nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2012‒05‒15
twenty-one papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Stochastic signaling: information substitutes and complements By Tom TRUYTS
  2. Optimal Coexistence of Long-Term and Short-Term Contracts in Labor Markets By Inés Macho-Stadler; David Pérez-Castrillo; Nicolés Porteiro
  3. Growth, Selection and Appropriate Contracts By Alessandra Bonfiglioli and Gino Gancia
  4. Multidimensional Screening in a Monopolistic Insurance Market By Pau Olivella; Fred Schroyen
  5. Collusive Communication Schemes in a First-Price Auction By Azacis, Helmuts; Vida, Péter
  6. Moral hazard, investment, and firm dynamics By Hengjie Ai; Rui Li
  7. Corporate investment decisions under asymmetric information and uncertainty By Bell, Peter
  8. The value of lies in an ultimatum game with imperfect information By Damien Besancenot; Delphine Dubart; Radu Vranceanu
  9. An anti corruption mechansim By Jellal, Mohamed
  10. (Un)Informed Charitable Giving By Silvana Krasteva; Huseyin Yildirim
  11. Beneficial consumer fraud By Silvia Martínez-Gorricho
  12. Strategic interactions, incomplete information and learning By Berardi, Michele
  13. A Sticky-Dispersed Information Phillips Curve: a model with partial and delayed information By Marta Areosa; Waldyr Areosa; Vinicius Carrasco
  14. The relationship between information asymmetry and dividend policy By Cindy M. Vojtech
  15. First Impressions Matter: Signalling as a Source of Policy Dynamics By Stephen Hansen; Michael McMahon
  16. Heterogeneous Information and Trade Policy By Giacomo Ponzetto
  17. Coordination structures By Alfonso Rosa García; Hubert Janos Kiss
  18. Centralization and accountability: theory and evidence from the Clean Air Act By Federico Boffa; Amedeo Piolatto; Giacomo A. M. Ponzetto
  19. Entrepreneurial School Dropouts: A Model on Signalling, Education and Entrepreneurship By Baumgarten Skogstrøm, Jens Fredrik
  20. Social Capital, Government Expenditures, and Growth By Giacomo Ponzetto; Ugo Troiano
  21. Simple Mediation in a Cheap-Talk Game By Chirantan Ganguly; Indrajit Ray

  1. By: Tom TRUYTS
    Abstract: I develop a model of stochastic costly signaling in the presence of exogenous imperfect information, and study whether equilibrium signaling decreases (‘information substitutes’) or increases (‘information complements’) if the accuracy of exogenous information increases. A stochastic pure costly signaling model is shown to have a unique sequential equilibrium in which at least one type (and possibly all) engages in costly signaling. In the presence of exogenous information, a unique threshold level of prior beliefs generically exists which separates the cases of information complements and substitutes. More accurate exogenous information can induce a less informative signaling equilibrium, and can result in a lower expected accuracy of the uninformed party’s equilibrium beliefs. An application to signaling in networks, in which a social network is the source of exogenous information, the relation between network characteristics (size, density, centrality, component size) and equilibrium signaling.
    Date: 2012–05
  2. By: Inés Macho-Stadler; David Pérez-Castrillo; Nicolés Porteiro
    Abstract: We consider a market where firms hire workers to run their projects and such projects differ in profitability. At any period, each firm needs two workers to successfully run its project: a junior agent, with no specific skills, and a senior worker, whose effort is not verifiable. Senior workers differ in ability and their competence is revealed after they have worked as juniors in the market. We study the length of the contractual relationships between firms and workers in an environment where the matching between firms and workers is the result of market interaction. We show that, despite in a one-firm-one-worker set-up long-term contracts are the optimal choice for firms, market forces often induce firms to use short-term contracts. Unless the market only consists of firms with very profitable projects, firms operating highly profitable projects offer short-term contracts to ensure the service of high-ability workers and those with less lucrative projects also use short-term contracts to save on the junior workers wage. Intermediate firms may (or may not) hire workers through long-term contracts.
    Keywords: Moral Hazard, long-term contracts, equilibrium contracts
    JEL: D86 C78
    Date: 2011–05
  3. By: Alessandra Bonfiglioli and Gino Gancia
    Abstract: We study a dynamic model where growth requires both long-term investment and the selection of talented managers. When ability is not ex-ante observable and contracts are incomplete, managerial selection imposes a cost, as managers facing the risk of being replaced tend to choose a sub-optimally low level of long-term investment. This generates a trade-off between selection and investment that has implications for the choice of contractual relationships. Our analysis shows that rigid long-term contracts sacrificing managerial selection may be optimal at early stages of economic development and when access to information is limited. As the economy grows, however, knowledge accumulation increases the return to talent and makes it optimal to adopt flexible contractual relationships, where managerial selection is implemented even at the cost of lower investment. Better institutions, in the form of a richer contracting environment and less severe informational frictions, speed up the transition to short-term relationships.
    Keywords: information, selection, appropriate contracts, development, growth, appropriate institutions
    JEL: D8 O40
    Date: 2011–06
  4. By: Pau Olivella; Fred Schroyen
    Abstract: In this paper, we consider a population of individuals who differ in two dimensions: their risk type (expected loss) and their risk aversion. We solve for the profit maximizing menu of contracts that a monopolistic insurer puts out on the market. First, we find that it is never optimal to fully separate all the types. Second, if heterogeneity in risk aversion is sufficiently high, then some high-risk individuals (the risk-tolerant ones) will obtain lower coverage than some low-risk individuals (the risk-averse ones). Third, we show that when the average man and woman differ only in risk aversion, gender discrimination may lead to a Pareto improvement.
    Keywords: insurance markets, asymmetric information, screening, gender discrimination, positive correlation test
    JEL: D82 G22
    Date: 2012–02
  5. By: Azacis, Helmuts (Cardiff Business School); Vida, Péter
    Abstract: We study optimal bidder collusion at first-price auctions when the collusive mechanism only relies on signals about bidders’ valuations. We build on Fang and Morris (2006) when two bidders have low or high private valuation of a single object and additionally each receives a private noisy signal from an incentiveless center about the opponent’s valuation. We derive the unique symmetric equilibrium of the first price auction for any symmetric, possibly correlated, distribution of signals, when these can only take two values. Next, we find the distribution of 2-valued signals, which maximizes the joint payoffs of bidders. We prove that allowing signals to take more than two values will not increase bidders’ payoffs if the signals are restricted to be public. We also investigate the case when the signals are chosen conditionally independently and identically out of n = 2 possible values. We demonstrate that bidders are strictly better off as signals can take on more and more possible values. Finally, we look at another special case of the correlated signals, namely, when these are independent of the bidders’ valuations. We show that in any symmetric 2-valued strategy correlated equilibrium, the bidders bid as if there were no signals at all and, hence, are not able to collude.
    Keywords: Bidder-optimal signal structure; Collusion; (Bayes) correlated equilibrium; First price auction; Public and private signals
    JEL: D44 D82
    Date: 2012–05
  6. By: Hengjie Ai; Rui Li
    Abstract: We present a dynamic general equilibrium model with heterogeneous firms. Owners of firms delegate investment decisions to managers, whose consumption and investment decisions are private information. We solve the optimal contracts and characterize the implied general equilibrium. Our calibrated model has implications on the cross-sectional distribution and time-series dynamics of firms' investment, managers' compensation, and dividend payout policies. Risk sharing requires that managers' equity shares decrease with firm sizes. That, in turn, implies it is harder to prevent private benefit in larger firms, where managers have a lower equity stake under the optimal contract. Consequently, small firms invest more, pay less dividends, and grow faster than large firms. Despite the heterogeneity in firms' decision rules and the failure of Gibrat's law, we show that the size distribution of firms in our model resembles a power law distribution with a slope coefficient about 1.06, as in the data.
    Date: 2012
  7. By: Bell, Peter
    Abstract: This paper develops a model to study corporate investment decisions using the principal-agent framework. The model has asymmetric information where the agent knows the true value of the company and the principal does not. The model also has uncertainty where the company is presented an investment opportunity with a certain cost and random benefit. The agent must decide whether they will sell stock to the principal and make the investment. Results show that the information asymmetry imposes a cost on the principal because the agent will forgo some profitable projects or undertake some with expected losses. A procedure for the principal to distinguish undervalued and overvalued companies is presented.
    Keywords: Corporate decision making; issuance of stock; value of investment
    JEL: C70 G30
    Date: 2012–04–16
  8. By: Damien Besancenot (CEPN - Centre d'Economie de l'Université Paris Nord - Université Paris XIII - Paris Nord - CNRS : UMR7234); Delphine Dubart (ESSEC Business School - ESSEC Business School); Radu Vranceanu (Economics Department - ESSEC Business School)
    Abstract: Humans often lie strategically. We study this problem in an ultimatum game involving informed proposers and uninformed responders, where the former can send an unverifiable statement about their endowment. If there are some intrinsically honest proposers, a simple message game shows that the rest of them are likely to declare a lower-than-actual endowment to the responders. In the second part of the paper, we report on an experiment testing this game. On average, 88.5% of the proposers understate the actual endowment by 20.5%. Regression analysis shows that a one-dollar gap between the actual and declared amounts prompts proposers to reduce their offer by 19 cents. However, responders appear not to take such claims seriously, and thus the frequency of rejections should increase. The consequence is a net welfare loss, that is specific to such a "free-to-lie" environment.
    Keywords: Ultimatum game; Asymmetric information; Lying costs; Strategic lies; Deception; Welfare loss
    Date: 2012–04–16
  9. By: Jellal, Mohamed
    Abstract: Using the principal-agent- supervisor paradigm, this paper examines the occurrence of collusion in a setting where the principal has no information about the supervisor and the agent does not necesarily know the supervisor’s preferences.We formally prove the occurrence of collusion is more likely when the agent has information about the supervisor. This result suggests thaht corruption, which is likely to emerge in long term reciprocal relationships between public officials and potential bribery, may be reduced by the means of staff rotation. Evidence from an experimental study supports this proposition.
    Keywords: Principal-agent-supervisor; corruption; bureaucracy ;rotation
    JEL: D73 D82
    Date: 2012
  10. By: Silvana Krasteva; Huseyin Yildirim
    Abstract: Evidence suggests that donors have little demand for information before giving to charity. To understand this behavior and its policy implications, we present a model in which each individual can acquire costly information about her true value of charity. We observe that an individual who considers giving less is less likely to become informed; and indeed, an uninformed donor is, on average, less generous than an informed one. This implies that since the free-rider problem in giving worsens in a larger population, the percentage of informed givers becomes vanishingly small, leaving the total expected donations strictly below its highest level to be reached by a fully informed population. We show that while a direct government grant to the charity causes severe crowding-out by discouraging information acquisition, a matching grant increases donations by encouraging it. We further show that a “warm-glow” motive for giving does not necessarily weaken incentives to be informed, and that a (first-order) stochastic increase in true values for charity may actually decrease donations.
    Keywords: charitable giving, search cost, value of information, crowding-out, warm-glow
    JEL: H00 H41 D82 D83
    Date: 2011
  11. By: Silvia Martínez-Gorricho (Dpto. Análisis Económico Aplicado)
    Abstract: This article considers a two-sided private information model. We assume that two exogenouslygiven qualities are offered in a monopolistic market. Prices are fixed. A low quality seller choosesto be either honest (by charging the lower market price) or dishonest (by charging the higherprice). We discuss the signalling role of consumers’ information on the equilibrium level ofdishonesty, incidence of fraud and trade. We demonstrate that the equilibrium incidence offraud is non-monotonic in information. This result holds as long as information is noisy andregardless of its private or public nature. Welfare consequences are ambiguous.
    Keywords: Consumer Fraud; Asymmetric Information; Price Signalling
    JEL: D42 D82 G14 L15 L51
    Date: 2012–04
  12. By: Berardi, Michele
    Abstract: In a model of incomplete, heterogeneous information, with externalities and strategic interactions, we analyze the possibility for learning to act as coordination device. We build on the framework proposed by Angeletos and Pavan (2007) and extend it to a dynamic multiperiod setting where agents need to learn to coordinate. We analyze conditions under which adaptive and eductive learning obtain, and show that adaptive learning conditions are less demanding than the eductive ones: in particular, when actions are strategic substitutes, the equilibrium is always adaptively learnable, while it might not be eductively so. In case of heterogeneous preferences, moreover, convergence only depends on the average characteristic of agents in the economy. We also show that adaptive learning dynamics converge to the game theoretical strategic equilibrium, which means that agents can learn to act strategically in a simple and straightforward way.
    Keywords: Learning; heterogeneity; interaction; coordination
    JEL: D83 C73 C62
    Date: 2012–05–06
  13. By: Marta Areosa; Waldyr Areosa; Vinicius Carrasco
    Abstract: We study the interaction between dispersed and sticky information by assuming that firms receive private noisy signals about the state in an otherwise standard model of price setting with sticky-information. We compute the unique equilibrium of the game induced by the firms' pricing decisions and derive the resulting Phillips curve. The main effect of dispersion is to magnify the immediate impact of a given shock when the degree of stickiness is small. Its effect on persistence is minor: even when information is largely dispersed, a substantial amount of informational stickiness is needed to generate persistence in aggregate prices and inflation.
    Date: 2012–04
  14. By: Cindy M. Vojtech
    Abstract: This paper examines how the quality of firm information disclosure affects shareholders' use of dividends to mitigate agency problems. Managerial compensation is linked to firm value. However, because the manager and shareholders are asymmetrically informed, the manager can manipulate the firm's accounting information to increase perceived firm value. Dividends can limit such practices by adding to the cost faced by a manager manipulating earnings. Empirical tests match model predictions. Dividend-paying firms show less evidence of earnings management. Furthermore, nondividend payers changed earnings announcement behavior more than dividend payers following the Sarbanes-Oxley Act, a law that increased financial disclosures.
    Date: 2012
  15. By: Stephen Hansen; Michael McMahon
    Abstract: We first establish that policymakers on the Bank of England's Monetary Policy Committee choose lower interest rates with experience. We then reject increasing confidence in private information or learning about the structure of the macroeconomy as explanations for this shift. Instead, a model in which voters signal their hawkishness to observers better ts the data. The motivation for signalling is consistent with wanting to control inflation expectations, but not career concerns or pleasing colleagues. There is also no evidence of capture by industry. The paper suggests that policy-motivated reputation building may be important for explaining dynamics in experts' policy choices.
    Keywords: Signalling, Learning, Monetary Policy
    JEL: D78 E52
    Date: 2011–08
  16. By: Giacomo Ponzetto
    Abstract: Protectionism enjoys surprising popular support, in spite of deadweight losses. At the same time, trade barriers appear to decline with public information about protection. This paper develops an electoral model with heterogeneously informed voters which explains both facts and predicts the pattern of trade policy across industries. In the model, each agent endogenously acquires more information about his sector of employment. As a result, voters support protectionism, because they learn more about the trade barriers that help them as producers than those that hurt them as consumers. In equilibrium, asymmetric information induces a universal protectionist bias. The structure of protection is Pareto inefficient, in contrast to existing models. The model predicts a Dracula effect: trade policy for a sector is less protectionist when there is more public information about it. Using a measure of newspaper coverage across industries, I …find that cross-sector evidence from the United States bears out my theoretical predictions.
    Keywords: Protectionism, Voters, Imperfect information, Media coverage, Dracula effect, Pareto inefficiency
    JEL: F13 D72 D83
    Date: 2011–12
  17. By: Alfonso Rosa García (Universidad de Murcia); Hubert Janos Kiss (Universidad Autónoma de Madrid)
    Abstract: We study a coordination problem where agents act sequentially. Agents are embedded in anobservation network that allows them to observe the actions of their neighbors. We find thatcoordination failures do not occur if there exists a sufficiently large clique. Its existence isnecessary and sufficient when agents are homogenous and sufficient when agents differ and theirtypes are private. Other structures guarantee coordination when agents decide in some particularsequences or for particular payoffs. The coordination problem embodied in our game is appliedto the problems of revolts and bank runs.
    Keywords: Social networks, coordination failures, multiple equilibria, revolts, bank runs.
    JEL: C72 D82 D85 G21 Z13
    Date: 2012–04
  18. By: Federico Boffa (Università di Macerata & IEB); Amedeo Piolatto (Universitat de Barcelona & IEB); Giacomo A. M. Ponzetto (CREI, Universitat Pompeu Fabra & Barcelona GSE)
    Abstract: This paper studies fiscal federalism when voter information varies across regions. We develop a model of political agency with heterogeneously informed voters. Rent-seeking politicians provide public goods to win the votes of the informed. As a result, rent extraction is lower in regions with higher information. In equilibrium, electoral discipline has decreasing returns. Thus, political centralization efficiently reduces aggregate rent extraction. The model predicts that a region’s benefits from centralization are decreasing in its residents’ information. We test this prediction using panel data on pollutant emissions across U.S. states. The 1970 Clean Air Act centralized environmental policy at the federal level. In line with our theory, we find that centralization induced a differential decrease in pollution for uninformed relative to informed states.
    Keywords: Political centralization, government accountability, imperfect information, elections, environmental policy, air pollution
    JEL: D72 D82 H73 H77 Q58
    Date: 2012
  19. By: Baumgarten Skogstrøm, Jens Fredrik (Ragnar Frisch Centre for Economic Research,)
    Abstract: I present a theory on the relationship between educational choice and entrepreneurship in a labour market with asymmetric information. The model shows that, in a labour market where education is used as a signalling device, an imperfect relationship between productivity in education and in the labour market can lead to an equilibrium where a fraction of the high-ability individuals choose to quit school and become entrepreneurs. Using a comprehensive set of Norwegian register data, I find that this is prediction is confirmed empirically: Individuals combining low education with high ability have the highest entrepreneurship rates in the population.
    Keywords: Entrepreneurship; self-employment; education; ability
    JEL: J24 L26 M13
    Date: 2012–04–02
  20. By: Giacomo Ponzetto; Ugo Troiano
    Abstract: Countries with greater social capital have higher economic growth. We show that social capital is also highly positively correlated across countries with government expenditure on education. We develop an infinite-horizon model of public spending and endogenous stochastic growth that explains both facts through frictions in political agency when voters have imperfect information. In our model, the government provides services that yield immediate utility, and investment that raises future productivity. Voters are more likely to observe public services, so politicians have electoral incentives to under-provide public investment. Social capital increases voters' awareness of all government activity. As a consequence, both politicians' incentives and their selection improve. In the dynamic equilibrium, both the amount and the efficiency of public investment increase, permanently raising the growth rate.
    Keywords: Social Capital, Government Expenditures, Economic Growth, Public Investment, Elections, Imperfect Information
    JEL: D72 D83 H50 H54 O43 Z13
    Date: 2012–02
  21. By: Chirantan Ganguly; Indrajit Ray
    Abstract: In the Crawford-Sobel (uniform, quadratic utility) cheap-talk model, we consider a simple mediation scheme (a communication device) in which the informed agent reports one of the N possible elements of a partition to the mediator and then the mediator suggests one of the N actions to the uninformed decision-maker according to the probability distribution of the device. We show that no such simple mediated equilibrium can improve unpon the unmediated N-partition Crawford-Sobel equilibrium when the preference divergence parameter (bias is small).
    Keywords: Cheap Talk, Mediated Equilibrium
    JEL: C72
    Date: 2012–04

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