nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒07‒28
eight papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Post-Crisis Lesson for EMU Governance from the Principal-Agent Approach By Luca Barbone; Grzegorz Poniatowski
  2. TULLOCK CONTESTS WITH ASYMMETRIC INFORMATION By Ezra Einy; Ori Haimanko; Diego Moreno; Aner Sela; Benyamin Shitovitz
  3. Learning, Words and Actions: Experimental Evidence on Coordination-Improving Information By Nicolas Jacquemet; Adam Zylberstejn
  4. Exploitation Aversion: When Financial Incentives Fail to Motivate Agents By Carpenter, Jeffrey P.; Dolifka, David
  5. High Frequency Trading in the Equity Markets During U.S. Treasury POMO By Cheng Gao; Bruce Mizrach
  6. Investment Coordination in Network Industries: The Case of Electricity Grid and Electricity By Höffler, Felix; Wambach, Achim
  7. Strategic Interaction in A Stock Trading Chat Room By Jie Lu; Bruce Mizrach
  8. Seasrch Deterrence By Armstrong, Mark; Zhou, Jidong

  1. By: Luca Barbone; Grzegorz Poniatowski
    Abstract: This paper contributes to the ongoing debate on fiscal consolidation and the questionable effectiveness of the Stability and Growth Pact by addressing the problem of economic governance in the EMU with a game-theoretic principal-agent approach. Following the theory of delegation, we develop a principal-multi agent model where the EMU authorities act as a collective principal that designs contracts for each of two agents that reflect Europe’s ”South” and ”North”. We investigate what happens when agents face hidden-information moral hazard problem and when they are able to coordinate their actions. Bearing in mind the applicability of incentive mechanisms, we discuss the optimal contracts for the principal and each of the agents. We prove that the most efficient solution consists of tailor-made contracts, according to which highly indebted countries must be offered strong incentive mechanisms in the form of substantial penalties but also rewards (e.g., preferential loans). We also stress the importance of taking into account positive spillover effects, which could be facilitated by economic integration and fiscal policy coordination between the EMU Members.
    Keywords: Moral Hazard, Principal-Agent, EU Economic Governance, Fiscal Compact
    JEL: D82 E61 H60
    Date: 2013–07
  2. By: Ezra Einy (Department of Economics, Ben-Gurion University of the Negev, Israel); Ori Haimanko (Department of Economics, Ben-Gurion University of the Negev, Israel); Diego Moreno (Departamento de Economia, Universidad Carlos III de Madrid.); Aner Sela (Department of Economics, Ben-Gurion University of the Negev. Israel); Benyamin Shitovitz (Department of Economics, University of Haifa)
    Abstract: Under standard assumptions about players'cost functions, we show that a Tullock contest with asymmetric information has a pure strategy equilibrium. Next we study Tullock contests in which players have a common value and a common state-independent linear cost function. A two-player contest in which one player has an information advantage has a unique equilibrium. In equilib- rium both players exert the same expected effort, and although the player with an information advantage wins the prize with probability less than one-half, his payoff is greater or equal to that of his opponent. When there are more than two players in the contest, having information advantage leads to higher payoffs, but the other properties of equilibrium no longer hold.
    JEL: C72 D44 D82
    Date: 2013
  3. By: Nicolas Jacquemet (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, BETA - Bureau d'économie théorique et appliquée - CNRS : UMR7522 - Université de Strasbourg - Université Nancy II); Adam Zylberstejn (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: We experimentally study an asymmetric coordination game with two Nash equilibria: one is Pareto-efficient, the other is Pareto-inefficient and involves a weakly dominated strategy. We assess whether information about the interaction partner helps eliminate the imperfect equilibrium. Our treatments involve three information-enhancing mechanisms: repetition and two kinds of individual signals: messages from partner or observation of his past choices. Repetition-based learning increases the frequencies of the most efficient outcome and the most costly strategic mismatch. Moreover, it is superseded by individual signals. Like previous empirical studies, we find that signals provide a screening of partners' intentions that reduces the frequency of coordination failures. Unlike these studies, we find that the transmission of information between partners, either via messages or observation, does not suffice to significantly increase the overall efficiency of outcomes. This happens mostly because information does not restrain the choice of the dominated action by senders.
    Keywords: coordination game; communication; cheap-talk; observation
    Date: 2013
  4. By: Carpenter, Jeffrey P. (Middlebury College); Dolifka, David (Middlebury College)
    Abstract: Empirical studies of the principal-agent relationship find that extrinsic incentives work in many instances, linking rewards to performance increases effort, but that they can also backfire, reducing effort. Intrinsic motivation, the internal drive to work to master a skill or to improve one's self image, is thought to be the key to whether incentives work or not. If the incentives crowd-out intrinsic motivation, and the effect is large enough, the net motivational effect on effort will be negative. We posit that an aversion to being exploited, i.e. being used instrumentally for the benefit of another, is one facet of intrinsic motivation, triggered by the combination of high-powered incentives and egoistic principal intent, that can cause incentives to fail. Using an experiment that provides the material circumstances necessary for exploitation to occur, we find that agent compliance is significantly lower for exploitative principals who use high-powered incentives and have a financial interest to do so, compared to neutral principals who use the same contracts but do not benefit from them. To corroborate our interpretation of the results we show that a surveyed "exploitation aversion" scale moderates this effect. Exploitation averse participants are less likely to comply with the incentives than exploitation tolerant participants when the principal signals an exploitative intent, but they are no less likely to comply with the same incentives when the principal is neutral. Our results have implications for the design and implementation of incentive structures within organizations.
    Keywords: financial incentives, intrinsic motivation, crowding, exploitation, experiment
    JEL: C92 J33 M52 M55
    Date: 2013–07
  5. By: Cheng Gao (Rutgers University); Bruce Mizrach (Rutgers University)
    Abstract: We analyze high frequency trading (HFT) activity in equities during U.S. Treasury permanent open market (POMO) purchases by the Federal Reserve. We construct a model to study HFT quote and trade behavior when private information is released and confirm it empirically. We estimate that HFT firms reduce their inside quote participation by up to 8% during POMO auctions. HFT firms trade more aggressively, and they supply less passive liquidity to non-HFT firms. Market impact also rises during Treasury POMO. Aggressive HFT trading becomes more consistently profitable, and HFT firms earn a higher return per share. We also estimate that HFT firms earn profits of over $105 million during U.S. Treasury POMO events.
    Keywords: high frequency trading, Federal Reserve, open market operations, private information
    JEL: G12 G21 G24
    Date: 2013–07–16
  6. By: Höffler, Felix (Energiewirtschaftliches Institut an der Universitaet zu Koeln); Wambach, Achim (Department of Economics, University of Cologne)
    Abstract: Liberalization of network industries frequently separates the network from the other parts of the industry. This is important in particular for the electricity industry where private firms invest into generation facilities, while net- work investments usually are controlled by regulators. We discuss two regulatory regimes. First, the regulator can only decide on the network extension. Second, she can additionally use a "capacity market" with payments contingent on private generation investment. For the first case, we find that even absent asymmetric information, a lack of regulatory commitment can cause inefficiently high or inefficiently low investments. For the second case, we develop a standard handicap auction which implements the first best under asymmetric information, if there are no shadow costs of public funds. With shadow costs, no simple mechanism can implement the second best outcome.
    Keywords: Regulation; commitment; capacity markets; transmission system investment
    JEL: D44 K23 L51 L94
    Date: 2013–06–24
  7. By: Jie Lu (Rutgers University); Bruce Mizrach (Rutgers University)
    Abstract: We consider a model of an internet chat room with free entry but secure identity. Traders exchange messages in real time of both a fundamental and non-fundamental nature. We explore conditions under which traders post truthful information and make trading decisions. We also establish a symmetric Bayesian Nash equilibrium in which momentum traders profit from their exposure to informed traders in the chat room. The model generates a number of empirical predictions: (1) the non-skillful traders follow the skillful traders; (2) the more skillful traders are more frequently followed by others; (3) the non-skillful traders benefit from following. We test and confirm all three predictions using a data set of chat room logs from the Activetrader Financial Chat Room.
    Keywords: chat room, strategic information, individual traders, behavioral finance
    JEL: G14
    Date: 2013–07–16
  8. By: Armstrong, Mark; Zhou, Jidong
    Abstract: A seller wishes to prevent the discovery of rival offers by its prospective customers. We study sales techniques which serve this purpose by making it harder for a customer to return to buy later after a search for alternatives. These include making an exploding offer, offering a "buy-now" discount, or requiring payment of a deposit in order to buy later. It is unilaterally profitable for a seller to deter search under mild conditions, but sellers can suffer when all do so. In a monopoly setting where the buyer has an uncertain outside option, the optimal selling mechanism features both buy-now discounts and deposit contracts. When a seller cannot commit to its policy, it exploits the inference that those consumers who try to buy later have no good alternative. In many cases the outcome then involves exploding offers, so that no consumers return to buy after search.
    Keywords: Consumer search; sales techniques; price discrimination; sequential screening
    JEL: D18 D83 L13 L80
    Date: 2013–06

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