nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒06‒16
sixteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Subjective Evaluation versus Public Information By Bester, Helmut; Münster, Johannes
  2. Exit Options and the Allocation of Authority By Bester, Helmut; Krähmer, Daniel
  3. Signalling Rivalry and Quality Uncertainty in a Duopoly By Bester, Helmut; Demuth, Juri
  4. The bilateral trade model in a discrete setting By Vermeulen A.J.; Schr?der M.J.W.; Flesch J.
  5. A Folk Theorem for Repeated Elections with Adverse Selection By John Duggan
  6. Optimal Truncation in Matching Markets By Peter Coles; Ran Shorrer
  7. Information Sharing Networks in Linear Quadratic Games By Sergio Currarini; Francesco Feri
  8. Screening Peers Softly: Inferring the Quality of Small Borrowers By Iyer, Rajkamal; Khwaja, Asim Ijaz; Luttmer, Erzo F. P.; Shue, Kelly
  9. Pandering, Faith and Electoral Competition. By Gabriele Gratton
  10. Adverse Selection and Moral Hazard in Anonymous Markets By Klein, T.J.; Lambertz, C.; Stahl, K.
  11. Asymmetric Multiple-Object First-Price Auctions By Paul Pezanis-Christou
  12. Efficient Entry in Competing Auctions By James Albrecht, Pieter Gautier, Susan Vroman
  13. Market Transparency, Market Quality and Sunshine Trading By Frutos, M. A. de; Manzano, Carolina
  14. Updating Beliefs with Ambiguous Evidence: Implications for Polarization By Roland G. Fryer, Jr.; Philipp Harms; Matthew O. Jackson
  15. Bayesian Games With a Continuum of States By Ziv Hellman; Yehuda (John) Levy
  16. Endogenous group formation in experimental contests By Herbst, Luisa; Konrad, Kai A.; Morath, Florian

  1. By: Bester, Helmut; Münster, Johannes
    Abstract: This paper studies a principal-agent relation in which the principal's private information about the agent's effort choice is more accurate than a noisy public performance measure. For some contingencies the optimal contract has to specify ex post inefficiencies in the form of inefficient termination (firing the agent) or third-party payments (money burning). We show that money burning is the less efficient incentive device: it is used at most in addition to firing and only if the loss from termination is small. Under an optimal contract the agent's wage may depend only on the principal's report and not on the public signal. Nonetheless, public information is valuable as it facilitates truthful subjective evaluation by the principal.
    Keywords: Subjective evaluation; moral hazard; termination clauses; third-party payments
    JEL: D23 D82 D86 J41 M12
    Date: 2013–05–24
  2. By: Bester, Helmut; Krähmer, Daniel
    Abstract: We analyze the optimal allocation of authority in an organization whose members have conflicting preferences. One party has decision-relevant private information, and the party who obtains authority decides in a self-interested way. As a novel element in the literature on decision rights, we consider exit option contracts: the party without decision rights is entitled to prematurely terminate the relation after the other party's choice. We show that under such a contract it is always optimal to assign authority to the informed and not to the uninformed party, irrespective of the parties' conflict of interest. Indeed, the first-best efficient solution can be obtained by such a contract.
    Keywords: Authority; decision rights; exit options; incomplete contracts; asymmetric information
    JEL: D23 D82 D86
    Date: 2013–03–13
  3. By: Bester, Helmut; Demuth, Juri
    Abstract: This paper considers price competition in a duopoly with quality uncertainty. The established firm (the `incumbent') offers a quality that is publicly known; the other firm (the `entrant') offers a new good whose quality is not known by some consumers. The incumbent is fully informed about the entrant's quality. This leads to price signalling rivalry because the incumbent gains and the entrant loses if observed prices make the uninformed consumers more pessimistic about the entrant's quality. When the uninformed consumers' beliefs satisfy the `intuitive criterion' and the `unprejudiced belief refinement', prices signal the entrant's quality only in a two-sided separating equilibrium and are identical to the full information outcome.
    Keywords: Quality uncertainty; Signalling; Oligopoly; Price competition
    JEL: D43 D82 L15
    Date: 2013–05
  4. By: Vermeulen A.J.; Schr?der M.J.W.; Flesch J. (GSBE)
    Abstract: We consider a bilateral trade model in which both players have a finite number of possible valuations. The sellers valuation and the buyers valuation for the object are private information, but the independent beliefs about these valuations are common knowledge. In this setting, we provide a characterization of the set of interim individually rational-implementable trading rules, analogous to the result of Myerson and Satterthwaite 1983. Thereafter, we derive necessary conditions for incentive compatible and ex post individually rational direct mechanisms. For the special class of corner mechanisms with discrete uniform beliefs, we characterize the set of ex post individually rational-implementable trading rules. In this context it is also shown that ex post efficiency can only be achieved if the number of different valuations is small. The maximal number of different valuations for which efficiency is still possible depends on the prior probability distribution of valuations.
    Date: 2013
  5. By: John Duggan (W. Allen Wallis Institute of Political Economy, 107 Harkness Hall, University of Rochester, Rochester, NY 14627-0158)
    Abstract: I establish a folk theorem for a model of repeated elections with adverse selection: when citizens are sufficiently patient, arbitrary policy paths through arbitrarily large regions of the policy space can be supported by a refinement of perfect Bayesian equilibrium. Politicians are policy-motivated (so office benefits cannot be used to incentivize policy choices), the policy space is one-dimensional (limiting the dimensionality of the set of utility imputations), and politicians’ preferences are private information (so punishments cannot be targeted to a specific type). The equilibrium construction relies critically on differentiability and strict concavity of citizens’ utility functions. An extension of the arguments allows policy paths to depend on the office holder’s type, subject to incentive compatibility constraints.
    Date: 2013–05
  6. By: Peter Coles (Harvard Business School); Ran Shorrer (Harvard University and Harvard Business School)
    Abstract: Since no stable matching mechanism can induce truth-telling as a dominant strategy for all participants, there is often room in matching markets for strategic misrepresentation (Roth [25]). In this paper we study a natural form of strategic misrepresentation: reporting a truncation of one's true preference list. Roth and Rothblum [28] prove an important but abstract result: in certain symmetric, incomplete information settings, agents on one side of the market (“the women”) optimally submit some truncation of their true preference lists. In this paper we put structure on this truncation, both in symmetric and general settings, when agents must submit preference lists to the Men-Proposing Deferred Acceptance Algorithm. We first characterize each woman's truncation payoffs in an incomplete information setting in terms of the distribution of her achievable mates. The optimal degree of truncation can be substantial: we prove that in a uniform setting, the optimal degree of truncation for an individual woman goes to 100% of her list as the market size grows large, when other women are truthful. In this setting, we demonstrate the existence of an equilibrium where all agents use truncation strategies. Compared to truthful reporting, in any equilibrium in truncation strategies, welfare diverges for men and women: women prefer the truncation equilibrium, while men would prefer that participants truthfully report. In a general environment, we show that the less risk averse a player, the greater the degree of her optimal truncation. Finally, when correlation in preferences increases, players should truncate less. While several recent papers have focused on the limits of strategic manipulation, our results serve as a reminder that without the pre-conditions ensuring truthful reporting, even in settings where agents have little information, the potential for manipulation can be significant.
    Keywords: Matching Markets, Truncation
    JEL: C78 C62 D61
    Date: 2013–05
  7. By: Sergio Currarini (University of Leicester, Universita' di Venezia, Euro-Mediterranean Center on Climate Change, CIP Division and FEEM); Francesco Feri (Royal Holloway, University of London)
    Abstract: We study the bilateral exchange of information in the context of linear quadratic games. An information structure is here represented by a non directed network, whose nodes are agents and whose links represent sharing agreements. We first study the equilibrium use of information in any given sharing network, finding that the extent to which a piece of information is "public" affects the equilibrium use of it, in line with previous results in the literature. We then study the incentives to share information ex-ante, highlighting the role of the elasticity of payoffs to the equilibrium volatility of one's own strategy and of one's opponents' strategies. For the case of uncorrelated signals we fully characterize pairwise stable networks for the general linear quadratic game. For the case of correlated signals, we study pair-wise stable networks for three specific linear quadratic games - Cournot oligopoly, Keynes’ beauty contest and Public good provision - in which strategies are substitute, complement and orthogonal, respectively. We show that signals’ correlation favors the transmission of information, but may also prevent all information from being transmitted.
    Keywords: Information Sharing, Networks, Bayesian Equilibrium, Beauty Contest, Oligopoly
    JEL: D43 D82 D85 L13
    Date: 2013–05
  8. By: Iyer, Rajkamal (MIT); Khwaja, Asim Ijaz (Harvard University); Luttmer, Erzo F. P. (Dartmouth University); Shue, Kelly (University of Chicago)
    Abstract: The recent banking crisis highlights the challenges faced in credit intermediation. New online peer-to-peer lending markets offer opportunities to examine lending models that primarily cater to small borrowers and that generate more types of information on which to screen. This paper evaluates screening in a peer-to-peer market where lenders observe both standard financial information and soft, or nonstandard, information about borrower quality. Our methodology takes advantage of the fact that while lenders do not observe a borrower's exact credit score, we do. We find that lenders are able to predict default with 45% greater accuracy than what is achievable based on just the borrower's credit score, the traditional measure of creditworthiness used by banks. We further find that lenders effectively use nonstandard or soft information and that such information is relatively more important when screening borrowers of lower credit quality. In addition to estimating the overall inference of creditworthiness, we also find that lenders infer a third of the variation in the dimension of creditworthiness that is captured by the credit score. This credit-score inference relies primarily upon standard hard information, but still draws relatively more from softer or less standard information when screening lower-quality borrowers. Our results highlight the importance of screening mechanisms that rely on soft information, especially in settings targeted at smaller borrowers.
    JEL: D53 D80 G21 L81
    Date: 2013–05
  9. By: Gabriele Gratton (School of Economics, The University of New South Wales)
    Abstract: We study an election with two perfectly informed candidates. Voters share common values over the policy outcome of the election, but possess arbitrarily little information about which policy is best for them. Voters elect one of the candidates, effectively choosing between the two policies proposed by the candidates. We explore under which conditions candidates always propose the ex-post optimal policy for the voters. The model is extended to include strategic voting, policy-motivated candidates, imperfectly informed candidates, and heterogeneous preferences.
    Keywords: pandering; elections; information aggregation
    JEL: D72 D82
    Date: 2013–01
  10. By: Klein, T.J.; Lambertz, C.; Stahl, K. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: We study the effects of improvements in eBay’s rating mechanism on seller exit and continuing sellers’ behavior. Following a large sample of sellers over time, we exploit the fact that the rating mechanism was changed to reduce strategic bias in buyer rating. That improvement did not lead to increased exit of poorly rated sellers. Yet, buyer valuation of the staying sellers—especially the poorly rated ones—improved significantly. By our preferred interpretation, the latter effect results from increased seller effort; also, when sellers have the choice between exiting (a reduction in adverse selection) and improved behavior (a reduction in moral hazard), then they prefer the latter because of lower cost.
    Keywords: Anonymous markets;adverse selection;moral hazard;reputation building mechanisms.
    JEL: D83 L15
    Date: 2013
  11. By: Paul Pezanis-Christou (School of Economics, University of Adelaide)
    Abstract: The paper reports on the effects of one-sided imperfect information on bidding behaviour in simultaneous and sequential first-price auctions of non-identical objects when bidders have multi-unit demands. The analysis provides the following four main results. First, when different objects are to be sold in sequence, the seller maximises her expected revenues by selling the most valuable object first. Second, the more the objects are different and the more the sequential format favours the informed bidder. Third, by switching the order of sales, the seller may want to change her initial preference for a simultaneous format (in which bidders submit object-specific bids) to one for a sequential format. Fourth, sequential auctions are mostly preferred by the seller when the objects are likely to be of low value and the precision of the informed bidder's signal is low.
    Keywords: multiple-object auctions, sequential and simultaneous procedures, first-price auctions, asymmetric bidders, multi-unit demands, common value, price trends, order of sales.
    JEL: C7 D4 D44 D8
    Date: 2013–05
  12. By: James Albrecht, Pieter Gautier, Susan Vroman (Department of Economics, Georgetown University)
    Abstract: In this paper, we demonstrate the e¢ ciency of seller entry in a model of competing auctions. We generalize the competitive search literature by simultaneously allowing for nonrival (many on one) meetings and private information. We consider both the case in which buyers learn their valuations before visiting a seller and the case in which they learn their valuations after visiting the seller. We also allow for seller heterogeneity with respect to reservation values.
    Keywords: JEL Codes:
    Date: 2013–01–05
  13. By: Frutos, M. A. de; Manzano, Carolina
    Abstract: This paper analyzes the implications of pre-trade transpareny on market performance. We find that transparency increases the precision held by agents, however we show that this increase in precision may not be due to prices themselves. In competitive markets, transparency increases market liquidity and reduces price volatility, whereas these results may not hold under imperfect competition. More importantly, market depth and volatility might be positively related with proper priors. Moreover, we study the incentives for liquidity traders to engage in sunshine trading. We obtain that the choice of sunshine/dark trading for a noise trader is independent of his order size, being the traders with higher liquidity needs more interested in sunshine trading, as long as this practice is desirable. Key words: Market Microstructure, Transparency, Prior Information, Market Quality, Sunshine Trading
    Keywords: Mercats financers, Informació -- Aspectes econòmics, 33 - Economia,
    Date: 2013
  14. By: Roland G. Fryer, Jr.; Philipp Harms; Matthew O. Jackson
    Abstract: We introduce and analyze a model in which agents observe sequences of signals about the state of the world, some of which are ambiguous and open to interpretation. Instead of using Bayes' rule on the whole sequence, our decision makers use Bayes' rule in an iterative way: first to interpret each signal and then to form a posterior on the whole sequence of interpreted signals. This technique is computationally efficient, but loses some information since only the interpretation of the signals is retained and not the full signal. We show that such rules are optimal if agents sufficiently discount the future; while if they are very patient then a time-varying random interpretation rule becomes optimal. One of our main contributions is showing that the model provides a formal foundation for why agents who observe exactly the same stream of information can end up becoming increasingly polarized in their posteriors.
    JEL: D03 J01
    Date: 2013–06
  15. By: Ziv Hellman; Yehuda (John) Levy
    Abstract: Negative results on the the existence of Bayesian equilibria when state spaces have the cardinality of the continuum have been attained in recent years. This has led to the natural question: are there conditions that characterise when Bayesian games over continuum state spaces have measurable Bayesian equilibria? We answer this in the affirmative. Assuming that each type has finite or countable support, measurable Bayesian equilibria may fail to exist if and only if the underlying common knowledge $\sigma$-algebra is non-separable. Furthermore, anomalous examples with continuum state spaces have been presented in the literature in which common priors exist over entire state spaces but not over common knowledge components. There are also spaces over which players can have no disagreement, but when restricting attention to common knowledge components disagreements can exist. We show that when the common knowledge $\sigma$-algebra is separable all these anomalies disappear.
    Date: 2013–05
  16. By: Herbst, Luisa; Konrad, Kai A.; Morath, Florian
    Abstract: We study endogenous group formation in tournaments employing experimental threeplayer contests. We find that players in endogenously formed alliances cope better with the moral hazard problem in groups than players who are forced into an alliance. Also, players who are committed to expending effort above average choose to stand alone. If these players are forced to play in an alliance, they invest even more, whereas their co-players choose lower effort. Anticipation of this exploitation may explain their preference to stand alone. -- Wir untersuchen die endogene Bildung von Gruppen in Wettkämpfen in experimentellen Drei-Spieler-Wettbewerben. Es zeigt sich, dass Spieler in endogen gebildeten Allianzen besser mit dem Moral Hazard-Problem in Gruppen zurechtkommen als Spieler, die in eine Allianz gezwungen werden. Außerdem entscheiden sich Spieler, die bereit sind, überdurchschnittlichen Einsatz zu leisten, allein zu agieren. Sind diese Spieler gezwungen in einer Allianz zu spielen, investieren sie sogar mehr, wogegen ihre Mitspieler ihren Einsatz reduzieren. Die Erwartung dieser Ausbeutung ist eine mögliche Erklärung für ihre Präferenz allein zu agieren.
    Keywords: endogenous group formation,contest,conflict,alliance,experiment,moral hazard problem,free-riding,in-group favoritis
    JEL: D72 D74
    Date: 2013

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