nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒07‒13
eighteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. When Ignorance is Bliss* : Information Asymmetries Enhance Prosocial Behavior in Dicator Games By Winschel, Evguenia; Zahn, Philipp
  2. Search and Retirement under Asymmetric Information By Bi, Sheng; Langot, François
  3. Information acquisition and learning from prices over the business cycle By BjÖrn Ohl; Taneli Mäkinen
  4. Moral Hazard in Repeated Procurement of Services By Esteve González, Patrícia
  5. Optimal Security Design under Asymmetric Information and Profit Manipulation By Koufopoulos, Kostos; Kozhan, Roman; Trigilia, Giulio
  6. Economic Effects of Risk Classification Bans By Georges Dionne; Casey G. Rothschild
  7. Modern regulation of firms in developing countries By Jellal, Mohamed
  8. Why prediction markets work : The role of information acquisition and endogenous weighting By Siemroth, Christoph
  9. Social structure bureaucracy and corruptionA By Jellal, Mohamed
  10. Incentives and optimal antitrust policy By Jellal, Mohamed; Souam, Said
  11. Bargaining and collusion in a regulatory relationship By Fiocco, Raffaele; Gilli, Mario
  12. Optimal Prudential Regulation of Banks and the Political Economy of Supervision By Thierry Tressel; Thierry Verdier
  13. Does one word fit all? The asymmetric effects of central banks' communication policy By Bennani, Hamza
  14. Markovian Nash equilibrium in financial markets with asymmetric information and related forward-backward systems By Umut \c{C}etin; Albina Danilova
  15. Risk Taking and Information Aggregation in Groups By Spiros Bougheas; Jeroen Nieboerr; Martin Sefton
  16. Corporate Efficiency, Credit Status and Investment By Quader, Manzur; Taylor, Karl
  17. Fee-Setting Mechanisms: On Optimal Pricing by Intermediaries and Indirect Taxation By Loertscher, Simon; Niedermayer, Andras
  18. Pricing the Cost of Deposit Insurance and Assessing Moral Hazard Effect: Evidence from Banking Sector in Sudan By Onour, Ibrahim

  1. By: Winschel, Evguenia; Zahn, Philipp
    Abstract: In most laboratory experiments concerning prosocial behavior subjects are fully informed how their decision influences the payoff of other players. Outside the laboratory, however, individuals typically have to decide without such detailed knowledge. To asses the effect of information asymmetries on prosocial behavior, we conduct a laboratory experiment with a simple non-strategic interaction. A dictator has only limited knowledge about the benefits his prosocial action generates for a recipient. We observe subjects with heterogenous social preferences. While under symmetric information only individuals with the same type of preferences transfer, under asymmetric information different types transfer at the same time. As a consequence and the main finding of our experiment, uninformed dictators behave more prosocially than informed dictators.
    Keywords: Asymmetric Information , Prosocial Behavior , Efficiency Concern , Inequality Aversion , Dictator Game
    JEL: D82 C91
    Date: 2014
  2. By: Bi, Sheng (Paris School of Economics); Langot, François (University of Le Mans)
    Abstract: We consider a labor market where the competitive search equilibrium is inefficient due to asymmetrical information. At the time when firms commit to specific hiring costs, workers hold private information on their intention of entering into retirement before the termination of the contract. When retirement is an event which occurs exogenously and information is complete, the long term employment relationship is preferred by the risk adverse workers. This implies that firms must implement a screening process when the information is asymmetric. We show that the optimal separating contract (an ascending wage profile) distorts the allocation of the workers who will retire later (the 'good' workers) in order to prevent the workers who will retire early (the 'bad' workers) from applying for these jobs. Secondly, we endogenize the retirement decision by considering two cases: an ex ante or ex post heterogeneity. In these two cases, we show that a separating equilibrium always exists, whereby good workers accept an ascending wage profile in order to make themselves differentiate from the 'bad' workers. These asymmetries in the information lead to an excess of retirement compared to the full information economy. Finally, in the case of ex post heterogeneity, we are able to show that the employment rate is unambiguously lower.
    Keywords: competitive search equilibrium, separating equilibrium, retirement
    JEL: D82 D86 J14 J26 J64
    Date: 2014–06
  3. By: BjÖrn Ohl (Narodowy Bank Polski); Taneli Mäkinen (Banca d'Italia.)
    Abstract: We study firms’ incentives to acquire costly information in booms and recessions to understand the role of endogenous information in explaining business cycles. We find that when the economy has been in a recession in the previous period, and firms enter the current period with a pessimistic belief, the incentive to acquire information is stronger than when the economy has been in a boom and firms share an optimistic belief. The cyclicality of the aggregate learning outcome is moderated by the price system, which transmits information from informed to uninformed firms, thus dampening information demand. Though learning from equilibrium prices acts to stabilize fluctuations by discouraging information acquisition, it can be welfare-enhancing to make information prohibitively costly to obtain.
    Keywords: information acquisition, rational expectations equilibrium, asymmetric information, strategic substitutability
    JEL: D51 D83 E32
    Date: 2014
  4. By: Esteve González, Patrícia
    Abstract: This paper analyzes repeated procurement of services as a four-stage game divided into two periods. In each period there is (1) a contest stage à la Tullock in which the principal selects an agent and (2) a service stage in which the selected agent provides a service. Since this service effort is non-verifiable, the principal faces a moral hazard problem at the service stages. This work considers how the principal should design the period-two contest to mitigate the moral hazard problem in the period-one service stage and to maximize total service and contest efforts. It is shown that the principal must take account of the agent's past service effort in the period-two contest success function. The results indicate that the optimal way to introduce this `bias' is to choose a certain degree of complementarity between past service and current contest efforts. This result shows that contests with `additive bias' (`multiplicative bias') are optimal in incentive problems when effort cost is low (high). Furthermore, it is shown that the severity of the moral hazard problem increases with the cost of service effort (compared to the cost of contest effort) and the number of agents. Finally, the results are extended to more general contest success functions. JEL classification: C72; D82 Key words: Biased contests; Moral Hazard; Repeated Game; Incentives.
    Keywords: Jocs no-cooperatius (Matemàtica), 33 - Economia,
    Date: 2014
  5. By: Koufopoulos, Kostos (University of Pireaus, Department of Banking and Financial Management); Kozhan, Roman (Warwick Business School); Trigilia, Giulio (Department of Economics, University of Warwick)
    Abstract: We consider a model of external financing under ex ante asymmetric information and profit manipulation (non verifability). Contrary to conventional wisdom, the optimal contract is not standard debt, and it is not monotonic. Instead, it resembles a contingent convertible (CoCo) bond. In particular: (i) if the profit manipulation and/or adverse selection are not severe, there exists a unique separating equilibrium in CoCos; (ii) in the intermediate region, if the distribution of earnings is unbounded above there exists a unique pooling equilibrium in CoCos, otherwise debt might be issued but it is never the unique equilibrium; (iii) finally, if profit manipulation is severe, there is no financing. These findings suggest that the standard monotonicity constraint exogenously imposed in the security design literature must be reconsidered. Crucially, profit manipulation is part of the optimal contract, and non-monotonic, convertible securities mitigate the asymmetric information problem. We discuss milestone payments in venture capital as an application. Key words: Security design ; nancial innovation ; capital structure ; asymmetric information ; venture capital
    Date: 2014
  6. By: Georges Dionne; Casey G. Rothschild
    Abstract: Risk classification refers to the use of observable characteristics by insurers to group individuals with similar expected claims, to compute the corresponding premiums, and thereby to reduce asymmetric information. Permitting risk classification may reduce informational asymmetry-induced adverse selection and improve insurance market efficiency. It may also have undesirable equity consequences and undermine the implicit insurance against reclassification risk which legislated restrictions on risk classification could provide. We use a canonical insurance market screening model to survey and to extend the risk classification literature. We provide a unified framework for analyzing the economic consequences of legalized vs. banned risk classification, both in static-information environments and in environments in which additional information can be learned, by either side of the market, through potentially costly tests.
    Keywords: Adverse selection, Classification risk, Classification bans, Equity, Efficiency
    JEL: D82 I13 I14 I18 I38 G22
    Date: 2014
  7. By: Jellal, Mohamed
    Abstract: In developing countries, empirical evidence suggests that labor unions entail a positive wage gap for unionized workers, in particular in monopolistic and publicly controlled firms. In this paper, we analyze how the presence of a labor union affects the regulation of a monopoly under asymmetric information. Since part of the informational rent left to the monopolistic firm benefits to the syndicate, we prove that the regulator is induced to lower the rent when the union has a large bargaining power. The net consumers' surplus can either increase or decrease with the firm's bargaining power depending on the firm's effciency type
    Keywords: Asymmetric information, labor union, monopolistic firm, regulation , incentives
    JEL: D42 D82 J51
    Date: 2014–07–08
  8. By: Siemroth, Christoph
    Abstract: In prediction markets, investors trade assets whose values are contingent on the occurrence of future events, like election outcomes. Prediction market prices have been shown to be consistently accurate forecasts of these outcomes, but we don't know why. I formally illustrate an information acquisition explanation. Traders with more wealth to invest have stronger incentives to acquire information about the outcome, thus tend to have better forecasts. Moreover, their trades have larger weight in the market. The interaction implies that a few well-endowed traders can move the asset price toward the true value. One implication for institutions aggregating information is to put more weight on votes of agents with larger stakes, which improves on equal weighting, unless prior distribution accuracy and stakes are negatively related.
    Keywords: Information Acquisition , Information Aggregation , Forecasting , Futures Markets , Prediction Markets
    JEL: D83 D84 G10
    Date: 2014
  9. By: Jellal, Mohamed
    Abstract: Using the principal-agent- supervisor paradigm, this paper examines the occurrence of collusion in a setting where the principal has no information about the supervisor and the agent does not necessarily know the supervisor’s preferences. We formally prove the occurrence of collusion is more likely when the agent has information about the preferences of the supervisor. This result suggests that corruption, which is likely to emerge in long term social reciprocal relationships between public officials and potential bribery may be reduced by the means of bureaucratic staff rotation. Evidence from an experimental study supports this proposition and our theoretical finding.
    Keywords: Principal-agent-supervisor, collusion, staff rotation, social structure
    JEL: A13 D82 K42
    Date: 2014–07–06
  10. By: Jellal, Mohamed; Souam, Said
    Abstract: We analyze a model where an antitrust authority delegates to an audit inspector the mission of gathering the sufficient information to condemn a cartel. The authority has two instruments at her disposal: rewarding the inspector with a proportion of the collected fine or providing him with information which enhances the probability of the success of the prosecution. More precisely, we explore the efficiency consequences of a contest between the audit inspector and the cartel. Both of them bid to win the contest by expending efforts. We show that the race issue depends positively on the financial incentives proposed to the inspector but the impact of an increase of the level of the fine, to be paid once an illegal agreement is detected, is ambiguous. Moreover, we show that the optimal combination of the two instruments consists in two regimes. When the marginal cost of providing the relevant information is relatively high, the antitrust authority equally shares the collected fine and does not provide the inspector with any information. Conversely, when this marginal cost is relatively small, the authority uses the two instruments. She has to provide him with the maximum level of information consistent with winning the contest with certainty.
    Keywords: Antitrust Enforcement, Incentives, Collusion, Moral Hazard, Contest
    JEL: K2 K21 K42 L4 L44
    Date: 2014–07–10
  11. By: Fiocco, Raffaele; Gilli, Mario
    Abstract: We investigate regulation as the outcome of a bargaining process between a regulator and a regulated firm. The regulator is required to monitor the firm’s costs and reveal its information to a political principal (Congress). In this setting, we explore the scope for collusion between the regulator and the firm, which results in the manipulation of the regulator’s report on the firm’s costs to Congress. The firm’s bene.t of collusion arises from the higher price the efficient firm is allowed to charge when the regulator reports that it is inefficient. However, a higher price reduces the gains from trade the parties can share in the bargaining process. As a result of this trade-off, the efficient firm has a stake in collusion only if the regulator’s bargaining power in the regulatory relationship is relatively high. Then, we derive the optimal institutional response to collusion and characterize the conditions under which allowing collusion is desirable.
    Keywords: asymmetric information; auditing; bargaining; collusion; regulation.
    JEL: D73 D82 L51
    Date: 2014
  12. By: Thierry Tressel; Thierry Verdier
    Abstract: We consider a moral hazard economy in banks and production to study how incentives for risk taking are affected by the quality of supervision. We show that low interest rates may generate excessive risk taking. Because of a pecuniary externality, the market equilibrium may not be optimal and there is a need for prudential regulation. We show that the optimal capital ratio depends on the macro-financial cycle, and that, in presence of production externalities, it should be complemented by a constraint on asset allocation. We show that the political process tends to exacerbate excessive risk taking and credit cycles.
    Keywords: Bank supervision;Bank capital;Regulatory forbearance;Prudential bank regulations;Political economy;Moral hazard;Banking Regulation, Regulatory Forbearance, Political Economy.
    Date: 2014–05–28
  13. By: Bennani, Hamza
    Abstract: This paper provides an extension of Morris and Shin's (2002) model (Morris, S., Shin, H. S. (2002). Social value of public information. The American Economic Review, 92(5), 1521-1534.). It considers an "interpretation bias" of the public signal sent by central banks such as the ECB or the FED. It is shown that such a bias is detrimental and should be considered when central banks implement their communication policy.
    Keywords: central bank communication, monetary policy, public information.
    JEL: C71 C78 E52 E58
    Date: 2014–07–07
  14. By: Umut \c{C}etin; Albina Danilova
    Abstract: We show the existence of a continuous-time Nash equilibrium in a financial market with risk averse market makers and an informed trader with a private information. The unwillingness of market makers to bear risk causes the informed trader to absorb large shocks in their inventories. The informed trader's optimal strategy is to drive the market price to its fundamental value while participating in the risk sharing with the market makers. The optimal strategies of the agents turn out to be solutions of a forward-backward system of partial and stochastic differential equations. In particular, the price set by the market makers is the solution to a non-standard `quadratic' backward stochastic differential equation.
    Date: 2014–07
  15. By: Spiros Bougheas (School of Economics, University of Nottingham); Jeroen Nieboerr (Department of Social Policy, London School of Economics and Political Science); Martin Sefton (School of Economics, University of Nottingham)
    Abstract: We report an experiment examining risk taking and information aggregation in groups. Group members come to the table with an individual preference for a choice under risk, based on privately received information, and can share this information with fellow group members. They then make a decision under risk on behalf of the group using a random dictatorship mechanism, as well as an individual decision. Our analysis reveals that, while the behavior of many subjects is consistent with Bayesian rationality, a considerable number of subjects exhibited ‘reverse confirmation bias’: they place less weight on information from others that agrees with their private signal and more weight on conflicting information. We also observe a striking degree of consensus: in most groups all members made the same choice on behalf of the group. The pattern of individual choices after group deliberation suggests that the high degree of group consensus is due to persuasive arguments of other group members.
    Keywords: Group behavior; Teams; Decision Making; Risk; Experiment
  16. By: Quader, Manzur (Chittagong Independent University); Taylor, Karl (University of Sheffield)
    Abstract: Using a panel of 1122 UK firms listed on the London Stock Exchange over the period of 1981 to 2009, endogenous switching regression models (SRM) incorporating a predicted corporate efficiency index are estimated in this paper in an effort to clarify the role of cash flow in examining the impact of capital-market imperfections. It is revealed that a firm's constrained credit status changes with the improvement of its efficiency. The results further reveal that financially constrained firm's investment is comparatively more sensitive to cash flow, but this sensitivity is negatively and significantly related with corporate efficiency. These results point to the fact that high investment sensitivity to cash flow may not be solely driven by measurement error in investment opportunity, but may still be interpreted as a consequence of imperfect substitutability between internal and external financing arising from the capital market imperfections.
    Keywords: asymmetric information, financial constraints, switching regression
    JEL: C34 D92 G14 L21
    Date: 2014–06
  17. By: Loertscher, Simon; Niedermayer, Andras
    Abstract: Mechanisms according to which private intermediaries or governments charge transaction fees or indirect taxes are prevalent in practice. We consider a setup with multiple buyers and sellers and two-sided independent private information about valuations. We show that any weighted average of revenue and social welfare can be maximized through appropriately chosen transaction fees and that in increasingly thin markets such optimal fees converge to linear fees. Moreover, fees decrease with competition (or the weight on welfare) and the elasticity of supply but decrease with the elasticity of demand. Our theoretical predictions fit empirical observations in several industries with intermediaries.
    Keywords: brokers , applied mechanism design , linear commission fees , optimal indirect mechanisms , auction houses
    JEL: C72 C78 L13
    Date: 2014
  18. By: Onour, Ibrahim
    Abstract: The primary aim of this paper to evaluate the cost of deposit insurance premium and assess moral hazard effect in the banking sector in Sudan. The analysis of moral hazard in this paper is based on two types of risks, credit default risk, measured as the ratio of non-performing loans to the total size of loans for each bank, and operational risk measured as technical inefficiency. The findings of the research indicate there is a positive association between insurance coverage premium and increase in each of these two risks, implying evidence of moral hazard effect. A policy implication of this result is that the moral hazard behavior in the banking sector can be mitigated by changing the current policy of flat rate deposit insurance premium to risk based insurance premium policy.
    Keywords: Deposit; Insurance; Moral hazard; Risk.
    JEL: G12 G2
    Date: 2013

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