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on Contract Theory and Applications |
| By: | Georges Dionne |
| Abstract: | We discuss the difficult question of measuring the effects of asymmetric information problems on resource allocation. Three problems are examined: moral hazard, adverse selection, and asymmetric learning. One theoretical conclusion, drawn by many authors, is that information problems may introduce significant distortions into the economy. However, we verify, in different markets, that efficient mechanisms have been introduced in order to reduce these distortions and even eliminate, at the margin, some residual information problems. This conclusion is stronger for pure adverse selection. One explanation is that adverse selection is related to exogenous characteristics, while asymmetric learning and moral hazard are due to endogenous actions that may change at any point in time. Dynamic data help to identify the three information problems by permitting causality tests. |
| Keywords: | Empirical measure, information problem, moral hazard, adverse selection, learning, insurance fraud, causality tests, dynamic data |
| JEL: | C12 C18 C23 C26 D80 G22 C25 G11 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1233&r=cta |
| By: | Alessandro De Chiara; Luca Livio |
| Abstract: | We examine a hierarchical model where a principal hires a risk averse supervisor to monitor the e ort exerted by a productive agent. We assume that the supervisor can misreport the collected evidence without incurring any cost. We develop a corruption-proof contract which makes it sequentially rational for the supervisor to report truthfully. Crucial features of our contract are the timing at which the report is sent and the supervisor's payment scheme. In particular, the report must be sent before the outcome observation and the principal must reward the supervisor if and only if her report maximizes the conditional probability of the realized outcome. We also highlight a non-trivial interplay between corruption incentives, the signal precision and the supervisor's risk aversion. |
| Keywords: | corruption; moral hazard; soft information; supervision; truthful reporting |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/126622&r=cta |
| By: | Georges Dionne; Nathalie Fombaron; Neil Doherty |
| Abstract: | In this survey we present some of the more significant results in the literature on adverse selection in insurance markets. Sections 1 and 2 introduce the subject and Section 3 discusses the monopoly model developed by Stiglitz (1977) for the case of single-period contracts extended by many authors to the multi-period case. The introduction of multi-period contracts raises many issues that are discussed in detail; time horizon, discounting, commitment of the parties, contract renegotiation and accidents underreporting. Section 4 covers the literature on competitive contracts. The analysis is more complicated because insurance companies must take into account competitive pressures when they set incentive contracts. As pointed out by Rothschild and Stiglitz (1976), there is not necessarily a Cournot-Nash equilibrium in the presence of adverse selection. However, market equilibrium can be sustained when principals anticipate competitive reactions to their behavior or when they adopt strategies that differ from the pure Nash strategy. Multi-period contracting is discussed. We show that different predictions on the evolution of insurer profits over time can be obtained from different assumptions concerning the sharing of information between insurers about individual's choice of contracts and accident experience. The roles of commitment and renegotiation between the parties to the contract are important. Section 5 introduces models that consider moral hazard and adverse selection simultaneously and Section 6 covers adverse selection when people can choose their risk status. Section 7 discusses many extensions to the basic models such as risk categorization, multidimensional adverse selection, symmetric imperfect information, reversed or double-sided adverse selection, principals more informed than agents, uberrima fides and participating contracts. |
| Keywords: | Adverse selection, insurance markets, monopoly, competitive contracts, self-selection mechanisms, single-period contracts, multi-period contracts, commitment, contract renegotiation, accident underreporting, risk categorization, participating contracts. |
| JEL: | D80 D81 G22 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1231&r=cta |
| By: | Yair Tauman (Department of Economics, Stony Brook University); Alex Barrachina (University of Valencia and ERI-CES.) |
| Abstract: | We analyze industrial espionage in a model of two firms: a monopoly incumbent, M, and a potential entrant, E, who owns a noisy intelligence system (IS) of a certain precision a . The IS generates a signal on M’s action and E decides whether or not to enter based on this signal. We show that if a is commonly known, M is the one who benefits from a perfect IS and E who spies on M prefers a less accurate IS. If however a is a private information of E, the opposite result is obtained. E is best off with a perfect IS and M with a less accurate one. |
| Keywords: | Espionage; Monopoly; Entry; Asymmetric information; Signaling game. |
| JEL: | C72 D82 L10 L12 |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:12-06&r=cta |
| By: | Georges Dionne; Casey G. Rothschild |
| Abstract: | Risk classification refers to the use of observable characteristics by insurers to group individuals with similar expected claims, compute the corresponding premiums, and thereby reduce asymmetric information. With perfect risk classification, premiums fully reflect the expected cost associated with each class of risk characteristics and yield efficient outcomes. In the health sector, risk classification is also subject to concerns about social equity and potential discrimination. We present an analytical framework that illustrates the potential trade-off between efficient insurance provision and social equity. We also review empirical studies on risk classification and residual asymmetric information that inform this trade-off. |
| Keywords: | Adverse selection, Classification risk, Distributional equity, Empirical test of asymmetric information, Ex-ante efficiency, Financial equity, Genetic test, Group equity, Horizontal equity, Insurance rating, Interim efficiency, Moral hazard, Risk characteristic, Risk classification, Risk pooling, Risk separation, Social equity |
| JEL: | D82 I14 I18 I38 G22 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1232&r=cta |
| By: | Tröger, Thomas; Mylovanov, Timofiy |
| Abstract: | We show that, in environments with independent private values and transferable utility, a privately informed principal can solve her mechanism selection problem by implementing an allocation that is ex-ante optimal for her. No type of the principal can gain from proposing an alternative mechanism that is incentivefeasible with any belief that puts probability 0 on types that would strictly lose from proposing the alternative. We show that the solution exists in essentially any environment with finite type spaces, and in any linear-utility environment with continuous type spaces, allowing for arbitrary disagreement outcomes. As an application, we consider a bilateral exchange environment (Myerson and Satterthwaite, 1983) in which the principal is one of the traders. If the property rights over the good are dispersed among the traders, then the principal will implement an allocation in which she is almost surely better off than if her type is commonly known. The optimal mechanism is a combination of a participation fee, a buyout option for the principal, and a resale stage with posted prices and, hence, is a generalization of the posted price that would optimal if the principal's valuation were commonly known. |
| Keywords: | mechanism design, informed principal, ex-ante optimality, buyout option |
| JEL: | D82 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:mnh:wpaper:32385&r=cta |
| By: | Alistair Wilson |
| Abstract: | I develop a novel model of group-based deliberation in which communication is costly in two directions: agents must pay separate costs to send and to receive messages. Equilibrium strategies have an intuitive characterization - those with the best information send, those with the worst information receive. But free-riding leads to less information exchange than is optimal. Testing the model`s predictions with an experiment I find that subjects overcommunicate when costs are high, but fail to benefit from this as much as they should. In welfare terms the experiment finds that listening costs are more harmful to welfare, in contrast with theory, which indicates sending costs. The experiment also suggests that the existence of costly communication channels can reduce total welfare. |
| Keywords: | Group Communication, Information transmission, Information public goods |
| JEL: | C72 C92 D83 D84 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:pit:wpaper:499&r=cta |
| By: | Pradeep Dubey (Department of Economics, Stony Brook University); Siddhartha Sah (Department of Mathematics, Rutgers University, New Brunswick, New Jersey) |
| 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. |
| JEL: | C70 C72 C79 D44 D63 D82 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:12-02&r=cta |
| By: | Ting Liu (Department of Economics, Stony Brook University); Ching-to Albert Ma (Department of Economics, Boston University) |
| Abstract: | We study delegating a consumer's treatment plan decisions to an altruistic physician. The physician?s degree of altruism is his private information. The consumer's illness severity will be learned by the physician, and also will become his private information. Treatments are discrete choices, and can be combined to form treatment plans. We distinguish between two commitment regimes. In the first, the physician can commit to treatment decisions at the time a payment contract is accepted. In the second, the physician cannot commit to treatment decisions at that time, and will wait until he learns about the patient's illness to do so. In the commitment game, the first best is implemented by a single payment contract to all types of altruistic physician. In the noncommitment game, the first best is not achieved All but the most altruistic physician earn positive profits, and treatment decisions are distorted from the first best. |
| Keywords: | Optimal contract, delegation, altruistic physician, commitment. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:12-08&r=cta |
| By: | Qingmin Liu (Department of Economics, Columbia University); George J. Mailath (Department of Economics, University of Pennsylvania); Andrew Postlewaite (Department of Economics, University of Pennsylvania); Larry Samuelson (Department of Economics, Yale University) |
| Abstract: | A large literature uses matching models to analyze markets with two-sided heterogeneity, studying problems such as the matching of students to schools, residents to hospitals, husbands to wives, and workers to firms. The analysis typically assumes that the agents have complete information, and examines core outcomes. We formulate a notion of stable outcomes in matching problems with one-sided asymmetric information. The key conceptual problem is to formulate a notion of a blocking pair that takes account of the inferences that the uninformed agent might make from the hypothesis that the current allocation is stable. We show that the set of stable outcomes is nonempty in incomplete information environments, and is a superset of the set of complete-information stable outcomes. We provide sufficient conditions for incomplete-information stable matchings to be efficient. |
| Keywords: | Matching, Stability, Stable outcome, Incomplete information, Core |
| JEL: | C71 C78 D5 D |
| Date: | 2012–08–26 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:12-032&r=cta |
| By: | David Pérez-Castrillo; David Wettstein |
| Abstract: | We study innovation contests with asymmetric information and identical contestants, where contestants' efforts and innate abilities generate inventions of varying qualities. The designer offers a reward to the contestant achieving the highest quality and receives the revenue generated by the innovation. We characterize the equilibrium behavior, outcomes and payoffs for both nondiscriminatory and discriminatory (where the reward is contestant-dependent) contests. We derive conditions under which the designer obtains a larger payoff when using a discriminatory contest and describe settings where these conditions are satisfied. |
| Keywords: | contests, auctions, innovations, discrimination |
| JEL: | O31 D44 J71 |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:654&r=cta |
| By: | Luciano Greco (University of Padova) |
| Abstract: | The economic literature on PPPs has generally overlooked agency problems within private consortia. We provide a first contribution in this direction, relying on a simple incomplete contracts framework where a Builder and an Operator set up a Special Purpose Vehicle (SPV) to carry out a contract with the government. Because of incomplete contracts, the bundling of tasks is imperfect, and the SPV ownership structure is the main tool to regulate the power of private incentives. The scope for welfare-improving PPPs reduces with respect to the case of perfect bundling, and the private negotiation always awards a suboptimal SPV-ownership share to the Builder. Thus, imposing ownership requirements in PPPs is a welfare-improving policy. |
| Keywords: | Incomplete contracts; Nash Bargaining; Ownership; Special-Purpose Vehicle. |
| JEL: | D86 L33 H11 H57 |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:pad:wpaper:0147&r=cta |
| By: | Dhillon, Amrita (University of Warwick); Iversen, Vegard (University of Manchester); Torsvik, Gaute (University of Bergen) |
| Abstract: | We study ex-post hiring risks in low income countries with limited legal and regulatory frameworks. In our theory of employee referral, the new re- cruit internalises the rewards and punishments of the in-house referee meted out by the hiring firm. This social mechanism makes it cheaper for the rm to induce worker discipline. The degree of internalization depends on the un- observed strength of the endogenous social tie between the referee and the recruit. When the referee's utility is increasing in the strength of ties, referee workplace incentives do not matter and referee and employer incentives are aligned, in this case industries and jobs with high costs of opportunism and where dense kinship networks can match the skill requirements of employers will have clusters of close family and friends, they will show a high incidence of referrals rather than anonymous hiring and will show a wage premium to referred workers matched by their higher productivity. This no longer applies if the referee's utility is decreasing in the strength of ties: referrals are then more costly for firms, they will be used less frequently by employers and will require higher referee wages (or status). We illustrate how these insights add to our understanding of South-Asian labour markets. |
| Keywords: | Efficiency wage Contracts, Moral hazard, Referee incentives, Referrals, Networks, Strength of ties, Spot market |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:cge:warwcg:89&r=cta |
| By: | Daniele Nosenzo (School of Economics, University of Nottingham); Theo Offerman (CREED, Department of Economics, University of Amsterdam); Martin Sefton (School of Economics, University of Nottingham); Ailko van der Veen (CBESS, School of Economics, University of East Anglia) |
| Abstract: | We experimentally investigate a repeated “inspection game” where, in the stage game, an employee can either work or shirk and an employer simultaneously chooses to inspect or not inspect. Combined payoffs are maximized when the employee works and the employer does not inspect. However, the unique equilibrium of the stage game is in mixed strategies with positive probabilities of shirking/inspecting. We examine the effects of allowing the employer to sanction or reward the employee after she has inspected the employee. We find that rewards or sanctions can both discourage shirking, and have similar effects on joint earnings. In games allowing sanctions a reduction in shirking is accomplished with a lower inspection rate and the efficiency gains accrue to employers. In games allowing rewards employers actively reward employees for working and the efficiency gains are shared more equitably. A treatment where employers can combine sanctions and rewards leads to efficiencies similar to the single-instrument treatments, and outcomes more closely resemble those of the reward treatment in that the efficiency gains are shared. |
| Keywords: | inspection game, costly monitoring, discretionary incentives, rewards, punishment, experiment |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:not:notcdx:2012-10&r=cta |