nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒08‒28
twelve papers chosen by
Simona Fabrizi
Massey University

  1. Corruption in PPPs, Incentives and Contract Incompleteness By Elisabetta Iossa; David Martimort
  2. Principal-agent relationship in resource management, multiple principals and spatial dynamics By Philippe Delacote; Arnaud Dragicevic; Serge Garcia
  3. Doubts and Dogmatism in Conflict Behavior By Sidartha Gordon; Alessandro Riboni
  4. Incentives, Wages, Employment, and the Division of Labor in Teams By Michael T. Rauh
  5. On the Optimality of Not Allocating By Angel Hernando-Veciana; Fabio Michelucci
  6. L’opérateur de transport public à Bruxelles (STIB) et la Région de Bruxelles-Capitale :25 ans de vie commune By Christophe Goethals
  7. Meeting Technologies and Optimal Trading. Mechanisms in Competitive Search Markets By Benjamin Lester (Federal Reserve Bank of Philadelphia), Ludo Visschers (The University of Edinburgh & Universidad Carlos III, Madrid), Ronald Wolthoff (University of Toronto)
  8. Central Bank Purchases of Private Assets By Stephen Williamson
  9. Handing out guns at a knife fight: behavioral limitations of subgame-perfect implementation By Ernst Fehr; Michael Powell; Tom Wilkening
  10. Prejudice and Competitive Signaling By Sue H. Mialon
  11. Managerial compensation, regulation and risk in banks: theory and evidence from the financial crisis By Vittoria Cerasi; Tommaso Oliviero
  12. Supply chain screening without certification: The critical role of stakeholder pressure By Susan A. Kayser; John W. Maxwell; Michael W. Toffel

  1. By: Elisabetta Iossa (Faculty of Economics, University of Rome "Tor Vergata"); David Martimort (Paris School of Economics-EHESS)
    Abstract: In a public procurement setting, we discuss the desirability of completing contracts with state-contingent clauses providing for monetary compensations to the contractor when revenue shocks occur. Realized shocks are private information of the contractor and this creates agency costs of delegated service provision. Verifying the contractor’s messages on the shocks entails contracting costs that make incomplete contracts attractive, despite their higher agency costs. A public official (supervisor) has private information on contracting costs and chooses the degree of contractual incompleteness on behalf of an upper-tier public authority. As the public official may be biased towards the contractor, delegating the contractual choice to that lower-tier may result in incomplete contracts being chosen too often. Empirical predictions on the use of incomplete contracts and policy implications on the benefits of standardized contract terms are discussed.
    Keywords: Corruption, Incomplete Contracts, Moral Hazard, Principal-Agent-Supervisor Model, Public-Private Partnerships, Risk Allocation
    JEL: D23 D82 K42 L33
    Date: 2014–07–18
  2. By: Philippe Delacote (Laboratoire d'Economie Forestière, INRA - AgroParisTech; Climate Economic Chair); Arnaud Dragicevic (Laboratoire d'Economie Forestière, INRA - AgroParisTech; Chaire Forêts pour Demain, Agro ParisTech–Office National des Forêts); Serge Garcia (Laboratoire d'Economie Forestière, INRA - AgroParisTech)
    Abstract: Public authorities (often local) frequently mandate public or private agencies to manage their natural resources. Contrary to the agency, which is an expert in resource management, public authorities usually do not know the sustainable harvest level. In this paper, we model the contractual relationship between a principal, who owns the resource, and an agent, who holds private information on its sustainable harvest level, and look for the Pareto-optimal allocations. The agent can strategically use his private information to harvest outside the sustainability interval. We consider the case where the agent simultaneously interacts with several principals. From a simple dynamic spatial game, we show how the existence of multiple interacting principals with diverse qualities on information can help the least wellinformed principals to reduce the information rent and lead to the Pareto-optimal allocation.
    Keywords: Resource management, Sustainable harvesting, Principal-agent model, Spatial dynamics
    JEL: D82 Q20
    Date: 2014–10
  3. By: Sidartha Gordon (Département d'économie); Alessandro Riboni
    Abstract: Conflicts are likely less violent if individuals entertain the possibility that the opponent may be right. Why is it so difficult to observe this attitude? In this paper, we consider a game of conflict where two opponents fight in order to impose their preferred policy. Before entering the conflict, one opponent (the agent) trusts the information received by his principal. The principal wants to a↵ect the agent’s e↵ort, but he also cares that the agent selects the correct policy and that he has the right incentives to acquire information.We find conditions under which the principal induces hawkish attitudes in the agent. As a result, the agent has no doubts about the optimality of his preferred policy, conflicts are violent and bad decisions are sometimes made. Under some other conditions, the agent adopts dovish attitudes of systematic doubt and conflicts are less violent.
    Date: 2014–04
  4. By: Michael T. Rauh (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
    Abstract: We develop a theory of incentives, wages, and employment in the context of team production. A central insight is that specialization and division of labor not only improve productivity but also increase eort and the sensitivity of eort to incentives under moral hazard. We show that incentives and employment are complements for the principal when the positive eects of specialization and division of labor outweigh the negative eects of increased idiosyncratic risk and are substitutes otherwise. We provide new characterizations of the partnership, the rm, and the role of the budget-breaker that are quite dierent from the classical literature.
    Keywords: budget-breaker, division of labor, employment, endogenous team size, incentives, partnerships, size-wage dierential, specialization, teams, wages
    JEL: D02 D21 D86 L25 M5
    Date: 2013–08
  5. By: Angel Hernando-Veciana; Fabio Michelucci
    Abstract: We show that the commitment to not allocate may be exploited by a seller/social planner to increase the expected social surplus that can be achieved in the sale of an indivisible unit.
    Keywords: efficiency; auctions; mechanism design;
    JEL: D44 D82
    Date: 2014–07
  6. By: Christophe Goethals
    Abstract: Since 1989 and the regionalization of public transports in Belgium, the Société des transports intercommunaux de Bruxelles (STIB), i.e. the public operator of urban transport in Brussels, has undergone many changes, both structural and organizational. Meanwhile, the company has managed to improve its financial health in accordance with the objectives set by the regulatory transport authority, the Region of Brussels-Capital. The analysis of the system of actors shows that, in a principal-agent relationship characterized by high information asymmetry, the convergence of interests between the supervisory authority and the public company is neither natural nor automatic: it is built. This construction takes place at several levels and materializes incrementally, particularly through the management contract. In this regulatory system, the process organizing the dialogue between the company and the authority produces the desired beneficial effects, more than the legal value of the contract does. The interdependence between the actions of the Region and those of the STIB implies practices that can be described as a partnership. Finally, the analysis shows that the contractualization is not inconsistent with an evolution of the roles of each actor.
    Keywords: agency theory; asymmetric information; public enterprise; public policies; urban transport; regulatory reform; governance; system of actors; performance measurement
    JEL: D82 G38 L32 D20 P11
    Date: 2014–08–18
  7. By: Benjamin Lester (Federal Reserve Bank of Philadelphia), Ludo Visschers (The University of Edinburgh & Universidad Carlos III, Madrid), Ronald Wolthoff (University of Toronto)
    Abstract: In many markets, sellers advertise their good with an asking price. This is a price at which the seller will take his good off the market and trade immediately, though it is understood that a buyer can submit an offer below the asking price and that this offer may be accepted if the seller receives no better offers. Despite their prevalence in a variety of real world markets, asking prices have received little attention in the academic literature. We construct an environment with a few simple, realistic ingredients and demonstrate that using an asking price is optimal: it is the pricing mechanism that maximizes sellers’ revenues and it implements the efficient outcome in equilibrium. We provide a complete characterization of this equilibrium and use it to explore the positive implications of this pricing mechanism for transaction prices and allocations.
    Keywords: Asking Prices, Directed Search, Inspection Costs, Efficiency.
    JEL: C78 D44 D82 D83 L11 R31 R32
    Date: 2014–05–12
  8. By: Stephen Williamson (Washington University in St. Louis)
    Abstract: A model is constructed in which consumers and banks have incentives to fake the quality of collateral. Conventional central banking policy can exacerbate these problems, in that lower nominal interest rates make asset prices higher, which makes faking collateral more profitable, thus increasing haircuts and interest rate differentials. Central bank purchases of private mortgages can increase welfare by bypassing incentive problems associated with private banks, increasing asset prices, and relaxing collateral constraints. However, this may exacerbate incentive problems in the mortgage market.
    Date: 2014
  9. By: Ernst Fehr; Michael Powell; Tom Wilkening
    Abstract: The assumption that payoff-relevant information is observable but not verifiable is important for many core results in contract, organizational and institutional economics. However, subgame-perfect implementation (SPI) mechanisms - which are based on off-equilibrium arbitration clauses that impose fines for lying and the inappropriate use of arbitration - can be used to render payoff-relevant observable information verifiable. Thus, if SPI mechanisms work as predicted they undermine the foundations of important economic results based on the observable but non-verifiable assumption. Empirical evidence on the effectiveness of SPI mechanisms is, however, scarce. In this paper we show experimentally that SPI mechanisms have severe behavioral limitations. They induce retaliation against legitimate uses of arbitration and thus make the parties reluctant to trigger arbitration. The inconsistent use of arbitration eliminates the incentives to take first-best actions and leads to costly disagreements such that individuals - if given the choice - opt out of the mechanism in the majority of the cases. Incentive compatible redesigns of the mechanism solve some of these problems but generate new ones such that the overall performance of the redesigned mechanisms remains low. Our results indicate that there is little hope for SPI mechanisms to solve verifiability problems unless they are made retaliation-proof and, more generally, robust to other-regarding preferences.
    Keywords: Implementation theory, incomplete contracts, experiments
    JEL: D23 D71 D86 C92
    Date: 2014–08
  10. By: Sue H. Mialon
    Abstract: In a signaling game between a receiver and senders, prejudice occurs if senders are prejudged based on an index such as race without reference to their qualifying signals. This paper investigates what makes the receiver ignore senders' informative signals in favor of the uninformative index. Prejudice arises when competition between senders erodes their signaling incentive and reduces the quality of signaling significantly. To minimize the decrease in quality, the receiver may prescreen the senders using the index, removing the impact of competition. We advocate policies that enhance the quality of signals to ensure the effectiveness of competitive signaling systems.
    Date: 2013–11
  11. By: Vittoria Cerasi; Tommaso Oliviero
    Abstract: This paper analyzes the relation between CEOs monetary incentives, financial regulation and risk in banks. We present a model where banks lend to opaque entrepreneurial projects to be monitored by managers; managers are remunerated according to a pay-for-performance scheme and their effort is unobservable to depositors and shareholders. Within a prudential regulatory framework that defines a capital requirement and a deposit insurance, we study the effect of increasing the variable component of managerial compensation on risk taking. We then test empirically how monetary incentives provided to CEOs in 2006 affected banks’ stock price and volatility during the 2007-2008 financial crisis on a sample of large banks around the World. The cross-country dimension of our sample allows us to study the interaction between CEO incentives and financial regulation. The empirical analysis suggests that the sensitivity of CEOs equity portfolios to stock prices and volatility has been indeed related to worse performance in countries with explicit deposit insurance and weaker monitoring by shareholders. This evidence is coherent with the main prediction of the model, that is, the variable part of the managerial compensation, combined with weak insiders’ monitoring, exacerbates the risk-shifting attitude by managers.
    Keywords: managerial compensation, risk taking, financial regulation, monitoring
    JEL: G21 G38
    Date: 2014–07
  12. By: Susan A. Kayser (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); John W. Maxwell (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Michael W. Toffel (Harvard Business School)
    Abstract: To assess and manage reputational risks associated with supply chains, buyers are increasingly seeking information about their suppliers’ labor and environmental performance. Several voluntary programs have arisen to encourage suppliers to report this information in a standardized manner, but the information companies report might misrepresent their performance and can thus mislead rather than inform buyers. We hypothesize particular circumstances in which buyers can screen suppliers based on their participation in voluntary programs requiring public commitments and public reporting. In particular, we theorize that stakeholder scrutiny can effectively deter companies with misrepresentative disclosures from participating in such programs, and that this deterrence effect is stronger for smaller companies and in institutional contexts featuring stronger activist pressures and stronger norms of corporate transparency. Examining the decisions of 2,043 firms headquartered in 42 countries of whether to participate in the UN Global Compact, we find support for these hypotheses.
    Keywords: supply chain, certification, global compact
    JEL: L96
    Date: 2014–08

This nep-cta issue is ©2014 by Simona Fabrizi. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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