a missing ability to monitor bank managers. Our results underline that these problems appear to mislead bank managers showing an unreasonable risk-taking behavior. In a first stage, we rely on a theoretical model explaining that from the bank owners’ viewpoint three factors of the principal-agent relationships are determining the probability of choosing the optimal portfolio of risky assets. These factors cover the ability to control bank managers, the risk pooling capabilities of bank owners and bank managers, and the incentives of seeking high returns. To support our hypothesis we apply an empirical study to the distances-to-default of different German banking sectors. This demonstrates that risktaking attitudes of banks are closely related to banks’ ownership. Consequently, our findings offer evidence, that legislative and regulatory authorities should increase their vigilance in terms of principal-agent problems within certain sectors of the banking industry. |
| Keywords: | Financial crises; risk-taking behavior; risk aversion; efficient portfolios; information asymmetries and market efficiency; government policy and regulation; risk pooling; seeking for high returns; monitoring capabilities; capital and ownership structure; distance-to-default; capital asset ratio; return on assets |
| JEL: | G01 G12 G14 G28 G15 G32 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:lue:wpaper:236&r=cta |
| By: | Gersbach, Hans; Hahn, Volker |
| Abstract: | We introduce a new type of incentive contract for central bankers: inflation forecast contracts, which make central bankers’ remunerations contingent on the precision of their inflation forecasts. We show that such contracts enable central bankers to influence inflation expectations more effectively, thus facilitating more successful stabilization of current inflation. Inflation forecast contracts improve the accuracy of inflation forecasts, but have adverse consequences for output. On balance, paying central bankers according to their forecasting performance improves welfare. Optimal inflation forecast contracts stipulate high rewards for accurate forecasts. |
| Keywords: | central banks; incentive contracts; inflation forecast targeting; inflation targeting; intermediate targets; transparency |
| JEL: | E58 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8933&r=cta |
| By: | Ghosh, Sambuddha; Han, Seungjin |
| Abstract: | Competing mechanism games involve multiple principals contracting with one or more agents. This paper extends the static model of Epstein and Peters (1999) to the repeated setting, allowing agents' types to evolve over time according to a Markov process. Actions are perfectly monitored, but types and messages are private information. Perhaps surprisingly, when discounting is low the dynamic game is more tractable in the following senses. First, each principal's minmax value relative to arbitrarily general mechanisms equals that relative to simpler mechanisms, often direct mechanisms. This contrasts with one-shot games, where the minmax cannot be explicitly computed because it is not expresssible in terms of simple mechanisms. Second, the above result allows equilibrium payoffs to be expressed in terms of primitives of the model. From the applied perspective, this paper provides a sufficient class of simple mechanisms to which one can restrict attention without loss of generality. |
| Keywords: | dynamic competing mechanisms, minmax values, direct mechanisms, folk theorem, robust equilibria |
| JEL: | C73 D82 |
| Date: | 2012–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:ubc:pmicro:seungjin_han-2012-12&r=cta |
| By: | Sambuddha Ghosh; Seungjin Han |
| Abstract: | Competing mechanism games involve multiple principals contracting with one or more agents. This paper extends the static model of Epstein and Peters (1999) to the repeated setting, allowing agents' types to evolve over time according to a Markov process. Actions are perfectly monitored, but types and messages are private information. Perhaps surprisingly, when discounting is low the dynamic game is more tractable in the following senses. First, each principal's minmax value relative to arbitrarily general mechanisms equals that relative to simpler mechanisms, often direct mechanisms. This contrasts with one-shot games, where the minmax cannot be explicitly computed because it is not expresssible in terms of simple mechanisms. Second, the above result allows equilibrium payoffs to be expressed in terms of primitives of the model. From the applied perspective, this paper provides a sufficient class of simple mechanisms to which one can restrict attention without loss of generality. |
| Keywords: | dynamic competing mechanisms, minmax values, direct mechanisms, folk theorem, robust equilibria |
| JEL: | C73 D82 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:deptwp:2012-03&r=cta |
| By: | Andriy Zapechelnyuk (Queen Mary, University of London); Ro'i Zultan (Ben-Gurion University of the Negev) |
| Abstract: | The costs of searching for a job vacancy are typically associated with friction that deters or delays employment of potentially productive individuals. We demonstrate that in a labor market with moral hazard where effort is noncontractible, job search costs play a positive role, whose effect may outweigh the negative implications. As workers are provided incentives to exert effort by the threat of losing their job and having to search for a new vacancy, a reduction in job search costs leads to fewer employees willing to exert effort. The overall lower productivity will make more individuals and firms opting to stay out of the labor market, resulting in lower employment and decreased welfare. Eventually, a reduction of jobs search costs below a certain level results in collapse of the labor market. |
| Keywords: | : Job search, Moral hazard, Labor market, Unemployment insurance |
| JEL: | D83 J64 J65 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp693&r=cta |
| By: | Thomas Philippon; Vasiliki Skreta |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ste:nystbu:11-11&r=cta |
| By: | Ansgar Rannenberg (Deutsche Bundesbank, Economics Department) |
| Abstract: | The paper adds a moral hazard problem between banks and depositors as in Gertler and Karadi (2011) to a DSGE model with a costly state verification problem between entrepreneurs and banks as in Bernanke, Gertler and Girlchrist (1999, BGG). This modification amplifies the response of the external finance premium and the overall economy to monetary policy and productivity shocks. It allows the model to match the volatility and correlation with output of the external finance premium, bank leverage, entrepreneurial leverage and other variables in US data better than a BGG-type model. A reasonably calibrated simulation of a bank balance sheet shock produces a downturn of a magnitude similar to the "Great Recession". |
| Keywords: | Financial accelerator, bank leverage, DSGE model |
| JEL: | E44 G21 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:201204-224&r=cta |
| By: | Madhav S. Aney (School of Economics, Singapore Management University) |
| Abstract: | Why do agents engage in costly dispute resolution such as litigation and arbitration when costless settlement is available? I present a model with one sided asymmetric information where the payoff from litigation for both agents depends on the beliefs of the uninformed agent. Taking these payoffs as their outside options, agents negotiate over the allocation of an indivisible object that is in dispute and transfers. It is shown that it is impossible to implement an allocation that satisfies budget balance that guarantees the agents their payoff from conflict when agents can quit negotiations unilaterally at any stage. |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:siu:wpaper:18-2012&r=cta |
| By: | Seik Kim; Emiko Usui (Nagoya University and IZA) |
| Abstract: | This paper takes a new approach to testing whether employer learning is public or private. We show that public and private learning schemes make two distinct predictions about the curvature of wage growth paths when there is a job change, because the amount of information transferred to a new employer about workers' productivity is smaller in the private learning case than in the public learning case. This prediction enables us to account for individual and job-match heterogeneity, which was not possible in previous tests. Using the National Longitudinal Survey of Youth 1979 (NLSY79), we find that learning is primarily public. |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:udb:wpaper:uwec-2012-01&r=cta |
| By: | Mikhail Golosov; Vasiliki Skreta; Aleh Tsyvinski; Andrea Wilson |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ste:nystbu:11-17&r=cta |
| By: | Grazzini, J. (University of Turin) |
| Abstract: | This paper builds an agent based model to reproduce the results of an experimental stock market that studies how the market aggregates private information. The aim is to contribute to the relationship between experiments and agent-based modeling and to understand the behavior of the agents. Using the experimental environment and results, it is possible to formulate a hypothesis about the behavior of the subjects and thereby formalize (algorithmically) the behavior of the traders. This allows a better understanding of how the market converges toward the equilibrium and the mechanism that allows for the dissemination of private information in the market. |
| URL: | http://d.repec.org/n?u=RePEc:ams:ndfwpp:11-07&r=cta |
| By: | Simona Cicognani (School of Social Sciences, University of Trento, Italy); Aanna D'Ambrosio (School of Social Sciences, University of Trento, Italy); Werner Güth (Max Planck Institute of Economics, Strategic Interaction Group); Simone Pfuderer (School of Social Sciences, University of Trento, Italy); Matteo Ploner (Cognitive and Experimental Economics Laboratory, University of Trento, Italy) |
| Abstract: | We define and experimentally test a public provision mechanism that meets three basic ethical requirements and allows community members to influence, via monetary bids, which of several projects is implemented. For each project, participants are assigned personal values, which can be positive or negative. We provide either complete or only private information about others' personal values. This produces two distinct public provision games which are experimentally implemented and analysed for various projects. In spite of the complex experimental task, participants do not rely on truth-telling as an obvious and simple heuristic whose general acceptance would result in fair and efficient outcomes. Rather, they yield to strategic underbidding. Although underbidding is affected by projects' characteristics, the provision mechanism seems quite functional. |
| Keywords: | Public Provision, Procedural Fairness, Experiment |
| JEL: | C91 C72 D63 |
| Date: | 2012–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-015&r=cta |
| By: | Tsur, Yacov; de Gorter, Harry |
| Abstract: | When a nonpoint source pollution process involves many polluters, each taking his own contribution to aggregate pollution to be negligi- ble, ambient-based policies become ineffective due to lack of strategic interactions between dischargers. We offer a regulation mechanism for this case. The mechanism consists of inter-period and intra-period com- ponents. The first exploits ambient (aggregate) information to derive the optimal pollution and aggregate emission processes and the ensuing social price of emission. The intra-period mechanism takes as given the social price of emission and implements the optimal output-abatement- emission allocation across the heterogenous, privately informed firms in each time period. The mechanism gives rise to the full information outcome when the social cost of transfers is nil. A positive social cost of transfers decreases both output and abatement in each time period, though the effect on emission is ambiguous. |
| Keywords: | Nonpoint source pollution, abatement, stock externality, dynamic regulation, Markov decision process, asymmetric information, Crop Production/Industries, C61, D82, H23, L51, Q58, |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:ags:huaedp:122124&r=cta |
| By: | Teng , Jimmy |
| Abstract: | This paper introduces a new game theoretic equilibrium, Bayesian equilibrium by iterative conjectures (BEIC). It requires agents to make predictions, starting from first order uninformative predictive distribution functions (or conjectures) and keep updating with statistical decision theoretic and game theoretic reasoning until a convergence of conjectures is achieved. In a BEIC, rationality is achieved for strategies and conjectures. The BEIC approach is capable of analyzing a larger set of games than current Nash Equilibrium based games theory, including games with inaccurate observations, games with unstable equilibrium and games with double or multiple sided incomplete information games. On the other hand, for the set of games analyzed by the current games theory, it generates far lesser equilibriums and normally generates only a unique equilibrium. It also resolves inconsistencies in equilibrium results by different solution concepts in current games theory. |
| Keywords: | new equilibrium concept; iterative conjectures; convergence; Bayesian decision theory; Schelling point |
| JEL: | D84 D81 C72 |
| Date: | 2011–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:37969&r=cta |
| By: | Toru Suzuki (Max Planck Institute of Economics, Jena, Germany) |
| Abstract: | In the market where inattentive buyers can fail to notice some feasible choices, the key role of marketing is to make buyers aware of products. However, the eective marketing strategy is often subtle since marketing tactics can make buyers cautious. This paper provides a framework to analyze an eective marketing strategy to persuade an inattentive buyer in an adverse selection environment. We investigate how an attention-grabbing marketing can "backfire" and when it can be eective. |
| Keywords: | Signaling game, Consideration set, Counter signaling, Limited attention, Marketing, Advertising |
| JEL: | D03 D82 D83 L15 |
| Date: | 2012–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-014&r=cta |
| By: | Stephens, Eric (University of Alberta, Department of Economics); Thompson, James (University of Waterloo) |
| Abstract: | In traditional economic models of insurance, sellers typically employ a non-linear pricing scheme to elicit type information from buyers. In financial insurance contracts, such a policy is not possible since contracts are non-exclusive. In addition, counterparty risk in financial contracts can be particularly problematic relative to traditional insurance. Accordingly, we relax the standard assumption of contract exclusivity and allow the insured to contract with many sellers, some of which may be unstable. In contrast to the traditional insurance model, we show that separation of risk types among insured parties can be achieved with linear pricing when there is aggregate counterparty risk. This result is shown to collapse when contracts are cleared through a central counterparty, suggesting that such an arrangement can create opacity. |
| Keywords: | insurance; separation; mutual exclusion; counterparty risk |
| JEL: | D82 G21 G22 |
| Date: | 2012–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:ris:albaec:2012_008&r=cta |
| By: | Acharya, Viral V; Gabarro, Marc; Volpin, Paolo |
| Abstract: | We propose a model in which better governance incentivizes managers to perform better and thus saves on the cost of providing pay for performance. However, when managerial talent is scarce, firms' competition to attract better managers reduces an individual firm's incentives to invest in corporate governance. In equilibrium, better managers end up at firms with weaker governance, and conversely, better-governed firms have lower-quality managers. Consistent with these implications, in a sample of US firms, we show that (i) better CEOs are matched to firms with weaker corporate governance and more so in industries with stronger competition for managers, and, (ii) corporate governance is more likely to change when there is CEO turnover, with governance weakening when the incoming CEO is better than the departing one. |
| Keywords: | corporate governance; executive compensation; externalities |
| JEL: | D82 G18 G21 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8936&r=cta |
| By: | Abhijit Banerjee; Sendhil Mullainathan; Rema Hanna |
| Abstract: | In this paper, we provide a new framework for analyzing corruption in public bureaucracies. The standard way to model corruption is as an example of moral hazard, which then leads to a focus on better monitoring and stricter penalties with the eradication of corruption as the final goal. We propose an alternative approach which emphasizes why corruption arises in the first place. Corruption is modeled as a consequence of the interaction between the underlying task being performed by bureaucrat, the bureaucrat's private incentives and what the principal can observe and control. This allows us to study not just corruption but also other distortions that arise simultaneously with corruption, such as red-tape and ultimately, the quality and efficiency of the public services provided, and how these outcomes vary depending on the specific features of this task. We then review the growing empirical literature on corruption through this perspective and provide guidance for future empirical research. |
| JEL: | D02 O10 O12 O43 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17968&r=cta |
| By: | Ching-to Albert MA (Department of Economics, Boston University.); Henry Y. Mak (Department of Economics, European University Institute) |
| Abstract: | A health care provider chooses medical service quality and cost-reduction effort. Both choices are noncontractible. An insurer observes both quality and cost effort, and may credibly disclose them to consumers. In prospective payment, the insurer fully discloses care quality, and sets a prospective payment price. In cost reimbursement, the insurer discloses a value index, a weighted average of quality and cost effort, and pays a margin above cost. The first-best quality and cost effort can be implemented by prospective payment and by cost reimbursement. |
| Keywords: | prospective payment, cost reimbursement, fee for service, quality, cost reduction |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2012-008&r=cta |