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on Contract Theory and Applications |
| By: | Daniel Bird; Alexander Frug |
| Abstract: | A common feature of dynamic interactions is that the environment in which they occur typically changes, perhaps stochastically, over time. We consider a general fluctuating contracting environment with symmetric information, and identify a systematic effect of the fluctuations in the environment on optimal contracts. We develop a notion of a separable activity that corresponds to a large class of contractual components, and provide a tight condition under which these components manifest a form of seniority: any change that occurs in these components over time, under an optimal contract, favors the agent. We illustrate how our results can be applied in various economic settings. |
| Keywords: | dynamic contracting, stochastic opportunities |
| JEL: | D86 |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1085&r=all |
| By: | Inderst, Roman; Opp, Marcus |
| Abstract: | This paper provides a complete characterization of optimal contracts in principal-agent settings where the agent's action has persistent effects. We model generalinformation environments via the stochastic process of the likelihood-ratio. Themartingale property of this performance metric captures the information benefit ofdeferral. Costs of deferral may result from both the agent's relative impatience aswell as her consumption smoothing needs. If the relatively impatient agent is riskneutral, optimal contracts take a simple form in that they only reward maximalperformance for at most two payout dates. If the agent is additionally risk-averse,optimal contracts stipulate rewards for a larger selection of dates and performancestates: The performance hurdle to obtain the same level of compensation is in-creasing over time whereas the pay-performance sensitivity is declining. We derivetestable implications for the optimal duration of (executive) compensation and thematurity structure of claims in financial contracting settings. |
| Keywords: | Compensation design; duration of pay; Informativeness principle; moral hazard; Persistence; Principal-Agent Models |
| JEL: | D86 |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:13643&r=all |
| By: | Hoffmann, Florian; Inderst, Roman |
| Abstract: | Embedding consumer experimentation with a product or service into a market environment, we find that unregulated contracts induce too few returns or cancellations, as they do not internalize a pecuniary externality on other firms in the market. Forcing firms to let consumers learn longer by imposing a commonly observed statutory minimum cancellation or refund period is socially efficient only when firms appropriate much of the market surplus, while it backfires otherwise. Interestingly, cancellation rights are a poor predictor of competition, as in the unregulated outcome firms grant particularly generous rights when competition is neither too low nor too high. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:13641&r=all |
| By: | Frederiksen, Anders (Aarhus University); Flaherty Manchester, Colleen (University of Minnesota) |
| Abstract: | The Age Discrimination in Employment Act of 1978 expanded employee age protections to age 70, making the widespread practice by U.S. firms of mandating retirement at age 65 illegal. Building on the work of Lazear (1979), we propose that the law change not only weakened the long-term employment contract, but also contributed to the rise in pay-for-performance incentives. We model the firm's choice between offering long-term incentive contracts with low monitoring requirements and pay-for-performance (PFP) contracts with high monitoring requirements, showing how the law change increased the relative attractiveness of PFP contracts. We test the model's predictions using data from the Baker-Gibbs-Holmstrom firm, evaluating the effect of the law change on the slope of the age-pay profile, turnover rates, and the sensitivity of pay to performance. Further, we find direct evidence of strategic response to the law change by the firm, including the introduction of bonus payments, change in performance management system, and increase in the proportion of top managers. The setting also provides an opportunity to empirically investigate how firms navigate career incentives for employees. |
| Keywords: | incentive pay, pay for performance, long-term incentive contracts, promotions, slot constraints, career incentives |
| JEL: | M51 M52 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12264&r=all |
| By: | Inderst, Roman |
| Abstract: | We show how a brand manufacturerís control over retail prices can lead to e¢ cien-cies when consumers rely on prices as a signal of quality. For this we first show how higher prices can be associated with both higher quality perception as well as higher actual quality. We next identify a conflict of interest between retailers and manufactures. Retailers do not internalize the ensuing reputation spill-over that higher prices have on demand at all outlets. And they have less incentives to support brand image through higher prices as this erodes their own position in negotiations while increasing that of the manufacturer. Our efficiency defence for RPM thus applies even when retailers need not be incentivized to undertake non-contractible activities, as in our model the key opportunism problem, with respect to quality provision, lies between the manufacturer and consumers. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:13639&r=all |
| By: | Izabela Jelovac (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Samuel Nzale (AMU - Aix Marseille Université) |
| 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: | regulator-agent joint production,altruism,moral hazard,adverse selection |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01618043&r=all |
| By: | Mateus A. Cavaliere; Sergio Granville; Gerson C. Oliveira; Mario V. F. Pereira |
| Abstract: | This work presents a methodology for forward electricity contract price projection based on market equilibrium and social welfare optimization. In the methodology supply and demand for forward contracts are produced in such a way that each agent (generator/load/trader) optimizes a risk adjusted expected value of its revenue/cost. When uncertainties are represented by a discrete number of scenarios, a key result in the paper is that contract price corresponds to the dual variable of the equilibrium constraints in the linear programming problem associated to the optimization of total agents' welfare. Besides computing an equilibrium contract price for a given year, the methodology can also be used to compute the evolution of the probability distribution associated to a contract price with a future delivery period; this an import issue in quantifying forward contract risks. Examples of the methodology application are presented and discussed |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1904.04225&r=all |