nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒02‒15
seven papers chosen by
Simona Fabrizi
Massey University, Albany

  1. The value of public information in common value Tullock contests By Ezra Einy; Diego Moreno; Benyamin Shitovitz
  2. Bad Bets: Excessive Risk Taking, Convex Incentives, and Performance By Rui de Figueiredo; Evan Rawley; Orie Shelef
  3. Destructive Agents, Finance Firms, and Systemic Risk By Natasa Bilkic; Thomas Gries
  4. Policy Design with Private Sector Skepticism in the Textbook New Keynesian Model By Robert King; Yang Lu; Ernesto Pastén
  5. Monkey see, monkey do: truth-telling in matching algorithms and the manipulation of others By Guillén, Pablo; Hakimov, Rustamdjan
  6. The Voters' Curses: The Upsides and Downsides of Political Engagement By Prato, Carlo; Wolton, Stephane
  7. Incentives for Prosocial Behavior: The Role of Reputations By Christine Exley

  1. By: Ezra Einy; Diego Moreno; Benyamin Shitovitz
    Abstract: We study how changes in the information available to the players of a symmetric common-value Tullock contest with incomplete information affect their payoffs and their incentives to exert effort. For the class of contests where players' state dependent cost of effort is multiplicative, we show that if the players' Arrow-Pratt measure of relative risk aversion is increasing (decreasing), then the better informed they are, the smaller (greater) is the effort they exert, and the greater (smaller) is their payoff.
    Keywords: Tullock contests , Common values , Value of public information
    Date: 2014–01
  2. By: Rui de Figueiredo (Haas School of Business); Evan Rawley (Columbia Business School); Orie Shelef (Stanford Institute for Economic Policy Research)
    Abstract: Managerial incentives influence risk-taking as well as effort. Theoretical research has long considered risk-taking to be a potential side effect of incentive pay, but empirical analysis of risk-taking incentives has been more limited. This paper uses exogenous variation in incentives to examine how convex incentive schemes simultaneously influence performance and risk-taking. We study these questions in the context of the hedge fund industry in which the use of convex incentives is replete, given that most managers earn a combination of a base and an incentive fee if their performance exceeds a threshold. Consistent with other results in the literature, the paper first establishes that when managers fall below the threshold, above which they earn performance fees, risk-taking increases and performance drops. On average, risk-taking increases 50% and performance falls 2.3 percentage points when a hedge fund is below the incentive threshold.Having established these baseline results, the paper proceeds to more carefully examine the link between performance and risk-taking explicitly. First, given the empirical setting, we are able to separately identify the effort and risk-taking effects of being below the incentive threshold, and show that much of performance declines are due to excessive risk-taking rather than to reduced effort. Second, we show that risk-taking behavior is non-monotonic; managers who are significantly below the threshold reduce risk-taking relative to those who are relatively close. The importance of risk-taking to performance adds to the debate about the impact of incentives on behavior. Regardless of whether incentives are given or justified by concerns of moral hazard with respect to effort or risk-taking, or concerns of adverse selection or whether risk-aversion is an important consideration, risk-taking can have significant impacts. These results suggest that risk-taking, due to convex incentives, is not only inefficient-in the sense that risk-taking choices are dominated and lead to absolute performance declines.
    Date: 2014–01
  3. By: Natasa Bilkic (University of Paderborn); Thomas Gries (University of Paderborn)
    Abstract: Popular opinion suggests that malfunctioning, poorly designed incentive schemes in financial firms that encouraged greed and involved excessive salaries were responsible for the excessive risk taking that eventually led to the 2008 financial crash. In this paper we discuss this claim in a theoretical model. We use a modified version of delegated portfolio choice approach with performance contracts. If, in this modified model, we allow for the existence of destructive agents - when maximizing their private utility - each financial firm will take excessive risks. As a result the finance sector develops systemic risk. We define systemic risk as inefficient and excessive risk that is chosen in an endogenous and stable manner by the aggregate market.
    Keywords: delegated portfolio choice, systemic risk, destructive agent, adverse selection
    JEL: D82 D86 G14
    Date: 2014–02
  4. By: Robert King; Yang Lu; Ernesto Pastén
    Abstract: How should policy be optimally designed when a monetary authority faces a private sector that is skeptical about policy announcements and makes inferences about the monetary authority’s ability to follow through on policy plans from economic data? To provide an answer to this question, we extend the standard New Keynesian macroeconomic model to include imperfect inflation control and Bayesian learning by private agents about whether the monetary authority is a committed type (capable of following through on announced plans) or an alternative type (producing higher and more volatile inflation). We find that the optimal pattern of inflation management depends critically on how skeptical the private sector is and how it views the alternative monetary authority whether the latter is just mechanically more inflationary or if it would mimic the committed monetary authority’s actions.
    Date: 2014–01
  5. By: Guillén, Pablo; Hakimov, Rustamdjan
    Abstract: We test the effect of the amount of information on the strategies played by others in the theoretically strategy-proof Top Trading Cycles (TTC) mechanism. We find that providing limited information on the strategies played by others has a negative and significant effect in truth-telling rates. Subjects report truthfully more often when either full information or no information on the strategies played by others is available. Our results have potentially important implications for the design of markets based on strategy-proof matching algorithms.
    Date: 2014–01
  6. By: Prato, Carlo; Wolton, Stephane
    Abstract: Scholars have long deplored voters' lack of interest in politics and argue greater political engagement would improve the performance of democracy. We consider a model of elections where successful communication of political messages during campaigns requires efforts by politicians and a representative voter. The voter's incentive to pay attention to politics affects the effectiveness of the electoral process as screening and disciplining device. The performance of the electoral process and the voter's level of political activity are low when the voter cares little about politics--this is the curse of the apathetic voter--, or cares a lot about politics--this is the curse of the engaged voter. Consequently, an engaged voter is not always an active voter and fostering political engagement (e.g., by lowering the cost of political information or facilitating policy changes) might have negative consequences on voter's attention to politics and welfare.
    Keywords: Political Apathy, Political Engagement, Elections, Campaigns, Policy Change, Institutional Design, Political Information
    JEL: D72 D78 D83
    Date: 2014–02–05
  7. By: Christine Exley (Stanford University)
    Abstract: In public settings, the impact of monetary incentives on prosocial behavior is empirically mixed. Existing theory explains these finding by noting that incentives can introduce public signals that may or may not crowd out motivation to volunteer. The strength of these public signals are normally unobserved by the researcher, so it remains unclear as to when significant crowding out is likely to occur and render incentives ineffective. I overcome this ambiguity by examining individuals for whom the signal strength is likely zero - those with strong public reputations. In a laboratory experiment, I show that the crowd out in response to public incentives is much less likely among those with public reputations as opposed to private reputations, particularly for women.
    Date: 2013–01

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