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on Contract Theory and Applications |
| By: | Bruno Biais (Toulouse School of Economics (CNRS-CRM, IDEI), 21 Allée de Brienne, 31000 Toulouse, France.); Florian Heider (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Marie Hoerova (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.) |
| Abstract: | We analyze optimal hedging contracts and show that although hedging aims at sharing risk, it can lead to more risk-taking. News implying that a hedge is likely to be loss-making undermines the risk-prevention incentives of the protection seller. This incentive problem limits the capacity to share risks and generates endogenous counterparty risk. Optimal hedging can therefore lead to contagion from news about insured risks to the balance sheet of insurers. Such endogenous risk is more likely to materialize ex post when the ex ante probability of counterparty default is low. Variation margins emerge as an optimal mechanism to enhance risk-sharing capacity. Paradoxically, they can also induce more risk-taking. Initial margins address the market failure caused by unregulated trading of hedging contracts among protection sellers. JEL Classification: G21, G22, D82. |
| Keywords: | Insurance, moral hazard, counterparty risk, margin requirements, derivatives. |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20121413&r=cta |
| By: | Matthias Lang (Max Planck Institute for Research on Collective Goods, Bonn) |
| Abstract: | Should principals explain and justify their evaluations? In this paper the principal's evaluation is private information, but she can provide some justifications by sending a costly message. Indeed, it is optimal for the principal to explain her evaluation to the agent if and only if the evaluation turns out to be bad. The justification guarantees the agent that the principal has not distorted the evaluation downwards. On the equilibrium path, as long as the principal provides a justification, the wage increases in the performance of the agent. For good performances, however, the principal pays a given high wage without providing justifications. This wage pattern fits empirical observations that subjective evaluations are lenient and discriminate poorly between good performances. I show that this pattern is part of the optimal contract instead of biased behavior. Furthermore, it is possible to implement the optimal contract in an ex-post budget-balanced way if stochastic contracts are feasible. |
| Keywords: | disclosure, Communication, Subjective evaluation, Stochastic contracts, Message games, Centrality bias |
| JEL: | D82 D86 M52 J41 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2012_14&r=cta |
| By: | Simeon Schudy (Thurgau Institute of Economics at the University of Konstanz, Department of Economics, Germany); Verena Utikal (University of Erlangen-Nuremberg, Department of Economics, Germany) |
| Abstract: | We investigate the consequences of imperfect data privacy on information acquisition about personal health status. In a simplified game of persuasion players decide on whether or not to acquire information about their health status before searching for a matching partner (e.g. an insurance company). We contrast three institutional settings: automatic dissemination of certified test results, perfect data privacy and imperfect data privacy about certified test results (i.e. potentially involuntary dissemination). Assuming that the ex-ante expected payoff of a match with an unknown type is positive, we find that equilibria with complete information acquisition and complete information revelation exist only under perfect and imperfect data privacy whereas equilibria without any information acquisition exist under all institutional settings. We test our predictions in a laboratory experiment. Indeed, both imperfect and perfect data privacy yield almost perfect information acquisition. Automatic dissemination leads to incomplete information acquisition |
| Keywords: | data privacy, endogenous information acquisition, health, experiment |
| JEL: | D80 D82 I1 I12 |
| Date: | 2012–06–29 |
| URL: | http://d.repec.org/n?u=RePEc:knz:dpteco:1212&r=cta |
| By: | Bardey, David (University of Rosario (Colombia) and Toulouse School of Economics); De Donder, Philippe (Toulouse School of Economics (GREMAQ-CNRS and IDEI)) |
| Abstract: | We develop a model where a genetic test reveals whether an individual has a low or high probability of developing a disease. A costly prevention effort allows high-risk agents to decrease this probability. Agents are not obliged to take the test, but must disclose its results to insurers, and taking the test is associated to a discrimination risk. We study the individual decisions to take the test and to undertake the prevention e¤ort as a function of the effort cost and of its efficiency. If effort is observable by insurers, agents undertake the test only if the effort cost is neither too large nor too low. If the effort cost is not observable by insurers, moral hazard increases the value of the test if the e¤ort cost is low. We offer several policy recommendations, from the optimal breadth of the tests to policies to do away with the discrimination risk. |
| JEL: | D82 I18 |
| Date: | 2012–05–11 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:26029&r=cta |
| By: | Bardey, David (University of Rosario (Colombia) and Toulouse School of Economics); De Donder, Philippe (Toulouse School of Economics (GREMAQ-CNRS and IDEI)) |
| Abstract: | We develop a model where a genetic test reveals whether an individual has a low or high probability of developing a disease. A costly prevention effort allows high-risk agents to decrease this probability. Agents are not obliged to take the test, but must disclose its results to insurers, and taking the test is associated to a discrimination risk. We study the individual decisions to take the test and to undertake the prevention e¤ort as a function of the effort cost and of its efficiency. If effort is observable by insurers, agents undertake the test only if the effort cost is neither too large nor too low. If the effort cost is not observable by insurers, moral hazard increases the value of the test if the e¤ort cost is low. We offer several policy recommendations, from the optimal breadth of the tests to policies to do away with the discrimination risk. |
| JEL: | D82 I18 |
| Date: | 2012–05–11 |
| URL: | http://d.repec.org/n?u=RePEc:ide:wpaper:26027&r=cta |
| By: | Kiho Yoon (Department of Economics, Korea University, Seoul, Republic of Korea) |
| Abstract: | We characterize the optimal structure of prizes in contests, when the contest designer is interested in the maximization of either the expected total e¢çort or the expected highest e¢çort. The all-pay auction framework in the present paper makes it possible to derive all the results in Benny Moldovanu and Aner Sela's (2001, American Economic Review, 542-558) incomplete-information model of contests as well as other results in a particularly simple fashion. |
| Keywords: | Contests, Optimal structure, Prizes, All-pay auctions |
| JEL: | D44 J31 D72 D82 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:iek:wpaper:1207&r=cta |
| By: | Florian Heider (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Roman Inderst (Johann Wolfgang Goethe University Frankfurt, Institute for Monetary and Financial Stability, Grüneburgplatz 1, 60629 Frankfurt am Main, Germany and Imperial College London, UK) |
| Abstract: | We o¤er a theoretical framework to analyze corporate lending when loan o¢ cers must be incentivized to prospect for loans and to transmit the soft information they obtain in that process. We explore how this multi-task agency problem shapes loan o¢ cerscompensation, banksuse of soft information in credit approval, and their lending standards. When competition intensi es, prospecting for loans becomes more important and banksinternal agency problem worsens. In response to more competition, banks lower lending standards, may choose to disregard soft and use only hard information in their credit approval, and in that case reduce loan o¢ cers to salespeople with steep, volume-based compensation. Our model generates excessive lendingas banksoptimal response to an internal agency problem. JEL Classification: D82, G21, L13. |
| Keywords: | Banking; Soft information; Loan o¢ cers; Multi-task Moral-hazard; Competition. |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20121439&r=cta |
| By: | Laure ATHIAS; Raphael SOUBEYRAN |
| Abstract: | This article investigates the allocation of demand risk within an incomplete contract frame- work. We consider an incomplete contractual relationship between a public authority and a private provider (i.e. a public-private partnership), in which the latter invests in non-verifiable cost-reducing efforts and the former invests in non-verifiable adaptation efforts to respond to changing consumer demand over time. We show that the party that bears the demand risk has fewer hold-up opportunities and that this leads the other contracting party to make more effort. Thus, in our model, bearing less risk can lead to more effort, which we describe as a new example of ‘counter-incentives’. We further show that when the benefits of adaptation are important, it is socially preferable to design a contract in which the demand risk remains with the private provider, whereas when the benefits of cost-reducing efforts are important, it is socially preferable to place the demand risk on the public authority. We then apply these results to explain two well-known case studies. |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:lam:wpaper:12-20&r=cta |
| By: | Markus Kinateder (Dpto. Economía); Hubert Janos Kiss (Universidad Autónoma de Madrid) |
| Abstract: | We study the Diamond-Dybvig model of financial intermediation (JPE, 1983) under theassumption that depositors have information about previous decisions. Depositors decidesequentially whether to withdraw their funds or continue holding them in the bank. If depositorsobserve the history of all previous decisions, we show that there are no bank runs in equilibriumindependently of whether the realized type vector selected by nature is of perfect or imperfectinformation.JEL classification numbers: |
| Keywords: | Bank Run, Imperfect Information, Perfect Bayesian Equilibrium |
| JEL: | C72 D82 G21 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:ivi:wpasad:2012-16&r=cta |
| By: | Daniel C. Hardy |
| Abstract: | The level of a bank‘s capitalization can effectively transmit information about its riskiness and therefore support market discipline, but asymmetry information may induce exaggerated or distortionary behavior: banks may vie with one another to signal confidence in their prospects by keeping capitalization low, and banks‘ creditors often cannot distinguish among them - tendencies that can be seen across banks and across time. Prudential policy is warranted to help offset these tendencies. |
| Keywords: | Banks , Capital , Economic models , |
| Date: | 2012–05–07 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:12/114&r=cta |
| By: | De la Bruslerie, Hubert |
| Abstract: | This paper examines the combination of cash and share payments made during corporate acquisitions. Particularly, it analyzes the conditions of an optimal mixed payment in a context of asymmetry of information. Using a model, we highlight that the setting of conditions of payment is an endogenous part of a takeover agreement between the acquirer and the target. Our contribution is to show how, in the acquisition process, the cash percentage setting is a key element for conveying private information on the gains of synergy and the gains resulting from the transaction. We internalize in our model asymmetries of information and possible exaggeration biases. Both will influence the joint setting of a mixed payment scheme. |
| Keywords: | means of payment; information asymmetry; synergy; financing decision; mergers and acquisitions; |
| JEL: | G3 G34 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:ner:dauphi:urn:hdl:123456789/5066&r=cta |
| By: | Rafael Hortala-Vallve (Government Department, London School of Economics); Aniol Llorente-Saguer (Max Planck Institute for Research on Collective Goods, Bonn); Rosemarie Nagel (Universitat Pompeu Fabra, ICREA) |
| Abstract: | We analyze a bargaining protocol recently proposed in the literature vis-à-vis unconstrained negotiation. This new mechanism extracts “gains from trade” inherent in the differing valuation of two parties towards various issues where conflict exists. We assess the role of incomplete vs. complete information in the efficiency achieved by this new mechanism and by unconstrained negotiation. We find that unconstrained negotiation does best under a situation of complete information where the valuations of both bargaining parties are common knowledge. Instead, the newly proposed mechanism does best in a situation with incomplete information. The sources of inefficiencies in each of the two cases arise from the different strategic use of the available information. |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2012_12&r=cta |
| By: | Â Leif Brandes (Department of Business Administration, University of Zurich); Â Marc Brechot (Department of Business Administration, University of Zurich); Â Egon Franck (Department of Business Administration, University of Zurich) |
| Abstract: | We introduce agency concerns to social capital theory and predict that managers can use individual social capital to reduce personal effort costs, which is not in the best interest of the firm. To test this prediction, we collect data on all 8,019 hiring decisions from general managers in the National Basketball Association between 1981 and 2011. We find that managers have a clear preference for hiring players through social ties. The probability that a manager hires players from an NBA franchise to which he is socially tied is 27.6% higher than for an untied franchise. To isolate the motivation for this behavior, we complement our data with information on the sporting performance of teams. In line with agency theory, we find that the hiring of players through social ties reduces team performance. The effect is large: on average, each social-tie player reduces team winning percentage by 5.4%. Overall, this paper documents first empirical evidence that decision makers’ use of individual social capital can lead to reduced firm-level performance.  |
| Keywords: | Social Networks, Social Capital, Principal-Agent-Relationship, Worker Allocation, Basketball |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:iso:wpaper:0159&r=cta |
| By: | Xavier Freixas; Jean-Charles Rochet |
| Abstract: | We model a Systemically Important Financial Institution (SIFI) that is too big (or too interconnected) to fail. Without credible regulation and strong supervision, the shareholders of this institution might deliberately let its managers take excessive risk. We propose a solution to this problem, showing how insurance against systemic shocks can be provided without generating moral hazard. The solution involves levying a systemic tax needed to cover the costs of future crises and more importantly establishing a Systemic Risk Authority endowed with special resolution powers, including the control of bankers' compensation packages during crisis periods. |
| Keywords: | SIFI, dynamic moral hazard, risk taking |
| JEL: | G21 G32 G34 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1328&r=cta |