nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒11‒27
ten papers chosen by
Guillem Roig
University of Melbourne

  1. Efficiency and Adverse Selection: On the Desirability of Mutual Contracts By V. Chari
  2. Optimal Contracts for Research Agents By Yaping Shan
  3. Promotional allowances By Lømo, Teis Lunde; Ulsaker, Simen Aardal
  4. Delegating relational contracts to corruptible intermediarie By Marta Troya-Martinez; Liam Wren-Lewis
  5. Screening in Contract Design: Evidence from the ACA Health Insurance Exchanges By Michael Geruso; Timothy J. Layton; Daniel Prinz
  6. Past Performance and Procurement Outcomes By Francesco Decarolis; Giancarlo Spagnolo; Riccardo Pacini
  7. Multiple Contracting in Insurance Markets By Attar, Andrea; Mariotti, Thomas; Salanié, François
  8. Political Connections, Government Procurement Contracts, and the Cost of Debt By Reza Houston; David A. Maslar; Kuntara Pukthuanthong
  9. Optimal Ownership of Public Goods in the Presence of Transaction Costs By Müller, Daniel; Schmitz, Patrick W.
  10. Risk Sharing in an Adverse Selection Model By Raymond Deneckere; André De Palma; Luc Leruth

  1. By: V. Chari (Federal Reserve Bank of Minneapolis)
    Abstract: Abstract We study competitive equilibria in economies with adverse selection. In our model, a large population of agents contracts with a finite set of firms. Firms compete over privately informed agents by offering non-linear and endogenous contracts. These contracts are allowed to depend on the composition of agents that trade with one firm. In an insurance context, this is equivalent to mutualization of insurance contracts whereby each insuree's contract depends on the distribution of other insurees' claims. Our main result is that when such contracts are allowed, a competitive equilibrium always exists, is efficient and unique. We show this result for a variety of environments (the insurance market a la Rothschild and Stiglitz (1976), Spence's signaling model, Bester's loan market model, among others) and for one-dimensional distributions of private information among agents. Our result sheds light on optimal regulation of markets with adverse selection specially that of health insurance markets. It suggests that rather than using traditional tools such as mandates and regulation of contract characteristics, government must monitor insurance companies and enforce the mutualization of contracts whereby firms share the losses and gains from claims with all the insurers.
    Date: 2016
  2. By: Yaping Shan (School of Economics, University of Adelaide)
    Abstract: We study the agency problem between a firm and its research employees under several scenarios characterized by different R&D unit setups. In a multiagent dynamic contracting setting, we describe the precise pattern of the optimal contract. We illustrate that the optimal incentive regime is a function of how agents' efforts interact with one another; relative performance evaluation is used when their efforts are substitutes whereas joint performance evaluation is used when their efforts are complements. The optimal contract pattern provides a theoretical justification for the compensation policies used by firms that rely on R&D.
    Keywords: Dynamic Contract, Repeated Moral Hazard, Multiagent Incentive, R&D, Employee Compensation
    JEL: D23 D82 D86 J33 L22 O32
    Date: 2016–11
  3. By: Lømo, Teis Lunde (Department of Economics, University of Bergen); Ulsaker, Simen Aardal (Department of Economics, Norwegian School of Economics)
    Abstract: We study a setting of repeated trade between an upstream manufacturer and two downstream retailers that can exert valuable but noncontractible sales effort. Our focus is the manufacturer’s use of relational contracts with discretionary promotional allowances – payments that reward retailers for effort provision. We show that such contracts enable a sufficiently patient manufacturer to, in equilibrium, provide retailers with the correct incentives and extract the maximal industry profit in every period, and that this outcome cannot be replicated with formal two-part tariffs. These results have implications for the policy treatment of lump-sum payments from manufacturers to retailers, as well as for resale price maintenance.
    Keywords: Vertical restraints; Retail services; Repeated games; Relational contracts; Competition policy
    JEL: C73 L14 L42 L81
    Date: 2016–10–07
  4. By: Marta Troya-Martinez (NES - New Economics School - New Economics School); Liam Wren-Lewis (PSE - Paris-Jourdan Sciences Economiques - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - École des Ponts ParisTech (ENPC) - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics)
    Abstract: This article explores the link between productive relational contracts and corruption. Responsibility for a contract is delegated to a supervisor who cares about both production and kickbacks paid by the agent, neither of which are explicitly contractible. We characterize the optimal supervisor-agent relational contract and show that the relationship between joint surplus, kickbacks and production is nonmonotonic. Delegation may benefit the principal when relational contracting is difficult by easing the time inconsistency problem of paying incentive payments. For the principal, the optimal supervisor has incentives that are partially, but not completely, aligned with her own.
    Keywords: Relational contracts,delegation,corruption
    Date: 2016–09
  5. By: Michael Geruso; Timothy J. Layton; Daniel Prinz
    Abstract: By steering patients to cost-effective substitutes, the tiered design of prescription drug formularies can improve the efficiency of healthcare consumption in the presence of moral hazard. However, a long theoretical literature describes how contract design can also be used to screen consumers by profitability. In this paper, we study this type of screening in the ACA Health Insurance Exchanges. We first show that despite large regulatory transfers that neutralize selection incentives for most consumer types, some consumers are unprofitable in a way that is predictable by their prescription drug demand. Then, using a difference-in-differences strategy that compares Exchange formularies where these selection incentives exist to employer plan formularies where they do not, we show that Exchange insurers design formularies as screening devices that are differentially unattractive to unprofitable consumer types. This results in inefficiently low levels of coverage for the corresponding drugs in equilibrium. Although this type of contract distortion has been highlighted in the prior theoretical literature, until now empirical evidence has been rare. The impact on out-of-pocket costs for consumers affected by the distortion is substantial—potentially thousands of dollars per year—and the distortion creates an equilibrium in which contracts that efficiently trade off moral hazard and risk protection cannot exist.
    JEL: I11 I13 I18
    Date: 2016–11
  6. By: Francesco Decarolis; Giancarlo Spagnolo; Riccardo Pacini
    Abstract: Reputational incentives may be a powerful mechanism for improving supplier performance. We analyze their role in contract awarding, exploiting an experiment run by a firm which introduced a new vendor rating system scoring suppliers' past performance and linking it to the award of future contracts. We study responses in both price and performance to the announcement of the switch from price-only to price-and-rating auctions. Across the 136 parameters scored, overall compliance improves from 25 percent to 80 percent. Improvements involve all parameters and suppliers, but are more pronounced for parameters receiving a higher weight in the announced scoring auction. Prices do not significantly change overall, but we find some evidence of lower prices right after the announcement when suppliers compete to win contracts to get scored, and of higher prices once they have established a good reputation. Even under an upper bound estimate for this price increase, however, the cost of the policy is below its lower bound benefit estimate, which derives from a reduction in fatal accidents driven by improvements on the subset of parameters involving worksite safety.
    JEL: D44 D47 D82 H54 H57 I18 K12 L22 L74
    Date: 2016–11
  7. By: Attar, Andrea; Mariotti, Thomas; Salanié, François
    Abstract: We study insurance markets in which privately informed consumers can purchase coverage from several insurers. Under adverse selection, multiple contracting severely restricts feasible trades. Indeed, only one budget-balanced allocation is implementable by an entry-proof tariff, and each layer of coverage must be fairly priced given the consumer types who purchase it. This allocation is the unique equilibrium outcome of a game in which cross-subsidies between contracts are prohibited. Equilibrium contracts exhibit quantity discounts and negative correlation between risk and coverage. Public intervention should target insurers' strategic behavior, while consumers can be left free to choose their preferred amount of coverage.
    Keywords: Adverse Selection; Insurance Markets; Multiple Contracting
    JEL: D43 D82 D86
    Date: 2016–11
  8. By: Reza Houston; David A. Maslar; Kuntara Pukthuanthong
    Abstract: In this paper we show that while firms that have a greater percent of sales to the government tend to have a higher cost of debt, firms are able to offset this higher cost through political connections. We find that politically connected government contractors have, on average, lower costs of debt than non-connected contractors. Our results indicate that some of the documented benefits that accrue to shareholders of connected firms transfer to bondholders as well. Our results contribute to a better understanding of the costs and benefits of political connections as well as the determinants of the costs of debt.
    Date: 2016–11
  9. By: Müller, Daniel; Schmitz, Patrick W.
    Abstract: A non-governmental organization (NGO) can make a non-contractible investment to provide a public good. Only ownership can be specified ex ante, so ex post efficiency requires reaching an agreement with the government. Besley and Ghatak (2001) argue that the party with the larger valuation should be the owner. We show that when transaction costs have to be incurred before the bargaining stage can be reached, ownership by the government can be optimal even when the NGO has a larger valuation. Our finding also contrasts with the standard private-good setup where the investing party (i.e., the NGO) should always be the owner.
    Keywords: Bargaining; Incomplete Contracts; Property rights; Public Goods; transaction costs
    JEL: C78 D23 D86 H41 L31
    Date: 2016–11
  10. By: Raymond Deneckere (University of Wisconsin-Madison [Madison]); André De Palma (CES, ENS Cachan, CNRS, Universite Paris-Saclay, 94235 Cachan, France); Luc Leruth (University of Liege, IMF Office in Europe - EUO)
    Abstract: We introduce risk aversion in a mixed moral hazard/adverse selection model. Under plausible assumptions, the effort level of the firm is distorted downward from the first best level of effort for both agent types. Thus, the traditional result of no distortion on the top does not hold with risk aversion. We also show that the effort level of the low-cost type may be distorted more than that of the high cost type. With an observable cost shock, an increase in exogenous risk may increase the effort level of the efficient firm and lower the expected cost of the project.
    Keywords: Incentives,Contract Theory,Risk-Sharing., Regulation
    Date: 2016–11–07

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