nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒04‒09
five papers chosen by
Guillem Roig
University of Melbourne

  1. Screening and adverse selection in frictional markets By Lester, Benjamin; Shourideh, Ali; Venkateswaran, Venky; Zetlin-Jones, Ariel
  2. Contracting with Type-Dependent Naïveté. By Matteo Foschi
  3. Managerial Compensation under Privately-Observed Hedging By Sun, Bo; Liu, Qi
  4. Moral-Hazard-Free First-Best Unemployment Insurance By Parsons, Donald O.
  5. Thinning Markets in U.S. Agriculture By Adjemian, Michael; Brorsen, B. Wade; Hahn, William; Saitone, Tina L.; Sexton, Richard J.

  1. By: Lester, Benjamin (Federal Reserve Bank of Philadelphia); Shourideh, Ali (The Wharton School of the University of Pennsylvania); Venkateswaran, Venky (NYU–Stern School of Business); Zetlin-Jones, Ariel (Carnegi Mellon University)
    Abstract: We incorporate a search-theoretic model of imperfect competition into an otherwise standard model of asymmetric information with unrestricted contracts. We develop a methodology that allows for a sharp analytical characterization of the unique equilibrium and then use this characterization to explore the interaction between adverse selection, screening, and imperfect competition. On the positive side, we show how the structure of equilibrium contracts—and, hence, the relationship between an agent’s type, the quantity he trades, and the corresponding price—is jointly determined by the severity of adverse selection and the concentration of market power. This suggests that quantifying the effects of adverse selection requires controlling for the market structure. On the normative side, we show that increasing competition and reducing informational asymmetries can be detrimental to welfare. This suggests that recent attempts to increase competition and reduce opacity in markets that suffer from adverse selection could potentially have negative, unforeseen consequences
    Keywords: Adverse selection; Imperfect competition; Screening; Transparency; Search theory
    JEL: D41 D42 D43 D82 D83 D86 L13
    Date: 2016–03–10
  2. By: Matteo Foschi
    Abstract: I analyse the optimal contracting behaviour of an employer who faces workers with different, incorrect beliefs about their own productivity. While the literature has focused mostly on the exploitative (when the principal knows agents’ types, Eliaz and Spiegler, 2006) and speculative (when the principal has priors on agents’ types, Eliaz and Spiegler, 2008) aspects of contracts, I introduce the assumption that workers’ naïveté depends on their actual productivity level. The employer uses this information to form posteriors on agents’productivity and design more efficient contracts. In particular, I highlight the employer’s trade-off between exploiting strongly naïve workers and designing efficient contracts for the most widespread type of worker, according to her posteriors.
    Keywords: Self-Awareness, Naïveté, Contract, Screening, Non-Common Priors, Mechanism Design, Multidimensional Types.
    JEL: D42 D82 D84 D86 J41
    Date: 2016–03
  3. By: Sun, Bo; Liu, Qi
    Abstract: This paper studies how private information in hedging outcomes affects the design of managerial compensation when hedging instruments serve as a double-edged sword in that they may be used for both corporate hedging and earnings management. On the one hand, financial vehicles can offer customized contracts that are closely tailored to manage specific risk and improve hedging efficiency. On the other hand, involvement in hedging may give rise to manipulation through misstatement of the value estimates. We show that the use of privately-observed hedging may actually require greater pay-for-performance in managerial compensation. The cross-sectional variations in managerial compensation lend support to our model.
    Keywords: Managerial compensation ; Corporate hedging
    JEL: D82 D86 G38 J31
    Date: 2016–03
  4. By: Parsons, Donald O. (George Washington University)
    Abstract: Unemployment insurance replacement rates world-wide are well below 100 percent, a fact often attributed to search moral hazard concerns. As Blanchard and Tirole (2008) have illustrated, however, neither search nor layoff moral hazard (firing cost) distortions need arise in first-best insurance plans. Their counterexample depends on the functional form of the state utility function--utility with a single argument, consumption plus monetized leisure. The monetized leisure model is unattractive if leisure is a choice variable, however, and a review of the optimal UI literature reveals a surprising variety of alternative utility function assumptions. A standard neoclassical utility function is used to characterize the utility function conditions required to generate moral-hazard-free (MHF) first-best contracts. Two conditions emerge: (i) the necessary condition that leisure and consumption be substitutes (the cross-derivative of consumption and leisure be negative) and (ii) the sufficient condition that leisure be an inferior good, Rosen (1985). Leisure appears to be a normal good, which rules out the possibility of first-best moral-hazard-free (FB MHF) utility structures, but the first-best UI replacement rate remains very much an open question. The rich empirical literature on the "retirement consumption paradox" suggests that the rate is below 100 percent, easing moral hazard concerns, if not eliminating them.
    Keywords: unemployment insurance, utility functions, moral hazard, firing costs, consumption, retirement
    JEL: J65 J41 J33 J08
    Date: 2016–03
  5. By: Adjemian, Michael; Brorsen, B. Wade; Hahn, William; Saitone, Tina L.; Sexton, Richard J.
    Abstract: Concentration levels in U.S. agriculture are high and rising. As downstream competition declines, marketing opportunities for producers are constrained to—in some cases—a single buyer. Processors in thin markets (those with few purchasers, low trading volume, and low liquidity) could use informational advantages to depress farm-level prices for commodities (compared to a competitive market). Moreover, the low volume of trading in thin markets makes it difficult for participants and observers to gather market information and assess market performance. At the same time, many markets are moving away from traditional cash markets to bilateral contracts and vertical integration, which offer more opportunities for coordination and may foster efficiency gains that ultimately benefit producers. Both methods resolve information problems not addressed by the cash market, and forward-looking processors in many thin markets pay producers high enough prices to ensure a stable input supply. Thin market producers who can successfully enter and maintain contracts with these processors can achieve returns that meet or exceed their longrun costs. Attempting to impose greater competition on naturally thin markets can have adverse consequences for producers, processors, and consumers. However, small producers face new challenges in a thin market environment.
    Keywords: Thin markets, farm prices, competition, coordination, market power, contracts, Agribusiness, Crop Production/Industries, Industrial Organization, Livestock Production/Industries, Marketing,
    Date: 2016–03

This nep-cta issue is ©2016 by Guillem Roig. 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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.