nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒11‒07
sixteen papers chosen by
Simona Fabrizi
Massey University

  1. Bayes Correlated Equilibrium and the Comparison of Information Structures in Games By Dirk Bergemann; Stephen Morris
  2. Dynamic Revenue Maximization: A Continuous Time Approach By Dirk Bergemann; Philipp Strack
  3. Rules of Evidence and Liability in Contract Litigation: The Efficiency of the General Dynamics Rule By Vlad Radoias; Simon J. Wilkie; Michael A. Williams
  4. Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins By Biais, Bruno; Heider, Florian; Hoerova, Marie
  5. Asymmetric Information and Rationalizability By Gabriel Desgranges; Stéphane Gauthier
  6. Overcoming moral hazard with social networks in the workplace: An experimental approach By Dhillon, Amrita; Peeters, Ronald; Yuksel, Ayse Muge
  7. The Effect of the Decentralization Degree on Corruption: A New Interpretation By Maria Rosaria Alfano; Anna Laura Baraldi; Claudia Cantabene
  8. Do Actions Speak Louder Than Words? Auditing, Disclosure, and Verification in Organizations By Luca Anderlini; Dino Gerardi; Roger Lagunoff
  9. Leadership in the Prisoner's Dilemma with Inequity-Averse Preferences By Koji Abey; Hajime Kobayashi; Hideo Suehiro
  10. What do you know about your mayor? Voters’ information and jurisdiction size By Nicolas GAVOILLE; Jean-Michel JOSSELIN; Fabio PADOVANO
  11. Pay increase may not be a strong incentive for undertaking acquisitions By Swarnodeep Homroy
  12. Shills and Shipes By Subir Bose; Arup Daripa
  13. Central Bank Purchases of Private Assets By Williamson, Stephen D.
  14. Organizing public good provision: Lessons from managerial accounting By Benito Arruñada; Stephen Eliot Hansen
  15. Efficient risk sharing with limited commitment and storage By Abraham, Arpad; Laczo, Sarolta
  16. False News, Informational Efficiency, and Price Reversals. By J. Dugast; T. Foucault

  1. By: Dirk Bergemann (Cowles Foundation, Yale University); Stephen Morris (Dept. of Economics, Princeton University)
    Abstract: The set of outcomes that can arise in Bayes Nash equilibria of an incomplete information game where players may have access to additional signals beyond the given information structure is equivalent to the set of a version of incomplete information correlated equilibrium which we dub Bayes correlated equilibrium. A game of incomplete information can be decomposed into a basic game, given by actions sets and payoff functions, and an information structure. We identify a partial order on many player information structures (individual sufficiency) under which more information shrinks the set of Bayes correlated equilibria.
    Keywords: Correlated equilibrium, Incomplete information, Robust predictions, Information structure, Sufficiency, Blackwell ordering
    JEL: C72 D82 D83
    Date: 2013–09
  2. By: Dirk Bergemann (Cowles Foundation, Yale University); Philipp Strack (Microsoft Research New England & UC Berkeley)
    Abstract: We characterize the profit-maximizing mechanism for repeatedly selling a non-durable good in continuous time. The valuation of each agent is private information and changes over time. At the time of contracting every agent privately observes his initial type which influences the evolution of his valuation process. In the profit-maximizing mechanism the allocation is distorted in favor of agents with high initial types. We derive the optimal mechanism in closed form, which enables us to compare the distortion in various examples. The case where the valuation of the agents follows an arithmetic/geometric Brownian motion, Ornstein-Uhlenbeck process, or is derived from a Bayesian learning model are discussed. We show that depending on the nature of the private information and the valuation process the distortion might increase or decrease over time.
    Keywords: Mechanism design, Dynamic auctions, Repeated sales
    JEL: D44 D82 D83
    Date: 2014–07
  3. By: Vlad Radoias (Department of Economics, Towson University); Simon J. Wilkie (Department of Economics, University of Sourthern California); Michael A. Williams (Competition Economics)
    Abstract: We study the effects of different rules of evidence and liability in con- tract litigation. When a contracting firm fails to perform, it may blame the buyer for withholding private information. We show that the evidentiary and liability rules used by the Supreme Court in General Dynamics v. U.S. lead to a more efficient outcome than either a strict liability rule or an evidentiary rule requiring the disclosure of the buyer's private information for use by the contractor in litigation.
    Keywords: Procurement auctions, state-secrets privilege, superior knowledge, private information.
    JEL: D44 D82 H56 H57
    Date: 2014–10
  4. By: Biais, Bruno; Heider, Florian; Hoerova, Marie
    Abstract: Derivatives activity, motivated by risk-sharing, can breed risk taking. Bad news about the risk of the asset underlying the derivative increases the expected liability of a protection seller and undermines her risk prevention incentives. This limits risk-sharing, and may create endogenous counterparty risk and contagion from news about the hedged risk to the balance sheet of protection sellers. Margin calls after bad news can improve protection sellers incentives and enhance the ability to share risk. Central clearing can provide insurance against counterparty risk but must be designed to preserve risk-prevention incentives.
    Keywords: Hedging; Insurance; Derivatives; Moral hazard; Risk management;Counterparty risk; Contagion; Central clearing; Margin requirements
    JEL: D82 G21 G22
    Date: 2014–06
  5. By: Gabriel Desgranges (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise); Stéphane Gauthier (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We study how asymmetric information affects the set of rationalizable solutions in a linear setup where the outcome is determined by forecasts about this same outcome. The unique rational expectations equilibrium is also the unique rationalizable solution when the sensitivity of the outcome to agents' forecasts is less than one, provided that this sensitivity is common knowledge. Relaxing this common knowledge assumption, multiple rationalizable solutions arise when the proportion of agents who know the sensitivity is large, and the uninformed agents believe it is possible that the sensitivity is greater than one. Instability is equivalent to existence of some kind of sunspot equilibria.
    Keywords: Asymmetric information; common knowledge; eductive learning; rational expectations; rationalizability
    Date: 2013
  6. By: Dhillon, Amrita (King's College London); Peeters, Ronald (Maastricht University); Yuksel, Ayse Muge (Maastricht University)
    Abstract: The use of social networks in the workplace has been documented by many authors, although the reasons for their widespread prevalence are less well known. In this paper we present evidence based on a combined eld-laboratory experiment that social networks are used by employers to reduce worker moral hazard. The worker chooses an eort level given a xed wage under dierent settings of social proximity. Social proximity is captured using actual Facebook friendship information revealed anonymously to subjects once they have been recruited. Since employers themselves do not have access to social connections, they delegate the decision to referrers who can select among workers with dierent degrees of social proximity to themselves. We show that employers choose referrals over anonymous hiring about 80% of the time. In keeping with our predictions, referrers also choose workers with a greater social proximity to themselves and workers who are closer to referrers indeed pay back more to the referrer. The advantage of the lab setting is that we can isolate moral hazard and directed altruism as the main driving forces for these results.
    Keywords: Eciency wage contracts, Moral hazard, Dictator game, Referrals, Altruism, Reciprocity, Directed altruism, Social proximity, Facebook, Experiment, Social networks, Strength of ties, Spot market.
    Date: 2014
  7. By: Maria Rosaria Alfano; Anna Laura Baraldi; Claudia Cantabene
    Abstract: This work contributes to empirical studies on decentralization and corruption by trying to resolve the uncertainty that the literature so far has shown. It also gives reasons supporting the ‘best’ decentralization structure which a country can adopt to discourage corrupt behaviour, and suggests an intermediate degree of decentralization. The trade-off between the moral hazard and the adverse selection aspect of the principal-agent framework, that emerges in this literature, can be better captured by a non-linear specification (e.g. cubic, as the more general non-linear model); neither very small nor very high degrees of decentralization are appropriate against corruption, but an intermediate one. Being monitored by the voters, local politicians, in a intermediate decentralized setting, have an incentive to perform in the voters interest and, being local resources they manage not very much, they have little incentive to appropriate part of such resources for personal use.
    Keywords: Corruption, Decentralization, Principal-agent theory.
    JEL: H7 D73 C33
    Date: 2014–10–10
  8. By: Luca Anderlini (Department of Economics, Georgetown University); Dino Gerardi (Collegio Carlo Alberto, Universit' degli Studi di Torino); Roger Lagunoff (Department of Economics, Georgetown University)
    Abstract: We study the relative performance of disclosure and auditing in organizations. We consider the information transmission problem between two decision makers who take actions at dates 1 and 2 respectively. The first decision maker has private information about a state of nature that is relevant for both decisions, and sends a cheap-talk message to the second. The second decision maker can commit to only observe the message (disclosure), or can retain the option to observe the action of the first decision maker (auditing) or, at some cost, to verify the state. In equilibrium, state verification will never occur and the second decision maker effectively chooses between auditing and disclosure. When the misalignment is preferences reflects a bias in a decision maker's own action relative to that of the other - we call this an agency bias - then, in equilibrium, the second decision maker chooses to audit. Actions speak louder than words in this case. When one decision maker prefers all actions to be biased relative to the other decision maker - we call this an ideological bias - then, if the misalignment is large enough, in equilibrium the second decision maker chooses disclosure. In this case words speak louder than actions. While firms are usually characterized by agency bias, ideological bias is more common in political systems. Our results indicate that the ability to commit not to audit has value in the latter case. However such commitment is rarely feasible in the political sphere.
    Keywords: Auditing, Disclosure, Agency Bias, Ideological Bias
    JEL: C73 D63 D72 D74 H11
    Date: 2014–06–01
  9. By: Koji Abey (Faculty of International Social Sciences, Yokohama National University); Hajime Kobayashi (Faculty of Economics, Kansai University); Hideo Suehiro (Graduate School of Business Administration, Kobe University)
    Abstract: We consider the economic consequences of fairness concerns under the freedom to choose the timing of moves by developing a new economic theory of leadership. We study the prisoner' s dilemma in which players are endowed with Fehr and Schmidt preferences with inequity aversion as their private information and then choose cooperation or defection once at one of two timings that they prefer. In this model, we consider an equilibrium in which a leader-follower relationship endogenously emerges as a consequence of players' heterogeneous inequity aversions. We present three results. First, we provide a sufficient condition for the existence of a leadership equilibrium. Then, we present a comparative statics analysis of the equilibrium. Finally, we investigate who takes the leadership, depending on the game parameters. We provide a characterization of the equilibrium leadership patterns. These results also hold when agents can choose the timing of moves from more than two timings.
    Keywords: Leadership, Endogenous Timing, Prisoner' s Dilemma, Inequity Aversion
    JEL: C72 D03 D82
    Date: 2014–05
  10. By: Nicolas GAVOILLE (CREM-CNRS and Condorcet Center, University of Rennes 1, France); Jean-Michel JOSSELIN (CREM-CNRS and Condorcet Center, University of Rennes 1, France); Fabio PADOVANO (CREM-CNRS and Condorcet Center, University of Rennes 1, France, Department of Political Sciences, University Roma Tre, Italy)
    Abstract: This paper examines which set of informations voters use when they cast their vote. On the one hand, electoral accountability models assume that voters rely on past policy decisions of the incumbent politician. Gathering this information is, however, often costly. On the other hand, voters may prefer to rely on low-cost information, such as politicians’ personal observable characteristics. If incentives to collect costly information decrease as the size of the jurisdiction increases, a greater share of voters should take these “information shortcuts” in larger municipalities. To test those hypotheses, we use an original dataset encompassing 896 French municipalities of more than 10,000 inhabitants over the period 2000-2012. We find that although there is no correlation between mayors’ competence and their observable characteristics, voters rely on such information shortcuts. Mayors’ past policy-making matters only in small municipalities.
    Keywords: Political leaders, political selection, voters, French municipalities, jurisdiction size
    JEL: H11 D72 H72
    Date: 2014–06
  11. By: Swarnodeep Homroy
    Abstract: A large body of literature suggests that CEOs have misaligned incentives to undertake acquisitions in an attempt to increase their pay. This paper shows that the likelihood of post-acquisition CEO turnover can act as a constraint on such incentives. The acquisition premium in pay decreases by 50% if the likelihood of post-acquisition turnover is controlled for. This suggests a significant survivor bias in previous estimates of acquisition premium. Given a smaller pay premium for undertaking acquisitions and non-zero risk of dismissal, a risk-averse agent may not have strong incentives to undertake an acquisition for the marginal pay increase. The likelihood of dismissal seems to carry stronger incentive effects than post-acquisition pay increase.
    Keywords: Agency problem, mergers and acquisitions, CEO pay, Severance
    JEL: G34 J31 J33 M52
    Date: 2014
  12. By: Subir Bose; Arup Daripa
    Abstract: Online auctions with a fixed end-time often experience a sharp increase in bidding towards the end despite using a proxy-bidding format. We provide a novel explanation of this phenomenon under private values. We study a correlated private values environment in which the seller bids in her own auction (shill bidding). Bidders selected randomly from some large set arrive randomly in an auction, then decide when to bid (possibly multiple times) over a continuous time interval. A submitted bid arrives over a continuous time interval according to some stochastic distribution. The auction is a continuous-time game where the set of players is not commonly known, a natural setting for online auctions. Our results are robust with respect to the seller’s and the bidders’ priors regarding the set of bidders arriving at the auction. We show that there is a late-bidding equilibrium in which bids are delayed to the latest instance involving no sacrifice of probability of bid arrival, but shill bids fail to arrive with positive probability, and in this sense optimal late bidding serves to snipe the shill bids. We show conditions under which the equilibrium outcome is unique. Further, if these conditions do not hold, and there are any equilibria with a different outcome, they are necessarily characterized by early bidding. Any such equilibria are Pareto dominated for the bidders compared to the late-bidding equilibrium. Finally, our results suggest that under private values, the case against shill-bidding might be weak.
    Keywords: Online auctions, correlated private values, last-minute bidding, sniping, shill bidding, random bidder arrival, continuous bid time, continuous bid arrival process.
    JEL: D44
    Date: 2014–09
  13. By: Williamson, Stephen D. (Federal Reserve Bank of St. Louis)
    Abstract: A model is constructed in which consumers and banks have incentives to fake the quality of collateral. Conventional monetary easing can exacerbate these problems, in that the mispresentation of collateral becomes more profitable, thus increasing haircuts and interest rate differentials. Central bank purchases of private mortgages may not be feasible, due to misrepresentation of asset quality. If feasible, central bank asset purchase programs work by circumventing suboptimal fiscal policy, not by mitigating incentive problems in asset markets.
    Keywords: monetary policy; fiscal policy
    JEL: E31 E5 E58
    Date: 2014–10–01
  14. By: Benito Arruñada; Stephen Eliot Hansen
    Abstract: This paper applies ideas and findings from Managerial Accounting to the problem of public good provision. It first links the problems of traditional bureaucracies with those of "discretionary expense centers", which are characterized by poor user and supplier incentives as well as overproduction. It then describes alternative hybrid organizations that delegate authority and provide incentives on some dimensions, while maintaining control on others. Finally, it illustrates the ideas with several cross-country case studies on public registries, illustrating that such hybrids may provide a superior, if imperfect, solution to the problems that governments face when lacking sufficient information to directly control the activities of public goods' providers.
    Keywords: Public Good Provision, Managerial Accounting.
    JEL: H40 M48
    Date: 2014–09
  15. By: Abraham, Arpad; Laczo, Sarolta
    Abstract: We extend the model of risk sharing with limited commitment (Kocherlakota, 1996) by introducing both a public and a private (non-contractible and/or non-observable) storage technology. Positive public storage relaxes future participation constraints and may hence improve risk sharing, contrary to the case where hidden income or effort is the deep friction. The characteristics of constrained-efficient allocations crucially depend on the storage technology’s return. In the long run, if the return on storage is (i) moderately high, both assets and the consumption distribution may remain time-varying; (ii) sufficiently high, assets converge almost surely to a constant and the consumption distribution is time-invariant; (iii) equal to agents’ discount rate, perfect risk sharing is self-enforcing. Agents never have an incentive to use their private storage technology, i.e., Euler inequalities are always satisfied, at the constrained-efficient allocation of our model, while this is not the case without optimal public asset accumulation.
    Keywords: Risk sharing, Limited commitment, Hidden storage, Dynamic contracts
    JEL: E20
    Date: 2014
  16. By: J. Dugast; T. Foucault
    Abstract: Speculators can discover whether a signal is true or false by processing it but this takes time. Hence they face a trade-off between trading fast on a signal (i.e., before processing it), at the risk of trading on a false news, or trading after processing the signal, at the risk that prices already reflect their information. The number of speculators who choose to trade fast increases with news reliability and decreases with the cost of fast trading technologies. We derive testable implications for the effects of these variables on (i) the value of information, (ii) patterns in returns and trades, (iii) the frequency of price reversals in a stock, and (iv) informational efficiency. Cheaper fast trading technologies simultaneously raise informational efficiency and the frequency of ``mini-flash crashes": large price movements that revert quickly.
    Keywords: news, high-frequency trading, price reversals, informational efficiency, mini-flash crashes.
    JEL: G10 G12 G14
    Date: 2014

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