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on Contract Theory and Applications |
| By: | Gerardi, Dino |
| Abstract: | We study dynamic contracting with adverse selection and limited commitment. A firm (the principal) and a worker (the agent) interact for potentially infinitely many periods. The worker is privately informed about his productivity and the firm can only commit to short-term contracts. The ratchet effect is in place since the firm has the incentive to change the terms of trade and offer more demanding contracts when it learns that the worker is highly productive. As the parties become arbitrarily patient, the equilibrium outcome takes one of two forms. If the prior probability of the worker being productive is low, the firm offers a pooling contract and no information is ever revealed. In contrast, if this prior probability is high, the firm fires the unproductive worker at the very beginning of the relationship. |
| Keywords: | Dynamic Contracting; Limited Commitment; Ratchet Effect |
| JEL: | D80 D82 D86 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12699&r=cta |
| By: | Kemal Saygili (Department of Economics, Middle East Technical University, Ankara, Turkey); Serkan Kucuksenel (Department of Economics, Middle East Technical University, Ankara, Turkey) |
| Abstract: | In this paper, we provide new theoretical insights about the role of collusion in organizational hierarchies by combining the standard principal-supervisor-agent framework with a theory of social preferences. Extending Tirole’s (1986) model of hierarchy with the inclusion of Fehr and Schmidt’s (1999) distributional other-regarding preferences approach, the links between inequity aversion, collusive behavior throughout the levels of a hierarchy and the changes in optimal contracts are studied. It turns out that other-regarding preferences do change the collusive behavior among parties depending on the nature of both the agent’s and the supervisor’s other-regarding preferences. Most prominent impact is on the optimal effort levels. When the agent is inequity averse principal can exploit this fact to make agent exert higher effort level than she would otherwise. In order to satisfy the participation constraint of the supervisor, the effort level induced for the agent becomes lower when the supervisor is status seeker, and it is higher when the supervisor is inequity averse. |
| Keywords: | Other-Regarding Preferences, Hierarchy, Collusive Behavior, Optimal Contract Design |
| JEL: | D90 D82 L22 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:met:wpaper:1802&r=cta |
| By: | Jordi Brandts; Brice Corgnet; Roberto Hernán-González; José M. Ortiz; Carles Solà |
| Abstract: | We study the incentive effect of firing threats when bosses have limited information about workers. We show that a minimal amount of individual information about workers’ effort such as the time spent at their work station is sufficient to ensure strong incentive effects. This supports the use of firing threats based on rudimentary yet uncontroversial measures of work performance such as absenteeism, in organizational settings in which only limited information about workers is available. Our results help understand the limited link between pay and performance observed in compensation contracts calling for an extension of the principal-agent model to take into account how workers (mis-)perceive the intensity of incentives. |
| Keywords: | firing threats, Incentives, informativeness principle, laboratory experiments |
| JEL: | C92 D23 D82 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1023&r=cta |
| By: | Nian Yang (Nanjing University, China); Jun Yang (Indiana University, USA); Yu Chen (University of Graz, Austria) |
| Abstract: | This paper studies optimal contracting in a continuous-time model with three-sided moral hazard and cost synergies. One agent exerts initial effort to start the project; the other two agents exert ongoing effort to manage it. All three agents' efforts jointly determine the probability of the project's survival and its expected cash flows. We model cost synergies between the latter two agents as one's effort reduces the other's cost of effort. In the optimal contract, the timing of payments reflects the timing of efforts as well as cost synergies across agents. The agent exerting upfront effort claims all cash flows prior to a predetermined cutoff date. The two agents exerting ongoing effort divide all subsequent cash flows according to their moral hazard and cost synergies. This study sheds lights on a broad set of contracting problems, such as compensation plans in startups and profit sharing among business partners. |
| Keywords: | Optimal contracting; Moral hazard in teams; Cost synergies; Continuous time model |
| JEL: | C61 D86 J31 M52 |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:grz:wpaper:2018-06&r=cta |
| By: | Gryglewicz, Sebastian; Mayer, Simon; Morellec, Erwan |
| Abstract: | We develop a dynamic agency model in which the agent controls current earnings via short-term effort and firm growth via long-term effort and the firm is subject to both short- and long-run shocks. Under the optimal contract, agency conflicts can induce both over- and underinvestment in short- and long-term efforts compared to first best, leading to short- or long-termism in corporate policies. Exposure to long-run shocks introduces pay-for-luck in incentive compensation but only after sufficiently good performance due to incentive compatibility, thereby rationalizing the asymmetric benchmarking observed in the data. Correlated short- and long-run shocks to earnings and firm size lead to externalities in incentive provision over different time horizons. |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12720&r=cta |