nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒06‒09
fifteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. The value of information disclosure under local learning. The case of fixed types. By Ottorino Chillemi; Benedetto Gui; Lorenzo Rocco
  2. Incentive Contracts and Efficient Unemployment Benefits in a Globalized World By Carsten Helm; Dominique Demougin
  3. Market-based incentives By Borys Grochulski; Yuzhe Zhang
  4. Motivating Knowledge Agents: Can Incentive Pat Overcome Social Distance? By Erlend Berg; Maitreesh Ghatak; R. Manjula; D. Rajasekhar; Sanchari Roy
  5. Incomplete Information Models of Guilt Aversion in the Trust Game By Giuseppe Attanasi; Pierpaolo Battigalli; Elena Manzoni
  6. Fishing for excuses and performance evaluation By François Larmande; Jean-Pierre Ponssard
  7. Investments in Quality, Collective Reputation and Information Acquisition By Fulvio Fontini; Katrin Millock; Michele Moretto
  8. Strike, coordination, and dismissal in uniform wage settings By Karina Gose; Abdolkarim Sadrieh
  9. Credit ratings and bank monitoring ability By Leonard I. Nakamura; Kasper Roszbach.
  10. Endogenous vs. Exogenous Transmission of Information: An Experiment By Aurora García-Gallego; Penélope Hernández-Rojas; Amalia Rodrigo-González
  11. School Accountability: Can We Reward Schools and Avoid Pupil Selection? By Ooghe, Erwin; Schokkaert, Erik
  12. Strategic Complementarity, Fragility, and Regulation By Xavier Vives
  13. Credit Lines as Monitored Liquidity Insurance: Theory and Evidence By Heitor Almeida; Filippo Ippolito; Ander Perez; Viral Acharya
  14. The Menu-Size Complexity of Auctions By Sergiu Hart; Noam Nisan
  15. Learning Through Referrals By Manolis Galenianos

  1. By: Ottorino Chillemi (University of Padova); Benedetto Gui (University of Padova); Lorenzo Rocco (University of Padova)
    Abstract: A large population plays a two-period sequential common agency game. Agents are long lived, while principals are short lived. Preferences and technology are additively separable in time and time independent. At the onset, agents are matched in pairs under private information of individual types. At the end of the first period, in each pair the principal can disclose membersÕ reports, in which case members remain together in the second period, or conceal information, in which case members are randomly rematched and in the second period their type remains private information. We show that an equilibrium exists in which information disclosure is efficiency enhancing. Remarkably, information disclosure would have zero value if reassembling agent pairs was not an option, as in the standard one agency literature.
    Date: 2013–05
  2. By: Carsten Helm (University of Oldenburg); Dominique Demougin (European Business School at the EBS University, Wiesbaden)
    Abstract: Several European countries have reformed their labor market institutions. Incentive effects of unemployment benefits have been an important aspect of these reforms. We analyse this issue in a principal-agent model, higher level of unemployment benefits improves the workers' position in wage bargaining, leading to stronger effort incentives and higher output. However, it also reduces incentives for labor market participation. Accordingly, there is a trade-off. We analyze how changes in the economic environment such as globalization and better educated workers affect this trade-off.
    Keywords: Unemployment benefits, incentive contracts, Nash bargaining, moral hazard, globalization
    JEL: J65 D82 J41 E24
    Date: 2012–08
  3. By: Borys Grochulski; Yuzhe Zhang
    Abstract: We study optimal incentives in a principal-agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent's quitting forces the principal to give the agent a raise. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives, like bonuses. In fact, whenever the agent's option to quit is close to being "in the money," the market-induced incentive completely eliminates the need for standard incentives.
    Keywords: Labor market
    Date: 2013
  4. By: Erlend Berg; Maitreesh Ghatak; R. Manjula; D. Rajasekhar; Sanchari Roy
    Abstract: This paper studies the interaction of incentive pay and social distance in the dissemination of information.  We analyse theoretically as well as empirically the effect of incentive pay when agents have pro-social objectives, but also preferences over dealing with one social group relative to another.  In a randomised field experiment undertaken across 151 villages in South India, local agents were hired to spread information about a public health insurance programme.  Relative to flat pay, incentive pay improves knowledge transmission to households that are socially distant from the agent, but not to households similar to the agent.
    Keywords: Public services, information constraints, incentive pay, social proximity, knowledge transmission
    Date: 2013–03–29
  5. By: Giuseppe Attanasi; Pierpaolo Battigalli; Elena Manzoni
    Abstract: In the theory of psychological games it is assumed that players' preferences on material consequences depend on endogenous beliefs. Most of the applications of this theoretical framework assume that the psychological utility functions representing such preferences are common knowledge. But this is often unrealistic. In particular, it cannot be true in experimental games where players are subjects drawn at random from a population. Therefore an incomplete-information methodology is called for. We take a first step in this direction, focusing on models of guilt aversion in the Trust Game. We consider two alternative modeling assumptions: (i) guilt aversion depends on the role played in the game, because only the trustee can feel guilt for letting the co-player down, (ii) guilt aversion is independent of the role played in the game. We show how the set of Bayesian equilibria changes as the upper bound on guilt sensitivity varies, and we compare this with the complete-information case. Our analysis illustrates the incomplete-information approach to psychological games and can help organize experimental results in the Trust Game.
    Keywords: Psychological games, Trust Game, guilt, incomplete information
    JEL: C72 C91 D03
    Date: 2013–06
  6. By: François Larmande (EM-Lyon Business School); Jean-Pierre Ponssard (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: We study a principal-agent model in which the agent can provide ex post additional relevant information regarding his performance. In particular, he can provide a legitimate excuse, that is, evidence that a poor result is only due to factors outside his control. However, building a convincing case requires time, time that is not spent on exerting productive eff ort, and thus generating information represents an opportunity cost. We obtain necessary and suffi cient conditions for the principal to prefer a policy of adjusting ex post the performance measure for the information provided by the agent to a policy of conforming to a result-based system with no adjustments. The risk aversion and a possible limited liability of the agent play an important role in the analysis. This paper clarifi es the issues asso- ciated with the so-called \excuse culture" prevailing in some organizations.
    Keywords: Performance measurement Manipulation Controllability principle Excuse culture Influence activity
    Date: 2013–05–23
  7. By: Fulvio Fontini (Department of Economics and Management - Università degli Studi di Padova - University of Padua); Katrin Millock (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Michele Moretto (Department of Economics and Management - Università degli Studi di Padova - University of Padua)
    Abstract: In many cases consumers cannot observe firms' investment in quality or safety, but have only beliefs on the average quality of the industry. In addition, the outcome of the collective investment game of the firms may be stochastic since firms cannot control perfectly the technology or external factors that may affect production. In such situations, when only consumers' subjective perceptions of the industry level of quality matters, the regulator may make information available to firms or subsidize their information acquisition. Under what conditions is it desirable to make information available? We show how firms' overall level of investment in quality depends upon the parameters of the quality accumulation process, the cost of investment and the number of firms in the industry. We also show the potentially negative effects on the total level of quality from providing information on consumers' actual valuation.
    Keywords: Collective reputation; option value; quality
    Date: 2013–05
  8. By: Karina Gose (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Abdolkarim Sadrieh (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)
    Abstract: In our laboratory experiment, the employer in a gift exchange game with 12 workers can incur a loss, if the employees fail to provide enough effort. When the employer can offer individually differentiated wages, we observe high wage and effort choices. When restricted to uniform wages, however, trust and reciprocity drop dramatically due to widespread free-riding by employees on the workforce's reputation. Introducing two collective action mechanisms, strike and effort coordination, does not mitigate the free-riding problem. Introducing employment risk, however, reduces free-riding substantially and reinstalls employees´ reciprocity at the price of a small, but sustained unemployment.
    Keywords: fair wage-effort hypothesis, efficiency wages, wage compression, labor unions, contract design
    JEL: C92 D23 J33 M52
    Date: 2013–03
  9. By: Leonard I. Nakamura; Kasper Roszbach.
    Abstract: In this paper we use credit rating data from two large Swedish banks to elicit evidence on banks’ loan monitoring ability. For these banks, our tests reveal that banks’ credit ratings indeed include valuable private information from monitoring, as theory suggests. However, our tests also reveal that publicly available information from a credit bureau is not efficiently impounded in the bank ratings: The credit bureau ratings not only predict future movements in the bank ratings but also improve forecasts of bankruptcy and loan default. We investigate possible explanations for these findings. Our results are consistent with bank loan officers placing too much weight on their private information, a form of overconfidence. To the extent that overconfidence results in placing too much weight on private information, risk analyses of the bank loan portfolios in our data could be improved by combining the bank credit ratings and public credit bureau ratings. The methods we use represent a new basket of straightforward techniques that enable both financial institutions and regulators to assess the performance of credit rating systems. ; Supersedes Working Paper 10-21.
    Keywords: Credit ratings ; Risk assessment
    Date: 2013
  10. By: Aurora García-Gallego (LEE & Department of Economics, Universitat Jaume I, Castellón, Spain); Penélope Hernández-Rojas (ERI-CES & Department of Economic Analysis, University of Valencia, Spain); Amalia Rodrigo-González (Department of Business Finance, University of Valencia, Spain)
    Abstract: Based on Gossner, Hernández and Neyman’s (2006) 3-player game (hereafter GHN) we analyze communication efficiency in the lab. In that game, player 1 represents random nature an i.i.d. procedure, player 2 is a fully informed player (wiser), and player 3 is the less informed player (agent). The game is repeated and players 2 and 3 get 1 if both actions match nature’s actions and 0 otherwise. We propose an experiment following this game. We implement two treatments: one without chat (NC) and one with chat (C). In the treatment with chat, players may first send messages to each other through an online chat application, and then play the game. After the chat time, only the wiser player has perfect information on the realized (random) sequence played by nature. The players then play the finitely repeated binary game. In treatment NC, subjects just play the game. In the experiment we observed endogenous communication treatment NC as well as exogenous in treatment C, both of which result in higher payoffs. Furthermore, when explicit communication is possible we observe a chat effect which can be interpreted as a higher level of efficiency in communication. Strategies used by subjects are in line with GHN strategies.
    Keywords: communication, transmission of information, efficiency, experiments
    JEL: D8 C91 C73
    Date: 2013
  11. By: Ooghe, Erwin (K.U.Leuven); Schokkaert, Erik (K.U.Leuven)
    Abstract: School accountability schemes require measures of school performance, and these measures are in practice often based on pupil test scores. It is well-known that insufficiently correcting these test scores for pupil characteristics may provide incentives for inefficient pupil selection. We show that the trade-off between reward and pupil selection is not only a matter of sufficient information. A school accountability scheme that rewards school performance will create incentives for pupil selection, even under perfect information, unless the educational production function satisfies an (unrealistic) separability assumption. We propose different compromise solutions and discuss the resulting incentives in theory. The empirical relevance of our analysis – i.e., the rejection of the separability assumption and the magnitude of the incentives in the different compromise solutions – is illustrated with Flemish data.
    Keywords: school accountability, cream-skimming, educational production function
    JEL: H52 I22 I24
    Date: 2013–05
  12. By: Xavier Vives (IESE BUSINESS SCHOOL)
    Abstract: The paper analyzes a very stylized model of crises and demonstrates how the degree of strategic complementarity in the actions of investors is an important determinant of fragility. It is shown how the balance sheet composition of a financial intermediary, parameters of the information structure (precisions of public and private information), and the level of stress indicators in the market impinge on strategic complementarity and fragility. The model distinguishes between solvency and liquidity risk and characterizes them. Both a solvency (leverage) and a liquidity ratio are required to control the probabilities of insolvency and illiquidity. It is found that in a more competitive environment (with higher return on short-term debt) the solvency requirement has to be strengthened, and in an environment where the fire sales penalty is higher and fund managers are more conservative the liquidity requirement has to be strengthened while the solvency one relaxed. Higher disclosure or introducing a derivatives market may backfire, aggravating fragility (in particular when the asset side of a financial intermediary is opaque). The model is applied to interpret the 2007 run on SIV and ABCP conduits.
    Date: 2012
  13. By: Heitor Almeida (University of Illinois); Filippo Ippolito (Universitat Pompeu Fabra); Ander Perez (Universitat Pompeu Fabra); Viral Acharya (New York University)
    Abstract: Recent empirical and survey evidence on corporate liquidity management suggests that bank credit lines do not offer fully committed liquidity insurance, and that they are frequently used to finance future growth opportunities rather than for precautionary motives. In this paper, we propose and test a theory of corporate liquidity management that is consistent with these findings. We argue that a corporate credit line can be understood as a form of monitored liquidity insurance, which controls illiquidity-seeking behavior by firms through bank monitoring and credit line revocation. In addition, we allow firms to demand liquidity not to hedge against negative liquidity shocks, but to help finance future growth opportunities. We show that bank monitoring and credit line revocation play less of a role for such firms, because the nature of their liquidity demand reduces their incentives to engage in illiquidity-seeking behavior. Thus, firms that have low hedging-needs (e.g., high correlation between cash flows and investment opportunities) can access fully committed credit lines that dominate cash holdings as an optimal liquidity management tool. We use a novel dataset on corporate credit lines to provide empirical evidence that is consistent with the predictions of the model. The evidence suggests that credit line users have lower liquidity risk than firms that use cash for liquidity management. In addition, firms with low hedging-needs are more likely to use credit lines for liquidity management. Credit line covenants and covenant violations are less common when the credit line user has low hedging needs.
    Date: 2012
  14. By: Sergiu Hart; Noam Nisan
    Abstract: We consider the menu size of auctions as a measure of auction complexity and study how it affects revenue. Our setting has a single revenue-maximizing seller selling two or more heterogenous items to a single buyer whose private values for the items are drawn from a (possibly correlated) known distribution, and whose valuation is additive over the items. We show that the revenue may increase arbitrarily with menu size and that a bounded menu size can not ensure any positive fraction of the optimal revenue. The menu size turns out to "nail down" the revenue properties of deterministic auctions: their menu size may be at most exponential in the number of items and indeed their revenue may be larger than that achievable by the simplest types of auctions by a factor that is exponential in the number of items but no larger. Our model is related to a previously studied "unit-demand" model and our results also answer an open problem in that model.
    Date: 2013–04
  15. By: Manolis Galenianos (Pennsylvania State University)
    Abstract: This paper theoretically examines the firm's choice to use different search channels in order to hire new workers. An equilibrium model is developed where the quality of a match is uncertain and firms search for workers through the market and through referrals. The intensity of use of each search channel is endogenized through the choice of channel-specific search effort. When referrals generate more accurate signals regarding match quality, the model predicts that referred workers have higher starting wages, higher productivity and lower separation rates than non-referred candidates and that these differentials decrease over time due to selection, which is consistent with the data. The model is extended by introducing productivity heterogeneity in firms and allowing the endogenous determination of signal quality. It is shown that high productivity firms choose greater accuracy of signals which diminishes the referral-market differential and leads to lower referral intensity, consistent with the data. This type of selection on the firm side explains why regressions that do not include firm fixed effects find a negative effect of referrals on wages in contrast to firm-level and other evidence.
    Date: 2012

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