nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2018‒02‒19
seven papers chosen by
Guillem Roig
University of Melbourne

  1. On the Firms’ Decision to Hire Academic Scientists By Catalina Martínez; Sarah Parlane
  2. Superstars and mediocrities: a solution based on personal income taxation By Diego d'Andria
  3. Incentives under Upstream-Downstream Moral Hazard Contract By Patrice Loisel; Bernard Elyakime
  4. Informal Delegation and Training By Emre Ekinci; Nikos Theodoropoulos
  5. Evaluation of Individual and Group Lending under Asymmetric information By Peter Simmons; Nongnuch Tantisantiwong
  6. Financing Ventures By Jeremy Greenwood; Pengfei Han; Juan M Sanchez
  7. Prediction, Judgment and Complexity By Ajay K. Agrawal; Joshua S. Gans; Avi Goldfarb

  1. By: Catalina Martínez; Sarah Parlane
    Abstract: This paper provides a theoretical rationale for private investment in basic research. It explains the decision by some firms to hire scientists who have an intrinsic motivation to pursue academic research and allow them to do so while they also dedicate time to the firm’s applied agenda. We show that this decision maximizes firms’ profits in a context where basic and applied research activities are not strong substitutes and the opportunity cost, associated with deterring scientists from remaining in academia, is sufficiently low. Allowing scientists to pursue an academic agenda facilitates participation. When scientists are privately informed about their ’taste for science’, the contract requires that the more academically driven scientists dedicate greater attention to their personal agenda to satisfy incentive compatibility. When the reservation utility is weakly correlated with the scientist’s academic inclination, this restriction has no impact and the first best contract remains optimal. But as the correlation increases, the firms tend to select less academically driven scientists. Under-investment in basic research is not triggered by the need to reduce informational rents which are non-existent as scientists face countervailing incentives. Instead it arises from the need to curb the increased cost of efforts.
    Keywords: Contract theory; Intrinsic motivation; Adverse selection; Countervailing incentives
    JEL: D82 D86 J31 J33 M31
    Date: 2018–01
  2. By: Diego d'Andria (European Commission - JRC)
    Abstract: The markets for talent often produce large income inequality and therefore raise political attention. While such inequality can be due to superstar dynamics or factor complementarities, Terviö ("Superstars and Mediocrities: Market Failure in The Discovery of Talent", the Review of Economic Studies, 2009) first proposed a market failure that was previously unknown to the literature, pointing to long-term contracts as a solution. I extend the model in Terviö (2009) to include personal income tax policy reforms and demonstrate that tax design can be employed as a solution to the market failure when long-term contracts are unfeasible. With small enough entry payments that novice workers would sustain to compensate employers for the cost of learning, both a progressive tax and a tax incentive on entry wages are found effective. The tax incentive on entry wages, though, can be used even with very large deductible entry payments and with overall negative net entry wages.
    Keywords: superstars, personal income tax, entry wage, talent, learning
    JEL: H21 H24 J31 J6
    Date: 2018–01
  3. By: Patrice Loisel (MISTEA - Mathématiques, Informatique et STatistique pour l'Environnement et l'Agronomie - INRA - Institut National de la Recherche Agronomique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier); Bernard Elyakime (LEF - Laboratoire d'Economie Forestière - INRA - Institut National de la Recherche Agronomique - AgroParisTech)
    Abstract: Abstract : This paper explores the characteristics of an upstream-downstream moral hazard contract between two private initially non-associated producers in a spatialized and flow dependence, one upstream of the other, to provide an environmental public good. The performance of the payment function is studied in detail, in order to clarify how the moral hazard contract operates. After having drawn up and calculated the contract, we derive the incentive non-linear payment functions. The results of the downstream producer depend on the result of the upstream producer. Payments producers thus inherit this dependency structure : payment for the upstream contractor only depends on his results whereas payment for the downstream contractor depends on his own results and on those of the upstream contractor. In some cases, the behavior of the downstream payment function can lead to a possible non-acceptability of the payment function by contractors. To remedy the situation we add an acceptability constraint : a new type of bunching appears for the payment of the downstream producer.
    Abstract: Cet article étudie les caractéristiques d'un contrat de production d'un bien public environnemental avec aléa moral entre deux producteurs privés initialement non-associés mais dépendants par un flux physique, l'un étant en amont de l'autre. La performance de la fonction de paiement est étudiée en détail, afin de clarifier la façon dont le contrat avec aléa moral fonctionne. Après avoir présenté et calculé le contrat nous déduisons les fonctions de paiement non-linéaires incitatives. Les résultats du producteur en aval dépendent du résultat du producteur en amont. Les fonctions de paiement héritent donc de cette structure de dépendance : le paiement du producteur en amont ne dépend que de ses résultats alors que le paiement du producteur en aval dépend de ses propres résultats ainsi que de ceux du producteur en amont. Dans certains cas, le comportement de la fonction de paiement aval peut entraîner sa non-acceptabilité par les contractants. Pour y remédier nous proposons l'adjonction d'une contrainte d'acceptabilité : un bunching d'un nouveau type apparaît pour le paiement du producteur aval.
    Keywords: Public environmental policy,Environmental good,Partnership,Spatialized contract,ancillary statistics,Bunching
    Date: 2018–09
  4. By: Emre Ekinci; Nikos Theodoropoulos
    Abstract: This paper investigates the relationship between the firm’s incentives to provide training and to delegate authority. We consider a principal-agent model in which the firm is not able to commit to delegation contractually and the conflict of interest between the firm and the worker arises both because the latter is biased towards certain decisions and because players interpret information differently (i.e., they have differences of opinion). Our theoretical analysis consists of two parts. First, we examine the equilibrium behavior when the degree of incongruence between the firm and the worker is public information. Second, we analyze the equilibrium behavior when the firm is privately informed about its type wherein the type refers to the level of differences in opinion between the firm and the worker. This exercise shows the extent to which the firm can use training provision to convey its private information to the worker, thereby committing not to retract the agent’s authority it initially granted. In our empirical analysis, we use a cross section of matched employer-employee data of British establishments to examine the extent to which the model’s predictions are supported by data.
    Date: 2018–02
  5. By: Peter Simmons; Nongnuch Tantisantiwong
    Abstract: The paper attempts to find the socially best loan contract by comparing exante welfare, interest and default rates of individual and group lending. We introduce a general framework which allows auditing policies and interest rates to be simultaneously determined by maximising the social welfare. Both variables vary with the types of risk considered: independently identically distributed and positively correlated risk. An individual project outcome is private information of its owner, but reported outcomes can be audited at a cost which then publicly reveals the true project outcome. We find that incentive compatibility in a group loan context is delicate: the conditions for truth telling vary with the borrowers’ perception of the overall solvency of the group. In addition, group loans are often made to local groups who have established local networks. This may mean that the group has cheaper policing of truthtelling, but also that the risks on projects within the group are likely to be correlated. To explore this, we numerically solve for the optimal contracts with varying audit cost differences and correlation, using a betabinomial distribution. We find that with an audit cost advantage, small group loans (typically to two borrowers) dominate individual loans even with correlation. But if audit costs are identical, the individual loan dominates. In the larger the group, the higher the audit probability is required to ensure truthtelling. Our finding provides an argument for why the number of borrowers should be limited to 2-5.
    Keywords: Group lending, Heterogeneous and Correlated risk, Welfare, Loan Auditing
    JEL: D81 G21
    Date: 2018–02
  6. By: Jeremy Greenwood (University of Pennsylvania); Pengfei Han (University of Pennsylvania); Juan M Sanchez (Federal Reserve Bank of St. Louis)
    Abstract: The relationship between venture capital and growth is examined using an endogenous growth model incorporating dynamic contracts between entrepreneurs and venture capitalists. At each stage of financing, venture capitalists evaluate the viability of startups. If viable, VCs provide funding for the next stage. The success of a project depends on the amount of funding. The model is confronted with stylized facts about venture capital; viz., statistics by funding round concerning the success rate, failure rate, investment rate, equity shares, and the value of an IPO. Raising capital gains taxation reduces growth and welfare.
    Keywords: capital gains taxation, dynamic contract, endogenous growth, evaluating, funding rounds, growth regressions, IPO, monitoring, startups, research and development, venture capital
    Date: 2018–02
  7. By: Ajay K. Agrawal; Joshua S. Gans; Avi Goldfarb
    Abstract: We interpret recent developments in the field of artificial intelligence (AI) as improvements in prediction technology. In this paper, we explore the consequences of improved prediction in decision-making. To do so, we adapt existing models of decision-making under uncertainty to account for the process of determining payoffs. We label this process of determining the payoffs ‘judgment.’ There is a risky action, whose payoff depends on the state, and a safe action with the same payoff in every state. Judgment is costly; for each potential state, it requires thought on what the payoff might be. Prediction and judgment are complements as long as judgment is not too difficult. We show that in complex environments with a large number of potential states, the effect of improvements in prediction on the importance of judgment depend a great deal on whether the improvements in prediction enable automated decision-making. We discuss the implications of improved prediction in the face of complexity for automation, contracts, and firm boundaries.
    JEL: D81 D86 O33
    Date: 2018–01

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