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on Contract Theory and Applications |
| By: | Artashes Karapetyan (Norges Bank (Central Bank of Norway)); Bogdan Stacescu (BI Norwegian Business School,) |
| Abstract: | Information sharing and collateral reduce adverse selection costs, but are costly for lenders. When a bank learns more about the types of its rival's borrowers through information sharing (e.g., credit bureaus), it might seem that this information should substitute the role of collateral in screening their types. We instead show that information sharing may increase, rather than decrease, the role of collateral, which can be required in loans to high-risk borrowers in cases when it is not in the absence of information sharing. We extend to show that ex ante screening can substitute both collateral and information sharing. |
| Keywords: | Bank competition, Information sharing, Collateral |
| JEL: | G21 L13 |
| Date: | 2012–12–18 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2012_19&r=cta |
| By: | Asaf Manela (Washington University in St. Louis); Zhiguo He (University of Chicago) |
| Abstract: | We study the endogenous information acquisition and withdrawal-redeposit decisions of individual agents when a liquidity event triggers a spreading rumor and therefore exposes a bank to a run. Uncertainty about the bank's liquidity and potential failure motivates agents who hear the rumor to acquire additional information, and in equilibrium depositors with unfavorable information run on the bank gradually. Although the bank run equilibrium is unique given the additional signal's quality, multiple equilibria emerge with endogenous information acquisition. A bank run equilibrium exists when agents aggressively acquire information. We study the threshold parameters that eliminate bank runs. Public provision of solvency information (e.g. stress tests) can eliminate bank runs by indirectly crowding-out individual depositors' effort to acquire liquidity information. However, providing too much information that slightly differentiates competing solvent-but-illiquid banks can result in inefficient runs. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:170&r=cta |
| By: | Jianfeng Yu (University of Minnesota); Bin Wei (Federal Reserve Board); Zhiguo He (University of Chicago, Booth School of Business) |
| Abstract: | This paper introduces profitability uncertainty into an infinite-horizon variation of the classic Holmstrom and Milgrom (1987) model, and studies optimal dynamic contracting with endogenous learning. The agent's potential belief manipulation leads to the hidden information problem, which makes incentive provisions intertemporally linked in the optimal contract. We reduce the contracting problem into a dynamic programming problem with one state variable, and characterize the optimal contract with an ordinary differential equation. In the benchmark case of Holmstrom and Milgrom (1987) without learning, the optimal effort is constant, and the optimal contract is linear. In contrast, in our model with endogenous learning, the optimal effort policy becomes history dependent, and decreases over time on average. Moreover, we show that the optimal contract exhibits an option-like feature in that the incentives rise after good performance shocks. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:221&r=cta |
| By: | Mikel Berdud (Departamento de Economía-UPNA); Juan M. Cabasés (Departamento de Economía-UPNA); Jorge Nieto (Departamento de Economía-UPNA) |
| Abstract: | This paper explores optimality of contracts and incentives when the principal (public organisation) can undertake investments to change agents’ (public workers) identity. In the model, workers within the organisation can have different identities. We develop a principal-agent dynamical model with moral hazard, which captures the possibility of affecting this workers’ identity through contracts offered by the firm. In the model, identity is a motivation source which reduces agents’ isutility from effort. We use the term identity to refer to a situation in which the worker shares the organisational objectives and views herself as a part of the organisation. Contrary, we use the term conflict to refer to a ituation in which workers behave self-interested and frequently in the opposite way of the organisation. We assume that identity can be achieved when principal include mission-sense developing investments in contracts. By mission we mean a single culture that is shared by all the members of an organization. We discuss the conditions under which spending resources in changing workers’ identity and invest in this kind of motivational capital is optimal for organisations. Our results may help to inform public firms’ managers about the optimal design of incentive schemes and policies. For instance, we conclude that investing in motivational capital is the best option in the long run whereas pure monetary incentives works better in the short run. |
| Keywords: | contracts, moral hazard, identity, socialization, mission, motivational capital. |
| JEL: | D03 D86 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:nav:ecupna:1214&r=cta |
| By: | Jenny Kragl (Department of Governance &Economics, EBS University für Wirtschaft und Recht Wiesbaden, Germany); Anja Schöttner (Department of Economics, University of Konstanz, Germany) |
| Abstract: | We analyze the effects of wage floors on optimal job design in a moral-hazard model with asymmetric tasks and imperfect aggregate performance measurement. Due to cost advantages of specialization, assigning the tasks to different agents is efficient. A sufficiently high wage floor, however, induces the principal to dismiss one agent or to even exclude tasks from the production process. Imperfect performance measurement always lowers profit under multitasking, but may increase profit under specialization. We further show that variations in the wage floor and the agents' reservation utility have significantly different effects on welfare and optimal job design. |
| Keywords: | Job Design, Limited Liability, Minimum Wage, Moral Hazard, Multitasking, Performance Measurement |
| JEL: | M51 M52 M54 D82 D86 |
| Date: | 2012–12–14 |
| URL: | http://d.repec.org/n?u=RePEc:knz:dpteco:1236&r=cta |
| By: | Stefania Albanesi (Federal Reserve Bank of New York) |
| Abstract: | This paper examines optimal taxation of capital and labor income in a dynamic model with occupational choice. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:213&r=cta |
| By: | Bijlsma, M.; Boone, J.; Zwart, G. (Tilburg University, Tilburg Law and Economics Center) |
| Abstract: | Abstract: The financial crisis has been attributed partly to perverse incentives for traders at banks and has led policy makers to propose regulation of banks’ remuneration packages. We explain why poor incentives for traders cannot be fully resolved by only regulating the bank’s top executives, and why direct intervention in trader compensation is called for. We present a model with both trader moral hazard and adverse selection on trader abilities. We demonstrate that as competition on the labour market for traders intensifies, banks optimally offer top traders contracts inducing them to take more risk, even if banks fully internalize the costs of negative outcomes. In this way, banks can reduce the surplus they have to offer to lower ability traders. In addition, we find that increasing banks’ capital requirements does not unambiguously lead to reduced risk-taking by their top traders. |
| Keywords: | optimal contracts;remuneration policy;imperfect competition;financial institutions;risk. |
| JEL: | G21 G32 L22 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubtil:2012003&r=cta |
| By: | Zara Sharif (Erasmus University Rotterdam); Otto H. Swank (Erasmus University Rotterdam) |
| Abstract: | Decisions-makers often rely on information supplied by interested parties. In practice, some parties have easier access to information than other parties. In this light, we examine whether more powerful parties have a disproportionate influence on decisions. We show that more powerful parties influence decisions with higher probability. However, in expected terms, decisions do not depend on the relative strength of interested parties. When parties have not provided information, decisions are biased towards the less powerful parties. Finally, we show that compelling parties to supply information destroys incentives to collect information. |
| Keywords: | information collection; communication; interest groups; decision-making |
| JEL: | D72 D78 D82 H39 |
| Date: | 2012–12–05 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20120134&r=cta |
| By: | Artashes Karapetyan (Norges Bank (Central Bank of Norway)); Bogdan Stacescu (BI Norwegian Business School,) |
| Abstract: | Lending is often associated with significant asymmetric information issues between suppliers of funds and their potential borrowers. Banks can screen their borrowers, or can require them to post collateral in order to select creditworthy projects. We find that the potential for longer-term relationships increases banks' preference for screening. This is because posting collateral only provides the information that the current project of a given borrower is of good quality, whereas screening provides information that can be used in evaluating future projects as well as the current ones. |
| Keywords: | Collateral, Screening, Bank relationships |
| JEL: | G21 L13 |
| Date: | 2012–12–18 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2012_18&r=cta |
| By: | Rosa-Branca Esteves (Universidade do Minho - NIPE) |
| Abstract: | This paper investigates the competitive and welfare effects of information accuracy improvements in markets where firms can price discriminate after observing a private and noisy signal about a consumer’s brand preference. It shows that firms charge more to customers they believe have a brand preference for them, and that this price has an inverted-U shaped relationship with the signal’s accuracy. In contrast, the price charged after a disloyal signal has been observed falls as the signal’s accuracy rises. While industry profit and overall welfare fall monotonically as price discrimination is based on increasingly more accurate information, the reverse happens to consumer surplus. |
| Keywords: | Competitive Price Discrimination, Imperfect Customer Recognition, Imperfect Information |
| JEL: | D43 D80 L13 L40 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:12/2012&r=cta |
| By: | Itay Goldstein (University of Pennsylvania); Philip Bond (University of Minnesota) |
| Abstract: | Market prices are thought to contain a lot of useful information. Hence, government regulators (and other economic agents) are often urged to use market prices to guide decisions. An important issue to consider is the endogeneity of market prices and how they are affected by the prospect of government intervention. We show that if the government learns from the price when taking a corrective action, it might reduce the incentives of speculators to trade on their information, and hence reduce price informativeness. We show that transparency may reduce trading incentives and price informativeness further. Diametrically opposite implications hold for the alternative case in which the government's action amplifies the effect of underlying fundamentals. We derive implications for the optimal use of market information and for the government's incentives to produce its own information |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:225&r=cta |
| By: | Braz Camargo; Elena Pastorino |
| Abstract: | We analyze commitment to employment in an environment in which an infinitely lived firm faces a sequence of finitely lived workers who differ in their ability to produce output. The ability of a worker is initially unknown to both the worker and the firm, and a worker's effort affects the information on ability that is conveyed by performance. We characterize equilibria and show that they display commitment to employment only when effort has a persistent but delayed impact on output. In this case, by providing insurance against early termination, commitment encourages workers to exert effort, thus improving the firm's ability to identify their talent. We argue that the incentive value of commitment to retention helps explain the use of fixed probationary appointments in environments in which there exists uncertainty about ability. |
| Keywords: | Employment |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:475&r=cta |
| By: | Ansgar Rannenberg (Macroeconomic Policy Institute) |
| Abstract: | I add a moral hazard problem between banks and depositors as in Gertler and Karadi (2009) to a DSGE model with a costly state verification problem between entrepreneurs and banks as in Bernanke et al. (1999) (BGG). This modification amplifies the response of the external finance premium and the overall economy to monetary policy and productivity shocks. It allows my 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 combination of balance sheet shocks produces a downturn of a magnitude similar to the "Great Recession". JEL Classification: E44, E43, E32 |
| Keywords: | Leverage cycle, bank capital, financial accelerator, output effects of financial shock |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20121487&r=cta |
| By: | Giuseppe Coco (Università degli studi di Firenze); David De Meza (London School of Economics); Giuseppe Pignataro (Università degli studi di Bologna); Francesco Reito (Università degli studi di Catania) |
| Abstract: | Can a bank increase its profi t by subsidizing inactivity? This paper suggests this may occur, due to the presence of hidden information, in a monopolistic credit market. Rather than offering credit in a pooling contract, a monopolist bank can sort borrowers through an appropriate subsidy to inactivity. Under some conditions, sorting may avoid the collapse of the market and increases the welfare of everybody. The bank increases its profi ts, good borrowers bene fit from lower interest rates and bad potential borrowers from the subsidy. The subsidy policy however implies a cross subsidy between contracts and this is possible only under monopoly. |
| Keywords: | Credit market, Screening, Subsidy |
| JEL: | D60 D82 H71 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:frz:wpaper:wp2012_27.rdf&r=cta |
| By: | Loisel, O.; Pommeret, A.; Portier, T. |
| Abstract: | We study the role of monetary policy when asset-price bubbles may form due to herd behavior in investment in an asset whose return is uncertain. To that aim, we build a simple general-equilibrium model whose agents are households, entrepreneurs, and a central bank. Entrepreneurs receive private signals about the productivity of the new technology and borrow from households to publicly invest in the old or the new technology. The three main results of the paper are that bubbles (informational cascades) can occur in this general equilibrium setting; that the central bank can detect them even though it has directly access to less information than the investors; and that the central bank can eliminate bubbles by manipulating the interest rate. Indeed, monetary policy, by affecting the investors' cost of resources, can make them invest in the new technology if and only if they receive an encouraging private signal about its productivity. In doing so, it makes their investment decision reveal their private signal, and therefore prevents herd behavior and the asset-price bubble. We also show that such a “leaning against the wind" monetary policy, contingent on the central bank's information set, may be preferable to laisser-faire, in terms of ex ante welfare. |
| Keywords: | Monetary Policy – Asset Prices – Informational Cascades – Bubbles. |
| JEL: | E52 E32 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:412&r=cta |
| By: | Matthes, Christian; Rondina, Francesca |
| Abstract: | This paper investigates the role of learning by both private agents and the central bank (two-sided learning) in a New Keynesian framework populated by private agents and a central bank that have asymmetric imperfect knowledge about the true data generating process. We assume that all agents employ the data they observe (which can be different for different sets of agents) to form beliefs about the aspects of the true model of the economy that they do not know, use these beliefs to decide on actions, and revise beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of the model and policy recommendations coming out of our model, in particular concerning central bank communication. Two-sided learning can generate large increases in volatility and persistence, and can alter the behavior of the variables in the model in a significant way. We also show that our model does not converge to a symmetric rational expectations equilibrium and highlight one source that disables the convergence results of Marcet & Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank’ model is substantially misspecified. |
| Date: | 2012–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:019&r=cta |
| By: | Stephen Williamson (Washington University in St. Louis); Francesca Carapella (Board of Governors of the Federal Reserv) |
| Abstract: | A model of credit and government debt with limited commitment is constructed, building on a Lagos-Wright construct. In the baseline equilibrium, global punishments support an efficient equilibrium in which government debt is neutral - there is Ricardian equivalence. In a symmetric equilibrium with individual punishments, trade in government debt essentially always serves to increase welfare by altering the incentive to default. In asymmetric equilibria, all borrowers are fundamentally identical, but some default in equilibrium, there is an adverse selection problem in a segment of the credit market, and good borrowers pay a default premium. Government debt, in addition to altering the incentive to default, serves to mitigate the adverse selection problem. Thus, government debt relaxes incentive constraints, working through an endogenous collateral effect. The model highlights the role of government debt in helping to solve the problem of a self-fulfilling breakdown in credit markets. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:226&r=cta |
| By: | Aspen Gorry (UC, Santa Cruz) |
| Abstract: | This paper studies a labor market where workers have incomplete information about the quality of their employment match. The model allows past experience to provide information about the quality of a new match. Allowing workers to learn from past job experience generates a decline in job ï¬Ânding and job separation rates with age that is consistent with patterns found in the data. To provide evidence of this learning mechanism, the model generates a prediction that wage volatility on a new job should decline with past job experience. This decline in wage volatility is documented in data from NLSY79. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:154&r=cta |
| By: | Nolan Miller; Alexander F. Wagner; Richard J. Zeckhauser |
| Abstract: | A principal provides budgets to agents (e.g., divisions of a firm or the principal's children) whose expenditures provide her benefits, either materially or because of altruism. Only agents know their potential to generate benefits. We prove that if the more "productive" agents are also more risk-tolerant (as holds in the sample of individuals we surveyed), the principal can screen agents and bolster target efficiency by offering a choice between a nonrandom budget and a two-outcome risky budget. When, at very low allocations, the ratio of the more risk-averse type's marginal utility to that of the other type is unbounded above (e.g., as with CRRA), the first-best is approached. -- A biblical opening enlivens the analysis. |
| JEL: | D82 G31 H12 |
| Date: | 2012–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18634&r=cta |
| By: | Wilfredo L. Maldonado; José A. Rodrigues-Neto |
| Abstract: | We analyze a static game of public good contributions where finitely many anonymous players have heterogeneous preferences about the public good and heterogeneous beliefs about the distribution of preferences. In the unique symmetric equilibrium, the only individuals who make positive contributions are those who most value the public good and who are also the most pessimistic; that is, according to their beliefs, the proportion of players who value the most the public good is smaller than it would be according to any other possible belief. We predict whether the aggregate contribution is larger or smaller than it would be in an analogous game with complete information (and heterogeneous preferences), by comparing the beliefs of contributors with the true distribution of preferences. A tradeoff between preferences and beliefs arises if there is no individual who simultaneously has the highest preference type and the most pessimistic belief. In this case, there is a symmetric equilibrium, and multiple symmetric equilibria occur only if there are more than two preference types. |
| JEL: | C72 H41 |
| Date: | 2012–12 |
| URL: | http://d.repec.org/n?u=RePEc:acb:cbeeco:2012-599&r=cta |
| By: | Roger Myerson (University of Chicago) |
| Abstract: | We consider a simple overlapping-generations model with risk-averse financial agents subject to moral hazard. Efficient contracts for such financial intermediaries involve back-loaded late-career rewards. Compared to the analogous model with risk-neutral agents, risk aversion tends to reduce the growth of agents' responsibilities over their careers. This moderation of career growth rates can reduce the amplitude of the widest credit cycles, but it also can cause small deviations from steady state to amplify over time in rational-expectations equilibria. We find equilibria in which fluctuations increase until the economy enters a boom/bust cycle where no financial agents are hired in booms. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:182&r=cta |
| By: | Stefan Arping (University of Amsterdam) |
| Abstract: | In imperfectly competitive credit markets, banks can face a tradeoff between exploiting their market power and enforcing hard budget constraints. As market power rises, banks eventually find it too costly to discipline underperforming borrowers by stopping their projects. Lending relationships become "too cozy", interest rates rise, and loan performance deteriorates. |
| Keywords: | Banking Competition; Soft Budget Constraint Problem; Moral Hazard |
| JEL: | G2 G3 |
| Date: | 2012–12–20 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20120146&r=cta |
| By: | Butler, Jeffrey (Einaudi Institute for Economics and Finance); Carbone, Enrica (University of Naples "SUN"); Conzo, Pierluigi (University of Turin, Department of Economics); Spagnolo, Giancarlo (Stockholm Institute of Transition Economics) |
| Abstract: | This paper reports results from a laboratory experiment exploring the relationship between reputation and entry in procurement. There is widespread concern among regulators that favoring suppliers with good past performance, a standard practice in private procurement, may hinder entry by new (smaller or foreign) firms in public procurement markets. Our results suggest that while some reputational mechanisms indeed reduce the frequency of entry, so that the concern is warranted, appropriately designed reputation mechanisms actually stimulate entry. Since quality increases but not prices, our data also suggest that the introduction of reputation may generate large welfare gains for the buyer. |
| Keywords: | Entry; Feedback mechanisms; Governance; Incomplete contracts; Limited enforcement; Incumbency; Multidimensional competition; Participation; Past performance; Procurement; Quality; Reputation; Vendor rating |
| JEL: | H57 L14 L15 |
| Date: | 2012–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:hasite:0021&r=cta |