nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒08‒25
eleven papers chosen by
Simona Fabrizi
Massey University

  1. A theory of family education incentives and inequality By Jellal, Mohamed
  2. On discovery, restricting lawyers, and the settlement rate By Baumann, Florian; Friehe, Tim
  3. Honesty and Trade By Michael T. Rauh; Giulio Seccia
  4. Optimal Wage Redistribution in the Presence of Adverse Selection in the Labor Market By Bastani, Spencer; Blumkin, Tomer; Micheletto, Luca
  5. Information Asymmetry in SME Credit Guarantee Schemes: Evidence from Japan By SAITO Kuniyoshi; TSURUTA Daisuke
  6. Contagious Synchronization and Endogenous Network Formation in Financial Networks By Christoph Aymanns and Co-Pierre Georg
  7. Price revelation and existence of equilibrium in a private belief economy. By Lionel de Boisdeffre
  8. Don't Kill the Goose that Lays the Golden Eggs: Strategic Delay in Project Completion By Katolnik, Svetlana; Schöndube, Jens Robert
  9. Collusion-Proof Mechanism Design in Two-Agent Nonlinear Pricing Environments By Meng, Dawen; Tian, Guoqiang
  10. Strategic information revelation and capital allocation By Pedraza Morales, Alvaro
  11. Simple Agents, Intelligent Markets By Karim Jamal; Michael Maier; Shyam Sunder

  1. By: Jellal, Mohamed
    Abstract: In this paper, we examine the consequences of imperfect information on the pattern of transfers from parents to children. Drawing on the theory of mechanism design, we consider a model of family contract with two levels of effort. We prove that equal transfers among children are expected under perfect information, while the second-best contract implies risk-sharing between the two generations, so that poor families experience higher agency costs, therefore inequality persists.
    Keywords: Asymmetric information, Family ,Education, Incentives, Transfers, Inequality.
    JEL: D82 D86 I21 I22 I24 J1 J13
    Date: 2014–08–14
  2. By: Baumann, Florian; Friehe, Tim
    Abstract: This paper analyzes the principal-agent relationship between a plaintiff and his or her lawyer when the lawyer's investment in discovery is private information. The plaintiff uses the level of the contingency fee and potentially also restrictions on settlements to guide the lawyer's decision-making. We show that the plaintiff can increase the lawyer's investment in discovery by disallowing a settlement in the event of unsuccessful discovery, thereby reducing the pair's joint surplus. We establish that such a restriction may indeed be privately optimal for the plaintiff but can cast doubt on the social desirability of the discovery process. --
    Keywords: litigation,discovery,moral hazard,principal-agent relationship
    JEL: K41 H23
    Date: 2014
  3. By: Michael T. Rauh (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Giulio Seccia (University of Shouthampton)
    Abstract: There is substantial evidence that many parents value honesty in their children and that trust is an important determinant of trade. There is also evidence that certain institutions (i.e., religious institutions) foster trust, trade, and economic growth. In this paper we consider a parent who can enroll her child in an imperfect institution which can make her child honest with some probability less than one. We assume that institutional membership is observable so that institutions serve as both imperfect socialization technologies and potentially informative signals that such socialization has taken place. We provide necessary and sucient conditions for nonzero investments in honesty in the two main benchmark models of exchange under asymmetric information: the basic two-type screening model and a game-theoretic version of Akerlof's market for lemons. Consistent with the evidence, we show that when non-zero socialization occurs in equilibrium it improves economic performance by increasing allocative eciency in the screening model and reducing adverse selection in the market for lemons.
    Keywords: deception, exchange, honesty, institutions, religion, trade, trust
    JEL: D02 D03 D82 Z1
    Date: 2014–04
  4. By: Bastani, Spencer (Uppsala Center for Fiscal Studies); Blumkin, Tomer (Department of Economics, Ben Gurion University, Israel;); Micheletto, Luca (Uppsala Center for Fiscal Studies)
    Abstract: In this paper we allude to a novel role played by the non-linear income tax system in the presence of adverse selection in the labor market due to asymmetric information between workers and firms. We show that an appropriate choice of the tax schedule enables the government to affect the wage distribution by controlling the transmission of information in the labor market. This represents an additional channel through which the government can foster the pursuit of its redistributive goals.
    Keywords: adverse selection; labor market; optimal taxation; pooling; redistribution
    JEL: D82 H21 J31
    Date: 2014–07–23
  5. By: SAITO Kuniyoshi; TSURUTA Daisuke
    Abstract: In this paper, we investigate whether adverse selection and/or moral hazard can be detected in credit guarantee schemes for small and medium enterprises (SMEs). Using bank-level data, we analyzed whether the subrogation rate is positively associated with the ratio of guaranteed loans to total loans, and found that the data are consistent with an adverse selection and/or moral hazard hypothesis. Further analyses show that the relationship is stronger for 100% coverage than for 80% coverage, indicating that "20% self-payment" mitigates the problem, but is not enough to eliminate it.
    Date: 2014–07
  6. By: Christoph Aymanns and Co-Pierre Georg
    Abstract: When banks choose similar investment strategies the financial system becomes vulnerable to common shocks. We model a simple financial system in which banks decide about their investment strategy based on a private belief about the state of the world and a social belief formed from observing the actions of peers. Observing a larger group of peers conveys more information and thus leads to a stronger social belief. Extending the standard model of Bayesian updating in social networks, we show that the probability that banks synchronize their investment strategy on a state non-matching action critically depends on the weighting between private and social belief. This effect is alleviated when banks choose their peers endogenously in a network formation process, internalizing the externalities arising from social learning.
    Keywords: social learning, endogenous financial networks, multi-agent simulations, systemic risk
    JEL: G21 C73 D53 D85
    Date: 2014
  7. By: Lionel de Boisdeffre (Université de Pau - CATT et Centre d'Economie de la Sorbonne)
    Abstract: We consider a pure exchange financial economy, where rational agents, possibly asymmetrically informed, forecast prices privately and, therefore, face “exogenous uncertainty”, on the future state of nature, and “endogenous uncertainty” on future prices. At a sequential equilibrium, all agents expect the “true” price as a possible outcome and elect optimal strategies at the first period, which clear on all markets ex post. We introduce no-arbitrage prices and display their revealing properties. Under mild conditions, we show that a sequential equilibrium exists, whatever the financial structure and agents' private information or beliefs. This result suggests that existence problems of standard sequential equilibrium models, following Hart (1975) or Radner (1979), stem from the rational expectation and perfect foresight assumptions, which are both dropped in our model.
    Keywords: Sequential equilibrium, temporary equilibrium, perfect foresight, existence, rational expectations, financial markets, asymmetric information, arbitrage.
    JEL: D52
    Date: 2014–07
  8. By: Katolnik, Svetlana; Schöndube, Jens Robert
    Abstract: It's puzzling that most projects fail to complete within the predetermined timeframe given that timing considerations rank among the major goals in project management. We argue that when managers can extract private benefits from working on a project, project delay becomes optimal. We introduce a continuous-time framework for project management activities that incorporates this feature. A manager's unobserved effort cumulatively increases the project's success probability, but decreases the expected duration of the project and with it the expected flow of on-the-job benefits. A strict deadline limits incentives for effort delay, but also decreases the probability that the project will be terminated in due time. In this trade-off, the optimal deadline balances the increase in expected project value against the expected increase in project duration and costs. Since the manager does not want to "kill the golden goose" prematurely, he always prefers a stricter deadline compared to the principal. As a result, project completion is threatened by both effort provision over time and contractual agreements on time.
    Keywords: Optimal deadline, Dynamic incentives, Strategic delay, Project completion
    JEL: D82 M52
    Date: 2014–07
  9. By: Meng, Dawen; Tian, Guoqiang
    Abstract: This paper studies the cost requirement for two-agent collusion-proof mechanism design. Unlike the existing results for general environments with three or more agents, it is shown that collusive behavior cannot be prevented freely in two-agent nonlinear pricing environments with correlated types. Reporting manipulation calls for distortions away from the first-best efficiency, and arbitrage calls for further distortion. Moreover, we show that the distortionary patterns are quite different for positive and negative correlations. The second-best outcome is attainable as negative correlation is vanishing, while the limit of collusion-proof efficiency is strictly lower than the second-best level as positive correlation goes to zero. Allowing arbitrage therefore breaks the continuity between correlated and uncorrelated types.
    Keywords: Nonlinear pricing, collusion-proof, mechanism design, arbitrage, correlation
    JEL: D42 D62 D82
    Date: 2014–02
  10. By: Pedraza Morales, Alvaro
    Abstract: It is commonly believed that stock prices help firms'managers make more efficient real investment decisions, because they aggregate information about fundamentals that is not otherwise known to managers. This paper identifies a limitation to this view. It shows that if informed traders internalize that firms use prices as a signal, stock price informativeness depends on the quality of managers'prior information. In particular, managers with low quality information would like to learn about their own fundamentals by relying on the information aggregated in the stock price. However, in this case, the profitability of trading falls for informed speculators, who therefore reduce their trading volume, reducing the informativeness of prices. As a result, stock prices are not as useful in guiding capital toward its most productive use, leading to inefficient investment decisions. Using a sample of U.S. publicly traded companies between 1990 and 2010, the paper documents a positive correlation between the quality of managerial information and stock price informativeness. Contrary to the conventional view that less informed managers should rely more on stock prices when making investment decisions, the author finds no differences in the sensitivity of investment to stock prices for different levels of managerial information. The evidence suggests that while firms do learn from prices, the learning channel and its effects on real investment are limited.
    Keywords: Markets and Market Access,Emerging Markets,Debt Markets,Economic Theory&Research,Investment and Investment Climate
    Date: 2014–07–01
  11. By: Karim Jamal (University of Alberta); Michael Maier (University of Alberta); Shyam Sunder (School of Management, Yale University)
    Abstract: Attainment of rational expectations equilibria in asset markets calls for the price system to disseminate agents’ private information to others. Markets populated by human agents are known to be capable of converging to rational expectations equilibria. This paper reports comparable market outcomes when human agents are replaced by boundedly-rational algorithmic agents who use a simple means-end heuristic. These algorithmic agents lack the capability to optimize; yet outcomes of markets populated by them converge near the equilibrium derived from optimization assumptions. These findings point to market structure (rather than cognition or optimization) being an important determinant of efficient aggregate level outcomes.
    Keywords: Bounded rationality, Dissemination of asymmetric information, Efficiency of security markets, Minimally-rational agents, Rational expectations, Structural properties of markets
    JEL: C92 D44 D50 D70 D82 G14
    Date: 2012–07

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