nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2019‒09‒23
four papers chosen by
Guillem Roig
University of Melbourne

  1. Efficient Water Allocation when Climate is Changing: An interdisciplinary approach By Eugenio Figueroa; Ramón E. López; Gino Sturla
  2. Dancing With Activists By Lucian A. Bebchuk; Alon Brav; Wei Jiang; Thomas Keusch
  3. The dynamics of working hours and wages under implicit contracts By Guerrazzi, Marco; Giribone, Pier Giuseppe
  4. Overcoming Contractual Incompleteness: The Role of Guiding Principles By David Frydlinger; Oliver D. Hart

  1. By: Eugenio Figueroa; Ramón E. López; Gino Sturla
    Abstract: This study analyzes the effects of rising water supply variability provoked by climate change on the welfare of a society whose economy heavily depends on water availability. Several studies recommend that communities should impose policies that ensure a minimum level of water allocation for human consumption. We compare two contracts, one where society allocates to the firm a fixed proportion of the annual water-runoff; and the other one, where due to the uncertainties of climate change, the community instead allocates to human consumption a fixed annual amount of water-runoff. We consider a risk-averse community. We show that, unless water supply is absolutely fixed, a higher variability and scarcity of water supply does not necessarily imply that society is better off choosing a contract that assures a minimum water for human consumption. Depending on the characteristics of water supply frequency distribution, particularly the third moment, it is possible that society would not benefit by switching to the fixed allocation contract for human consumption. We illustrate the main analytical results using data and runoff climate change projections from a water basin located in the central region of Chile, showing that in this case the community is better-off sticking to the current contract.
    Date: 2019–09
  2. By: Lucian A. Bebchuk; Alon Brav; Wei Jiang; Thomas Keusch
    Abstract: An important milestone often reached in the life of an activist engagement is entering into a “settlement” agreement between the activist and the target’s board. Using a comprehensive hand-collected data set, we analyze the drivers, nature, and consequences of such settlement agreements. Settlements are more likely when the activist has a credible threat to win board seats in a proxy fight and when incumbents’ reputation concerns are stronger. Consistent with incomplete contracting, face-saving benefits and private information considerations, settlements commonly do not contract directly on operational or leadership changes sought by the activist but rather on board composition changes. Settlements are accompanied by positive stock price reactions, and they are subsequently followed by changes of the type sought by activists, including CEO turnover, higher shareholder payouts, and improved operating performance. We find no evidence to support concerns that settlements enable activists to extract rents at the expense of other investors. Our analysis provides a look into the “black box” of activist engagements and contributes to understanding how activism brings about changes in target companies.
    JEL: G12 G23 G32 G35 G38 K22
    Date: 2019–08
  3. By: Guerrazzi, Marco; Giribone, Pier Giuseppe
    Abstract: In this paper, we explore the out-of-equilibrium dynamics of working hours and wages in a model economy where workers and firms have agreed upon an implicit contract that smooths long-run consumption. Specifically, we analyse a deterministic and a stochastic framework in which a firm inter-temporally sets its level of labour utilization by considering that workers' earnings tend to adjust in the direction of a fixed level that seeks to stabilize their consumption. Without any uncertainty in labour effectiveness, this theoretical setting may have one, two or no stationary solution. The dynamics of the deterministic economy, however, can be assessed only in the two-solution case and it reveals that wages move counter-cyclically towards the allocation preferred by the firm. Adding uncertainty in labour effectiveness does not overturn the counter-cyclical pattern of wages but is helpful in explaining the wage stickiness observed at the macro level.
    Keywords: Implicit contract theory; Consumption smoothing; Out-of-equilibrium dynamics; Optimal Control
    JEL: D86 E24 J41
    Date: 2019–09–11
  4. By: David Frydlinger; Oliver D. Hart
    Abstract: We consider a buyer and seller who contract over a service. The contract encourages investment and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. The parties expect each other to behave “reasonably”, but given self-serving biases their views of reasonableness may not coincide, leading to aggrievement and deadweight losses. The adoption by the parties of guiding principles such as loyalty and equity in their contract can help. We provide supporting evidence in the form of case studies and interviews.
    JEL: D23 D86 K12
    Date: 2019–09

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