nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒07‒28
seventeen papers chosen by
Simona Fabrizi
Massey University

  1. Motivate and Select: Relational Contracts with Persistent Types By Radoslawa Nikolowa
  2. Adverse Selection, Moral Hazard and the Demand for Medigap Insurance By Michael P. Keane; Olean Stavrunova
  3. Corruption, Intimidation, and Whistle-blowing: a Theory of Inference from Unverifiable Reports By Sylvain Chassang; Gerard Padró i Miquel
  4. Delayed-response strategies in repeated games with observation lags By Fudenberg, Drew; Ishii, Yuhta; Kominers, Scott Duke
  5. Diaspora famille transferts et contrat implicite By Jellal, Mohamed
  6. One-Leader and Multiple-Follower Stackelberg Games with Private Information By Tomoya Nakamura
  7. Financial Contracting with Tax Evaders By Philipp Meyer-Brauns
  8. Bailouts and Financial Fragility By Todd Keister
  9. When Incentives Matter Too Much: Explaining Significant Responses to Irrelevant Information By Thomas Ahn; Jacob L. Vigdor
  10. Audits as Signals By Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
  11. Good Disclosure, Bad Disclosure By Liyan Yang; Itay Goldstein
  12. Bank Risk Within and Across Equilibria By Itai Agur
  13. Franchise value and risk-taking in modern banks By Natalya Martynova; Lev Ratnovski; Razvan Vlahu
  14. On the continuous equilibria of affiliated-value, all-pay auctions with private budget constraints By Li, Fei; Kotowski, Maciej Henryk
  15. Bribing in First-Price Auctions: Corrigendum By Kotowski, Maciej Henryk; Rachmilevitch, Shiran
  16. Diaspora transferts et signal de richesse By Jellal, Mohamed
  17. Auditor choice, audit fees and principalprincipal Conflict By Chiraz Ben Ali; Cédric Lesage

  1. By: Radoslawa Nikolowa (Queen Mary University of London)
    Abstract: We develop a model of relational contracts with moral hazard and asymmetric persistent information about an employee's type. We find that the form of the optimal contract depends on the job characteristics as well as the distribution of employees' talent. Bonus contracts are more likely to be adopted in complex jobs and when high talent is not too common or too rare. Firms with 'normal' jobs are more likely to adopt termination contracts. In labor market equilibrium, different contracts may be adopted by ex ante identical firms. Hence, we offer an explanation for the co-existence of different employment systems within the same industry.
    Keywords: Relational contracts, Job characteristics, Employment systems, Labor market segmentation
    JEL: D82 M5 L14
    Date: 2014–07
  2. By: Michael P. Keane (Nuffield College, University of Oxford); Olean Stavrunova (University of Technology, Sydney, Australia)
    Abstract: The size of adverse selection and moral hazard eects in health insurance markets has important policy implications. For example, if adverse selection eects are small while moral hazard eects are large, conventional remedies for ineciencies created by adverse selection (e.g., mandatory insurance enrolment) may lead to substantial increases in health care spending. Unfortunately, there is no consensus on the mag- nitudes of adverse selection vs. moral hazard. This paper sheds new light on this important topic by studying the US Medigap (supplemental) health insurance market. While both adverse selection and moral hazard eects of Medigap have been studied separately, this is the rst paper to estimate both in a unied econometric framework. Our results suggest there is adverse selection into Medigap, but the eect is small. A one standard deviation increase in expenditure risk raises the probability of insur- ance purchase by 0.055. In contrast, our estimate of the moral hazard eect is much larger. On average, Medigap coverage increases health care expenditure by 24%.
    Keywords: Health insurance, adverse selection, moral hazard, health care expendi- ture
    JEL: I13 D82 C34 C35
    Date: 2014–07–08
  3. By: Sylvain Chassang; Gerard Padró i Miquel
    Abstract: We consider a game between a principal, an agent, and a monitor in which the principal would like to rely on messages by the monitor to target intervention against a misbehaving agent. The difficulty is that the agent can credibly threaten to retaliate against likely whistleblowers in the event of an intervention. In this setting intervention policies that are very responsive to the monitor's message provide very informative signals to the agent, allowing him to shut down communication channels. Successful intervention policies must garble the information provided by monitors and cannot be fully responsive. We show that even if hard evidence is unavailable and monitors have heterogeneous incentives to (mis)report, it is possible to establish robust bounds on equilibrium corruption using only non-verifiable reports. Our analysis suggests a simple heuristic to calibrate intervention policies: first get monitors to complain, then scale up enforcement while keeping the information content of intervention constant.
    JEL: D73 D82 D86
    Date: 2014–07
  4. By: Fudenberg, Drew; Ishii, Yuhta; Kominers, Scott Duke
    Abstract: We extend the folk theorem of repeated games to two settings in which players' information about others' play arrives with stochastic lags. In our first model, signals are almost-perfect if and when they do arrive, that is, each player either observes an almost-perfect signal of period-t play with some lag or else never sees a signal of period-t play. The second model has the same lag structure, but the information structure corresponds to a lagged form of imperfect public monitoring, and players are allowed to communicate via cheap-talk messages at the end of each period. In each case, we construct equilibria in “delayed-response strategies,†which ensure that players wait long enough to respond to signals that with high probability all relevant signals are received before players respond. To do so, we extend past work on private monitoring to obtain folk theorems despite the small residual amount of private information.
    Date: 2014
  5. By: Jellal, Mohamed
    Abstract: In this paper, we consider a two-period model of migration and remittances as implicit contract in a context of asymmetric information. Our model offers new theoretical findings with respect to the previous literature on the main determinants of remittances. According to self-interest thesis, migrants make transfers in order to insure themselves against the risk of migration return. The low-skilled migrants are more likely to return to home country when informational symmetry is restored, then among others things, their optimal transfers is a decreasing function of the migrant's skill level and increasing function of the family’s wealth level
    Keywords: Diaspora, Education, Transfers, Incomplete Information, Implicit Contrat
    JEL: D82 D86 F22 F24 I25
    Date: 2014–07–17
  6. By: Tomoya Nakamura
    Abstract: This study analyzes one-leader and multiple-follower Stackelberg games with private information regarding demand uncertainty. In the equilibrium of the Stackelberg games, a leader's private information becomes public information among followers. This study demonstrates that the strategic relationship between the leader and each follower is determined by the weight on public information regarding a follower's estimation of demand uncertainty. If the weight is sufficiently low (high), then the relationship is a strategic substitute (complement), and the leader has a first-mover (dis)advantage, respectively. In the case of strategic complementarity, the leader can exit from a market. The threshold is determined by the intensity of Cournot competition among the followers.
    Date: 2014–07
  7. By: Philipp Meyer-Brauns
    Abstract: This paper derives the optimal financial contract when an entrepreneur can evade taxes in a model of costly state verification. In contrast to the previous literature, we find that standard debt contracts are not optimal when tax evasion is possible. Instead, the optimal contract is debt-like only for very low and very high profit realizations, and features a constant repayment and verification of returns in an intermediate range. This occurs because the entrepreneur has to be given a positive rent even under verification in order to not abuse her limited liability protection for excessive tax evasion activities.
    Keywords: financial contracting, security design, corporate tax evasion, costly state verification
    JEL: D82 D86 G3 H25 H26
    Date: 2014–01
  8. By: Todd Keister (Rutgers University)
    Abstract: Should policy makers be prevented from bailing out investors in the event of a crisis? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the policy maker will respond by using public resources to augment the private consumption of those investors facing losses. The anticipation of such a “bailout” distorts ex ante incentives, leading intermediaries to choose arrangements with excessive illiquidity and thereby increasing financial fragility. Prohibiting bailouts is not necessarily desirable, however: while it induces intermediaries to become more liquid, it may nevertheless lower welfare and leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can both improve the allocation of resources and promote financial stability.
    Keywords: bank runs, bailouts, moral hazard, financial regulation
    JEL: G28
    Date: 2014–01–29
  9. By: Thomas Ahn; Jacob L. Vigdor
    Abstract: When economic agents make decisions on the basis of an information set containing both a continuous variable and a discrete signal based on that variable, theory suggests that the signal should have no bearing on behavior conditional on the variable itself. Numerous empirical studies, many based on the regression discontinuity design, have contradicted this basic prediction. We propose two models of behavior capable of rationalizing this observed behavior, one based on information acquisition costs and a second on learning and imperfect information. Using data on school responses to discrete signals embedded in North Carolina’s school accountability system, we find patterns of results inconsistent with the first model but consistent with the second. These results imply that rational responses to policy interventions may take time to emerge; consequently evaluations based on short-term data may understate treatment effects.
    JEL: D03 I2 J33
    Date: 2014–07
  10. By: Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
    Abstract: A broad array of law enforcement strategies, from income tax to bank regulation, involve self-reporting by regulated agents and auditing of some fraction of the reports by the regulating bureau. Standard models of self-reporting strategies assume that although bureaus only have estimates of the of an agent’s type, agents know the ability of bureaus to detect their misreports. We relax this assumption, and posit that agents only have an estimate of the auditing capabilities of bureaus. Enriching the model to allow two-sided private information changes the behavior of bureaus. A bureau that is weak at auditing, may wish to mimic a bureau that is strong. Strong bureaus may be able to signal their capabilities, but at a cost. We explore the pooling, separating, and semi-separating equilibria that result, and the policy implications. Important possible outcomes are that a cap on penalties increases compliance, audit hit rates are not informative of the quality of bureau behavior, and by mimicking strong bureaus even weak bureaus can induce compliance.
    Date: 2014
  11. By: Liyan Yang (Joseph L. Rotman School of Management); Itay Goldstein (University of Pennsylvania)
    Abstract: We study the real-efficiency implications of public information in a model where relevant decision makers learn from the financial market to guide their actions. Whether disclosure is "good" or "bad" depends on the interactions between two effects on real decision makers' forecast. Disclosure has a positive direct effect of providing new information, and it also has an indirect effect of changing the price informativeness. If disclosure is about a variable of which real decision makers are well informed, then the indirect effect is also positive, and overall disclosure improves real efficiency. If disclosure is about a variable that real decision markers care to learn much, then the indirect effect is negative, and it dominates the positive direct effect if and only if the market aggregates information effectively.
    Date: 2014
  12. By: Itai Agur
    Abstract: The global financial crisis highlighted that the financial system can be most vulnerable when it seems most stable. This paper models non-linear dynamics in banking. Small shocks can lead from an equilibrium with few bank defaults straight to a full freeze. The mechanism is based on amplification between adverse selection on banks' funding market and moral hazard in bank monitoring. Our results imply trade-offs between regulators' microprudential desire to shield individual weak banks and the macroprudential consequences of doing so. Moreover, limiting bank reliance on wholesale funding always reduces systemic risk, but limiting the correlation between bank portfolios does not.
    Date: 2014–07–02
  13. By: Natalya Martynova; Lev Ratnovski; Razvan Vlahu
    Abstract: Traditional theory suggests that high franchise value limits bank risk-taking incentives. Then why did many banks with exceptionally valuable franchises get exposed to new financial instruments, resulting in significant losses during the crisis? This paper attempts to reconcile theory and evidence. We consider a setup where a bank takes risk by levering up, to invest in risky market-based instruments. High franchise value allows the bank to borrow more, so it can take risk on a larger scale. This offsets lower incentives to take risk of given size. As a result, a bank with a higher franchise value may have higher risk-taking incentives. The proposed effect is stronger when a bank can expand the balance sheet using inexpensive senior funding (such as repos), and when it can achieve high leverage thanks to better institutional environment (with more protection of creditor rights). This framework captures well the stylized patterns of bank risk-taking in the run-up to the crisis.
    Keywords: Banks; Risk-taking; Franchise value; Bank capital; Repo markets; Crises
    JEL: G21 G24 G28
    Date: 2014–07
  14. By: Li, Fei; Kotowski, Maciej Henryk
    Abstract: We consider all-pay auctions in the presence of interdependent, affiliated valuations and private budget constraints. For the sealed-bid, all-pay auction we characterize a symmetric equilibrium in continuous strategies for the case of N bidders. Budget constraints encourage more aggressive bidding among participants with large endowments and intermediate valuations. We extend our results to the war of attrition where we show that budget constraints lead to a uniform amplification of equilibrium bids among bidders with sufficient endowments. An example shows that with both interdependent valuations and private budget constraints, a revenue ranking between the two auction formats is generally not possible. Equilibria with discontinuous bidding strategies are discussed.
    Date: 2014
  15. By: Kotowski, Maciej Henryk; Rachmilevitch, Shiran
    Abstract: We clarify the sufficient condition for a trivial equilibrium to exist in the model of Rachmilevitch (2013). Rachmilevitch (2013), henceforth R13, studies the following game. Two ex ante identical players are about to participate in an independent-private-value first-price, sealed bid auction for one indivisible object. After the risk-neutral players learn their valuations but prior to the actual auction, player 1 can offer a take-it-or-leave-it (TIOLI) bribe to his opponent in exchange for the opponent dropping out of the contest. If the offer is accepted, player 1 is the only bidder and obtains the item for free; otherwise, both players compete non-cooperatively in the auction as usual. This is called the first-price TIOLI game.1 R13 shows that under the restriction to continuous and monotonic bribing strategies for player 1, any equilibrium of this game must be trivial—the equilibrium bribing function employed by player 1, if it is continuous and non-decreasing, must be identically zero. In this note, we clarify the sufficient conditions under which a trivial equilibrium exists. These are less stringent than originally proposed.
    Date: 2013
  16. By: Jellal, Mohamed
    Abstract: This paper shows that social interactions can induce families of migrants to care about hierarchical social status because it serves as a signal device of non-observable income. Hence , a concern for social status induces theses families to engage in conspicuous consumption in order to signal their relative wealth. Consequently, the model shows a positive correlation between disposable income and consumption of the positional good . As a corollary, families who receive large remittances tendto invest more in the signaling game of wealth.
    Keywords: Diaspora, Remittances, Status Seeking, Conspicuous Consumption, Signaling game
    JEL: A13 D03 D1 D11 D64 F22 F24 Z1
    Date: 2014–07–16
  17. By: Chiraz Ben Ali; Cédric Lesage
    Abstract: This study examines the behavior of auditors, considered as a monitoring mechanism, in the presence of a principal-principal agency conflict in a common-law country. Following the surprising findings of Holderness (2009) about ownership concentration of U.S firms, we examine ownership structure as a determinant of audit fees and auditor choice by disentangling managerial and controlling shareholding on a sample of U.S. listed firms. Our results show that audit fees and high-quality demand (big 4 auditors) (1) are negatively associated to managerial ownership and (2) positively associated with blockholders ownership. We also show that the impact of blockholders ownership is more complex then presumed and evidence a curvilinear relation (concave) between blockholders ownership and audit fees.
    Keywords: auditor behavior, principal-principal conflict, ownership
    Date: 2014–07–15

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