nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2017‒11‒05
ten papers chosen by
Guillem Roig
University of Melbourne

  1. Apparent Competition in Two-Sided Platforms By Gokhan Guven; Eren Inci; Antonio Russo
  2. Nitpicky Insurers and the Law of Contracts By Jean-Marc Bourgeon; Pierre Picard
  3. Internalizing Global Value Chains: A Firm-Level Analysis By Laura Alfaro; Paul Antràs; Davin Chor; Paola Conconi
  4. Regulation and Altruism By Izabela Jelovac; Samuel Kembou Nzale
  5. Relational Contracts, the Cost of Enforcing Formal Contracts, and Capital Structure Choice - Theory and Evidence By Matthias Fahn; Valeria Merlo; Georg Wamser
  6. Offset Contracts as an Insurance Device in Building the National Security By Vesa Kanniainen; Juha-Matti Lehtonen
  7. Profit Sharing and Incentives By Ozdenoren, Emre; Rubanov, Oleg
  8. Sequential Innovation, Naked Exclusion, and Upfront Lump-Sum Payments By Jay Pil Choi; Christodoulos Stefanadis
  9. The Impact of Contract Enforcement Costs on Outsourcing and Aggregate Productivity By Johannes Boehm
  10. CONTRACT DESIGN WITH LIMITED COMMITMENT By Gretschko, Vitali; Wambach, Achim

  1. By: Gokhan Guven; Eren Inci; Antonio Russo
    Abstract: We study a platform’s design of membership and transaction fees when sellers compete and buyers cannot observe the prices and features of goods without incurring search costs. The platform alleviates sellers’ competition by charging them transaction fees that increase with sales revenue, and extracts surplus via membership fees. It prices consumers’ membership below its cost to encourage their search. Examples include malls and online marketplaces. Most malls do not charge for parking while most lease contracts include percentage rents as well as fixed rents. Online marketplaces charge sellers for membership and per transaction while letting consumers access website for free.
    Keywords: consumer search, membership fees, retail agglomeration, transaction fees, two-sided platforms
    JEL: D21 D40 D83 L13 R33
    Date: 2017
  2. By: Jean-Marc Bourgeon; Pierre Picard
    Abstract: The standard economic analysis of the insured-insurer relationship under moral hazard postulates a simplistic setup that hardly explains the many features of an insurance contract. We extend this setup to include the situation that the insured was facing at the time of the accident and the circumstances of the loss. We show that if this information is costlessly observable, then it should be included in the contract to improve the risk sharing-incentive trade-off under moral hazard. However, in practice the insurer observes the circumstances of the loss only in particular cases - most of the time by performing a costly audit - and almost never the situation the insured was facing at the time of the accident. The resulting incompleteness of the contract opens the door to controversies and disputes that may lead to judicial procedures. We show how the law of insurance contracts should allow insurers to incentivize policyholders to exert an adequate level of effort, and, at the same time, to limit their propencity to nitpick.
    Keywords: insurance, moral hazard, incomplete contracts
    JEL: D82 D86 G22
    Date: 2017
  3. By: Laura Alfaro; Paul Antràs; Davin Chor; Paola Conconi
    Abstract: In recent decades, advances in information and communication technology and falling trade barriers have led firms to retain within their boundaries and in their domestic economies only a subset of their production stages. A key decision facing firms worldwide is the extent of control to exert over the different segments of their production processes. We describe a property-rights model of firm boundary choices along the value chain that generalizes Antràs and Chor (2013). To assess the evidence, we construct firm-level measures of the upstreamness of integrated and non-integrated inputs by combining information on the production activities of firms operating in more than 100 countries with Input-Output tables. In line with the model's predictions, we find that whether a firm integrates upstream or downstream suppliers depends crucially on the elasticity of demand for its final product. Moreover, a firm's propensity to integrate a given stage of the value chain is shaped by the relative contractibility of the stages located upstream versus downstream from that stage, as well as by the firm's productivity. Our results suggest that contractual frictions play an important role in shaping the integration choices of firms around the world.
    Keywords: global value chains, sequential production, incomplete contracts
    JEL: F14 F23 D23 L20
    Date: 2017–10
  4. By: Izabela Jelovac (University of Lyon, CNRS, GATE Lyon Saint-Etienne); Samuel Kembou Nzale (Aix-Marseille Univ. (Aix-Marseille School of Economics), CNRS, EHESS and Centrale Marseille)
    Abstract: We study optimal contracts in a regulator-agent setting with joint production, altruistic and selfish agents, and uneasy outcome measurement. Such a setting represents sectors of activities such as education and health care provision. The agents and the regulator jointly produce an outcome for which they all care to some extent that is varying from agent to agent. Some agents, the altruistic ones, care more than the regulator does while others, the selfish agents, care less. Moral hazard is present due to the agent’s effort that is not contractible. Adverse selection is present too since the regulator cannot a priori distinguish between altruistic and selfish agents. Contracts consist of a simple transfer from the regulator to the agents together with the regulator’s input in the joint production. We show that a screening contract is not optimal when we face both moral hazard and adverse selection.
    Keywords: altruism, Moral Hazard, adverse selection, regulator-agent joint production
    JEL: D64 D86
    Date: 2017–10
  5. By: Matthias Fahn; Valeria Merlo; Georg Wamser
    Abstract: This paper shows that the cost of enforcing contracts governing non-financial relationships between firms affects a firm’s financing structure. We analyze the interaction between a firm’s capital structure and the type of contracts it uses to deal with its suppliers. We first develop a theoretical model where a downstream party needs an intermediate good from an upstream party, and this intermediate good can be of high or low quality. Court-enforceable contracts can be used to enforce high quality, but their use is costly. If these costs are too high, relational contracts - self-enforcing informal arrangements that can be sustained in long-term relationships - are needed. Relational contracts, though, can only be sustained if debt is not too high. The reason is that a firm’s commitment in relational contracts is determined by its future profits in the cooperative relationship, and the need to repay debt reduces future profits. We therefore derive the prediction that, on average, higher costs of enforcing formal contracts should be associated with firms having less leverage. We test this prediction with the help of two datasets. First, the Microdatabase Directinvestment (MiDi) provided by Deutsche Bundesbank, which records balance-sheet information on the universe of German investments abroad, including detailed information on external debt and equity capital. Second, the World Bank’s Doing Business Database, which provides information on the average cost of enforcing (formal) contracts between a firm and a supplier of an intermediate good. Using a panel data model for fractional response variables, we can show that an increase in the cost of enforcing contracts in a country makes firms use substantially more equity financing.
    Keywords: relational contracts, organizational economics, capital structure, corporate finance
    Date: 2017
  6. By: Vesa Kanniainen; Juha-Matti Lehtonen
    Abstract: A dynamic multi-stage decision-theoretic approach is introduced to establish the optimal offset and its incidence, the contract price arising from bargaining, and the scale of the acquisition. A new rationale is suggested for offsets in terms of their role as an insurance devise. Results are derived for the pricing of delivery contracts subject to offset claims and their national security implications. It is shown that the national security is strictly convex in the offset transaction. As to the incidence of the offset, the offset claim is shown to be capitalised in the delivery price. The bargaining price is shown to depend on the value of the product to be delivered for the national security, the relative negotiation power of the contracting partners and the social cost of public funds. The analysis highlights the expectation effects of offsets on the bargaining price and the scale of delivery. The results aid in explaining why offsets are widely used in procurement contracts for defence materiel. As they contribute to the national security, they should be allowed to survive and not be denied under competition laws.
    Keywords: offsets, national security, defence material, insurance
    JEL: H12 H56
    Date: 2017
  7. By: Ozdenoren, Emre; Rubanov, Oleg
    Abstract: We model a firm as a team production process subject to moral hazard and derive the optimal profit sharing scheme between productive workers and outside investors together with incentive contracts based on noisy performance signals. More productive agents with noisier performance signals are more likely to receive shares which can explain why managers are motivated by shares, and law or consulting firms form partnerships. A firm that grows by opening branches is held almost entirely by outside investors when its output noise grows faster than the number of branches. Otherwise, insiders hold substantial amount of a large firm's shares.
    Date: 2017–10
  8. By: Jay Pil Choi; Christodoulos Stefanadis
    Abstract: We present a potentially benign naked exclusion mechanism that can be applied to sequential innovation; a non-patentable original innovation by the incumbent supplier fosters derivative innovation by rivals. In the absence of an appropriate legal framework, the original innovator’s equilibrium exclusivity contracts block subsequent efficient entry even if there is (leader-follower) competition in the contracting phase. However, the legal framework may maximize social welfare by imposing a ban on upfront lumps-sum payments in exclusivity contracts (by all suppliers) combined with an outright ban on exclusivity contracts by the derivative innovator. The former ban precludes the exclusion of socially beneficial derivative innovation by causing the incumbent supplier to resort to accommodation, rather than to pure exclusion, strategies. The latter ban complements the former by preventing inefficient or excessive derivative innovation.
    Keywords: exclusivity, entry, fixed cost, lump-sum payment, sequential innovation
    JEL: L42 D43 D45
    Date: 2017
  9. By: Johannes Boehm (Sciences Po)
    Abstract: Legal institutions affect economic outcomes, but how much? This paper studies how costly supplier contract enforcement shapes the patterns of intermediate input use and quantifies the impact of these distortions on aggregate productivity and welfare. Using the frequency of litigation between US firms to measure the potential for hold-up problems, I find a robust relationship between countries' input-output structure and their quality of legal institutions: in countries with high enforcement costs, firms have lower expenditure shares on intermediate inputs in sector pairs where US firms litigate frequently for breach of contract. I adapt a Ricardian trade model to the study of intersectoral trade, and show that the variation in intermediate input shares that is explained by contracting frictions is large enough to generate sizeable welfare increases when enforcement institutions are improved.
    Date: 2017
  10. By: Gretschko, Vitali; Wambach, Achim
    Abstract: We consider the problem of a principal who wishes to contract with a privately informed agent and is not able to commit to not renegotiating any outcome of any mechanism. We provide a general characterization of renegotiation-proof outcomes. We apply the solution to a setting with a continuous type space, private values and non-linear contracts. We find that the optimal renegotiation-proof outcomes for the principal are pooling outcomes and satisfy a “no-distortion-at-the-bottom” property.
    JEL: C72
    Date: 2017

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