nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2014‒12‒29
twelve papers chosen by
Guillem Roig
University of Melbourne

  1. Credence Goods, Costly Diagnosis, and Subjective Evaluation By Bester, Helmut; Dahm, Matthias
  2. The Informativeness Principle Under Limited Liability By Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
  3. The Value of Informativeness for Contracting By Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
  4. Competitive Screening under Heterogeneous Information By Garrett, Daniel; Gomes, Renato; Maestri, Lucas
  5. Network Games with Incomplete Information By De Martí, Joan; Zenou, Yves
  7. A Theory of Buyer Fragmentation: Divide-and-Conquer Intensifies Competition By Jeon, Doh-Shin; Menicucci, Domenico
  8. Optimal influence under observational learning By Nikolas Tsakas
  9. Reassessing competition concerns in electronic communications markets By Peitz, Martin; Valletti, Tommaso
  10. Natural Expectations and Home Equity Extraction By Roberto Pancrazi; Mario Pietrunti
  11. Can active labor market policy be counter-productive? By Saint-Paul, Gilles
  12. Licensing to vertically related markets By SCHOLZ, Eva-Maria

  1. By: Bester, Helmut; Dahm, Matthias
    Abstract: We study contracting between a consumer and an expert. The expert can invest in diagnosis to obtain a noisy signal about whether a low-cost service is sufficient or whether a high-cost treatment is required to solve the consumer’s problem. This involves moral hazard because diagnosis effort and signals are not observable. Treatments are contractible, but success or failure of the low-cost treatment is observed only by the consumer. Payments can therefore not depend on the objective outcome but only the consumer’s report, or subjective evaluation. A failure of the low-cost treatment delays the solution of the consumer’s problem by the high-cost treatment to a second period. We show that the first-best solution can always be implemented if the parties’ discount rate is zero; an increase in the discount rate reduces the range of parameter combinations for which the first-best can be obtained. In an extension we show that the first-best is also always implementable if diagnosis and treatment can be separated by contracting with two different agents.
    Keywords: credence goods; information acquisition; moral hazard; subjective evaluation
    JEL: D82 D83 D86 I11
    Date: 2014–11
  2. By: Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
    Abstract: This paper shows that the informativeness principle does not automatically extend to settings with limited liability. Even if a signal is informative about effort, it may have no value for contracting. An agent with limited liability is paid zero for certain output realizations. Thus, even if these output realizations are accompanied by an unfavorable signal, the payment cannot fall further and so the principal cannot make use of the signal. Similarly, a principal with limited liability may be unable to increase payments after a favorable signal. We derive necessary and sufficient conditions for signals to have positive value. Under bilateral limited liability and a monotone likelihood ratio, the value of information is non-monotonic in output, and the principal is willing to pay more for information at intermediate output levels.
    Keywords: contract theory; Informativeness principle; limited liability; options; pay-for-luck; principal-agent model; relative performance evaluation
    JEL: D86 J33
    Date: 2014–09
  3. By: Chaigneau, Pierre; Edmans, Alex; Gottlieb, Daniel
    Abstract: The informativeness principle demonstrates qualitative benefits to increasing signal precision. However, it is difficult to quantify these benefits -- and compare them against the costs of precision -- since we typically cannot solve for the optimal contract and analyze how it changes with informativeness. We consider a standard agency model with risk-neutrality and limited liability, where the optimal contract is a call option. The direct effect of reducing signal volatility is a fall in the value of the option, benefiting the principal. The indirect effect is a change in the agent's effort incentives. If the original option is sufficiently out-of-the-money, the agent can only beat the strike price if he exerts effort and there is a high noise realization. Thus, a fall in volatility reduces effort incentives. As the agency problem weakens, the gains from precision fall towards zero, potentially justifying pay-for-luck.
    Keywords: contract theory; informativeness principle; limited liability; options; pay-for-luck; principal-agent model; relative performance evaluation
    JEL: D86 J33
    Date: 2014–10
  4. By: Garrett, Daniel; Gomes, Renato; Maestri, Lucas
    Abstract: We study competition in price-quality menus when consumers privately know their valuation for quality (type), and are heterogeneously informed about the offers available in the market. While firms are ex-ante identical, the menus offered in equilibrium are ordered so that more generous menus leave more surplus uniformly over types. More generous menus provide quality more efficiently, serve a larger range of consumers, and generate a greater fraction of profits from sales of low-quality goods. By varying the mass of competing firms, or the level of informational frictions, we span the entire spectrum of competitive intensity, from perfect competition to monopoly.
    Keywords: adverse selection; competition; heterogeneous information; price discrimination; screening
    JEL: D82
    Date: 2014–06
  5. By: De Martí, Joan; Zenou, Yves
    Abstract: We consider a network game with strategic complementarities where the individual reward or the strength of interactions is only partially known by the agents. Players receive different correlated signals and they make inferences about other players' information. We demonstrate that there exists a unique Bayesian-Nash equilibrium. We characterize the equilibrium by disentangling the information effects from the network effects and show that the equilibrium effort of each agent is a weighted combinations of different Katz-Bonacich centralities where the decay factors are the eigenvalues of the information matrix while the weights are its eigenvectors. We then study the impact of incomplete information on a network policy which aim is to target the most relevant agents in the network (key players). Compared to the complete information case, we show that the optimal targeting may be very different.
    Keywords: Bayesian games; key player policies; social networks; strategic complementarities
    JEL: C72 D82 D85
    Date: 2014–12
  6. By: Aniol Llorente-Saguer (School of Economics and Finance, Queen Mary, University of London); Ro’i Zultan (BGU)
    Keywords: auctions, collusion, bribes, experiment.
    JEL: C72 C91 D44
    Date: 2014
  7. By: Jeon, Doh-Shin; Menicucci, Domenico
    Abstract: It is well-known from Innes and Sexton (1993, 1994) that divide-and-conquer contracts allow an incumbent facing a potential entrant to extract more surplus from buyers and hence buyers suffer from the strategy. In this paper, we show that when sellers compete by offering personalized non-linear tariffs, divide-and-conquer strategies intensify competition among sellers in the presence of indirect contracting externalities. Therefore, buyers prefer remaining fragmented to forming a buyer group. When buyer group formation is decided before the entry of an entrant, our result implies that buyers may deliberately induce a socially suboptimal entry by remaining fragmented in order to benefit from more intense competition upon the entry.
    Keywords: Divde-and-Conquer, Buyer Group, Indirect Contracting External- ities, Common Agency, Competition in Non-linear Tari¤s, Multimarket Contact.
    JEL: D4 K21 L41 L82
    Date: 2014–11–26
  8. By: Nikolas Tsakas (Singapore University of Technology and Design and Universidad Carlos III de Madrid)
    Abstract: We study a problem of optimal influence in a society where agents learn from their neighbors. We consider a firm that seeks to maximize the diffusion of a new product whose quality is ex–ante uncertain, to a market where consumers are able to compare the qualities of two alternative products as soon as they observe both of them. The firm can seed the product to a subset of the population and our goal is to find which is the optimal subset to target. We provide a necessary and sufficient condition that fully characterizes the optimal targeting strategy for any network structure. The key parameter in this condition is the agents’ decay centrality, which is a measure that takes into account how close an agent is to others, but in a way that very distant agents are weighted less than closer ones.
    Keywords: Social Networks, Targeting, Diffusion, Observational Learning.
    JEL: D83 D85 H23 M37
    Date: 2014–11
  9. By: Peitz, Martin; Valletti, Tommaso
    Abstract: Central features of today's electronic communications markets are complementarities between the different layers of the value chain, substitutability between some applications, network effects in the provision of content and services, two-sided business models that partly involve indirect revenue generation (such as advertising and data profiling), and a patchwork of regulated and unregulated segments of the market. This complexity requires a fresh look at the market forces shaping the industry and a rethinking of market definitions and of the assessment of market power. This article presents the state of play in European electronic communication markets, with a particular emphasis on the recent development of 'over the tops'. We also use a stylised model of an electronic communications market to draw some central lessons from economic theory and to elaborate on market definition and market power.
    Keywords: telecommunications,OTT,relevant market,two-sided markets,market power
    JEL: D82 L13 L41 L51 L86 L96
    Date: 2014
  10. By: Roberto Pancrazi (University of Warwick); Mario Pietrunti (Bank of Italy)
    Abstract: In this paper we show that long-run expectations about future housing prices of both households and, especially, financial intermediaries had a large impact on households' indebtedness during the recent boom in U.S. housing prices. We introduce the theory of natural expectations in a collateralized credit market model populated by households and banks and find: (1) that mild variations in long-run forecasts of housing prices result in large differences in the amount of home equity extracted during the boom; and (2) that the equilibrium level of debt and the interest rate are particularly sensitive to financial intermediaries' naturalness.
    Keywords: natural expectations, home equity extraction, consumption/saving decision, housing price
    JEL: E21 E32 E44 D84
    Date: 2014–10
  11. By: Saint-Paul, Gilles
    Abstract: We study active labor market policies (ALMP) in a matching model. ALMPs are modelled as a subsidy to job search. Workers differ in their productivity, and search takes place along an extensive margin. An additional job seeker affects the quality of unemployed workers. As a result, the Hosios conditions are no longer valid. To replicate the optimum the worker share in bargaining must exceed the Hosios level, and one must impose a tax on job search activity. The coalition in favor of ALMP is also studied.
    Keywords: active labor market policies; Hosios condition; job matching
    JEL: E24 E32 J41 J63 J64
    Date: 2014–11
  12. By: SCHOLZ, Eva-Maria (Université catholique de Louvain, CORE, Belgium)
    Abstract: We analyse the problem of a non-producing patentee who licenses an essential process innovation to a vertical Cournot oligopoly. The vertical oligopoly is composed of an upstream and a downstream sector which may differ in their efficiency or, in other words, in the benefit they derive from the innovation. In this framework we characterise the optimal licensing contract in terms of the licensing revenue maximising policy (fixed-fee or per-unit royalty) and sector (upstream and/or downstream sector). First, it is shown that under a fixed-fee contract licensing to the less efficient industry sector may be the patentee’s licensing revenue maximising strategy. Here, licensing to a less efficient downstream market is all the time optimal in terms of consumer surplus and aggregate economic welfare. Conversely, licensing to a less or equally efficient upstream industry is potentially inefficient. Second, our findings reveal that the optimal licensing policy is sector dependent. A per-unit royalty contract may dominate a fixed-fee policy on the downstream market in terms of licensing revenues, while offering a per-unit royalty contract to the upstream industry is never optimal. As a third and final point we address the case of licensing to both industry sectors. Here we also identify conditions under which two-sector licensing of both sectors is less profitable than one-sector licensing of a single industry (and vice versa).
    Keywords: licensing contracts, fixed-fee, royalties, vertical Cournot oligopoly
    JEL: D43 L13 O31 O34
    Date: 2014–06–11

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