nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2018‒03‒26
four papers chosen by
Guillem Roig
University of Melbourne

  1. On the firms’ decision to hire academic scientists By Catalina Martínez; Sarah Parlane
  2. Does Having Insurance Change Individuals Self-Confidence? By Guber, Raphael; Kocher, Martin; Winter, Joachim
  3. Loan Contract Structure and Adverse Selection: Survey Evidence from Uganda By Gulesci, Selim; Madestam, Andreas; Stryjan, Miri
  4. Optimal contract for a fund manager, with capital injections and endogenous trading constraints By Sergey Nadtochiy; Thaleia Zariphopoulou

  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. Underinvestment 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.
    JEL: D82 D86 J31 J33 M31
    Date: 2018–02
  2. By: Guber, Raphael (Munich Center for the Economics of Aging); Kocher, Martin (University of Vienna); Winter, Joachim (LMU Munich)
    Abstract: Recent research in contract theory on the effects of behavioral biases implicitly assumes that they are stable, in the sense of not being affected by the contracts themselves. In this paper, we provide evidence that this is not necessarily the case. We show that in an insurance context, being insured against losses that may be incurred in a real-effort task changes subjects\' self-confidence. Our novel experimental design allows us to disentangle selection into insurance from the effects of being insured by randomly assigning coverage after subjects revealed whether they want to be insured or not. We find that uninsured subjects are underconfident while those that obtain insurance have well-calibrated beliefs. Our results suggest that there might be another mechanism through which insurance affects behavior than just moral hazard.
    Keywords: overconfidence; insurance choice; underplacement;
    JEL: D84 D82 C91
    Date: 2018–03–12
  3. By: Gulesci, Selim; Madestam, Andreas; Stryjan, Miri
    Abstract: While adverse selection is an important theoretical explanation for credit rationing it is difficult to empirically quantify. One reason is that most studies measure the elasticity of credit demand of existing or previous borrowers as opposed to the population at large. We circumvent the issue by surveying a representative sample of microenterprises in urban Uganda and present evidence of adverse selection in two key dimensions of credit contracts - interest rates and collateral requirements. Theory suggests that a lower interest rate or a lower collateral obligation should increase take up among less risky borrowers. Using hypothetical loan demand questions, we test these predictions by examining if firm owners respond to changes in the interest rate or the collateral requirement and whether take up varies by firms' risk type. We find that contracts with lower interest rates or lower collateral obligations increase hypothetical demand, especially for less risky firms. The effects are particularly strong among manufacturing businesses. Our results imply that changes to the standard microfinance product may have substantial effects on credit demand.
    Keywords: Adverse Selection; Collateral; interest rates; Microfinance; SMEs
    JEL: D22 G21 O12
    Date: 2018–02
  4. By: Sergey Nadtochiy; Thaleia Zariphopoulou
    Abstract: In this paper, we construct a solution to the optimal contract problem for delegated portfolio management of the fist-best (risk-sharing) type. The novelty of our result is (i) in the robustness of the optimal contract with respect to perturbations of the wealth process (interpreted as capital injections), and (ii) in the more general form of principals objective function, which is allowed to depend directly on the agents strategy, as opposed to being a function of the generated wealth only. In particular, the latter feature allows us to incorporate endogenous trading constraints in the contract. We reduce the optimal contract problem to the following inverse problem: for a given portfolio (defined in a feedback form, as a random field), construct a stochastic utility whose optimal portfolio coincides with the given one. We characterize the solution to this problem through a Stochastic Partial Differential Equation (SPDE), prove its well-posedness, and compute the solution explicitly in the Black-Scholes model.
    Date: 2018–02

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