nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒02‒08
five papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Bidimensional Screening with Intrinsically Motivated Workers By F. Barigozzi; N. Burani
  2. Just Enough or All: Selling a Firm By Mehmet Ekmekci; Nenad Kos; Rakesh Vohra
  3. Product development capability and marketing strategy for new durable products By Sumitro Banerjee; David A. Soberman
  4. Optimal Monetary and Prudential Policies By Fabrice Collard; Harris Dellas; Behzad Diba; Olivier Loisel
  5. Imperfect Knowledge about Asset Prices and Credit Cycles By Pei Kuang

  1. By: F. Barigozzi; N. Burani
    Abstract: We study optimal contracts with bidimensional screening. A principal (a firm) needs to hire a worker to produce output. The worker has private information on her productive ability and on her intrinsic motivation, where intrinsic motivation is interpreted as the worker’s enjoyment of her personal contribution to the firm’s outcome or as a non-monetary benefit accruing to the worker when performing a certain task. We solve the discrete case with two ability levels and two degrees of motivation and completely characterize the optimal contracts. According to the magnitude of intrinsic motivation relative to ability, four different classes of fully participating and fully separating equilibria exist, which always dominate equilibria with some pooling and/or exclusion. We prove that truthful revelation is less distorsive when the difference in ability is higher than the difference in motivation, but the latter is sufficiently high.
    JEL: D82 D86 J31 M55
    Date: 2013–02
  2. By: Mehmet Ekmekci; Nenad Kos; Rakesh Vohra
    Abstract: We consider the problem of selling a firm to a single buyer. The magnitude of the post-sale cash flow rights (v) as well as the benefits of control (b) are the buyer’s private information. In contrast to research that assumes the private information of the buyer is one-dimensional, the optimal mechanism is a menu of tuples of cashequity mixtures. We provide sufficient conditions on the joint distribution of v and b such that the optimal mechanism takes one of the following forms: i) a take-it or leave-it offer for the smallest fraction of the company that facilitates the transfer of control, or ii) a take-it or leave-it offer for all the shares of the company. We also identify a sufficient condition for the seller to extract the full value, v, per share so that the buyer earns information rents only on the private benefits of control. JEL Code: D82, D86. Keywords: Multidimensional mechanism design, negotiated block trades, private benefits, privatization, takeovers, bilateral trade, asymmetric information, cashequity offers.
    Date: 2013
  3. By: Sumitro Banerjee (ESMT European School of Management and Technology); David A. Soberman (Rotman School of Management, University of Toronto)
    Abstract: Our objective is to understand how a firm’s product development capability (PDC) affects the launch strategy for a durable product that is sequentially improved over time in a market where consumers have heterogeneous valuations for quality. We show that the launch strategy of firms is affected by the degree to which consumers think ahead. However, only the strategy of firms with high PDC is affected by the observability of quality. When consumers are myopic and quality is observable, both high and low PDC firms use price skimming and restrict sales of the first generation to consumers with high willingness to pay (WTP). A high PDC firm, however, sells the second generation broadly while a low PDC firm only sells the second generation to consumers with low WTP. When consumers are myopic and quality is unobservable, a firm with high PDC signals its quality by offering a low price for the first generation, which results in broad selling. The price of the second generation is set such that only high WTP consumers buy. A firm with low PDC will not mimic this strategy. If a low PDC firm sells the first generation broadly, it cannot discriminate between the high and low WTP consumers. When consumers are forward looking, a firm with high PDC sells the first generation broadly. This mitigates the “Coase problem” created by consumers thinking ahead. It then sells the second generation product only to the high WTP consumers. In contrast, a firm with low PDC does the opposite. It only sells the first generation to high WTP consumers and the second generation broadly.
    Keywords: product development, marketing strategy, durable goods, quality, signaling game
    Date: 2013–01–28
  4. By: Fabrice Collard (University of Bern); Harris Dellas (University of Bern); Behzad Diba (Georgetown University); Olivier Loisel (CREST(ENSAE))
    Abstract: The recent financial crisis has highlighted the interconnectedness between macroeconomic and financial stability and has raised the question of whether and how to combine the corresponding main policy instruments (interest rate and bank-capital requirements). This paper offers a characterization of the jointly optimal setting of monetary and prudential policies and discusses its implications for the business cycle. The source of financial fragility is the socially excessive risk-taking by banks due to limited liability and deposit insurance. We characterize the conditions under which locally optimal (Ramsey) policy dedicates the prudential instrument to preventing inefficient risk-taking by banks; and the monetary instrument to dealing with the business cycle, with the two instruments co-varying negatively. Our analysis thus identifies circumstances that can validate the prevailing view among central bankers that standard interest-rate policy cannot serve as the first line of defense against financial instability. In addition, we also provide conditions under which the two instruments might optimally co-move positively and countercyclically.
    Keywords: Prudential policy, Capital requirements, Monetary policy, Ramsey-optimal policies
    JEL: E32 E44 E52
    Date: 2012–12
  5. By: Pei Kuang
    Abstract: I develop an equilibrium model with collateral constraints in which rational agents are uncertain and learn about the equilibrium mapping between fundamentals and collateral prices. Bayesian updating of beliefs by agents can endogenously generate booms and busts in collateral prices and largely strengthen the role of colateral constraints as an amplification mechanism through the interaction of agents' beliefs, collateral prices and credit limits. Over-optimism or pessimism is fueled when a surprise in price expectations is interpreted partially by the agents as a permanent change in the parameters governing the collateral price process and is validated by subsequently realized prices. I show that the model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. I also demonstrate that the leveraged economy with a higher steady state leverage ratio is more prone to self-reinforcing learning dynamics.
    Keywords: Booms and Busts, Collateral Constraints, Learning, Leverage
    JEL: D83 D84 E32 E44
    Date: 2013–01

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