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on Contract Theory and Applications |
| By: | Ennio Bilancini; Leonardo Boncinelli |
| Abstract: | In this paper we study how the presence of a small amount of noise in signaling games impacts on the likelihood of separation and, hence, the likelihood of information transmission. We consider a variant of a standard signaling model where a source of exogenous noise affects the signals that agents observe. Noise, even if tiny, poses tight constraints on beliefs by making all signals possible along the equilibrium path. We show that separation cannot be obtained in equilibrium if the noise is small enough - but not nil. In particular, for any separating profile, if noise is suciently small then the sender has a profitable deviation consisting of a signal reduction. Instead, the pooling equilibrium where all sender's types pool on the minimum signal always exists, independently of the level of noise. These results provide a new source of interest in pooling equilibria. |
| Keywords: | noise; separation; pooling; information transmission. |
| JEL: | D82 D83 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:101&r=cta |
| By: | Ennio Bilancini; Leonardo Boncinelli |
| Abstract: | In this paper we identify a novel reason why signaling may fail to separate types, which is specific to cases where the receiver has to incur a cost to acquire the signal sent by the sender. If the receiver chooses not to incur the acquisition cost, then all sender's types find it optimal to pool on the least costly signal; also, if all sender's types pool on the least costly signal, then the receiver finds it optimal not to incur the acquisition cost. This kind of coordination failure makes the resulting pooling equilibrium extremely robust, even when costs of signal acquisition are very small. Also, pooling is shown to be robust to all refinements based on out-of-equilibrium beliefs, even when the sender can engage in further signaling that can act as an "invitation" to acquire the main signal, and when acquisition costs are smooth and depend on the receiver's effort to acquire the signal. These results provide a new source of interest in pooling equilibria. |
| Keywords: | costly acquisition, pooling, equilibrium renements, forward induction |
| JEL: | D82 D83 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:100&r=cta |
| By: | Marco Buso (University of Padova) |
| Abstract: | This paper studies the benet coming from bundling two sequential activities in a context of Public Private Partnerships (PPPs). Differently from previous literature, I introduce a source of asymmetric information in the form of an externality parameter linking the building stage with subsequent operational activity. Within this framework, PPPs allow the government to extract private information about the sign and magnitude of the externality parameter and to to minimize the informational rents needed to incentivize the builder's effort. Our results suggest how PPPs can become those commitment devices that force governments to define more coherent and informed plans that optimize the first period welfare, improving investment to reduce unexpected ex post costs (cost overruns). |
| Keywords: | agency theory; information externality; sequential investment; bundling. |
| JEL: | D86 L33 H11 H57 C61 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:pad:wpaper:0176&r=cta |
| By: | Fraser, Rob; Hussein, Mohamud |
| Abstract: | This paper analyses an incentive payment-based approach to improving food safety in the supply chain. It develops a principal-agent model of the food supply chain in which the principal offers heterogeneous agents a payment to implement costly additional practices to improve food safety. It is shown that the presence or absence of the moral hazard problem affects the balance of benefits and costs from broadening the scope of the system from just lower cost larger agents to include higher cost smaller agents, thereby affecting the optimal design of the system. In particular, broadening the scope of the system to include smaller agents by increasing the size of the incentive payment can ameliorate the moral hazard problem among larger agents to the extent that this more costly approach is socially optimal. |
| Keywords: | incentive payments, moral hazard, food safety, supply chain, Demand and Price Analysis, Food Consumption/Nutrition/Food Safety, D82, L51, Q18, |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aesc14:170525&r=cta |
| By: | Ennio Bilancini; Leonardo Boncinelli |
| Abstract: | We develop a model of persuasion where, consistent with the psychological literature on dual process theory, the persuadee has to sustain a cognitive effort - the elaboration cost - in order to fully and precisely elaborate information. The persuader makes an offer to the persuadee and, aware that she is a dual process reasoner, also sends her a costly signal - the reference cue - which refers the oer to a category of offers whose average quality is known by the persuadee. Initially, the actual quality of the offer by the persuader is hidden to the persuadee, while the signal is visible. Then, the persuadee can either rely on cheap low elaboration and form expectations on the basis of the signal - thinking coarsely, i.e., by category - or engage in costly high elaboration to attain knowledge of the actual quality of the offer. This signaling setup allows us to keep the assumption that agents are both rational and Bayesian and, at the same time, to match many of the findings emphasized by well established psychological models of persuasion - such as the Elaboration Likelihood Model and the Heuristic-Systematic Model. In addition, the model provides novel theoretical results such as the possibility of separating equilibria that do not rely on the single-crossing property and, in particular, the emergence of a new phenomenon that we name reverse-signaling, where high types send low signals and low types send high signals. |
| Keywords: | persuasion, coarse reasoning, peripheral and central route, heuristic and systematic reasoning, reverse-signaling, counter-signaling. |
| JEL: | D01 D82 D83 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:mod:recent:102&r=cta |
| By: | Jak\v{s}a Cvitani\'c; Dylan Possama\"i; Nizar Touzi |
| Abstract: | We consider a contracting problem in which a principal hires an agent to manage a risky project. When the agent chooses volatility components of the output process and the principal observes the output continuously, the principal can compute the quadratic variation of the output, but not the individual components. This leads to moral hazard with respect to the risk choices of the agent. Using a recent theory of singular changes of measures for Ito processes, we formulate a principal-agent problem in this context, and solve it in the case of CARA preferences. In that case, the optimal contract is linear in these factors: the contractible sources of risk, including the output, the quadratic variation of the output and the cross-variations between the output and the contractible risk sources. Thus, like sample Sharpe ratios used in practice, path-dependent contracts naturally arise when there is moral hazard with respect to risk management. We also provide comparative statistics via numerical examples, showing that the optimal contract is sensitive to the values of risk premia and the initial values of the risk exposures. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1406.5852&r=cta |
| By: | Agarwal, Vikas; Mullally, Kevin Andrew; Tang, Yuehua; Yang, Baozhong |
| Abstract: | We examine the impact of mandatory portfolio disclosure by mutual funds on stock liquidity and fund performance. We develop a model of informed trading with disclosure and test its predictions using the SEC regulation in May 2004 requiring more frequent disclosure. Stocks with higher fund ownership, especially those held by more informed funds or subject to greater information asymmetry, experience larger increases in liquidity after the regulation change. More informed funds, especially those holding stocks with greater information asymmetry, experience greater performance deterioration after the regulation change. Overall, mandatory disclosure improves stock liquidity but imposes costs on informed investors. -- |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfrwps:1304r&r=cta |
| By: | Tri Vi Dang (Department of Economics, Columbia University); Gary Gorton (Department of Economics, Yale University); Beng Holmstrom (Department of Economics, MIT and NBER); Guillermo Ordonez (Department of Economics, University of Pennsylvania) |
| Abstract: | Banks are optimally opaque institutions. They produce debt for use as a transaction medium (bank money), which requires that information about the backing assets – loans – not be revealed, so that bank money does not fluctuate in value, reducing the efficiency of trade. This need for opacity conflicts with the production of information about investment projects, needed for allocative efficiency. Intermediaries exist to hide such information, so banks select portfolios of information-insensitive assets. For the economy as a whole, firms endogenously separate into bank finance and capital market/stock market finance depending on the cost of producing information about their projects. |
| Keywords: | Banks vs. Capital Markets, Financial Intermediation, Information and Opacity, Optimal Portfolio, Private Money |
| JEL: | G21 D82 G11 G14 E44 |
| Date: | 2014–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-022&r=cta |
| By: | Christoph Kuzmics (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | Motivated by trying to better understand the norms that govern pedestrian traffic, I study symmetric two-player coordination games with independent private values. The strategies of "always pass on the left" and "always pass on the right" are always equilibria of this game. Some such games, however, also have other (pure strategy) equilibria with a positive likelihood of mis-coordination. Perhaps surprisingly, in some such games, these Pareto-inefficient equilibria, with a positive likelihood of mis-coordination, are the only evolutionarily stable equilibria of the game. |
| Keywords: | incomplete information, continuously stable strategy, CSS, evolutionary stability, best-response dynamics |
| JEL: | C72 C73 D82 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:501&r=cta |
| By: | Jan Zabojnik (Queen's University) |
| Abstract: | Standard principal-agent theory predicts that large firms should not use employee stock options and other stock-based compensation to provide incentives to non-executive employees. Yet, business practitioners appear to believe that stock-based compensation improves incentives, and mounting empirical evidence points to the same conclusion. This paper provides an explanation for why stock-based incentives can be effective. In the model of this paper, employee stock options complement individual measures of performance in inducing employees to invest in firm-specific knowledge. In some situations, a contract that only consists of options is more efficient than a contract based solely on individual performance. |
| Keywords: | Stock-based Compensation, Employee Stock Options, Optimal Incentive Contracts, Firm-specific Knowledge |
| JEL: | D86 J33 M52 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1325&r=cta |
| By: | Rosato, Antonio |
| Abstract: | Empirical evidence from sequential auctions shows that prices of identical goods tend to decline between rounds. In this paper, I show how expectations-based reference-dependent preferences and loss aversion can rationalize this phenomenon. I analyze two-round sealed-bid auctions with symmetric bidders having independent private values and unit demand. Equilibrium bids in the second round are history-dependent and subject to a "discouragement effect": the higher the winning bid in the first auction is, the less aggressive the behavior of the remaining bidders in the second auction. When choosing his strategy in the first round, however, a bidder conditions his bid on being pivotal and hence expects not to be discouraged. Equilibrium behavior, therefore, leads the winner of the first round to overestimate the bid of his highest opponent and hence the next-round price so that equilibrium prices decline. Moreover, sequential and simultaneous auctions are not bidder-payoff equivalent nor revenue equivalent. |
| Keywords: | Reference-Dependent Preferences; Loss Aversion; Sequential Auctions; Afternoon Effect. |
| JEL: | D03 D44 D81 D82 |
| Date: | 2014–06–21 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:56824&r=cta |
| By: | DELPIERRE Matthieu; VERHEYDEN Bertrand; WEYNANTS Stéphanie |
| Abstract: | Empirical evidence on developing countries highlights that poor farm-households are less keen to adopt high risk / high return technologies than rich households. Yet, they tend to be more vulnerable to income shocks than the rich. This paper develops a model of informal risk-sharing with endogenous risk-taking which provides a rationale for these observations. In our framework, informal risk-sharing is incomplete due to risk externalities, which leads to moral hazard. We compare the .rst best and second best to a decentralized bargaining process, where the lack of coordination ampli.es moral hazard. The analysis of group composition yields counterintuitive results. First, if groups are homogeneous, poor groups share less risks than rich groups even though the rich take more risks. Second, the insurance level of rich households decreases in the presence of poor households, potentially making them reluctant to share risk with poorer households. |
| Keywords: | Risk-taking; Risk-sharing; Risk externality; Moral hazard |
| JEL: | O12 O13 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:irs:cepswp:2014-08&r=cta |