nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒01‒19
thirteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Observability of information gathering in agency models By Hoppe, Eva I.
  2. Information in Hierarchies By Kouroche Vafaï
  3. Take the money and run: making profits by paying borrowers to stay home By G. Coco; D. De Meza; G. Pignataro; F. Reito
  4. Incomplete Information in Cournot Oligopoly: The Case of Unknown Production Capacities By Richter, Jan
  5. Solomonic Separation: Risk Decisions as Productivity Indicators By Miller, Nolan; Wagner, Alexander F.; Zeckhauser, Richard J.
  6. Building Reputation for Contract Renewal: Implications for Performance Dynamics and Contract Duration By Iossa, Elisabetta; Rey, Patrick
  7. Sales Talk, Cancellation Terms, and the Role of Consumer Protection By Roman Inderst; Marco Ottaviani
  8. Supervision in Firms By Kouroche Vafaï
  9. Promotion Signals, Age and Education By Michael Bognanno; Eduardo Melero
  10. From tax evasion to tax planning By Arnaud Bourgain; Patrice Pieretti; Skerdilajda Zanaj
  11. Trading and Information Diffusion in Over-the-Counter Markets By Ana Babus; Péter Kondor
  12. Contractive Dual Methods for Incentive Problems By Matthias Messner; Nicola Pavoni; Christopher Sleet
  13. Credit and Insurance for Human Capital Investments By Alexander Monge; Lance Lochner

  1. By: Hoppe, Eva I.
    Abstract: We consider an adverse selection model in which the agent can gather private information before the principal offers the contract. There are two scenarios. In scenario I, information gathering is a hidden action, while in scenario II, the principal observes the agent's information gathering decision. We study how the two scenarios differ with respect to the agent's expected rent, the principal's expected profit, and the expected total surplus. In particular, it turns out that the principal may be better off when the agent's information gathering decision is a hidden action.
    Keywords: Hidden information; adverse selection; information gathering
    JEL: D86 D82 C72
    Date: 2013–01
  2. By: Kouroche Vafaï (Université Paris Descartes - Sorbonne Paris Cité - IUT, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne)
    Abstract: We determine the optimal policy to cope with information concealment in a hierarchy where a principal relies on a supervisor to obtain verifiable information about an agent's output. Depending on the information he has obtained, the informed supervisor may either collude with the agent or with the principal and conceal information. The principal has the choice of four policies to cope with information concealment : it can prevent both types of information concealment, allow both of them, or prevent one of them and allow the other one. We characterize the incentive contracts in this environment and show that it is not optimal to allow information concealment, that is, the optimal policy of a hierarchy exposed to multiple types of information concealment is to prevent them all.
    Keywords: Hierarchy; information concealment
    Date: 2012–12
  3. By: G. Coco; D. De Meza; G. Pignataro; F. Reito
    Abstract: Can a bank increase its profit 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 profits, good borrowers benefit 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.
    JEL: D60 D82 H71
    Date: 2013–01
  4. By: Richter, Jan (Energiewirtschaftliches Institut an der Universitaet zu Koeln)
    Abstract: A Cournot oligopoly in which firms face incomplete information with respect to production capacities is studied. For the case where the firms’ capacities are stochastically independent, the functional form of equilibrium strategies is derived. If inverse demand is concave, a unique symmetric equilibrium exists, and if demand is linear, then every equilibrium is symmetric. In the case of duopoly, the impact on social welfare when firms commit ex-ante on exchanging information is analyzed. Sharing information increases expected output and social welfare in a large class of models. If the demand intercept is sufficiently large, sharing information increases producer surplus and decreases consumer surplus (and vice versa).
    Keywords: Oligopoly; Incomplete Information; Cournot; Capacity Constraints; Information Sharing
    JEL: C72 D43 L13
    Date: 2013–01–10
  5. By: Miller, Nolan (University of IL); Wagner, Alexander F. (University of Zurich); Zeckhauser, Richard J. (Harvard University)
    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
    Date: 2012–11
  6. By: Iossa, Elisabetta (DEF, University of Rome Tor Vergata, CEPR, CMPO and EIEF); Rey, Patrick (TSE,IDEI)
    Abstract: We study how career concerns affect the dynamics of incentives in a multi-period contract, when the agent’s productivity can evolve exogenously (random shocks) or improve endogenously through investment. We show that incentives are stronger and performance is higher when the contract approaches its expiry date. Contrary to common wisdom, long-term contracts may strengthen reputational effects whereas short-term contracting may be optimal when investment has persistent, long-term effects.
    Keywords: Career concerns, contract duration,contract renewal, reputation and dynamic incentives.
    Date: 2012–11
  7. By: Roman Inderst; Marco Ottaviani
    Abstract: This paper analyses contract cancellation and product return policies in markets in which sellers advise customers about the suitability of their offering. When customers are fully rational, it is optimal for sellers to offer the right to cancel or return on favorable terms. A generous return policy makes the seller's "cheap talk" at the point of sale credible. This observation provides a possible explanation for the excess refund puzzle and also has implications for the management of customer reviews. When customers are credulous, instead, sellers have an incentive to set unfavorable terms to exploit the inflated beliefs they induce in their customers. The imposition of a minimum statutory standard improves welfare and consumer surplus when customers are credulous. In contrast, competition policy reduces contractual inefficiencies with rational customers, but it is not effective with credulous customers. Keywords: Cheap talk, advice, marketing, credulity, contract cancellation, refund, return policy, consumer protection. JEL Classi?cation: D18 (Consumer Protection), D83 (Search; Learning; Information and Knowledge), L15 (Information and Product Quality), L51 (Economics of Regulation).
    Date: 2012
  8. By: Kouroche Vafaï (Université Paris Descartes - Sorbonne Paris Cité - IUT, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne)
    Abstract: To control, evaluate, and motivate their agents, firms employ supervisors. As shown by empirical investigations, biased evaluation by supervisors linked to collusion is a persistent feature of firms. This paper studies how deceptive supervision affects agency relationships. We consider a three-level firm where a supervisor is in charge of producing a verifiable report on an agent's output. Depending on the output he has observed, the supervisor may either collude with the agent or with the principal, and make an uniformative report. We show that the proliferation of collusive activities in firms : modifies the configuration of the optimal preventive policy, may increase the expected cost of preventing each type collusion, is beneficial to the supervisor and detrimental to the agent, and is not always harmful.
    Keywords: Firm; group decision; control; biased supervision
    Date: 2012–12
  9. By: Michael Bognanno (Department of Economics, Temple University); Eduardo Melero (Department of Business Administration, Universidad Carlos III de Madrid)
    Abstract: This paper examines whether more informative job promotions carry larger wage increases. In job assignment models with asymmetric information, unexpected promotions send a signal to the external labor market to revise upward their assessment of a worker’s ability. The employing firm must then increase wages to prevent the worker from being bid away. Less educated workers are assumed to come from a group with lower average ability. Their promotion is hypothesized to signal a larger positive assessment of their ability than for more highly educated workers for whom promotion is expected. Promotions for younger workers, with less known about their abilities, should also result in strong signaling effects. We find results in accordance with our hypotheses regarding the effect of both age and education on the gains to promotion. However, the statistical significance of the estimates hinges on the promotion definition. Younger workers receive statistically significantly higher wage increases upon promotion only when promotion is defined by the attainment of managerial responsibilities not previously held. Less educated workers obtain statistically significantly larger wage increases upon promotion at a weak level of significance (10%) across definitions of promotion but at a high level of significance (5%) only when the subjective definition of promotion is used. We interpret the sensitivity to the definition of promotion to suggest that promotions may be heterogeneous in the information they reveal about the employee in way that depends on the characteristics of the employee.
    Keywords: promotion, signaling, internal labor markets
    JEL: J3
    Date: 2012–11
  10. By: Arnaud Bourgain (CREA, University of Luxembourg); Patrice Pieretti (CREA, University of Luxembourg); Skerdilajda Zanaj (CREA, University of Luxembourg)
    Abstract: The aim of this paper is to analyze within a simple model how a re- moval of bank secrecy can impact tax revenues and banks' profitability assuming that offshore centers are able to offer sophisticated but legal or not easily detectable tax planning. Two alternative regimes are considered. A first in which there is strict bank secrecy and a second where there is international information exchange for tax purposes. We show in particular that sharing tax information with onshore coun- tries can be a dominant strategy for an OFC if there is enough scope for providing tax planning. Moreover, a partial reduction of tax lia- bilities can already prompt OFCs to voluntarily exchange relevant tax information. We also highlight a surprising result. The possible re- moval of bank secrecy may, under some conditions, reduce the onshore country's tax revenue.
    Keywords: offshore centers, tax planning, tax evasion
    JEL: F21 H26 H87
    Date: 2012
  11. By: Ana Babus; Péter Kondor
    Abstract: We model trading and information diffusion in OTC markets, when dealers can engage in many bilateral transactions at the same time. We show that information diffusion is effective, but not efficient. While each bilateral price partially reveals all dealers' private information after a single round of trading, dealers could learn more even within the constraints imposed by our environment. This is not a result of dealers' market power, but arises from the interaction between decentralization and differences in dealers' valuation of the asset. We apply our framework to confront several explanations for the disruption of OTC markets with stylized facts from the empirical literature. We find more support for narratives emphasizing increased counterparty risk as opposed to increased informational frictions.
    Date: 2012–08–31
  12. By: Matthias Messner; Nicola Pavoni; Christopher Sleet
    Abstract: Several recent papers have proposed recursive Lagrangian-basedmethods for solving dynamic contracting problems. Thesemethods give rise to Bellman operators that incorporate either a dual inf-sup or a saddle point operation. We give conditions that ensure the Bellman operator implied by a dual recursive formulation is contractive. JEL codes: C61, C73, D82, E61. Keywords: Dynamic Contracts, Duality, Dynamic Programming, Contraction Mapping Theorem.
    Date: 2012
  13. By: Alexander Monge (Penn State University); Lance Lochner (University of Western Ontario)
    Abstract: Student loan debt in the US stands at roughly $1 trillion, exceeding credit card debt. In recent years, private lending for undergraduates has skyrocketed to account for roughly 20% of all student loan dollars disbursed. At the same time, youth from low-income families are significantly less likely to attend college relative to their higher-income counterparts. This paper examines the nature of credit for education in the presence of uncertainty and problems of limited commitment by borrowers, moral hazard, and adverse selection. Efficient lending contracts, combined with insurance against adverse labor market outcomes, are considered in a variety of economic environments. We examine the importance of different incentive problems in US data to aid in the design of improved credit and insurance for human capital investment.
    Date: 2012

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