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on Contract Theory and Applications |
| By: | Philipp König; David Pothier |
| Abstract: | How do banks choose their debt maturity structure when credit markets are subject to information frictions? This paper proposes a model of equilibrium maturity choice with asymmetric information and endogenous roll-over risk. We show that in the presence of public signals about firms' creditworthiness (credit ratings), firms choose to expose themselves to positive roll-over risk in order to minimize price distortions. Short-term financing is socially desirable when banks' capacity to repay short-term creditors depends on their credit rating, as it helps mitigate the underlying adverse selection problem. Notwithstanding these social benefits, the equilibrium maturity structure always exhibits inefficient short-termism. If banks receiving a credit downgrade face sufficiently high roll-over risk, the equilibrium maturity structure approaches the constrained efficient allocation. |
| Keywords: | Debt maturity, rollover risk, asymmetric information, global games |
| JEL: | G10 G20 G30 G32 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1364&r=cta |
| By: | Arnold, Marc |
| Abstract: | This article analyzes the impact of credit risk transfer on banks' screening incentives on the primary loan market. While credit derivatives allow banks to transfer risk to investors, they negatively affect the incentive to screen due to the asymmetry of information between banks and investors. I show that screening incentives can be reestablished with standardized credit derivatives that fully transfer the underlying loan default risk. In particular, a callable credit default swap reveals a loan's quality to the investor by letting him observe the bank's readiness to pay for the implicit call feature. The ability to signal loan quality induces screening incentives. The paper also examines the impact of current developments such as higher regulatory capital standards, stricter margin requirements, and central clearing on the design of the optimal credit risk transfer contract. |
| Keywords: | Credit Risk Transfer, Callable Credit Default Swaps, Screening Incentives |
| JEL: | G18 G28 |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2014:02&r=cta |
| By: | François Larmande; Jean-Pierre Ponssard |
| 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 effort, and thus generating information represents an opportunity cost. We obtain necessary and sufficient 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 clarifies the issues associated with the so-called “excuse culture” prevailing in some organizations. |
| Keywords: | performance measurement, manipulation, controllability principle, excuse culture, influence activity |
| JEL: | D82 M41 M52 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_4569&r=cta |
| By: | Dirk Bergemann; Benjamin A. Brooks; Stephen Morris |
| Date: | 2014–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000898&r=cta |
| By: | Herweg, Fabian; Karle, Heiko; Müller, Daniel |
| Abstract: | We consider a simple trading relationship between an expectation-based loss-averse buyer and profit-maximizing sellers. When writing a long-term contract the parties have to rely on renegotiations in order to ensure materially efficient trade ex post. The type of the concluded long-term contract affects the buyer’s expectations regarding the outcome of renegotiation. If the buyer expects renegotiation always to take place, the parties are always able to implement the materially efficient good ex post. It can be optimal for the buyer, however, to expect that renegotiation does not take place. In this case, a good of too high quality or too low quality is traded ex post. Based on the buyer’s expectation management, our theory provides a rationale for “employment contracts†in the absence of non-contractible investments. Moreover, in an extension with non-contractible investments, we show that loss aversion can reduce the hold-up problem. |
| Keywords: | Behavioral Contract Theory; Expectation-Based Loss Aversion; Incomplete Contracts; Renegotiation |
| JEL: | C78 D03 D86 |
| Date: | 2014–02–13 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:454&r=cta |
| By: | Gani Aldashev (Center for Research in the Economics of Development, University of Namur and ECARES, ULB); Giorgio Zanarone (Colegio Universitario de Estudios Financieros (CUNEF)) |
| Abstract: | We model the State as a self-enforcing agreement over the use of force. A principal contracts with an agent, and a powerful ruler enforces their contracts through a mix of monetary fines and coercion. If the ruler fails to enforce, or if he uses his power to expropriate, all parties revert to low production forever after. Our model has two important implications. First, a better coercion technology moves the optimal system from private ordering, where contracts are enforced by the threat of termination, to the State, where they are enforced by the threat of coercion. This is consistent with the historical correlation between improvements in coercion and the transition from the Law Merchant enforcement system to the State. Second, contract enforcement and non-expropriation are complementary inputs in the State, in the sense that improvements in the enforcement technology increase the agents effort only if the ruler has limited expropriation power, so that the rulers incentive constraint on contractual enforcement is binding. This result relates to the Acemoglu and Johnson (2005) finding that constraints on rulers have affected the development of nations more than improvements in contractual enforcement. Using their data we find that, consistent with our model, contractual enforcement does affect development, but only when the rulers expropriation power is sufficiently constrained. |
| Keywords: | Enforcement, Punishment, Coercive power, Relational contracts, State |
| JEL: | D23 K42 P37 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:nam:wpaper:1403&r=cta |
| By: | Dirk Bergemann; Tibor Heumann; Stephen Morris |
| Date: | 2014–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000892&r=cta |
| By: | Francesco Nava; Michele Piccione |
| Abstract: | The paper discusses community enforcement in infinitely repeated, two-action games with local interaction and uncertain monitoring. Each player interacts with and observes only a fixed set of opponents, of whom he is privately informed. the main result shows that when beliefs about the monitoring structure have full support, efficiency can be sustained with sequential equilibria that are independent of the players' beliefs. Stronger results are obtained when only acyclic monitoring structures are allowed or players have unit discount rates. These equilibria satisfy numerous robustness properties. |
| JEL: | J1 |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:54250&r=cta |
| By: | Sang-Hyun Kim (University of East Anglia) |
| Abstract: | In a typical study of political economy, citizens are regarded as principals, and government as agent. This is a modern way of thinking in the sense that classical theorists of democracy such as Jean-Jacques Rousseau and James Madison were more interested in the dual nature of people; they are principals (citizens sharing the sovereign power) and, at the same time, agents (subjects under the laws). Government, in their framework, is an intermediate body which helps people solve their self-control problem. Equipped with tools of modern economics, this paper explores the classical problem to see how economic development and political institutionalization relate to the structure of government and the quality of public sector. In particular, I consider repeated games with a large population and incomplete information, in which players decide whether to sacrifice private consumption to provide public goods. Because both people and the executive of public projects are subject to moral hazard, the people spend resources to monitor the executive and the people themselves. The optimal self-enforcing contract, which can be interpreted as an efficiency upper bound of political systems, is characterized. The analysis of the contract shows that as a country gets more economically developed and politically institutionalized, the agency problem on the people's side becomes negligible, and the citizens' demand for accountable government becomes stronger, in which case the standard principal-agent framework is good enough to describe the political reality. |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:uea:aepppr:2012_59&r=cta |
| By: | Eling, Martin; Jia, Ruo; Yao, Yi |
| Abstract: | This paper demonstrates the existence of adverse selection in the group insurance market with no individual choice. We provide evidence against the “conventional wisdom” that group insurance mitigates adverse selection because of the mixture of high risks and low risks. We show, however, that asymmetric learning effects mitigate the group adverse selection after a few policy periods. |
| Keywords: | Information Asymmetry, Asymmetric Learning, Insurance Decision, Group Health Insurance, Critical Illness Insurance |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2014:03&r=cta |
| By: | Peters, Michael |
| Abstract: | The recent literature on competing mechanisms has devoted a lot of effort at understanding a very complex and abstract issue. In particular, an agent's type in a competitive environment is hard to conceptualize because it depends on information the agent has about what is going on in the rest of the market. This paper explains why this such an important practical problem and illustrates how the literature has 'solved' it. |
| Date: | 2014–02–19 |
| URL: | http://d.repec.org/n?u=RePEc:ubc:pmicro:michael_peters-2014-7&r=cta |
| By: | Johannes Horner; Satoru Takahashi; Nicolas Vieille |
| Date: | 2014–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000881&r=cta |
| By: | G. Chiesa |
| Abstract: | Securitization performs two functions. One refers to the risk allocation between the bank and outside investors; the other consists of creating transferable/liquid securities. A key ingredient of liquid/claimtransferability is bankruptcy remoteness - the insolvency of the sponsor (the loan originator) has no impact on the securities. We explore the implications of bankruptcy remoteness on risk allocation and regulatory/policy issues. Under traditional banking, when debt/deposits coexist with securitization, bankruptcy remoteness amounts to: i) a seniority structure when debt/deposits (the claim that insist on the bank as a whole) have the lowest priority; ii) the bank finds it optimal to grant securities maximum protection - securitization without risk transfer. This constrains incentive-compatible lending below the social optimum, whenever at an optimal allocation not all risk bears on the bank. Policies that implement the social optimum are derived. |
| JEL: | G21 G28 K22 D86 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:bol:bodewp:wp928&r=cta |
| By: | Florian Ederer; Richard Holden; Margaret A. Meyer |
| Date: | 2014–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:786969000000000875&r=cta |