nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒07‒02
four papers chosen by
Guillem Roig
University of Melbourne

  1. Dynamic Contracts with Random Monitoring By Andrei Barbos
  2. Motivating with Simple Contracts By Juan F. Escobar; Carlos Pulgar
  3. Electricity Market Mergers with Endogenous Forward Contracting By Brown, David P.; Eckert, Andrew
  4. Natural Gas Contract Decisions for Electric Power By Matthew Doyle; Ian Lange

  1. By: Andrei Barbos (Department of Economics, University of South Florida)
    Abstract: In environments where a principal contracts with many agents who each execute numerous independent tasks, it is often infeasible to evaluate an agent'?s performance on all tasks. Incentives under moral hazard are instead provided by monitoring only a subset of randomly selected tasks. We characterize optimal dynamic contracts implemented with this type of random monitoring technology. We consider a stochastic environment where the agent?'s cost of effort varies over time, and analyze situations where this cost is public or private information. In an optimal contract, the terms the agent is promised when monitoring reveals compliance are as good as when no monitoring is performed, and for some cost types are better. These latter types receive a monitoring reward. We also elicit the dynamics of contract parameters over time. As time passes and the agent becomes richer, the monitoring reward decreases as the threat of forgoing the promised stream of future compensation provides sufficient incentives for compliance.
    Keywords: Dynamic Contracts, Random Monitoring, Optimal Contracts, Moral Hazard
    JEL: D82 D86
    Date: 2016–06
  2. By: Juan F. Escobar; Carlos Pulgar
    Abstract: In practice, incentive schemes are rarely tailored to the specific characteristics of contracting parties. However, according to economic theory, optimal contracts should be highly dependent on individual conditions. We reconcile these observations in the context of a principal-agent model with both moral hazard and adverse selection. Motivating an agent could be increasingly costly to the principal because a more productive agent could also be more able to manipulate the terms of the contract. As a result, the principal may optimally pool some types by offering a contract with constant transfer and bonus. We also explore parameterizations where the optimal contract is fully separating but simple contracts attain a significant portion of the optimal welfare. JEL classiffication: D86, L51, L22. Key words: Keywords: Moral hazard, adverse selection, regulation, simple contracts.
    Date: 2016
  3. By: Brown, David P. (University of Alberta, Department of Economics); Eckert, Andrew (University of Alberta, Department of Economics)
    Abstract: We analyze the effects of electricity market mergers in an environment where firms endogenously choose their level of forward contracts prior to competing in the wholesale market. We apply our model to Alberta's wholesale electricity market. Firms have an incentive to reduce their forward contract coverage in the more concentrated post-merger equilibrium. We demonstrate that endogenous forward contracting magnifies the price increasing impacts of mergers, resulting in larger reductions in consumer surplus. Current market screening procedures used to analyze electricity mergers consider firms' pre-existing forward commitments. We illustrate that ignoring the endogenous nature of firms' forward commitments can yield biased conclusions regarding the impacts of market structure changes such as mergers. In particular, we show that the price effects of mergers can be largely underestimated when forward contract quantities are held at pre-merger levels. Whether the profits of the merged firm are greater with fixed or endogenous forward quantities is ambiguous.
    Keywords: Electricity; Mergers; Forward Contracts; Market Power; Regulation
    JEL: D43 L40 L51 L94 Q40
    Date: 2016–06–07
  4. By: Matthew Doyle (Division of Economics and Business, Colorado School of Mines); Ian Lange (Division of Economics and Business, Colorado School of Mines)
    Abstract: Natural gas power plants can further specify their procurement contracts with pipeline distributors using a firm contract option that guarantees delivery at an additional cost. Using transaction level data from 2008-2012 we empirically test what characteristics lead to use of firm contracts and how the premium for firm contracts changes with these characteristics. Using variation in power plants technology type (combined vs. simple cycle) and electricity market structure (restructured vs. regulated), we generally find support for transaction cost theory in the data. Smaller plants, plants located in states with more variance in electricity demand, and plants in states with more inflow pipeline capacity are statistically less likely to use a firm contract. Firm contracts are on average 2.5% (14 cents per Mcf) more expensive and this premium increases as the weather is colder and the state a plant is located in has less inflow capacity.
    Keywords: Natural Gas, Procurement Contracts, Pipelines, Electricity
    JEL: Q40 L94 L95 L14
    Date: 2016–06

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